Economics For Finance Nitin Guru

Chapter-1, Unit-I: National Income Accounting By: CA Nitin Guru
CHAPTER 1: UNIT-I: NATIONAL INCOME ACCOUNTING
Question 1:
Define National Income.
Answer:
 National Income is defined as the net value of
 all economic goods and services produced
 within the domestic territory of a country
 in an Accounting Year
 plus the Net Factor Income from Abroad (NFYA).
Question 2:
Explain the usefulness and significance of National Income estimates.
Answer:
National income accounts are extremely useful, for following:
(i) Evaluating the Short-Run Performance:
 Provide a comprehensive, conceptual and accounting framework for analyzing and evaluating the
short-run performance of an economy.
 The level of national income indicates the level of economic activity and economic development.
(ii) Determines Present and Future Demand:

 The distribution pattern of National Income determines the pattern of demand for goods and
services, and
 Enables businesses to forecast the future demand for their products.
(iii) Measure of Economic Welfare
 Economic welfare demand on the magnitude and distribution of national income, size of per
capita income and the growth of these over time.
(iv) International Comparisons:
 International comparisons in respect of incomes and living standards assist in determining
eligibility for loans, and/or other funds or conditions on which such loans, and/or funds are
made available.
(v) Economic Forecasting:

 National income or a relevant component of it is an indispensable variable considered in
economic forecasting and to make projections about the future development trends of the
economy.
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Question 3:
What is UN System of National Accounts (SNA)?
Answer:
UN System of National Accounts (SNA) developed by United Nations to provide a comprehensive conceptual
and accounting framework for compiling and reporting macroeconomic statistics for analyzing and evaluating
the performance of an economy.
Question 4:
Explain three sides of NIA.
Answer:
National income accounts have three sides: a product side, an expenditure side and an income side:
(i) Product Side:

(ii) Expenditure Side:
(iii) Income Side:
National income is the sum total of all the incomes accruing over a specified period to the residents of a
country and consists of wages, salaries, profits, rent and interest.
Question 5:
Explain the Gross Domestic Product (GDPMP).
Answer:
 Gross domestic product (GDP) is a measure of the market value of all final economic goods and
services, gross of depreciation, produced within the domestic territory of a country during a given
time period.
 It is the sum total of ‘value added’ by all producing units in the domestic territory and includes
value added by current production by foreign residents or foreign-owned firms.
 The term ‘gross’ implies that GDP is measured ‘gross’ of depreciation.
 ‘Domestic’ means domestic territory or resident production units.
 GDP excludes transfer payments, financial transactions and non- reported output generated
through illegal transactions such as narcotics and gambling (these are also known as ‘bads’ as
opposed to goods which GDP accounts for).
GDPMP = Value of Output in the Domestic Territory – Value of International Consumption
GDPMP = Σ Value Added
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 Important Points:
(i) Only Final Goods and Services:

(ii) Intermediate Consumption:
 Intermediate goods used to produce other goods rather than being sold to final purchasers are
not counted as it would involve double counting.
(iii) Economic Activities:
 Economic Activities and Non-Economic Activities include all human activities which create goods
and services that are exchanged in a market and valued at market price.
(iv) ‘Flow’ Concept:
 National income is a ‘flow’ measure of output per time period—for example, per year—and
includes only those goods and services produced in the current period.
(v) Inventory Investment:
 The net change in inventories of final goods awaiting sale or of materials used in the
production which may be positive or negative.
 Additions to inventory stocks of final goods and materials belong to GDP because they are
currently produced output.
Question 6:
Explain Nominal GDP v/s Real GDP, i.e. GDP at current and constant prices.
Question 7:
Explain Gross National Product (GNP).
Answer:
 Gross National Product (GNP) is a measure of the market value of all final economic goods and
services, gross of depreciation, produced within the domestic territory of a country by normal
residents during an accounting year including net factor incomes from abroad.
 Gross National Product (GNP) is evaluated at market prices.
GNPMP = GDPMP + Net Factor Income from Abroad
GDPMP = GNPMP – Net Factor Income from Abroad
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 Note:
NFIA is the difference between the aggregate amount that a country's citizens and companies earn
abroad, and the aggregate amount that foreign citizens and overseas companies earn in that country.
 If Net Factor Income from Abroad is positive, then GNPMP would be greater than GDPMP.
National = Domestic + Net Factor Income from Abroad
Question 8:
Explain Net Domestic Product at market prices (NDPMP).
Answer:
Net domestic product at market prices (NDP MP) is a measure of the market value of all final economic
goods and services, produced within the domestic territory of a country by its normal residents and non
residents during an accounting year less depreciation.
NDPMP = GDPMP –Depreciation
NDPMP = NNPMP – Net Factor Income from Abroad
Gross = Net + Depreciation

OR
Net = Gross – Depreciation
Question 9:
Explain Net National Product at Market Prices (NNPMP).
Answer:
Net National Product at Market Prices (NNP MP) is a measure of the market value of all final economic
goods and services, produced by normal residents within the domestic territory of a country including Net
Factor Income from Abroad during an accounting year excluding depreciation.
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NNPMP = GNPMP – Depreciation

NNPMP = NDPMP + Net Factor Income from Abroad
NNPMP = GDPMP + Net Factor Income from Abroad – Depreciation
Question 10:
Explain Gross Domestic Product at Factor Cost (GDPFC).
Question 11:
Explain Net Indirect Tax.
Answer:
 Indirect Taxes - Subsidy
Market Price = Factor Cost + Net Indirect Taxes

= Factor Cost + Indirect Taxes – Subsidies
Factor Cost = Market Price – Net Indirect Taxes

= Market Price – Indirect Taxes + Subsidies
Question 12:
Explain Net Domestic Product at Factor Cost (NDPFC).
Question 13:
Explain Net National Product at Factor Cost (NNPFC) or National Income.
Question 14:
Explain Per Capita Income.
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Answer:
 The GDP per capita is a measure of a country's economic output per person.
 It is obtained by dividing the country’s gross domestic product, adjusted by inflation, by the total
population. It serves as an indicator of the standard of living of a country.
Question 15:
Explain Measurement of National Income in India.
Answer:
 National Accounts Statistics (NAS) in India are compiled by National Accounts Division in the Central
Statistics Office, Ministry of Statistics and Programme Implementation.
 Annual as well as quarterly estimates are published.
 As per the mandate of the Fiscal Responsibility and Budget Management Act 2003, the Ministry of
Finance uses the GDP numbers (at current prices) to determine the fiscal targets.
 Now, the base year has revised from 2004-05 to 2011-12.
Question 16:
Explain the Value Added Method, Income Method , Expenditure Method.
Question 17:
Explain the system of regional accounts in India.
Answer:
The system is as explained below:
 Regional accounts provide an integrated database on the innumerable transactions taking place in the
regional economy and help decision making at the regional level.
 All the states and union territories of India compute state income estimates and district level
estimates. State income or Net State Domestic Product (NSDP) is a measure n monetary terms of
the volume of all goods and services produced in the state within a given period of time.
 Per Capital State Income is obtained by dividing the NSDP (State Income) by the midyear projected
population of the state.
 The state level estimates are prepared by the State Income Units of the respective State
Directorates of Economics and Statistics (DESs).
Question 18:
What are Supra-regional sectors?
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Answer:
The Supra-regional sectors are explained as below:
 Certain activities such as railways, communications, banking and insurance and central government
administration, that cut across state boundaries, and thus their economic contribution cannot be
assigned to any one state directly and are known as the 'Supra-regional sectors' of the economy.
 The estimates for these supra regional activities are compiled for the economy as a whole and
allocated to the states on the basis of relevant indicators.
Question 19:
Explain the limitations and challenges of National Income computation.
Answer:
The limitations are explained as below:
GDP measures ignores the following -
a) Inadequate measure of welfare - Countries may have significantly different income distributions and,
consequently, different levels of overall well-being for the same level of per capital income.
b) Ignores Qualitative data - Quality improvements in systems and processes due to technological as well
as managerial innovations which reflect true growth in output from year to year.
c) Doesn't count hidden transactions - Productions hidden from government authorities, either because
those engaged in it are evading taxes or because it is illegal (drugs, gambling etc).
d) Doesn't count non - market production - Nonmarket production and Non-economic contributors to
well-being for example: health of a country’s citizens, education levels, political participation, or
other social and political factors that may significantly affect well-being levels are ignored.
e) Economic bads are not accounted for - Economic ’bads’ for example: crime, pollution, traffic
congestion etc which make us worse off are not considered in GDP.
f) Volunteer work excluded - The volunteer work and services rendered without remuneration undertaken
in the economy, even though such work can contribute to social well-being as much as paid work.
g) Things that contribute to economic welfare - Many things that contribute to our economic welfare
such as, leisure time, fairness, gender equality, security of community feeling etc.,
h) Better off or preventing worse off -
 The distinction between production that makes us better off and production that only prevents us
from becoming worse off, for e.g. defense expenditures such as on police protection.
 Increased expenditure on police due to increase in crimes may increase GDP but these expenses only
prevent us from becoming worse off.
 No reflection is made in national income of the negative impacts of higher crime rates.
Question 20:
What is meant by Domestic Territory?
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Answer:
In layman's language, domestic territory means the political frontiers of a country. In addition to political
frontiers, domestic territory also includes:
1. Ships and aircrafts owned and operated by normal residents between two or more countries.
2. Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents of a country
in the international waters where they have exclusive rights of operation.
3. Embassies, consulates and military establishments of a country located abroad.
Domestic territory doesn't include -

1. Embassies, consulates and military establishments of a foreign country.
2. International organizations like UNO, WHO, etc. located within geographical boundaries of a country.
Question 21:
Differentiate between :
1. Factor Income and Transfer Income.
2. Final Goods and Intermediate Goods
3. Consumption Goods and Capital Goods
4. Domestic Income (NDPFC) and National Income (NNPFC)
5. Depreciation and capital loss
6. Personal Income and Private Income
7. Personal Income and National Income
Answer:
Factor Income and Transfer Income
Basis Factor Transfer Income
Meaning It refers to income received by It refers to income received
factors of production for rendering without rendering any productive
factor services in the production service in return.
process.
Nature It is included in both National It is neither included in National
Income and Domestic Income. Income nor in Domestic Income.
Concept It is an earning concept. It is a receipt concept.
Final Goods and Intermediate Goods

Basis Final Goods Intermediate Goods
Meaning Final goods refer to those goods Intermediate goods refer to those
which are used either for goods which are used either for
consumption or for investment. resale or for further production in
the same year.
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Nature They are included in both national They are neither included in
and domestic income. national income nor in domestic
income.
Value addition They are ready for use by their They are not ready for use, i.e.
final users i.e. no value has to be some value has to be added to the
added to the final goods intermediate goods.
Production boundary They have crossed the production They are still within the production
boundary. boundary.
Example Milk purchased by households for Milk used in dairy shop for resale,
consumption, car purchased as an coal used in factory for further
investment. production.
Consumption Goods and Capital Goods

Basis Consumption Goods Capital Goods
Satisfaction of These goods satisfy human wants Such goods satisfy human wanted
human wants directly. So, such goods have direct indirectly. So, such goods have
demand. derived demand.
Production capacity They do not promote production They help in raising production
capacity. capacity.
Expected life Most of the consumption goods Capital goods generally have an
(except durable goods) have limited expected life of more than one
expected life. year.
Domestic Income and National Income

Basis Domestic Income National Income
Nature of concept It is a territorial concept as it It is a national concept as it
includes the value of final goods and includes the value of final goods and
services produced within domestic services produced in the entire
territory of a country. world.
Category of It considers all producers within the It considers all producers who are
Producers domestic territory of the country. normal residents of the country.
NFIA It does not include NFIA It includes NFIA
Depreciation and Capital Loss

Basis Depreciation Capital Loss
Meaning It refers to fall in the value of It refers to loss in value of the
fixed assets due to normal wear fixed assets due to unforeseen
and tear, passage of time or obsolescence, natural calamities,
expected obsolescence. thefts, accidents, etc.
Provision for loss Provision is made for replacement No such provision is made in case of
of assets as it is an expected loss. capital loss as it is an unexpected
loss.
Production process It does not hamper the production It hampers the production process.
process.
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Personal Income and Private Income

Basis Personal Income Private Income
Meaning It refers to income actually It refers to the income which
received by households from all accrues to private sector from all
sources. sources.
Concept It is a narrower concept as it is a It is a broader concept as it
part of private income. includes personal income.
Formula Personal Income = Private income - Private income = Personal income +
Corporate tax - Retained earnings Corporate tax + Retained earnings
Personal Income and National Income

Basis Personal Income Private Income
Meaning It is the sum total of all incomes
that are actually received by
households from all the sources.
Nature of Income It includes both factor incomes as It includes only the factor incomes.
well as transfer incomes.
Public sector income It does not include income earned It includes income earned by public
by public sector. sector.
Domestic Income (NDPFC)
Income from Domestic Product Income from Domestic Product

accruing to Private Sector accruing to Public Sector
Income from Property and

Savings of Non-Departmental
Entrepreneurship accruing to
Enterprises
Government Administrative
Question 22: Departments
What does private income refer to?
Answer:
Private income refers to the income which accrues to private sector from all the sources within and outside
the country.
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Private Income includes:
Factor Income earned: Transfer Income received:
within Domestic from Rest of the

within Domestic from Rest of the
territory World (ROW)
territory World (ROW)
Income from Interest on Net current

