Macroeconomics

Macroeconomics
(CCF)
Semester -2
University of Calcutta
By
Gobind Kumar Jha GKJ
۰ CHARTERED ACCOUNTANT (F)
۰ L.L.B(HONS)
۰ M.COM FROM CU
۰ B.COM (GOENKAN)
۰ DOUBLE GRADUATE
JOIN NOW
+919874411552
/ Gobind Kumar Jha gkj
strivingforlargest_gkj
CONTENTS
Chapter Name Page No.
1. Economics Basic Concepts 1-3
2. National Income 4 - 12
3. Equilibrium National Income Determination 13 - 21
4. Money And Inflation 22 - 31
5. Public Finance 32 - 37
Chapter Name Page No.

?
?
Calcutta University Questions 3
Gobind Kumar Jha
9874411552
1 ECONOMICS
Chapter
Basic Concepts
Introduction: Economics is the study of how individual and societies choose to use the scarce
resources that nature and previous generations have passed to them. Economics is the science which
studies how scarce resources are employed for the satisfaction of the needs of men living in society.
On the one hand, it is interested in the essential operations of production, distribution and
consumption of goods and on the other hand in the institutions and activities whose object is to
facilitate these operations.
Scope of Economics: Let us take a brief look at the two major divisions of economics-
➢ Microeconomics
➢ Macroeconomics
Macro Economics: The word macro comes from the Greek word Makros, whose meaning is large. An
economic which deal with the total parts of the economic system is called Macro-economic. In other
words, macroeconomics is concerned with aggregate and average of the total parts of the economic
system. Thus, macroeconomics takes a macroscopic view of the economic system. National Income,
aggregate output, total consumption expenditure, total investment expenditure, total savings, total
employment, general price level, supply of money, bank, international trade, public finance etc.
included in the analytic of macro-economics. Macroeconomics is a branch of economics that deals with
the performance, structure, behaviour and decision-making of the entire economy, be that a national,
regional, or the global economy. So, macroeconomics deals with aggregated data expressed in terms
of large totals or averages.
According to Prof. Ackley "Macro Economics deals with economic affairs in the large, it concerns
the overall dimensions of economic life. It looks at the total size, shape and functioning of the
elephant of economic experience, rather than working of articulation or dimensions of the individual
parts. It studies the character of the forest, independently of the trees which compose it."
According to Kenneth Bouldering, “Macro deals with individual income but with national income, not
with individual prices but with the price level, not with individual outputs but with national outputs.”
According to Paul Samuelson, “Macroeconomics is the study of the behaviour of the economy as a
whole. It examines the forces that affect many firms, consumers and workers at the same time.”
Basic Concepts of Macro Economics:

➢ Consumer goods (Consumption goods): The goods which are used for consumption purpose are
called consumer goods. They are used for direct consumption, and not for producing any other
goods.
➢ Capital goods: All the durable goods like Building, Machines, Motor cars, Aircraft etc. used to
produce goods and services for sale in the market are known as capital goods.
➢ Consumption: Consumption means satisfactions of wants. In general words we have wants that
we consume various goods and services. Consumption defined the satisfaction of human wants
through the consume the goods and services.
➢ Saving & Savings: Saving means whatever is left in the hands of an individual after expenditure
is the saving. The sum total of funds in the hands of an individual obtained by accumulating the
savings of the past years is called the savings of the individual.
1
Gobind Kumar Jha
9874411552
➢ Investment: An investment is the purchase of goods and services that are not consumed today
but are used in the future to generate wealth.
Scope of Macroeconomics: As a method of economic analysis, macroeconomics is of much

theoretical and practical importance:
➢ To Understand the Working of the Economy: The study of macroeconomics and

macroeconomic variables is indispensable for understanding the working of the economy. It is
very essential for a proper and accurate knowledge of the behaviour pattern of the aggregation
variables like total income, output, employment, and general price level in the economy.
➢ Formulation of Economic Policies: Macroeconomics is extremely useful from the point of view
of economic policy. The days of 'laissez-faire' are over and government intervention in economic
matters is an accomplished fact. We know in underdeveloped or developing economies, there
exist some problems like overpopulation, inflation, balance of payments crisis, general under
production etc. The government in such situation formulates their economic policies to regulate
or control the economic problems. Macroeconomics helps us to identify and analyse the causes
and to adopt suitable policies to overcome the problem.
➢ Inflation and Deflation: The study of macroeconomics is important to analyse and understand
the effects of inflation and deflation to the different sections of society as a result of the
changes in the value of money. Through the macroeconomic study we can take difference steps
like making changes in fiscal and monetary policy to counter the adverse effect of inflation or
deflation.
Macroeconomic Variables: Macroeconomic variables are indicators or main signpost signalling the
current trends in the economy. Like all experts, the governments in order to do a good job of macro-
managing the economy, must study, analyze and understand the major variables that determine the
current behaviour of the macro-economy.
The main variable of macroeconomics:
• National Income
• Employment
• Economic Growth
• Balance of Payments
• Inflation
Objectives of Maro-Economics: The basic objectives of macro-economics are as follows:

• Full employment
• Price Stability
• Economic growth
• Balance of payments equilibrium and exchange rate stability
• Social objectives
Stock: It is an important to economic activity

Flow: It means goods move from one person to another
Stock Flow
A stock has no dimension. A flow has a time dimension.
A stock is measured at a point of time A flow is measured per time period
(Example: as on 31st March, 2024) (Example: - Daily, Weekly, monthly etc.)
2
Gobind Kumar Jha
9874411552
A stock indicates the static aspects of an A flow variable indicates the dynamic
economy. aspects of an economy.
A stock often influences a flow, e.g. higher A flow variable also influences a stock e.g.
stock of capital would lead to higher flow greater flow of savings per year would result
of goods and services in an economy. in higher investment and greater capital
stock.
Microeconomics VS Macroeconomics
Microeconomics Macroeconomics
It is that branch of economics which deals It is that branch of economic which deals
with the economic decision making of with aggregates and average of the
individual economic agents such as the economy, e.g. aggregate output, national
producer, the consumer etc. income, aggregate savings and investment
etc.
In microeconomics, the economic decision- In macroeconomics, the decision-making
making units are individual consumer, units are the central Planning Authority,
individual producers. Central Bank (RBI)
It takes into account small components of It takes into consideration the economy of
the whole economic. any country as a whole.
It deals with the process of price It deals with the general price level in any
determination in case of individual economy.
products and factors of production.
Calcutta University
1.
Calcutta University Questions
Questions
Distinguish Between Stock and Flow Concepts in macroeconomics? (2015)
??
2. What is the basic objective of studying macroeconomics? (2015)
3. What is a capital goods? Can any final goods be a capital goods? (2016)
4. What is inventory investment? (2016)
5. What is the difference between the concepts of stock and flow variable in macroeconomics?
(2017)
6. Distinguish between gross investment and net investment. (2017)
7. Distinguish between consumer goods and capital goods. Which of these two are final goods?
(2018)
8. How is macroeconomic different from microeconomics? (2018)
9. State which of the following issues are covered under macroeconomic study:(a) general price
level (b) economic growth of a nation, (c) output of iron and steel industry, (d) price of food
grain. (2019)
10. What do you mean by full employment output? (2019)
3
Gobind Kumar Jha
9874411552
2
Chapter
National Income
National Income: National Income (NI) refers to the money value of final goods and services
produced by the residents of a country whether operating Within the domestic territory of the
country or outside, generally during a year. So, NI is the value of income generated within the
country plus the income earned from abroad. It can also be expressed in terms of the aggregate
expenditure or the aggregate factor income.
National Income is the sum total of factor incomes earned by normal residents of a country during
the period of one year.
𝐧𝐧
𝐄𝐄𝐄𝐄 = ∑ 𝐅𝐅𝐅𝐅𝐅𝐅
𝐢𝐢 = 𝟏𝟏
Economist/ Definitions of NI
Committee
Marshall “labour and capital of a country acting on its natural resource,
produce annually certain net aggregate of commodities, material
and immaterial, including services of all kind”.
AC Pigou “that part of the objective income of the community including of
course, income derived from abroad which can be measured in
money”.
Samuelson “its is the loose name we give the money measure of the overall
annual flow of goods and services in the money”.
National income “a NI estimate measures the volume of commodities and services
committee of India turned out during a given period, counted without duplication”.
Concepts and Measurement of GDP, GNP, NNP, NDP, PI, DPI
➢ Gross Domestic Product (GDP): Gross domestic product (GDP) is the total monetary or market
value of all the finished goods and services produced within a country’s borders in a specific
time period. In the other words gross domestic product in the sum of all the final goods and
services produced by the residents of a country in one year. GDP can be defined by different
ways, as follows:
GDP Explanation
GDP at constant prices If the domestic product is estimated on the basis of fixed prices by
considering a base year then it will be called GDP at constant prices.
GDP at current prices If the domestic product is estimated on the basis of current or
prevailing prices, then it will be called GDP at current prices.
GDP at factor cost It is estimated as the sum of net value added by the different
(GDPFC) producing units and the consumption of fixed capital. It can also be
estimated as the sum of domestic factor income and the consumption
of fixed capital.
GDP at market It is the valuation of goods and services by market prices.

prices(GDPMP)
4
Gobind Kumar Jha
9874411552
Therefore, we can argue that GDPMP and GDPFC must be equal. But these two are not same because
the former includes indirect business taxes (IBT) and does not take into account the subsidies (SUB)
given by the government.
Hence, GDPFC= GDPMP - IBT+SUB
➢ Net Domestic Product (NDP): The net domestic product is obtained by subtracting
depreciation (D) from the gross domestic product (GDP). capital goods like machine, equipment,
tools, factory buildings etc. get depreciated during the process of production. After sometime,
they need replacement.
A part of capital is, therefore set aside in the form of ‘ Depreciation Allowance’ or ‘ Capital
Consumption Allowance’ ( CCA).
Deduction of the depreciation allowance from the GDP, provides us the NDP. Therefore,
Net Domestic Product= Gross Domestic Product - Depreciation
NDP = GDP - CCA.
➢ Gross National Product (GNP): The gross national product is the sum total of all final goods
and service produced by the people of a country in one year. The GNP is a flow concept. GNP
measures the total monetary value of the output produce by a country’s residents.
Therefore,
• any output produced by foreign residents within the country’s borders must be excluded in
calculations of GNP,
• while any output produced by the country’s residents outside of its borders must be counted.
GNP = GDP+NFIA
➢ Net National Product (NNP): Net National Product

