Net JRF Economics
Uploaded by
Surbhi AggarwalNet JRF Economics
Uploaded by
Surbhi AggarwalConducted by National Testing Agency (NTA)
By
Gopal Garg
Revised by
Dr. Anupam Agrawal
&
Dr. S.S.S. Chauhan
Upkar Prakashan, Agra-2
( ii )
© Publishers
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( iii )
Contents
● Previous Year’s Solved Paper
UNIT-1
● Micro-Economics ......................................................................................................... 3–94
● Objective Questions ...................................................................................................... 95–133
UNIT-2
● Macro-Economics ........................................................................................................ 134–199
● Objective Questions ...................................................................................................... 200–234
UNIT-3
● Statistics and Econometrics ........................................................................................... 235–294
● Objective Questions ...................................................................................................... 295–305
UNIT-4
● Mathematical Economics .............................................................................................. 306–356
● Objective Questions ...................................................................................................... 357–366
UNIT-5
● International Economics ................................................................................................ 367–411
● Objective Questions ...................................................................................................... 412–432
UNIT-6
● Public Economics ......................................................................................................... 433–455
● Objective Questions ...................................................................................................... 456–464
UNIT-7
● Money and Banking ...................................................................................................... 465–485
● Objective Questions ...................................................................................................... 486–488
( iv )
UNIT-8
● Growth and Development Economics ............................................................................. 489–534
● Objective Questions ...................................................................................................... 535–557
UNIT-9
● Environmental Economics and Demography ................................................................... 558–579
● Objective Questions ...................................................................................................... 579–581
UNIT-10
● Indian Economy A Few Facts : At a Glance .................................................................... 582–679
● Objective Questions ...................................................................................................... 680–690
● Miscellaneous Questions ............................................................................................... 691–704
( v )
Syllabus
Unit-1 : Micro Economics
• Theory of Consumer Behaviour
• Theory of Production and Costs
• Decision Making Under Uncertainty Attitude Towards Risk
• Game Theory – Non Cooperative Games
• Market Structures, Competitive and Non-Competitive Equilibria and Their Efficiency Properties
• Factor Pricing
• General Equilibrium Analysis
• Efficiency Criteria : Pareto-Optimality, Kaldor – Hicks and Wealth Maximization
• Welfare Economics : Fundamental Theorems , Social Welfare Function
• Asymmetric Information : Adverse Selection and Moral Hazard
Unit-2 : Macro Economics
• National Income : Concepts and Measurement
• Determination of Output and Employment : Classical & Keynesian Approach
• Consumption Function
• Investment Function
• Multiplier and Accelerator
• Demand for Money
• Supply of Money
• IS – LM Model Approach
• Inflation and Phillips Curve Analysis
• Business Cycles
• Monetary and Fiscal Policy
• Rational Expectation Hypothesis and its Critique
Unit-3 : Statistics and Econometrics
• Probability Theory : Concepts of Probability, Distributions, Moments, Central Limit Theorem
• Descriptive Statistics : Measures of Central Tendency & Dispersions, Correlation, Index Numbers
• Sampling Methods & Sampling Distribution
( vi )
• Statistical Inferences, Hypothesis Testing
• Linear Regression Models and their Properties – BLUE
• Identification Problem
• Simultaneous Equation Models – Recursive and Non-recursive
• Discrete Choice Models
• Time Series Analysis
Unit-4 : Mathematical Economics
• Sets, Functions and Continuity, Sequence, Series
• Differential Calculus and its Applications
• Linear Algebra – Matrices, Vector Spaces
• Static Optimization Problems and their Applications
• Input-Output Model, Linear Programming
• Difference and Differential Equations with Applications
Unit-5 : International Economics
• International Trade : Basic Concepts and Analytical Tools
• Theories of International Trade
• International Trade under Imperfect Competition
• Balance of Payments : Composition, Equilibrium and Disequilibrium and Adjustment Mechanisms
• Exchange Rate : Concepts and Theories
• Foreign Exchange Market and Arbitrage
• Gains from Trade, Terms of Trade, Trade Multiplier
• Tariff and Non-Tariff Barriers to Trade; Dumping
• GATT, WTO and Regional Trade Blocks; Trade Policy Issues
• IMF & World Bank
Unit-6 : Public Economics
• Market Failure and Remedial Measures : Asymmetric Information, Public Goods, Externality
• Regulation of Market – Collusion and Consumers’ Welfare
• Public Revenue : Tax & Non-Tax Revenue, Direct & Indirect Taxes, Progressive and Non-Progressive Taxation,
Incidence and Effects of Taxation
• Public Expenditure
• Public Debt and its Management
• Public Budget and Budget Multiplier
• Fiscal Policy and its Implications
( vii )
Unit-7 : Money and Banking
• Components of Money Supply
• Central Bank
• Commercial Banking
• Instruments and Working of Monetary Policy
• Non-Banking Financial Institutions
• Capital Market and its Regulation
Unit-8 : Growth and Development Economics
• Economic Growth and Economic Development
• Theories of Economic Development : Adam Smith, Ricardo, Marx, Schumpeter, Rostow, Balanced & Unbalanced
Growth, Big Push Approach.
• Models of Economic Growth : Harrod-Domar, Solow, Robinson, Kaldor
• Technical Progress : Disembodied & Embodied; Endogenous Growth
• Indicators of Economic Development : PQLI, HDI, SDGs
• Poverty and Inequalities : Concepts and Measurement
• Social Sector Development : Health, Education, Gender
Unit-9 : Environmental Economics and Demography
• Environment as a Public Goods
• Market Failure
• Coarse Theorem
• Cost-Benefit Analysis and Compensation Criteria
• Valuation of Environmental Goods
• Theories of Population
• Concepts and Measures : Fertility, Morbidity, Mortality
• Age Structure, Demographic Dividend
• Life Table
• Migration
Unit-10 : Indian Economy
• Economic Growth in India : Pattern and Structure
• Agriculture : Pattern & Structure of Growth, Major Challenges, Policy Responses
• Industry : Pattern & Structure of Growth, Major Challenges, Policy Responses
• Services : Pattern & Structure of Growth, Major Challenges, Policy Responses
( viii )
• Rural Development : Issues, Challenges & Policy Responses
• Urban Development : Issues, Challenges and Policy Responses
• Foreign Trade : Structure and Direction, BOP, Flow of Foreign Capital, Trade Policies
• Infrastructure Development : Physical and Social; Public-Private Partnerships
• Reforms in Land, Labour and Capital Markets
• Centre-State Financial Relations and Finance Commissions of India; FRBM
• Poverty, Inequality & Unemployment
UGC Economics (Dec. 19) | 1
Economics
UGC-NET/JRF Exam.
(December 2019)
Solved Paper
2019
(Held on 3 December, 2019)
Economics
(Paper-II)
UGC Economics (Dec. 19) | 3
4 | UGC Economics (Dec. 19)
0.5 0 0 0
0 0.25 0 0
0 0 0.2 0
0 0 0 1
0.5 0 0 0
0 0.25 0 0
0 0 1 0
0 0 0 0.4
b b
>0 <0
(b − a ) (b − a )
a a
>0 <0
b−a b−a
2 0 0 0
0 4 0 0
0 0 5 0
0 0 0 1
0.25 0 0 0
0 0.5 0 0
0 0 0.2 0
0 0 0 1
0.2 0 0 0
0 1 0 0
0 0 0.25 0
0 0 0 0.5
UGC Economics (Dec. 19) | 5
6 | UGC Economics (Dec. 19)
1 1 1 1 1
1− + − + −
2 4 8 16 32
1 1 1
2 + 2 +1+ + +
2 2 2 2
UGC Economics (Dec. 19) | 7
8 | UGC Economics (Dec. 19)
UGC Economics (Dec. 19) | 9
10 | UGC Economics (Dec. 19)
14·0
12·0
GDP growth (g)
10·0
8·0
6·0
4·0
2·0
–10·0 –5·0 0 5·0 10·0 15·0 20·0 25·0
–2·0
Industrial growth (x)
–4·0
UGC Economics (Dec. 19) | 11
12 | UGC Economics (Dec. 19)
UGC-NET/JRF Exam. June 2019 Solved Paper
Economics
(Paper-II)
(Held on 21-6-2019)
1. Under non-cooperative games, it is— (c) It is based on increasing returns to scale
(A) essential to understand one’s opponent’s point of (d) Output elasticities with respect to factors are
view constant
(B) not essential to understand one’s opponent’s point Select the correct option :
of view (A) (a) and (c) (B) (a) and (d)
(C) essential to understand one’s opponent’s point of (C) (b) and (c) (D) (c) and (d)
view and to deduce his likely responses accor-
Directions—(Q. 5-7) Go through the following
dingly
paragraph and diagram and answer the questions given
(D) essential to understand one’s opponent’s likely
responses below—
Monopoly charges a price above marginal cost, not all
2. Which of the following methods of selecting a strategy
consumers who value the good at more than its cost, buy
is consistent with risk averting behaviour ?
it. Thus, the quantity produced and sold by a monopoly
(A) If two strategies have the same expected profit,
is below the socially efficient level. The deadweight loss
select the one with smaller standard deviation
(B) If two strategies have the same standard deviation, represented by the area of the triangle between the demand
select the one with smaller expected profit curve and the marginal cost curve.
(C) If two strategies have the same standard deviation, Y
select the strategy with larger coefficient of varia-
tion E A
(D) If two strategies have different expected profits, MC
G
Price
C
select the one with the larger standard deviation F
B
3. Match List-I with List-II— Demand Curve
List-I MR
(a) Various combinations that a consumer can O X1 X2 X
purchase Output
(b) Various combinations of two commodities provi-
ding equal satisfaction to consumer 5. Deadweight loss is represented by the area of—
(c) A set of indifference curves (A) X1X2CA (B) X1BCX2
(d) Point of tangency of a budget line on an (C) OX1AE (D) BAC
indifference curve
6. What price will be charged under monopoly ?
List-II
(A) OF (B) X2C
(i) Indifference map
(C) OE (D) OG
(ii) Indifference curve
(iii) Budget line 7. Which is the socially efficient level of production ?
(iv) Consumer’s equilibrium (A) OX1 (B) OX2
(C) AX 1 (D) CX2
Choose the correct option from those given below :
(a) (b) (c) (d) 8. The inconsistency of which one of the following
(A) (i) (ii) (iv) (iii) criteria is labelled as Scitovsky Paradox ?
(B) (iv) (iii) (i) (ii) (A) Little criterion (B) Pareto criterion
(C) (ii) (iii) (iv) (i) (C) Bergson criterion (D) Kaldor-Hicks criterion
(D) (iii) (ii) (i) (iv)
9. Pareto's marginal condition for efficiency in composi-
4. Which of the following statements are true regarding tion of output (product-mix) requires—
Cobb-Douglas production function ? (A) MRTSX Y Z
L,K = MRTSL,K = MRTSL,K
(a) It is long period production function
(b) It is short period production function (B) MRSA A B
X,Y = MRSX,Z = MRSX,Z
2 | U.G.C.–NET Economics (J-19)
18. Vertical equity in taxation means that—
(C) MRTPX,Y = MRSA B
X,Y = MRSX,Y (A) people in different income groups should be taxed
(D) MRTSY A Z
L,K = MRSX,Y = MRSX,Y equally
10. The firms are competitive and profit maximizing the (B) people in different income groups should be taxed
demand curve for labour is determined by— differently
(A) the opportunity cost of worker’s time (C) people in different groups should be charged
(B) the value of marginal product of labour proportionately
(C) offsetting income and substitution effect (D) unequal people should be treated equally
(D) the value of marginal product of capital 19. According to Marxian analysis the surplus value
11. Why do individuals act in riskier ways after being depends upon—
insured ? (A) surplus and necessary labour time
(A) Due to the problem of adverse selection (B) necessary labour time only
(B) Due to the problem of false confidence (C) surplus labour time only
(C) Due to the problem of moral hazard (D) nominal wage rate
(D) Due to the problem of screening costs 20. Three pillars of the Asia-Pacific Economic Cooperation
12. General equilibrium analysis determines— (APEC) are—
(A) prices and quantities in all markets simultaneously (a) trade and investment liberalization
(B) prices and quantities in all markets simultaneously (b) business facilitation
and explicitly takes feedback effects into account (c) economic and technical cooperation
(C) feedback effects (d) military cooperation
(D) prices in all markets Choose the correct option :
(A) (a), (b), (d) (B) (a), (b), (c)
Directions—(Q. 13-15) Read the passage given below (C) (a), (c), (d) (D) (b), (c), (d)
and answer the questions that follow it :
Suppose that for a particular economy for some 21. The provision under the membership clause of the
time period, investment was equal to 100, government IMF is that any country can become a member, if—
expenditure was equal to 75, net taxes were fixed at 100 and (A) the country is willing to be a member of the World
consumption (C) was given by the consumption function : Bank and willing to pay all subscriptions in gold
(B) the country is willing to be a member of the WTO
C = 25 + 0.8 YD and willing to pay all subscriptions in gold
where YD is disposable income and Y is GDP. (C) the country is willing to be a member of the World
∆Y Bank and willing to pay subscription
13. What is the value of tax multiplier ? (D) the country is willing to be a member of UNO
∆T
and willing to pay subscription
(A) – 3 (B) – 2
(C) – 5 (D) – 4 22. Which of the following is NOT the function of a capital
market ?
14. What is the level of equilibrium income (Y) ?
(A) Mobilising savings into investment
(A) 700 (B) 600
(B) Channelising funds from less profitable to more
(C) 850 (D) 800
profitable
15. What is the value of the government expenditure (C) Mobilising funds from surplus units to deficit
∆Y units
multiplier ?
∆G (D) Providing better returns to direct investors
(A) 5 (B) 4 23. As income falls, consumption declines but propor-
(C) 6 (D) 3 tionately less than the decrease in income because
16. Which of the following factors is NOT the cause for the consumer desires to sustain previous standard of
‘market failure’ ? living. This is called—
(A) A symmetric information (A) ratchel effect
(B) Public goods (B) wealth effect
(C) Externality (C) demonstration effect
(D) Lack of demand (D) income effect
17. Which of the following is NOT part of Wiseman and 24. By ‘financial crowding out’ economists mean—
Peacock hypothesis ? (A) credit rationing
(A) Concentration effect (B) Displacement effect (B) what the government borrows cannot be used for
(C) Inspection effect (D) Taxation effect private investment
U.G.C.–NET Economics (J-19) | 3
(C) government borrowings drive up interest rate (c) IFCI (iii) 1955
(D) Reserve Bank of India controls on commercial (d) IDBI (iv) 1948
bank lendings Choose the correct option from those given below :
25. Direct credit programmes introduced— (a) (b) (c) (d)
(A) security-oriented credit (A) (i) (ii) (iii) (iv)
(B) development-oriented credit (B) (ii) (iii) (iv) (i)
(C) purpose-oriented credit (C) (iii) (i) (iv) (ii)
(D) welfare-oriented credit
(D) (iii) (ii) (i) (iv)
26. In the Balance of Payments Account, the transfer
payments are included in which one of the following ? 32. An increase in fiscal spending leads to—
(A) Capital Account (A) a shift of Phillips curve to the left
(B) Service Account (B) a shift of Phillips curve to the right
(C) Current Account (C) movement along the Phillips curve such that unem-
(D) Official Reserves Account ployment rises inflation also rises
27. During a depression which of the following policy (D) Movement along Philips curve in such a way that
instruments should be used ? shows the decline in employment rate with every
(A) Taxes should be increased increase in inflation rate
(B) Taxes are kept unchanged and public expenditure
33. The concept of fiscal deficit implies which of the
is increased
following ?
(C) Public expenditure is reduced
(D) There should be a balanced budget (A) Revenue and interest receipts minus revenue
expenditure
28. The long-term chronic unemployment arising from
imbalance between the skills and other characteristics (B) Revenue receipts and recovery of loans and other
of workers in the market and the needs of employers receipts minus total expenditure
is known as— (C) Receipts minus disbursement in Capital Account
(A) cyclical unemployment (D) Total receipts minus total expenditure
(B) frictional unemployment 34. In efficiency wage model, the real wage is set to—
(C) structural unemployment
(A) minimise the efficiency of worker per rupee of
(D) seasonal unemployment
real wages received
29. An increase in money supply will increase the demand (B) clear the labour market
for goods and services by—
(C) not to clear the labour market
(A) reducing government spending
(B) lowering the interest rate so that investment (D) maximise the efficiency of worker per rupee of
spending increases real of wages received
(C) raising interest rate so that investment spending 35. A tax is said to be direct, when—
reduces (A) impact and incidence fall upon the same person
(D) increasing government spending on goods and (B) only incidence falls upon the same person
services
(C) impact is shifted to another person
30. The commodity or Net Barter Terms of trade are (D) person escapes from paying tax
represented by the formula—
quantity of exports 36. A toll tax is a tax based on which of the following ?
(A) ×100 (A) The benefit principle (B) Horizontal equity
quantity of imports
price × quantity of exports (C) Vertical equity (D) Tax progressively
(B) ×100
price × quantity of imports 37. Which one of the following is NOT the method of
volume of exports debt redemption ?
(C) ×100 (A) Refunding (B) Repudiation
volume of imports
price index of exports (C) Sinking fund (D) Capital levy
(D) ×100
price index of imports 38. In J. Robinson’s growth model, capital accumulation
31. Match List-I with List-II— depends on—
List-I List-II (A) saving-income ratio
(Institutions) (Established) (B) profit-wage relation and labour productivity
(a) ICICI (i) 1971 (C) profit-income ratio and capital productivity
(b) IRBI (ii) 1964 (D) saving-investment ratio
4 | U.G.C.–NET Economics (J-19)
39. Which one of the following items is included in the (D) are correct on an average but are subject to errors
Capital Account of the balance of payments of a that are distributed randomly
country ? 45. Which consideration a commercial bank does NOT
(A) Investment income
keep in mind to manage its assets and liabilities ?
(B) Invisibles
(A) Liquidity (B) Profitability
(C) Commercial borrowings
(C) Solvency (D) Equity
(D) Private transfer
46. According to Marshall-Lerner condition for the
40. External drains leave which type of impact on
commercial bank ? foreign exchange market to be stable, the sum of the
(A) Lowers the reserve of bank elasticities of demand for imports and the demand for
(B) Increases further deposits exports should be—
(C) Increases credit creation (A) less than 1 (B) equal to zero
(D) Creates demand deposits (C) equal to 1 (D) more than 1
41. Match List-I with List-II— 47. The liquidity aggregates are classified as—
List-I (A) L1, L2 and L3 (B) M1, M2 and M3
(a) Accelerator and multiplier interaction (C) NM3 (D) M1, M2, M3 and M4
(b) Cambridge approach 48. During recession which of the following measures is
(c) Life cycle hypothesis initiated ?