Domestic product Net Factor Income National Debt + transfers from
accruing to private from Abroad (NFIA) Current transfers ROW (d)
sector (a) (b) from Government
(c )
Question 23:
What is the meaning of Personal Disposable Income?
Question 24:
Explain National Disposable Income (Net and Gross).
Answer:
National Disposable Income (NDY) refers to the income which is available to the whole country for disposal.
National Disposable Income = National Income + Net indirect taxes + Net current transfers from rest of
the world
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National Disposable Income (NDY) = National Consumption Expenditure + National Savings
Gross National Disposable Income

When depreciation is added to the net National Disposable Income, we get Gross National Disposable
Income.
Gross National Disposable Income = Net National Disposable Income + Depreciation
National Income
(+) Net Indirect Taxes
(+) Net Current Transfers from rest of the world
Net National Disposable Income
(+) Depreciation
Gross National Disposable Income
Question 25:
Give formulae for determination of Nominal GDP and Real GDP.
Answer:
The formulae are as follows:
Nominal GDP and Real GDP can be determined in the following manner:
Real GDP = x 100
Nominal GDP =
Question 26:
Explain GDP Deflator (or Price Index).
Answer:
The concept is explained as follows:
GDP deflator measures the average level of prices of all the goods and services that make up GDP.
GDP Deflator (or Price Index) = x 100
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Chapter-1, Unit-II:The Keynesian Theory By: CA Nitin Guru
CHAPTER 1: UNIT-II: THE KEYNESIAN THEORY OF

DETERMINATION OF NATIONAL INCOME
Question 1:
Who first explained determination of equilibrium income and output.
Answer:
The factors that determine the level of national income and the determination of equilibrium aggregate
income and output in an economy.
British economist John Maynard Keynes in his masterpiece ‘The General Theory of Employment Interest and
Money’ published in 1936.
Question 2:
Explain circular flow in a simple two sector model.
Answer:
 Two sectors in the economy viz., households and firms.
 Households own all factors of production and they sell their factor services to earn factor incomes
 The business firms are assumed to hire factors of production from the households; they produce and
sell goods and services to the households.
 The government sector does not exist
 The economy is a closed economy, i.e., foreign trade does not exist; there are no exports and
imports and external inflows and outflows
 National income equals the net national product
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Question 3:
Define equilibrium.
Answer:
 ‘Equilibrium’ (defined as a state in which there is no tendency to change; or a position of rest).
 Equilibrium output occur when the desired amount of output demanded by all the agents in the
economy exactly equals the amount produced in a given time period.
 An economy can be said to be in equilibrium when the production plans of the firms and the
expenditure plans of the households match.
Question 4:
Explain the aggregate demand function: Two sector model.
Answer:
In a simple two-sector economy aggregate demand (AD) or aggregate expenditure consists of only two
components:
(i) aggregate demand for consumer goods (C), and
(ii) aggregate demand for investment goods (I)
AD = C + I
The short-run aggregate demand function can be written as:

AD = C + ̅
Where ̅ = constant investment.
Question 5:
Explain the consumption function.
Answer:
1. Consumption function expresses the functional relationship between aggregate consumption expenditure
and aggregate disposable income, expressed as:
C = f (Y)
2. The positive relationship between consumption spending and disposable income is described by the
consumption function.
3. According to Keynes, the total volume of private expenditure in an economy depends on the total
current disposable income of the people and the proportion of income which they decide to spend on
consumer goods and services. Consumption function, proposed by Keynes is as follows:
C = a + bY
Where C = aggregate consumption expenditure; Y = total disposable income; a is a constant term,
value of consumption at zero level of disposable income; and b is the marginal propensity to consume
(MPC).
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4. . When income is low, consumption expenditures of households will exceed their disposable income and
households dissave.
5. The Keynesian assumption is that consumption increases with an increase in disposable income, but
that the increase in consumption will be less than the increase in disposable income
Question 6:
Explain Marginal Propensity to Consume (MPC).
Answer:
The concept of MPC describes the relationship between change in consumption (∆C) and the change in income
(∆Y). The value of the increment to consumer expenditure per unit of increment to income is termed the
Marginal Propensity to Consume (MPC).
MPC = = b
MPC tends to decline at higher income levels.
Question 7:
Explain Average Propensity to Consume (APC).
Answer:
The ratio of total consumption to total income is known as the average propensity to consume (APC).
APC = = C/Y
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Basis APC MPC

Meaning It is the ratio of consumption expenditure It is the ratio of change in consumption
(C) to the corresponding level of income expenditure (∆Y) over a period of time.
(Y) at a point of time.
Value more than one APC can be more than one as long as MPC cannot be more than one as change
consumption is more than national income, in consumption cannot be more than
i.e. till the break even point. change in income.
Response to change When income increases, APC falls but at a When income increases, MPC also falls
in income rate less than thatof MPC. but at a rate more than that of APC.
Formula APC= C/Y MPC = ∆C / ∆Y
Question 8:
Explain Savings Function (Propensity to Save).
Answer:
 Saving is also a function of income, i.e., saving also depends upon the level of income.
 Saving is the excess of income over consumption expenditure.
 Saving function refers to the functional relationship between saving and national income.
S = f (Y)
Where, S= Saving, Y = National Income, f = Functional Relationship
 Saving function or Propensity to save, shows the saving of households at a given level of income
during a given time period.
Important observations from Saving Schedule and Saving Curve:

 Starting Point of Saving Curve:
Savings Curve (SS) starts from point S on the Y-axis, indicating that there is negative saving, when
National Income is zero.
 Slope of Saving Curve:

SS has a positive slope, which indicates the positive relationship between saving and income.
 Break-Even Point (S=0):

Saving curve crosses the X-axis at a point which is known as break-even point as at that point,
savings is zero.
 Positive saving: After the Break-even Point, saving is positive.
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Question 9:
Explain the Marginal Propensity to Save (MPS).
Solution 9:
Comparison between APS and MPS
Basis APC MPC
Meaning It refers to the ratio of saving (S) to the It refers to the ratio of change in saving
corresponding level of income (Y) at a (∆S) to change in total income (∆Y) over
point of time. a period of time.
Value less than zero APS can be less than zero when there are MPS can never be less than zero as
dissavings, i.e., till consumption is more change in saving can never be negative,
than national income. i.e., change in consumption can never be
more than change in income.
Formula APS = S / Y MPS = ∆S / ∆Y
Question 10:
Explain Investment Function.
Answer:
 Investment refers to the expenditure incurred on creation of new capital assets.
 The investment expenditure is classified under two heads:
(i) Induced Investment
(ii) Autonomous Investment
 Induced Investment:
It refers to investment which depends on the profit expectations and is directly influenced by income
level.
Induced Income vs Autonomous Investment
Basis Induced Investment Autonomous Investment
Motive It is driven by profit motive, i.e., it It is done for social welfare and not for
depends on profit expectations. profit.
Income Elasticity It is income elastic, i.e., increase in It is unaffected by changes in income
income level raises its level. level.
Investment Curve Its curve slopes upwards as it is income Its curve is parallel to X-axis as it is
elastic. income inelastic.
Sector It is generally done by the private sector. It is generally done by the government
sector.
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Question 11:
Explain The Two-Sector Model Of National Income Determination.
Answer:
The two-sector model of determination of equilibrium levels of output and income in its formal form using the
aggregate demand function and the aggregate supply function.
(I)
According to Keynesian theory of income determination, the equilibrium level of national income is a situation
in which aggregate demand (C+ I) is equal to aggregate supply (C + S) i.e.
C + I = C + S or I = S
In a two sector economy, the aggregate demand (C+ I) refers to the total spending in the economy i.e. it is
the sum of demand for the consumer goods (C) and investment goods (I) by households and firms
respectively.
(II)
The saving schedule S slopes upward because saving varies positively with income. In equilibrium, planned
investment equals saving.
 Corresponding to this income, the saving schedule (S) intersects the horizontal investment schedule
(I).
 At the equilibrium level of income, saving equals (planned) investment.
 The equality between saving and investment can be seen directly from the identities in national income
accounting.
Y = C + S;
Y = C + I;
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 The two together, we have C + S = C + I, or S = I.

 An important point to remember is that Keynesian equilibrium with equality of planned aggregate
expenditures and output need not take place at full employment.
 Output will remain at less than the full employment rate as long as there is insufficient spending in
the economy.
Note:
A steeper aggregate demand function—as would be implied by a higher marginal propensity to consume—
implies a higher level of equilibrium income.
Equilibrium by Saving and Investment Approach
Income (Y) Consumption (C) Saving (S) Investment (I) Remarks
0 40 -40 40 S < I
100 120 -20 40 S < I
200 200 0 40 S < I
300 280 20 40 S < I
400 360 40 40 S = I
Equilibrium
500 440 60 40 S > I
600 520 80 40 S > I
Question 12:
Explain the concept of Investment Multiplier.
Answer:
 The concept of Investment Multiplier is an important contribution of Prof. J.M. Keynes.
 Keynes believed that an initial increment in investment increases the final income by many times,
Multiplier expresses the relationship between an initial increment in investment and the resulting
increase in aggregate income.
 Multiplier shows how many times the income increases as a result of an increase in investment.
 Multiplier (K) is the ratio of increase in National Income (∆Y) due to an increase in investment (∆I).
K = ∆Y / ∆I
 Suppose an additional investment (∆I) of Rs. 4,000 crores in an economy generates an additional
income (∆Y) of Rs. 16,000 crores.
K = 16,000 / 4,000 = 4
 The concept of Multiplier is based on the fact that one person’s expenditure is another person’s
income. When investment is increased, it also increases the income of people.
 In case of higher MPC, people will spend a large proportion of their increased income on consumption.
 In case of low MPC, people will spend lesser proportion of their increased income on consumption.
K = 1 / (1 - MPC)
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Formula of Multiplier (K)

 K = ∆Y / ∆I
 K = 1 / (1 - MPC)
 K = 1 / MPS
Maximum Value of Multiplier:

 The maximum value of multiplier is infinity, when the value of MPC is 1.
Minimum Value of Multiplier:

 The minimum value of multiplier is 1, when the value of MPC is zero.
Working of Multiplier:
One person’s expenditure is another person’s income. When an additional investment is made, then income
increases many times more than the increase in investment.
 Suppose, an additional investment of Rs.100 crores (∆I) is made.

 If MPC is assumed to be 0.90, then recepients of this additional income will spend 90% of Rs.100
crores.
 In the next round, 90% of the additional income of Rs.90 crores, i.e., Rs.81 crores will be spent on
consumption and the remaining amount will be saved.
 This multiplier process will go on and the consumption expenditure in every round will be 0.90 times of
the additional investment.
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Question 13:
Explain Determination Of Equilibrium Income: Three Sector Model.
Answer:
Aggregate demand in the three sector model of closed economy (neglecting foreign trade) consists of three
components namely, household consumption(C), desired business investment demand(I) and the government
sector’s demand for goods and services(G). Thus in equilibrium, we have Y = C+I+G
 GDP and national income are equal.
 As prices are assumed to be fixed, all variables are real variables and all changes are in real terms.
 Each of the variables in the model is a flow variable.
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 The variables measured on the vertical axis are C, I and G. The autonomous expenditure components
namely, investment and government spending.
 C + I + G schedule lies above the consumption.
 The line S + T in the graph plots the value of savings plus taxes. This schedule slopes upwards
because saving varies positively with income.
 The equilibrium level of income is shown at the point E 1 where the (C + l + G) schedule crosses the
45° line, and aggregate demand is therefore equal to income (Y).
 In equilibrium, it is also true that the (S + T) schedule intersects the (I + G) horizontal schedule.
Question 14:
Explain Determination Of Equilibrium Income: Four Sector Model.
Answer:
 The four sector model includes all four macroeconomic sectors, the household sector, the business
sector, the government sector, and the foreign sector.
 The foreign sector includes households, businesses, and governments that reside in other countries.
In the four sector model, there are three additional flows namely: exports, imports and net capital inflow
which is the difference between capital outflow and capital inflow.
The C+I+G+(X-M) line indicates the total planned expenditures of consumers, investors, governments, and
foreigners (net exports) at each income level.
Y = C + I + G + (X-M)
 Exports are the injections in the national income,
 imports act as leakages or outflows of national income.
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 Equilibrium is identified as the intersection between the C + I + G + (X - M) line and the 45-degree
line.
 The equilibrium income is Y. The leakages(S+T+M) are equal to injections (I+G+X) only at
equilibrium level of income.
 If net exports are positive (X > M), there is net injection and national income increases.
 If X<M, there is net withdrawal and national income decreases.
 When the foreign sector is included in the model (assuming M > X), the aggregate demand schedule
C+I+G shifts downward with equilibrium point shifting from F to E.
 The inclusion of foreign sector (with M > X) causes a reduction in national income from Y0 to Y1.
 Equilibrium income is expressed as a product of two terms: ∆ Y = k ∆I;

 the level of autonomous investment expenditure and the investment multiplier.
 The autonomous expenditure multiplier in a four sector model includes the effects of foreign
transactions and is stated as 1 / (1−𝑏+𝑣), where v is the propensity to import which is greater than
zero.
 The multiplier in a closed economy is 1 / (1−𝑏).
1. The greater the value of v, the lower will be the autonomous expenditure multiplier. The more open an
economy is to foreign trade, (the higher v is) the smaller will be the response of income to aggregate
demand shocks, such as changes in government spending or autonomous changes in investment demand.
 The higher the value of v, larger the proportion of this induced effect on demand for foreign, not
domestic, consumer goods.
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 Consequently, the induced effect on demand for domestic goods and, hence on domestic income
will be smaller.
 The increase in imports per unit of income constitutes an additional leakage.
2. An increase in demand for exports of a country is an increase in aggregate demand for domestically
produced output and will increase equilibrium income.
If the demand for a country’s exports has an expansionary effect on equilibrium income, whereas an
autonomous increase in imports has a contractionary effect on equilibrium income.
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Chapter-2, Unit-I: Fiscal Functions: An Overview By: CA Nitin Guru
CHAPTER 2: UNIT – I: FISCAL FUNCTIONS: AN OVERVIEW