(NNP) is equal to gross national product minus capital consumption allowance:
Net National Product (NNP) = Gross National Product (GNP) - Depreciation.
NNP = GNP - CCA
Alternative, it represents the sum total of NDP and NFIA (Net Factor Income from Abroad)
NNP = NDP + NFIA
➢ National Income (NI): National Income (NI) is equal to net national product minus indirect
business taxes.
NI = NNP - IBT(Indirect Business Taxes).
➢ Personal Income (PI): and personal Disposable Income: personal income includes compensation
from a number of sources including salaries, wages, and bonuses received from employment or
self- employment, dividends and distribution received from investment, rental receipts from
real estate investments and profit sharing from businesses.
Disposable personal (DPI) refers to the amount of money that a population has left after taxes
have been paid. It differs from personal income in that it takes taxes into account.
➢ Disposable Personal Income(DI): Di is the portion of income available to an income earner

after all income taxes are deduction. The signification of disposable income are as follows:
• Disposable income is used by analysis to measure the state of an economy.
• It can also be used to measure the households’ financial reserves.
• It helps economists to measures the savings and spending rates of the households.
• Disposable income is used to derive several economic indicators and measures such as
discretionary income and personal saving rate.
5
Gobind Kumar Jha
9874411552
Disposable Personal Income (DI)

= Personal Income - Personal Income Taxes (Direct Tax)
Basis GDP GNP

Definition It is the value of the finished It is the value of all finished
domestic goods and services goods and services produced by
produced within a nation’s borders. a country’s citizens both
domestically and abroad.
Formula GDP = C+1+G(X-M) GNP = GDP+NFIA
Reflection ⚫ Efficiency in Resource Distribution of Resources over
Utilization. the Earth.
⚫ Stability of Government ⚫ Skill set of people
⚫ Functioning of Institutions of ⚫ Regional Imbalances
the Nation.
Significance When GDP grows faster than GNP, When GNP grows faster than
it denotes that the nation is GDP, it denotes a possible brain
advancing in the economic and drain.
technological arena (Possibly).
Stresses The production that is obtained The production that is achieved
domestically. by the citizens living in
different nations.
Gross National Product and Net National Product (GNP and NNP):
Basis GNP NNP

Definition The total market value of all final GNP minus the amount of GNP
goods and services produced by a required to purchase new goods to
country's citizens both domestically maintain existing
and overseas in a given period. stock(depreciation)
Focus Measures the overall income earned Measures the sustainable income of
by a country’s residents, regardless a country after accounting For the
of geographical location. wear and tear of capital goods.
Calculation Sum of GDP (gross domestic It excludes depreciation
product) and net factor income from NNP = GNP - Depreciation
abroad
(NFIA).
GNP = GDP+ NFIA
Interpretation Shows the overall size and Provides a more accurate picture of
productivity of a country’s economy. long - term economic growth and
sustainability as it taken into
account capital consumption.
NI It cannot be treated as NI. It can be treated as NI at factor
cost.
Uses Less commonly used than GDP. Primarily used in environmental
economics and sustainability
studies.
6
Gobind Kumar Jha
9874411552
Importance of GDP Deflator

The GDP deflator is a key metric in macroeconomics that helps us understand and analyse real
economic growth, inflation trends, policy impacts and sectoral dynamics. The GDP deflator plays a
crucial role in macroeconomics for several reasons:
➢ Measuring real changes in economic activity: Nominal GDP which sums up the market value
of all goods and services produced in an economy can be misleading if prices are changing. For
example, a nominal GDP increase could simply reflect inflation, not real growth in production.
The GDP deflator adjusts for these price changes, allowing us to measure real GDP which
reflects the actual volume of goods and services produced. This enables accurate comparisons
of economic activity across different years and economies.
➢ Estimating inflation: While the Consumer Price Index (CPI) focuses on price changes for
goods and services bought by consumers, the GDP deflator offers a broader perspective It
measures the average price changes for all domestically produced goods and services,
encompassing purchases by consumers, businesses and the government. This makes it a valuable
tool for understanding overall inflation trends in an economy.
➢ Analysis economic policies: Policymakers rely on the GDP deflator to assess the
effectiveness of economic policies, such as monetary and fiscal measures. It helps differentiate
between real economic growth driven by increased production and growth simply due to price
inflation. This information is crucial for designing and implementing appropriate policies to
stabilize the economy and achieve desired outcomes.
➢ Understanding sectoral impacts: The GDP deflator can be used to analyse inflation
differentials across different sectors of the economy. By comparing the deflator for specific
sectors to the overall deflator, economists can identify sectors experiencing higher or lower
than average inflation. This information can be helpful in analysing sectoral trends, resource
allocation and potential policy adjustments.
➢ International comparisons: When comparing economic activity across different countries

with varying inflation rates, the GDP deflator is essential for making meaningful comparisons.
Real GDP allows for accurate assessments of relative economic size and growth, providing
valuable insights for international trade, investment and development partnerships.
Difference between Consumer Price Index (CPI) and GDP Deflator
Both Consumer Price Index (CPI) and GDP deflator can be used to measure the rate of inflation. GDP
deflator takes in account the purchases by the business, government as well as consumers but CPI
measures purchases by only consumers.
The circular flow of income: The circular flow of income and expenditure refers to the process
whereby the national income and expenditure of an economy flow in a circular manner continuously
through time.
The various components of national income and expenditure such as savings, investments, taxation,
government expenditure, exports, imports etc.
7
Gobind Kumar Jha
9874411552
Importance of the Circular Flow of Income

The circular flow of income is a fundamental concept in macroeconomics, providing a simplified model
to understand how money flows through an economy. Its importance stems from several key
contributions.
1. Visualization of Economic Activity: It presents a clear visual representation of the continuous

exchange of goods, services and income between households (consumers) and firms (producers).
This helps grasp the interconnections of different economic actors and how their decisions
impact each other.
2. Measurement of National Income: The model serves as a framework for calculating national
income by tracking the flow of income through wages, profits, rent and interen This
measurement allows policymakers to gauge overall economic health and track changes in output
and prosperity.
3. Identification of Leakages and Injections: The model helps identify "leakages" from the
circular flow-factors that remove money from circulation, such as savings, taxes and imports.
Conversely, it also highlights "injections" that add money back in, such as government spending
and investments. Understanding these factors is crucial for analysis economic growth and
fluctuations.
4. Explanation of Interdependence: The model emphasizes the interdependence of different

sectors and actors. If consumers spend less, demand for goods and services falls, impacting
production and income for firms. This, in turn affects wages and income for households,
potentially leading to further decreased consumption a cycle, the model helps illustrate
5. Policy Analysis Tool: The circular flow model serves as a tool for analysis the potential impact
of different economic policies. Changes in government spending, taxation or interest rates can
be simulated within the model to assess their effects on overall income, consumption and
investment.
The circular flow of income while a simplified model plays a crucial role in macroeconomics. It
provides a visual framework for understanding economic activity, facilitates measurement of national
income, identifies key factors like leakages and injections, highlights interdependence and serves as a
tool for analysing policy impacts. Although it has limitations, its simplicity and clarity make it a
valuable teaching tool and a fundamental building block for more complex macroeconomic models.
Circular Flow of Income in a Two-Sector Economy: The circular flow of income model is a
simplified representation of how money flows through an economy.
In a two-sector model, the economy is divided into two main sectors: households and firms.
This model helps us understand how income is generated, distributed and spent within an economy.
Circular Flow of income in a Three-Sector Economy: In our two-sector model, we have ignored
the existence of the government for the sake of making our circular flow model simple. This is quite
unrealistic because the government absorbs a good part of the incomes earned by households.
Government affects the economy in a number of ways: Here, we will concentrate on its
taxing, spending and borrowing roles. Government purchases goods and services just as households
and firms do. Government expenditure takes many forms including spending on capital goods and
8
Gobind Kumar Jha
9874411552
infrastructure (highways, power, communication), on defence goods and education and public health
and so on.
Real and Nominal GDP and GDP Deflator

➢ Nominal GDP
• Concept of Nominal GDP: Nominal GDP is the total value of all goods and Services produced in
a given time period usually quarterly or annually.
Nominal GDP is GDP evaluated at current market prices
Calculation of Nominal GDP
▪ Nominal GDP Calculation for 2022:
Let prices of product X per unit is ₹ 10 in 2022. Therefore, For ₹ 1,000 units,
Nominal GDP= Quantity of X x price per unit of X
Nominal GDP = 1,000 units x ₹ 10/unit = ₹ 10,000
▪ Nominal GDP Calculation for 2023:
Now let’s consider that in the year 2023, the economy produces 1,200 units, but the price
per unit has increased to ₹12/unit due to inflation.
Nominal GDP = Quantity of widgets x price per widget
Nominal GDP = ₹ 1,200 units x ₹ 12/unit = ₹ 14,400
➢ Real GDP
• Concept of Real GDP: Real GDP is nominal GDP adjusted for inflation. Real GDP is used to
measures the actual growth of production without any distorting effects from inflation.
Real GDP is GDP evaluated at the market prices of some base year.
Calculation of Real GDP:
Now let’s calculate real GDP to account for inflation using a hypothetical price index (GDP
deflator)
Let’s assume, the GDP deflator for 2022 is ₹ 100 and for 2023 is ₹ 120 (
based on the prices of ₹ 10 and ₹12 in the previous example).
▪ Real GDP Calculation for 2022:

Real GDP[ = National GDP / GDP Deflator for 2022
Real GDP = ₹ 10,000 / 100= ₹ 100
▪ Real GDP Calculation for 2023:
Real GDP = Nominal GDP/ GDP Deflator for 2023
Real GDP = ₹ 14,400/120=₹ 120
Nominal Vs Real GDP

