Money: Meaning, Forms and Functions

Money is a concept which we all understand but which is difficult to define in exact
terms. This is because it fulfills many functions and comes in many forms each of them
providing a criterion of moneyness. For this reason, Prof. Walker defines money as ‘‘Money is
what money does’’. Since general acceptability is the fundamental characteristic of money, in
simple words, money may be defined as anything which is generally acceptable by the people in
exchange of goods and services or in repayment of debts.

One of the traditional definitions of Money calls it “a unit of account, a means of

payment and a store of value”. Professor Coulborn defines money as “the means of valuation and
of payment; as both the unit of account and the generally acceptable medium of exchange.”
These are the functional definitions of money because they define money in terms of the
functions. Some economists define money in legal terms saying that “anything which the state
declares as money is money.”

Forms of money
There are many forms of money. Following are the main forms of money.

1. Metallic Money: The money made of any metal such as gold, silver etc is called
metallic money. It exists in the form of coins. Metallic money has the following two types:

a) Full Bodied Coins: When the face value of the coin is equal to the value of metal
contained in the coin, the coin is called a full bodied coin. The gold and silver coins of old times
are examples of full bodied coins.

b) Token Money: When the face value of a coin is greater than the value of the metal it
contains, it is called token money. In our country, all the coins are token money.

2. Paper Money: Paper money refers to notes of different value made of paper which is
issued by the central bank or government of the country. The paper money can be classified into
following types:

a) Representative Money: Representative money is that money which is fully backed by

equal metallic reserve. The holder of a bank note can easily get it converted into metallic (gold &
silver) form on demand.

b) Convertible Money: It is the form of money which can be converted into gold, silver
i.e. metallic reserves. But all these notes issued by the government are not fully backed by gold.
The amount of gold kept by the government is a particular proportion of the notes issued.

c) Inconvertible Money/fiat Money: Inconvertible or fiat money is one that we have in

our pocket and use in daily business. The face value of such money is more than the value of the
paper. For Example, the value of the paper of 100 rupee note is almost nil but its purchasing
power is equal to Rs.100. it has this value because it has been declared as legal money by the
government. So it is generally accepted as a medium of exchange.

3. Bank Money: This is the most modern form of money this money is also called credit.
It only consists of the following:

a) Cheques: A cheque is an unconditional order by the client on his bank to pay a certain
sum of money to him or to any other party.

a) Bills of Exchange: A bill of exchange is an order by the drawer to the drawee to pay a
sum of money to the drawer or to any other party.

c) Draft: Draft is a cheque drawn by a bank on its own branch or the branches of another
bank requesting it to pay on demand a specific amount to a person named on it.

4. Legal Tender Money: The money that a person accepts as a means of payment and in
discharge of debt is called legal tender notice. All the notes and coins issued by the government
and the central bank are legal tender money. Legal tender money is of two types:

a) Limited Legal Tender Money: The money which can be used a means of payment up
to a certain limit is called limited tender money.

b) Un-limited Legal Tender Money: The money that can be used a means of payment
up to any limit or amount.

c) Non legal tender money: Non legal tender money implies optional money which a
person may or may not accept as a means of payment. Bank money in the form of cheques, bills
of exchange, promissory notes is not legal tender money therefore they represent Non legal
tender money.

5. Plastic Money: Plastic money means the credit cards, smart cards. Plastic cards which
have specially printed set of characters. Recently the use of this money has increase.

6. Standard Money: Standard money is that in which the value of goods as well as all
other forms of money are measured. Thus, in India all prices of goods are measured in terms of
rupees. Moreover, the other forms of money such as two-rupee notes, ten rupee notes, hundred
rupee notes and one half rupee coin are expressed in terms of rupees. Thus rupee is the standard
money of India. Standard money is always made the unlimited legal tender money.

7. Near Money: A type of money which can easily be converted into money. It included
deposits, government bonds, printed bonds etc.
 8. Fiduciary Money: Fiduciary money depends for its value on the confidence that it
will be generally accepted as a medium of exchange. Unlike fiat money, it is not declared legal
tender by the government, which means people are not required by law to accept it as a means of
payment. Instead, the issuer of fiduciary money promises to exchange it back for a commodity or
fiat money if requested by the bearer. Examples of fiduciary money include cheques, banknotes,
or drafts

9. Commodity money: Commodity money is a commodity that has intrinsic value and is
used as a medium of exchange. Salt, animal, gems, beads, gold, silver etc. are examples of
commodity money.

Functions of Money
In general terms, the main function of money in an economic system is to facilitate the

exchange of goods and services and help in carrying out trade smoothly. Money performs a

number of primary, secondary, contingent and other functions which not only remove the

difficulties of barter but also oils the wheels of trade and industry in the present day world. We

discuss these functions one by one.

1. Primary Functions: The two primary functions of money are to act as a

medium of exchange and as a unit of value.

a) Money as a Medium of Exchange: By serving as a medium of exchange, money

removes the need for double coincidence of wants and the inconveniences and difficulties
associated with barter. The introduction of money as a medium of exchange decomposes the
single transaction of barter into separate transactions of sale and purchase thereby eliminating the
double coincidence of wants. Thus money gives us a good deal of economic independence and
also perfects the market mechanism by increasing competition and widening the market.

As a medium of exchange, money acts as an intermediary. It facilitates exchange. When

acting as the intermediary, it helps one good or service to be traded indirectly for others. It helps

production indirectly through specialization and division of labor which, in turn, increase

efficiency and output.

 b). Money as a Unit of Account or Measure of Value: Money serves as a unit of
account or a measure of value. Money is the measuring rod, i.e., it is the units in terms of which
the values of other goods and services are measured in money terms and expressed accordingly
Different goods produced in the country are measured in different units like cloth m meters, milk
in liters and sugar in kilograms.
Without a common unit, exchange of goods becomes very difficult Values of all goods
and services can be expressed easily in a single unit called money Again without a measure of
value, there can be no pricing process. Without a pricing process organized marketing and
production is not possible. Thus, the use of money as a measure of value is the basis of
specialized production.

2. Secondary Functions: Money performs the following three secondary

functions which are as follows:

a) Money as a Store of Value: As a secondary function, money acts as a store of value.

Wealth can be stored in terms of money for future. It serves as a store value of goods in liquid
form. By spending it, we can get any commodity in future. People therefore normally wish to
keep a part of their wealth in the form of money because savings in terms of goods is very
difficult. Clearly money is the best form of store of value. Wheat or any other product which will
command a value cannot be stored for a long period.

b) Money as the Standard of Deferred Payments: Deferred payments are payments

which are made some time in the future. The use of money as the standard of deterred or delayed
payments immensely simplifies borrowing and lending operations because money generally
maintains a constant value through time. Thus, money facilitates the formation of capital markets
and the work of financial intermediaries like Stock Exchange, Investment Trust and Banks.
Money is the link which connects the values of today with those of the future.

c) Money as a Transfer of Value: Since money is a generally acceptable means of

payment and acts as a store of value, it keeps on transferring values from person to person and

place to place. A person who holds money in cash or assets can transfer that to any places.

3. Contingent Functions: Money also performs certain contingent or incidental

functions which are as follows:
 4. Other Functions: Money also performs such functions which affect the
decisions of consumers and governments.

a) Helpful in making decisions: Money is a means of store of value and the consumer

meets his daily requirements on the basis of money held by him. In this way, money helps in

taking decisions.

b) Money as a Basis of Adjustment: To carry on trade in a proper manner, the

adjustment between money market and capital market is done through money. Similarly,

adjustments in foreign exchange are also made through money.

The fundamental aspect of banking is acting as a financial intermediary, accepting deposits
from savers and providing loans to borrowers, thereby facilitating the flow of money in the
economy. Key functions include accepting deposits for safekeeping and earning interest, granting
loans for various purposes, enabling payment and settlement systems (like cards and transfers),
offering agency services for transactions, and providing a range of other financial services such
as wealth management, foreign exchange, and locker facilities.
Core Functions of Banking
1. 1. Accepting Deposits:
Banks provide a secure place for individuals and businesses to deposit their money in various
accounts, including savings, current, and fixed deposits, earning interest on these funds.
2. 2. Granting Loans and Advances:
Banks use the pooled deposits to lend money to individuals and businesses for personal needs,
mortgages, business expansion, and more, contributing to economic activity.
3. 3. Payment and Settlement Systems:
Banks offer various mechanisms for making and receiving payments, such as checks, electronic
funds transfers (EFT), debit and credit cards, and online banking, facilitating smooth financial
transactions.
Other Important Functions
• Agency Services:
Banks act as agents for their customers by collecting or making payments on their behalf, such
as paying utility bills or managing dividends.
• Wealth Management and Investments:
They provide services like investment advice, wealth management, and access to investment
products like mutual funds to help customers grow their wealth.
• Financial Security and Risk Management:
Banks offer facilities like safe deposit lockers, foreign exchange services, and insurance products
to help customers safeguard their assets and manage financial risks.
• Facilitating Economic Growth:
By connecting those with surplus funds to those in need of funds, banks ensure efficient
allocation of capital, supporting overall economic growth and stability.
In economics, a household is a basic economic unit consisting of individuals living together
and making joint decisions about resource allocation, consumption, and production. Key
economic functions of households include consumption, the satisfaction of member needs
through goods and services; income generation through wages, investments, and
transfers; decision-making to balance needs with limited resources; and engaging in saving and
investment for future consumption and wealth. Households also perform production by creating
goods and services, either for self-consumption or for sale, and they supply the labor that firms
need to produce market goods and services.
Core Economic Functions of Households
• Consumption:
Households are the primary consumers of goods and services, deciding how to allocate their
limited income to satisfy their diverse needs and wants.
• Income Generation:
Households earn income from various sources, including wages from employment, returns on
investments, and government transfers.
 • Production:
Households engage in producing goods and services for their own use (e.g., food, clothing) or for
market sale.
• Saving and Investment:
Households save a portion of their income and can invest in assets like stocks, bonds, or real
estate to secure their financial future.
Key Aspects of Household Behavior
• Decision-Making:
Households make strategic decisions about allocating their financial and temporal resources to
maximize member welfare and utility.
• Household Budget:
Households have a limited budget that they must manage carefully to meet their members'
needs.
• Labor Supply:
Household members provide labor to the market, selling their time and skills to firms in exchange
for income.
• Household Production Theory:
Economist Gary Becker modeled households as "small factories" that produce basic
commodities, using time and income to optimize their output.
Household in the Broader Economy
• Interdependence with Firms:
Households consume what firms produce and supply the labor that firms need, creating a
fundamental link in the economic system.
• Market vs. Non-Market Activities:
Households decide which goods and services to produce themselves and which to purchase
from the market, balancing cost, time, and utility.
• Macroeconomic Sector:
In macroeconomic statistics, households form an important institutional sector, along with
government and firms, that participates in the economy's production, consumption, and income
flows.

In economics, the fundamentals of firms center on their role as organizations that combine
resources (land, labor, capital, entrepreneurship) to produce and sell goods and services, with
the primary goal of maximizing profit and creating value for stakeholders. Key aspects include the
firm's purpose, its interaction with factor and product markets, the importance of efficient
production through the production function, and the concept of economies of scale, where costs
decrease as output increases.
Core Concepts
• Purpose and Mission:
Firms exist to fulfil specific purposes, whether it's meeting market demands, generating profits
for owners, or providing jobs.
• Stakeholder Value:
Firms create value for a range of stakeholders, including shareholders, employees, customers,
and the wider community.
• Profit Maximization:
A fundamental assumption in classical economic theory is that firms aim to maximize their
profits by efficiently producing goods and services.
Factors of Production
Firms acquire and combine these inputs to create outputs:
• Land: All natural resources used in production, like minerals or the land itself.
• Labor: The human effort, skills, and work involved in production.
• Capital: Man-made goods and tools used to produce other goods and services, such as
machinery and buildings.
• Entrepreneurship: The ability to combine the other factors of production, innovate, and
take risks to establish and run a business.
Interaction with Markets
• Factor Markets: Firms are consumers of resources in these markets, buying inputs like
labor and raw materials.
• Product Markets: Firms supply finished goods and services in these markets, where they
interact with customers.
Efficiency and Scale
• Production Function:
This describes the relationship between inputs and the maximum possible output, assuming
efficient use of resources and given technical knowledge.
• Economies of Scale:
As a firm's output increases, its average cost per unit often decreases, leading to cost advantages
from large-scale production.
The Firm's Existence
• Reducing Transaction Costs:
Firms are formed to reduce the costs and complexity of always having to go to the market for every
transaction, decision, or negotiation.
• Sociotechnical System:
Firms are viewed as structured, self-regulating systems that are open to their environment and
adapt to achieve their goals
Chapter 31
Economies of scale

As businesses grow and their output increases, they commonly benefit from a reduction in average costs of
production. Total costs will increase as output increases. However, the cost of producing each unit falls as
output increases. This fall in average costs as output increases indicates that a business is benefitting from
economies of scale. This reduction in average costs is what gives larger businesses a competitive advantage
over smaller businesses.

Economies of scale are an important aspect of efficiency in production. Economies of scale can be defined as:
‘the reduction in average costs of production that occur as a business increases its scale of production’.

Costs in the short and long run

When examining economies of scale it is worth looking at both the short run and long run average costs
of the business. In the short run costs can be both variable and fixed, but in the long run all costs become
variable. For example, rent negotiated over a 12 month contract is a fixed cost in the short run – i.e. it does
not alter in relation to changes in demand or output. However, if rent rises after 12 months, then it too is
regarded as a variable cost. It is this switch to all costs becoming variable that separates the short run from
the long run.