 Steps taken By Government
To control the potential rise in prices: To bring in welfare to the underprivileged To provide incentives for the promotion
sections of production/use of resources
 Crop worry  fortified mid – day  subsidize Smart phones
 Rate Cut  Spend money on rural jobs  No tax on credit, debit card
transactions up to Rs. 2,000
 The Government intervenes with the economic variables:

 To direct them to function in particular directions
 Certain goods and services are provided exclusively by the government.
 Types of Economic System
TYPES OF ECONOMIC SYSTEM
MARKET GOVERNMENT MIXED
 Need of Economic System

 To solve the problem of scarcity
 To answer the basic questions such as what, how and for whom to produce and how many resources should be used.
 Role of Government as advocated by Adam Smith.

 Resource allocation role for government in national defence, maintenance of justice and the rule of law, establishment and
maintenance of highly beneficial public institutions and public works.
 ‘The Theory of Public Finance’(1959), introduced the three branch taxonomy of the role of government in a market economy.
Functions of Government
Resource Income Macroeconomic

Allocation Redistribution Stabilization
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Functions of Government
Allocation Function (Efficiency) Redistribution Function (Fairness) Stabilization Function
MICROECONOMIC FUNCTIONS MACROECONOMIC FUNCTION
 It aims to correct the  It aims at fair distribution of  It aims at maintenance of high levels of
sources of inefficiency. wealth and income. employment, price stability, the problems of
macroeconomic stability, monetary and fiscal
policy.
 ALLOCATION FUNCTION
Define Problem of Resource Market failures provide the Performance and various instruments
Allocation rationale for Government of Government
 available factors of  Imperfect competition  suitable corrective action  Fiscal policy
production are and presence of For example:  Budgeting
allocated among the monopoly (a) property rights;  An optimum mix of various social
various uses.  Failure to provide (b) enforces contracts goods (both public goods and
 Determines the collective goods through provision of law merit goods).
quantity actually to  Externalities enforcement and courts.  allocation instruments are are as
be produced.  Factor immobility  Goods involving externalities follows:
 Imperfect information that are not met by the 1. Production of Economic goods
 Inequalities in the market. 2. Influence private allocation
distribution of income  Merit goods also fall under 3. Competition/Merger policies
and wealth this purview. 4. Regulatory Activities
 The government acts as a 5. Legal and administrative
complement rather than as a frameworks
substitute. 6. Mixture of intermediate
techniques.
 Government failure
 Government is not always infallible
 Cost of measures > Cost of market failure.
Governments may contribute to generate them.
 Inadequate information, conflicting objectives and administrative costs.
 Not always be unbiased and benevolent.
 Market economy leads to non – egalitarian because:
 Distribution of income and wealth among individuals is likely to be skewed as few have most of the wealth.
 Intervention required to ensure a more desirable and just distribution.
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 REDISTRIBUTION FUNCTION
Definition Aims Examples Two edged sword and its
solutions
 For whom to produce. 1. Equitable Distribution 1. Taxation Policies  Conflict between efficiency
 Distribution to ensure 2. Advancement of Well Being 2. Progressive taxes used for and equity.
equity and fairness. of Deprived financing public services,  Efficiency costs or
3. Equality 3. Employment Reservations deadweight losses.
4. Security and preferences  Corrective measures are as
5. Minimal Standard Of Living 4. Regulation of manufacture follows:
and sale of certain  Optimal budgetary policy.
products  Minimal efficiency costs
5. Special schemes for
backward regions
 STABILIZATION FUNCTIONS
Definition Need Areas of Work Two major components Stabilization intervention
of Fiscal Policy policies
important for
Stabilization
 Deliberate  Prolonged  Labour employment and 1. Overall Effect 1. Monetary policy
stabilization instabilities capital utilization, Balance between Controlling the size of
policies.  Stagflation  Overall output and the resources and money supply and
 Eliminating  Contagion income, expenditures interest rate.
macroeconomic effect.  General price levels, 2. Microeconomic 2. Fiscal policy
fluctuations arising  The rate of economic Effect By means of
from suboptimal growth, and By Specific Policies expenditure and
allocation.  Balance of international taxation decisions.
payments.
 Steps taken by government during:
Inflation Deflation
1. The government cuts down its expenditure or raises 1. The government increases its expenditure or cuts down
taxes. taxes or adopts a combination of both.
2. Contractionary fiscal policy 2. Expansionary fiscal policy
3. Surplus budgets
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Chapter-2, Unit-II: Market Failure By: CA Nitin Guru
CHAPTER 2: UNIT-II: MARKET FAILURE

 Market Failure and its aspects
 Misallocation of scarce resources resulting in overproduction or underproduction.
Aspects of Market
Failure
Demand Side Supply Side
1. Demand side market failures: Demand curves do not take into account the full willingness of consumers to pay.
2. Supply side market failures: Supply curves do not incorporate the full cost of production.
 Reasons for Market Failures
Market Power Externalities

Reasons for
Market Failure
Public goods Incomplete Information
 Different types of Externalities

TYPES OF
EXTERNALITIES
UNIDIRECTIONAL RECIPROCAL POSITIVE NEGATIVE
 Social Cost
Social Cost = Private Cost + External Cost
 Private costs borne by individuals directly

 External costs borne by third parties not directly involved
 The problem of harmful externalities does not usually float up much because:
 Producers of harmful externalities not known.
 Cause-effect linkages are so unclear.
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Characteristics of Private Goods and Public Goods

Private Goods Public Goods
Utility Utility
Private Property Rights No direct payment
Rivalrous Non – Rival in consumption
Excludable Non – Excludable
No Free Rider Problem Indivisibility
Horizontal Summation of Individual Demand Curves Vulnerable
Rejection Additional Resource cost is zero
Additional Costs
Issues of fairness and justice tend to rise
Efficiently allocated resources
 ‘Theory of Public Goods’ - Paul A. Samuelson

 ‘Collective consumption good’ in his path-breaking 1954 paper ‘The Pure Theory of Public Expenditure’.
 A public good (also referred to as collective consumption good or social good) is defined as one which all enjoy in common.
 Classification of goods
Excludable Non-excludable
Rivalrous (A) (B)
Private goods food, clothing, cars Common resources such as fish stocks, forest resources, coal
Non-rivalrous (C) (D)
Club goods, cinemas, private parks, satellite Pure public goods such as national defence
television
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 Impure goods
 Hybrid goods that possess some features of both public and private goods.
 Partially rivalrous or congestible.
 Consumption reduces, but does not eliminate, the benefits of others.
 Impure public goods also differ from pure public goods in that they are often excludable.
 The possibility of exclusion from the use of an impure public good has two implications.
1. Elimination of Free Riding
2. Controlled degree of congestion
 Two broad classes of goods have been included in the studies related to impure public goods.
1. Club goods; first studied by Buchanan
2. Variable use public goods; first analyzed by Oakland and Sandmo
 Quasi – Public goods (Mixed Goods)

 Mix of services from the provision of goods
 Near public good i.e. all qualities of the private goods and some benefits of public good.
 Chargeable
 Some sold through markets and others being provided by government.
 Their markets are called incomplete markets and considered as inefficiency and market failure.
 Example - Vaccinations provide private benefits but also reduce the chances of others getting infected who are in contact
with vaccinated person.
 Common Access Resources (or Common pool resources)

 Special class of impure public goods which are non-excludable and rivalrous.
 Their consumption lessens the benefits available for others.
 Free of charge.
 Sustainability threat.
 ‘Tragedy of the commons’ occurs when rivalrous but non – excludable goods are overused, to the disadvantage of the entire
world.
 Examples of common access resources are fisheries, common pastures, rivers, sea, backwaters biodiversity etc.
 Global Public Goods

 Widespread impact on different countries and regions, population groups and generations.
 WHO delineates two categories of global public goods namely:
1. Final public good (outcomes), e.g. the eradication of polio and
2. Intermediate public goods, (contribute to the provision of final public goods) e.g. International Health Regulations aimed
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at stopping the cross-border movement of communicable diseases and thus reducing cross-border health risks.
 World Bank identifies five areas of global public goods which it seeks to address namely:
1. The environmental commons ,
2. Communicable diseases
3. International trade,
4. International financial architecture, and
5. Global knowledge for development.
 No mechanism (either market or government) to ensure an efficient outcome.
 Free rider problem

 ‘Benefiting from the actions of others without paying’.
 A free rider is a consumer or producer who does not pay for a non – exclusive good in the expectation that others will pay.
 Public goods provide a very important example of market failure.
 If every individual plays the same strategy of free riding, the strategy will fail because nobody is willing to pay and
therefore, nothing will be provided by the market. Then, a free ride for any one becomes impossible.
 There is no meaningful demand curve for public goods.
 If the free-rider problem cannot be solved, the following two outcomes are possible:
1. No public good will be provided in private markets
2. Private markets will seriously under produce public goods.
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Chapter-2, Unit-III: Government Intervention to Correct Market Failure By: CA Nitin Guru
CHAPTER 2: UNIT-III: GOVERNMENT INTERVENTIONS TO

CORRECT MARKET FAILURE
 Need of Government interventions
 Efficient functioning of markets.
 Creation of the basic framework for fair and open competitive markets.
 Establishment of the ‘rule of law’,
 Government creates and protects property rights.
 Framed competition and consumer law framework.
 The governments adopt various intervention mechanisms to ensure greater welfare of the society as follows:
Public Finance
Government Interventions to correct Market Failure
Minimize Market Correct Merit & Correcting Equitable

Power Demerit Goods Information Distribution
Failure
 Different forms of government interventions

As Supplier Public
Goods/Information
Direct
Government As Buyer/ Procurement

Intervention
Taxes/Subsidies to
alter costs
Indirect
Regulation/Influence
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 Government intervention to minimize Market Power.
 Market power exercised either by seller or buyer

(a) Higher prices than competitive prices.
(b) Restricts output and leads to deadweight loss.
(c) The government intervenes as follows:
1. Competition Laws, e.g. the Competition Act, 2002 etc
2. Exceptions e.g. patent and copyright laws grant exclusive rights of products or processes.
3. Price Regulations e.g. electricity, gas and water supplies.
4. Rate of Return Regulation
5. Setting Price Caps
 Government Intervention to correct Negative Externalities.

Government Initiative towards
Negative Externalities
Market Based
Direct Controls
Policies
A. DIRECT CONTROLS
They openly regulate the actions of those involved in generating negative externalities by:
1. Prohibiting specific activities that explicitly create negative externalities, for example smoking is banned in public places.
2. Passing laws to alleviate the effects of negative externalities For example, India has enacted the Environment (Protection)
Act, 1986.
3. Charging an emission fee
4. Forming Special bodies for instance the Ministry of Environment & Forest,
B. MARKET-BASED POLICIES
 They operate through price mechanism to create an incentive for change.
MARKET BASED POLICIES
Setting Prices DIRECTLY through Setting Prices INDIRECTLY through

Pollution Tax Cap - Trade - System
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1. Pollution Tax
Market Outcomes of Pollution Tax
2. Cap – Trade System (also known as Tradable Emissions Permits)

(a) These are marketable licenses to emit limited quantities of pollutants and can be bought and sold by polluters.
(b) India is experimenting with cap-and-trade in the form of Perform, Achieve & Trade (PAT) scheme and carbon tax in
the form of a cess on coal.
 Problems in administering an efficient pollution tax

1. Difficult to determine and administer
2. Use of complex and costly administrative procedures
3. Does not provide any genuine solutions
4. Shift the tax burden
5. Negative consequences on employment and investments
 Advantages and disadvantages of Tradable permits

 The advantages of Tradable Permits are as follows:
 Flexibility and efficiency
 Cheap and simple
 Incentives for innovation
 Lower prices
 The disadvantages of Tradable Permits are as follows:
 Only provide an incentive but does not completely stop pollution.
 Higher prices to consumers.
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 Government Intervention to correct Positive Externalities.