GDP is a measure of the market or money value of all final goods and services produced by the
economy in a given year. Since, market value is measured by money, it is hard to compare the market
value of GDP from year to year, if the value of money7 its self change in response to inflation and
deflation.
To solve this problem,
We deflate GDP when prices rise and inflate GDP when prices fall
According to a base year.
• Nominal GDP(Unadjusted for inflation): Refers to GDP based on the prices of a product in
the year, it was produced. Not inflated or deflated.
• Real GDP (adjusted For inflation): Refers to a GDP that has been adjusted for inflation or
deflation to accurately show the increase or decrease in production for comparison of economic
to growth from year and measured in relation to the price index of a given year. Having presented
the measurement of GDP , it remains to be seen as how the changes in the GDP value are
9
Gobind Kumar Jha
9874411552
expressed in relation to price level changes as price change affect the value of the national
income aggregates.
➢ GDP Deflator
Concept of GDP Deflator: The GDP deflator is an index that tracks price changes from a
base year. The formula implies that dividing the Nominal GDP by the Real GDP and multiplying
it by Rs.100 will give the GDP Deflator, hence “deflating” the Nominal GDP into a real
measure.
Formula of GDP Deflator: it is measure of price level in an economy and is measured as a
ration of nominal to real GDP. This means that GDP deflator is calculated as nominal GDP
divided by real GDP multiplied by ₹ 100.
GDP deflator = (Nominal GDP/ Real GDP)x ₹ 100
If nominal GDP is ₹ 5.65 crores and Real GDP is ₹ 4.50 crores, then
5.65
GDP deflator = ₹( ) x ₹100= ₹125.56
4.50
Circular flow of Income in a two-sector economy: In simple economy if there is two sectors
i.e. household and firm, then transaction between these two sector will lead to a circular flow of
income. The real flow implies the flow of goods and services across different sector of economy and
money flow implies flow of money in the form of expenditure on various goods and services. The
Circular flow of income is based on the following assumptions –
• All economic decisions are taken by Households and Firms.
• Production takes place in firms and sold to households.
• Households are the suppliers of factor of production.
• Households spend money to purchase goods produced by a firm.
The concept of circular flow can be explained with the help of the following diagram.
In the upper part of this diagram Households supply different factors to firm as shown by real flow
(A) and in return household received factors income from firms as shown by money flow (B). In factor
market households are sellers and firms are buyers. The expenses of firms is the income of
households. In lower part of diagram firms supply goods and services to households as shown by real
flow (C). In return households payments for goods and services to firms as shown by money flow (D).
In product market households are buyer and firms are sellers. The money flows from households to
firm. In other words the expenditure of households is the income of the firm. Since the starting
point and the final point are the same therefore this is called circular flow.
10
Gobind Kumar Jha
9874411552
Circular flow of Income in a three-sector economy: In our above analysis of money flow, we
have ignored the existence of government for the sake of making our circular flow model simple. This
is quite unrealistic because government absorbs a good part of the incomes earned by households’
government affects the economy in a number of ways. Here we will concentrate on its taxing,
spending and borrowing roles. When part of income is spent on tax payment then that part of
spending by any household or a firm can not arise as income of another firm or household. So this tax
payment is considered as the leakage or withdrawal form the circular flow of income. When
government purchase goods and service product by any sector (says firm sector) then income earned
by the firm sector does not depend on expenditure made by the household sector. So the government
expenditure considered as injection into the circular flow of income. It should be noted that in any
economy injection must be equal to withdrawal.
On left part of diagram shows the flow of income and expenditure between household sector and the
government. Household sector pays net tax (tax-transfer payment). On the other hand, the
government also purchase goods and services from the household in form of wages and salaries or
also makes transfer payments in the form pension funds, relief, sickness benefits, health, education
etc. On the right side of the diagram shows the flow of income and expenditure between business
sector and the government business firms pay net taxes (tax-subsidies) to the government. On the
other hand the government provides subsidies and purchase goods and services from the business
sector.
Calcutta University
Calcutta University Questions
Questions ? ?
1. How do you consider pension and unemployment compensation in National Income Accounting?
(2015)
2. What is GDP at factor cost? (2015)
3. What is meant by 'value added' in the context of National Income analysis? (2015)
4. How is personal income different from national income? (2015)
5. How can you deduce personal income from National Income? (2016)
6. How would you distinguish between GDP and GNP? (2016)
7. What adjustments are required to arrive at the figure of Net National Product at Cost, given
the Net National Product at Market Prices? (2016)
8. What is the problem of double-counting in the context of National Income analysis? (2016)
9. What is GDP deflator? Specify its importance. (2017)
10. Distinguish between nominal GDP and real GDP. (2017)
11. What is meant by GNP? (2017)
12. Define National Income. 2017
11
Gobind Kumar Jha
9874411552
13. How would you treat the following issues while estimating National Income: (i) rent-free
house to an employee by an employer, (ii) interest paid on loan taken to purchase a personal
car. (2018)
14. What adjustments are required to arrive at the figure of NNP at factor cost given the GNP
at market price? (2018)
15. What is meant by 'value added' in the context of National Income analysis? (2018)
16. How is Personal Income different from National Income? (2018)
17. What is transfer payment? While estimating NI how do you consider the issues of pension
and unemployment benefits? (2019)
18. Distinguish between GDP at current price and at constant price. (2019)
19. Distinguish between NNP and NDP. (2019)
20. What is the problem of 'double-counting' in the context of NI analysis? (2019)
12
Gobind Kumar Jha
9874411552
3 Equilibrium National
EQUILIBRIUM NATIONAL INCOME
Chapter
Income Determination
DETERMINATION
Theory of Income Determination:

Concepts of Equilibrium National Income (NI)
National income equilibrium refers to a situation when the level of national output (commonly
measured as Gross Domestic Product - GDP) is stable over time and the equilibrium level of the
national income is defined as that point where the aggregate supply and the aggregate demand are
equal to each other.
Classical and Keynesian View:

The classical economics held the view that this equilibrium level of employment would be full
employment level.
There will be no involuntary unemployment.
Either of labour or of capital. If there were to be any unemployment resources, wages rates and
interest rates would move.
Keynes, a British Economist propounded his own theory and in 1936 brought out his famous book
“General Theory of Income, Interest and Money” which brought about a revolution in economic
thought. Salient point of his theory is :
An economy can be in equilibrium even at less than full employment level.
Economic system does not ensure automatic equality between ‘aggregate demand’ and ‘aggregate
supply at full employment’ as believed by Classical.
Consumption and Its Determinants: Consumption is defined as the use of goods and services by a
household. It is a component in the calculation of the Gross Domestic Product (GDP). Consumer
spending is the total money spent on final goods and services by individuals and households for
personal use and enjoyment in an economy. Contemporary measures of consumer spending include all
private purchases of durable goods, non-durable goods, and services.
Ex-ante and Ex-post
Ex-post and Ex-ante means “after the event” & “before the event” respectively. Hence ‘Ex-ante’
refers to intended or desired or planned whereas ‘Ex-post’ refers to actual or realised.
➢ Ex-ante Savings: It is what the savers plan (or intend) to save at different levels of income
in an economy. It is also known as intended saving or planned savings.
➢ Ex-post Savings: It refers to actual or realised saving in an economy during a year.
➢ Ex-ante Investment: It is what the investors plan (or intend) to invest at different levels
of income in an economy. It is also known as intended investment or planned investment.
➢ Ex-post Investment: It refers to actual or realised investment in an economy during a year.
Keynesian Short Run Consumption Function

Keynes was concerned with the short run consumption function; he assumed price level, interest rate,
stock of wealth etc. constant in his theory of consumption Thus, with these factors being assumed
constant in the short run, Keynesian consumption function considers consumption as a function of
income (Y). Thus,
C = f(Y)
The Keynesian concept of consumption function stems from the fundamental. Psychological law of
consumption which states that,
13
Gobind Kumar Jha
9874411552
• There is a common tendency for people to spend more on consumption when income increases,
• But not to the same extent as the rise in income because a part of the income is also income.
Features of Consumption Function

Consumption function, C = f(Y) shows the relationship between the aggregate consumption in an
economy and the aggregate national income.
The important features of the C – fn are as follows:
➢ If income (Y) increases or decreases, then the consumption spending (C) of the people will also
increases or decreases. So both are directly related.
Y ↑ means C ↑
Y ↓ means C↓
When ∆Y > 0 then ∆C > 0
When ∆Y < 0 then ∆C < 0
𝜟𝜟𝜟𝜟
Therefore, > 𝟎𝟎
𝜟𝜟𝜟𝜟
➢ When income rises, consumption also rises but not as much as the income. The reason why
consumption rises less than income is that a part of the increase in income is saved. It means,
∆C < ∆Y
Change in consumption expenditure < Change in income
𝜟𝜟𝜟𝜟
Therefore, > 𝟏𝟏
𝜟𝜟𝜟𝜟
➢ The Marginal propensity to consume (MPC) refers to the ratio of change in the consumer’s
expenditure due to the change in income. It means,
𝜟𝜟𝜟𝜟
𝑴𝑴𝑴𝑴𝑴𝑴 =
𝜟𝜟𝜟𝜟
In other words, MPC measures how consumption will vary with the change in income. From the
above discussion, we can formulate,
𝜟𝜟𝜟𝜟
𝟏𝟏 > > 𝟎𝟎
𝜟𝜟𝜟𝜟
𝟏𝟏 > 𝑴𝑴𝑴𝑴𝑴𝑴 > 𝟎𝟎
This is called the “Range” of MPC
MPC lies in between zero and one
MPC is a positive fraction.
➢ The Average Propensity to Consume (APC) is the ratio of consumption expenditure (C) to
income (Y). It means,
𝐶𝐶
𝐴𝐴𝐴𝐴𝐴𝐴 =
𝑌𝑌
It is important to note that the average propensity to consume varies inversely with income
over time.
Difference between APC and MPC

APC MPC
It defines the amount of It defines the amount of consumption in
consumption in every one rupee every last unit rupee of income for all levels
of income for all levels of of income.
income.
It is the ratio between the It is the ratio between the change in
consumption and income in the consumption and change in income in the
economy at a given point of economy at a given point of time.
time.
14
Gobind Kumar Jha
9874411552
𝐂𝐂 𝚫𝚫𝚫𝚫
𝐀𝐀𝐀𝐀𝐀𝐀 = 𝐌𝐌𝐌𝐌𝐌𝐌 =
𝐘𝐘 𝚫𝚫𝚫𝚫
APC varies inversely with income MPC remains constant (for linear C – fn )
over time. with income over time.
Y ↑ APC ↓ Y ↑ MPC -
Autonomous and Induced Consumption Expenditure

A study of the short run consumption function reveals the following two types of consumption
expenditure:
• Autonomous consumption: It means that the level of consumption is independent of the
changes in income.
𝐂𝐂 ≠ 𝐟𝐟(Y)
This is an amount of consumption which will take place even when the income is zero (Y = 0).
• Induced consumption: It means the level of consumption which changes with the change in
income.
C = f(Y)
As the income rises, consumption also rises and vice versa.
Subjective and Objective Factors of C-fn

We have seen that income (Y) is the most important determinant of aggregate consumption (C). But
there are various other factors also which influence the consumption. Keynes talked in these other
factors determining consumption. He mentioned these in his book “The General Theory of
Employment, Interest and Money.
These determinants are classified into two categories,
• Objective factors
• Subjective factors
Long Run Consumption Function: Concept, Features, Difference between Short Run, Long
Run and Kuznets Puzzle
A study conducted by Simon Kuznets in 1946 showed a different type of consumption expenditure.
In the long run, it was observed that on average APC did not decline with an increase in income.
Therefore, APC and MPC were equal even as income grew along the trend.
▪ Concept
The short run consumption is non – proportional in the sense that consumption is partly
autonomous and induced that is related to the current income. The long run consumption fully
depends on income. The long run autonomous consumption is zero and according to Keynes, in
the long run, we all die if fail to generate our own income.
▪ Long Run C – line and It’s Features

Let us consider a long run consumption function in a linear form is,
C = bY
The features of C – line are as follows:
1) The long run consumption fully depends on income.
2) The long run autonomous consumption is zero.
3) The long run consumption function / line is a straight line from the origin.
4) The long run consumption function / line is flatter than the 450 line.
5) The entire C – line lies below the 450 line, it means C < Y.
15
Gobind Kumar Jha
9874411552
6) The average propensity to consume (APC) is constant.