(d) Efficiency wage model (A) Cutting taxes and boosting government spending
List-II (B) Increasing taxes and decreasing government
(i) Modigliani, Ando and Brumberg spending
(ii) Akerlof and Yellen
(C) Keeping tax rates constant and increasing
(iii) Paul Samuelson
government spending
(iv) Alfred Marshal and A.C. Pigou
(D) Increasing tax rates and keeping government
Choose the correct option from those given below—
spending constant
(a) (b) (c) (d)
(A) (i) (iv) (ii) (iii) 49. A foreign exchange risk involves the transaction
(B) (iii) (iv) (i) (ii) exposure, the accounting exposure and—
(C) (ii) (i) (iii) (iv) (A) the translation exposure
(D) (iv) (iii) (ii) (i) (B) the flexibility exposure
42. Which one of the following does NOT determine (C) the rigidity exposure
the amount of years of schooling demanded by an (D) the economic exposure
individual to qualify for modern job ? 50. Which one of the following growth models takes
(A) The wage or income differential technology as exogenous variable ?
(B) The probability of success in finding modern (A) Solow model (B) Robinson model
sector employment (C) Lucas model (D) Todaro model
(C) Opportunity cost of schooling
51. ‘Immiserizing growth’ is the term given by—
(D) Expansion of healthcare infrastructure in urban
(A) Amartya Sen (B) N. Kaldor
sector
(C) Paul Krugman (D) Jagdish Bhagwati
43. The excess supply of a commodity above the no-trade
equilibrium price gives one nation’s— 52. Match List-I with List-II—
(A) import demand for the commodity
List-I List-II
(B) export supply and import demand for the (a) Theory of big push (i) J. H. Boeke
commodity (b) Warranted rate of growth (ii) Paul Romer
(C) export supply of the commodity (c) Social dualism (iii) Rosenstein-Rodan
(D) import supply of the commodity (d) Endogenous growth thoery (iv) R. F. Harrod
Choose the correct option from those given below :
44. The rational expectations hypothesis suggests that the
forecasts that people make concerning future inflation
(a) (b) (c) (d)
rates— (A) (ii) (iii) (iv) (i)
(A) consistently overestimates the actual rate of (B) (iii) (i) (iv) (ii)
inflation in the future (C) (iii) (iv) (i) (ii)
(B) are always correct (D) (iv) (ii) (iii) (i)
(C) consistently underestimates the actual rate of 53. Under which system the central bank is authorised
inflation in the future by law to issue a fixed amount of notes against
U.G.C.–NET Economics (J-19) | 5
government securities and any excess is to be fully TABLE
backed by gold/silver ? MPCE (in `) of 8 Households
(A) Maximum fiduciary system State
1 2 3 4 5 6 7 8
(B) Minimum reserve system
State—A 950 1100 1000 975 750 775 790 1400
(C) Fixed fiduciary system
State—B 1250 1150 1400 1100 550 600 490 1200
(D) Maximum and minimum fiduciary system
The value of Z (poverty line MPCE cut off) is ` 800.
54. Which of the following is an example of a public good ?
61. From the table calculate the estimates of Poverty Gap
(A) Residential building
Ratio (PGR) for State—A and State—B and select the
(B) National defence correct option—
(C) Restaurant meals (A) State—A : 0·133; State—B : 0·0119
(D) Swimming pool of a house (B) State—A : 0·153; State—B : 0·0135
55. Which is NOT the main objective of credit control ? (C) State—A : 0·0133; State—B : 0·119
(A) Stabilization on general price level (D) State—A : 0·0153; State—B : 0·135
(B) Promoting economic growth 62. Estimate of head count ratio in State—A and State—B
(C) Ensuring adequate flow of credit to productive are—
sectors
(A) State—A : 0·375; State—B : 0·375
(B) State—A : 0·475; State—B : 0·375
(D) Promoting economic welfare (C) State—A : 0·575; State—B : 0·575
56. Who among the following is not associated with the (D) State—A : 0·385; State—B : 0·425
endogenous growth theory ? 63. From the table calculate the estimates of Square
(A) Robert Solow (B) Paul Romer Poverty Gap Ratio (SPGR) and then show that the
(C) Rebelo (D) Robert Lucas SPGR in State—A is—
57. Calculate the rate of effective protection by using the (A) same as in State—B
(B) higher than that in State—B
t − ai ti
formula g = if g = 0·3, ai = 0·8 and ti = 0, (C) lower than that in State—B
1− ai (D) significantly different from zero
then the value of t is— 64. A simultaneous equation model is exactly identified,
(A) 0·2 (B) 0·3 if—
(C) 0·1 (D) 0·4 (A) unique numerical values of structural parameters
58. Liquidity approach is also known by the name— can be obtained
(A) Gurley-Shaw approach (B) more than one numerical value can be obtained for
some of the parameters of the structural equation
(B) Radcliffe approach
(C) unique solution of all the structural coefficients
(C) Traditional approach
is not possible
(D) Monetarist approach (D) structural coefficient cannot be estimated
59. Which one is NOT axiom of inequality measures ? 65. The cost function of a monopolist is C = 40 + 12X.
(A) Principle of scale invariance Write his demand function as P = 60 – 3X. What is
(B) Principle of equity his profit maximising output level ?
(C) Principle of translation invariance (A) 12 (B) 11
(D) Axiom of decomposibility (C) 8 (D) 9
60. Assume that an economy begins in macroeconomic 66. Match List-I with List-II—
equilibrium, then taxes are significantly decreased. As
List-I List-II
(a) Skewness (i) Dispersion
a result of this change—
(b) Variance (ii) Random variation
(A) there is expansion and deflation in the economy
(c) Earthquake (iii) Ratio of variances
(B) there is recession and deflation in the economy (d) F-test (iv) Lack of symmetry
(C) there is expansion and inflation in the economy Choose the correct option from those given below :
(D) there is stagflation in the economy (a) (b) (c) (d)
Directions—(Q. 61 and 62) Consider the following (A) (iii) (iv) (i) (ii)
table that gives the monthly per capita consumption (B) (iv) (i) (ii) (iii)
expenditure (MPCE) of eight households and answer the (C) (i) (iii) (iv) (ii)
questions given below : (D) (ii) (i) (iv) (iii)
6 | U.G.C.–NET Economics (J-19)
67. Second National Commission on Labour has recom- 73. For a moderately skewed distribution, the value of
mended a three-tier system including— mode is 10 and value of median is 20. Then the mean
(A) Lok Adalats, Labour Courts and Labour Com- is—
mission (A) 15 (B) 30
(B) Lok Adalats, Labour Courts and Labour Relations (C) 25 (D) 35
Commission 74. Which age structure is important for demographic
(C) Lok Adalats, Labour Courts and Judicial Courts dividend ?
(D) Lok Adalats, Labour Courts and Labour Inspectors (A) 0-14
68. National Food Security Law covers— (B) 15-59
(A) 65% of rural population (C) 60 and above
(B) 70% of rural population (D) 0-14 and 60 and above
(C) 75% of rural population 75. Who propounded optimum theory of population ?
(D) 80% of rural population (A) Robbins (B) Dalton
69. “Under some conditions, it makes no difference to (C) Cannan (D) Carr Saunders
efficiency whether the polluter has a right to pollute 76. Market failure occurs in case of most of the environ-
or the victim has a right to clean air.” This statement mental goods, because—
is related to the work of— (A) environmental goods are rival products
(A) G. Hardin (B) R. Coase (B) environmental goods are excludable products
(C) N. Kaldor (D) Julian Simon (C) environmental goods are non-rival in production
(D) environmental goods are non-rival and non-
6 5 5
excludable in consumption
70. If A = 3 −11 −5 , then | A | is equal to—
77. Assertion (A) : The share of the non-commodity
3 − 5 −2
sector in the national income has been increasing in
(A) 15 (B) 16
India.
(C) 27 (D) 20
Reason (R) : Industry and Agriculture have been
71. Match List-I with List-II— growing at a relatively slower pace in India.
List-I Choose the correct answer from the options given
(a) Gauss-Markov below :
(b) Coefficient of determination (A) Both (A) and (R) are true and (R) explains (A)
(c) H0 : B2 = 0, H1 : B2 = 70 (B) Both (A) and (R) are true, but (R) does not explains
(d) Heteroscedasticity (A)
List-II (C) (A) is true, but (R) is false
(i) R2 (D) (A) is false, but (R) is true
(ii) One sided test 78. In an open economy input-output model, the viability
(iii) Goldfeld-Quandt test is examined by—
(iv) BLUE (A) Hawkins-Simon conditions
Choose the correct option from those given below : (B) Kuhn-Tucker conditions
(a) (b) (c) (d) (C) Dickey-Fuller test
(A) (iv) (i) (ii) (iii) (D) Goldfeld-Quandt test
(B) (i) (ii) (iv) (iii) 79. What is the equation of corrected birthrate ?
(C) (ii) (iii) (i) (iv) (A) Corrected birthrate
(D) (iii) (i) (ii) (iv) Registered births in one year + Possible birth
= × 1,000
72. In a two variable (X and Y) regression analysis, the Mid year population
regression coefficients are bxy = 0·6 and byx = 0·8. If (B) Corrected birthrate
y is dependent variable and x is independent variable, Live births in one year
= × 1,000
what is the percentage of variations in Y explained by Mid year population
X? (C) Corrected birthrate
(A) 47% (B) 48% Number of female births
= × 1,000
(C) 49% (D) 36% Mid year population
U.G.C.–NET Economics (J-19) | 7
(D) Corrected birthrate 87. Match List-I with List-II—
Registered births + Possible births List-I List-II
= × 1,000 (a) World Environment Day (i) 11th July
Mid year female population
(b) World Wildlife Day (ii) 5th June
80. When the null hypothesis is there as an equality, the
(c) World Water Day (iii) 3rd March
level of significance is the probability of making—
(d) World Population Day (iv) 22nd March
(A) type II error (B) type I error
Choose the correct option from those given below :
(C) type I and II errors (D) type I and III errors
(a) (b) (c) (d)
81. Standard Error (SE) of Sample mean (x) in random (A) (i) (ii) (iii) (iv)
sampling from an infinite population or in random (B) (iii) (i) (iv) (ii)
sampling with replacement is given by—
(C) (iv) (iii) (ii) (i)
σ2 (D) (ii) (iii) (iv) (i)
(A) SE where s is the population standard
n
deviation 88. Applying OLS to simultaneous equations results in
σ the parameters being—
(B) SE where s is the population standard (A) inefficient
n2
deviation (B) inconsistent
σ3 (C) biased
(C) SE where s is the population standard (D) biased and inconsistent
n
deviation 89. Multiplicative decomposition model is used to—
σ (A) deseasonalise the time series data
(D) SE where s is the population standard
n (B) build cost of living index
deviation (C) test a hypothesis
82. A linear programming problem can be solved by (D) estimate probability
using— 90. If AR = 15 and MR = 5, the price elasticity of demand
(A) ARIMA techniques (B) Simplex method is—
(C) Unit root method (D) None of these (A) 2·3 (B) 1·5
83. Which of the following is NOT correct with reference (C) 1·75 (D) 1
to the service sector of Indian economy ? 91. The RBI made Indian rupee fully convertible in current
(A) Service sector has the largest share in the GDP account transactions related to goods and services in
(B) Service sector has the largest share in employment the year—
(C) Service sector’s growth has been higher than (A) 1985 (B) 2002
growth of agriculture sector (C) 1994 (D) 2011
(D) Productivity per worker in service sector is highest
92. Which of the following is NOT an instrument of capital
84. “Education as investment in human resources plays market with special reference to India ?
an important role among the factors which contribute (A) Equity share (B) Debenture
to economic growth.” This statement was given by— (C) Gold ETF (D) Commercial paper
(A) New Education Policy, 1985
93. Which of the following items completes the life
(B) Education Commission, 1966
table ?
(C) NCERT
(D) Supreme Court of India Age Ix dx Lx Tx exº
7 90,000 500 89,750 48,50,000 ?
85. In a binomial distribution, the probability of x
successes in n trials in any order is given by—
(A) 50·50 (B) 54·00
(A) p(x) = nCxpx·qn – x (B) p(x) = nC1p2x·qn – 1
(C) 53·89 (D) 51·31
(C) p(x) = nCxp2·qn – 1 (D) p(x) = nCxpx·qn – 2 94. Under TRIPs protection for copyrights is for—
86. The IRR is the discount rate that equates the project (A) 20 years after death of the author
NPV to ........... and benefit-cost ratio to. (B) 30 years after death of the author
(A) 1, 0 (B) 0, 1 (C) 40 years after death of the author
(C) 0, 0 (D) 1, 1 (D) 50 years after death of the author
8 | U.G.C.–NET Economics (J-19)
95. The correct relationship among Arithmetic Mean 99. The ‘hedonic price’ method measures the value of
(AM), Geometric Mean (GM) and Harmonic Mean environmental assets through—
(HM) is— (A) using ‘existence’ of an environmental asset
(A) GM = AM + HM (B) AM < HM (B) using linkages between variations of inhouse
(C) [GM]2 = HM × AM (D) AM = GM – HM prices
(C) using WTP to value of environmental asset
96. Match List-I with List-II—
(D) using WTA to value of environmental asset
List-I List-II
(a) Thomos Doubleday (i) Destiny theory 100. In 2011 the proportion of urban population was more
(b) Thomas Sadler (ii) Biological theory than 40 per cent in the States of—
(c) Leibenstein (iii) Diet theory (A) Tamil Nadu, Punjab, Andhra Pradesh, Gujarat
(B) Tamil Nadu, Haryana, Gujarat, Maharashtra
(d) Herbert Spencer (iv) Motivation theory of
(C) Tamil Nadu, Kerala, Andhra Pradesh, West
population growth
Bengal
Choose the correct option from those given below—
(D) Tamil Nadu, Kerala, Maharashtra, Gujarat
(a) (b) (c) (d)
(A) (i) (ii) (iii) (iv) Answers
(B) (iii) (i) (iv) (ii) 1. (C) 2. (A) 3. (D) 4. (B) 5. (D)
(C) (iv) (iii) (ii) (i) 6. (C) 7. (B) 8. (D) 9. (C) 10. (B)
(D) (iv) (ii) (i) (iii) 11. (C) 12. (B) 13. (D) 14. (B) 15. (A)
97. Difference equation in concerned with— 16. (D) 17. (D) 18. (B) 19. (A) 20. (B)
(A) discrete changes 21. (C) 22. (D) 23. (A) 24. (C) 25. (C)
26. (C) 27. (B) 28. (C) 29. (B) 30. (D)
(B) continuous changes
31. (C) 32. (*) 33. (B) 34. (D) 35. (A)
(C) Both of the above 36. (A) 37. (B) 38. (B) 39. (C) 40. (A)
(D) None of the above 41. (B) 42. (D) 43. (C) 44. (D) 45. (D)
98. Which of the following is NOT part of the ‘PM Kisan 46. (D) 47. (A) 48. (A) 49. (D) 50. (A)
Samman Nidhi’ scheme as announced on 1-02-2019 ? 51. (D) 52. (C) 53. (C) 54. (B) 55. (D)
(A) All farmers having land holdings up to 2 hectares 56. (A) 57. (*) 58. (B) 59. (B) 60. (C)
are eligible under the scheme 61. (C) 62. (A) 63. (C) 64. (A) 65. (C)
66. (B) 67. (B) 68. (C) 69. (B) 70. (C)
(B) The scheme will be applicable from 1st April,
71. (A) 72. (B) 73. (C) 74. (B) 75. (C)
2019 76. (D) 77. (A) 78. (A) 79. (A) 80. (B)
(C) The government will transfer ` 6,000 per annum 81. (D) 82. (B) 83. (B) 84. (B) 85. (A)
into the bank accounts of eligible beneficiaries 86. (B) 87. (D) 88. (D) 89. (A) 90. (B)
(D) The money will be given in three equal instalments 91. (C) 92. (D) 93. (C) 94. (D) 95. (C)
of ` 2,000 each 96. (B) 97. (A) 98. (B) 99. (B) 100. (D)
* Bonus Marks
Economics
UNIT-1
Micro-Economics
Theory of Consumer Behaviour brother in the family, a teacher in the school or
college etc.)
Consumer behaviour deals with the decision making
● Social class and caste.
process of an individual when consumer engaged in
evaluating, acquiring, using or disposing goods/services. ● Culture.
The decision making is basically depend on two ● Psychological Determinants
important aspects- (i) Needs/wants of the consumer and ● Motivation Theory : Human Behaviour is
(ii) the resources that are available with the consumer for motivated, and an unsatisfied need is a
spending. Consumer Behaviour can be defined as the motivator.
sum total of how individuals and groups recognize and ● Learning Theory : There develops a bond
determine their needs and “how cannot how often” they between behaviour producing stimulus and a
purchase and experience goods and services to meet behaviour response. As advertisement is a
those needs. It includes the “what-where-when and how” stimulus whereas purchase is response.
of the purchase and experience process. In simple terms
consumer behaviour refers to “the mental and emotional ● Psychoanalytical Theory : A person is unable
processes and the observable behaviour of consumers to satisfy all his needs. As a result such
during searching, purchasing and post con-sumption of a unsatisfied needs create tension within a
product or service.” person. Such tension is always said to exist in
the sub-conscious and continues to influence
Determinants of Consumer Behaviour consumer behaviour.
● Economic Determinants ● Perception : Different individuals perceive
● Income : Income reflects purchasing power. different products, brands, stores and ads
Higher the income, higher is the purchasing differently.
power of a person and vice versa. ● Personality traits : An understanding of
● Income expectations of consumers. personality traits of the consumer helps
marketers to identify the kind of behaviour their
● Availability of consumer credit. Higher the
consumers might have which helps a long way
availability of consumer credits higher the
in formulating suitable marketing strategies.
tendency among consumer to buy durables such
as T.V. Car, House etc. ● Attitudes : Attitudes towards products vary
● Possession of liquid assets such as cash. among different individuals.
● Economic Theories such as (i) Law of Dimi- ● Self-concept : Individual behaviour is
nishing Marginal Utility and (ii) Law of influenced by his own images as viewed by
Equilibrium – Marginal Utility. himself or the manner in which he wants others
to see him.
● Sociological Determinants
How consumes make decisions to spend their
● Family : In every family there is a role available resources such as money, time and effort on
specialization. They are (i) Husband dominated consumption is the subject of consumer behaviour.
decisions (ii) Wife dominated decisions and Consumer behaviour has two aspects : the final purchase
(iii) joint decisions. activity which is visible to us and the decision process
● Reference groups : These are the groups used which may involve the interplay of number of complex
by an individual as a point of reference for his variables not visible to us. In fact, purchase behaviour is
own judgment, beliefs and behaviour. the end result of a long process of consumer decision
● Opinion Leaders : A person makes reference making. The study of consumer behaviour involves what
to an individual and not to a group in order to consumers buy, why they buy it, how they buy it, where
formulate his or her behaviour pattern (e.g., a they buy it, how frequently they buy it and how they
father in the family or in the Church, eldest dispose of the product after use. The study of consumer
4U | Economics (NET)
behaviour investigates and develops methods of II.Triggering Cues: These influence the decision
quantify, forecast and influence the behaviour of process but do not activate it. They are two kinds.
consumers. ● Product cues are external stimuli received form
Consumer Behaviour Models the product directly, e.g., colour of package,
weight, style, price etc.