1. Subsidy
2. Direct entry by the Government
3. Direct production of Environmental Quality
 Government Intervention in the case of Merit Goods.

1. Regulation - For example, the way in which education is to be imparted is government regulated.
2. Subsidies - For example subsidy for windmill or solar panel.
3. Direct Government Provision
4. Combination of Government Provision and Market Provision
 Reasons for government provision of Merit goods.

1. Loss of Social Welfare
2. Information Failure
3. Equity Considerations
4. Uncertainty
 Government Intervention in the case of Demerit Goods.

A. Steps taken By Government
1. Complete Ban
2. Persuasion
3. Legislations
4. Limitations on Access
5. Regulatory Controls
6. High taxes
7. Fixing Minimum Price
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B. Limitations
1. The demand is often highly inelastic.
2. Additional taxation and shift of the taxes to consumers.
3. Stringent regulation resulting in goods traded in a hidden market.
 Government Intervention in the case of Public Goods
1. The non-rival nature of consumption provides a strong argument for the government to provide:
(a) Pure public goods
(b) Excludable public goods
2. Governments grant licenses to private firms to build a public good facility.
3. Certain goods are produced and consumed as public goods and services
 Price Intervention by Government

 Price interventions are legal restrictions on price.
 The Price interventions of the government are as follows:
1. Price controls may take the form of:
(a) Price floor (a minimum price buyers are required to pay); or
(b) Price ceiling (a maximum price sellers are allowed to charge for a good or service).
 Examples of such market intervention are fixing of minimum wages and rent.
a
2. Intervention in Primary markets

(a) For example in India, Minimum Support Price (MSP) programme as well as procurement by government agencies at
the set support prices.
Market Outcome of Minimum Support Price
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(b) Price ceilings (also called maximum price)

Market Outcome of Price Ceiling
(c) Maintenance of buffer stocks
 Government Intervention for Correcting Information Failure

1. Accurate labeling and Content Disclosure
2. Public Dissemination of Information
3. Regulation of Advertising
 Government Intervention for Equitable Distribution.

1. progressive income tax,
2. targeted budgetary allocations,
3. unemployment compensation,
4. transfer payments,
5. subsidies,
6. social security schemes,
7. job reservations,
8. land reforms,
9. gender sensitive budgeting etc.
 Government also intervenes to combat black economy and market distortions associated with a parallel black economy.
Note:
 Government failure occurs when:
 intervention is ineffective
 intervention produces fresh and more serious problems
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Chapter-2, Unit-IV: Fiscal Policy By: CA Nitin Guru
CHAPTER 2: UNIT-IV: FISCAL POLICY

 Objectives of Fiscal Policy
 Vary from country to country.
 The most common objectives of fiscal policy are:
(a) Achievement and maintenance of full employment,
(b) Maintenance of price stability,
(c) Acceleration of the rate of economic development, and
(d) Equitable distribution of income and wealth,
 For instance, while stability and equality may be the priorities of developed nations, economic growth, employment and
equity may get higher priority in developing countries.
 Automatic Stabilizers and Discretionary Fiscal Policy.

A. Automatic Stabilizers (Non-discretionary fiscal policy)
 Definition
 ‘Built-in’ fiscal mechanisms that operate automatically
 Any government programme that automatically tends to reduce fluctuations in GDP is called an automatic stabilizer.
 Tendency for increasing GDP when it is falling and reducing GDP when it is rising.
 Examples - Personal income taxes, corporate income taxes and transfer payments (unemployment compensation, welfare
benefits).
 Automatic Stabilizers occur as follows during:
(a) Recession (b) Expansion
1. Reduction in income, less taxes and refunds. 1. Increase in income and taxes lead to less disposable
2. Increase in Government expenditure. income resulting in decline in consumption and aggregate
3. Limiting the decrease in disposable income during the demand.
contraction phase. 2. Higher corporate taxes and lower surplus cause decline
in consumption and investment.
3. all types of incomes rise and the amount of transfer
payments decline.
B. Discretionary Fiscal Policy

 Deliberate policy actions on the part of government:
 to change the levels of expenditure,
 taxes to influence the level of national output,
 employment and prices
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 Governments influence the economy by:

 changing the level and types of taxes,
 the extent and composition of spending,
 the quantity and form of borrowing.
 Governments may directly as well as indirectly influence the way resources are used in an economy.
 It is evident from the equation that governments can influence economic activity (GDP) by controlling G directly and
influencing C, I, and NX indirectly, through changes in taxes, transfer payments and expenditure.
 Instruments of Fiscal Policy
Instruments of Fiscal Policy
Government Government
Public Debt
Expenditure Budget
 Government Expenditure as an Instrument of Fiscal Policy.

A. Public Expenditure
 Income generating and include all types of government expenditure such as capital expenditure on public works, relief
expenditures etc.
 It includes governments’ expenditure towards consumption, investment, and transfer payments.
B. Government expenditure
Government expenditure include:
1. Current expenditures
2. Capital expenditures
3. Transfer payments
C. Government expenditure during Recession
1. Steps taken by government
 Directly generate incomes to labour and suppliers of materials and services.
 Indirect effect in the form of working of multiplier.
 Induce secondary and tertiary employment.
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2. The two concepts of public spending during depression

(a) Pump Priming (b) Compensatory Spending
 One-shot injection of government expenditure into a  Government spending is deliberately carried out with the
depressed economy. obvious intention to compensate for the deficiency in
 Permanent recovery from a slump. private investment.
3. Public Expenditure used as Policy Instrument

 To reduce the severity of inflation by reducing government expenditure.
 Reduced incomes on account of decreased public spending helps to eliminate excess aggregate demand.
 Taxes as an Instrument of Fiscal Policy.

Overview During Recession During Inflation
1. For establishing stability. 1. To encourage private consumption 1. New taxes and existing taxes are
2. Encouraging or restricting private and investment. raised.
expenditures on consumption and 2. Low corporate taxes increase the 2. Excessive taxation usually stifles new
investment. prospects of profits for business and investments.
3. Determine the size of disposable promote further investment.
income.
 Public Debt as an Instrument of Fiscal Policy.
Sources of Public Debt
Internal External
(From its Own people) (From Outside Sources)
 Public debt takes two forms:
Market loans Small savings
 Govt. issues treasury bills and government securities of  Not negotiable and are not bought and sold in the market.
varying denominations and duration.  National Savings Certificates, National Development
 For capital projects – Long term capital bonds Certificates are few examples.
 For short term expenditures – treasury bills  Borrowing from the public curtails the aggregate demand.
 Repayments by governments increase the availability of money
in the economy and increase aggregate demand.
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 Budget as an Instrument of Fiscal Policy.

 A statement of revenues earned from taxes and other sources and expenditures made by government in a year.
Balanced Budget Surplus Budget Deficit Budget
 Expenditures = Revenues  Expenditures < Revenues  Expenditures > Revenues
 No net effect on  Negative net effect on aggregate demand  Positive net effect on aggregate demand
aggregate demand since leakages exceed injections. since total injections exceed leakages.
 A nation’s debt is the difference between its total past deficits and its total past surpluses.
 A budget surplus reduces government debt, increases savings and reduces interest rates.
 Higher levels of domestic savings decrease international borrowings and lessen the current account deficit.
 Types of Fiscal Policy.

TYPES OF FISCAL POLICY
EXPANSIONARY FISCAL POLICY CONTRACTIONARY FISCAL POLICY
Particulars EXPANSIONARY POLICY CONTRACTIONARY POLICY

When is this policy At the time of Recession At the time of Inflation
needed?
How does the government  Contractionary policy measures so that
uses this policy? The aggregate demand curve (AD) shifts
to the left and the equilibrium may be
established at the full employment level
of real GDP
 This can be achieved either by:
1. Decrease in government spending
2. Increase in personal income taxes
and/or business taxes
3. A combination of the above two
measures
 Real GDP at Y1 level lies below the natural

level, Y2.
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 There are two views as follows:

1. Classical Economists’ View
 Reduction in wages costs would increase
supply and the short run aggregate supply
curve SAS1 will shift to the right say SAS
2 and bring the economy back to the level of
full employment at Y2.
2. Keynesian View
 Wages are not much flexible and are ‘sticky
downward,’
 Increase in government expenditures causes
a shift in the aggregate demand curve to  As real GDP rises above its natural level
the right from AD 1 to AD 2. Y, prices also rise, prompting an increase
 As a response to the shift in AD, output in wages and other resource prices.
increases.  This causes the SAS curve to shift from
 More output, and hiring more workers. SAS 1 to SAS 2.
 The government uses a deficit budget,  As a result, the price level goes up from
financed either through borrowing or through P 1 to P 3.
monetization.  The real GDP remains the same at Y.
Note: Expansionary fiscal policy will be  The government intervenes to control
successful only if there is accommodative inflation by Contractionary fiscal policy,
monetary policy. to reduce aggregate demand so that the
aggregate demand curve (AD1) does not
shift to AD2.
 The government needs to reduce
expenditures or raise taxes.
 Recessionary gap (Contractionary gap)

 Existing levels of aggregate production < Levels of Aggregate production with full employment of resources.
 When the aggregate demand is not sufficient to create conditions of full employment.
 Occurs during the contractionary phase of business-cycle and results in higher rates of unemployment.
 Few examples of Fiscal Policy for long run economic growth.

 Fiscal policies such as those involving infrastructure spending generally have positive supply-side effects.
 When government supports building a modern infrastructure, the private sector is provided with the requisite overheads it
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needs.
 Government provision of public goods such as education, research and development etc. provide momentum for long-run
economic growth.
 A well designed tax policy that rewards innovation and entrepreneurship, without discouraging incentives will promote private
businesses.
 Fiscal Policy reduces Inequalities of Income and Wealth.

A few such measures to achieve desired distributional effects are as follows:
1. Progressive Direct Tax System
2. Differential Indirect Taxes
3. Public Expenditure policy
 Limitations of Fiscal Policy

1. Existence of Different types of Lags
There are different types of lags involved in fiscal-policy action as follows:
(a) Recognition Lag
(b) Decision Lag
(c) Implementation Lag
(d) Impact Lag
2. Wrong timing
3. Rigid policies
4. Difficult to reduce Government Expenditure
5. Non adjustment of Public works
6. Forecasting Difficulties
7. Conflicts in different Objectives
8. Opinion of Supply side Economists
9. Perpetual Burden
10. Crowding out
11. Price Spiral
 Crowding out.
1. Government spending replaces private spending, the latter is said to be crowded out.
2. For example, if government provides free computers to students, the demand from students for computers may not be
forthcoming.
3. Fiscal policy becomes ineffective as the decline in private spending partially or completely offset the expansion in demand
resulting from an increase in government expenditure.
4. During deep recessions, crowding-out is less likely to happen.
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Chapter-3, Unit-I: Concept of Money Demand By: CA Nitin Guru
CHAPTER 3: UNIT-I: CONCEPT OF MONEY DEMAND

 Definition of Money
Assets which are commonly used and accepted as a means of payment or as a medium of exchange or of transferring
purchasing power.
 Purchasing Power
 All Medium of exchange not Money
 Liquid Asset
 No Intrinsic Value of Currency
 Fiat Money
 Electronic records
 Money as per economic theory.