7) Average propensity to consume is equal to the marginal propensity to consume, APC = MPC.
▪ Difference between Short Run and Long Run Consumption Function

To understand the basic difference in short run and long run consumption function or the
consumption lines let us try to develop a table by mentioning the features on the basis of some
parameters.
Concept of saving: saving is the portion of income not spent on current expenditures. In other
words, Its is the money set aside for future use and not spent immediately. Saving is national
income minus consumption, S=NI(Y)-C.
1. National income equals national product,
2. National Income / Product is consumption plus investment, Y=C+1
Determinants of Savings and S – fn.

We know,
Y=C+S
Thus,
S=Y-C
Where, Y = Income; S = Savings; C = Consumption
• The equation shows that the remaining amount after the deduction of total expenditure from
total income is savings.
• Thus, saving is that part of income which is not spent on consumption.
The propensity to save depends upon the following factors :
1) Level of income (Y) : Higher the level of income, more will be the propensity to save. Rich
people cannot spend all their income. Therefore their propensity to save is high compared to
the people at a poor level.
2) Distribution of income (D) : Rich persons have high MPS (marginal propensity to
save);therefore unequal distribution of income will raise the level of saving in the economy.
3) Rate of interest (r) : High rate of interest induces people to save more. Therefore, high rate
of interest will lead to more propensity to save.
4) Taxation policy (T) : Taxes reduce the disposable income of the individuals and compel them
to cut down their consumption expenditure. As a result, the level of compulsory savings
increases.
5) Price level (P) : At high prices the value of real balance held by the people falls which reduces
consumption and increases savings.
➢ Investment Functions: In Keynesian Terminology, Investment refers to “real investment”

which adds to capital equipment. It leads to increase in the levels of income and production by
increasing the production and purchase of capital goods. In the words of Joan Robinson,
“Investment is an addition to the stock of capital.” Symbolically, let I be investment and be
capital in year.
Different Types and Their Differences:
We can distinguish between different types of investment:
1. Gross and Net Investment:
"Gross investment comprises investment in fixed capital such as machines, tools, plants,
factory building etc. and inventory investment such as stock of raw materials. semi-finished
goods, finished products etc. while the former promotes the production potential of an
economy, the latter helps to maintain uninterrupted supply of goods for consumption.
16
Gobind Kumar Jha
9874411552
"Net investment" refers to that amount of expenditure which is obtained after deducting
the replacement investment or capital consumption from the gross investment.
Gross Investment
Net Investment + Capital Consumption or Replacement Investment, or Net Investment
Gross Investment" Capital Consumption or Replacement Investment.
2. Financial Investment and Real Investment:
* The "financial investment" simply means transfer of rights from one party to another. It does
not add to the stock of real capital of an economy. The purchase of stocks and shares,
debentures, government bonds and equities is a financial investment. It is simply a transfer of
titles of ownership from one individual to another. It does not add to the wealth of a country.
* "Real investment" means creation of additional productive capacity.
The establishment of a factory or a workshop is a real investment. The rate of economic growth
depends on the real investment.
3. Planned and Unplanned Investment:

* The former refers to the investment which the entrepreneurs intend to undertake during a
given period of time. It proceeds according to the set targets.
* The latter does not proceed according to the set targets. It is also known as unintended
investment. Total volume of planned and unplanned investment provides us the realised or actual
investment.
Determinants of Investment Decisions: Factors affecting Investment Decisions are as follows:

➢ Technological Changes: Technological development increases the productivity of labour and capital. The
selection of new technology depends on the net benefit over the cost of having the technology.
➢ Competitors' Strategy: If the competitors are installing the new equipment to expand output or to
improve their products, the firm under consideration will have no alternating but to follow suit. It is
therefore; often found that the competitor's strategy regarding capital investment plays a very
significant role in forcing capital decisions of the firm.
➢ Demand Forecast: The long-term demand forecast is one of the determinants of investment
➢ Decisions. If the firm finds market potentials for the product in the long run, the firm will have to take
decision for investment.
➢ Outlook of Management: Investment decisions depend on the management outlook. If the management is
progressive in its outlook, the innovations will be encouraged.
Concept of Equilibrium Level of NI:

National income. (GNI) or national output (GNP) is the total output available to satisfy people's wants. The
theory of income determination seeks to find out the equilibrium level (value) of national income. The
equilibrium level of the national income is defined as that point where the aggregate supply and the aggregate
demand are equal to each other. The theory of national income determination was first presented in a
systematic way by J.M. Keynes in 1936. The theory which explains the level of national income and changes
therein is called the theory of income determination.
Conditions for Equilibrium: In a two -Sector Keynesian model,

➢ Income-Expenditures equality: aggregate demand is composed of planned or dermis demand (C)
* and planned investment demand (1) The total of planned (say K = C + D must be equal to the
value of output or economy to be in equilibrium Y = C + 1 income (V) for a simple economy to be
equilibrium Y =C+1.
➢ Saving- Investment equality: Savings equilibrium national income is determined at that point
When planned saving (S) and planned investment (1) are equal to each other i \in S = I.
17
Gobind Kumar Jha
9874411552
Assumptions of the Simple Keynesian Two-Sector Model

1. Existence of two sectors, household and business.
2. The economy is having unemployed resource and idle capacity.
3. Wage is rigid or constant.
4. The aggregate price level remains fixed. 5. No government intervention i.e. laissez-faire
6. The economy is closed in nature, there is no export and import.
7. Consumption is partly autonomous and partly induced, let C = a + bY where - a > 0.1 > b = MPC > f
8. All investment is autonomous and thus independent of national income, left = g where g autonomous
investment > 0.
Effects on Investment Multiplier

The multiplier theory is based on the assumption that the MPC reminiscent within the short run. The
However, practically it may change even in the short run. This is due to the change which might occur
in the pattern of income distribution in the short run. Hence, the number value of the multiplier may
also change in the short run.,
Continuous Increase in Investment: There should be a continuous increase in the level of
investment as it is required to maintain the increased level of saving and investment so as to have a
multiple increase in the national income future. However, if the level of additional investment is not
maintained national income would down to the previous level.
The multiplier theory explains that there will be a spontaneous increase in the national income as a
result of an increase in investment. However, in reality this is not so. This is due to the fact thud
when investment increases, part of goods and services take time to be manufactured and later on the
distribution or rewards to factors also take time. Then there exists the time lag in the demand for
the goods and services. Hence, there is a considerable time lag between increase in investment and
the consequent increase in national income, which has clearly been ignored in the multiplier theory.
Different Multiplying Processes in the Phases of a Cycle: In reality the numerical value of
the multiplier does not remain constant throughout the four phases of a cycle. During the phase of
expansion/boom, the MPC is generally high and so would be the value of multiplier. Conversely during a
period of depression, the MPC is very low as would be the value of the multiplier.
Growth of Induced Investment is Excluded: The multiplier theory deals with a change in
autonomous investment and the consequent change in National Income. It completely ignores the
change in induced investment. In fact, when autonomous investment goes up, so does the national
income level through an increase in consumption according to MPC. The increase in consumption
results in a tendency to increase the induced investment and therefore, the national income increases
to a larger extent than the actual increase as stated by the multiplier theory. Hence, induced
investment should have been included in the concept of multiplier to arrive at a more accurate
measurement of increase in the national income.
Marginal Propensity to Spend: This is contrast to MPC: as marginal propensity to spend means
the expenditure on both consumer as well as capital goods whereas MPC only refers to consumer
goods. Some economists believe that the initial change in investment does not only affect
consumption but also investment. Hence, they say that the theory of multiplier should be based on
the marginal propensity to spend instead of the MPC.
➢ National Income Determination: National income, (GNI) or national output (GNP) is the total
output available to satisfy people’s wants. The theory of income determination seeks to find out
the equilibrium level(value) of national income. The equilibrium level of the national income is
defined as that point where the aggregate supply and the aggregate demand are equal to each
other.
➢ Investment multiplier: In Keynesian theory of income and employment, the investment
multiplier (m) plays one of the most important roles as a tool to explain the income propagation
18
Gobind Kumar Jha
9874411552
and business cycle. In Keynesian theory concept of multiplier, for a two sector (household and
business) aggregate demand is a summation of consumption and investment expenditure.
Therefore,
AD= C+1.
The three sector includes the government sector and the equation becomes,
AD=C+I+G
And for four sector, due to the inclusion of trade gap, we can write,
AD=C+I+G+(X-M)
Where X and M represent the volume of export and import respectively.
Now multiplier represent the effects on equilibrium NI due to a change in a single component of
AD, other factors remaining. Thus, the effects of G can be represented by government
expenditure multiplier, effects of X can be shown by export multiplier, effects of M by import
multiplier etc. Similarly, the effects of investment can be depicted by investment multiplier.
The Investment multiplier(m) represents the effects on equilibrium NI due to a change in
autonomous investment expenditure by extra one unit, other factors like C,G,X and M remaining
constant.
Government Expenditure Multiplier (Graphical Analysis), Tax Multiplier and Balanced

Budget Multiplier (Concepts).
The Balanced Budget Multiplier (BBM) shows the impact of an expansionary fiscal policy. In this case,
the increase in taxes (∆T) and increase in government expenditure (∆G) are of equal amount, i.e.
∆T=∆G still there is an increase in income. The basis for the expansionary effect of the kind of
balanced budget is that a tax merely tends to reduce the level of disposable income. Therefor when
only a portion of an economy’s disposable income is used for consumption purpose, the economy’s
consumption expenditure will not fall by the full amount of the tax. Thus, the government expenditure
rises more than the fall in consumption expenditure due to the tax and there is net increase in NI.
▪ Assumptions
It takes into account only government expenditure on goods and services and excludes the
transfer payment.
Uniform MPC for those who pay taxes and those who sell their goods and services to the
government.
It does not take into consideration the impact of government expenditure and taxes on
investment.
Less than full amount.
GEM (Government Expenditure Multiplier)

The GEM Considers the idea that since only a percentage of money that anyone receives is saved, and
the rest is put back into the economy, so if the government gives someone a dollar (deficit
Spending).it will end up meaning that much more than a dollar will be added to the economy.one way to
think about it is the GEM is the amount that Y. Total income ,changes as G, Government expenditure
changes.so we look at our formula with the consumption function includes, we have:
Y = C + I G, where C=C (YD) = C (Y-T)
Therefore ,Y =C (Y-T) + I + G
Or dY = C ‘.dY + dG
Or dY - C ‘.dY = dG
Or dY (1- C’) = dG
19
Gobind Kumar Jha
9874411552
Or dY (1-MPC) = dG
𝑑𝑑𝑑𝑑 1
= 1− MPS which, in fact, gives
𝑑𝑑𝑑𝑑
𝑑𝑑𝑑𝑑 1
GEM = 𝑑𝑑𝑑𝑑 =𝑀𝑀𝑀𝑀𝑀𝑀 .
TCM (Tax Cut Multiplier)