Each business’s long run average cost curve is made up of a series of short run average cost curves. As a
business grows it moves from one short run average cost curve to another short run average cost curve,
each one being progressively lower and so reducing average costs of output. This is represented in the graph
below.

Costs Economies of scale

Short run and long run cost curves

SRAC

SRAC 2
SRAC 3 LRAC

Output
Imagine a building site with one foreman and one worker. The worker’s role is digging trenches; the
foreman’s role is to oversee the digging of trenches. The foreman earns £10 an hour, the worker’s wage is £5
an hour. The worker is capable of digging five metres of trench in an hour. With one worker, each metre of
trench would therefore cost £3: i.e. the £5 wages of the worker and the £10 wages of the supervisor divided
by 5 metres dug – equalling £3 per metre.

If another worker was taken on then we would now have 10m of trench per hour at a total cost of £20 (£10 +
£5 + £5). Therefore the cost per metre of the trench is now £2. With three workers, we now have 15 metres
of trench at a total cost of £25; which gives a cost of £1.66 per metre. This represents decreasing average
costs in the short run.

In the long run the building site could, instead of using workers and spades, use a digger. This would allow a
move on to another short run average cost curve – lowering potential average costs even further. This is an
example of how economies of scale reduce average costs of production.

Internal and external economies of scale

We can break down economies of scale into two broad groups – these are internal and external.

Internal economies of scale

Reductions in average cost per unit of output as a result of increasing internal efficiencies of the business.

Purchasing

Technical Financial

Internal
economies
of scale

Managerial Marketing
Purchasing economies – as businesses grow they increase the size of orders for raw materials or
components. This may then result in discounts being given and the cost of each individual component
purchased will fall. This will therefore reduce the average cost of production.

Technical economies – as businesses grow they are able to purchase the latest equipment and incorporate
new methods of production. This increases efficiency and productivity, reducing average costs of output.

Financial economies – as businesses grow they will have access to a wider range of finance. As the assets of
businesses grow, they are able to offer more security when seeking to borrow money – reducing the risk to
the lender. As a result, larger businesses can often negotiate more favourable rates of interest on any money
they do borrow.

Managerial economies – as businesses grow they are able to employ specialist managers. These managers
will know how to get the best value for each pound (£) spent in the business, whether it is in production,
marketing or purchasing. This will increase efficiency and thereby reduce the average costs of producing
goods and selling the goods or services on offer.

Marketing economies – as businesses grow each pound (£) spent on advertising will have greater benefit for
the business. Imagine a chain of local supermarkets: a TV advertisement is placed to cover the region. If there
were 10 stores in the chain the cost of the advert must be borne by each of the 10 stores. However, if they
have 20 stores, then the cost of the advert would be spread across each of the 20 stores and the benefit of
the advert applies to each of the 20 stores.

External economies of scale

The advantages of scale that benefit a whole industry and not just an individual business.

Financial
services

External
economies
of scale

Educational Supplier
The largest businesses often benefit from external economies of scale, especially if the industry is
concentrated in one geographical area.

Supplier economies – a network of suppliers may be attracted to an area where a particular industry is
growing. The setting up locally of supplier businesses, often in competition with one another, reduces buying
costs and allows the use of systems such as Just-in-Time.

Educational economies – local colleges will set up training schemes suited to the largest employers’ needs,
giving an available pool of skilled labour. This reduces recruitment and training costs for those businesses
who make up the industry concerned.

Financial economies – financial services can improve, with banks and other financial institutions providing
services that may be particularly geared towards a particular industry. For example, for an industry where
cash flow may be a particular problem, debt factoring services may be made available at competitive rates.

These economies of scale can be regarded as quantitative in nature, i.e. they can be measured using financial
methods. We know exactly how much is saved on purchasing raw materials, we know exactly how much is
saved when a loan is renegotiated at a lower interest rate.

Diseconomies of scale

The factors that cause higher costs per unit of output when the scale of an organisation continues to
increase – the causes of inefficiency in large organisations.

When diseconomies occur, the average costs of production rise with output. Let’s go back to the example of
the building site.

Maybe the foreman is capable of looking after 10 workers effectively and ensuring that each digs five metres
per hour; but if there were 15 workers average output may start to fall. This happens because the supervisor
is not able to supervise all the workers and ensure that each is working to their maximum capacity and some
may take advantage of this and work more slowly. Now there are increasing average costs of output. We have
diseconomies of scale.

Like economies of scale, diseconomies can be both internal and external.

Internal diseconomies of scale

Coordination issues – The larger an organisation becomes, the more difficult it is to coordinate. Inevitably
there is a good deal of delegation and this empowerment of more and more managers to make their own
decisions can result in different departments heading in different directions. To counter this, numerous
management meetings have to be held. The time that managers spend in meetings, in an attempt to ensure
better coordination within large organisations, can be viewed as a significant overhead cost.

Communication issues – As an organisation grows and levels of hierarchy increase, the efficiency and
effectiveness of communication breaks down. This leads to increasing misunderstanding and inefficiency
as each level of hierarchy grows further and further apart and messages become distorted, resulting in
increasing average costs.
Motivation issues – With larger businesses it is harder to satisfy and motivate workers as many may feel that
their views are ignored, as they distanced from the organisation’s decision makers. This means that they may
not give of their best as they are not focused on the organisation’s aims and objectives.

These diseconomies of scale are often qualitative in nature and are difficult to measure financially –
nonetheless, they still reduce the efficiency of the organisation.

External diseconomies of scale

Overcrowding in industrial areas – Traffic congestion may occur – resulting in late deliveries and staff arriving
late for work. Local residents may resent this and public relations may suffer.

Increased price of resources – More businesses in an area means increased demand for labour to work in
that industry and the best employees may be harder to recruit and keep. Land, services and materials may all
become more expensive as the industry grows and demand for such resources increases.

Economies of scale and stakeholders

• Economies of scale have led to significant price drops in some market segments which have been
advantageous to consumers. Electronics, clothes and phone services are just three of the sectors that
have seen real price falls over the last 20 years. Therefore, consumers do benefit from the fall in a
business’s costs if they are reflected in lower prices.
• Shareholders may well benefit if economies of scale have helped businesses prosper as they have
increased in size, resulting in increased share values.
• Some businesses have increased their scale to such an extent that they have become monopoly
suppliers and eliminated their competitors. These were no longer able to compete as their larger
competitors took more and more advantage of the economies of scale available to them.
• Suppliers are increasingly finding themselves under pressure to provide cheaper goods and services
to businesses who operate on a large scale. This has proven to be the case with large supermarkets,
resulting in many farmers going out of business as the profit margins that they were operating proved
to be unsustainable.

Survival of small businesses

Small businesses are unlikely to benefit in any major way from economies of scale, so they will be less
efficient and have higher costs than their bigger competitors. How do they survive? Well of course many
don’t. We have all seen local businesses and independent stores close as a result of larger competition
moving into the area. However, many still do well, and there are a number of possible reasons for their
success.

They provide a service that is difficult to scale up. Most plumbers, electricians and roofers are local small
businesses. They seem better able to deal with fluctuations in demand, adapting their target market to
changing market conditions. In this case it seems that flexibility is the key. Other factors leading to the
survival of small businesses are:

• Target market size – sometimes the potential sales are suited to small businesses, for example dog
grooming services or kennels.
• Population density – large businesses need large target markets: if these don’t exist then the market is
left to small businesses.
• Quality of service and product – often it is this added value aspect of the business that justifies the
 higher prices charged.
• Customer loyalty – even in the modern retailing environment there are customers that remain loyal to
local shops and service providers.
• Niche markets – sometimes the segment the small business is targeting is just too small to be
worthwhile to big business or the product is legally protected for a period of time.

Discussion themes

Watch the economies of scale video to identify the main types.

https://www.youtube.com/watch?v=6ihehRMtRWc

Explain how Apple benefits from economies of scale. Does Apple suffer from any disadvantages from being
so big?

Apple – Economies and diseconomies of scale

https://fayblack.wordpress.com/2012/09/11/economies-of-scale-apple/

What are diseconomies of scale?

Some small businesses survive and thrive even though they are unable to benefit from economies of scale.
Explain why this happens.
Market Structure

Market Structure: Meaning, Characteristics and Forms

According to Prof. R. Chapman, “The term market refers not necessarily to a place but
always to a commodity and the buyers and sellers who are in direct competition with one another.”
The market for a product refers to the whole region where buyers and sellers of that product
 are spread and there is such free competition that one price for the product prevails in the entire
region.

The essential features of a market are

(1) An Area:
In economics, a market does not mean a particular place but the whole region where sellers
and buyers of a product ate spread. Modem modes of communication and transport have made the
market area for a product very wide.
(2) One Commodity:
In economics, a market is not related to a place but to a particular product. Hence, there are
separate markets for various commodities. For example, there are separate markets for clothes,
grains, jewelry, etc.
(3) Buyers and Sellers:
The presence of buyers and sellers is necessary for the sale and purchase of a product in
the market. In the modem age, the presence of buyers and sellers is not necessary in the market
because they can do transactions of goods through letters, telephones, business representatives,
internet, etc.
(4) Free Competition:
There should be free competition among buyers and sellers in the market. This competition
is in relation to the price determination of a product among buyers and sellers.
(5) One Price:
The price of a product is the same in the market because of free competition among buyers
and sellers.
(6) Buyers and Sellers:
The presence of buyers and sellers is necessary for the sale and purchase of a product in
the market. In the modem age, the presence of buyers and sellers is not necessary in the market
because they can do transactions of goods through letters, telephones, business representatives,
internet, etc.

(7) Free Competition:

There should be free competition among buyers and sellers in the market. This competition
is in relation to the price determination of a product among buyers and sellers.

(8) One Price:

The price of a product is the same in the market because of free competition among buyers
and sellers.

MARKET STRUCTURE

Meaning:
Market structure refers to the nature and degree of competition in the market for goods and
services. The structures of market both for goods market and service (factor) market are
determined by the nature of competition prevailing in a particular market.
There are a number of determinants of market structure for a particular good.
 • The number and nature of sellers - The market structures are influenced by the
number and nature of sellers in the market.
• The number and nature of buyers - The market structures are also influenced by the
number and nature of buyers in the market.
• The nature of the product - It is the nature of product that determines the market
structure.
• The conditions of entry into and exit from the market - The conditions for entry and exit
of firms in a market depend upon profitability or loss in a particular market.

Economies of scale - Firms that achieve large economies of scale in production grow large in
comparison to others in an industry.

On the basis of competition, a market can be classified in the following ways:

1. Perfect Competition Market:
A perfectly competitive market is one in which the number of buyers and sellers is very
large, all engaged in buying and selling a homogeneous product without any artificial restrictions
and possessing perfect knowledge of market at a time.
According to R.G. Lipsey, “Perfect competition is a market structure in which all firms in
an industry are price- takers and in which there is freedom of entry into, and exit from, industry.”
Characteristics of Perfect Competition:
• Large Number of Buyers and Sellers
• Freedom of Entry or Exit of Firms
• Homogeneous Product
• Absence of Artificial Restrictions
• Profit Maximization Goal
• Perfect Mobility of Goods and Factors
• Perfect Knowledge of Market Conditions
• Absence of Transport Costs
• Absence of Selling Costs
Examples of perfect competition

In the real world, it is hard to find examples of industries which fit all the criteria of ‘perfect
knowledge’ and ‘perfect information’. However, some industries are closed.

1. Foreign exchange markets. Here currency is all homogeneous. Also, traders will have
access to many different buyers and sellers. There will be good information about relative
prices. When buying currency, it is easy to compare prices
2. Agricultural markets. In some cases, there are several farmers selling identical products to
the market, and many buyers. At the market, it is easy to compare prices. Therefore,
agricultural markets often get close to perfect competition.
3. Internet related industries. The internet has made many markets closer to perfect
competition because the internet has made it very easy to compare prices, quickly and
efficiently (perfect information). Also, the internet has made barriers to entry lower. For
example, selling popular goods on the internet through a service like e-bay is close to perfect
competition. It is easy to compare the prices of books and buy from the cheapest. The internet
has enabled the price of many books to fall in price so that firms selling books on the internet
are only making normal profits.

Imperfect Competition
Definition: Imperfect competition is a competitive market situation where there are many sellers,
but they are selling heterogeneous (dissimilar) goods as opposed to the perfect competitive market
scenario. As the name suggests, there are competitive markets that are imperfect in nature.
Description: Imperfect competition is the real-world competition. Today some of the industries
and sellers follow it to earn surplus profits. In this market scenario, the seller enjoys the luxury of
influencing the price in order to earn more profits.
If a seller is selling a non-identical good in the market, then he can raise the prices and earn profits.
High profits attract other sellers to enter the market and sellers who are incurring losses can very
easily exit the market.