In economic theory As a statistical concept
 Set of liquid financial assets Money could include certain liquid liabilities of a particular set
 Its stock variation could impact on aggregate economic of financial intermediaries or other issuers’.(Reserve Bank of
activity. India Manual on Financial and Banking Statistics, 2007).
 Functions of Money
1. Convenient medium of exchange
2. Unit of value or unit of account
3. Unit or standard of deferred payment
4. Store of value
 General characteristics of money

Money should be:
 generally acceptable
 durable or long-lasting
 effortlessly recognizable.
 difficult to counterfeit i.e. not easily reproducible by people
 relatively scarce, but has elasticity of supply
 portable or easily transported
 possessing uniformity; and
 divisible into smaller parts in usable quantities or fractions without losing value
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 The demand for money

1. Desire to hold money
2. Demand for liquidity
3. Role of Money
4. Holding Money
5. Opportunity Cost
 Classic Theory of Demand for Money (The Quantity Theory  The Neo Classical Approach (The Cambridge Approach)
of Money) by Irving Fisher. Demand for Money.
 There is strong relationship between money and price level  Money increases utility in the following two ways:
1. enabling the possibility of split-up of sale and purchase
to two different points of time (transaction motive), and
2. being a hedge against uncertainty (temporary store of
wealth)
 Also called ‘equation of exchange’ or ‘transaction approach’  Also called Cash Balance Approach

 MV = PT d
M = k PY
Where, M= the total amount of money in circulation (on an d
average) in an economy Where, M = is the demand for money
V= transactions velocity of circulation i.e. the average Y = real national income
number of times across all transactions a unit of P = average price level of currently produced goods
money(say Rupee) is spent in purchasing goods and and services
services PY = nominal income
P = average price level (P= MV/T) k = proportion of nominal income (PY) that people
T = the total number of transactions. want to hold as cash balances
 Later, Fisher extended the equation of exchange to include

demand (bank) deposits (M’) and their velocity (V’) in the
total supply of money as follows:
MV + M’V’ = PT
Where, M’ = the total quantity of credit money

V' = velocity of circulation of credit money.
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 The Keynesian Theory of Demand for Money (‘Liquidity Preference Theory’)

 People hold money (M) in cash for three motives:
Three Motive to Hold Cash
Transactions Precautionary Speculative

Motive Motive Motive
1. Transaction Motive: The need for cash arises because there is lack of synchronization between receipts and expenditures.
 The transactions demand for money is a direct proportional and positive function of the level of income as follows:
Lr = kY
Where Lr, = the transactions demand for money,
k = ratio of earnings which is kept for transactions purposes
Y = the earnings
2. Precautionary Motive: Everyone keeps a portion of their income to finance such unanticipated expenditures.
3. Speculative Motive: It reflects people’s desire to hold cash to invest in any attractive investment opportunity requiring cash
expenditure. There can be three cases as follows:
Case A: When (rn > rc) i.e. rise in bond prices, then they will convert their cash balances into bonds
Case B: When (rn<rc) i.e. fall in bond prices, then they would have an incentive to hold their wealth in the form of liquid
cash rather than bonds.
Case C: When rn = rc, then they will be indifferent to holding either cash or bonds.
 The speculative demand for money of individuals can be diagrammatically presented as follows:
 The speculative demand for money and current rate of interest are inversely related as shown below
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 Post Keynesian developments in the Theory of Demand for Money.

Inventory Approach to Transaction
Friedman's Restatement of the Quantity The Demand for Money as Behavior
Balances (Deterministic Theory) Theory toward Risk
 By Boumol and Tobin  By Milton Fredman By Tobin in ‘Liquidity Preference as
Behavior towards Risk’
 Money or ‘real cash balance’ as an  Demand for money is affected by :  Provided the foundation for the
inventory held for transaction 1. Permanent income. liquidity preference and for a negative
purposes. 2. Relative returns on assets. (which relationship between the demand for
incorporate risk) money and the interest rate.
 Inventory models assume that there  Friedman identifies the following four  The optimal portfolio structure is
are two media for storing value: determinants of the demand for money. determined by
1. money and The nominal demand for money: (i) the risk/reward characteristics of
2. an interest-bearing alternative 1. is a function of total wealth, different assets
financial asset. 2. is positively related to the price (ii) the taste of the individual in
 People hold an optimum combination level, maximizing his utility consistent
of bonds and cash balance. 3. rises if the opportunity costs of with the existing opportunities
 Excess cash will be invested in bonds money holdings (i.e. returns on bonds  rational behaviour of a risk-averse
or put in an interest – bearing and stock) decline and vice versa. economic agent holds an optimally
account. 4. is influenced by inflation, structured wealth portfolio which is
comprised of both bonds and money
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Chapter-3, Unit-II: Concept of Money Supply By: CA Nitin Guru
CHAPTER 3: UNIT-II: CONCEPT OF MONEY SUPPLY

 Money supply
 Total quantity of money available to the people.
 It is important to note two things
1. Stock variable i.e. money available at any particular point of time.
2. Change in the stock of money.
 The term ‘public’ includes all economic units (households, firms and institutions) except the producers of money (i.e. the
government and the banking system).
 Rationale of measuring Money Supply

1. Deeper Understanding
2. Framework to Evaluate
 Sources of Money Supply
Sources Of Money Supply
Credit Money
High Powered Money
(Responses of Commercial Banks to
(Decision of Central Bank)
Changes by Central Bank)
 Measurement of Money Supply

 Four alternative measures of money supply denoted by M1, M2, M3 and M4 besides the reserve money.
 The respective empirical definitions of these measures are given below:
M1 = Currency notes and coins with the people + demand

deposits of banks (Current and Saving deposit accounts)
M2 = M1 + savings deposits with post office savings banks.
Post
 M1 is the most liquid and M4 is the least liquid of the four measures.
 M1 is also called Narrow Money.
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 The new monetary aggregates are:
Reserve Money = Currency in circulation + Bankers’ deposits

with the RBI + Other deposits with the RBI
= Net RBI credit to the Government + RBI credit to

the Commercial sector + RBI’s Claims on banks +
RBI’s net Foreign assets + Government’s Currency
Liabilities to the public – RBI’s net non - monetary
Liabilities
NM1 = Currency with the public + Demand deposits with the banking
system + ‘Other’ deposits with the RBI.
NM2 = NM1 + Short-term time deposits of residents (including and up to
contractual maturity of one year).
NM3 = NM2 + Long-term time deposits of residents + Call/Term funding
from financial institutions
 M1 includes the demand deposits and reserve money includes the cash reserves of banks.
 Reserve money is also known as central bank money, base money or high-powered money.
 The central bank also measures ‘liquidity’ aggregates in addition to the monetary aggregates.
 Close substitutes of money issued by the non-banking financial institutions are also included.
 Determinants of Money Supply

There are two alternate theories in respect of determination of money supply.
 First View: Money supply is determined exogenously by the Central bank.
 Second View: Money supply is determined endogenously by changes in the economic activities i.e.joint behaviour of the
central bank, the commercial banks and the public.
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 Money Multiplier
 The money supply is defined as
Where,
M is the money supply, m is money multiplier and MB is the monetary base or high powered money.
 From the above equation we can derive the money multiplier (m) as
Money supply
Money Multiplier (m)=
Monetary base
 A ratio that relates the changes in the money supply to a given change in the monetary base.
 The Money Multiplier Approach to Supply of Money.

 The money multiplier approach to money supply propounded by Milton Friedman and Anna Schwartz, (1963) considers three
factors as immediate determinants of money supply, namely:
(i) the stock of high-powered money (H) i.e. Behaviour of Central Bank
(ii) the ratio of reserves to deposits, e = {ER/D} i.e. behaviour of Commercial Bank
(iii) the ratio of currency to deposits, c ={C/D} i.e. behaviour of Public
(i) Behaviour of Central Bank

 Supply of the nominal high-powered money.
 If the behaviour of the public and the commercial banks remains unchanged over time, the total supply of nominal
money in the economy will vary directly with the supply of the nominal high-powered money issued by the central bank.
(ii) Behaviour of Commercial Bank
 The behaviour of the commercial banks in the economy is reflected by Reserve Ratio.
 There are two cases, where required reserve ratio changes and other variables remain same as follows:
Case A – Required Reserve ratio increases, more reserves would be needed.
Case B – Required reserve ratio falls, there will be expansions of deposits
 The banking system's excess reserves ratio is negatively related to the market interest rate.
(iii) Behaviour of Public
 The behaviour of the public influences bank credit through the decision on ratio of currency to the money supply known
as the ‘currency ratio’.
 Currency in public hands causes multiple expansion to decline, and therefore, money multiplier also falls.
 Money multiplier and the money supply are negatively related to the currency ratio c.
 An increase in TD/DD ratio means that greater availability of free reserves and thus increase in volume of multiple
deposit expansion and monetary expansion.
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 The effect of Government Expenditure on Money Supply.

 The excess reserves created because of lending by RBI to government, potentially lead to an increase in money supply
through the money multiplier process
 The Credit Multiplier (the deposit multiplier or the deposit expansion multiplier)
 How much new money will be created by the banking system for a given increase in the high- powered money.
 Bank's ability to increase the money supply.
 The credit multiplier is the reciprocal of the required reserve ratio.
Credit Multiplier =
 Are Deposit multiplier and money multiplier same?

 The deposit multiplier and the money multiplier though closely related are not identical because:
a) Generally banks do not lend out all of their available money but instead maintain reserves at a level above the minimum
required reserve.
b) All borrowers do not spend every Rupee they have borrowed. They are likely to convert some portion of it to cash.
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Chapter-3, Unit-III: Monetary Policy By: CA Nitin Guru
CHAPTER 3: UNIT-III: MONETARY POLICY

 Monetary Policy
 the use of monetary policy instruments to regulate
(a) the availability, cost and use of money and credit to promote economic growth,
(b) price stability,
(c) optimum levels of output and employment,
(d) balance of payments equilibrium and stable currency etc.
 all actions of the central bank aimed at:
(a) directly controlling the money supply and; (b) indirectly at regulating the demand for money.
 Monetary Policy Framework

A. The Objectives of monetary policy B. The Analytics of monetary policy C. The Operating procedure which
which focus on the transmission focuses on the operating targets and
mechanisms instruments
1. General Objectives are as follows: The process or channels through which  day-to-day implementation of monetary
(a) Balance between price stability and the change of monetary aggregates policy.
economic growth. affects the level of product and prices is
(b) rapid economic growth, known as ‘monetary transmission
(c) debt management, mechanism’.
(d) moderate long-term interest
rates,
(e) exchange rate stability
(f) external balance of payments
equilibrium
2. The monetary policy of Developing  Four different mechanisms are:  The direct instruments comprise of:
countries has objectives of: (a) The interest rate channel (a) Cash reserve ratios and liquidity
(a) Economic growth, (b) The exchange rate channel reserve ratios
(b) Adequate flow of credit to the (c) The quantum channel (e.g., relating to (b) Directed credit
productive sectors, money supply and credit) (c) Administered interest rates
(c) sustaining - a moderate structure  Two distinct channels under quantum  The indirect instruments mainly consist
of interest rates of:
channel:
(d) creation of an efficient market for (a) Repos
1. The Bank lending channel
government securities. (b) Open market operations
2. The balance sheet channel
(c) Standing facilities, and
(d) The asset price channel i.e. via equity
(d) Market-based discount window.
and real estate prices
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 Operating Framework.
 All aspects of implementation of monetary policy.
 It primarily involves three major aspects, as follows:
1. Choosing the operating target
2. Choosing the intermediate target
3. Choosing the policy instruments
 Cash Reserve Ratio (CRR) and Monetary Policy

 Fraction of the total net demand and time liabilities (NDTL) of Bank.
 To be maintained as cash deposit with the Reserve Bank.
 Uniform to all scheduled banks.
 Does not apply to Non – Bank Financial Institution (NBFIs)
 The Reserve Bank does not pay any interest on the CRR balances
 Higher the CRR, lower will be the liquidity and vice versa.
 During slowdown in the economy, the RBI reduces the CRR in order to enable the banks to expand credit and increases the
supply of money available in the economy.
 The cash reserve ratio as on 16th February, 2020 was 4.0 per cent.
 Statutory Liquidity Ratio (SLR) and Monetary Policy

 Prudential measure.
 Stipulated percentage of their total Demand and Time Liabilities (DTL) / Net DTL (NDTL) in one of the following forms:
 Cash
 Gold, or
 Investments in un-encumbered Instruments that include:
(a) Treasury-bills of the Government of India.
(b) Dated securities including those issued by the Government of India
(c) State Development Loans (SDLs) issued by State Governments
(d) Other instruments as notified by the RBI
 SLR on 15th February, 2020 was 19%.
 A powerful tool for controlling liquidity.
 Influences the availability of resources in the banking system.
 During high liquidity period, SLR is raised.
 Provides a market for government securities.
 Liquidity Adjustment Facility (LAF) and Monetary Policy

 Central Bank (Bankers bank) provides liquidity to banks through its discount window.
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 Banks can borrow from the discount window against the collateral of securities like commercial bills, government securities,
treasury bills, or other eligible papers.
 From June 2000, the RBI has introduced Liquidity Adjustment Facility (LAF).
 Following are under Liquidity Adjustment Facility (LAF).
(i) Repurchase Option (REPO)
 An instrument for borrowing funds by selling securities with an agreement to repurchase the securities on a mutually
agreed future date at an agreed price which includes interest for the funds borrowed’.
 Report on the electronic platform called the Negotiated Dealing System (NDS).
 The rate charged is called the ‘repo rate’. Repo operations thus inject liquidity into the system.
 If the RBI wants to make it more expensive for banks to borrow money, it increases the repo rate.
 REPO rate reported in February 2020 was 5.15%
(ii) Reverse REPO
 ‘Reverse Repo’ is defined as an instrument for lending funds by purchasing securities with an agreement to resell the
securities on a mutually agreed future date at an agreed price which includes interest for the funds lent.
 Reverse repo operation takes place when RBI borrows money from banks by giving them securities.
 The interest rate paid by RBI for such transactions is called the ‘reverse repo rate’.
 Reverse repo operation in effect absorbs the liquidity in the system.
 There are three types of repo markets operating in India namely:
(i) Repo on sovereign securities
(ii) Repo on corporate debt securities ,and
(iii) Other Repos
 ‘Term Repo’ (repos of duration more than a day) is for 14 days and 7 days tenors.
 Marginal Standing Facility (MSF) and Monetary Policy?