In this case, we want to know how much a change in the tax rate will affect total income. Our
derivation follows the same lines as before. In this case we have:
Y = C ( Y- T) + 1 +G
Or dY = C’. (dY-dT)
Or dY = MPC (dY -dT)
dY ( 1-MPC) = - MPC dT, which gives
𝑑𝑑𝑑𝑑 𝑀𝑀𝑀𝑀𝑀𝑀 𝑀𝑀𝑀𝑀𝑀𝑀
TCM = =- =-
𝑑𝑑𝑑𝑑 1− 𝑀𝑀𝑀𝑀𝑀𝑀 𝑀𝑀𝑀𝑀𝑀𝑀
In general, IGEM I >ITCM I Since : MPC < 1.
BBM (Balanced Budget Multiplier)

This is a sort of combination of the previous two multipliers, where any change in spending
corresponds to a change in tax rates, i.e. dG = dT. Now we can take the derivative of our equation
with respect to all three variables.
Y = C (Y - T) + 1 + G
or, dY = C’ (dY - dT) + dG
dY = MPC (dY - dT) + dG
dY= (1-MPC)= - MPCdT + dG. Now, we set dG=dT
Dy (1-MPC)=dT(1-MPC)which gives
Thus, if we have a balanced budget with respect to government spending and taxation , total
income will response at a same rate.
Calcutta University
Questions
Calcutta University Questions ? ?
1. Consider a linear type of Keynesian consumption function. Define MPC and indicate its range. Explain
graphically, in this context what happens to APC and MPC with rise in income? (2015)
2. Given consumption function as C-80+08Y and autonomous Investment incr20. Given the consumption
function and consumption. If autonomous investment increases 180 then what will be the increase in
equilibrium income? (2015)
3. Assume that both savings and investment are functions of income and further that MPS > MPI,
then show how people's increased desire to save will ultimately result in a lower level of aggregate
savings in the society? (2015)
4. In an economy, with every rise in national income, 20% of the increased income is saved Now
suppose that a fresh investment of ₹150 crores takes place in the economy. Calculate the change in
income and change in consumption expenditure. (2015)
5. What is Keynesian Consumption function? How would you derive the savings function from the
Keynesian Consumption function? Explain your answers diagrammatically. (2016)
6. What is Investment Multiplier? Find out the value of this multiplier if the Marginal Pro density to
Save is 0-15. Mention, in this context two possible sources of leakages in the multiplier mechanism.
(2016)
20
Gobind Kumar Jha
9874411552
7. Derive the Tax Multiplier and the Government Expenditure Multiplier in the Simple Keynesian
Model. Which one has a larger magnitude and with what implications on the net expansion of output?
(2016)
8. If the consumption function is given by C = 40+ 0-8Y and the investment function is expressed as
1=60-200r, then find the equation for commodity market equilibrium. What will be the shape of the
resulting curve obtained from this equation? (2016)
9. Explain the concepts of inflationary gap and deflationary gap with the help of suitable diagrams.
(2016)
10. Consider a linear type of Keynesian Consumption function. Then define APC and MPC Show the
impact of an increase in MPC on the C-function with the help of a diagram. (2017)
11. For a closed economy with a Keynesian short run C-function and autonomous investment
expenditure, how would you derive the equilibrium graphically? How can you express the same
equilibrium by savings-investment equality? (2017)
12. Considering a Simple Keynesian model with investment as an autonomous expenditure, show how an
increase in investment expenditure produces a magnified impact on equilibrium level of income? 2017
13. Suppose the savings function is 502Y-500 and the investment function is 1-0-19-500, find the
consumption function and the equilibrium level of income Now assume that the savings function
changes to S-03Y-500, then what will be the new equilibrium level of income? is there any implication
of this result? - Explain. (2017)
14. Suppose MPC-1. What will be the shape of C-function if there is so autonomous consumption? In
this case what will be the value of MPS? Under which assumption will the C-function and the S-
function be parallel to each other? (2018)
15. In order to increase in investment in an economy, it is essential to step up capital formation and
for that purpose it is necessary to increase savings. But an increased desire to save may actually
result in less savings and investment in the economy than before. Does this result puzzle you? Give
reasons. (2018)
16. Consider a closed economy with a government sector. Suppose that govt, expenditure and
investment expenditure are autonomously given while consumption expenditure depends on disposable
income, further suppose that the govt. plans to increase its tax revenue by increasing the amount of
tax (being lump sum in nature). Explain the effect of this increase in the tax amount on the
equilibrium income. (2018)
17. If MPC 0-75, how much additional investment is required to increase income by 600? Also find the
value of multiplier in this case. What will be the value of the multiplier if the entire additional income
is converted into additional consumption? (2018)
18. What do you mean by equilibrium level of NI? How is it determined in a two-sector model? (2019)
19. How the equilibrium NI is determined at a level where saving is equal to investment? (2019)
20. What is C-function? How do you derive APC and MPC from the C-function? State the relation
between APC and MPC in the short run? (2019)
21. How is investment used in Keynesian macroeconomics? Given the nature of investment in Simple
Keynesian Model what will be the impact of increase in investment on equilibrium income? (2019)
22. In a closed economy with government intervention explain what is government expenditure
multiplier and tax multiplier? Show that the tax multiplier is always less effective than the
government expenditure multiplier? (2019)
21
Gobind Kumar Jha
9874411552
4 Money and
Chapter
Inflation
MONEY AND INFLATION
Concepts of Money
The textbook definition states that money satisfies three basic functions: acts as a medium of
exchange, it acts as a unit of account and it uses two times store of value.
➢ As a medium of exchange, the item must be readily accepted as payment for goods purchased or
services rendered.
➢ Defining money as a unit of account means that the value of assets and commodities is given in
terms of money.
➢ As a store of value, money allows individuals to save a portion of their present income for
consumption in the future.
Definitions of Money
The money came into existence to overcome the drawbacks of the barter system. Earlier, people used
to exchange goods and services as a form of commerce. This often led to many advantages, one of
which was the double co-incidence of wants. To solve this problem, a standard medium of exchange
money was introduced.
Author Definition
Britannica Money is a commodity accepted by general consent as a medium of
Money in a it is the medium in which prices and Value are expressed. It
Circulates from person to person and country to country, facilitating
trade and it is the principal measure of wealth.
The Economic A medium of exchange that is centralism, generally accepted, and

Times facilitates transactions of goods and services, is known as money. Money
is a medium of exchange for various goods and services in an economy
Money is one thing that possesses general acceptability. Recognized.
Seligman Money is simply purchasing power something which buys thing, it is
anything which is habitually or widely used as a means of payment and is
generally acceptable in the settlement of debts.
GDH Cole Money is anything that is commonly used and generally accepted as means
of exchange and at the same time acts as measure and store of value.
Crowther Money includes all those things which are at given time or place generally
current without doubt or special enquiry as a means of commodities or
services and of defraying expenses. purchasing
Marshall Money itself is that by delivery of which debt contracts and price
contracts are discharged and in the shape of which a store of general
purchasing power is held
Keynes Money itself is that by delivery of which debt contracts and price
contracts are discharged and in the shape of which a store of general
purchasing power is held.
Function of Money
Money serves various purposes, money has taken many forms through the ages but money consistently
has three functions: store of value, unit of account, and medium of exchange.
22
Gobind Kumar Jha
9874411552
Key Functions Different Activities

Primary * Medium of exchange
function * Measures of value
Secondary * Standard of exchange
function * Store of value
* Transfer of value
Contingent * Distribution of income
function * Basis of credit
* General form of capital
Other * Liquidity
functions * Bearer of options
* Guarantor of solvency
Following are the functions that will help us understand the importance and need of
money as far as the economy is concerned.
➢ Medium of Exchange: Money is the generally accepted medium of exchange that is used to
make all the transactions. Ex-payments of goods, payment of tax etc.
➢ A Measure of Value: Money expresses the value of every service as well as goods.
Therefore, it is a common denomination.
➢ Standard of Deferred Payments: Money is considered the standard for future payments
Ex: The payment of the electricity bill on the upcoming due date.
➢ Store of Value: It means that money is capable of being stored and transferring the
purchasing power from today to the future. Ex: Using the money in a savings account to buy
new furniture.
➢ Distribution of Social Income: Income can easily be distributed with the help of money.
Ex: Distribution of total money earned by a school in the form of salaries, wages, utility bills
etc.
➢ Basis of Credit Creation: The "store of value" function of the money helps in credit
creation by the banks. Ex: Using the money of demand deposits as a tool for credit creation.
➢ Liquidity: Money is the most liquid asset of the economy. Ex: Credit cards, debit cards.
cash.
Types of Money
The following are the different types of money:
➢ Market Determined Money: Any good that can be generally accepted by the people of the
economy to exchange it indirectly for various goods and services between different parties is
called Market Determined Money.
➢ Fiat Money and Legal Tender: The form of money that is issued by the government and is not
backed by any commodity is known as fiat money, Ex: INR, Dollar, Pounds etc. The term legal
tender states the money that is legally issued by the government. Ex: Coins and Banknotes.
➢ Crypt currencies: Crypt currencies are an electronic medium of exchange that exists virtually.
Crypt is a peer-to-peer system that runs on the blockchain. In simple terms, it is an intangible
form of currency and has opportunities for international exchange.
23
Gobind Kumar Jha
9874411552
Demand For Money: The amount of money people wish to hold or the function determining this. In
Keynesian economics, the main motives for holding money rather than other forms of wealth are,
➢ The transaction motives (to meet day to day needs),
➢ The precautionary motive( to meet unexpected future outlays),
➢ The speculative motive (in anticipation of a fall in the price of assets).
Concepts and Factors Affecting