There are four types of imperfect markets:

- Monopoly (only one seller)
- Oligopoly (few sellers of goods)
- Monopolistic competition (many sellers with highly differentiated products)
- Monopoly (only one buyer of a product)
1. Monopoly Market:
Monopoly is a market situation in which there is only one seller of a product with
barriers to entry of others. The product has no close substitutes. The cross elasticity of
demand with every other product is very low. This means that no other firms produce a
similar product.
According to D. Salvatore, “Monopoly is the form of market organization in which there
is a single firm selling a commodity for which there are no close substitutes.”
Characteristics of Monopoly
• Under monopoly, there is one producer or seller of a particular product and
there is no difference between a firm and an industry. Under monopoly a firm
itself is an industry.
• A monopoly may be individual proprietorship or partnership or Joint Stock
Company or a cooperative society or a government company.
• A monopolist has full control over the supply of a product. Hence, the elasticity
of demand for a monopolist’s product is zero.
• There is no close substitute for a monopolist’s product in the market. Hence,
under monopoly, the cross elasticity of demand for a monopoly product with
some other goods is very low.
• There are restrictions on the entry of other firms in the area of monopoly products.
• A monopolist can influence the price of a product. He is a price-maker, not a price-
taker.
• Pure monopoly is not found in the real world.
• Monopolists cannot determine both the price and quantity of a product
simultaneously.
• Monopolist’s demand curve slopes downwards to the right.
Sources of Monopoly Power

In a monopoly, specific sources generate individual control of the market. Sources of power
include:

• Economies of scale
• Capital requirements
• Technological superiority
• No substitute goods
• Control of natural resources
• Network externalities
• Legal barriers
• Deliberate actions

Monopoly vs. Competitive Market

Monopolies and competitive markets mark the extremes in regard to market structure.
There are a few similarities between the two including: the cost functions are the same,
both minimize cost and maximize profit, the shutdown decisions are the same, and both are
 assumed to have perfectly competitive market factors.

However, there are noticeable differences between the two market structures including:
marginal revenue and price, product differentiation, number of competitors, barriers to
entry, elasticity of demand, excess profits, profit maximization, and the supply curve. The
most significant distinction is that a monopoly has a downward sloping demand instead of
the “perceived” perfectly elastic curve of the perfectly competitive market.

Profit Maximization Function for Monopolies

Monopolies set marginal cost equal to marginal revenue in order to maximize profit.
Monopolies have much more power than firms normally would in competitive markets,
but they still face limits determined by demand for a product. Higher prices (except under the
most
extreme conditions) mean lower sales. Therefore, monopolies must make a decision about
where to set their price and the quantity of their supply to maximize profits. They can either
choose their price, or they can choose the quantity that they will produce and allow market
demand to set the price.

2. Oligopoly
Definition
“Oligopoly is an industry structure characterized by a small number of firms producing all
or most of the output of some good that may or may not be differentiated”.

Oligopoly is a market situation in which there are a few firms selling homogeneous
or differentiated products. It is difficult to pinpoint the number of firms in ‘competition
among the few.’ With only a few firms in the market, the action of one firm is likely to
affect the others. An oligopoly industry produces either a homogeneous product or
heterogeneous products.

Characteristics of Oligopoly
• Interdependence
• Advertisement
• Competition
• Barriers to Entry of Firm
• Lack of Uniformity
• Demand Curve
• No Unique Pattern of Pricing Behaviors

Explanation of Price and Output Determination under Oligopoly

We cannot explain the pricing and output decisions under duopoly a single theory. It will not
be satisfactory. The reasons are:
• The number of firms may vary which is dominating the market. Sometimes there
may be only two or three firms that dominate the entire market (Tight oligopoly).
 At another time there are 7 to 10 firms that capture 80% of the market (loose
oligopoly).
• The goods produced may or may not be standardized under oligopoly.
• Sometimes the firms under oligopoly cooperate with each other in the fixing of
price and output of goods. At another time, they choose to act independently.
• Sometimes barriers to entry are very strong in oligopoly and at another time, they
are quite loose.
• Sometimes a firm under oligopoly cannot certainly predict with the reaction of
the rival firms if any changes occur in the prices and output of its goods.
Considering the wide range of diversity of market situations, a number of
models have been developed which
• explain the behavior of the oligopolistic firms.

3. Monopolistic Competition
Monopolistic competition refers to a market situation where there are many firms selling a
differentiated product. “There is competition which is keen, though not perfect, among many
firms making very similar products.” Thus, monopolistic competition refers to competition
among a large number of sellers producing close but not perfect substitutes for each other.
Features of monopolistic competition
• Large Number of Sellers
• Product Differentiation
• Freedom of Entry and Exit of Firms
• Nature of Demand Curve
• Independent Behaviour
• Product Groups
• Selling Costs
• Non-price Competition

4. Monopoly
Monopoly consists of a market condition that is heavily influenced by a single
buyer. It is the opposite of monopoly – a market condition with only one seller. In
monophonies, the buyer exerts a majority of control over the purchase of a good or a
service, which gives them higher power during negotiations.
Characteristics/Features of Monopoly:
Monopoly in the labor market, is said to exist when there is a single buyer of labor.
The main characteristics of monopoly are as under.
• The firm or employer hires a large portion of the total employment of a certain
type of labour.
• The mobility of labour is very much limited either geographically or in terms of
skills of offer.
 • The monopolist faces imperfect competition in the labour market but
perfect competition in the product market.
• The single buyer faces a large number of workers who are unorganized or
non- unionized.

Monophonies are common in the labor market in situations where only one
company is responsible for supplying a lot of jobs. Labor market monophonies tend to be
disadvantageous for workers since companies can negotiate for lower wages due to their
power in the market.
MONOPOLY POWER
• A monopoly has buying or bargaining power in their market.
• This buying power means that a monopoly can exploit their bargaining
power with a supplier to negotiate lower prices.
• The reduced cost of purchasing input increases their profit margins,
increasing the chances of a business making super-normal profit
• Monopoly exists in both product and labour markets – in this chapter we
focus on buying power in the markets for goods and services.
• This means that the employer has buying power over their potential
employees. This gives them wage-setting power in the industry labour
market.
• Monopoly is a potential cause of labour market failure. For a monopoly employer,
the supply curve of labour equals the average cost of labour. The monopoly
employer will have to bid up wages in order to attract new workers. But the wage
they pay will not necessarily be equal to the true marginal revenue product of
people they have employed.
Analysis of monopoly power when setting wages

Advantages of Monopoly
• Being a monopsonist in the labor market allows companies to achieve
economies of scale and lower long-run average costs. It increases profits and
returns to stakeholders.
• For monopsonists that invest in R&D, capital investment, and/or charitable
causes, it helps the rich give back to society.
Disadvantages of Monopoly
• Suppliers are squeezed to settle at lower prices due to restrictions on alternatives.
• Specific to the labor market, lower wages may sometimes mean that wages
fall below the productivity of workers. It may slow down the growth of the
economy and have detrimental effects on educational attainment.
Bilateral Monopoly
Definition of Bilateral Monopoly: A Bilateral Monopoly occurs in an industry where
there is only one producer of a good and only one supplier. It means there is a monopsonist
(buyer of labour) and a monopoly (single supplier)
 Fiscal Policy
Meaning
Fiscal policy is one of the key tools that governments attempt to regulate and influence
the economy to achieve Macroeconomics Goal. In simple words, Fiscal policy refers the use of
government spending and tax policy to influence the path of the economy over time. It means the
use of taxation and public expenditure by the government for stabilization or growth of the
economy. n other words, Fiscal policy refers to the budgetary policy of the government, which
involves the government controlling its level of spending and taxation within the economy. It is
the sister strategy to monetary policy.

Types of Fiscal policy

There are two main types of fiscal policy. They are:

1. Neutral Fiscal policy: Fiscal policy is said to be neutral when the level of
government spending in relation to tax revenue is stable over time. This type of policy is
usually undertaken when an economy is in equilibrium- neither rapidly expanding nor
contracting. In this instance, government spending is fully funded by tax revenue, which has a
neutral effect on the level of economic activity.

2. Discretionary fiscal policy: Discretionary fiscal policy refers to government fiscal

policy that alters government spending or taxes. Its purpose is to expand or shrink the economy
as needed. It has two sub-types as:

(i) Expansionary Fiscal Policy: Discretionary fiscal policy is said to be Expansionary

when the government spends more money than its revenue collected through taxes. This type of
fiscal policy is usually undertaken during recessions to increase the level of economic activity.
(ii) Contractionary Fiscal Policy: Discretionary fiscal policy is said to be
Contractionary when government spending is lower than tax revenue. This type of Fiscal policy
is undertaken to pay down government debt and to curb inflation.

Objectives of Fiscal policy

The objective of fiscal policy is to maintain the condition of full employment, economic
stability and to stabilize the rate of growth. General objectives of Fiscal Policy are given below:
1. Full employment: The first and foremost objective of fiscal policy in a developing
economy is to achieve and maintain full employment in an economy. In such countries, even if
full employment is not achieved, the main motto is to avoid unemployment and to achieve a state
of near full employment. Therefore, to reduce unemployment and under-employment, the state
should spend sufficiently on social and economic overheads. These expenditures would help to
create more employment opportunities and increase the productive efficiency of the economy
 2. Price stability: Various classes of society such as consumers, laborers and employees,
agriculturists, producers, traders, etc. are affecting by fluctuation in prices. The general public is
adversely affected by increasing prices. The fiscal policy endeavors to bring stability in prices by
removing demerits of increase/decrease in prices. The impact of the price increase can be
reduced by providing subsidy or decreasing taxes

3. Accelerating the rate of economic development: Primarily, fiscal policy in a

developing economy, should aim at achieving an accelerated rate of economic
growth. Therefore, fiscal measures such as taxation, public borrowing and deficit financing etc.
should be used properly so that production, consumption and distribution may not adversely
affect. It should promote the economy as a whole which in turn helps to raise national income
and per capita income.

4. Optimum allocation of resources: Fiscal measures like taxation and public

expenditure can greatly affect the allocation of resources in various occupations and sectors.
Public expenditure in the form of subsidies and incentives can favorably influence the allocation
of resources in the desired channels. For example, tax exemptions and tax concessions may help
a lot in attracting resources towards the favored industries. On the contrary, high taxation may
draw away resources in a specific sector.

5. Equitable distribution of income and wealth: A welfare state should provide social
justice by giving equitable distribution of income and wealth. Fiscal policy can serve as an
effective means of achieving this much desired goal of socialism in developed as well as
developing countries. Progressive tax system can be of much use in realizing this objective.
Moreover, public expenditure helps in redistributing income from the rich to the poor section of
the society

6. Economic stability: Economic stability is another prime aim of a sound fiscal policy.
This goal implies maintenance of full employment with relative price stabilization. Inflation
should be curbed and deflation should be avoided. In short, economic growth and stability are
the twin objectives jointly pursued by a developing country’s fiscal policy. The forces
stimulating growth process should be given a boost at a time while inflationary pressures are to
be curbed. Fiscal measures promote economic stability in the face of short-run international
cyclical fluctuations. These fluctuations cause variations in terms of trade, making the most
favorable to the developed and unfavorable to the developing economies. Therefore, fiscal policy
plays a leading role in maintaining economic stability in the face of internal and external forces.

7. Capital formation: The fiscal policy also aims at increasing the rate of investment in
the private and public sector. The rate of capital formation in developing countries is very low
due to unemployment and low per capita income. The vicious circle of poverty is main the
problem of these countries. Therefore, fiscal policy is adopted in such a way that it reduces
consumption and encourages savings is used to reduce undesirable consumption in developed
countries
 From the above discussion, it follows that the objectives of fiscal policy are not
conflicting but complementary to each other.

Components of Fiscal policy

All the decisions taken by government in terms of taxation, resource mobilization and
expenditure comprise the Fiscal Policy. There are four key components of Fiscal Policy are as
follows:
1.Taxation Policy: The government tries to keep the taxes in nature and with the help of direct
and indirect taxes controls, The government generates its revenue by imposing both indirect taxes
and direct taxes at the same time maintain Price stability . Thus, it is important for the government
to follow a judicial system for taxation and impose correct tax rates such as progressive tax. This is
because of two reasons:

(a)The higher the tax, lower the purchasing power of the people. This will lead to a decrease in
investment and production.

(a) The lower tax will leave more money with people that lead to high spending and thus higher
inflation
2. Expenditure Policy: Expenditure policy of the government deals with revenue and capital
expenditures. Capital Expenditures of the government include acquisition of long-term assets,
such as facilities or manufacturing equipment etc, which will generate business or additional
profits to government. Revenue Expenditures are those expenditures which don’t create any
productive assets such as interest paid by the Government of India on all the internal and external
loans or pension and salaries of government employees.
3. Investment and Disinvestment Policy: Investment and Disinvestment Policy refers to
investment in the form of FDI or FII in an economy from outside the country or disinvestment of
government holding to public or private shares.
4. Debt / Surplus Management: If the government received more than it spends, it is called
surplus. If government spends more than income, then it is called deficit. To fund the deficit, the
government has to borrow from domestic or foreign sources. It can also print money for deficit
financing

Role of Fiscal Policy in Developing Economy

The main goal of fiscal policy in a newly developing economy is the promotion of the
highest possible rate of capital formation. The fiscal policy in developing economy should
apparently be conducive to rapid economic development. Developing Economy, fiscal policy can
no longer remain a compensatory fiscal policy. It has a tough role to play in a developing
economy and has to face the problem of growth-cum-stability. The Roles of Fiscal Policy in
Developing Economy are discussed as below:
 1. Resource Mobilization: Owing to acute poverty, the marginal propensity to consume
is very high in developing economies. As a result the level of saving is very low in these
economies. Therefore fiscal policy has an important role to play in mobilizing saving for capital
formation through taxation and public borrowing. It can also influence capital formation and sav-
ings in the private sector through granting of various tax concessions and subsidies.
2. Development of Private Sector: In a developing economy private sector forms an
important constituent of the economy. The production and productivity of private sector can be
influenced by fiscal policy. Tax relief, rebates, subsides may be granted to boost up the
productive activity in the private sector. Fiscal tools and measures can be used to activate capital
market to ensure availability of adequate resources for the private sector.
3. Optimization of Resources Allocation: In developing economies, fiscal tools can be
utilized to effect optimum allocation of resources. Very often resources in private sector are
directed towards the production of goods which cater to the requirement of richer section of
society. Fiscal tools can be employed to allocate the mobilized resources in desirable channels of
investment. Thus, process of reallocation can be done by various tax incentive measures and
subsidy programmes.
4. Creation of Social and Economic Overheads: In developing economics, there is the lack of
proper development of basic infrastructures which are vital requirements for economic de-
velopment. Provision of social overheads like education and health service will directly enhance
the productive capacity of the people. Expenditure incurred for the provision of economic
overheads like transport facilities, power generation and telecommunication facilities which will
speed up the process of industrialization. Hence, government has to provide investments on
Building of social and economic overheads through fiscal measures of taxation and expenditure
programmes.
5. Balanced Regional Development: Developing economies face the problem of
regional imbalance in the matter of economic development. Fiscal tools like tax concession, tax
holiday, subsidies, concessions in infrastructure utilization etc., can be given to private investors
to attract private investment in these backward geographical areas as part of the strategies for
balanced growth.