 RBI acts as a lender of last resort.
 Scheduled commercial banks can borrow additional amount of overnight money from the central bank over and above what is
available to them through the LAF window by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a
penal rate of interest.
 Safety valve against unexpected liquidity.
 Banks can borrow through MSF on all working days except Saturdays, between 7.00 pm and 7.30 pm, in Mumbai. The
minimum amount which can be accessed through MSF is Rs. 1 crore and more will be available in multiples of Rs. 1 crore.
 The MSF rate was 5.65% in February, 2020.
 Market Stabilization Scheme (MSS) and Monetary Policy?

 MOU between the Reserve Bank of India (RBI) and the Government of India (GOI).
 The primary aim of aiding the sterilization operations of the RBI.
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 Under this scheme, the Government of India borrows from the RBI and issues treasury-bills/dated securities for absorbing
excess liquidity from the market arising from large capital inflows.
 Bank Rate and Monetary Policy

 Bank Rate is the standard rate at which the Reserve Bank is prepared to buy or re- discount bills of exchange or other
commercial paper eligible for purchase under the Act.
 Used only for calculating penalty on default in the maintenance of CRR and SLR.
 Open Market Operations and Monetary Policy

 Market operations conducted by the Reserve Bank of India by way of sale/ purchase of Government securities to/ from the
market with an objective to adjust the rupee liquidity conditions in the market.
 When the RBI feels there is excess liquidity in the market, it resorts to sale of securities thereby reducing out the rupee
liquidity.
 The Organisation Structure for Monetary Policy Decisions

I. The Monetary Policy Framework Agreement II. The Monetary Policy Committee (MPC)
 Agreement reached between the Government of India and  Six-member Monetary Policy Committee (MPC) constituted
the Reserve Bank of India (RBI) on the maximum tolerable in September, 2016
inflation rate for price stability.  determine the policy rate required to achieve the inflation
target.
 Inflation targeting.  The new system is intended to incorporate:
 Once in every five years. Accordingly,  diversity of views,
 Consumer Price Index (CPI) for the period from August  specialized experience,
5, 2016 to March 31, 2021 is 4% with the upper  independence of opinion,
tolerance limit of 6 per cent and the lower tolerance  representativeness, and
limit of 2 per cent.  accountability.
 Monetary Policy Report every six months is mandatory.  Assisted by The Reserve Bank’s Monetary Policy
 The following factors are notified:
Department (MPD)
(a) the average inflation > the upper tolerance
 The Financial Markets Operations Department (FMOD)
level
operationalises the monetary policy.
(b) the average inflation < the lower tolerance level
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Chapter-4, Unit-I: Theories of International Trade By: CA Nitin Guru
CHAPTER 4: UNIT-I :
THEORIES OF INTERNATIONAL TRADE
 International Trade And the complexities involved
 International Trade:
 Exchange of goods and services as well as resources between countries.
 Transactions between residents of different countries.
 Involves transactions in multiple currencies.
 Complexities Involved:
 heterogeneity of customers and currencies,
 differences in legal systems,
 more elaborate documentation,
 diverse restrictions in the form of taxes, regulations, duties, tariffs, quotas, trade barriers,
 standards, restraints to movement of specified goods and services and issues related to shipping
and transportation.
 Arguments supporting International Trade.

 Economic efficiency and contribution to economic growth
 Cheaper raw material, new material and foreign exchange
 Increases the scope for mechanization and specialization
 Raising standards of livelihood
 Trade strengthens bond between nations
 Arguments against Trade Openness

 Unhealthy occupational environments
 Not equally beneficial to all nations
 Exhaustion of natural resources
 Threat to domestic industries
 Welfare of people may be ignored
 Severe competition
 The Mercantilists’ view of International Trade (Policy of Europe’s great powers)

 Based on increasing exports and collecting precious metals in return.
 The more gold and silver a country accumulates, the richer it becomes.
 Advocated maximizing exports and minimizing imports.
 This view argues that trade is a ‘zero-sum game’, and one country’s gain is equal to another country’s
loss.
 The Theory of Absolute Advantage.

 International trade is not a zero-sum game.
 Exchange of goods between two countries will take place only if each of the two countries can
produce one commodity at an absolutely lower production cost than the other country.
 Principle of division of labour constitutes the basis for his theory of international trade.
 By specializing and trading freely, global output is maximized and more of both goods are available to
the consumers in both the countries.
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 The Theory of Comparative Advantage (By David Ricardo in ‘Principles of Political Economy and Taxation)
 Even if one nation is less efficient than (has an absolute disadvantage with respect to) the other
nation in the production of all commodities, there is still scope for mutually beneficial trade.
 It is based on ‘labour theory of value’, which assumes that the value or price of a commodity depends
exclusively on the amount of labour going into its production.
 The above assumption is quite unrealistic because there are other factors of production also.
 Haberler’ Solution:
 Haberler introduced the opportunity cost concept from Microeconomic theory to explain the theory of
comparative advantage in which no assumption is made in respect of labour as the source of value.
 According to the opportunity cost theory, the cost of a commodity is the amount of a second
commodity that must be given up to produce one extra unit of the first commodity.
 Opportunity Cost of Producing X = Labour required for 1 Unit of X/ Labour required for 1 Unit of Y
Note: international differences in relative factor-productivity are the cause of comparative advantage and a
country exports goods that it produces relatively efficiently.
 Limitations of Ricardian Theory:

 Its emphasis is on supply conditions and excludes demand patterns.
 The theory does not examine why countries have different costs.
 The Heckscher-Ohlin Theory of Trade (Factor-Endowment Theory of Trade or Modern Theory of Trade)
 The immediate cause of inter-regional trade is that goods can be bought cheaper in terms of money
than they can be produced at home.
 If a country is a capital abundant one, it will produce and export capital-intensive goods.
 The Heckscher-Ohlin theory of foreign trade can be stated in the form of two theorems:
(i) Heckscher-Ohlin Trade Theorem (ii) Factor-Price Equalization Theorem
 a country tends to specialize in the  A corollary to the Heckscher-Ohlin trade theory.
export of a commodity whose  International trade tends to equalize the factor prices
production requires intensive use of between the trading nations.
its abundant resources; and  Whichever factor receives the lowest price before two
 imports a commodity whose countries integrate economically and effectively become one
production requires intensive use of market, will therefore tend to become more expensive
its scarce resources. relative to other factors.
 Comparison of Theory of Comparative Costs and Modern Theory:

Theory of Comparative Costs Modern Theory
The basis is the difference between countries is Explains the causes of differences in comparative
comparative costs. costs as differences in factor endowments.
Based on labour theory of value. Based on money cost which is more realistic.
Considered labour as the sole factor of production Widened the scope to include labour and capital as
and presents a one-factor (labour) model. important factors of production. This is 2-factor
model and can be extended to more factors.
Treats international trade as quite distinct from International trade is only a special case of inter-
domestic trade. regional trade.
Studies only comparative costs of the goods Considers the relative prices of the factors which
concerned. influence the comparative costs of the goods.
Attributes the differences in comparative advantage Attributes the differences in comparative advantage
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to differences in productive efficiency of workers. to the differences in factor endowments.

Does not take into account the factor price Considers factor price differences as the main cause
differences. of commodity price differences.
Does not provide the cause of differences in Explains the differences in comparative advantage in
comparative advantage. terms of differences in factor endowments.
Normative; tries to demonstrate the gains from Positive; concentrates on the basis of trade.
international trade.
 New Trade Theory.

 Developed and big countries are trade partners when they are trading similar goods and services.
 This is particularly true in key economic sectors such as electronics, IT, food, and automotive.
 NTT argues that, because of substantial economies of scale and network effects, it pays to export
phones to sell in another country. Those countries with the advantages will dominate the market, and
the market takes the form of monopolistic competition.
 According to NTT, two key concepts give advantages to countries that import goods to compete with
products from the home country:
Economies of Scale Network Effects:
 As a firm produces more of a product its cost per unit  The value of the product or service is
keeps going down. So if the firm serves domestic as enhanced as the number of individuals
well as foreign market instead of just one, then it can using it increases.
recap the benefit of large scale of production  This is also referred to as the ‘bandwagon
consequently the profits are likely to be higher. effect’.
 Consumers like more choices, but they also
want products and services with high
utility, and the network effect offers
increased utility from these products over
others.
 A good example will be Mobile App such as
Whats App and software like Microsoft
Windows.
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Chapter-4, Unit-II: The Instruments of Trade Policy By: CA Nitin Guru
CHAPTER 4: UNIT-II: THE INSTRUMENTS OF TRADE POLICY

 Trade Policy and its instruments
 All instruments that governments may use to promote or restrict imports and exports.
 The instruments of trade policy can be classified as:
1. Price- related measures such as tariffs, and
2. Non-price measures or non-tariff measures (NTMs).
 Tariff as Trade Policy Instrument and its various types.

 Tariffs (Custom Dues)
 Taxes or dues imposed on goods and services which are imported or exported.
 Import dues being pervasive than export dues, tariffs are often identified with import dues.
Aim Forms of Import Tariffs Other variations of the these two
tariffs,
 Alter the relative (i) Specific Tariff: a) Mixed Tariffs
prices, so as to contract  Assigns a fixed monetary tax b) Compound Tariff or a Compound
the domestic demand. per physical unit of the good Duty
 Regulate the volume of imported. It is calculated on c) Technical/Other Tariff
their imports. the basis of a unit of measure, d) Tariff Rate Quotas
 World market price of such as weight, volume, etc., e) Most-Favored Nation Tariffs
the goods unaffected; of the imported good. f) Variable Tariff
while raise their prices  Its protective value varies g) Preferential Tariff
in the domestic market. inversely with the price of the h) Bound Tariff
 Raise revenue for the import. i) Applied Tariffs
government, and (ii) Ad Valorem Tariff: j) Escalated Tariff
 protect the domestic  A constant percentage of the k) Prohibitive Tariff
import-competing monetary value of one unit of l) Import Subsidies
industries. the imported good. m) Tariffs as Response:
 Protective value of tariff on  The following sections relate to
home producer. such tariff responses to
 Gives incentives to deliberately distortions related to foreign
undervalue the good’s price on dumping and export subsidies:
invoices and bills of lading to 1) Anti-Dumping Duties
reduce the tax burden 2) Countervailing Duties
 Effects of Tariff on the World Economics

 Obstacles to Trade
 Domestic consumers suffer a loss in consumer surplus
 Encourage Domestic Consumption
 Increases consumer surplus
 High Profits and Increase in Employment
 Tariffs discourage efficient production in the rest of the world
 Increase Government Revenues
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 Non-Tariff Measures and it’s Two Categories?

 Potentially have an economic effect on international trade in goods, changing quantities traded, or
prices or both.
 Alter the conditions of international trade.
 NTMs are not the same as non-tariff barriers (NTBs) as they encompass a broader set of measures.
 Two categories of NTMs:

(i) Technical Measures: (ii) Non-Technical Measures:
 Product-specific properties such as  Relate to trade requirements; for example; shipping
characteristics of the product, requirements, custom formalities, trade rules, taxation
technical specifications and production policies, etc.
processes.  These are further distinguished as:
 Intended for ensuring product quality, a) Hard measures (e.g. Price and quantity control
food safety, environmental protection, measures),
national security and protection of b) Threat measures (e.g. Anti-dumping and safeguards) and
animal and plant health. c) Other measures such as trade-related finance and
investment measures.
 Furthermore, the categorization also distinguishes between:

1) Import-related measures
2) Export-related measures
3) Procedural Obstacles
 Technical Measures
Sanitary and Phytosanitary (SPS) Measures  Technical Barriers to Trade (TBT):
 Protect human, animal or plant life from risks  Both food and non-food traded products refer
arising from additives, pests, contaminants, to mandatory ‘Standards and Technical
toxins or disease-causing organisms and to Regulations’.
protect biodiversity.  It defines the specific characteristics that a
 Ban or prohibition of import of certain goods, product should have, such as its size, shape,
all measures governing quality and hygienic design, labeling / marking / packaging,
requirements, production processes, and functionality or performance and production
associated compliance assessments. methods, excluding measures covered by the
 For example: prohibition of import of poultry SPS Agreement.
from countries affected by avian flu etc.  Compulsory quality, quantity and price control of
goods before shipment from the exporting
country.
 Some examples of TBT are: food laws, quality
standards, industrial standards, organic
certification, eco-labeling, marketing and label
requirements.
 Non-Technical measures
 Neutralize the possible adverse effects of imports in the market of the importing country.
 Following are the most commonly practiced measures in respect of imports:
Contact No. 9211122778 Page 4.2.2

1. Import Quotas:
(a) Binding Quotas
(b) Non-Binding Quotas
(c) Absolute Quotas
2. Price Control Measures ('para-tariff' measures):