Demand for money refers to the total amount of money that individuals, businesses, and governments
are willing to hold in cash or in easily accessible forms.
The demand for money is the total amount of money that the population of an economy wants to hold.
The demand for money gets affected by several factors such as the interest rate, the level of
income, inflation and the uncertainties in the future etc.
➢ Primary Factors
• Interest Rates (r):
M and 'r' both are inversely related.
Higher interest rates incentivise individuals to save rather than spend, reducing the demand
for money. Conversely, lower rates encourage spending, increasing money demand.
• Income Levels (Y):
M and 'Y' both are directly related.
Rising incomes elevate the demand for money as people engage in more transactions. Higher
incomes mean more money is needed for daily expenses and investments.
The main factors that affect demand for money are prices, interest rates, national income,
and the pace of financial innovations, as well as expectations concerning inflation.
➢ Secondary Factors:
• Inflation Rates: High inflation erodes the purchasing power of money. To cope, people demand
more money to maintain their standard of living, intensifying money demand.
• Economic Stability: In stable economies, people have confidence in their financial future,
leading to a steady demand for money. Economic instability, however prompts precautionary
measures, increasing money demand.
• Political Stability: Stable political environments in still confidence in the economy. Political
unrest or uncertainty can lead to increased need for money as people seek financial security.
• Global Economic Conditions: Economic conditions worldwide, especially in interconnected
economies, impact local money demand. Global recessions or economic booms influence trade
and investment, affecting money demand locally.
• Government Policies: Monetary policies, such as changes in interest rates and quantitative
easing, directly affect money demand. Government regulations also influence the ease of
accessing money, shaping demand patterns.
• Financial Innovations: New financial products and services like mobile banking apps, can alter
money demand patterns. Increased accessibility can reduce the need for holding large sums of
physical cash.
Three Motives of Holding Money

According to Keynes: Money is demanded for three motives:
Transaction motive
Precautionary motive
Speculative motive.
24
Gobind Kumar Jha
9874411552
Transaction Demand for Money (M)

The amount of money required for current transactions of companies and individuals is known
transaction demand for money. Two examples of transaction demand for money include the chase of
goods and services and the transfer of funds.
• Requirement of cash to meet day to day needs is known as transaction motive.
In the classical sense, people want to hold money only for transaction purposes. That means
demand for money does not depend on interest rate, it depends only on volume of transaction.
Money only works as the medium of exchange but not a store of value in classical viewpoint.
• According to Keynes, the transaction demand for money depends only on the real income and not
influenced by the rate of interest.
𝑀𝑀𝑡𝑡 = f(Y)
Precautionary Demand for Money (M)

Under precautionary motive, people holds money in cash form or liquid form for unforeseen
contingencies such as sickness, accidents, danger of unemployment. The precautionary demand is
dependent on the size of income. With more income, the precautionary demand will increase because
there are more likely to be surprises due to the correspondingly higher expenditures.
𝑀𝑀𝑝𝑝 = f(Y)
Different Features of Fisher’s Quantity Theory and Cambridge Version of Cash Balance
Theory:
Feature Fisher’s Quantity Theory Cambridge Cash Balance
Theory
Focus Supply of money Demand For money
Equation MV =PT M= kPY
Key M (money supply, M (demand for money),,
variables V (velocity of circulation), k (income elasticity of demand for
P(average price level), money),
T (transactions) Y (income)
Underlying Constant velocity of circulation. Fixed income proportion of desired

assumptions money holdings.
Mechanism Increased money supply leads to Excess money supply creates
of price higher prices. excess demand for goods and
level services, leading to higher prices.
changes
Policy Central bank control of money supply government fiscal policy
Implications to stabilize prices. adjustments to influence income
and demand for money.
Flow vs. Fisher's approach considers money as Cambridge views it as a stock held
Stock a flow of transactions. for transactions and safe keeping.
Definition Fisher emphasizes the medium of Cambridge focuses on the store of
of money exchange function. value function.
25
Gobind Kumar Jha
9874411552
Supply of Money: The supply of money is a stock at a particular point of time though it Conveys
the idea of a flow over time.
The tern 'the supply of money' is synonymous with such terms as 'money stock,' 'stock of
money,' 'money supply' and ' quantity of money '
The supply of money (M) at any moment is the total amount of money in the economy.
There are three alternative views regarding the definition or measures of money supply.
The most common view is associated with the traditional and Keynesian thinking which stresses the
medium of exchange function of money.
Determinants of Money Supply

There are two theories of the determination of the money supply.
• According to the first view, the money supply is determined exogenous by the central bank.
• The second view holds that the money supply is determined endogenously by changes the
economic activity which affects people's desire to hold currency relative to deposit the rate of
interest, etc.
Monetary Base the determinants of money supply are both exogenous and endogenous which can be
described broadly as: the minimum cash reserve ratio, the level of bank reserves and the desire of
the people to hold currency relative to deposits. The last two determinants together are called the
monetary base or the high-powered money.
➢ The Required Reserve Ratio (RRR)
The required reserve ratio (or the minimum cash reserve ratio or the reserve deposit ratio) is
important determinant of the money supply.
▪ An increase in the required reserve ratio reduces the supply of money with commercial
banks and
▪ a decrease in required reserve ratio increases the money supply.
The RRR is the ratio of cash to current and time deposit liabilities which is determined by las
Every commercial bank is required to keep a certain percentage of these liabilities in the form
of deposits with the central bank of the country.
➢ The Statutory Liquidity Ratio (SLR)
The Statutory Liquidity Ratio (SLR) has been fixed by law as an additional measure to determine
the money supply.
The SLR is called secondary reserve ratio in other countries while the required reserve ratio is
referred to as the primary ratio.
▪ The raising of the SLR has the effect of reducing the money supply with commercial banks
for lending purposes and
▪ the lowering of the SLR tends in increase the money supply with banks for advances.
➢ The Level of Bank Reserves (BR)
The level of bank reserves is another determinant of the money supply. Commercial bank
resends
consist of reserves on deposits with the central bank and currency in their tills or vaults. Thus,
the higher reserve ratio, the higher required reserves to be kept by a bank and vice versa.
Measures of Money supply: The measures of money supply, often denoted as M1, M2, M3, etc,
represent different categories of money within an economy, each including varying degrees of
liquidity and accessibility. Central banks and economists use these measures to analyse and track the
money supply in an economy. Here’s an explain of the most commonly used measures:
26
Gobind Kumar Jha
9874411552
➢ M1 (Narrow Money): M1 represent the narrowest measure of the money supply and includes the
most liquid assets readily available for spending. M1 is calculated on the basis of the below
formula-
M1=C+D+CB
➢ M2 (Broad money): M2 is a broader measure of the money supply than M1. it includes all the
components of M1 plus some additional assets that are less liquid but can still be quickly
converted into cash. The M2 formula is-
M2= M1+S+T+SD+MMMFs
➢ M3 (Broadest Money): M3 is an even broader measure of the money supply that includes all the
components of M2 plus additional assets that are even less liquid. The formula to calculateM3 is
as follows-
M3+M2+L+ RPs + IMMMFs
High- Powered Money: The current practice is to explain the determinants of the money supply in
terms of the monetary base of high- powered money.
High- powered money is the sum of currency (notes and coins) held
by the public and commercial bank reserves.
H=C+R…………(I)
High- powered money is the base for the expansion of bank deposits and creation of the money
supply.
The supply of money (M)
• Varies directly with changes in the monetary base (h), and
• Varies inversely with the currency and reserve rations (Cr and Rr).
The use of high- powered money (H) consists of,
• The demand of commercial banks for the legal limit or required reserves (RR) with the central
bank and
• Excess reserves (ER)and
• The demand of the public for currency (c).
Thus, high - powered money,
H=C+R
H=C+RR+ER……..(ii)
Where,
C represents currency,
RR the required reserves and
ER the excess reserves.
Money Multiplier: Money multiplier (m) represents the effects on money supply due to a one unit
change in high- powered money, other factors remain constant, Therefore,
∆𝑀𝑀
m=
∆𝐻𝐻
The quotient of equation (v) is the money multiplier “m” Thus,
𝐶𝐶𝐶𝐶+1
m=
𝐶𝐶𝐶𝐶+𝑅𝑅𝑅𝑅
𝐶𝐶𝐶𝐶+1
or, m = 𝐶𝐶𝐶𝐶+𝑅𝑅𝑅𝑅𝑅𝑅+𝐸𝐸𝐸𝐸𝐸𝐸
Now the relation between in the money supply and high- powered money of equation (v) becomes:
M = m.H………………………………….(vii)
Equation (vii) expresses the money supply as a function of “m” and “H” . In other words the money
supply is determined by high- powered money(H) and the money multiplier(m).
27
Gobind Kumar Jha
9874411552
Definitions and Views of Inflation:

* Inflation refers to a broad rise in the prices of goods and services across the economy over time ,
eroding purchasing power for both consumers and business.
* Inflation is a process of continuously rising prices, or equivalently of continuously falling value of
money" (Laidler and Parkin. 1975, p. 741).
* According to Coulborn, inflation can be defined as, "too much money chasing too few goods.”
* According to Parkin and Bade, "Inflation is an upward movement in the average level of prices.
* According to the famous monetarist economist Milton Friedman, "Inflation is always and
everywhere a monetary phenomenon.”
School Views
Classical View The classical theory of inflation attributes sustained price
inflation to excessive growth in the quantity of money in
circulation. For this reason, the classical theory is sometimes
called the "quantity theory theory of inflation, not a theory of
money. of money," even though it is a theory of inflation, not a
theory of money.
Monetarist View Monetarists believe that the most significant factor influencing
inflation or deflation is how fast the money supply grows or
shrinks.
Keynesian View Keynesian economic theory proposes that changes in money
supply do not directly affect prices and that visible inflation is
the result of pressures in the economy expressing themselves in
prices. The supply of money is a major but not the only, cause of
inflation.
Different Types of Inflation:

Economists believe inflation is the result of an increase in the amount of money relative to the supply
of available goods. While high inflation is generally considered harmful, some economists believe that
a small amount of inflation can help drive economic growth. Inflation is the rate at which prices for
goods and services rise. Inflation is sometimes classified into three types: demand- pull inflation,
cost-push inflation and built-in inflation.
Type Reasons
Demand-pull caused by increase in aggregate demand due to increased private and
inflation government spending etc.
Demand inflation is constructive to a faster rate of economic growth, since
the excess demand and favourable market conditions will stimulate investment
and expansion.
Cost-push caused by a drop in aggregate supply (potential output). This may be due to
inflation/ natural disasters, or increased prices of inputs. For example, a sudden
Supply shock decrease in the supply of oil, leading to increased oil prices, can cause cost-
inflation push inflation. Producers for whom oil is a part of their costs could then pass
this on to consumers in the form of increased prices.
Built-in induced by adaptive expectations, and is often linked to the "price/ wage
inflation spiral". It involves workers trying to keep their wages up with prices (above
the rate of inflation) and firms passing these higher labour costs on to their
customers as higher prices, leading to a 'vicious circle.
28
Gobind Kumar Jha
9874411552
Concept of Inflation:
➢ Inflation refers to a broad rise in the prices of goods and services across the economy over
time, eroding purchasing power for both consumers and businesses.
➢ “Inflation is a process of continuously rising prices, or equivalently of continuously falling value
of money” (La-idler and Parkin, 1975, p.741).
➢ According to Coulborn, inflation can be defined as, “too much chasing too few goods.”
➢ According to Parkin and Bade, “Inflation is an upward movement in the average level of prices.
➢ According to the Famous monetarist economist Milton Friedman, “Inflation is always and
everywhere a monetary phenomenon.”
Cost -push Inflation: There are many reasons why costs might rise. Those are given below.
Reasons Explanation
Rising ⚫ Perhaps caused by inflation in countries that are heavily dependent on
imported raw exports of these commodities or
materials ⚫ Alternatively, by a fall in the value of the currency in the foreign exchange
costs markets which increases the domestic price of imported inputs.
Rising labour ⚫ Caused by wage increase which exceeds any improvement in productivity.
costs ⚫ This cause is important in those industries which are ‘labour- intensive’.
⚫ In the long run, wage inflation tends to move closely with price inflation.
Higher ⚫ A rise in the rate of excise duty (say, for example on alcohol and
indirect cigarettes),
taxes ⚫ An increase in fuel duties or perhaps
imposed by ⚫ A rise in the standard rate of value- added tax or
the ⚫ An extension to the range of products to which VAT is applied.
government These taxes are levied on producers (suppliers) who can opt to pass on the
burden of the tax onto consumers.
Demand- pull Inflation: Demand -pull inflation is likely when there is full employment of resources
and when short run aggregate supply (SRAS) is Inelastic. In these circumstances, an increase
aggregate demand (AD) will Lead to an increase in prices.
AD might rise for a number of reason (given below) - some of which occurs together at the same
moment of the economic cycle.
Reasons and Explanation of Demand -Pull Inflation
Reasons Explanation
The rapid This perhaps happens as a consequence of increased bank and building
growth of society borrowing if interest rates are low. Monetarist economists believe
the money that the root causes of inflation are monetary - in particular when the
supply. monetary authorities permit an excessive growth of the supply of money in
circulation beyond that needed to finance the volume of transactions
produced in the economy.
A reduction If direct taxes reduced, consumers have more real disposable income
in the causing demand to rise. A reduction in indirect taxes will mean that a given
direct or amount of income will now buy a greater real volume of goods and services.
indirect both factors can take aggregate demand and real GDP higher and beyond
taxation. potential GDP.
29
Gobind Kumar Jha
9874411552
A It has the effect of increasing the prices of Imports and reduces the
depreciation foreign prices of UK Exports. If consumers buy fewer imports whiles
of the foreigners buy more exports, AD will rise. If the economy is already at full
exchange employment/ prices are pulled upwards.
rate
Rising Would lead an increase in total household demand for goods and services.
consumer
confidence
Monetary and Fiscal Measures to Control Inflation.

We have studied above that inflation is caused by the failure of aggregate supply to equal the
increase in aggregate demand. Inflation can, therefore be controlled by
. increasing the supplies and
. Reducing money incomes in order to control aggregate demand.
The various method is usually grouped under three heads:
⚫ Monetary measures,
⚫ Fiscal measures and
⚫ Other measures.
Monetary Measures
Monetary measures aim at reducing money incomes.
a) Credit Control: One of the important monetary measures is monetary policy. The central bank
of the country adopts a number of methods to control the quantity and quality of credit. For
this purpose, it raises the bank rates, sells securities in the open market, raises the reserve
ratio and adopts a number of selective credit control measures, such as raising margin
requirements and regulating consumer credit.
b) Demonetisation of currency: However, one of the monetary measures is to demonetize
currency of higher denominations. Such a measures is usually adopted when there is abundance
of black money in the country.
Fiscal Measures
Monetary policy alone is incapable of controlling inflation. It should therefore, be supplemented by
fiscal measures. Fiscal measures are highly effective for controlling government expenditure,
personal consumption expenditure, private and public investment. The principle fiscal measures are
the following:
(a) Reduction in unnecessary Expenditure: the government should reduce unnecessary expenditure
on non- development activities in order to curb inflation. this will also put a check on private
expenditure which is dependent upon government demand for goods and services.
(b) Surplus Budget: it is an important anti- inflationary budgetary policy. here government should
give up deficit financing and instead have surplus budgets, means collecting more in revenue
and spending less.
(c) Public debt: in this case, government should borrow more to reduce money supply with the
public.
30
Gobind Kumar Jha
9874411552
Calcutta University
Questions Calcutta University Questions
??
1. What is money? Distinguish between 'narrow money" and "broad money". (2015)
2. Define Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). What is "High Powered
Money"? (2015)
3. Explain the concepts of inflationary gap and deflationary gap with the help of suitable diagrams.
(2016)
4. Examine the relationship between quantity of money and price level with the help of the Quantity
Theory of Money. (2016)
5. Explain the causes of a demand-pull inflation. (2017)
6. Critically discuss the Keynesian theory of demand for money. (2017)
7. Explain the relationship between the quantity of money and the price level with the help of any
single version of the Quantity Theory of Money. (2018)
8. What is speculative demand for money? How is it related to the rate of interest? (2018)
9. What is meant by supply of money? In this respect, distinguish between narrow money and broad
money. What do you mean by velocity of money? (2019)
10. Explain the three basic motives of demand for money according to Keynes. (2019)
11. Distinguish between voluntary and involuntary unemployment. (2019)
12. Distinguish between frictional and structural unemployment. What is the natural rate of
unemployment? (2019)
13. How do you define inflation? Explain briefly the theory of Demand-pull inflation. (2015)
14. Explain the concept of High-powered Money. If there is an increase in the High-powered Money,
then what will be its impact of the total supply of money. (2016)
15. What is Cost-Push inflation? Explain the causes of cost-push inflation? (2016)
16. (i) What is meant by money supply and on what factors does it depend? (2017)
(ii) Distinguish between narrow money and broad money. (2017)
17. Explain briefly the uses of monetary and fiscal policies to control inflation. (2017)
18. What is High-powered money? Explain the Currency-Deposit Ratio and Reserve-Deposit Ratio.
Show that is an economy actual supply of money is much larger than the high-powered money.
(2018)
19. Explain the concept if Inflationary Gap. Bring out the significance of this concept in explaining the
inflationary process. (2018)
20. What is ‘Money Multiplier’? How it can be derived by currency ratio and reserve ratios? State the
relationship.
21. What is inflation? Distinguish the reasons behind the inflation both due to demand side and supply
side factors separately? (2019)
22. What are the quantitative monetary instruments used to control the availability of credit?
Discuss the impact of ‘any two’ of such instruments in controlling inflation. What are the limitations
of monetary and fiscal policies in controlling inflation? (2019)
31
Gobind Kumar Jha
9874411552
5 Public
Chapter
Finance
PUBLIC FINANCE
Difference Between Public Finance and Private Finance
Basis of Public Finance Private Finance
Distinction
Meaning Public Finance is concerned with the Private Finance is considered
expenditure and revenue of the with expenditure and revenue of
government individuals
And business Firms.
Nature of the Government usually makes a deficit Private entities usually make a
budget budget, i.e., where expenditure surplus budget, i e, where
exceeds revenue. revenue exceeds
Expenditure.
Objective The objective of public finance is to The objective of private finance
encourage social welfare and is to only enhance the profit of
provides benefits to the general the entities.
public.
Elasticity of Public finance is more elastic as it Private finance is less elastic
Finance has a scope of drastic changes. than public finance as there is
not much scope for changes in i
Financial The financial transactions in this The financial transactions in this
Transaction case are open and known to case are kept a secret.
everyone.
Sources of The government has more sources Private entities have limited
Revenue for creating money, such as printing sources to generate revenue.
money and establishing laws to raise.
Determination The government determines the A private individual first

of Expenditure amount of expenditure first and evaluates his income before
then searches for ways to generate deciding how much money is
income. needed to be spent.
Right to Print The government has complete Private entities are not allowed
Currency authority over the currency. They to create currency.
can create, distribute and monitor
the currency.
Effect on Public Finance has a tremendous Private Finance has little or
Economy impact on the overall economic negligible impact on the overall
system. economic system.
Differences in In public finance, the government's There is no fixed time horizon
Credit Status capacity for borrowing or public for private finance.
credit is unlimited.
Time Horizon The time horizon of public finance is There is no fixed time horizon
one year. for private finance.
Example Public Debt, Taxation, Public Mortgage and other loans,
Spending, Monetary Policy, etc. Insurance, Stock Market,
Investment, Personal Savings
and Investments etc.
32
Gobind Kumar Jha
9874411552
GOVERNMENT BUDGET: AN OVERVIEW
Definition of Budget
The government budget is a statement of the estimates of the government receipts and expenditure
during a period of the financial year. It reveals fiscal policy of the government, focusing on growth
and stability of the economy.
Objectives Activities
Re-Allocation It refers to the direction of resources from one use to the other. The
of Resources Government of a country directs the distribution of resources through its
resources in order to strike a balance between the goals of profit maximization
and social welfare
Reducing Economic inequality means unequal distribution of income and wealth between
Inequalities different groups of society.
in Income and * The Government aims to reduce such inequalities through its budgetary policy
Wealth * This policy places priority on the welfare of the poor at the same time and
imposes heavy taxes on the rich.
* Equitable distribution is a way to achieve social justice.
Economic *stability can be achieved by protecting the economy from the effects of
Stability various trade cycles and their phases like boom, recession, depression and
recovery.
*Budget is used as an essential policy to combat inflation and deflation in the
economy.
Growth of * The Government makes various policies and provisions through its budgetary
the Economy policy to enhance savings and investment in an economy.
* This is done by providing various tax rebates and other incentives for
productive ventures.
The Government spends on essential services and facilities to have a solid
infrastructural base for the economy, like health, education, housing and
transport.
Employment Budgetary policy focuses on employment generation through investment in public

Opportunities enterprises to create employment among poor people and reduce the problem of
poverty.
Management The main aim of the public sector enterprises is to promote the public's welfare.
of Public The budget is prepared to manage the public sector enterprises and to provide
Enterprises financial help.
Regional To remove regional disparities,

Balanced * the government encourages the setting-up of production units in economic
Growth backward regions.
Reducing * various types of tax concessions are offered to production units to take
Regi- onal initiatives.
Disparities * government also provides subsidies to encourage production units.
33
Gobind Kumar Jha
9874411552
Balanced Budget
A balanced budget is a condition of financial planning of the budgeting procedure where the total
revenues pre-equivalent to or greater than the total expenditure. A budget can be Considered as
balanced in experience after a complete year's account of revenues and expenditure have been
recorded. A company’s budget for the upcoming year can be called balanced based on anticipations or
approximate values.
Merits:
(a) It ensures financial stability.
(b) It avoids wasteful expenditure.
Demerits:
(a) The process of economic growth can be hindered.
(b) Welfare activities may be restricted.
The concept of a balanced budget has been evocated by classical economists like Adam Smith. A
balanced budget was considered by them as neutral in its effects on the working of the economy and
hence, they regarded it as the best. However, modern economists believe that the policy of balanced
budget may not always be suitable for the economy, for instance during the period of depression
when economic activities are at low level, resulting in unemployment. The government may come to the
rescue of the people. It can borrow money and spend it on public works. This will increase employment
and total demand for goods & services and encourage investment.
Unbalanced Budget
A government budget is said to be unbalanced if the estimated government receipts are not equal to
the estimated government expenditure.
(a) Surplus Budget: A surplus budget is a condition when incomes or receipts over reach costs or
outlays (expenditures). A surplus budget normally refers to the financial conditions of the
governments. However, individuals choose to use the term 'savings' rather than "budget surplus."
Surplus is a manifestation that the government is being effectively operated and regulated.
(b) Deficit Budget: A deficit budget is said to have occurred when expenses exceeds the revenue
and it is a symptom of financial health. The government normally uses this term to its spending
instead of entities or individuals. Accrued government deficits form of the national debt.
Functions of a Government Budget