There are various consumer models which help in
● Informational cues are external stimuli which
understanding consumer behaviour. These are listed
provide information about the product, like
below.
advertisement, sales promotion, talking to other
1. Economic Model : The economic model of people, suggestions of sales personnel etc.
consumer behaviour is based on the premise that , being Response is what the buyer does, i.e., buy or not
a rationale person the consumers’ ultimate objective is buy.
to maximize his utility with the available resources with
him. Economic model is based on : III.Reinforcement : When a person has a need to
buy, say clothing, and passes by a showroom and is
(i) Price Effect : Lesser the price of the product, attracted by the display of clothing their colour and
more will be the quantity purchased. style, which acts as a stimulus, and he makes a purchase.
(ii) Substitution effect : Lesser the price of the If he likes it, enforcement takes place and he is happy
substitute products, lesser will be the utility of the and satisfied with the purchase. Reinforcement part thus
original product bought. is an important part of buyer behaviour and the marketer
(iii) Income effect : When more income is earned, tries to create a good image of the product in the mind of
or more money is available, more will be the quantity the consumer for repeating purchases through Rein-
purchased. forcement.
The economic model, according the behavioral 4. Sociological Model : A consumer is a part of the
scientists, is not complete as it assumes the homogeneity society and is a member of many groups-formal or
of the market, similarity of buyer behaviour and informal in a society. The buying behaviour of consumer
concentrates only on the product or price. It ignores all is influenced by these groups such as family, friends,
the other aspects of consumer behaviour such as and social institutions etc.
perception, motivation, learning, attitudes, personality 5. Howarth- Sheth Model : This model is slightly
and socio-cultural factors. complicated and shows that consumer behaviour is a
2. Psychological Model : Psychologists have complex process under which the behavior of the
studied the consumer behaviour in terms of all those consumer is influenced by the learning, perception and
factors which influence the consumer to purchases any attitudes of the consumer. This model of decision
goods and services. This has been explained by A.H. making is applicable to individuals. It has four sets of
Maslow in his hierarchy of needs. The behaviour of an variables which are : (1) Input, (2) Perceptual and
individual at a particular time is determined by his Learning constructs, (3) Outputs (4) Exogenous or
strongest need at that time. This also shows that needs external variables.
have a priority. First they satisfy the basic needs and Input constructs psychological variables, e.g.,
then go on for secondary needs. The purchasing process motives, attitudes and perception which further
and behaviour is governed by motivational forces. influence consumer’s decision making process. The
Motivation stimulates people into action. Motivation consumer receives the stimuli and interprets it. Two
starts with the need. It is a driving force and also a factors that influence his interpretation are stimulus -
mental phenomenon. Need arises when one is deprived ambiguity and perpetual bias. Stimulus ambiguity occurs
of something then a tension is created in the mind of the when the consumer cannot interpret or fully understand
individual which leads him to a goal directed by the meaning of the stimuli he has received, and does not
behaviour which satisfies the need. Once a need is know how to respond. Perceptual bias occurs when
satisfied, a new need arises and the process is individual distorts the information according to his
continuous. needs and experiences. These two factors influence the
individual for comprehension and rating of the brand. If
3. Pavlovian Model : The model , named after the the brand is rated high, he develops confidence in it and
Russian Physiologist Ivan Pavlov, discusses the finally purchases it. Output means the purchase
consumer behaviour in terms of learning which is decision. After purchase there is satisfaction or
defined the changes in behaviour which occur by dissatisfaction. Satisfaction leads to positive attitude and
practice and, based on previous experience. The learning increases brand comprehension. With dissatisfaction, a
process consists of the following factors. negative attitude is developed. Exogenous or External
I. Drive : This is a strong internal stimuli which Variables do not directly influence the decision process.
impels action. Because of the drive, a person is They influence the consumer indirectly and vary from
stimulated to action for fulfilling his desires. Drives can one consumer to another. These are the individual’s own
be innate (in born), which stem from physiological personality traits, social class, importance of purchase
needs, such as a hunger, thirst, pain, cold, sex etc. and financial status. All the four factors discussed above
Economics (NET) | 5U
are dependant on each other and influence the decision storage and consumption. The feedback from field four
making process. The model though complicated, deals is fed into the firms attributes or field one, and the
with the purchased behaviour in an exhaustive manner. feedback from the experience is responsible for
6. Engel – Blackwell – Kollat Model : It consists changing the pre-disposition of the consumer and later
of four components (i) Information Processing, (ii) his attitude towards the product.
Central control units, (iii)Decision process, and (iv) 9. The psychoanalytical model : The psychoanaly-
Environmental influences. tical model draws from Freudian psychology. According
to this model, the individual consumer has a complex set
The information processing consists of exposure, of deep seated motives which drive him towards certain
attention, comprehension and retention of the marketing buying decisions. The buyer has a private world with all
and non-marketing stimuli. The stimuli processes and his hidden fears, suppressed desires and totally subjective
interprets the information received by an individual. The longings. His buying action can be influenced by
basic drawback of the model is that the roles of some appealing to those desires and longings.
variables are very vague. The model is somewhat 10. Learning model : All theories of buyer
mechanistic in its treatment of the decision process. behaviour have been basically based on a learning model
Despite these limitations, this model is very use for as it namely, Stimulation-Response or more popularly known
is updated and various variables are incorporated here as SR model. SR learning theory is very useful to
modern marketing and marketers. Learning is the
from time to time.
centrifugal point in the entire study of human behaviour.
7. Model of Family Decision Making : In a family Learning refers to a change in the behaviour which
decision making model, it is important to understand occurs as a result of practice. It is a change in the
how the family members interact with each other in the behaviour that results from previous experience and
context of their consumer decision making. There are behaviour in similar situations. Learning is a product of
different consumption roles played by various members reasoning, thinking, information processing and, of
of the family. These roles are as follows : course, perception. Therefore, behaviour is deeply
affected by the learning experiences of the buyers.
(i) Influencers : The members who influence the
purchase of the product by providing information to the I. Theory of Consumer Behaviour
family members.
Demand Analysis
(ii) Gate keepers : These members control the flow
of information for a product or brand that they like and Demand is a crucial economic decision variable for
influence the family to buy the product of their choice. the functioning of a business enterprise. It constitutes
They provide the information favourable to themselves one side of the product market, since, price of any
and, withhold information about other product which commodity or economic service is determined by the
they do not favour. interaction of demand and supply. A study of demand is
imperative for decision-taker, as it has bearings on
(iii) Deciders : These are the people who have the production as well as profit. Even if the firm pursues
power or money and authority to buy. They play a major objectives other than profit maximisation, demand
role in deciding which product to buy. concepts remain relevant. For example, discharging of
(iv) Buyers : Buyers are the people who actually ‘social responsibility of business’ requires the evaluation
buy. of tastes, preferences and choices of the consumers. All
8. Nicosia Model : Nicosia Model is a compre- these concepts are built into the economic concepts of
hensive model of dealing with all aspects of building demand.
attitudes, purchase and use of product including the post Demand reflects the size as well as pattern of
purchase behaviour of the consumer. This model market and the market determines the magnitude of
explains the consumer behaviour on the basis of four business activities. Investment decisions of business
fields. The output of field one becomes the input of field firms are limited by the size of the market. If the market
two, and so on. Field one further consists of subfields conditions reflect rising demand, the firms raise
one and two. Subfield one is the firm‘s attributes and the production. Information about size and type of demand
product’s attributes. The subfield two is of the pre- helps management to plan its requirements of various
disposition of the consumer and his won characteristics inputs. A substantial and sustained increase in long-term
and attributes, which are affected by his exposure to demand may persuade the firm to install a new plant to
various types of information and message, and is meet the demand on a permanent basis. On the other
responsible for the building of attitude of the consumer. hand, if the demand for the firm's product is falling,
Field two is the pre-action field, where the consumer while that of rival is rising, the firm under consideration
goes on for research and evaluation and gets motivated has to undertake aggressive advertising by planning its
to buy the product. Field three is the act of purchase or sales tactics to fill demand-production gap. In this way,
the decision making to buy the product. The customer demand can be created by the firm. Further, if the
buys the product and uses it. Field four highlights the demand for product is subject to temporary business
post purchase behaviour and the use of the product, its recession, the firm may have to plan to pile up the stock
6U | Economics (NET)
of unsold products. Thus, demand is one of the major A demand curve has been shown in figure.
factors for the survival of any business. Further-more, if
there is no demand, the output becomes unwarranted.
Demand analysis is one area of Economics that has
been used most extensively in business. The whole
range of planning by the firm-manpower utilisation,
production planning, inventory management, investment
decisions, cost budgeting, purchase plan, market
research, pricing decision, advertising budget, profit
planning, etc., call for a detailed analysis of demand.
The decision of management with respect to any
functional area always hungs on an analysis of demand.
Demand Function
Five main variables influence the quantity of each In this curve we see, when the price of commodity
product that is determined by each individual consumer, is P1 the quantity demanded is OM 1 when the price falls
these variables are, (I) Price of the commodity, (II) to OP the quantity demanded increase to OM.
Income of the consumer, (III) Prices of the related
goods, (IV) Taste of the consumer, (V) Consumers’ 2. Relationship between Demand for
expectations about the future. Commodity and Prices of Related
In actual life, most of the demands are usually Goods
closely interrelated. The interrelated demands can be Expressed as Dn = f(PR ). i.e., other things being
classified as : (1) Joint demands (2) Derived demands equal demand for commodity ‘n’ depends upon the
(3) Composite demands. prices of their related commodities. In Economics
This statement can be expressed in symbolic form Related Commodities are of two types—(I) comple-
in the following manner— mentary goods and (II) competitive or substitute goods.
Dn = f(Pn; P1 …P n-1, Y, T, E, U), (I) Complementary Goods—are those wherein
one commodity having utility and is demanded only
This equation is known as Demand function. when the second related goods is also available. For
where, example a ball-pen without its refill is useless, similarly
Dn = Demand for commodities ‘n’ bricks and cement etc. are complementary goods, thus
goods are complementary when they are demanded
P n = Price of ‘n’ commodities together, change in the price of one affects the demand
P 1 …….Pn-1 = Prices of related goods for others. If the prices of refills falls the demand for
ball-pens will go up, and vice-versa. And its relationship
Y = Income is known as inverse relationship and is represented by a
T = Taste of the consumer downward sloping curve as shown in figure below—
E = Consumer expectation about the future
U = Other factors
F = Functional relationship
Thus, the demand equation tells us that the quantity
demanded is a function of the price of the commodity,
prices of related goods, income of the consumer, his
tastes and future expectations.
1. Relationship between Demand and
Price
Dn = f(Pn); i.e., other things being equal demand for
commodity ‘n’ depends upon its price. If income and
tastes of the consumer and prices of the related goods do
not change, while the price of the commodity falls then
its demand will ordinarily rise, other things remaining
the same if the price of the commodity rises, its demand
will fall, thus demand for a goods is inveresly related to (II) Substitute Goods—are those goods that can be
prices. And the curve showing demands at various prices substituted for each other, for instance, tea and coffee,
is called demand curve and it has a negative slope. motorcycle and scooter, etc are substitutes. Therefore, a
Economics (NET) | 7U
change in the price of any one of these goods is likely to consumer gives up the consumption of the inferior
affect the demand for the other. If the price of coffee goods, and prefers to consume better quality goods.
falls, consumer may substitute coffee for tea, thus A curve indicating the relationship between demand
demand for tea, shall come down even though its price for an inferior good and consumers income is shown in
has not changed. Figure (VI).
This type of relationship between demand for a
commodity and level of income is also known as income
demand.
4. Tests of the Consumers
Dn = f(T), i.e., other things being equal demand
for a commodity depends upon consumer's tests and
preference.
5. Consumer’s Expectations About the
Substitutes Future
This shows that demand for substitute goods move Dn = f(E) or expectations of a consumer about the
in the opposite direction, and its slope of the demand future prices also influence his current demand.
curve is positive, i.e., the demand curve slopes upwards Other factors expressed as Dn = f(u ) i.e., other
from left to right as shown in figure. things being equal, the demand for commodity is also
This type of relationship between demand for a determined by the following factors; size of population,
commodity and price of the related commodity is also composition of population and distribution of income.
known as cross demand. Kinds of Demand
3. Relationship between Demand and Demand may be classified into four types –
Income
Dn = f(Y), i.e., other things being equal, demand
for a commodity depends upon the level of income.
Generally with an increase in income demand for goods
increase. But this may not always be true. We can
distinguish between three types of commodities (a)
Necessaries (b) Comforts, and (c) Inferior goods.
OX = Quantity demanded DD = Demand for
OY = Income of the consumer interior goods
(a) Necessaries goods, occupy a place of priority in 1. Direct Demand—Refers to demand for a
the consumer’s order of preference. Therefore, even at a commodity that is directly consumed to satisfy human
low level of income, a large share of income is spent on wants, for example demand for bread, butter and fruits.
such goods. So, with the rise in income it is possible that (a) Price Demand—It refers to the demand for a
consumers demand for necessaries may increase, but the commodity at a particular price—
increase cannot be infinite so beyond a level of income,
Dx = f(Px), Ceteris Paribus
demand for necessaries becomes income inelastic like in
the fig. (b) Income Demand—It refers to the demand for a
(b) Certain Demand for comforts and luxuries has a commodity at various levels of consumer’s income—
positive association with income and it is shown by Dx = f(Y); Ceteris Paribus
curve in Fig. (c) Cross Demand—It refers to quantity demanded
(c) Certain Demand for inferior commodities, on of a commodity due to change in the price of other
the other hand, is inversely related to the level of commodity—
income. With an increased in the level of income the Dx = f(P2 ); Ceteris Paribus
8U | Economics (NET)
2. Indirect Demand or Derived Demand— Commodities such as Pen, Pepsi, Maruti Car have close
Demand for factors of production is indirect because substitutes and hence have an inelastic demand.
they help in the production of a commodity which is (b) Income of the Consumers—If the income
directly demanded by the consumer in the market. level of consumers is high, the elasticity of demand will
3. Joint Demand—It refers to the demand for those be less. It is because change in the price will not affect
goods which are always demanded jointly as for the quantity demanded by greater proportion.
example—Car and Petrol. (c) Luxuries versus Necessities—The price
4. Composite Demand—It refers to the total elasticity of demand is likely to be low for necessities
demand for a commodity which can be used for various and high for luxuries.
purposes. (d) Cost Relative to Total Income—Higher the
cost of the goods relative to total income of the
Elasticity of Demand consumer, more will be the price elasticity of demand.
Economic theory finds it useful to distinguish (e) Number of Uses of the Commodity—The
between those goods which are more responsive to the more the number of uses a commodity can be put to, the
price changes and those which are less responsive. In more elastic is the demand. If a commodity has few uses
technical jargon, economists say that the forever goods it has an inelastic demand.
have a demand which is more elastic than that of the
(f) Level of Price—If the price of the commodity
inelaste goods, or their elasticity of demand is greater.
is high the price elasticity of demand is more and if it is
Elasticity of demand is therefore a technical term used
low, its price elasticity of demand is less.
by economists to describe the degree of responsiveness
in the demand for a commodity to a change in its price. Types of Elasticity of Demand
Alfred Marshall introduced the concept of There are three main types of elasticity of demand :
elasticity of demand into economic theory. He said that 1. Price elasticity of demand;
elasticity of demand in a market is great or small
2. Income elasticity of demand; and
according as the amount demanded increases much or
little for a given fall in price and diminishes much or 3. Cross elasticity of demand.
little for a given rise in price. 1. Price Elasticity of Demand
Price Elasticity is thus defined as the ratio of
It may be defined as the degree of responsiveness of
percentage change in quantity demanded of a good to a
quantity demanded of a commodity in response to
percentage change in its price. It may be defined as the
change in its price. Therefore, the price elasticity of
degree of responsiveness of quantity demanded of a
demand refers to the ratio of the percentage change in
commodity in response to change in its price.
the quantity demanded of a commodity to given percen-
Percentage Change in the tage change in its price.
Quantity Demanded
ep = Percentage Change in the Quantity Demanded
Percentage Change in Price ep =
Percentage Change in Price
Change in Quantity Demanded Different Types of Price Elasticity of Demand—
Original Quantity Demanded Price elasticity of demand may be expressed in terms of
ep =
Change in Price its numerical value. The numerical value of price
Original Price elasticity of demand ranges from zero to infinity. In
ΔQ terms of its numerical value i.e., the degree of elasticity
Q ΔQ P there are five types of price elasticity of demand—
= – =– ×
ΔP ΔP Q 1. Perfectly Inelastic Demand (ed = 0)—When the
P demand of a commodity does not change as a result of
where, change in its price, the demand is said to be perfectly
inelastic i.e. zero. The perfectly inelastic demand curve
ΔQ = Change in the quantity demanded is a vertical line parallel to Y axis.
Q = Original in the quantity demanded
ΔP = Change in the price
e=0
P = Original Price
ep = Coefficient of elasticity of demand
Determinants of Price Elasticity of De-
mand
(a) Availability of Substitute—Goods having close
substitutes will have an elastic demand and goods with
no close substitutes will have an inelastic demand. Perfectly inelastic Demand Curve
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Price (R) Demand (units) 4. Elastic Demand (1 < e d < ∝ )—When a small
15 10 change in price leads to a more than proportionate
10 10 change in demand, the demand is said to be elastic or
20 10 more than unit elastic. The coefficient of elasticity of
demand is greater than unity.
2. Inelastic Demand (ed < 1)—Demand is inelastic
when the percentage change in quantity demanded of a Price (R) Demand (units)
commodity is less than the percentage change in its 10 20
price. When a considerable change in price leads to less 9 40
than proportionate change in demand, the demand is said
to be less elastic or inelastic.
Price (R) Demand (units)
e>1
10 20
2 21
3. Unitary Elastic Demand (ed = 1)— When the
given percentage change in demand is equal to the
percentage change in price, the demand for the
commodity is said to be unitary elastic. Elastic Demand Curve
5. Perfectly Elastic Demand (ed = ∝)—When
consumers are prepared to purchase all that they can
e<1
get at a particular price but nothing at all at a slightly
higher price, then the price elasticity of demand for a
commodity is said to be infinite. When the demand for a
commodity rises or falls to any extent without any
change in price, the demand for the commodity is said to
be perfectly elastic.
Inelastic Demand Curve
Price (R) Demand (units)
Price (R) Demand (units) 10 10
10 20 10 5
5 30 10 20
e>∞
e=1
Unitary Elastic Demand Curve Perfectly Elastic Demand Curve
Different Values of Elasticity of Demand
Coefficient Types of ed Description Type of Goods Shape of Demand
of ed Curve
1. ed = 0 Perfectly inelastic This occurs when to a percentage change Essentials like Vertical
demand in price there is no change in quantity life saving drugs
demanded.
2. 0 < ed < 1 Inelastic (or less than This occurs when to a percentage change Necessities like Steeper
unitary elastic) demand in price there is less than proportionate food, fuel
change in quantity demanded.