3. Non-Automatic Licensing and Prohibitions:
4. Financial Measures:
5. Measures Affecting Competition:
6. Government Procurement Policies:
7. Trade-Related Investment Measures:
8. Distribution Restrictions:
9. Restriction on Post-sales Services:
10. Administrative Procedures:
11. Rules of Origin:
12. Safeguard Measures:
13. Embargos:
 Export-related measures.
(i) Ban on Exports:
(ii) Export Taxes:
(iii) Export Subsidies and Incentives:
(iv) Voluntary Export Restraints:
Contact No. 9211122778 Page 4.2.3

Chapter-4, Unit-III: Trade Negotiations By: CA Nitin Guru
CHAPTER 4: UNIT-III: TRADE NEGOTIATIONS

 Introduction
 Intense bilateral and multilateral negotiations among different nations.
 India has already become part of 19 such agreements and currently negotiating more than two dozens
of such proposals.
 International Trade Negotiations

 Complex interactive processes.
 Stakeholders are not national governments alone but many interest groups, lobbying groups, pressure
groups and-Non Governmental Organizations (NGO) exert their influence on the process.
 Taxonomy of Regional Trade Agreements

 Regional Trade Agreements
 Groupings of countries, which are formed with the objective of reducing barriers to trade
between member countries.
 Different Types of Agreements
1. Unilateral Trade Agreements
2. Bilateral Agreements
3. Regional Preferential Trade Agreements
4. Trading Bloc
5. Free-Trade Area
6. Customs Union
7. Common Market
8. Economic and Monetary Union
 Few Political Institutions that help in International Trade

 Former General Agreements on Tariffs and Trade (GATT) and the World Trade Organization (WTO).
 Development of GATT and Reasons for its failure
 General Agreement on Tariffs and Trade (GATT):

 Provided the rules for much of world trade for 47 years, from 1948 to 1994.
 It was only a multilateral instrument governing international trade or a provisional agreement along
with the two full-fledged “Bretton Woods” institutions, the World Bank and the International
Monetary Fund.
 Eight rounds of multilateral negotiations known as “trade rounds” held under the GATT resulted in
international trade liberalization.
 Reasons for Failure:
The GATT lost its relevance by 1980s because:
 Obsolete
 Substantial expansion
 Did not cover Intellectual property rights and trade in services
 World merchandise trade was beyond its Scope
 Ambiguities
 Agriculture
 Inadequacies in Dispute Settlement
Contact No. 9211122778 Page 4.3.1

 Uruguay Round and the Establishment of WTO.

 More powerful and comprehensive institution was needed.
 The biggest reform of the world’s trading system.
 Members established 15 groups to work on limiting restrictions in the areas of tariffs, non-tariff
barriers, tropical products, natural resource products, textiles and clothing, etc.
 In December 1993, the Uruguay Round, the eighth and the most ambitious and largest ever round of
multilateral trade negotiations in which 123 countries participated, was completed after seven years
of elaborate negotiations.
 World Trade Organization (WTO) and its structure.

 WTO:
 Has authority not only in trade in industrial products but also in agricultural products and
services.
 WTO replaced GATT as an international organization, the General Agreement still exists as the
WTO’s umbrella treaty for trade in goods.
 Objectives of WTO:
 raising standards of living
 ensuring full employment and a large and steadily growing volume of real income and effective
demand
 expanding the production of and trade in goods and services
 Structure of WTO:
 Supported by a Secretariat located in Geneva, headed by a Director General.
 Three-tier system of decision making. The WTO’s top level decision-making body is the
Ministerial Conference which can take decisions on all matters. The Ministerial Conference meets
at least once every two years.
 General Council which meets several times a year at the Geneva headquarters. The General
Council also meets as the Trade Policy Review Body and the Dispute Settlement Body.
 At the next level, the Goods Council, Services Council and Intellectual Property (TRIPS) Council
report to the General Council. These councils are responsible for overseeing the implementation of
the WTO.
 Numerous specialized committees, working groups and working parties deal with the individual
agreements and other areas such as the environment, development, membership applications and
regional trade agreements.
 The WTO accounting for about 95% of world trade currently has 164 members, of which 117 are
developing countries or separate customs territories accounting for about 95% of world trade.
 Guiding Principles of World Trade Organization (WTO).

 Trade without discrimination: Most-favored-nation (MFN)
 The National Treatment Principle (NTP)
 Free Trade
 Predictability
 Principle of general prohibition of quantitative restrictions
 Greater Competitiveness
 Tariffs as legitimate measures for the protection of domestic industries
 Transparency in Decision Making
 Progressive Liberalization
 Market Access
Contact No. 9211122778 Page 4.3.2

 Special privileges to less developed countries

 Protection of Health & Environment
 A transparent, effective and verifiable dispute settlement mechanism
 Some main features of WTO.

 Agreement on Agriculture
 Agreement on the Application of Sanitary and Phytosanitary (SPS)
 Agreement on Textiles and Clothing
 Agreement on Technical Barriers to Trade (TBT)
 Agreement on Trade-Related Investment Measures (TRIMS)
 Anti-Dumping Agreement
 Customs Valuation Agreement
 Agreement on Pre-Shipment Inspection (PSI)
 Agreement on Rules of Origin
 Agreement on Import Licensing
 Agreement on Subsidies and Countervailing Measures
 Agreements on Safeguards
 General Agreement on Trade in Services (GATS)
 Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS)
 Understanding on Rules and Procedures Governing the Settlement of Disputes (DSU)
 Trade Policy Review Mechanism (TPRM)
 Plurilateral Trade Agreements:
1. Agreement on Trade in Civil Aircraft
2. Agreement on Government Procurement
 “The Doha Round”.

 The Doha Round, formally the Doha Development Agenda, which is the ninth round since the Second
World War was officially launched at the WTO’s Fourth Ministerial Conference in Doha, Qatar, in
November 2001.
 To accomplish major modifications of the international trading system through lower trade barriers
and revised trade rules.
 The negotiations include 20 areas of trade, including agriculture, services trade, market access for
nonagricultural products, and certain intellectual property issues.
 The most controversial topic in the yet to conclude Doha Agenda has been agriculture trade.
 Few concerns of WTO.

 Multilateral Negotiations are very slow
 Regional Agreements introduces Uncertainties
 Difficulty in Liberalizing Agriculture / Textile
 Doha Development Round
 Dissatisfaction among Developing Countries
 Concerns of Developing Countries
 High Tariffs
 Tariff Escalation
 Narrowing Rate Differences
 Least Developed Countries
Contact No. 9211122778 Page 4.3.3

Chapter-4, Unit-IV: Exchange Rate and Its Economic Effects By: CA Nitin Guru
CHAPTER 4: UNIT-IV:
EXCHANGE RATE AND ITS ECONOMIC EFFECTS
 Foreign Exchange and Exchange Rate
Foreign Exchange Exchange Rate:
 Money denominated in a currency other than  the rate at which the currency of one country
the domestic currency, exchanges for the currency of another
 Has a price. country.
 Two ways to express nominal exchange rate between two currencies

(i) Direct Quote: (ii) Indirect Quote:
 Number of units of a local currency  number of units of a foreign currency
exchangeable for one unit of a foreign exchangeable for one unit of local currency.
currency.  domestic currency is the base currency; and
 foreign currency is the base currency; and  foreign currency is the counter currency.
 domestic currency is the counter currency.
 Cross Trade
 Two pairs of currencies with one currency being common between the two pairs.
 For instance, exchange rates may be given between a pair, X and Y and another pair, X and Z. The
rate between Y and Z is derived from the given rates of the two pairs (X and Y, and, X and Z) and
is called ‘cross rate’.
 Exchange Rate Regimes

 System by which a country manages its currency in respect to foreign currencies.
 It refers to the method by which the value of the domestic currency in terms of foreign currencies
is determined.
 There are two major types of exchange rate regimes at the extreme ends; namely:
Floating Exchange Rate Regime (or Flexible Fixed Exchange Rate Regime (or pegged
Exchange Rate) exchanged rate)
 The equilibrium value of the exchange rate  Country‟s Central Bank and/ or government
of a country‟s currency is market- announces or what its currency will be worth
determined. in terms of either another country‟s
 Any intervention by the central banks is currency.
intended for only moderating the rate of  Government intervenes in the foreign
change and preventing undue fluctuations in exchange market so that the exchange rate
the exchange rate. of its currency is different from what the
market would have produced
 In the real world, there is a spectrum of „intermediate exchange rate regimes‟ which are either
inflexible or have varying degrees of flexibility that lie in between these two extremes (fixed and
flexible).
 IMF Classifications and Definitions of Exchange Rate Regimes

 Refer the Chapter -4 Unit IV notes
Contact No. 9211122778 Page 4.4.1

 Advantages and limitations of Fixed Rate Regime.

 Advantages:
 Eliminates Exchange Rate Risks
 Lower Levels of Inflation
 Greater Trade and Investment
 Credibility of the Country‟s Monetary-Policy
 Limitations:
 Central Bank Intervention
 Foreign Exchange Reserves
 Advantages and limitations of Floating Exchange Rate Regime.

 Advantages:
 Independent Monetary Policy
 Policy Tool
 No Obligation and No Intervention
 Limitations:
 Uncertainties in relation to International Transactions
 Add a Risk Premium
 Nominal Exchange Rate, Real Exchange Rate and Real Effective Exchange Rate (REER).
Nominal Exchange Rate: Real Exchange Rate: Real Effective Exchange Rate
 how much of one  „how many‟ of a good or service in  the nominal effective
currency (i.e. money) one country can be traded for „one‟ exchange rate (a measure of
can be traded for a of that good or service in a foreign the value of a domestic
unit of another country. currency against a weighted
currency when prices  It is calculated as : average of various foreign
are constant.  Nominal exchange rate X currencies) divided by a price
(Domestic Price Index / Foreign deflator or index of costs.
price Index )
 The Foreign Exchange Market

 Wide-reaching collection of markets and institutions that handle the exchange of foreign currencies.
 The participants use one currency to purchase another currency.
 An electronically linked network.
 Various parties participate in foreign exchange market

Major Participants: Other Participants:
 central banks,  individuals who form only a very
 commercial banks, insignificant fraction in terms of volume
 governments, and value of transactions.
 foreign exchange Dealers,
 multinational corporations that engage in international
trade and investments,
 non-bank financial institutions
 insurance companies,
 brokers,
 arbitrageurs, and
 speculators
Contact No. 9211122778 Page 4.4.2

 Arbitrage.
 Practice of making risk-less profits by intelligently exploiting price differences of an asset at
different dealing locations.
 When price differences occur in different markets, participants purchase foreign exchange in a low-
priced market for resale in a high-priced market and makes profit in this process.
 Two types of transactions

(i) Current Transactions:
Carried out in the spot market and the exchange involves immediate delivery.
(ii) Future Delivery:
Contracts to buy or sell currencies for future delivery which are carried out in forward and/or
futures markets.
 Define:
(a) Spot Exchange Rates:
Exchange rates prevailing for spot trading (for which settlement by and large takes two days) are
called spot exchange rates.
(b) Forward Exchange Rates:
The exchange rates quoted in foreign exchange transactions that specify a future date are called
forward exchange rates.
(c) Forward Premium
A forward premium is said to occur when the forward exchange rate is more than a spot trade rates.
(d) Forward Discount:
On the contrary, if the forward trade is quoted at a lower rate than the spot trade, then there is a
forward discount.
 “Vehicle Currency”
Most transactions involve exchanges of foreign currencies for the U.S. dollars even when it is not the
national currency of either the importer or the exporter. Thus, dollar is often called a ‘vehicle currency’.
 Reasons for Demand for Foreign Exchange

 purchase goods and services from another country
 for unilateral transfers such as gifts, awards, grants, donations or endowments
 to make investment income payments abroad
 to purchase financial assets, stocks or bonds abroad
 to open a foreign bank account
 to acquire direct ownership of real capital, and
 for speculation and hedging activities related to risk-taking or risk-avoidance activity
 Reasons for supply of Foreign Exchange

The participants on the supply side operate to:
 sell goods and services to another country
 for unilateral transfers such as gifts, awards, grants, donations or endowments
 to make investment income receipts from abroad
 to sell financial assets, stocks or bonds abroad
 to open a foreign bank account
 to sell direct ownership of real capital, and
 for speculation and hedging activities related to risk-taking or risk-avoidance activity.
Contact No. 9211122778 Page 4.4.3

 Determination of Foreign Exchange Rate

 The equilibrium rate of exchange is determined by the interaction of the supply and demand for a
particular foreign currency.
Determination of Nominal Exchange Rate
 Changes in Exchange Rates

 Appreciation
 Currency appreciates when its value increases with respect to the value of another currency or a
basket of other currencies.
 Depreciation
 Currency depreciates when its value falls with respect to the value of another currency or a
basket of other currencies.
 Home Currency Depreciation and Appreciation under Floating Exchange Rates

Home Currency Depreciation under Floating Home Currency Appreciation under Floating
Exchange Rates Exchange Rates
 Difference between Devaluation (Revaluation) and Depreciation (Appreciation) of currency.