6. Economic Stability: Fiscal tools such as taxation and expenditure programmes can be
utilized as an effective tool to control cyclical fluctuations arising during the process of
economic development. Taxation is an effective instrument to deal with inflationary and
deflationary situations.
7. Reduction of Inequality: Provision of equality in income wealth and opportunities
form an integral part of economic development in developing economics. Fiscal policy has an
important role to play in reducing inequality.
Instruments of taxation must be used as a means to bring about redistribution of income. The
various fiscal measures directed towards reduction of inequality in income, wealth and
opportunity are: progressive taxation of income and property, imposition of heavy taxation on
luxury goods, tax exemption or concession to commodities of mass consumption, government
expenditure on relief programmes, and provision of essential commodities at subsidized price
through fair price shops to the poor etc.
Differences between Fiscal Policy and Monetary Policy

1. While fiscal policy is concerned with how money is spent and collected by the
government, monetary policy is concerned with the overall supply of money within the
economy.

2. Fiscal policy is usually set by the executive and legislative functions. Monetary policy is
generally determined by central banks.

3. Governments adjust fiscal policy by changing levels of taxation and spending in order to
stimulate (or discourage) consumer spending and maintain healthy levels of employment
and inflation. The key metric here is aggregate demand.

4. Central banks adjust monetary policy by buying and selling treasury bonds to expand or
contract the amount of currency in circulation, and by raising or lowering the interest rate
and reserve ratio (i.e. the amount of money banks are required to hold onto at any given
time) in order to stimulate (or discourage) lending by banks
 Paper: Indian Economy –II

Topic: Monetary Policy

Meaning: Monetary policy is the macroeconomic policy laid down by the central bank of an
economy. The policy involves an operational framework which uses certain instruments and
targeting mechanisms to achieve macroeconomic objectives like price stability, reviving
consumption, growth and liquidity. The Reserve Bank of India (RBI) is vested with the
responsibility of conducting monetary policy. This responsibility is explicitly mandated under
the Reserve Bank of India Act, 1934.

Monetary policy refers to that policy which is concerned with the measures taken to regulate the
volume of credit created by the banks. Monetary policy thus involves the use of monetary
instruments under the control of the central bank to achieve price stability, financial stability and
adequate availability of credit for growth.

OBJECTIVES

1. To Regulate Money Supply in the Economy: Money supply includes both money in
circulation and credit creation by banks. Monetary policy is framed to regulate the money
supply in the economy by credit expansion or credit contraction. By credit expansion
(giving more loans), the money supply can be expanded. By credit contraction (giving less
loans) money supply can be decreased. The main aim of the monetary policy of the
Reserve Bank is to control the money supply in such a manner as to expand it to meet the
needs of economic growth and at the same time contract it to curb inflation. In other
words monetary policy aimed at expanding and contracting money supply according to
the needs of the economy.

2. To Attain Price Stability: Another major objective of monetary policy in India is to

maintain price stability in the country. It implies Control over inflation. Price level, is
affected by money supply. Monetary policy regulates money supply to maintain price
stability.

3. To Promote Economic Growth: An important objective of monetary policy is to make

available necessary supply of money and credit for the economic growth of the country.
Those sectors which are quite significant for the economic growth are provided with
adequate availability of credit.
 4. To Promote saving and Investment: By regulating the rate of interest and checking
inflation, monetary policy promotes saving and investment. Higher rates of interest
promote saving and investment.

5. To Control Business Cycles: Boom and depression are the main phases of business
cycle. Monetary policy puts a check on boom and depression. In period of boom, credit is
contracted, so as to reduce money supply and thus check inflation. In period of depression,
credit is expanded, so as to increase money supply and thus promote aggregate demand in
the economy.

6. To Manage Aggregate Demand: Monetary authority tries to keep the aggregate demand
in balance with aggregate supply of goods and services. If aggregate demand is to be
increased than credit is expanded and the interest rate is lowered down. Because of low
interest rate, more people take loan to buy goods and services and hence aggregate
demand increases and vice-verse.
7. To ensure more Credit for Priority Sector: Monetary policy aims at providing more
funds to priority sector by lowering interest rates for these sectors. Priority sector includes
agriculture, small- scale industry, weaker sections of society, etc.

8. To Promote Employment: By providing concessional loans to productive sectors, small

and medium entrepreneurs, special loan schemes for unemployed youth, monetary policy
promotes employment.
9. To Promote Exports: By providing concessional loans to export oriented units monetary
policy encourages such industries and thus help to improve the position of balance of
payments.

10. To Develop Infrastructure: Monetary policy aims at developing infrastructure. It

provides concessional funds for developing infrastructure.
11. To Regulate and Expand Banking: RBI regulates the banking system of the economy.
RBI has expanded banking to all parts of the country. Through monetary policy, RBI
issues directives to different banks for setting up rural branches for promoting agricultural
credit. Besides it, government has also set up cooperative banks and regional rural banks.

EXPANSIONARY MONETARY POLICY VERSUS CONTRACTIONARY MONETARY

POLICY

The monetary policy may be categorized as: expansionary monetary policy or contractionary
monetary policy.
 a) Expansionary Monetary Policy: This is known as loose monetary policy. Expansionary
policy increases the supply of money and credit to generate economic growth.
Key Actions implements:
►Decreasing the discount rate
►Purchasing government securities
►Reducing the reserve ratio
In recession period the central bank reduces the rate of interest.
b) Contractionary policy: This is known as tight monetary policy. It is a monetary measure
referring to restrict the supply of money and credit by a central bank. It is exactly
opposite to expansionary policy. It is implemented in extreme inflation case.
►Increasing the discount rate
►Selling of government securities
►Increasing the reserve ratio

INSTRUMENTS OF MONETARY POLICY

There are several direct and indirect instruments that are used for implementing monetary policy.

1. Quantitative, general or indirect (CRR, SLR, Open Market Operations, Bank Rate, Repo Rate,
Reverse Repo Rate)

2. Qualitative, selective or direct (change in the margin money, direct action, moral suasion)

QUANTITATIVE TOOLS

1. Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of
exchange or other commercial papers. It is thus basically an interest rate at which RBI gives
loans and advances to commercial banks.

2. Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain
with the Reserve Bank as a share of such per cent of its Net demand and time liabilities
(NDTL).The Reserve Bank may notify CRR from time to time in the Gazette of India.

3. Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in
safe and liquid assets, such as, government securities, cash and gold. Changes in SLR often
influence the availability of resources in the banking system for lending to the private sector.

4. Open Market Operations (OMOs): Open market operations refer to sale and purchase of
securities in the money market by the central bank of the country
 5. Repo Rate: It is rate at which RBI lends money to the commercial banks for any shortfall in
their funds. Thus it is a short term lending rate of RBI.

6. Reverse Repo Rate: It is the rate at which RBI borrows money from the commercial baks to
wipe out / absorbs excess funds from their hand. It is the borrowing rate of the RBI.

QUALITATIVE TOOLS

Margin Requirement

The RBI follows the margin requirement strategy to avoid bank loss. Under this system, the RBI
provides loans less than the requirement of the bank .

Moral Suasion

Sometimes it is not possible or required to control the flow of money directly. At such times, the
RBI releases informal advisories to the customers and the banks.

Direct Action

When the banks fail to follow the rules and guidelines passed by the RBI, then it has to take
some steps against such banks.

CHANGES IN THE MONETARY POLICY MECHANISM IN INDIA

1. Liquidity Adjustment Facility (LAF): The LAF was launched in 2000and was subsequently
revised in 2004. It is a short term liquidity management technique. Under this, the RBI sells and
purchase govt securities at repo rate and reverse repo rate respectively to absorb or inject money
into the economy on short term basis.

2. Market Stabilization Scheme (MSS): This instrument for monetary management was
introduced in 2004 to withdraw excess liquidity from the economy by selling govt. bonds. .
Surplus liquidity arising from large capital inflows is absorbed through sale of government
bonds.

3. Marginal Standing Facility (MSF): It was launched in 2011 under LAF for lending funds to
the commercial banks. It is a facility under which scheduled commercial banks can borrow
additional amount of overnight money from the Reserve Bank.

4. Demonetization: Demonetization means that Reserve Bank of India has withdrawn the old
₹500 and ₹1000 notes as an official mode of payment. Demonetization is the act of stripping a
currency unit of its status as legal tender. . On November 2016 the government took the great
initiative of demonetization to crack down on black money in the country.

5. Financial Inclusion: Financial Inclusion is described as the method of offering banking and
financial solutions and services to every individual in the society without any form of
discrimination. It primarily aims to include everybody in the society by giving them basic
financial services. The main objective is to serve the basic banking services to the unreserved
people in the country. Under this, the services should be available for disadvantaged people and
low-income groups.
ECONOMIC GROWTH

The term economic growth is defined as the process whereby the country’s real national
and per capita income increases over a long period of time.

This definition of economic growth consists of the following features of economic growth:

• Economic Growth implies a process of increase in National Income and Per-

Capita Income. The increase in Per-Capita income is the better measure of
Economic Growth since it reflects increase in the improvement of living standards
of masses.
• Economic Growth is measured by increase in real National Income and not just
the increase in money income or the nominal national income. In other words, the
increase should be in terms of increase of output of goods and services, and not
due to a mere increase in the market prices of existing goods.
• Increase in Real Income should be Over a Long Period: The increase of real
national income and per-capita income should be sustained over a long period of
time. The short-run seasonal or temporary increases in income should not be
confused with economic growth.
• Increase in income should be based on Increase in Productive Capacity: Increase
in Income can be sustained only when this increase results from some durable
increase in productive capacity of the economy like modernization or use of new
technology in production, strengthening of infrastructure like transport network,
improved electricity generation etc.

ECONOMIC DEVELOPMENT

Economic development is defined as a sustained improvement in material wellbeing of

society. Economic development is a wider concept than economic growth. Apart from
growth of national income, it includes changes – social, cultural, political as well as
economic which contribute to material progress. It contains changes in resource
supplies, in the rate of capital formation, in size and composition of population, in
technology, skills and efficiency, in institutional and organizational set-up. These
changes fulfil the wider objectives of ensuring more equitable income distribution,
greater employment and poverty alleviation. In short, economic development is a
process consisting of a long chain of interrelated changes in fundamental factors of
supply and in the structure of demand, leading to a rise in the net national product of a
country in the long run.

The economic growth is a narrow term. It involves increase in output in quantitative

terms, but economic development includes changes in qualitative terms such as social
attitudes and customs along with quantitative growth of output or national income
FACTORS AFFECTING ECONOMIC GROWTH

The process of economic growth is a highly complex phenomenon and is influenced by

numerous and varied factors such as political, social and cultural factors.

These factors are as follows:

A. Economic Factors

1. Natural Resources: The principal factor affecting the development of an economy is

the natural resources. The natural resources include the land area and the quality of the
soil, forest wealth, good river system, minerals and oil resources, good climate, etc. For
economic growth, the existence of natural resources in abundance is essential. A country
deficient in natural resources may not be in a position to develop rapidly. However, the
availability of rich natural resources is a necessary condition for economic growth but not
a sufficient one. In less developed countries, natural resources are unutilized,
underutilized or mis utilised. This is one of the reasons of their backwardness. On the
other hand, countries such as Japan, Singapore etc. are not endowed with abundant
natural resources but they are among the developed nations of the world. These
countries have shown commitment towards preserving the available resources, putting
best efforts to manage the resources, minimizing waste of resources etc.

2. Capital Formation: Capital formation is another important factor for development of

an economy. Capital formation is the process by which a community’s savings are
channelised into investments in capital goods such as plant, equipment and machinery
that increases nation’s productive capacity and worker’s efficiency thus ensuring a larger flow
of goods and services in a country. The process of capital formation implies that a community
does not spend whole of its income on goods for current consumption but saves a part of it and
uses it to produce or acquire capital goods that greatly add to productive capacity of the nation.
3. Technological Progress: Technological progress is a very important factor in determining the
rate of economic growth. Technological progress mainly implies the research into the use of new
and better methods of production or the improvement of the old methods. Sometimes technical
progress results in the availability of natural resources. But generally technological progress
results in increase in productivity. In other words, technological progress increases the ability to
make a more effective and fruitful use of natural and other resources for increasing production.
Using improved technology, it is possible to have greater output from the use of given resources,
or a given output can be obtained using a smaller quantity of resources. The technological
progress improves an ability to make a fuller use of the natural resources e.g. with the aid of power
- driven farm equipment a marked increase has been brought about in agricultural production.
The USA, UK, France, Japan and other advanced industrial nations have all acquired the industrial
strength from use of advanced technology. In fact, economic development is facilitated with the
adoption of new techniques of production.