3. ed = 1 Unitary elastic demand This occurs when to a percentage change Normal goods The linear demand
in price there is equal change in quantity curve forming 45°
demanded. angle with both the
axes
4. 1<e d < ∞ Elastic (or more than This occurs when to a percentage change Luxuries Flatter (dB)
unitary elastic) demand in price there is more than proportionate
change in quantity demanded
5. ed = ∞ Perfectly elastic demand This occurs when there is infinite change Imaginary Horizontal
in quantity situation demanded without
any change in price.
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Methods for Calculating Price Elasticity of Thus, the price elasticity of the demand at different
Demand—Important methods for calculating price points of the demand curve will be different. The
elasticity of demand are as follows : different values at different points can be illustrated as
(1) Total outlay method shown on over leaf :
(2) Point method and (1) If D 1 M = MD, then ep = 1
(3) Arc method. (2) If D 1 M > MD, then ep > 1
Change Elastic Unitary Elastic (3) If D 1 M < MD, then ep < 1
in Price Demand Demand Inelastic Demand
(ep = 1) (ep < 1) (4) If D 1 M = O, then ep = 0
(ep > 1)
(5) If MD = O, then ep = ∝
Fall in Total outlay Total outlay Total Outlay Falls
Price increases unchanged The above said point elasticity formula is not
Rise in Total outlay Total outlay Total expenditure restricted to linear demand curves only. It can be used to
Price falls unchanged rises find elasticity of demand even in the case of the non-
(1) Total Outlay Method—Total outlay method linear demand curves. For example, consider the non-
for measuring elasticity of demand was originally linear demand curve DD in the following figure. Let us
suggested by Alfred Marshal. According to this method, suppose we are interested in calculating the value of the
the price elasticity of demand can be measured on the ep at the point P, for this purpose we draw a tangent to
basis of change in total outlay or total expenditure in the demand curve at point P. Let us suppose that this
response to a change in price of the commodity. tangent touches the X-axis at point R and Y-axis at point
Marshall maintains that elasticity of demand can be of S. Then elasticity of demand at point P is given by—
three types :
PR Lower Segment
(i) Unitary Elasticity (ep = 1)—If small changes in ep = =
PS Upper Segment
price leave total outlay unaffected, price elasticity
of demand is unity.
(ii) Elastic Demand (ep > 1)—If a small reduction in
price, increases total outlay or if small increase in
price reduces total outlay, demand is elastic.
(iii) Inelastic Demand (ep < 1)—Demand is inelastic
when, with fall in price total outlay also falls or,
with rise in price, total outlay also rises.
Thus, the relationship between elasticity of demand
and total outlay or total expenditure can be summarized
as follows :
(2) Point Method or Geometrical (or graphical)
Method—The point method of measuring elasticity of
demand was developed by Prof. Marshall. Elasticity Elasticity of Demand in case of Non-Linear
measured at a point on a demand curve is known as Demand Curve
point elasticity of demand. (3) Arc Method—When elasticity of demand is
Point elasticity on a straight line demand curve can measured over a finite range or ‘arc’ of a demand
be calculated by the help of the following formula : curve, it is called arc elasticity of demand. The point
Lower Segment of the tangent on the elasticity method can measure only the changes in
Demand Curve demand for small or minute changes in prices. Arc
ep = elasticity is an average reaction or the average
Upper Segment of the tangent on the
Demand Curve responsiveness.
In terms of demand curve, when we have to
measure the price elasticity over an arc of the demand
curve such as between points A and B on the demand
curve DD in the following figure, the point elasticity
formula will not yield the true and correct measure of
price elasticity.
ep < 1 For measuring price elasticity in such cases when
the changes in price are somewhat large or the price
elasticity over an arc of the demand curve is to be
measured, the concept of arc elasticity is used. We take
the average of the two prices (original and subsequent)
ep at different points of a demand curve and average of the two quantity figures (original and
Economics (NET) | 11U
subsequent). Thus, the formula for measuring arc price demand for goods decreases showing negative elasticity
elasticity of demand is : of demand. Therefore, the same good may be superior or
normal or inferior depending upon the level of income.
Fig. The Relation between Quantity Demanded
Δq Δp Δq P + P2/2 and Income
ep = ÷ = × 1
q1 + q2 p1 + p2 q1 + q2 ΔP
2 2 2
Determinants of Income Elasticity of
Demand
Δq P1 + P2
= × 1. Availability of substitutes
ΔP q1 + q2
2. Nature of the commodity
2. Income Elasticity of Demand 3. Proportion of income spent
4. The number of uses of the commodity
Income elasticity of demand is the responsiveness
of demand to the change in Income. It measures the 5. Time factor
degree of responsiveness of quantity demanded of a 6. Postponement of consumption
commodity to changes in income of the consumers. It is 7. Price range
defined as given ahead :
Percentage Change in 3. Cross Elasticity of Demand
Quantity Demanded Cross Elasticity of Demand measures the res-
ey =
Percentage Change in Income ponsiveness of the change in quantity demanded of one
Symbolically : commodity due to a change in the price of another
commodity. The degree of responsiveness of quantity
ΔQ
Q × 100 ΔQ Y demanded of one commodity to changes in the price of
= = × another commodity is called cross-elasticity of demand.
ΔY ΔY Q
× 100 Let X and Y be two commodities, P x and Py their prices,
Y the cross elasticity of demand can be defined as :
Where, Percentage Change in Quantity
Q = Original quantity; Demanded of X-commodity
Y = Original income; ec =
Percentage Change in Price
ΔY = Change in income; of Y-commodity
ΔQ = Change in quantity; and Dqx Py
Symbolically, ec = ×
ey = Income elasticity of demand. Dpy qx
Income elasticity is positive for most of the goods e c varies from minus infinity to plus infinity.
i.e., an increase in income increases the quantity Complementary goods have negative cross elasticities
demanded and vice versa, some economists define goods and substitute good have positive cross elasticities.
as normal, superior and infeior on the basis of income i.e., for substitutes O < ec < ∞
elasticity of demand :
(I) If 1 < ey < ∞ the good is superior for complementary goods ∞ < ec < O.
(II) If 0 <e y < 1 the good is normal Complements like bread and butter, pen and ink will
have negative cross elasticities, and substitute like coffee
(III) e y < 0 the good is inferior and tea, etc. have positive cross elasticities.
In the above figure the curve OY shows that, the
demand for good increases as income increase from 0 to Importance of Elasticity of Demand
E, therefore, income elasticity of demand is positive in (1) To a Producer—Every producer especially a
this range. From point E to F income does not have any monopolist has to decide his volume of output and the
effect on demand the income elasticity of demand is price at which he has to sell it. For this price elasticity is
zero or perfectly inelastic. After M1 level of income the very useful.
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(2) To a Monopolist—A monopolist adopts a price the consumer derives greater utility from one
discriminatory policy i.e., charging different prices from commodity, he can increase his level of satisfaction by
different consumers. It is possible only when elasticity spending more on that commodity and less on the others,
of demand are different. until the above equilibrium condition is fulfilled.
(3) To a Finance Minister—The Finance Minister Derivation of Demand Curve
while levying taxes takes into account the elasticity of
The inverse relationship which exists between price
demand for the commodities on which taxes is being and quantity demanded for a normal commodity can
imposed. be derived with the help of condition laid down for
(4) Useful in Factor Pricing—The concept of consumer’s equilibrium, i.e.,
elasticity of demand helps in explaining the relative MUY
MUx MUn
shares of factors of production i.e., wages in the output. = =…=
P′x P′Y Pn
(5) Useful in International Trade—A country
Suppose that the commodity X has price Px , Y
benefits from such exports which have price – inelastic
represents all other commodities, and that the consumer
demand because a better price can be fetched.
is originally in equilibrium.
(6) Explanation of the ‘Paradox of Plenty’—
A fall in the price of X to P’x will increase the value
The concept of elasticity of demand also helps in
MUx MUy
explaining ‘paradox of plenty’ in agriculture i.e., bumper of the ratio so that it is no longer equal to ,
P′x P′y
crops bring in smaller income to the farmers. A bumber
i.e., the consumer is no more in equilibrium. To
crop instead of raising income of the farmers reduces the
restore equilibrium the ratio m must be reduced until it is
prices of agricultural products in view of the inelastic
MUx
demand for these products. That is why the government brought back to equality with . To reduce the value
P′x
fixes the minimum support prices. of, the consumer has no control over the prices of X, but
Theory of Consumer Behaviour he does have control over the marginal utility of the last
unit consumed of X. His marginal utility of X falls as he
1. CARDINAL APPROACH increases consumption of X. The consumer will continue
Consumer’s equilibrium is a situation in which a to purchase and consume a greater quantity of X until
consumer has allocated his given income on different M U x has fallen to a level of MU′ X such that
available commodities in such a manner that he gets the MUx MUY
highest possible utility. He will not like to change from = and equilibrium is restored. The effect of a
P′x P′Y
this situation.
fall in price, then, is to increase the quantity demanded.
Cardinal approach to the determination of
consumer’s equilibrium postulates that utility can be A rise in quantity demanded induces a fall in
measured. The utility can be measured by the monetary marginal utility, and if equilibrium is to be maintained,
units (i.e., the amount of money) that the consumer is price must also fall. Hence, ceteris paribus, quantity
prepared to pay for another unit of the commodity. demanded is inversely related to price.
The approach is based on two further assump- Weaknesses
tions :
The cardinal approach suffers from certain basic
● Axiom of diminishing marginal utility—The utility
weaknesses :
gained from successive units of a commodity
diminishes. In other words, the marginal utility of a ● The assumption of cardinal measurement of utility
commodity diminishes as the consumer acquires is highly doubtful. Utility is a subjective pheno-
larger quantities of it. menon; as such it cannot be measured in any
● The total utility of a ‘basket of goods’ depends on objective numbers.
the quantities of individual commodities. If there ● The axiom of diminishing marginal utility has been
are n commodities in the bundle with quantities q1 , ‘established’ from introspection, it is a psychological
q2 , … qn, the total utility is law which must be taken for granted.
U = f(q1, q2 , … … , qn ) 2. ORDINAL APPROACH
The theory states that the condition for the
equilibrium of the consumer is the equality of the ratios The ordinal approach postulates that utility is not
of the marginal utilities of the individual commodities to measurable. Utility is an ordinal magnitude. The
their prices, i.e., consumer need not know in specific units the utility of
various commodities to make his choice. It suffices for
MUx MUY MUn him to be able to rank the various ‘baskets of goods’
= =…=
Px PY Pn according to the satisfaction that each bundle gives him.
The utility derived from spending an additional unit He must be able to determine his order of preference
of money must be the same for all the commodities. If among the different bundles of goods.
Economics (NET) | 13U
The ordinal approach employs the device of The consumer expects to get the same level of
indifference curves for the purpose of determination of satisfaction from the consumption of any of the market
consumer’s equilibrium. four combinations of the two commodities, namely, A,
B, C and D. The resultant curve is known as indifference
A set of indifference curves plotted in an
curve.
‘indifference map’ determine the consumer’s order of
preferences. We can draw different levels of satisfaction. These
Given the market prices of the commodities and the can be represented in the form of an indifference map, as
money income to be spent on them we can locate the in following fig. :
attainable combinations of commodities. These can be
plotted in the form of a straight line, called the budget
line.
Consumer’s equilibrium is established at the point
where an indifference curve from the given indifference
map is tangent to the given budget line.
Assumptions of the Theory of Indiffe-
rence Curves
Indifference curves theory of consumer behaviour is
based on the following assumptions :
● Rationality. The consumer aims at the maximisation In the above fig., we have presented a set of four
of his utility, given market prices and money indifference curves. Combinations marked A1 , and B 1
income. He is assumed to have all relevant yield an equal level of satisfaction represented by the
information. indifference curve IC1. Combinations marked A2 and
● Consistency. The consumer is consistent in his B 2 yield an equal level of satisfaction represented by
choice. If he prefers a commodity basket. A over the indifference curve IC2 ; but the level of satisfaction
commodity basket B in one period of time he will represented by IC2 is higher than that represented by
not prefer B over A in another period of time. IC1 . Likewise, the level of satisfaction represented by
Symbolically, if A > B, then B > A IC3 is higher than that on IC 2 and that on IC 4 higher than
● Transitivity. If commodity basket A is preferred to on IC3 . In other words, as we move towards right, each
B, and B is preferred to C, then A is preferred to C. indifference curve represents a higher level of
Symbolically, if A > B, and B > C, then A > C satisfaction.
● Diminishing marginal rate of substitution. A set of indifference curves is called an indifference
map.
Indifference Curves An indifference map shows all the indifference
An indifference curve is the locus of points— curves which rank the preferences of the consumer.
particular combinations or baskets of two commodities— Combinations of goods situated on an indifference curve
which yield the same level of satisfaction (or utility) to yield the same utility. Combinations of goods lying on a
the consumer, so that he is indifferent as to the particular higher indifference curve yield higher level of satisfac-
combination he consumes. tion and are preferred. Combinations of goods on a
Symbolically, an indifference curve is given by the lower indifference curve yield a lower utility.
equation In an indifference map as many indifference curves
U = f(X1, X2 …, Xn) = k can be drawn as all the possible values of K.
where, k is a constant. Properties
Such a curve is drawn in following Fig. :
1. An indifferences curve always slopes downwards
from left to right; i.e., it has a negative slope. It denotes
that if the quantity of one commodity (say Y) decreases,
the quantity of the other (X) must increase, if the
consumer is to stay on the same level of satisfaction.
2. Indifference curves do not intersect. If they did,
the point of their intersection would supply two different
levels of satisfaction, which is impossible.
3. Indifference curves are convex to the origin.
Convexity of indifference curves is due to the assump-
tion of the diminishing marginal rate of substitution.
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The marginal rate of substitution of X for Y is preference)—a consumer would be willing to substitute
defined as the number of units of commodity Y that one good for the other at a rate of one for one. The
must be given up in exchange for an extra unit of indifference curves would thus be a set of parallel lines
commodity X so that the consumer maintains the same with a slope of –1 as shown in given ahead Fig. :
level of satisfaction.
The assumption of diminishing marginal rate of
substitution expresses the observed behavioural rule that
the number of units of X the consumer is willing to
sacrifice in order to obtain an additional unit of Y
increases as the quantity of Y decreases. It becomes
increasingly difficult to substitute X for Y as we move
along the indifference curve.
Diminishing Marginal Rate of Substi-
tution
Indifference curves for perfect substitutes are
The negative of the slope of an indifference curve at
straight lines, the slopes of which indicate the rate at
any one point is called the marginal rate of substitution which one good can be substituted for the other.
of the two commodities, X and Y, and is given by the
slope of the tangent at that point : 2. Perfect Complements.
Slope of indifference Two goods are perfect complements, if one of them
is of no use without the other : left and right-foot shoes.
Curve = (–) = MRSXY
This gives rise to the indifference curves as shown
The diminishing marginal rate of substitution can be in following Fig. :
illustrated graphically as in following fig. :
As would be seen there is no rate at which the
Three combinations, A, B and C are marked on IC1. consumer will substitute one kind of shoe for the other
On horizontal axis, OX1 = X1 X2 = X2 X3. when he starts with equal numbers of each. Of course,
We consider first the movement from A to B. The he would prefer more pairs to fewer, so the curve IC2
MRSXY at B is represents a higher level of satisfaction than does
curve IC1 .
OY1 – OY2 YY
= 1 2 Thus, Indifference curves for perfect complements
OX2 – OX1 X1 X2
are ‘L-shaped’.
Similarly, for a movement from B to C, the MRSXY
at C is 3. When one good gives zero utility or is a
‘neuter’.
By construction X1 X2 = X2 X3; but very obviously
When one good in a given bundle gives no
Y1Y2 > Y2 Y3. Hence, MRS XY at C is less than at B. This satisfaction at all, a person would be unwilling to
can also be shown by decreasing slopes of the tangents sacrifice even the smallest amount of other good to
at A, B and C. attain any quantity of the good in question. Such would
Alternative Shapes of Indifference Cur- be the case of a salwar-suit for a student who only wears
jeans.
ves
In this situation indifference curves would be
1. Perfect Substitutes. horizontal straight lines indicating a marginal rate of
If the two goods are perfect substitutes-like Maxell substitution of zero for salwar-suits, as shown in ahead
and Amkette floppies (assuming there is no brand Fig. :
Economics (NET) | 15U
allowed to reduce his consumption of the offending
products.
In the following fig. we have a consumer who is
forced to eat more and more pastries. At the amount Q,
he has all the pastries he could possibly want. Beyond Q,
his indifference curves have positive slopes, indicating
that he gets negative utility from consuming extra
pastries, and so would be willing to sacrifice some
amount of other products to avoid consuming it.
Since the consumer likes jeans, the curve IC2
indicates a higher level of satisfaction than does IC1 , but
in both cases her satisfaction is not affected by the
amount of salwar-suits she has (since, no matter how
many she is given, she will wear none of them.)
Thus, Indifference curves for a product yielding
zero satisfaction are parallel to that product’s axis.
4. An Absolute Necessity.
In a bundle there may be a commodity, a minimum
quantity of which is an absolute necessity-some
minimum quantity of water is necessary to sustain life. Thus, when, beyond some level of consumption, the
No amount of other goods will persuade any consumer consumer’s utility is reduced by further consumption,
to cut his water consumption below that amount. the indifference curves have positive slopes.
In this situation, the shape of indifference curves is [Note : In case the consumer can dispose of the
illustrated in following Fig. : extra unwanted units at no cost, the indifference curves
would become horizontal beyond Q.]
6. A good that is not consumed (used).
Typically, a consumer will consume (use) only one
or two of all of the available cameras, cricket bats, jeans,
etc. If a consumer is in equilibrium, consuming a zero
amount of, say, cheese, he will be in what is called a
corner solution, where his indifference curve cuts the
axis of the non-consumed goods with a slope flatter than
the budget line (shown by the straight line AB in
following Fig.) :
As consumption of water falls towards Q,
increasingly large amounts of other goods are necessary
to persuade the consumer to cut down on his water
consumption. Thus, each indifference curve becomes
steeper and steeper as it approaches Q and the marginal
rate of substitution increases.
Thus, the marginal rate of substitution for an
absolute necessity reaches infinity as consumption falls
towards the amount that is absolutely necessary.
5. A good that confers a negative utility after
some level of consumption 7. If in a bundle a good is a ‘bad’ and another
Beyond some point, further consumption of many ‘good’.
goods would reduce satisfaction, i.e., these yield A ‘good’ is a good whose consumption yields some
negative utilities-pastries, chocolates, beverages beyond utility to the consumer. A ‘bad’ is a good whose
a point. Beyond that point, the indifference curves begin consumption only brings a loss of utility to the
to slope upwards, because the consumer would be consumer. In this situation, indifference curves will have
willing to sacrifice some amount of other goods to be a positive slope as shown in following fig.