A government budget is a crucial tool for economic management, acting as a road map for the
country's financial plans. It fulfils several key functions:
Key Functions Explanation

Resource Prioritization: Budgets allocate limited resources to different sectors like social
Allocations welfare, infrastructure, defence, education and healthcare. This decision
determines which areas receive priority and guides government spending
Efficiency: Efficient allocation ensures public expenditure maximizes benefits
for the economy and citizens.
Economic Fiscal Policy By adjusting taxes and expenditure, governments can influence
Stabilization aggregate demand and manage economic cycles. Taxes can be increased to fight
inflation while expenditure can be boosted during recessions..
Stability: Consistent budget policies create predictability and confidence in
the economy, encouraging investment and business activity
Income Redistribution :Taxes and subsidies are used to transfer wealth from richer to
34
Gobind Kumar Jha
9874411552
Distribution poorer sections of society, aiming to reduce income, inequality and promote
social justice.
Targeted Programs: Specific programs for poverty alleviation, education and
healthcare can address specific needs and improve equity.
Growth and Infrastructure Investment: Budgets allocate funds for infrastructure
Development development like roads, ports and power grids which stimulates economic
activity and creates jobs.
Human Capital Investment: Expenditure on education, healthcare and skills
training improves the workforce and contributes to long-term growth.
Accountability Public Scrutiny: The Budget process involves parliamentary debates and public
and discussions, ensuring transparency and accountability in government-spending.
Transparency Performance Measurement: Budgets set targets for various ministries and
departments, allowing for performance evaluation and course correction if
needs.
special Balancing Growth and Inclusion: India's budget faces the challenge of
reference to promoting economic growth while addressing issues like poverty, inequality and
India rural development.
Fiscal Deficit Management: Maintaining a sustainable fiscal deficit is crucial for
avoiding inflation and debt accumulation.
Infrastructure Focus: India's infrastructure needs significant investment and

budgets often priorities infrastructure development projects.
Social Sector Spending: Increasing allocation to education, healthcare and
social welfare programs remains a key focus.
Direct Benefit Transfers: Government initiatives like Aadhaar-linked direct
benefit transfers aim to ensure efficient and targeted delivery of subsidies and
benefits.
Components of a government budget

To understand the concept of different components of a government budget, we will use a flow chart
first and then a table.
There are two primary components of a government budget, namely -
i. The revenue budget and
ii. The capital budget
Revenue budget, accounts for the total revenue generated (revenue receipts) and the revenue
expenses (revenue expenditures) met through this revenue. Capital budget on the other hand,
accounts for the assets and liabilities under the government. Let us check each component
individually.
➢ Revenue Budget: It consists of the Revenue Expenditure and Revenue Receipts.
• Revenue Receipts are receipts which do not have a direct impact on the assets and liabilities
of the government. It consists of the money earned by the government through tax and non-
tax sources.
• Revenue Expenditure is the expenditure by the government which does not impact its assets
or liabilities. For example, this includes salaries, interest payments, pension and administrative
expenses.
➢ Capital Budget: It includes the Capital Receipts and Capital Expenditure.
35
Gobind Kumar Jha
9874411552
• Capital Receipts indicate the receipts which lead to a decrease in assets or an increase in
liabilities of the government. It consists of: (i) the money earned by selling assets such as
shares of public enterprises and (ii) the money received in the form of borrowings or
repayment of loans by states.
• Capital Expenditure is used to create assets or to reduce liabilities. It consists of: (i) the long
term investments by the government on creating assets such as roads and hospitals and (ii) the
money given by the government in the form of loans to states or repayments of its borrowings.
Classifications of Receipts
Revenue Receipts: Revenue Receipts comprise the income made by the government from all the
sources without generating any liability or a decrease in assets.
Capital Receipts: Capital Receipts are those receipts which generate a liability or a decrease in
assets. Funds are raised through borrowings, loan recoveries and assets disposal.
Classification of Expenditure
Revenue Expenditure: Revenue Expenditures are that expenditure which is incurred for the day-to-
day administration of government departments and for the provision of basic infrastructural services
to the public.
Capital Expenditure: An expenditure that is proposed to generate assets with a wide span is capital
expenditure.
Measures of Government Deficit- Revenue Deficit, Fiscal Deficit, Primary Deficit: Based
on the deficit incurred, budgetary deficit has been divided into three forms:
➢ Revenue Deficit,
➢ Fiscal Deficit,
➢ Primary Deficit
Revenue Deficit (RD): The revenue deficit refers to the excess of revenue expenditure over
revenue income in a financial year. It mainly focuses on the revenue aspects of the government, like
revenue expenditure and revenue income/ receipts. Revenue deficits happen due to the insufficiency
of the government’ s fund to meet the expenditure.
Revenue Deficit= Revenue Expenditure – Revenue Receipts
Fiscal Deficit (FD): The Fiscal deficit refers to the excess of total expenditure over total receipts/
income, excluding borrowings in a fiscal year. It mainly focuses on the borrowings of the government.
It is when the government spends more than it is supposed to.
➢ FD= Total Expenditure- Total Receipts (except borrowings)
➢ FD= (Revenue Expenditure + Capital Expenditure)- (Revenue Receipts + Capital Receipts
excluding Borrowings)
➢ FD= (Revenue Expenditure- Revenue Receipts) + (Capital Expenditure – Capital Receipts
excluding Borrowings)
➢ FD= Revenue Deficit+ (Capital Expenditure- Capital Receipts Excluding Borrowings)
Difference Between Revenue Deficit and Fiscal Deficit

Basis of Revenue Deficit (RD) Fiscal Deficit(FD)
Distinction
Meaning It is the excess of revenue expenditure It is the excess of total
over revenue income in a financial year. expenditure over total
receipts/income, excluding
36
Gobind Kumar Jha
9874411552
borrowings, in a fiscal year.
Indicator Revenue Deficit indicates government's Fiscal Deficit measures the

inability to meet its recurring and regular government total borrowing
expenditures. requirements.
Borrowing Revenue Deficit shows the borrowing Fiscal Deficit shows the extent
needs of the government to manage its of government's borrowing
budgetary expenditure. when the interest on payment
is accounted for.
Represents Revenue Deficit represents government's Fiscal Deficit represents the
dis savings. additional financial resources
required by the government to
meet its expenditure.
Occurs When When Revenue Deficit occurs in an Fiscal Deficit occurs when the
economy when the realized income is less government spends more than
than the projected/expected its it earns or beyond its
resources income. resources.
Formula Revenue Deficit = Revenue Expenditure Fiscal Deficit Total
Revenue Receipts. Expenditure - Total Receipts
(except borrowings)
Primary Deficit (PD): Primary Deficit is the difference between the fiscal deficit (total income-
total expenditure of the government) of the current year and the interest paid on the borrowings of
the previous year. It indicates the borrowings requirements of the government for the purposes,
excluding the interest payment.
Primary Deficit = Fiscal Deficit- Interest payment
37

Macroeconomics - Semester - 2 - 14-06-24

Uploaded by

Copyright:

Available Formats

Macroeconomics - Semester - 2 - 14-06-24

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Macroeconomics - Semester - 2 - 14-06-24

Uploaded by

Copyright:

Available Formats

/ Gobind Kumar Jha gkj

Chapter Name Page No.

Basic Concepts of Macro Economics:

Scope of Macroeconomics: As a method of economic analysis, macroeconomics is of much

➢ To Understand the Working of the Economy: The study of macroeconomics and

Objectives of Maro-Economics: The basic objectives of macro-economics are as follows:

Stock: It is an important to economic activity

Concepts and Measurement of GDP, GNP, NNP, NDP, PI, DPI

GDP at market It is the valuation of goods and services by market prices.

Hence, GDPFC= GDPMP - IBT+SUB

➢ Net National Product (NNP): Net National Product

➢ Disposable Personal Income(DI): Di is the portion of income available to an income earner

Disposable Personal Income (DI)

Basis GDP GNP

Basis GNP NNP

Importance of GDP Deflator

➢ International comparisons: When comparing economic activity across different countries

Difference between Consumer Price Index (CPI) and GDP Deflator

Importance of the Circular Flow of Income

1. Visualization of Economic Activity: It presents a clear visual representation of the continuous

4. Explanation of Interdependence: The model emphasizes the interdependence of different

Real and Nominal GDP and GDP Deflator

▪ Real GDP Calculation for 2022:

Nominal Vs Real GDP

Theory of Income Determination:

Classical and Keynesian View:

Keynesian Short Run Consumption Function

Features of Consumption Function

Difference between APC and MPC

Autonomous and Induced Consumption Expenditure

Subjective and Objective Factors of C-fn

▪ Long Run C – line and It’s Features

6) The average propensity to consume (APC) is constant.

▪ Difference between Short Run and Long Run Consumption Function

Determinants of Savings and S – fn.

➢ Investment Functions: In Keynesian Terminology, Investment refers to “real investment”

3. Planned and Unplanned Investment:

Determinants of Investment Decisions: Factors affecting Investment Decisions are as follows:

Concept of Equilibrium Level of NI:

Conditions for Equilibrium: In a two -Sector Keynesian model,

Assumptions of the Simple Keynesian Two-Sector Model

Effects on Investment Multiplier

Government Expenditure Multiplier (Graphical Analysis), Tax Multiplier and Balanced

GEM (Government Expenditure Multiplier)

TCM (Tax Cut Multiplier)

BBM (Balanced Budget Multiplier)

The Economic A medium of exchange that is centralism, generally accepted, and

Key Functions Different Activities

Concepts and Factors Affecting

Three Motives of Holding Money

Transaction Demand for Money (M)

Precautionary Demand for Money (M)

Underlying Constant velocity of circulation. Fixed income proportion of desired

Determinants of Money Supply

Definitions and Views of Inflation:

Different Types of Inflation:

Monetary and Fiscal Measures to Control Inflation.

Determination The government determines the A private individual first