Entrepreneurship

Entrepreneurship implies an ability to find out new investment opportunities, willingness to take
risks and make investment in the new and growing business units. Most of the underdeveloped
countries in the world are poor not because there is shortage of capital, weak infrastructure,
unskilled labour and deficiency of natural resources, but because of acute deficiency of
entrepreneurship. It is, therefore, essential in the under-developed nations to create climate for
promoting entrepreneurship by emphasizing education, new research, and scientific and
technological developments

4. Human Resources Development: A good quality of population is very important in determining

the level of economic growth. So, the investment in human capital in the form of educational and
medical and such other social schemes is very much desirable. Human resource development
increases the knowledge, the skills and the capabilities of the people that increase their
productivity.

5. Population Growth: Labor supply comes from population growth, and it provides expanding
market for goods and services. Thus, more labour produces larger output which a wider market
absorbs. In this process, output, income and employment keep on rising and economic growth
improves. But the population growth should be normal. A galloping rise in population retards
economics progress. Population growth is desirable only in an under-populated country. It is,
however, unwarranted in an overpopulated country like India.
6. Social Overheads: Another important determinant of economic growth is the provision of
social overheads like schools, colleges, technical institutions, medical colleges, hospitals and
public health facilities. Such facilities make the working population healthy, efficient and
responsible. Such people can well take their country economically forward. Non-Economic
Factors

Non-Economic factors that include socio-economic, cultural, psychological and political factors
are also equally significant as are economic factors in economic development. We discuss here
some of the essential non-economic factors which determine the economic growth of an
economy.

1. Political Factors: Political stability and strong administration are essential and helpful in
modern economic growth. The stable, strong and efficient government, honest administration,
transparent policies and their efficient implementation develop confidence of investors and
attracts domestic as well as foreign capital that leads to faster economic development.

2. Social and Psychological Factors: Social factors include social attitudes, social values and
social institutions which change with the expansion of education and transformation of culture
from one society to the other. The modern ideology, values, and attitudes bring new discoveries
and innovations and consequently to the rise of the new entrepreneurs. The outdated social
customs restrict occupational and geographical mobility and thus pose an obstacle to the
economic development.

3. Education: It is now recognized that education is the main vehicle of development. Greater
progress has been achieved in those countries, where education is widespread. Education plays
an important role in human resource development, improves labour efficiency and removes
mental block to new ideas and knowledge thus contributes to economic development.

4. Desire for Material Betterment: The desire for material progress is a necessary precondition for
economic development. The societies that focus on self-satisfaction, self-denial, faith in fate etc.
limit risk and enterprise and thus keep the economy backward.

COMMON FEATURES OF UNDERDEVELOPED COUNTRIES

1. Low per Capita Income: The level of per capita income is very low in underdeveloped countries.

2. Poor Level of Living: The vast majority of people in underdeveloped nations lie under the
conditions of poverty, malnutrition, disease, illiteracy, etc. Even basic necessities of life such as
minimum food clothing and shelter are not easily accessible to the poor masses.

3. High Rate of Growth of Population: Population growth in underdeveloped countries neutralizes

economic growth. High population implies greater consumption expenditure and lower
investments in productive activities and slows down the economic development.

4. Highly Unequal Income Distribution: The income inequality between the rich and the poor
people within the underdeveloped countries is also very high.

5. Prevalence of Mass Poverty: Low level of per capita income combined with high degree of
inequalities in its distribution leads to widespread poverty in underdeveloped countries.

6. Low Levels of Productivity: The Productivity level (i.e. output produced per person) tends to be
very low in an underdeveloped country which is mainly due to :

(i) inefficient workforce which itself is a consequence of poverty, ill health and lack of education

(ii) Low work culture

(iii) Low use of capita in the form of machinery and equipment.

7. Low Rate of Capital Formation: The saving rate in an underdeveloped country is quite low and
rate of capital formation is also very slow.

8. Technological Backwardness: In most of the sectors, an underdeveloped economy the

techniques of production employed are generally obsolete mainly due to low saving rate.

9. High Level of Unemployment: Unemployment levels are very high in the underdeveloped
countries mainly due to lack of capital and low level of development in various economic sectors,
these countries are not able to absorb the rising labour supply.

10. Low Social Indicators of Development: The under-developed countries have very low social
indicators such as low literacy rate, high infant mortality rate, low expectancy of life, etc. as
compared to the developed countries.
 Inflation: Meaning and Types
In economics, inflation is defined a sustained increase in the general price level of goods and
services in an economy over a period of time. It is measured as an annual percentage increase. When the
general price level rises, each unit of currency buys fewer goods and services. This implies that inflation
reflects a reduction in the purchasing power per unit of money. In other words, inflation indicates a loss of
real value in the medium of exchange and unit of account in the economy.
Different definitions of inflations have been given by different Economists some of which are as
follows:
1. In the words of Peterson, “The word inflation in the broadest possible sense refers to any
increase in the general price-level which is sustained and non-seasonal in character.”
2. According to Coulborn inflation can be defined as, “too much money chasing too few goods.”
3. According to Samuleson-Nordhaus, “Inflation is a rise in the general level of prices.
4. As per Johnson, “Inflation is an increase in the quantity of money faster than real national
output is expanding”.
5. Keynes has presented his view that true inflation is the one in which the elasticity of supply of
output is zero in response to increase in supply of money.

Types of inflation
Inflation is usually categorized on different basis which are given as below:
A. On the basis of Rate: Inflation has been categorized into following types on the basis of its different
rates:
1. Creeping Inflation: Creeping Inflation also known as a Mild Inflation or Low Inflation refers
to that type of inflation when the rise in prices is very slow like that of snail or creeper. It is the mildest
form of inflation with less than 3% per annum.
2. Chronic Inflation: If creeping inflation persist for a longer period of time then it is often called
as Chronic or Secular Inflation. It is called chronic because if an inflation rate continues to grow for a
longer period without any downturn which may possibly lead to Hyperinflation.
3. Walking or Trotting Inflation: When prices rise moderately with a single digit of less more
than 3% but less than 10% per annum it is called as Walking Inflation.
4. Running Inflation: A rapid acceleration in the rate of rising prices is referred as Running
Inflation. This type of inflation occurs when prices rise by more than 10% per annum.
5. Galloping Inflation: Galloping inflation also known as Jumping inflation occurs when prices
rise by double or triple digit inflation rates of more than 20% but less than 1000% per annum.
6. Hyperinflation: when prices rise at an alarming high rate with quadruple or four digit inflation
rate of above 1000% per annum then is termed as Hyperinflation. It is a situation where the prices rise so
fast that it becomes very difficult to measure its magnitude. During a worst case scenario of
hyperinflation, value of national currency of an affected country reduces almost to zero. Paper money
becomes worthless and people start trading either in gold and silver or sometimes even use the old barter
system of commerce. Two worst examples of hyperinflation recorded in world history are of those
experienced by Hungary in year 1946 and Zimbabwe during 2004-2009 under Robert Mugabe's regime.

B. On the basis of Causes: Inflation has been categorized into following types on the basis of its different
causes:
1. Demand-Pull Inflation: Demand-Pull Inflation also known as Excess Demand Inflation takes
place when aggregate demand for a good or service outstrips aggregate supply. In other words, when
aggregate demand for all purposes- consumption, investment and government expenditure-exceeds the
supply of goods at current prices then it is called Demand-Pull Inflation. Demand-Pull inflation gives rise
to a situation often economists describe as “Too much money chasing too few goods”.
2. Cost-Push Inflation: When prices rise due to growing cost of production of goods and services
then it is known as Cost-Push Inflation. Cost-push inflation also came to known as “New Inflation” is
determined by supply-side factors mainly caused by higher wage-push, Profit-Push and higher costs of
raw materials.
3. Scarcity Inflation: Scarcity inflation occurs due to hoarding by unscrupulous traders and black
marketers so as to create an artificial shortage of essential goods like food grains, kerosene,etc. with an
intension to sell them only at higher prices to make huge profits.
4. Structural Inflation: Structural inflation is that type of inflation often experienced in
developing countries which is caused by structural rigidities such as agricultural bottlenecks, resource
constraints bottlenecks, foreign exchange bottlenecks, physical infrastructural bottlenecks etc.

C. On the basis of Coverage: Inflation has been categorized into following types on the basis of its
coverage:
1. Comprehensive Inflation: When the prices of all commodities rise throughout the economy it
is known as Comprehensive Inflation also known Economy Wide Inflation.
2. Sporadic Inflation: When prices of only few commodities in few regions rise, it is known as
Sporadic Inflation. It is sectional in nature. For example, rise in food prices due to bad monsoon
represents this type of inflation.

D. On the basis of Occurrence: Inflation has been categorized into following types on the basis of its
time of occurrence:
1. War-Time Inflation: when inflation that takes place during the period of a war-like
situation then it is known as War-Time inflation. During a war, scare productive resources are all diverted
and prioritized to produce military goods and equipments resulting in extreme shortage of resources use
producing essential commodities. Consequently, prices of essential goods keep on rising in the market
resulting in War-Time Inflation.
2. Post-War Inflation: Inflation that takes place soon after a war is known as Post-War Inflation.
After the war, government controls are relaxed, resulting in a faster hike in prices than what experienced
during the war.
3. Peace-Time Inflation: When prices rise during a normal period of peace then it is known as
Peace-Time Inflation. It is due to huge government expenditure or spending on capital projects of a long
gestation period.

E. On the basis of Government Reaction: Inflation has been categorized into following types on the
basis of Government's degree of reaction:
1. Open Inflation: When government does not attempt to restrict inflation, it is known as Open
Inflation. In a free market economy, where prices are allowed to take its own course, open inflation
occurs.
2. Suppressed Inflation: When government prevents price rise through price controls, rationing,
etc., it is known as Suppressed Inflation. It is also referred as Repressed Inflation. However, when
government controls are removed, Suppressed inflation becomes Open Inflation. Suppressed Inflation
leads to corruption, black marketing, artificial scarcity, etc.
How to Control Inflation in India with Short
and Long-Term Steps
Inflation means that the prices of things keep going up. When this happens, people cannot buy as
many items with the same money. Food, clothes, fuel, and other needs become costlier. This affects
daily life badly. The poor and middle class feel the pain the most. So, it becomes essential to learn how
to control inflation. The good news is we can control inflation using the right tools and actions. The
Reserve Bank of India (RBI), and governments play a significant role. They change interest rates,
taxes, and spending methods to decrease inflation.
India has often seen inflation due to fuel price hikes, poor rainfall, and global events. Inflation hurts
savings and stops people from investing. It also causes worry in markets and business sectors. So,
stopping inflation is very important for a strong economy. Inflation control helps balance prices and
protects ordinary people from high costs. When we understand how inflation works, we can quickly
avoid significant economic problems.

What is Inflation?
Inflation is a rise in the overall price level of goods and services over time. This means you pay more
for the same things you bought earlier. When inflation happens, the value of money falls. Your ₹100
cannot buy what it used to. This affects every person, whether rich or poor. Everyone needs food,
clothes, fuel, and medicines. If their prices go up, life becomes hard for all.
Inflation is expected in any economy. A small amount of inflation is good. It shows that the economy is
growing. But when inflation rises fast and for a long time, it becomes a problem. It worries people,
reduces their savings, and increases the cost of borrowing. That is why controlling inflation is essential.
To understand inflation better, let's look at the two main ways to measure it:
• Consumer Price Index (CPI): CPI index shows the price of items people use every day, such
as vegetables, milk, clothes, and fuel. It directly shows how inflation affects ordinary people.
• Wholesale Price Index (WPI): This shows the price of goods sold in bulk, like steel, cement,
and crops, before they reach the market. It is vital for industries and businesses.

Types of Inflation
Inflation does not always occur for the same reason. It can rise because of high demand, rising costs,
or other long-term factors. Each type of inflation affects prices differently. Knowing the types of inflation
helps us choose the best method to control it.
1. Demand-Pull Inflation
Demand pull inflation happens when too many people want to buy goods, but not enough goods are
available. For example, more people purchase sweets or clothes during festive seasons. If shops don't
have enough stock, they raise the prices.
2. Cost-Push Inflation
This takes place when it becomes expensive to make goods. This can happen when petrol, electricity,
or raw material prices increase. As a result, the final product becomes more costly for customers.
3. Built-in Inflation
This happens when workers want higher pay because things are costlier. Then, companies increase
their product prices to cover this new wage cost. It becomes a cycle—prices rise, then salaries rise, and
again prices rise.
4. Hyperinflation
This is a hazardous type. Prices go up very fast, sometimes every day. This happened in countries like
Zimbabwe. A loaf of bread costs millions of their currency, destroying the economy quickly.
Each type needs a special solution. Understanding the reason for inflation is essential before we try to
fix it.

How to Control Inflation?

Inflation is like a fire—it starts small, but if you don't act quickly, it spreads and burns everything. That is
why it is essential to understand how to control inflation early. Controlling inflation means slowing down
the fast rise in prices. To do this, governments and central banks use special tools. These tools help
reduce too much money in the market, cut down demand, and improve the supply of goods. Inflation
control also helps protect savings, jobs, and business profits. In India, the RBI and the Government are
taking steps to control inflation. Let's look at their methods in detail.