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Indifference curves will have a positive slope since Budget Line : Mathematical Presentation
the consumer needs more of the good to compensate him The income constraint, in the case of two
for the loss of utility from the additional ‘bad’. commodities, may be written as :
M = P XQX + PYQY …(1)
We may present the income constraint graphically
by the budget line, whose equation is derived from
expression 1, by solving for QY.
1 P
QY = M – X QX
Py PY
Assigning successive values to QX (given the
income, M, and the commodity prices PX and PY), we
may find the corresponding values of QY. Thus, if QX =
0 (that is, if the consumer spends all his income on Y),
the consumer can buy M/PY units of Y-commodity.
Similarly, if QY = 0 (that is, if the consumer spends all
his income on X). The consumer can buy M/P X of X. In
Budget Line the fig. (shown on next page) these results are shown by
Budget line is drawn on the assumption that the points A and B. If we join these points with a line we
consumer has a given income which sets limits to his obtain the budget line, whose slope is the ratio of the
maximising behaviour. prices of the two commodities.
Geometrically, the slope of the budget line is
Given the market prices of the two commodities and
the income constraint, we can identify a set of attainable OA M/PY P X
= =
combinations of two commodities, X and Y. By plotting OB M/PX P Y
these combinations on a graph we get a straight line; the Mathematically the slope of the budget line is the
line is called the budget line. derivative
dQY P
A budget line, on the given assumption, is drawn in = X
dQX PY
following fig. :
In the fig. of budget line, we have drawn a budget
line on the assumption of a given money income and
given market prices of the two commodities, X and Y.
With a given income the consumer can purchase
either OA of Y with zero X, or OB of X with zero Y. Changes in Money Income
Alternatively, he can purchase any of the combina- If the money income of the consumer increases
tions of the two commodities, X and Y, falling on the (or alternatively decreases), given the prices of the two
line AB; for example, a, b or c. A combination like e is commodities as before, it only means that :
unattainable, since it lies outside the budget space. A P
combination like d is attainable, but in this case whole of (a) The price ratio of the two commodities, i.e., X
PY
the money income does not get spent. Since we assume has not changed—the slope of the budget line remains
that the consumer has to spend all of his income, the unchanged;
actual combination of X and Y will be one among those (b) The consumer can purchase more quantity of
which lie on the budget line. both X and Y with his increased income than what he
The slope of the budget line is the ratio of the prices could at an early level of income.
P The new budget line would shift to the right,
of the two commodities, i.e., x.
Py parallel to the original line. With every subsequent
Economics (NET) | 17U
increase in money income, the new budget line would marginal rate of substitution (MRSXY) must be
shift to the right, parallel to the original line, as shown in declining.
following Fig. Given the indifference map of the consumer and his
budget line, the equilibrium is defined by the point of
tangency of the budget line with the highest possible
indifference curve. This is illustrated in the fig. on next
page.
Change in the Price
Given the’ money income, if the price of a
commodity, say X, falls, the price ratio between X and
Y will change, i.e., the slope of the budget line will In the above fig., the budget line AB is tangent to
undergo a change, as shown in following fig. : IC2 at point E. This is the highest attainable level of
satisfaction, given the budget constraint.
At the point of tangency (E) the slopes of the budget
line (PX/PY) and of the indifference curves (MRSXY =
MUX/MUY) are equal.
Thus, the first condition is denoted graphically by
the point of tangency of the two relevant curves. The
second condition is implied by the convex shape of the
indifference curves. The consumer maximises his utility
by buying OQ of X and OK of Y.
Mathematical Derivation of the Equi-
librium
Given the money income and the market prices of
As X becomes cheaper, the consumer can purchase the two commodities, the consumer aims at the
larger quantity of X with no effect on Y. Thus, in maximisation of his utility.
different situations, the budget line originates at point A Assume there are N commodities available to the
on Y-axis but falls subsequently to B1, B 2 and B3 . consumer, with given market prices P 1 , P2 … P N. The
consumer has a money income (M) which he spends on
Consumer’s Equilibrium the available commodities.
Two important tools to illustrate the consumer’s Formally, the problem may be stated as follows :
equilibrium are : Maximise U = f(Q1, Q2 ... QN)
(i) consumer’s indifference map, and N
(ii) budget line. Subject to ∑ QiP i = Q1 Q2 + Q2 P 2 + … + QNPN = M
i=1
Two conditions must be fulfilled for the consumer
We use the ‘Lagrangian multipliers’ method for the
to be in equilibrium.
solution of this constrained maximum. The steps invol-
The first condition : The first condition is that the ved in this method may be outlined as follows :
marginal rate of substitution be equal to the ratio of
commodity prices: (a) Rewrite the constraint as :
MUX P X M – S 1 P 1 – Q 2 P 2 … Q NP N = 0
MRSXY = = (b) Multiply the constraint by a constant λ which is
MUY P Y
This is necessary but not sufficient condition for the Lagrangian multiplier
equilibrium. λ(M – Q1 P 1 – Q2 P 2 … QNP N = 0
The second condition : The indifference curve be (c) Add the above constraint to the utility function
convex to the origin, i.e., at the point of equilibrium the and obtain the ‘composite function’
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φ = U + λ(M – Q1 P 1 – Q2 P 2 … QNP N)
It can be shown that maximisation of the ‘composite
function’ implies maximisation of the utility function.
The first condition for the maximisation of a
function is that its partial derivatives be equal to zero.
Defferentiating φ with respect to Q1 …..Q N and λ
and equating to zero we find
∂φ ∂U
= – λ(P1 ) = 0
∂Q1 ∂Q1
∂φ ∂U
= – λ(P1 ) = 0
∂Q2 ∂Q2
∂φ ∂U But this need not be so always. The ICC can assume
= – λ(PN) = 0
∂QN ∂QN different shapes; what shape an ICC assume will depend
on individual’s preferences.
∂φ
= Q1 P 1 – Q 2 P 2 – Q NP N + M = 0 Price Consumption Curve
∂λ
From these equations we obtain A price consumption curve (PCC) shows the
equilibrium combinations of two commodities, X and Y
∂φ purchased when their price ratios change, the money
= λP1
∂Q1 income remaining constant.
∂φ Derivation of PCC is illustrated in following fig. :
= λP2
∂Q2
| | |
∂φ
= λPN
∂QN
∂U
But = MU1 ,
∂Q1
∂U ∂U
= MU2 … = MUN
∂Q2 ∂QN
Substituting and solving for λ we find
MU1 MU2 MUN
λ = = =…=
P1 P2 PN
Alternatively, we may divide the preceding equation It would be seen from the above fig. that as the price
corresponding to commodity X, by the equation which of commodity X falls the slope of the budget line
refers to commodity Y, and obtain changes, from AB1 to AB 2 to AB 3 . With every fall in the
MUX P price of X, the consumer’s equilibrium point shifts from
= X = MRSXY
MUY PY E1 on IC1 to E2 on IC2 , to E 3 on IC3 . By combining the
three equilibrium points E1 , E2 and E3 we obtain the
Income Consumption Curve PCC.
An income consumption curve (ICC) shows the
equilibrium combinations of two commodities, X and Y, Determination of Consumer’s Equili-
purchased at various levels of money income, nominal brium when we Measure Money Income
prices remaining constant throughout. from Y-axis and Units of Good-X from
Derivation of ICC is illustrated in the following X-axis
fig. It would be seen from that fig that as the levels of Let us assume that the money income of consumer
money income increase, represented by upward shifting is R 100 and price of good-X is R 5 per unit. In case the
budget line A1B 1 , A2 B 2 and A 3 B 3 , consumer’s consumer spends whole of his income on good-X he can
equilibrium correspondingly shifts from E1 to E2 to E3 . purchase 20 units of good-X. If we join R 100 on Y-axis
By joining these various equilibrium combinations with that of 20 units on X-axis we get a budget line
we get a line, called the income consumption curve. AB. Point A shows R 100 whereas point B is obtained
The ICC in fig. shows that as the income level of the by dividing money income by the price of good-X (i.e.,
R 100/ R 5 = 20).
consumer keeps moving up the consumer begins to
demand more of both the commodities, X and Y. The Given the indifference map of the consumer, one of
ICC has a positive slope. the indifference curves IC0 is tangent to the budget line
Economics (NET) | 19U
AB at point e0. Since the slope of indifference curve is Corresponding to e0, e 1 , e 2 equilibrium points, the
equal to slope of budget line at point e 0 , it is termed as quantity consumed of good-X is OX0 , OX1 and OX2 as
consumer’s equilibrium. shown in Panel a. These quantities of good-X are
extended to Panel b and each quantity plotted against its
price which represents demand curve. These prices and
quantities are shown in table.
Table : Prices and Quantities of Commodity–X
Budget Line Price of X Quantity of Y
AB OA OX0
OP 0 =
OB
AB 1 OA OX1
OP 1 =
OB 1
OA
AB 2 OP 2 = OX2
What does this point of equilibrium (e0 ) reveal ? OB 2
It tells us that by taking OX0 of good-X and keeping In table prices corresponding to budget line AB,
with himself OM0 of money income (for purchase of AB1 and AB2 , are OP0 , OP 1 and OP2 respectively.
other goods), the consumer is attaining maximum These indicate the slopes of budget lines obtained by
satisfaction. In other words, the consumer spends AM0 dividing vertical distance by horizontal distance. Since
of money income on OX0 of good-X and retains with vertical distance (OA) remains same whereas horizontal
himself OM0 of money income for purchase of other distance increases from OB to OB1 to OB2 obviously,
goods. It shows that the indifference curve analysis is OP > OP1 > OP2 and
not limited to two goods alone, it can be extended to OX0 < OX1 < OX2 .
more than two goods.
Derivation of Demand Curve with the
Help of Indifference Curve Technique
Using indifference curve analysis we can derive
demand curve with the help of price consumption curve.
Price consumption curve, as described above, is the
locus of consumer’s equilibrium points as the price of
one good changes, everything else assumed to be
constant. Here, we measure money income on Y-axis
and good X on X-axis. Given the money income and the
price of good-X, and budget line is AB. As price of
good-X fills, the budget line shifts to AB1 .
With further fall in price of good-X the budget line
shifts to AB2 . Thus we have three budget lines. Given Price Effect = Substitution Effect +
indifference map, IC0 is tangent to the budget line AB at Income Effect
e0, IC 1 is tangent to the budget line AB1 at e1; IC2 is When the price of a good changes, the price of the
tangent to the budget line AB2 at e 2 . Locus of other good as also the consumer’s money income
remaining unchanged, the consumer moves from one
equilibrium points e 0 , e1, e2 gives price consumption
equilibrium point to another. The overall change in
curve as shown in the Panel a of given ahead Fig. : quantity demanded from one equilibrium position to
another is called the total effect or the price effect. :, A
change in the nominal price of a commodity actually
exerts two influences on quantity demanded.
In the first place, there is change in relative price—a
change in the terms at which a consumer can exchange
one good for another. The change in relative price along
leads to a substitution effect.
Second, a change in the nominal price of a good
(nominal income remaining constant) causes a change in
real income, or in the size of the combinations of goods
and services a consumer can buy. If the nominal price of
one good falls, money income and other nominal
prices remaining constant, real income rises because the
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consumer can now buy more, either of the good whose Graphically, we show it by drawing an imaginary
price declined or of the other goods. This change in real budget line, CC1 , which is placed to the left of and is
income leads to an income effect on quantity demanded. parallel to the new budget line A1 B 2 (the budget line
Thus, the price effect of a change in the price of a after the fall in the price of X).
commodity can be decomposed into two effects : the The CC1 line shows as follows :
substitution effect and the income effect. Formally, ● Hed the consumer’s real income not changed,
● Price effect is the total change in quantity demanded consumer’s equilibrium point would have shifted
as the consumer moves from one equilibrium to to S because of a relative fall in price of X in
another. relation to the price of Y.
● Substitution effect is the change in quantity deman- ● At this equilibrium, at S, the consumer would have
ded resulting from a change in relative price after increased his purchase of X from OX1 to OX3.
compensating the consumer for the change in real ● X1X3 can be regarded as the substitution effect.
income.
We know the total effect is X1 X2. Out of this X1 X3
● Income effect is the change in quantity demanded is accounted for as the substitution effect. We are still
resulting exclusively from a change in real income, left with X3X2.
all other prices and money income held constant.
Shift from the imaginary budget line CC1 to the
Hicks’ Approach actual new budget line A 1 B 2 represents an increase in
We know the price effect is the sum total of the real income. Since the price ratios at CC1 and A1 B 2 are
substitution effect and the income effect. the same, change in quantity demanded (from OX3 to
Let us illustrate it diagrammatically with the help of OX2) may be considered as the real-income pheno-
indifference curves as in fig. menon. Thus, OX3 to OX2 may be considered as the
We begin with the budget line marked A1 B 1 , and income effect of the price change.
equilibrium point as R on IC1 . With a fall in the price of In short, a fall in the price of X results in :
commodity—X the budget line rotates to A1B 2 ; the new 1. A change in relative price ratio, and hence an
equilibrium is at point T on a higher indifference curve increase in the quantity purchased of X, from OX1 to
IC2 . OX3, OX1 to OX3 is the measure of the substitution
effect.
2. An increase in the real income of the consumer,
and hence an increase in the quantity purchased of X
from OX3 to OX2 , OX3 to OX2 is the measure of the
income effect.
3. The total effect is the sum total of X1 X3 + X3 X2 =
X1X2, and may be called the price effect.
Slutsky’s Approach
Slutksy also decomposes the price effect into
substitution effect and income effect, by holding real
income constant, but in a slightly different way, as
would be clear from following fig. :
The total change in quantity demanded is from OX1
(at R) to OX 2 (at T), i.e., OX 2 – OX1 = X1 X2. This may
be called the price effect.
The total effect (X 1 X2) can be decomposed into two
effects : substitution effect and income effect.
We have defined substitution effect as the change in
quantity demanded resulting from a change in relative
price after compensating the consumer for the change in
real income.
“Compensating the consumer for the change in real
income”: by this expression what we mean is (a) the
consumer has experienced a gain in real income due to a To begin with, the original budget line is A1 B 1 .
fall in the price of commodity-X; (b) we take away this With the fall in the price of X, the budget line
gain from him by reducing his money income to a level changes into A1 B 2 .
so that he remains on the original indifference curve, The equilibrium point shifts from point R on IC1 to
IC1 . point T on IC3 .
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Slutsky assumes that we take away some nominal
income from the consumer, so that the Consumer will
have to go back to point R. This is shown by drawing an
imaginary income line passing through the point R (and
parallel to A1 B 2 ). This line is CC1. But at CC1 also we
find the consumer does not like to go back to R; instead
he prefers S which is on a higher indifference curve. He
likes to purchase OX3 quantity of X.
This increased purchase of X, i.e., X1X3, consequent
on a fall in the relative price of X may be considered as
the substitution effect.
Likewise, an increase in the quantity
purchased of X from OX3 to OX2 , i.e., X 3 X2, may be
considered as the real income effect. Fig. (a)
In short, the only difference between the
Hicksian and the Slutsky approach relates to the fact that
the real income is held to be constant in different ways.
Broadly, the results are the same.
Inferior Goods and Giffen Goods
For ‘normal’ or so-called ‘superior’ goods, income
effect is always positive, i.e., an increase in income
results in larger purchases of the commodity. The
quantity purchased of such goods is further increased
under the influence of the substitution effect’ thus, a
larger quantity is purchased at a lower relative price and
vice versa.
However, we can conceive of at least two other
situations where these normal relations do not obtain. Fig. (b)
In the case of inferior goods we can postulate as 3. If we decompose this total effect into income
follows : effect and substitution effect, we find :
1. With increase in income, demand for these goods substitution effect is Ox2 – Ox 1 = x1x3
falls, i.e., income effect for these goods is negative. income effect is Ox2 – Ox 3 = – x 2 x3
∴ total effect is = x1x3 – x2x3 = x1x2
2. With increase in real income, demand for these
goods falls, but the substitution effect of the fall in the Income effect in case of inferior goods is negative
relative price of these goods may still result in consumer but it is offset by substitution effect, therefore the
purchasing more of these commodities at a lower price. consumer ends up purchasing more of the inferior good
These results are shown in Fig. (a) and Fig. (b). In Fig. at a lower price.
(a) we have plotted an inferior good on X-axis. As the In the case of Giffen goods, we postulate as follows :
money income of the consumer increases, the consumer In case of a Giffen good substitution effect of a fall
shifts to a higher budget line and high equilibrium in the price of good is weak enough to offset the
positions. But along with every subsequent increase in negative real income effect.
income, the quantity purchased of the inferior good falls, This is illustrated in following Fig. :
from OX1 to OX2 to OX3.
The ICC slopes backwards
[Students may attempt for inferior commodity on
Y-axis; in this case, ICC will slope down-wards.]
In Fig. (b) we have demonstrated the effect of a fall
in the price of an inferior good on its quantity purchased.
It would be seen as follows from Fig. (b) :
1. The original budget line is A1 B 1 ; the equilibrium
is at point R.
2. With a fall in the price of the inferior commodity,
the equilibrium shifts to K. The consumer ends up
purchasing larger quantity (Ox 2 ) of the inferior
commodity.
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● To begin with the consumer is in equilibrium at R ● It is more flexible and lends itself to many
on the budget line, A1 B 1 . applications.
● With a fall in the price of X, consumer’s equilibrium However, notwithstanding its advantages over the
shifts to T on the budget line A1 B 2 . cardinal approach, the approach has also been subject to
certain criticisms.
● Quantity purchased of X falls from Ox1 to Ox2, i.e.,
– x1 x2 is the total effect of a fall in the price of X. ● The main weakness of this approach is its axiomatic
assumption of the existence and convexity of the
Let us decompose this total effect; x 1 x3 is the indifference curves.
substitution effect.
● It is questionable whether the consumer is able to
– x2x3 is the income effect. order his preferences as precisely and rationally as
∴ (x1 x3) + (– x2x3) = – x1 x2 is the total effect. the theory implies.
Thus, a Giffen good is a special case of a group of ● The theory has retained most of the weaknesses of
commodities called inferior goods. the cardinal theory with the strong assumption of
rationality and the concept of the marginal utility
Evaluation implicit in the definition of the MRS.
Indifference curve analysis has often been dubbed ● The theory does not analyse the effects of
as an old wine in the new bottle. This is prima facie advertising, of past behaviour, of stocks, of the
because of the fact the equilibrium conditions are interdependence of the preferences of the consumers,
identical in the cardinalist approach and the indifference which lead to behaviour that would be considered as
irrational, and hence is ruled out by the theory.
curves approach. In both theories we have
● Speculative demand and random behaviour are
MUx MUy MUu
= =…= ruled out in this approach. These factors are very
Px Py Pn important for the pricing and output decisions of the
Thus, although in the indifference curves approach firm.
cardinality of utility is not required, the MRS requires
knowledge of the ratio of the marginal utilities, given PRODUCTION
that the first order condition for any two commodities
The act of production involves the transformation of
may be written as : inputs into outputs. The word production in economics
MUX is not merely confined to effecting physical trans-
= MRSXY
MUY formation in the matter, it is creation or addition of
Hence, the concept of marginal utility is implicit value. Therefore, production in economics also covers
in the definition of the slope of the indifference curves, the rendering of services such as transporting,
financing, marketing.
although its measurement is not required by this
approach. Production may be defined as a process by which
inputs are transformed into an output. An input is any
Nevertheless, the indifference curves analysis has
good or service transformed into an output. An output is
been a major advance in the field of consumer’s demand. any good or service that comes out of the production
● The most important theoretical contribution of this process. This production is a process, not an act. The
approach is the establishment of a better criterion relationship between the input to the production process
for the classification of goods into substitutes and and resulting output is described by a production
complements. Earlier theorists were using the total function.
effect of a price change for this purpose, without
compensating for the change in real income.