Basis of Difference Devaluation of currency Depreciation of currency
Meaning It is a deliberate downward adjustment It is a decrease in a currency's value
in the value of a country's currency due to market forces.
relative to another currency, group of
Contact No. 9211122778 Page 4.4.4

currencies or standard.
Exchange Rate System It is done under fixed exchange rate It is done under floating exchange rate
system. system.
Reason Devaluation takes place due to Depreciation takes place due to market
government policy. forces.
Impact on Economy It affects the economy for a short It affects the economy for a longer
term. term.
Frequency There is no fixed time for it but it It occurs on a daily basis.
doesn‟t occur in regularly.
 Impacts of foreign exchange rate deprecation on Domestic Economy.

(a) On Country‟s Trade
(b) On Price of goods and services in International Markets
(c) On Economic Activity
(d) On Change International Competitiveness
(e) Consumer Price Inflation
(f) Shift in use of factors of production
(g) On Balance of Payment
(h) On Borrowing Companies
(i) On International Investments
 The other impacts of currency depreciation are:
(i) Windfall gains for export oriented sectors.
(ii) Remittances to homeland by non – residents and businesses abroad fetches more in terms of
domestic currency
(iii) Enhance government revenues from import related taxes, especially if the country imports more of
essential goods
(iv) Higher amount of local currency for a given amount of foreign currency borrowings of government.
(v) Positive impact on country‟s trade deficit as it makes imports more expensive for domestic
consumers and exports cheaper for foreigners.
(vi) Positive impact on controlling spiraling gold imports (mostly wasteful) and thereby improve trade
balance.
 Can depreciation of currency lead to Contractionary effects?

 In an under developed or semi industrialized country, where - inputs (such as oil) and components for
manufacturing are mostly imported and cannot be domestically produced, increased import prices will
increase firms‟ cost of production , push domestic prices up and decrease real output.
 Therefore, depreciation may also cause contractionary effects.
 Impacts of foreign exchange rate appreciation on Domestic Economy

(a) Rise in price of exports
(b) Dependent on stage of business cycle
(c) Reduction in the levels of inflation
(d) Lower International Competitiveness
(e) Deficit Current Account Balance
Contact No. 9211122778 Page 4.4.5

Chapter-4, Unit-V: International Capital Movements By: CA Nitin Guru
CHAPTER 4: UNIT-V:
INTERNATIONAL CAPITAL MOVEMENTS
 Components/types of Foreign Capital
 includes any inflow of capital into the home country from abroad.
 Some of the important components of foreign capital flows are:
1. Foreign aid or assistance
2. Borrowings which may take different forms such as:
3. Deposits from non-resident Indians (NRI)
4. Investments in the form of :
(i) Foreign portfolio investment (FPI) in bonds, stocks and securities, and
(ii) Foreign direct investment(FDI) in industrial, commercial and similar other enterprises
 Foreign Direct Investment (FDI)

(i) A process whereby the resident of one country (i.e. home country) acquires ownership of an asset in
another country (i.e. the host country).
(ii) According to IMF manual,
Acquisition of more than 10 percent of the shares of the target asset.
(iii) According to the IMF and OECD definitions, the acquisition of at least ten percent of the ordinary
shares or voting power in a public or private enterprise by non- resident investors makes it eligible to be
categorized as foreign direct investment (FDI). India also follows the same pattern of classification.
 Types of components of Foreign Direct Investment

 FDI has three components as follows:
1. Equity capital,
2. Reinvested earnings, and
3. Other direct capital in the form of intra-company loans between direct investors (parent
enterprises) and affiliate enterprises.
 The main forms of direct investments are:
(a) the opening of overseas companies, including the establishment of subsidiaries or branches,
(b) creation of joint ventures on a contract basis,
(c) joint development of natural resources, and
(d) purchase or annexation of companies in the country receiving foreign capital.
 Categories of Foreign Direct Investment

(a) Horizontal direct investment
(b) Vertical investment
(c) Conglomerate type of foreign direct investment
(d) Two- way direct foreign investments
 Foreign Portfolio Investment (FPI)

 Flow of ‘financial capital’ and does not involve ownership or control on the part of the investor.
 Examples of foreign portfolio investment are the deposit of funds in an Indian or a British bank by an
Italian company or the purchase of a bond (a certificate of indebtedness) of a Swiss company etc.
 Not concerned with either manufacture of goods or with provision of services.
 The singular intention is to earn a remunerative return through investment.
 Portfolio investments are characterised by lower stake in companies with their total stake in a firm
at below 10 percent.
 Short term nature and speculative.
Contact No. 9211122778 Page 4.5.1

 Difference between Foreign Direct Investment and Foreign Portfolio Investment is as follows:
Basis of Difference Foreign direct investment (FDI) Foreign portfolio investment (FPI)
Investment Investment involves creation of physical Investment is only in financial assets.
assets.
Duration Has a long term interest and therefore Only short term interest and generally
remain invested for long. remain invested for short periods.
Withdrawal Relatively difficult to withdraw. Relatively easy to withdraw.
Nature Not inclined to be speculative. Speculative in nature.
Technology Transfer Often accompanied by technology Not accompanied by technology

transfer. transfer.
Impact on Labour and Direct impact on employment of labour and No direct impact on employment of
wages wages. labour and wages.
Impact on Management Enduring interest in management and No abiding interest in management and
and Control control. control.
Securities held Securities are held with significant degree Securities are held purely as a financial
of influence by the investor on the investment and no significant degree of
management of the enterprise. influence on the management of the
enterprise.
 Reasons for Foreign Direct Investment

 Expectation of higher rate of return.
 Firm-specific knowledge or assets (such as superior management skills or an important patent)
 Other reasons are as follows:
(a) Increasing Interdependence
(b) Internationalization of Production and Investment
(c) Economies of Large Scale
(d) Lack of feasibility of Licensing Agreements
(e) Necessity to retain Direct Control of production knowledge
(f) Avoid competition
(g) Retain complete control
(h) Desire to capture markets
(i) Desire to access to minerals or raw materials
(j) Cheaper Labour
(k) Tax Differentials
 Host country determinants of Foreign Direct Investment

Refer to the Unit – V of Chapter 4
 Few factors that discourage Foreign Direct Investment

(i) infrastructure lags,
(ii) high rates of inflation,
(iii) balance of payment deficits,
(iv) poor literacy and low labour skills,
(v) rigidity in the labour market,
(vi) bureaucracy and corruption,
Contact No. 9211122778 Page 4.5.2

(vii) unfavourable tax regime,

(viii) cumbersome legal formalities and delays,
(ix) small size of market and lack of potential for its growth,
(x) political instability,
(xi) absence of well- defined property rights,
(xii) exchange rate volatility,
(xiii) poor track-record of investments,
(xiv) prevalence of non-tariff barriers,
(xv) stringent regulations,
(xvi) lack of openness,
(xvii) language barriers,
(xviii)high rates of industrial disputes,
(xix) lack of security to life and property,
(xx) lack of facilities for immigration and employment of foreign technical and administrative
personnel,
(xxi) double taxation and
(xxii) lack of a general spirit of friendliness towards foreign investors.
 Modes of Foreign Direct Investment.

(i) Opening of a subsidiary or associate company in a foreign country
(ii) Equity injection into an overseas company,
(iii) Acquiring a controlling interest in an existing foreign company,
(iv) Mergers and acquisitions(M&A)
(v) Joint venture with a foreign company.
(vi) Green field investment (establishment of a new overseas affiliate for freshly starting production by a
parent company).
 Benefits of Foreign Direct Investment

1. Competitive environment
2. Finance more investment
3. Accelerate growth and economic development
4. Political Reforms
5. Direct Employment
6. Indirect Employment
7. Relatively higher wages
8. Access to foreign markets
9. Secure Foreign Exchange
10. Source New Tax Revenue
11. Better work culture and higher productivity
 Potential problems associated with Foreign Direct Investment

1. Low employment opportunities
2. Leads to Inequalities
3. Rise in interest rates
4. Instability of Balance of Payment
5. Lack of Quality jobs
6. Anti – Ethical
7. Decreasing Competitiveness of Domestic Companies
8. Exploitation of natural resources
Contact No. 9211122778 Page 4.5.3

 Foreign Direct Investment in India.

 Import substitution policy was followed after independence.
 FERA permitted upto 40% of foreign equity holding in a joint venture.
 The Industrial Policy announcements of 1980 and 1982 and the Technology Policy Statement (1983)
provided for a moderately lenient attitude towards foreign investments by:
(a) Endorsement of manufacturing exports
(b) Modernisation of industries through liberalised imports of capital goods and technology
(c) Tariff reduction
 In 1991, India had an economic liberalisation and reforms and few Initiatives of Government are as
follows:
(a) automatic approval of FDI,
(b) simplification of procedures,
(c) setting up of Foreign Investment Promotion Board (FIPB abolished wef May 2017), etc.
 In India, foreign investment is prohibited in the following sectors:
(a) Lottery business including Government / private lottery, online lotteries, etc.
(b) Gambling and betting including casinos etc.
(c) Chit funds
(d) Nidhi company
(e) Trading in Transferable Development Rights (TDRs)
(f) Real Estate Business or Construction of Farm Houses
(g) Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes
(h) Activities / sectors not open to private sector investment e.g. atomic energy and railway
operations (other than permitted activities).
 The FDI regime was liberalized on 20-June-2016, to make India an open economy and provide
employment and included:
(a) increase in sectoral caps,
(b) bringing more activities under automatic route and
(c) easing of conditions for foreign investment.
 The liberalized policy 2016, included easing of FDI in:
(a) defence sector,
(b) e-commerce
(c) food products manufactured or produced in India,
(d) pharmaceuticals (Greenfield and Brownfield), etc.
 Overseas Direct Investment (ODI) by Indian Companies.

 Overseas direct investments by Indian companies was made possible by:
(a) progressive relaxation of capital controls and
(b) simplification of procedures for outbound investments from India
 ODI have undergone substantial changes in terms of: size, geographical spread and sectoral
composition.
 Outward Foreign Direct Investment (OFDI) from India stood at US$ 1.86 billion in the month of
June 2016.
 The overseas investments have been primarily driven by resource seeking, market seeking or
technology seeking motives.
 Overseas investments are made by Indian companies:
(a) To acquire energy resources in Australia, Indonesia and Africa.
(b) To have higher tax benefits in countries such as Mauritius, Singapore, British Virgin Islands, and
the Netherlands
 At present, an Indian investor cannot make ODI in certain real estate activities.
Contact No. 9211122778 Page 4.5.4

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Chapter-1, Unit-I: National Income Accounting By: CA Nitin Guru

CHAPTER 1: UNIT-I: NATIONAL INCOME ACCOUNTING

(ii) Determines Present and Future Demand:

(v) Economic Forecasting:

Contact No. 9211122778 Page 1.1.1

(i) Product Side:

GDPMP = Value of Output in the Domestic Territory – Value of International Consumption

GDPMP = Σ Value Added

Contact No. 9211122778 Page 1.1.2

(i) Only Final Goods and Services:

GNPMP = GDPMP + Net Factor Income from Abroad

GDPMP = GNPMP – Net Factor Income from Abroad

Contact No. 9211122778 Page 1.1.3

National = Domestic + Net Factor Income from Abroad

NDPMP = GDPMP –Depreciation

NDPMP = NNPMP – Net Factor Income from Abroad

Gross = Net + Depreciation

Contact No. 9211122778 Page 1.1.4

NNPMP = GNPMP – Depreciation

Market Price = Factor Cost + Net Indirect Taxes

Factor Cost = Market Price – Net Indirect Taxes

Contact No. 9211122778 Page 1.1.5

Contact No. 9211122778 Page 1.1.6

Contact No. 9211122778 Page 1.1.7

Domestic territory doesn't include -

Final Goods and Intermediate Goods

Contact No. 9211122778 Page 1.1.8

Consumption Goods and Capital Goods

Domestic Income and National Income

Depreciation and Capital Loss

Contact No. 9211122778 Page 1.1.9

Personal Income and Private Income

Personal Income and National Income

Domestic Income (NDPFC)

Income from Domestic Product Income from Domestic Product

Income from Property and

Contact No. 9211122778 Page 1.1.10

Private Income includes:

Factor Income earned: Transfer Income received:

within Domestic from Rest of the

Income from Interest on Net current

Contact No. 9211122778 Page 1.1.11

National Disposable Income (NDY) = National Consumption Expenditure + National Savings

Gross National Disposable Income

Gross National Disposable Income = Net National Disposable Income + Depreciation

(+) Net Indirect Taxes

(+) Net Current Transfers from rest of the world

Net National Disposable Income

Gross National Disposable Income

Real GDP = x 100

GDP Deflator (or Price Index) = x 100

Contact No. 9211122778 Page 1.1.12

Contact No. 9211122778 Page 1.1.13

CHAPTER 1: UNIT-II: THE KEYNESIAN THEORY OF

Contact No. 9211122778 Page 1.2.1

The short-run aggregate demand function can be written as:

Contact No. 9211122778 Page 1.2.2

Contact No. 9211122778 Page 1.2.3

Basis APC MPC