Role of the Reserve Bank of India (RBI): Monetary Tools

The RBI controls inflation using monetary policy tools. These tools reduce the money supply in the
economy and make borrowing costlier. Here's how each one works:
1. Repo Rate
This is the rate at which banks borrow money from the RBI. When the RBI raises this rate, banks must
pay more interest, so banks give fewer loans to customers. People then spend less money on big
things like houses, cars, or gadgets. Less spending means less demand, which helps bring down
prices. This is one of the most direct and powerful ways to control inflation.
2. Reverse Repo Rate
This is the interest RBI gives banks when depositing their money with RBI. When RBI increases this
rate, banks park more money with RBI instead of giving it as loans. This reduces the money flow in the
economy. Less money in the market means less spending and less price rise.
3. Cash Reserve Ratio (CRR)
CRR is the percentage of money banks must keep from RBI from their total deposits. When RBI
increases CRR, banks have less money to give out as loans. This cuts down extra cash in the system
and reduces consumer spending.
4. Open Market Operations (OMO)
RBI also buys or sells government securities in the open market. When it sells securities, money goes
back to RBI from banks and people. This reduces liquidity and helps control inflation. When money is
tight, prices tend to fall or stop rising fast.

Role of the Government: Fiscal Tools

The Government uses fiscal policy tools to influence spending and demand directly. These tools either
increase or decrease the amount of money in the public's hands.
1. Cutting Public Spending
When the Government spends less on large projects like highways, buildings, or welfare schemes,
there is less money going into the economy. This helps reduce inflation by lowering demand. This step
is important when inflation becomes too high.
2. Raising Taxes
If people pay more taxes on income or goods, they have less money to spend. When people spend
less, demand goes down. When demand falls, prices also begin to drop or rise more slowly.
3. Reducing Subsidies
The Government gives subsidies to lower the prices of food, gas, or electricity. But if everyone gets too
many subsidies, demand increases. The Government can stop unnecessary demand by targeting
subsidies only to low-income people and removing them for others.
4. Importing Essential Goods
The Government can allow cheap imports of food, oil, or raw material prices to rise due to low local
supply. More supply in the market helps bring prices down. This is a quick way to control inflation
caused by shortages.

Causes of Inflation
Prices do not rise without reason. Many small and big events come together and push costs higher.
Sometimes, people spend more money than usual. Sometimes, goods are not available in enough
quantity. Other times, it costs more to make or move items. When these things happen again and
again, inflation starts to grow. In India, inflation often rises due to food shortages, fuel price hikes, or
sudden global events. These causes are called inflation's causes, and each affects the economy
differently.
1. Too Much Demand
Prices rise when people have more money and want to buy more, but the market does not have
enough goods. This is common during economic booms when people earn more and spend more. If
supply stays the same but demand increases, inflation will rise.
2. Supply Shortage
If farmers grow less food due to bad rain or if factories make fewer products, there will be less supply.
At the same time, if people still want to buy, they will pay more. For example, if there's a shortage of
onions, their price will increase quickly.
3. Cost Increase
If the price of petrol or diesel goes up, transportation becomes expensive. Companies spend more to
move goods, raising the final product price to cover this cost. Also, if electricity or wages increase, it
adds to the cost.
4. Weak Rupee
When the value of the Indian Rupee falls compared to the US Dollar, all imported items become costly.
India imports oil, gadgets, and gold. A weak rupee increases the cost of these items and causes
inflation.
5. Too Much Money
If RBI prints a lot of money or banks give easy loans, people have extra cash. They start buying more,
which leads to demand-pull inflation. If this is not controlled, inflation keeps growing.
6. Global Events
Inflation also rises due to things happening outside India. War, pandemics, and global oil crises can
disturb trade and increase the cost of goods and services everywhere.

How to Control Inflation in India?

Inflation in India often rises due to factors like food shortages, rising fuel prices, heavy imports, and
weak supply chains. India's large population and income differences also make price control more
difficult. So, to know how to control inflation in India, we must look at short-term and long-term
solutions. The Reserve Bank of India and the Central Government work together to keep inflation within
safe levels. They use tools to manage money flow, boost supply, and reduce unnecessary spending.
But to stop inflation, we also need better infrastructure, farming, and fuel policies. Let's now understand
how India can control inflation with better planning and timely action.

Short-Term Solutions to Control Inflation in India

These steps help bring down prices quickly when inflation rises suddenly.
1. Release Buffer Stock of Food Grains
The Government keeps food grains like wheat and rice in storage. When food prices rise, it can release
this stock into the market. This increases supply, balances demand, and helps reduce prices. It also
stops hoarding and panic buying during shortages.
2. Cut Import Duties on Essential Items
When the price of items like edible oil or pulses increases, India can reduce import taxes. This makes
foreign goods cheaper in the Indian market, increases competition, improves supply, and quickly brings
down the prices of basic food items.
3. Increase Interest Rates through RBI
The Reserve Bank of India can raise the repo rate to make loans costlier. When people and businesses
borrow less, they also spend less. This reduces demand, and prices begin to cool down naturally.
4. Give Targeted Subsidies
Instead of giving subsidies to everyone, the Government can only help the poor and needy. This
reduces overall demand while still protecting those who need support. It also allows the Government to
use tax money more wisely.
5. Ban or Regulate Exports of Essentials
If the local supply is low, India can stop exporting essential food items like onions or rice. This keeps
more goods inside the country and protects local prices from rising too much.

Long-Term Measures to Control Inflation in India

Short-term steps fix the problem for now. However, to prevent inflation in the future, we must improve
the systems that support the economy.
1. Strengthen Agriculture and Irrigation
A primary reason for inflation in India is the rise in food prices. We need to help farmers grow more
crops with better seeds, water systems, and market access to control this. More farm output means
more food in the market and lower prices.
2. Improve Cold Storage and Transport
India wastes a lot of food because of insufficient storage places and transport trucks. We can stop this
waste by building cold storage units and better roads. This will keep the supply high and help control
food inflation.
3. Promote Renewable Energy
India depends heavily on imported oil, which makes fuel expensive and increases transport costs. By
using solar and wind power more, we can reduce oil imports and keep inflation under control.
4. Encourage Local Manufacturing
Making products in India instead of importing them helps control inflation. "Make in India" plans can
reduce foreign costs, create jobs, and balance prices in the long run.
5. Build Digital and Financial Infrastructure
Digital payment systems, like UPI and online banking, help the government track money flow better.
This reduces black money, improves tax collection, and lets the Government manage inflation with
better data.

Role of Citizens in Inflation Control

Citizens also have a role in keeping prices under control. People who act wisely can help reduce
demand and avoid unnecessary inflation pressure.
• Buy only what you need: Avoid over-shopping during panic times. This stops sudden demand
spikes.
• Save more when prices rise: Spend less on luxury items when inflation is high.
• Support local sellers: Buy goods made in India to reduce the need for expensive imports.
• Report hoarding and black marketing: This helps authorities quickly restore price balance.

How to Control Inflation FAQs

1. What is the best way to control inflation?
It is best to use a mix of monetary and fiscal tools. The RBI controls interest rates, while the
Government controls spending.

2. How can inflation in India be controlled?

India can control inflation by raising repo rates, cutting import taxes, boosting local supply, and
improving infrastructure.

3. Why does inflation happen?

Inflation happens when demand is more than supply or production costs rise.

4. Can people help control inflation?

People can spend wisely, avoid panic buying, and report black marketing.

5. What is the role of RBI in controlling inflation?

RBI raises interest rates, adjusts CRR, and buys/sells bonds to reduce or add money to the market.

6. Which government schemes help reduce inflation?

PM Garib Kalyan Yojana, Ujjwala Yojana, and MSP reforms help manage inflation impact.
Recession
In the dynamic world of economics, recessions are inevitable phases that every economy goes
through over time. Although recessions are often associated with challenges and uncertainties,
they also provide an opportunity to assess and improve the resilience and adaptability of
economic systems.
Recession Meaning: What is a recession?
A recession is a phase of economic downturn characterized by a significant decline in economic
activity over a prolonged period of time, typically indicated by a decline in gross domestic
product (GDP) for two consecutive quarters. This condition manifests itself in a variety of
negative developments, such as an increase in unemployment, a decline in consumer spending,
a reduction in industrial production and investment, and a general decline in confidence in the
economy. Recessions are part of the natural economic cycle and can be triggered by various
factors, including financial crises, external shocks, high inflation rates or political uncertainty.
Overcoming a recession often requires coordinated economic policy measures to stabilize the
economy and lay the foundations for recovery.
Definition of the term: What does the word recession mean?
The word "recession" comes from the Latin "recessio", which means decline or retreat. The
term was originally used to describe a general slowdown in the economy and has evolved over
time into a technical term in economics that specifically denotes two or more consecutive
quarters of negative growth in gross domestic product (GDP). The term thus reflects a period
in which the economy "declines" or is in a state of contraction, as opposed to expansion or
growth.
What happens during a recession?
In a recession, the economy shrinks, which can lead to lower levels of employment, worsening
corporate performance, deteriorating stock market results, and higher borrowing costs for both
consumers and companies.
Recession Effect & Characteristics
A recession is characterized by several key features that together paint a picture of economic
slowdown. These features together lead to a self-reinforcing cycle of economic contraction that
is difficult to break without targeted intervention by governments and central banks. These
characteristics of a recession include:
Recession Significance for the citizen
A recession affects the daily lives of citizens through a combination of financial difficulties,
insecurity and limited access to resources and opportunities. A recession has the following
effects, which can manifest themselves in various aspects of daily life:
1. Unemployment: One of the most noticeable signs of a recession is the rise in
unemployment rates. Companies are forced to cut costs, which often leads to layoffs.
2. Loss of income: For those who have jobs, a recession can still mean a loss of income,
whether through reduced working hours, lack of pay rises or the loss of bonuses and
overtime.
3. Declining purchasing power: Even if personal income remains stable, the inflation
that sometimes accompanies recessions can reduce people's purchasing power, making
access to goods and services more difficult.
4. Uncertainty and stress: Uncertainty about one's own financial future and that of the
economy as a whole can lead to increased stress and anxiety, which in turn affects
quality of life.
5. Investments and retirement savings: The reduction in value of investments and
retirement accounts is another direct impact, as markets often react to a recession by
dropping in value.
6. Access to credit: Banks and lending institutions may apply stricter lending criteria in
times of recession, making it more difficult to obtain loans for homes, cars or education.
7. Government benefits and services: In a recession, the government may be forced to
cut spending, which can lead to a reduction in public services and support.
Recession Significance for the economy
A recession has far-reaching effects on the economy and the monetary system, which can
change the foundations and functioning of the economic ecosystem:
1. Economic growth: The most obvious characteristic of a recession is the decline in
economic growth, measured in terms of gross domestic product (GDP). This decline
signals a reduction in goods and services produced.
2. Investment: Companies and individuals are often reluctant to invest capital in times of
uncertainty. This leads to a decline in investment, which in turn can inhibit the
economy's future growth potential.
3. Interest rates: Central banks may lower interest rates in response to a recession in
order to stimulate the economy. Lower interest rates are designed to encourage
investment and spending but can also reduce incentives to save.
4. Inflation: The impact of a recession on inflation can be mixed. While a slowdown in
demand can lead to lower prices (deflation), monetary policy measures to combat the
recession can encourage inflationary tendencies in the long term.
 5. Corporate profits and insolvencies: Profits decline as demand falls, which can lead
to a higher rate of insolvencies, especially among financially weaker companies.
6. Labor market: Unemployment rises as companies reduce their workforce due to lower
demand and profits.
7. State finances: On the one hand, government revenues fall due to lower tax receipts.
On the other hand, spending on social safety nets often increases, which can increase
budget deficits.
8. Exchange rates: The currency of a country going through a recession can lose value
against other currencies, which increases import costs and reduces purchasing power
abroad.
A recession therefore affects both the micro and macro levels of the economy, affecting
financial conditions, investment activity, government budgetary policy and general living
standards. Coping with its effects requires coordinated policy measures to mitigate the negative
effects and lay the foundations for recovery.
What types of recession are there?
There are different types of recessions, which can be distinguished according to their cause,
duration and the economic conditions that characterize them. Each type of recession has unique
causes and requires specific policy and economic measures to mitigate its effects and promote
recovery. Here are some of the most common types:

Type of Description
Recession

Cyclical This occurs when the natural economic cycle goes through a phase of
recession slowdown. Cyclical recessions are part of the normal ups and downs of an
economy and are often triggered by a decline in consumer demand and
investment.

Structural It is caused by profound changes in the structure of the economy, such as

recession technological change or permanent changes in industry. This type of recession
can last longer and often requires structural adjustments in the economy.

Shock-induced A recession triggered by a sudden, unexpected event, such as a natural disaster,

recession a war or a sharp rise in oil prices. This type of recession can be severe, but
recovery can begin as soon as the shock is over.

Financial crisis This is triggered by problems in the financial system, such as the collapse of
recession banks, credit crises or stock market crashes. It can be severe, as problems in
the financial system often lead to a restriction in lending, which further
dampens investment and consumption.

Global A global recession occurs when recessionary conditions in several major

recession economies occur simultaneously and reinforce each other. It is often caused
by global shocks or the close interdependence of the global economy.
 Type of Description
Recession

Mild vs. deep Recessions can also be classified according to their depth. A mild recession is
recession characterized by a small decline in economic activity and a quick recovery,
while a deep recession is characterized by a sharp decline in economic activity
and a slow recovery.