Agents of Production
● Compared with the cardinal analysis this approach The resource utilised for production were classified
into four factors of production–Land, Labour Capital
requires less restrictive assumptions. The consumer
and Entrepreneur.
only has to be able to rank alternative combinations
by order of preference. In the cardinal approach, Land and Labour are regarded as the primary
factors of production because they are not the products
the consumer must be able not only to rank
of any economic activity. Capital represents the
combinations but also to tell how much more produced means of production. Hence, it is treated
preferred one combination is over another. as a secondary factor of production.
● This approach presents a more complete picture of Land—It refers to all gifts of nature. It is fixed in
the consumer’s options and choice than the other supply and has no cost of production. David Ricardo and
approach does. It not only shows the equilibrium T.R. Malthus built their theories on what they regarded
points but also clearly indicates all other combina- as the unique feature of land namely, that it is the subject
tions the consumer could choose. to the law of diminishing marginal returns.
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Labour—It is defined as the exercise of human
mental and physical effort in the production of goods
and services. Labour is heterogeneous in quality.Yet for
the purpose of analysis we assume that it is
homogeneous. The growth-rate of labour is the key
element in all theories of economic growth; it sets the
upper limits to what can be attained by the use of
available non-labour resources.
Capital—It refers to those goods which are used for
further production of goods.Thirtwall points out that
capital is a wider concept than what the traditional Fig. (II)
definition means. It may be defined as any asset that In Fig. I each curve shows the relation between Q
generates a future flow of income. Defined in that way, and L for given K. As labour increases, ceteris paribus,
many goods normally considered as consumption goods output increases, we move along the curve depicting the
may have to be classified as capital goods. production. If capital (and/or other factors) increases, the
Entrepreneur—Entrepreneur is an economic agent production function O = f(L) shifts upwards.
who perceives market opportunities and organizes the Types of Production Function
other factors of production (land, labour and capital). In There are two types of production function (i) short-
the large firm the entrepreneur is a theoretical abstraction term production function, and (ii) long-term production
whose functions are divided between the management function.
and the shareholders. (i) Short-term Production Function—It refers to
production in the short-run where there are some fixed
Production Function factors and some variable factors. In the short-run,
The production function is a purely technical production will increase when more units of variable
relation which connects factor inputs and outputs. It factors are used with the fixed factor. Law of variable
describes the law of production, i.e., the transformation proportion comes under short-run-production.
of factor inputs into outputs at any particular time (ii) Long-Run Production Function—It refers to
period. The production function includes all the production in the long-run where all factors become
technically efficient methods. variable. In the long-run production can be increased by
Mathematically, a production function can be increasing units of all the factors simultaneously and in
written as : the same proportion. Laws of returns to scale comes
Y = f(L, K, R, S, V, r) under long-run production function.
Where, Y is output, L is labour input, K is capital
input, R is raw material, S holds for land, V is Returns Total, Average and Marginal
to Scale and r is efficiency parameter. Products
The production function is purely a technical I. Total Product (TP)—Total product refers to
relation. Prices of factor do not enter into the production aggregate output resulting from the use of total
function. quantities of all inputs. In the case of production
If we take two inputs, labour and capital, the with one variable input, total product refers to the
production function assumes the form aggregate output resulting from the use of a given
Q = f (L, K) amount of a fixed input and a certain quantity of the
variable input.
The most commonly used diagrams for the produc-
tion function of a single commodity are shown in figures II. Average Product (AP)—Average product of an
below : inputs is defined as the total product divided by the
amount of input used to produce it. Thus,
TP
APL = Q/L =
L
Where,
APL = Average Product of Labour
Q = Total output
L = Amount of Labour
III. Marginal Product (MP)—The marginal product of
an input is defined as the change in total output due
to the change in the amount of an input. Thus,
ΔQ
MPL =
Fig. (I) ΔL
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Where, In Ist stage average product inreases throughout. In
MPL = Marginal product of labour stage II marginal product from the point where it equals
average product falls throughout but remains positive
ΔQ = Change in output
and in stage III total product falls and marginal product
ΔL = Change in the amount of labour. is negative.
Law of Variable Proportions
Since not all inputs can vary in the short-run, the
proportion at which inputs are combined vary. Thus, the
name returns to variable proportions is given to one
input-output relationship depicted by the short-run
production function. The long-run production function
describes the input-output relationship when all inputs
can be freely varied when all inputs on be freely varied.
This law is also known as the “law of non-
proportional returns” or “the law of the diminishing
marginal return.” Most of the earlier economists talked
of the law of diminishing returns in the field of
production. Famous Malthusian theory of production
and the celebrated Ricardian theory of rent are based on Law of Variable Proposition
“the law of diminishing returns”. The Stage of Actual Operation—The rational
The level of output of a firm depends on the producer will operate in stage II. It is not difficult to
combination of different factors of production. Such as follow why production will not be done in stage III. In
land, labour, capital and entrepreneur. In order to bring stage III less output is produced by using more of the
about a change in the level of production, the quantities variable inputs which means that production costs would
of various factors engaged in production will have to be higher in stage III than they were in stage II. Obviously
changed. An increase in production can be had only any rational producer will always avoid such inefficien-
when either the quantity of all factors is increased cies on the use of production input. During the first stage
simultaneously or when the quantity of some of the the marginal product rises at increasing rate and
factors is increased, while other remains constant. Since ultimately begins to fall, the average output on the other
all factors are not easily available in the required hand rises. During this stage, the quantity of the fixed
quantities, it becomes necessary to keep the scarce factors are more relative to the quantity of the variable
factor constant and increase in the quantity of other factor, so that if some units of the fixed factor are
factors. withdrawn the total product would rise, i.e., the marginal
The law of variable proportions is widely observed product of the fixed factors is negative. No producer will
law of production which takes place in the short-run. In operate in this stage, even if the fixed factors are
the short-run, production can be increased by using more supplied free of cost to him, because the fixed factors
of variable factors. The law was formulated by Joan only bring on negative marginal returns.
Robinson.
The law of variable proportions states that when Relationship between TP, AP and MP
total output or production of commodity is increased by in Short Period
adding units of a variable input while the quantities of 1. AP curve is the slope of the straight line from the origin
other inputs are held constant, the increase in total pro- to each point on the TP curve. MP curve is the slope of
duction becomes after some point smaller and smaller. the TP curve at each point.
Assumptions of Law 2. When AP is maximum, MP = AP.
(1) State of technology remains the same. If there is any 3. When TP is maximum, MP = O.
improvement in technology, the averge and 4. When TP is falling, MP is negative.
marginal output will not decrease but increase. 5. As long as TP is positive, AP is positive.
(2) All units of the variable factors are homogeneous. 6. Both AP and MP curve are inverted U-shaped.
(3) There must always be some fixed input which can 7. When MP > AP, this means that AP is rising.
not be increased in the short-term. 8. When MP = AP, this means that AP is constant.
(4) Only one factor is variable and the other factors are 9. When MP < AP, this means that AP is falling.
kept constant. This law does not apply in case all
factors are proportionately varied. Thus the Ist and IIIrd stages are also known as
(5) It is possible to vary the proportions in which the stages of economic absurdity or economic nonsense. A
various inputs are combined. This law does not producer will always seek to operate in the second stage.
apply to those cases where the factors must be used At which point the producer will operate in this stage
in rigidly fixed proportions to yield a product. will depend upon the prices of the factors.
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Three Stages of Production
Stages Term used TP AP MP Reference Point
Stage I Increasing Starts from origin, increases Starts from the origin Increases, reaches a From origin to
Returns to the at an increasing rate and then and then increases till maximum & then point b
factor increases at a decreasing rate its maximum point starts falling
Stage II Diminishing Increases at a decreasing Falls continuously Falls continously From point b to
Returns to the rate till it reaches the till it is equal to point d
factor maximum point zero
Stage III Negative returns Falls Falls continuously It is negative point d onwards
to the factor
In brief, the law of variable proportions tells us then the returns to scale is classsified as follows :
about the possibility of the operation irrentially of both S > 1 : Increasing Returns to Scale
the law of increasing returns and the law of diminishing S = 1 : Constant Returns to Scale.
returns with an intermediate situation of the law of S < 1 : Decreasing Returns to Scale.
constant returns. Ultimately, the law of diminishing
returns operates. Three Stages of Returns to Scale
A rational producer will never choose to produce in 1. Stage I—Increasing Returns to Scale—It occurs
stage III where the marginal product of variable factor is when the increase in output is more than propor-
tional to increase in inputs. The first stage starts
negative. A rational producer will also not choose to
from the point of origin and continues till the
produce in stage I where the marginal product of fixed average product is maximum.
factor is negative. A producer producing in stage I
2. Stage II—Constant Returns to Scale—It occurs
means that he will not be making the best use of the when the increase in output is proportional to the
fixed factor and further he will not be utilizing fully the increase in input.
opportunities of increasing production and increasing
3. Stage III—Decreasing Returns to Scale—It occurs
quantity of the variable factor whose average product when the increase in output is less than proportional
continues to rise throughout the stage I. Thus stages I to the increase in inputs.
and III represent non-economic region in production
function. A rational producer will always seek to Stages in the Law of Returns to Scale
produce in stage II where both marginal product and Stages Term TP AP MP Refe-
average product of variable factor are diminishing. The used rence
stage II represents range of rational production. Point
Stage Increasing It increa- Rises Econo- From
Laws of Returns to Scale I Returns to ses at an rapididly mies of point A
scale increasing Scale to B
The term ‘returns to scale’ refers to the response of rate
total output to changes in all inputs by the same Stage Constant It Increa- Constant — From
II Returns to ses at a point B
proportion. The laws of ‘returns to scale’ refers to the scale constant to C
effects of scale relationship. rate
Stage Decreasing It increa- Falls Diseco- From
The law of returns to scale states that when all III returns to ses at a rapidly nomic point C
factors of production are increased in the same scale decreas- of Scale to D
proportion, the output will increase but the increase may ing rate
be at increasing rate or constant rate or decreasing rate.
Depending on whether the proportionate change
in output equals, exceeds, or falls short of the
proportionate change in both inputs, a production
function is classified as showing constant, increasing or
decreasing returns to scale. The ratio of the proportionate
change in output to a proportionate change in all inputs
is called the function coefficient, (S) that is—
Δq/q
S =
Δz/z
where the proportionate changes in output and all inputs
Δq dx
are shown by and respectively.
q z Scale of Inputs
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Three Stages of Returns to Scale 3. Exhaustibility of Natural Resources—Another
factor responsible for diminishing returns in some
Scale of inputs Total Marginal Product activities is limitations of natural resources.
Prdt.
1 Labour + 1 Capital 10 10⎤ Stage 1 : Laws of Returns
2 Labour + 2 Capital 30 20⎥
⎥ Increasing The laws of production describe the technically
3 Labour + 3 Capital 60 30⎦ Returns possible ways of increasing the level of production.
4 Labour + 4 Capital 100 40⎤ Stage 2 : Output may increase in various ways.
5 Labour + 5 Capital 140 40⎥
⎥ Constant Output can be increased by changing all factors or
6 Labour + 6 Capital 180 40⎦ Returns production. Clearly this is possible only in the longrun.
Thus the laws of returns to scale refer to the long-run
7 Labour + 7 Capital 210 30⎤ Stage 3 :
8 Labour + 8 Capital 230 20⎥
⎥ Decreasing
analysis of production.
9 Labour + 9 Capital 240 10⎦ Returns In the short-run output may be increased by using
more of the variable factor, while capital (and possibly
Causes of Increasing Returns to Scale other factors as well) are kept constant. The marginal
product of the variable factor will decline eventually as
Following are the reasons which underline the more and more quantities of this factor are combined
increasing returns to scale : with the other constant factors. The expansion of output
1. Indivisibility of Factors—Indivisibility means with one factor constant is described by the law of
that certain factors are available only in large and lumpy diminishing returns of the variable factor, which is
units and can therefore be utilized with utmost efficiency often referred to as the law of variable proportions.
at a large level of output. As the scale of production Laws of Returns to Scale : Long-run Analysis of
increases, these indivisible factors are utilized better and Production
more efficiently. This leads to increasing returns to In the long-run expansion of output may be
scale. achieved by varying all factors. In the long-run all
2. Division of Labour and Specialisation of factors are variable. The laws of returns to scale refer to
the effects of scale relationships.
Labour—As the number of variable factor is increased
in the stage I, the efficiency of variable factor itself In the long-run output may be increased by
changing all factors by the same proportion, or by
increases. This is because of division of labour and
different proportions. Traditional theory of production
specialisation. With more labourers (variable factor), it concentrates on the first case, that is, the study of output
is possible to divide the work among the labourers as all inputs change by the same proportion. The term
according to their skill and aptitude. This results in 'return to scale' refers to the changes in output as all
specialisation and increase in efficiency. factors change by the same proportion.
3. Dimensional Economies—Another important Suppose we start from an initial level of inputs
cause of increasing returns to scale lies in dimensional and output
relations, which have been emphasized by Prof. Boumol. X0 = f (L, K)
A wooden box of 3 foot-cube contains 9 times greater and we increase all the factors by the same
wood than the wooden box of 1 foot-cube. proportion m. We will clearly obtain a new level of
Causes of Decreasing Returns to Scale output X*, higher than the original level X0,
X* = f (mL, mK)
Decreasing returns to scale are explained largely in * If X* increases by the same proportion m as the
terms of three types of diseconomies of scale :
inputs, we say that there are constant returns to scale.
1. Entrepreneur is a Fixed Factor—Some
* If X * increases less than proportionally with the
economists are of the view that the entrepreneur is a
fixed factor of production. An increase in the scale may increase in the factors, we have decreasing returns to
scale.
come to a point where the abilities and skills of the
* If X * increases more than proportionally with the
entrepreneur may be fully utilized. An increase in the
scale beyond this point may decrease the efficiency of increase in the factors, we have increasing returns to
scale.
the entrepreneur. This gives rise to diseconomies of
scale. Returns to Scale and Homogeneity of the
Production Function
2. Management Problem—Use of too much of
variable factor like labour also creates the problem of Suppose we increase both factors of the function
effective management. When there are too many X0 = f(L, K)
workers, they may shift responsibility to others. It by the same proportion m , and we observe the
becomes difficult to manage them. The labourers can resulting new level of output X*
avoid work. All this leads to decrease in efficiency. X* = f(mL, mK)
Economics (NET) | 27U
If m can be factored out, then the new level of
output X * can be expressed as a function of m (to any
power a) and the initial level of output
X* = ma f(L, K)
or, X* = ma X0
and the production function is called homogeneous.
If m cannot be factored out, the production function is
non-homogeneous. The power a of m is called the
degree of homogeneity of the function and is a measure —
Product line for K given
of the returns to scale :
* If a = 1, we have constant returns to scale. Thus
production function is something called linear homo-
geneous.
* If a < a, we have decreasing returns to scale.
* If a > 1, we have increasing returns to scale.
Returns to scale are measured mathematically by
the coefficients of the production function. For example,
in a Cobb-Douglas function
X = b0 Lb 2 Kb2
the returns to scale are measured by the Sum Homogeneous Production Function
(b1 + b2 ) = a.
Proof
Let L and K increase by m. The new level of output
is
X* = b0 (mL)b1 (mK)b 2
= (b0Lb 1 + Kb 2 )m b 1 + b2
or X* = mb 1 + b 2 X
Thus a = (b1 + b2 )
Linear Homogeneous Production
Function
Production function can take several forms but a Non-homogeneous Production Function
particular form of production function enjoys wide
popularity among the economists. This is a linear Among all possible product lines of particular
homogeneous production, that is, production function interest are the so-called isoclines. An isocline is the
which is homogeneous of the first degree. Homogeneous locus of points of different isoquants at which the
production function of the first degree implies that if all MRS of factors is constant.
the factors of production are increased in some If the production function is homogeneous the
proportion, output also increases in the same proportion.
isoclines are straight lines through the origin. Along any
Hence, linear homogeneous production function
represents the case of constant returns to scale. one isocline the K/L ratio is constant. Of course the K/L
ratio (and the MRS) is different for different isoclines.
Product Lines If the production function is non-homogeneous the
A product line shows that movement from one isoclines will not be straight lines, but their shape will be
isoquant to another as we change both factors or a twiddly. The K/L ratio changes along each isocline.
single factor. A product line is drawn independently
of the prices of factors of production. The product line Graphical Presentation of the Returns to
describes the technically possible alternative paths of Scale for a Homogeneous Production
expanding output. What path will actually be chosen by
the firm will depend on the prices of factors.
Function
The product line passes through the origin if all The returns to scale may be shown graphically by
factors are variable. If only one factor is variable (the the distance (on an isocline) between successive
other being kept constant) the product line is a straight 'multiple-level-of-output' isoquants, that is, isoquants
line parallel to the axis of the variable factor. The K/L that show levels of output which are multiples of some
ratio diminishes along the product line. base level of output e.g., X, 2X, 2X etc.
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Constant Returns to Scale may have increasing or decreasing returns to scale.
Along any isocline the distance between successive Production functions with varying returns to scale are
multiple isoquants is constant. Doubling the factor difficult to handle and economists usually ignore for the
inputs achieves double the level of the initial output, analysis of production.
trebling inputs achieves treble output, and so on. Causes of Increasing Returns to Scale
Decreasing Returns to Scale The increasing returns to scale are due to technical
The distance between consecutive multiple isoquants and/or managerial indivisibilities. Usually most
increases. By doubling the inputs output increases by processes can be duplicated, but it may not be possible
less than twice its original level. In figure the point a', to halve them.
defined by 2K and 2L, lies on an isoquant below the one
showing 2X.
Causes of Decreasing Returns to Scale
The most common causes is ‘diminishing returns
to management’. The management is responsible for
the co-ordination of the activities of various sections
of the firm. Even when authority is delegated to
individual managers (production manager, sales
manager, etc.) the final decision have to be taken from
the final ‘centre of top management.’ As the output
grows, top management becomes efficient overburdened
and hence less difficult in its role as co-ordinator and
ultimate decision-maker.
Another cause for decreasing returns may be found
in the exhaustible natural resources doubling the fishing
Decreasing Returns to Scale : oa < ab < bc fleet may not lead to a doubling of the catch of fish, or
doubling the plant in mining or on an oil-extraction field
Increasing Returns to Scale may not lead to a doubling of output.
The distance between consecutive multiple-
isoquants decreases. By doubling the inputs, output is Marginal Rate of Technical Substitution
more than doubled. In figure doubling K and L leads to The principle of marginal rate of technical
point b' which lies on an isoquant above the one substitution (MRTS) is based on the production function
denoting 2X. where two inputs can be substituted in variable
proportions in such a way as to produce constant level of
output.
Marginal rate of technical substitution indicates the
rate at which factors can be substituted at the margin
without altering the level of output. More precisely,
marginal rate of technical substitution of factor X for
factor Y may be defined as amount of factor Y which
can be replaced by one unit of factor X, the level of
output remaining unchanged. This can be understood
with the aid of isoquant schedule.
Constant Returns to Scale : oa > ab > bc
Isoquant Schedule
Returns to scale are usually assumed to be the same Combinations Factor X Factor Y MRTSxy
everywhere on the production surface, that is, the same A 1 12 –
along all the expansion-product lines. All processes are B 2 8 4
assumed to show the same returns over all ranges of C 3 5 3
output : either constant returns everywhere, decreasing D 4 3 2
returns everywhere, or increasing returns everywhere. E 5 2 1
However, the technological conditions of production
may be such at returns to scale may vary over different Each of the input combinations A, B, C, D and E
ranges of output. Over some range we may have yields the same level of output. Moving down the table
constant returns to scale, while over another range we from combination A to combination B, 4 units of Y are
Economics (NET) | 29U
replaced by 1 units of X in the production process dQ
without any change in the level of output. Therefore, the dY dY dX
Solving for we obtain – =
marginal rate of technical substitution is 4 at this stage. dY dX dQ
Switching from input combination B to input dY
combination C involves the replacement of 3 units of MPx
= = MRTSxy
factor Y by an additional unit of factor X, output MPy
remaining the same. Thus MRTSxy is now 3. The marginal rate of substitution as a measure of the
The marginal rate of technical substitution at a point degree of substitutability of factors has a serious defect.
on the equal product curve can be known from the slope It depends on the units of measurement of the factors. A
of the equal product curve at that point. Consider a small better measure of the case of factor substitution is
movement down the equal product curve P from G to H provided by the elasticity of substitution. The elasticity
in figure where a small amount of factor Y, say dy is of substitution is defined as the percentage change in
replaced by an amount of factor X, say dx without any the capital labour ratio, divided by the percentage
loss of output. change in the MRS. Thus,
Elasticity of Substitution
Percentage Change in K/L
=
Percentange Change in RS
d(K/L)/(K/L)
or σ =
d(MRS)/(MRS)
where, σ = elasticity of substitution
K = capital
L = labour
MRS = marginal rate of substitution
The slope of the isoproduct curve P at point G is The elasticity of substitution is a pure number
ΔY
therefore equal to . Thus, marginal rate of technical independent of the units of measurement of K and L,
ΔX since both the numerator and the denominator are
substitution measured in the same units.
ΔY
MRTSxy = – Factor Intensity
ΔX
An important point to be noted about the marginal The factor intensity of any production process is
rate of technical substitution is that it is equal to the ratio measured by the slope of the line through the origin
of the marginal products of two factors. representing the particular process. Thus the factor
intensity is the capital-labour ratio. In figure process P 1
Proof—The slope of a curve is the slope of the is more capital intensive than process P2 . Clearly
tangent at any point of the curve. The slope of the K1 K2
tangent is defined by the total differential. In the case of >
L1 L2
the isoquant the total differential is the total change in Q
(output) resulting from small changes in both factors X
and Y. Clearly if we change Y by dX, the output Q will
change by the product dY times the marginal product of
factor Y or (d Y) ( )
dQ
dX
Similarly, if we change factor X by an infinitesimal
amount dX, the resulting change in Q is (d X)
dQ
dY ( )
Now along any isoquant the quantity Q is constant,
so that the total change in Q (the total differential) must
be equal to zero. Thus
d Q = (d Y) (dd QY) + (d X) (dd QX) = 0 Factor Intensity
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The upper part of the isoquant includes more Further more, the basic theory of production usually
capital-intensive processes. The lower part of the concentrates on the range of output over which the
isoquant includes more labour intensive techniques. marginal products of factors, although positive,
Marginal Products of the Factors decrease, that is, over the range of diminishing (but
non-negative) productivity of the factors of production :
The marginal product of a factor is defined as the the ranges of output considered by the traditional theory
change in output resulting from a (very small) change of are AB and CD in figure.
this factor, keeping all other factors constant.
Mathematically the marginal product of each factor Alternatively we may say that the theory of
is the partial derivative of the production function with production concentrates on levels of employment of the
respect to this factor. Thus factors over which their marginal product are positive
but decrease. Thus
dQ
MPL =
dL d(MPL)
MPL > 0 but < 0
dQ dL
and MPK =
dK
d(MPK)
where, and MPK > 0 but < 0
dK
MPL = marginal product of labour
MPK = marginal product of capital These conditions imply that the traditional theory of
Graphically the marginal product is shown by the production concentrates on the range of isoquants over
slope of the total product curve. which their slope is negative and convex to the origin.
In principle the marginal product of a factor may
assume any value, positive, zero or negative. However, Ridge Lines
basic production theory concentrates only on the In figure the production function is depicted in the
efficient part of the production function, that, on the form of a set of isoquants. By construction the higher to
range of output over which the marginal products of the the right an isoquants, the higher the level of output it
factors are positive. No rational firm would employ
depicts. Clearly isoquants cannot intersect, by their
labour beyond OB, or capital beyond OD, since an
increase in the factors beyond these levels would results construction. We said that traditional economic theory
in the reduction of the total output of the firm. Ranges of concentrates on efficient ranges of output, that is, ranges
output over which the marginal products of the factors over which the marginal products of factors are
would be negative imply irrational behaviour of the diminishing but positive. The locus of points of
firm, and are not considered by the theory of production. isoquants where the marginal products of the factors
are zero form the ridge lines. The upper ridge line
implies that the MP of capital is zero. The lower ridge
line implies that the MP of labour is zero.
Production techniques are only (technically) efficient
inside the ridge lines. Outside the ridge lines the
marginal products of factors are negative and the
methods of production are inefficient, since they require
more quality of both factors for producing a given level
of output. Such inefficient methods are not considered
by the theory of production, since they are imply
irrational behaviour of the firm.
d
d
d
d
d
d
Marginal Product of Capital Ridge Lines
Economics (NET) | 31U
The condition of positive but declining marginal hundred units of product for one hundred units of
products of the factors defines the range of efficient product X.
production (the range of isoquants over which they are The alternative production possibilities of the table
convex to the origin). have been graphically illustrated in figure. The curve AF
Production Possibility Curve has been obtained when the data of the table are plotted.
This curve AF is called the production possibility
We explained above the behaviour of the firm in curve which represents the various combinations of two
choosing the factor combination for producing a products that the firm can produce with a given amount
product. We have assumed so far that the firm is a single
of resources. The production possibility curve shows
product firm, that is, it produces only one product o r
that, with given resources, an increase in the production
good. But the majority of firms produce more than one
of one good necessitates the reduction in the output of
product. For convenience, we take a firm producing two
the other good.
products X and Y. To produce two products the firm has
to decide the proportion in which to produce them. For
this, the concept of production possibility curve, or the
transformation curve is used.
The concept of production possibility curve is based
on the following assumptions :
1. The firm has given quantities of an input with which
it produces the two products.
2. There is no change in the production technique.
3. It can produce the two goods X and Y in different
proportions.
The concept of production possibility curve can be
understood from the following table. The table given
below displays various production possibilities of
products X and Y.
Alternative Production Possibilities
Production Product X Product Y
Production Possibility Curve
Possibilities (Hundreds) (Hundreds)
A 0 15 The production possibility curve is also called the
Product Transformation Curve or simply the
B 1 14 Transformation Curve because in moving from one
C 2 12 point to another on it, one product is transformed into
D 3 9 another, not physically but by transferring resources
from one line of production to the other. With given
E 4 5 resources being fully employed and utilized by the firm,
F 5 0 the combination of two products produced must lie
anywhere on the production possibility curve AF and not
If all the given resources are employed by the firm inside or outside it. The greater the amount of resources
for the production of product Y and none for X, 15 available with the firm for production, the higher the
hundred units of product Y are produced. On the other level of production possibility curve. The rate at which
hand, if the firm devotes all the resources for the one product is transformed into another, resources
production of X and none for Y, then 5 hundred units of remaining unchanged, is called the marginal rate of
product X are produced. But these are only two extreme transformation. In other words, the marginal rate of
production possibilities. In between these two there will transformation between X and Y is the amount of
be many other production possibilities, such as B, C, D transformation between X and Y is the amount of Y
and E. As the firm moves from production possibility A which is sacrificed for the production of an additional
towards F it withdraws some resources from the unit of X. As shown above, the sacrifice of product Y
production of product Y and devotes them to the for an additional unit of X goes on increasing as the firm
production of product X. In other words, the firm gives produces more of X and less of Y. Thus, the marginal
up some of product Y in order to produce some more of rate of transformation increases as the firm produces
product X. It is thus clear that with a given amount of more of X and less of Y. The increasing marginal rate
one product only by cutting down the production of the of transformation makes the production possibility
other product. As it moves for alternative A to B, it curves concave to the origin. The marginal rate of
sacrifices one hundred units of product Y for the sake of transformation (MRT) at a point on the production
one hundred units of product X. Again, as the form possibility curve is given by the slope of the curve at
moves further from alternative B to C, it sacrifices two that point.
32U | Economics (NET)
It should be noted here that the production For Q = A.Kα. Lβ, the percentage rise in Q for 1%
possibility curve is convex only when the increasing rise in L will be
returns occur.
%ΔQ ΔQ/Q ΔQ L
= = ×
Cobb-Douglas Production Function %Δ L ΔL / L Δ L Q
The Cobb-Douglas production function is based on In terms of partial derivatives, we can write
the empirical study of the American manufacturing dQ L
industry made be Paul H. Douglas and C.W. Cobb. It is EL = ×
dL Q
a linear homogeneous production function which takes
into account only two inputs labour and capital for the
entire output of the manufacturing industry. The Cobb-
( )
= β×
Q
L
L
× =β
Q
Douglas production function is dQ K
Similarly, EK = ×
Q = A.Kα.Lβ dK Q
where,
Q = output
(
= α× )Q
K
K
× =α
Q
K = capital Hence, if β = 0·5 then 1% rise in the amount of
labour used (keeping capital constant) will raise output
L = labour
by 0·5%.
A, α, β = Positive constants
4. The Cobb-Douglas production function can be
Properties extended easily to more than two inputs e.g., capital
The Cobb-Douglas production function has some and labour, natural resources, non-production labour, etc.
interesting mathematical properties which make them 5. The elasticity of substitution
very useful for managerial decision-making. The d(K/L)/(K/L)
important properties are the following : α =
d(MRS)/(MRS)
1. The marginal product of capital and labour depends
substitute the MRS and obtain
only on the quantities of capital and labour used in
the production process. The equation for the d(K/L)/(K/L)
α =
βK βK
marginal product of capital is given by
MPK =
dQ
= αA.Kα – 1 · L β
( )( )
d ·
αL
·
αL
dK d(K/L)/(β/α)
= =1
= α (A.Kα · Lβ)K –1 β
= α·
Q
[Q Q = A.Kα · Lβ]
() α
d (K/L)
K Hence, such a production function the elasticity
= α(APK) of factor substitution is equal to one.
where,
given that β/α is constant and does not affect the
APK = the average product of capital derivative.
Similarly, the equation for the marginal product of
labour is given by 6. Factor Intensity—In a Cobb-Douglas function
factor intensity is measured by the ratio β/α. The higher
dQ
MPL = = βA.Kα · Lβ – 1 this ratio the more labour intensive the technique. Simi-
dL
larly the lower the ratio β/α the more capital intensive
= β(A.Kα · Lβ)L–1 the technique.
Q
= β· [Q Q = A.Kα · Lβ] 7. The sum of the two exponents (α and β) shows
L
returns to scale. In the Cobb-Douglas case the returns to
= β (APL)
scale can be predicted as follows—
It is to be noted here that MPK and MP L both are
(a) When (α + β) = I the production function
positive but constantly diminishing.
exhibits constant returns to scale,
2. The marginal rate of substitution
(b) When (α + β) > 1 it exhibits increasing returns
dQ/dL to scale, and
MRSLK =
dQ/dK
(c) When (α + β) < 1 it exhibits decreasing returns
β (Q/L) β K
= = · to scale.
α (Q/L) α L
This property may now be explained and illustrated.
3. Thirdly α and β the exponents of K and L
respectively, show the output elasticities of labour (EL) Let us take the Cobb-Douglas function i.e.,
and capital (E K). Q1 = A.Kα. Lβ
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and multiple each input by the factor m. So we get Technical progress may also change the shape of the
Q2 = A.(mK)α.(mL)β isoquant. Hicks has distinguished three types of technical
= A.mαKα.mβ.L β progress, depending on its effect on the rate of
= A.Kα.Lβ.m(α + β) substitution of the factors of production.
= Q1. m (α + β) Capital-deepening Technical Progress
8. The Cobb-Douglas production function has an Technical progress is capital-deepening (or capital-
additional property. It is a homothetic production using) if, along a line on which the K/L ratio is
function. A homothetic production function has straight constant, the MRSLX increases. This implies that
line expansion path. technical progress increases the marginal product of
capital by more than the marginal product of labour. The
ratio of marginal products (which is the MRSLK)
decreases in absolute value, but taking into account that
the slope of the isoquant is negative, this sort of
technical progress increases the MRS LK . The slope of
the shifting isoquant becomes less steep along any given
radius. The capital-deepening technical progress is
shown in figure.
The Expansion Path for the Cobb Douglas Function
Technological Progress and the Produc-
tion Function
As knowledge of new and more efficient methods of
production becomes available, technology changes.
Furthermore new inventions may result in the increase
of the efficiency of all methods of production. At the
same time some techniques may become inefficient and Downward Movement of the Isoquant
drop out from the production function. These changes in
technology constitute technological progress.
Graphically the effect of innovation in process is
shown with an upward shift of the production function,
or a downward movement of the production isoquant.
This shift shows that the same output may be produced
by less factor inputs, or more output may be obtained
with the same inputs.
Capital-deepening Technical Progress
Labour-deepening Technical Progress
Technical progress is labour-deepening if, along a
radius through the origin (with constant K/L ratio), the
M R S L K increases. This implies that the technical
progress increases the MPL faster than the MPK . Thus
the MRSLK being the ratio of the marginal products,
increase in absolute value (but decreases if the minus
Upward Shift of the production Function sign is taken into account).
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Output elasticities are also expressed as the ratios of
the marginal and average product of the respective
inputs. Thus the output elasticity of input L is
MPL
eL =
APL
and of input K,
MPK
eL =
APK
If MP and AP of a input are positive, its output
elasticity is also positive. The output elasticity of an
Labour-deepening Technical Progress input is greater than, equal to, or less than unity
according as its MP is respectively greater than, equal to
The downwards-shifting isoquant becomes steeper or less than its AP. When MP is greater than AP, the
along any given radius through the origin. output elasticity of input L is greater than unity. When
MP equals AP the output elasticity is unity. When MP is
Neutral-technical Progress zero and AP is greater than the former, the output
Technical progress is neutral if it increases the elasticity is zero.
marginal product of both factors by the same percentage, The sum of output elasticities of inputs L and K
so that the MRSLK (along any radius) remains constant. equal to degree of homogeneity. If the production
The isoquant shifts downwards parallel to itself. function is homogeneous of degree one, the sum of
output elasticities of L and K also equal to one.
Equilibrium of the Firm : Choice of Optimal
Combination of Factors of Production
In this section, we shall show the use of the
production function in the choice of the optimal
combination of factors by the firm. In part A we will
examine two cases in which the firm is faced with a
single decision, namely maximising output for a given
cost, and minimising cost subject to a given output.
Both, these decisions comprise cases of constrained
profit maximisation in a single period.
In part B, we will consider the case of unconstrained
Neutral Technical Progress profit maximisation, by the expansion of output over
time.
Output Elasticities In all the above cases, it is assumed that the firm can
If the production function is Q = f (L. K), the output choose the optimal combination of factors, that it can
elasticity of L is the ratio of proportionate change in employ any amount of any factor in order to maximise
output Q to the proportionate change in input L, given its profits. This assumption is valid if the firm is new, or
if the firm is in the long-run. However, an existing firm
the input of K. Similarly, the output elasticity of K is the
may be coerced, due to pressure of demand, to expand
ratio of proportionate change in output Q to the its output in the short-run, when atleast one factor,
proportionate change in K, given the input of L. If eL be usually capital, is constant.
the output elasticity of L, then In all cases, we make the following assumptions :
Proportionate Change in Q
eL = 1. The goal of the firm is profit maximisation-that is,
Proportionate Change in L the maximisation of the difference
ΔQ/Q ΔQ L π = R–C
= = ×
Δ L/L Δ L Q where,
where, Δ = change π = profits, R = revenue
Q = output C = cost
L = labour input. 2. The price of output is given,
Similarly, if the output elasticity of input K be eK, 3. The price of factors are given :
then —w is the given wage rate.
ΔQ/Q ΔQ K
eK = = × –r is the given price of capital services.
ΔK/K ΔK Q
Economics (NET) | 35U
A. Single Decision of the Firm The slope of an isoquant is
dK MPL dX/dL
The problem facing the firm is that of a constrained – = MRSLK = =
dL MPK dX/dK
profit maximisation, which may take one of the
The isocost line is defined by the cost equation
following forms : C = (r) (K) + (w) (L)
(a) Maximise Profit p , subject to a Cost where,
Constraint. In this case, total cost and price are given C = cost
– —w , –r , px)
– and the problem may be stated as follows : w = wage rate
(c,
r = price of capital services
— — — K = quantity of capital
Maximum (π) = R – C or π = Px X – C
L = quantity of labour
Clearly maximisation of π is achieved in this case if The isocost line is the locus of all combinations of
— — factors the firm can purchase with a given monetary cost
X (output) is maximised, since C and Px are given
outlay. There is a close analogy between the consumer's
constants by assumption.
price line and firm’s isocost line.
(b) Maximise Profit π , for a given level of The slope of the isocost line is equal to the ratio of
Output—For example, a contractor wants to build a the prices of the factors of production. Thus,
bridge (X is given) with the maximum profit. In this w
Slope of isocost line =
case we have r
Price of Labour
Maximum (p) = R – C =
Price of capital
— — Case 1 : Maximisation of output Subject to a
or, p = Px · X – C
Cost Constraint (financial constraint)
Clearly maximisation of π is achieved in this case if The firm is in equilibrium when it maximizes its
— output given its total cost outlay and the prices of the
C is minimised, given that X and Px are given constants
by assumption. factors, w and r.