L-shaped, V- These terms describe the course of economic recovery after a recession. V-
shaped, U- shaped stands for a rapid recovery, U-shaped for a slower recovery, W-shaped
shaped and W- for a double-dip recession with an interim recovery and L-shaped for a long
shaped period of stagnation.
recessions

Causes of a recession
The causes of a recession are varied and often interlinked, with external shocks, internal
economic imbalances or a combination of both factors playing a role. The most common causes
include:
• High interest rates: High interest rates can increase borrowing costs for businesses
and consumers, which reduces spending and investment and slows economic growth.
• Financial crises: Collapses in the banking and financial sector can lead to a reduction
in lending, which curbs investment and consumption and leads to a recession.
• Falling consumer demand: A decline in consumer demand caused by factors such as
falling incomes, unemployment or loss of consumer confidence can reduce production
and economic growth.
• Falling exports: A global economic slowdown or an appreciation of the domestic
currency can reduce exports, which is particularly damaging for export-oriented
economies and can lead to a recession.
• Oil price shocks: Sharp fluctuations in oil prices can have a significant impact on the
economy, especially in countries that are heavily dependent on oil imports.
• Government policy: Fiscal policy decisions, such as tax increases or cuts in
government spending, can dampen economic activity and lead to a recession.
• Technological changes: Rapid technological changes can lead to structural shifts in the
economy, which can have disruptive effects in the short term.
• Overinvestment or speculative bubbles: Excessive investment in certain sectors of
the economy, often driven by speculative bubbles, can lead to an uneven distribution of
resources. When these bubbles burst, this can lead to sudden economic downturns and
recession.
• Political uncertainty and conflict: Political unrest, war or international conflict can
affect investor and consumer confidence and disrupt economic activity, leading to
recession.
 • Global pandemics: As the COVID-19 pandemic has shown, global health crises can
cause widespread disruption to economic activity, from business closures to disruptions
to global supply chains.
These causes can occur individually or in combination and trigger or exacerbate a recession.
Combating a recession often requires a combination of monetary policy measures by central
banks and fiscal policy measures by governments in order to stimulate economic activity and
restore confidence.
Measures to control a recession include both government-led fiscal and monetary policies
and individual/business strategies. Governments use expansionary policies like
increasing spending, cutting taxes, and lowering interest rates to boost
demand. Individuals and businesses can protect themselves by building emergency funds,
reducing debt, diversifying investments, and focusing on cash flow and financial health.
Government-Led Measures
• Expansionary Fiscal Policy:
The government increases its spending on public projects or reduces taxes to stimulate
economic activity.
• Monetary Policy:
Central banks like the Reserve Bank of India (RBI) may lower interest rates or increase
liquidity in the banking system to encourage borrowing and investment.
• Sector-Specific Support:
Governments may offer targeted incentives or relief to struggling sectors, such as the auto
industry.
• Support for Employment:
Implementing schemes like short-time work compensation can help maintain employment by
allowing companies to reduce hours rather than lay off staff.
Individual & Business Strategies
• Build an Emergency Fund:
Save enough to cover several months of expenses to withstand financial shocks.
• Reduce Debt:
Pay down existing debts to improve financial stability and free up more money for essentials
and savings.
• Diversify Investments:
Spread your investments across different asset classes, such as stocks, bonds, and real estate,
to mitigate losses.
• Manage Cash Flow:
Businesses should focus on maintaining sufficient liquidity and proactively managing their
finances to survive a downturn.
• Focus on Essential Spending:
Reduce discretionary spending on non-essential items and create a detailed budget to track
expenses.
• Seek Income Opportunities:
Actively look for ways to increase income, whether through new jobs, side hustles, or by
diversifying revenue streams for businesses.
What is the Difference Between Inflation and Recession?
Simply put, inflation and recession represent direct opposites in terms of economic conditions.
Inflation is a rise in the prices of goods and services over time, while recession refers to the
decline in economic activity, which is again defined by reduced consumer spending, higher
unemployment, and a further decline in GDP. This contrast will explain why these two
phenomena might differently affect industries, workers, or government action.

Aspect Inflation Recession

The rate at which prices for goods
Often involves tightening
Definition and services rise, eroding monetary policies, and raising
purchasing power. interest rates.
Economic activity slows down;
Economic Increased demand leads to higher
businesses cut back on
Activity prices.
production and lay off workers.
Typically low, as businesses expand Usually high, as businesses lay
Unemployment
to meet demand. off workers to reduce costs.
Governments may stimulate the
Government Often involves tightening monetary
economy through fiscal policies,
Response policies, raising interest rates.
such as spending or tax cuts.
GDP contraction, rising
Consumer Price Index (CPI) and
Key Indicators unemployment rates, declining
Producer Price Index (PPI).
industrial production.
Consumers cut back on
Effects on The cost of living increases,
spending due to uncertainty and
Consumers decreasing purchasing power.
job losses.
Investment activity may
Impacts on Often involves tightening monetary decrease due to economic
Investment policies and raising interest rates. uncertainty and business
closures.

Inflation Meaning
Inflation is the sustained increase in the general price level of goods and services in an economy
over time. It implies that over time, the purchasing power of money decreases, and for the same
money, consumers can buy fewer goods and services. Such central banks, like the U.S. Federal
Reserve, frequently monitor the inflation rate through indices such as the Consumer Price
Index (CPI), or Producer Price Index (PPI), which reflect changes in the price of a basket of
goods and services consumers and businesses buy.
Key Factors Influencing Inflation
• Demand-Pull Inflation: This occurs as the demand for goods and services exceeds the
supply. As the economy is growing, higher demand automatically results in an increase
in prices.
• Cost-Push Inflation: This is caused when the cost of production increases. It could be
because of increased wages or enhanced prices of raw materials, which later are passed
on to the customer through higher prices.
 • Money-based Inflation: It arises when the amount of money in circulation is more than
that of goods and services. If a central bank prints more money, inflation can be caused.
Impacts from Inflation

The impacts of inflation are widespread, affecting various sectors of the economy. Some of the
key effects include:

• Reduced Buying Power: More dollars with the same amount of money buy less.
Increases in prices decrease the standard of living for consumers whose incomes are
fixed or whose wages are not increasing sufficiently to keep pace with inflation.
• Uncertainty in Investment: Inflation creates unpredictability in the market, making it
challenging for investors to forecast returns. When inflation runs rampant, it makes it
difficult for companies to pass the increased cost through to the consumer and, hence,
plummet profits.
• Wage-Price Spiral: At times, inflation boosts wages, since workers need to pay more
for the cost of living. The increased wages may in turn inflate the costs of production,
thus making prices increase even further.
• Interest Rate Hikes: A central bank may increase interest rates if there is inflation.
High interest rates become expensive, thus dampening investments as well as spending
by consumers.
• Income Redistribution: Inflation affects different people through their income
sources. The implication is that fixed-income earners such as retirees lose, while the
assets linked to inflation, such as real estate, will gain.

Recession Meaning

A recession is a sharp decline in economic activity that lasts for months, even years. Essentially,
it is characterized by downturns in Gross Domestic Products. It is an increase in unemployment
and a slowdown in industrial production and retail sales. A recession usually starts when the
economy faces a prolonged period of negative growth, which leads to decreased consumer
spending, lower business investments, and higher job losses.

A recession can be caused by external shocks, such as financial crisis; excessive inflation; or
an imbalance in the overall economy that reduces consumer confidence and business activity.
The impact of a recession hits all areas of the economy, which may lead to an economic period
characterized by suffering for both individuals and businesses.

Causes of Recession

Recessions can arise from a variety of causes, both internal and external. Some common causes
include:

• Economic Shocks: Natural catastrophes, terrorist attacks, or pandemics can halt the
economy, sending it into recession.
 • High Inflation: In cases where inflation is significantly high, the central bank may
raise interest rates to curb it. This may weaken consumer expenditure and investment,
thereby pushing the economy into recession.
• Financial Crises: A system-wide crisis in major financial institutions or markets can
have far-reaching repercussions for the economy and send it into recession.
• Declining Consumer Confidence: Worried consumers will reduce their spending,
causing the demand for goods and services to decrease and leading to an economic
recession.
• Global Trade Issues: A breaking point in international trade, such as tariffs, a trade
war, or sanctions, can bring about reduced global demand and trigger a recession.

Impacts from Recession

The impacts of a recession can be devastating, particularly for individuals and businesses.
Some of the most significant effects include:

• Unemployment: One of the most obvious effects of a recession is unemployment. As

revenue declines, businesses can show less expense. Therefore, lay off workers to
further reduce their costs, thus raising joblessness.
• Reduced Consumers’ Expenditure: Consumers in a recession event usually cut down
on their expenditures because of fear and uncertainty regarding their future income,
which exacerbates depression in demand for goods and services. Hence perpetuating
the recessionary period.
• Reduced Business Investment: Poor profitability and subsequent losses may mean a
business postponing or rescheduling expansion plans, implying lower business
investments in the economy.
• Dropping Stock Market: Repercussions from recession usually come with
plummeting stock market performance since investors will become increasingly risk-
averse and try to salvage losses.
• Government Response: There is a response from governments when a recession hits
as such policies as cutting taxes, public spending, or monetary policy can be used to
stimulate the economy.

To control a recession in India, the Reserve Bank of India (RBI) can use monetary policies like
lowering interest rates and injecting liquidity, while the government can employ fiscal policies
such as tax cuts, increased public spending on infrastructure, and strengthening social safety
nets to boost consumption and investment. Businesses can adapt by focusing on core
competencies and managing debt, while individuals can prepare by building emergency funds
and diversifying income.

Measures to Control Recession:

• Monetary Policy (RBI):

• Lowering Interest Rates: Makes borrowing cheaper for businesses and
consumers, encouraging investment and spending.
 • Injecting Liquidity: Using tools like the Liquidity Adjustment Facility (LAF)
and Open Market Operations (OMOs) to increase the amount of money
available in the financial system, easing pressure on the economy.
• Lowering Reserve Ratios: Reducing the Cash Reserve Ratio (CRR) allows
banks to lend more money.
• Fiscal Policy (Government):
• Tax Reductions: Cutting taxes for individuals and businesses can increase
disposable income and encourage spending and investment.
• Increased Public Spending: Governments can increase spending on
infrastructure projects, which creates jobs, stimulates demand, and has a
positive multiplier effect on the economy.
• Strengthening Social Security: Providing support for the unemployed helps
maintain consumer spending.
• Enhancing Ease of Doing Business: Attracting foreign investment can help
stimulate economic recovery and growth.

Business and Individual Preparedness:

• For Businesses:
• Adaptation: Focus on core competencies and efficient operations to stay
competitive.
• Debt Management: Prioritize debt repayment to improve financial stability.
• For Individuals:
• Build an Emergency Fund: Save money to cover 6-10 months of essential
expenses to provide a financial safety net.
• Reduce Debt: Pay down loans and credit card debt to free up money for savings
and spending.
• Diversify Income: Create multiple sources of income to reduce reliance on a
single source.

Addressing External Factors:

• Global Linkages: Recognizing that India's economy is linked to global markets is

crucial. A slowdown in other major economies can decrease demand for Indian goods
and services, affecting production and employment.
• Managing Capital Flows: Policies need to be in place to manage volatile capital flows.

Bargain shoppers know there’s nothing better than a price drop. But a one-off sale is a world
away from deflation, which is the general reduction of prices for thousands of everyday goods
and services.

Not only does deflation signal a stagnating economy, it can lead to high unemployment,
unaffordable debt repayment, and dismal outcomes for businesses. In the worst cases, deflation
can lead an economy into a recession, or even a depression.
Deflation definition

Just like inflation, deflation is a story of supply and demand. But instead of prices for goods
and services going up over time, they go down. Generally, this means purchasing power
increases — people are able to buy more with the same amount of money.

Deflation often comes as a relief to consumers in the short term, but a prolonged period of
deflation can be a major roadblock to economic growth.

How is deflation measured?

The Consumer Price Index, or CPI, tracks the prices of about 80,000 items on sale in the United
States (plus sales or excise taxes) each month.1 There are also sub-indexes that measure prices
in various regions and cities throughout the country.

There are eight major groups represented in the CPI:

• Food and beverages

• Housing (rents only)
• Apparel
• Medical care
• Transportation (including fuel costs)
• Recreation
• Education and communication
• Other goods and services

Items that aren’t included in the CPI are income taxes, Social Security taxes, stocks, bonds,
real estate, and life insurance because they aren’t related to everyday consumption.

When prices rise month to month or year to year, they’re represented by a positive percentage.
For example, from March 2022 to March 2023, the index for all items rose 5%. If the inflation
rate a few months later is 4%, that represents disinflation — prices are dropping, but still
showing overall growth. Deflation, by contrast, doesn’t occur until the inflation rate is below
0%.

What causes deflation?

As with inflation, deflation is typically caused by a change in government policy and

consumers’ reactions to it. It can be difficult to isolate a single driver of rising or falling prices
in the middle of the trend. Even years later, the causes are often found to be multi-faceted.

Here are three common scenarios that can lead to deflation:

• Decrease in the money supply: When the Federal Reserve deploys a tight monetary
policy, that means it’s pulling back on spending and raising interest rates. This makes
it harder for people to borrow money to buy goods and services.
 • Decline in consumer demand: When demand falls, whether because the government is
tightening its purse strings or the stock market is on a downswing and investors are
hoarding more cash, businesses may lower prices to encourage people to spend.
• Increase in business productivity: Technological advances can help businesses produce
more goods at a lower cost, increasing the supply on the shelves. With increased supply
and level demand, prices fall (think about how cheap TVs have become).

The effects of deflation

Deflation isn’t all bad. In the short term, it can help consumers buy more with the same pay
check. Beyond that, the negative effects can mount quickly. Here are a few.

• Falling incomes/higher unemployment: When businesses are selling goods for lower
prices, they earn less profit. To make up for it, they may cut wages or lay off employees,
and spend less on innovation and investing in the company.
• Less consumer spending: If consumers have less income to spend, they buy fewer
discretionary goods and services. Less overall spending weakens the economy,
furthering a deflationary spiral. Another theory for reduced consumer spending is that
perception drives outcomes — when prices are continuously dropping, people may save
money and put off big purchases to hold out for a lower price tag in the future.
• More expensive debt: If the monthly payment on your mortgage or car loan stays the
same, but your income falls, you’re spending more of your pay check on debt. At the
same time, the asset you’re paying off — like a house or a car — is dropping in value.

India's living standards

India's living standards are characterized by vast regional disparities, with some states
showing high human development and others facing significant deprivation. While the
country has seen progress in reducing extreme poverty and improving key development
indicators like life expectancy and education, it continues to struggle with issues of
income inequality, access to quality basic services, and employment, particularly for
women. Economic growth has not been uniformly distributed, and challenges remain
in ensuring a robust standard of living for a large portion of the population.
Key Aspects and Challenges
• Regional Disparity:
There is a significant difference in living standards across India's states. While some
states like Delhi, Goa, and Kerala show high living standards, others, particularly in
northern and eastern India, exhibit lower levels of development.
• Poverty and Inequality:
India has made progress in reducing extreme poverty, but a significant portion of the
population still lives below poverty lines, unable to meet basic needs. The gap
between the rich and the poor continues to grow.
• Human Development Index (HDI):
 India's HDI has been rising, indicating improvements in life expectancy, education,
and economic well-being. However, the country remains in the medium human
development category, with ongoing challenges in reaching high development
thresholds.
• Access to Services:
While access to basic amenities like drinking water has improved, progress in access
to high-quality healthcare, sanitation, and education varies significantly across
regions and income groups.
• Job Quality and Women's Employment:
Despite improved employment numbers since 2020, concerns persist regarding the
quality of jobs and the real growth in wages. Furthermore, women's participation in
the labor force remains low.
• Impact of Global Trends:
Global events and demographic shifts can impact India's progress, with the pace of
poverty reduction slowing at times and the country needing climate-resilient growth
to achieve its aspirations.
Overall Trend
India's living standards have been on an upward trajectory over the past few decades,
leading to a decrease in extreme poverty and improved access to various services and
technologies. However, persistent challenges, including inequality, regional disparities,
and ensuring broad-based gains for the bottom half of the population, require sustained
effort to achieve a higher and more equitable standard of living for all citizens.
Living standards are a measure of a population's access to necessities and wants, including income,
health, education, and housing, evaluated by indicators like GDP per capita, life expectancy, literacy
rates, healthcare access, and quality of housing. While economic factors are key, indicators also
encompass social dimensions such as political stability, environmental quality, and personal
freedom.

Key Aspects of Living Standards

• Well-being:

The overall level of well-being, encompassing both material and non-material aspects of life.

• Material Well-being:

A focus on physical necessities and comfort, measured by income, wealth, consumption, and access
to goods and services.

• Access to Essentials:

The ease with which people can satisfy their needs and wants through access to food, decent housing,
healthcare, and education.

Common Indicators

• Economic Indicators:

• Gross Domestic Product (GDP) per capita: Measures the average income and
economic output per person, adjusted for inflation.

• Poverty Rate: The percentage of the population living below a certain income level.

• Income and Consumption: Average income and spending levels of households.

• Employment and Unemployment: The availability of jobs and the rate of

unemployment.

• Health Indicators:

• Life Expectancy: The average number of years a person is expected to live.

• Infant Mortality Rate: The number of deaths of infants per a thousand live births.

• Access to Healthcare: The availability and quality of medical services and facilities.

• Social and Environmental Indicators:

• Education and Literacy Rates: Access to educational opportunities and the ability of
people to read and write.

• Housing Quality and Affordability: The availability of safe, decent, and affordable
housing.

• Environmental Quality: The health of the natural environment and its impact on well-
being.

• Safety and Crime Rates: The level of personal safety and occurrence of criminal
activity.
Composite Indices

Some measures combine multiple indicators into a single index:

• Human Development Index (HDI): A composite statistic of life expectancy, education (mean
years of schooling and expected years of schooling), and per capita income.

• Physical Quality of Life Index (PQLI): Focuses on basic literacy, life expectancy, and infant
mortality.

Living standards or standards of living refer to all the factors that contribute to a person’s well-
being and happiness

Measuring Living Standards

• GDP per head/capita: this measures the average income per person in an economy.
Real GDP per capita = Real GDP / Population

Merits of using GDP per capita to measure living standards:

• GDP is a useful measure of the total production taking place in the country, and so indicates
the material well-being of the economy

• it also takes population into consideration, adding emphasis on the goods and services
available to individuals

• since it is calculated on output, is a good indicator of the jobs being created

• GDP data is readily available so is population data

Limitations of using GDP per capita to measure living standards:

• it takes no account of what people can buy using their incomes. A country with a high GDP
per head may be no better off than a country with a low GDP per head, if there are far fewer
products to choose from

• similarly, GDP doesn’t consider changes in technology that can have a large impact on
living standards. People might have had more income in the last decade but they couldn’t
benefit from all the technology available today

• distribution of income is very unequal in reality, so the GDP per head isn’t accurate. Some
people might be very rich while others very poor, but the GDP per head will only give the
average incomes

• real GDP excludes the unpaid work people do for charities and voluntary organizations etc.
Thus, it understates the total output

• GDP also doesn’t differentiate between the positive and negative values economies
place on different output/expenditure. For example, if the output rises because the sales of
tobacco, alcohol or pornographic materials, it might show in the records as a rise in GDP per
head but might not actually make people better off. Similarly, GDP might rise if the government
has to rebuild after a natural disaster, which doesn’t mean living standards have risen
 • the official GDP figures can be overstated due to technical errors or by political manipulation
to look good, and give a wrong picture of living standards

• this measure doesn’t consider leisure activities, health and education levels, environmental
quality- all that determines people’s happiness and well-being

• in order to effectively compare GDP per head across countries, they need to be converted to a
common currency and adjusted for differing purchasing power in different countries

• comparing GDP per head can also be unreliable as GDP accounting methods can be different
for different countries

• Human Development Index (HDI): used by the United Nations to compare living standards
across the globe, the HDI combines different measures into one to give a HDI value from 0
(lowest) to 1(highest). These are:

• Income index, measured using the average national income – GNI per head adjusted
for differences in exchange rate and prices in different countries (purchasing power
parity)

• Education index, measured by how many years on average, a person aged 25 will have
spent on education (mean years of schooling) and how many years a young child
entering school can now be expected to spend in education in his entire life (expected
years of schooling)

• Healthcare index: measured by average life expectancy at birth

The benefits of using HDI to measure living standards:

• it takes into account some major indicators of living standards

• recognises that it is not just output or income that determines living standards, but also social
factors

• it is a useful method to compare global living standards– it shows clear patterns of living
standards

• it is very useful and reliable measure since its produced by the UN and is thus also widely
used and recognised

The limitations of HDI to compare living standards:

• it combines a set of separate indicators into one, so a country with good literacy
rates and living standards but poor life expectancy can have a low HDI value

• there are wide divergences in HDI within countries

• GNI per head doesn’t say anything about inequalities in income and wealth within
countries

• it doesn’t consider other factors such as environmental quality, access to safe

drinking water, political freedom, crime rates etc. which are also important indicators
of living standards
 • the HDI information for all countries may not be available such as war-struck
countries where civilisation has been disrupted

In the 2019 HDI index published by the UN, Norway comes first with an HDI index of 0.954 while Niger
comes last with an index of just 0.377 owing to very low levels of education and GNI per head. See the
full list at http://hdr.undp.org/en/content/2019-human-development-index-ranking

Reasons for differences in living standards and income distribution within and between countries

These have been discussed above in the merits and limitations of using GDP per capita and HDI. More
will be discussed in the coming chapters. Some other reasons are discussed below

Difference in living Standards within a country: there can be variations in living standards within a
country. An excellent example of this is the high living standards of the Indian state of Kerala (where
IGCSE AID is based!) which has a HDI index of 0.779 while the poorest state of Bihar stands at 0.567
(2018).

• Regional variances in income and consumption

• Major type of sectors/jobs: manufacturing and services heavy regions will have higher
incomes, education and health services compared to agricultural regions

• Local government provisions of education and health

Difference in living Standards between countries:

• Productivity of industries: more productive industries yield more output and incomes

• Major industries: what makes countries like Qatar and Norway achieve some of the world’s
highest per capita incomes is that their income comes mostly from petroleum industries that
are scare and highly demanded internationally

• Population: dense population lower per capita income and put pressure on scarce resource

• Ability of citizens pay taxes: higher tax-base and taxable incomes allow governments to
invest in infrastructure and welfare programmes

• Provision of health and educational facilities

• Variety of goods/services produced: if citizens can choose from a wide variety of products,
living standards rise. Western countries like US enjoy this

• War, crime and natural disasters: war-struck countries of Asia, the high crime rates of Latin
America and frequent natural disasters in island countries, drive down their living standards
as they damage infrastructure and put people into hardship
 Standard of Living vs. Quality of Life:
What's the Difference?
Standard of Living vs. Quality of Life: An Overview
Standard of living refers to the level of wealth, comfort, material goods, and necessities
available to a certain socioeconomic class or geographic area. Quality of life, on the other hand,
is a subjective term that can measure happiness.

The two terms are often confused because there may be some perceived overlap in how they
are defined. But knowing the different nuances of each can affect how you evaluate a country
where you might be looking to invest some money.

Standard of Living
Standard of living is a comparison tool used when describing two different geographic areas.
Metrics may include things like wealth levels, comfort, goods, and necessities that are available
to people of different socioeconomic classes in those areas. The standard of living is measured
by things that are easily quantified, such as income, employment opportunities, cost of goods
and services, and poverty. Factors such as life expectancy, the inflation rate, or number of paid
vacation days people receive each year are also included.

Other factors commonly associated with the standard of living include:

• Class disparity
• Poverty rate
• Quality and affordability of housing
• Hours of work required to purchase necessities
• Gross domestic product (GDP)
• Affordable access to quality healthcare
• Quality and availability of education
• Incidence of disease
• Infrastructure
• National economic growth
• Economic and political stability
• Political and religious freedom
• Environmental quality
• Climate
• Safety

The standard of living in the United States may be compared to that of Canada's. It may also
draw comparisons between smaller geographic areas such as New York City versus Detroit.
Standard of living can be used to compare distinct points in time. For example, the standard of
living in the U.S. is considered to have greatly improved compared to a century ago. Now, the
same amount of work buys a larger quantity of goods and items that were once luxuries such as

Fontinelle, Amy. “Standard of Living vs. Quality of Life: What's the Difference?” Investopedia, Investopedia, 7 Mar.
2019, www.investopedia.com/articles/financial-theory/08/standard-of-living-quality-of-life.asp.
refrigerators and automobiles. Leisure time and life expectancy have also increased, while
annual hours worked has decreased.

One measure of standard of living is the Human Development Index (HDI), developed by the
United Nations in 1990. It considers life expectancy at birth, adult literacy rates, and per
capita GDP to measure a country's level of development.

Quality of Life
Quality of life is a more subjective and intangible term than standard of living. As such, it can
often be hard to quantify. The factors that affect the overall quality of life vary by people's
lifestyles and their personal preferences. Regardless of these factors, this measure plays an
important part in the financial decisions in everyone's lives.

Some of the factors that can affect a person's quality of life can include conditions in the
workplace, healthcare, education, and material living conditions.

The United Nations' Universal Declaration of Human Rights, adopted in 1948, provides an excellent list
of factors that can be considered in evaluating quality of life. It includes many things that citizens of the
United States and other developed countries take for granted, which are not available in a significant
number of other countries around the world. Although this declaration is more than 70 years old, in
many ways it still represents an ideal to be achieved, rather than a baseline. Factors that may be used to
measure the quality of life include the following:

• Freedom from slavery and torture

• Equal protection of the law
• Freedom from discrimination
• Freedom of movement
• Freedom of residence within one's home country
• Presumption of innocence unless proved guilty
• Right to marry
• Right to have a family
• Right to be treated equally without regard to gender, race,
language, religion, political beliefs, nationality, socioeconomic
status, and more
• Right to privacy
• Freedom of thought
• Freedom of religion
• Free choice of employment
• Right to fair pay
• Equal pay for equal work
• Right to vote
• Right to rest and leisure
• Right to education
• Right to human dignity

Fontinelle, Amy. “Standard of Living vs. Quality of Life: What's the Difference?” Investopedia, Investopedia, 7 Mar.
2019, www.investopedia.com/articles/financial-theory/08/standard-of-living-quality-of-life.asp.
Standard of Living vs. Quality of Life: Flawed Indicators
Standard of living is somewhat of a flawed indicator. While the United States ranks high in
many areas as a nation, the standard of living is very low for some segments of the population.
For example, some of the country's poor, urban areas struggle with a lack of quality
employment opportunities, short life expectancies, and higher rates of disease and illness.

Similarly, the quality of life can vary between people, making it a flawed indicator as well. There
are various segments of the American population that may have a lower quality of life
compared to others. They may experience discrimination in society and the workplace or don't
have access to clean drinking water, proper healthcare, or education.

Key Takeaways

• Standard of living is a tangible, quantifiable term that refers to factors available to a

certain socioeconomic class or geographic area.
• Quality of life is a subjective term that can measure happiness.
• Both can be flawed indicators because the factors can vary between people in the same
geographic area or socioeconomic class.

Fontinelle, Amy. “Standard of Living vs. Quality of Life: What's the Difference?” Investopedia, Investopedia, 7 Mar.
2019, www.investopedia.com/articles/financial-theory/08/standard-of-living-quality-of-life.asp.