In figure, we see that the maximum level of output
For a graphical presentation of the equilibrium of the firm can produce, given the cost constraint, is X2
the firm (its profit maximising position) we will use the defined by the tangency of the isocost line, and the
isoquant map and the isocost-line. highest isoquant. The optimal combination of factors of
production is K 2 and L2 , for price w and r. Higher levels
of output (to the right of e ) are desirable but not
attainable due to the cost constraint. Other points on AB
or below it lie on a lower isoquant than X2 . Hence X2 is
the maximum output possible under the above
assumptions (of given cost outlay, given production
function, and given factor prices). At the point of
tangency (e) the slope of the isocost line (w/r) is equal to
the slope of the isoquant (MPL/MP K). This constitutes
the first condition for equilibrium. The second condition
is that the isoquant be convex to the origin. I n
summary : the conditions for equilibrium of the firm
are—
Isoquant Map
Isocost Line Equilibrium of the Firm
36U | Economics (NET)
(a) Slope of Isoquant = Slope of Isocost line
w MPL
or =
r MPK
w dX/dL w
= = MRSLK.
r dX/dK r
(b) The isoquants must be convex to the origin. If
the isoquant is concave the point of tangency of the
isocost and the isoquant curves does not define an
equilibrium position.
Output X2 (depicted by the concave isoquant) can
be produced with lower cost at e2 which lies on a lower
isocost curve than e With a concave isoquant we have
a ‘corner solution’.
Least-Cost Combination
Concave Isoquant Clearly the conditions for equilibrium (least cost)
Case 2 : Minimisation of Cost for a given Level are the same as in case 1, that is, equality of the slopes
of Output of isoquant and the isocost curves, and convexity of the
The conditions for equilibrium of the firm are isoquant.
formally the same as in case 1. That is, there must be Formal Derivation of the Equilibrium
tangency of the (given) isoquant and the lowest possible
isocost curve, and the isoquant must be convex. How- Conditions
ever, the problem is conceptually different in case of The equilibrium conditions may be obtained by
cost minimisation. The entrepreneur wants to produce a applying calculus and solving a ‘constrain maximum’
— problem which may be states as follows. The rational
given output (for example, a bridge, a building, or X entrepreneur seeks the maximisation of his output,
tons of a commodity) with the minimum cost outlay. given his total-cost outlay and the prices of factors.
In this case we have a single isoquant (fig.) which Formally,
denotes the desired level of output, but we have a set of Maximise X = f(L, K)
isocost curves (fig.). Curves closer to the origin show a
—
lower total cost outlay. The isocost lines are parallel Subject to C = wL + r K
because they are drawn on the assumption of constant = cost constraint
prices of factors. Since w and r do not change, all the This is a problem of constrained maximum and the
w
isocost curves have the same slope . above conditions for the equilibrium of the firm may be
r obtained from its solution.
The firm minimises its costs by employing the We can solve this problem by using Lagrangian
combination of K and L determined by the point of multipliers. The solution involves the following steps :
—
tangency of the X isoquant with the lowest isocost line Rewrite the constraint in the form
(fig.). Points below e are desirable because they show —
— C – wL – rK = 0
lower cost but are not attainable for output X . Points Multiply the constraint by a constant λ which is the
above e show higher costs. Hence, point e is the least- Lagrangian multiplier :
cost point, the point denoting the least-cost com-
—
bination of the factors K and L for producing X. λ( C – wL – rK) = 0
Economics (NET) | 37U
The Lagrangian multipliers are undefined constants Expansion Path
which are used for solving constraints maxima or The line joining the minimum cost combinations is
minima. Their value is determined simultaneously with called the expansion path because it shows, how the
the values, of the both unknowns (L and K). factor combination with which the firm produces will
From the ‘composite’ function alter as the firm expands its level of output. Thus the
— expansion path may be defined as the locus of the points
∅ = X + λ( C – wL – rK)
of tangency between the equal product curves and the
It can be shown that maximisation of the ∅ function
iso-cost lines. The expansion path is also known as
implies maximisation of the output.
scale-line because it shows how the entrepreneur will
The first condition for the maximisation of a change the quantities of the two factors when it
function is that its partial derivatives be equal to zero. increases the scale of production.
The partial derivatives of the above function with
respect to L, K and λ are :
d∅ dX
= λ + (– w) = 0 …(1)
dL dL
d∅ dX
= + λ (– r) = 0 …(2)
dL dL
d∅ —
= C – wL – rK = 0 …(3)
dL
Solving the first two equations for λ we obtain
dX
= λw
dL
d X/d L MPL
or, λ = =
w w
dX Expansion Path : Homogeneous Production Function
and = λr Since expansion path represents minimum cost
dK
d X/d K MPK combinations for various levels of output, it shows the
or, λ = = cheapest way of producing each output, given the
w L
relative prices of the factors.
The two expressions must be equal, thus
d X/d L d X/d K In the long-run all factors of production are
= variable. There is no limitation (technical or financial) to
w w
MPL the expansion of output. The firm's objective is the
d X/d L w
or, = = choice of the optimal way of expanding its output, so as
MPK d X/d K r
to maximise its profits. With given factor prices and
This firm is in equilibrium when it equates the given production function, the optimal expansion path is
ratio of the marginal productivities of factors to the determined by the points of tangency of successive
ratio of their prices. isocost lines and successive isoquants.
It can be shown that the second-order conditions for
equilibrium of the firm require that the marginal product
curves of the two factors have a negative slope.
The slope of the marginal product curve of
labour is the second derivative of the production
function :
d 2X
Slope of MP L curve =
d L2
d 2X
and slope of MPK curve =
d K2
The second-order conditions are
d 2X d 2X
2 < 0 and <0
dL d K2
d 2X d 2X d 2X 2
and ( )( ) (
dL 2 dK 2 > )
d Ld K
These conditions are sufficient for establishing the Expansion Path : Non-Homogeneous Production
convexity of the isoquants. Function
38U | Economics (NET)
If the production function is homogeneous the (iv) Isoquants of CES production function are of normal
expansion path will be a straight line through the origin, convex shape.
whose slope (which determines the optimal K/L ratio) Production Function with Elasticity of Substitu-
depends on the ratio of the factor prices. In figure the tion (σ σ ) = ∝ — This production function is of the
optimal expansion path will be OA, defined by the locus following form Q = a K + b L
of points of tangency of the isoquants with successive
parallel isocost line with s slope of w/r. Where, a and b are constants
If the ratio of the prices increases the isocost lines The graph of this production function yields
become flatter (for example, with a slope of w’/r’) and downward sloping parallel straight lines with slope
the optimal expansion path will be the straight line OB. equal to (b/a). This is a case of perfect substitutes with
Of course, if the ratio of prices of factors was initially elasticity of substitution being equal to infinity.
w/r and subsequently changes to w’/r’, the expansion
path changes : initially the firm moves along OA, but
after the change in the factor prices it moves along OB.
If the production function is non-homogeneous
the expansion path will not be a straight line, even if the
ratio of prices of factors remains constant. It is due to the
fact that in equilibrium we must equate the (constant)
w/r ratio with the MRSLK, which is the same on a curved
isocline.
Constant Elasticity of Substitution
(CES) Production Function
CES production function has been developed jointly Fixed Proportions Production Function
by Arrow, Chenery, Minhas and Solow. CES Production In this production function factors are used in a
function is quite a general production function wherein fixed ratio. The isoquants for this type of production
elasticity of factor substitution can take any positive function are right-angled or L-shaped.
constant value.
Mathematical form of CES production function is
given by :
Q = γ [δ k-p + (1-δ) L-p]–1/p
Where, γ is an efficiency parameter, δ is a
distribution parameter and p is a substitution parameter.
Main Features of CES Production Function—
Following are the main features of CES production
function :
(i) A change in the efficiency parameters (γ) causes a
shift in the production function that can occur as a
result of technological or organizational changes.
In this production function, the firms will always
(ii) The distribution parameter δ indicates the relative operate along the ray from the origin where capital—
importance of capital (K) and labour (L). labour ratio (K/L) is fixed at b/a. As in this factor ratio
(iii) The substitution parameter (p) indicates the (K/L) remains constant and therefore, the value of
substitution possibilities in the production process. elasticity of substitution equal to zero.
The elasticity of substitution (s) between factors
depends upon this parameters and mathematically CONCEPT OF COST
expressed as—
1 Cost is a derived function. It is derived from
σ = production function which describes the most efficient
1+p
method of producing a commodity. Cost of producing a
When p = 0, then σ = 1
commodity is the payment made to the factor of
When p = ∝, then σ = O production which are used in the production of that
When p = – 1, then σ = ∝ commodity.
Economics (NET) | 39U
The concept of cost guides the producers in Where, T and Pt indicate that they are assumed
determining what to produce, how much to produce and to be held constant, effect of changes in technology and
sell. So in general that cost determines the supply of any factor prices on cost of production are shown to cause a
commodity and the theory of cost is mostly a restatement shift in the function either downward or upward.
of the theoryof production in monetary term.
Cost of production is not a single-valued concept. It Different Kinds of Cost
is multi-faced and complicated concept. It means the Money vs. Real Cost—Money cost is defined as
total expenditure in money terms incurred by the money expenditure incurred by a firm for hiring or
producers in putting the commodity for sale. It includes buying of inputs needed for producing a given output of
payment to factors of production. commodity, e.g., the money expenditure on the payment
Cost of production depends upon three factors : of wages and salaries.
(a) The price paid to the owners of various factors Real Cost—Real cost of production is the pain,
of production; sacrifice and discomfort faced by the labour during
producing the commodity. It is a subjective concept and
(b) The level of output of the firm; and
cannot be measured accurately.
(c) The period of production.
Explicit Cost—Explicit cost or direct cost is the
All cost functions are derived from the production actual expenditure incurred by a firm to purchase or hire
function both in short run and long run. Total cost is a the inputs in production process. These include wages,
multivariable function i.e., total cost is determined by and interest.
many factors.
Implicit Cost or Imputed Cost—Implicit cost
Cost Function refers to the imputed (estimated) value of the inputs
owned by the firm and used by it in its own production
The short-run costs are incurred on the purchases
unit. It is the cost of inputs incurred by the firm and used
of labour, raw material, chemicals, which vary with
the changes in the level of output. by the firm in its own production process. It includes
payment for owned premises and self-invested capital
The long-run costs are the costs incurred during etc.
a period which is sufficiently large to allow the variation
in all factors of production including land, equipment to Fixed Cost and Variable Cost—Fixed costs are
produce a level of output. incurred on the fixed factors of production like machines,
building. Fixed costs can not be changed during short-
(i) Short-run Cost Function—In the short-run, not run.
only the technology and factor prices but also capital
Variable cost are incurred on variable factors of
equipment are fixed. Therefore, the short-run cost
function relates the cost of production with all those production like labour, raw materials and transport.
other factors remaining constant and can be written as Opportunity Cost—Opportunity cost is the cost of
C = ƒ (Q, T, P, K.) alternative opportunity that is sacrifice or given up. It
arises because resources are scarce and they have
Where, K indicates that capital which are also held
constant along with the given technology and given alternative uses. It is also known as displacement cost.
factor prices. The opportunity cost of any good is the next best
alternative good that is given up to produce this good.
(ii) Long-run Cost Function—The long-run cost
function can be written as— Opportunity cost in money terms is the sum total of
explicit and implicit cost i.e., economic cost.
C = ƒ (Q. T. Pf)
Private and Social Cost—Private cost refers to
Where, cost of production incurred by an individual firm in
C = Total cost of production producing a commodity. Social cost, on the other hand,
Q = The level of output refers to the cost that the society has to bear on account
T = The technology of production of commodity.
P f = is the prices of factors of production Social Cost = Private Cost + External Cost
40U | Economics (NET)
Marginal Cost—Marginal cost (MC) is defined as
the addition to or the subtraction from the total cost as a
result of increasing or decreasing production by one or
more unit.
In Symbols
MC n = TCn – TC(n-1)
For instance if the TC of producing 5 pencils is
R 150 and when 6 pencils are produced, TC raised
to R 162 then MC is R 12.
Since the marginal cost is change in total cost as a
result of change in output by one unit it can be written
as :
curve and average fixed cost. In the beginning both
ΔTC
MC = AVC and AFC curves fall. The ATC curve therefore
ΔQ falls sharply in the beginning when AVC curve begins
where, Δ is the Greek letter showing change resing but AFC curve is falling steeply, the ATC curve
Δ TC is change in total cost. continues to fall. This is because during this stage the
Δ Q is change in the quantity of output fall in AFC curve weighs more than the rise in AVC
curve. But as output increases further there is a sharp
MC Schedule rise in AVC which is more than offset to the fall in AFC.
Unit TC MC Therefore, the ATC curve rises after a point. Therefore,
0 10 - ATC like AVC curve first falls reaches its minimum
1 20 10 value and then rises. The average total cost curve is
therefore of U shape.
2 28 8
TC
3 40 12 ATC =
Q
4 55 15
Average Fixed Cost (AFC)—Average fixed cost
is the total fixed costs divided by the number of units of
Average Total Cost (ATC) Average Cost—The
output poduced.
average total cost or what is called simply average cost
is the total cost divided by the number of units of output TFC
AFC =
produced. Q
Where TFC , represents total fixed cost and Q
represents the number of units of output produced.
When output becomes very large average fixed cost
approaches Zero. It will be seen that average fixed cost
curve continuously falls throughout. The AFC curve gets
nearer to but never touches either axis. The average
fixed cost curve is rectangular hyperbola shape.
Since the total cost is the sum of total variable cost
and total fixed cost the average total cost is also the sum
of average variable cost and average fixed cost.
TC
ATC =
Q
TC = TVC + TFC
TVC + TFC
ATC =
Q
The ATC Curve—Average total cost or simply
average cost is the per unit cost of both fixed and
variable factor of production. It needs to be emphasized
that the behaviour of the average total cost curve will be
depend upon the behaviour of the average variable cost Cost Curves
Economics (NET) | 41U
Average Ariable Cost (AVC)—Average variable relation to the fixed input as the fixed input has been
cost is the total variable cost divided by the numbers of fully utilized. Therefore, the efficiency of variable factor
units of output declines. Therefore, the AVC curve is sloped positively
TVC at higher levels of output since the average efficiency of
AVC = variable inputs decreases as successive units of variable
Q
inputs are added.
Thus, average variable cost is variable cost per unit
of output. The AVC falls as the output increases from Since the Total Variable Cost (TVC) is equal to
zero to the normal capacity output, due to the occurrence the amount of variable factor employed multiplied by
of increasing return. the price per unit (W) of the variable factor i.e., (TVC
= L.W)
The U-shape of AVC follows directly from the law
of variable proportions. Initially there is too little of L.W
AVC =
variable input in comparison to the fixed inputs resulting Q
in underutilization of fixed inputs. Therefore, as the Since Q = AP.L
quantity of variable input increases fixed input is better
utilised, increasing the efficiency of the variable factor.
Efficiency of variable input increases also because
∴ AVC =
L.W W
Q
=
AP
=W
1
AP ( )
of specialisation and division of labour. Therefore, the
AVC curve is negatively sloped over early levels of Thus the average variable cost is equal to the
production. But as the quantity of variable input goes on reciprocal of average product multiplied by the constant
increasing, the variable input becomes too much in W. AVC and AP vary inversely with each other.
Average Variable Cost, Average Fixed Cost, Average Total Cost and Marginal Cost
No. of Output, (Metres AVC AVC ATC MC
Worker of Cloth) ⎡⎢ Δ TVC⎤⎥
(L) (Q)
TVC
(w. = R 60) w.L [ ]
TVC
Q
TFC
[ ] [
TFC
Q
TVC + TFC
Q ] ⎢⎣ Δ Q ⎥⎦
I II III IV V VI VII VIII
0 0 0 0 120 0 0 –
1 10 60 6 120 12 18 6·0
2 22 120 5·45 120 5·45 10·9 5
3 36 150 5·0 120 3·35 8·33 4·20
4 52 240 4·61 120 2·30 6·92 3·75
5 70 300 4·28 120 1·71 6·00 3·33
6 86 360 4·19 120 1·39 5·58 3·75
7 100 420 4·20 120 1·20 5·40 4·28
8 112 480 4·29 120 1·07 5·36 5·00
9 122 540 4·42 120 0·98 5·41 6·00
10 130 600 4·62 120 0·92 5·54 7·50
11 137 660 4·82 120 0·87 5·69 8·57
12 143 720 5·03 120 0·84 5·87 10·00
13 148 780 5·27 120 0·81 6·08 12·00
14 152 840 5·52 120 0·79 6·32 15·00
15 155 900 6·00 120 0·77 6·58 20·00
Total Cost (TC) is the sum of total fixed cost and total variable cost.
TC = TFC + TVC
TFC Curve—Horizontal Line
42U | Economics (NET)
Total Fixed Cost (TFC) are costs that do not
change with change in output. They are incurred
irrespective of amount of goods produced. Examples of
fixed costs are rent and interest.
Output TFC
0 10
1 10
2 10
3 10
Relationship between MC and AC
Total Variable Cost are those cost which vary with dc dx dz dz
the quantity of output produced. Variable cost include MC = =Z =X =Z+X
dx dx dx dx
cost of direct labour, running expenses. Or MC = AC + (x) (Slope of AC)
Output TFC Given AC > 0 and X > 0 the following results
0 0 emerge :
1 10 (a) if (slope of AC) < 0 then MC < AC
2 18 (b) if (slope of AC) > 0 then MC > AC
3 30
4 45
(c) if (slope of AC) = 0 then MC = AC
Long Run and Short Run Costs
Economic theory distinguishes between short-run
costs and long-run costs. Short-run costs are the costs
over a period during which some factors of production
are fixed. The long-run costs are the costs over a period
long enough to permit the change of all factors of
production. In the long-run all factors become variable.
Both in the short-run and in the long-run, total cost
TVC Curve—inverse-S Shape
is a multivariable function, that is, total cost is
Relationship between AC and MC determined by many factors. Symbolically we may write
the long-run cost function as
There is an apparent relationship between AC and C = f(X, T, Pf)
MC since both have been derived from total cost. The
and the short-run cost function as
relationship between the marginal cost and average cost
—
is same as that between any other marginal and average C = f(X, T, Pf, K )
quantities— where,
(1) When MC is less than AC, AC falls because MC C = total cost
pulls AC down. X = output
(2) When MC = AC, AC is constant and it is minimum. T = technology
(3) When MC is more than AC, AC rises because MC P f = prices of factors
pulls AC up. —
The relationship between the MC and AC curves K = fixed factors
will become clearer with the use of simple calculus. Opportunity or Alternative Cost
Given
C=X and Z = ƒ(x) The concept of opportunity cost occupies a very
important place in modern economic analysis. The
Where, Z = AC opportunity cost of any good is the next best alternative
Then MC is— good that is sacrificed. The factors which are used for
δC δ(ZX) the manufacture of a car may also be used for the
=
δX δX production of an equipment for the military. Therefore,
the opportunity cost of production of a car is the output
U = ƒ1 (x) and V = ƒ2 (x) and then
of the military equipment foregone or sacrificed, which
[
dy/dx = u.
dv
dx
+ v. ]
du
dx
. We have could have been produced with the same amount of
factors that have gone into the making of a car.
Economics (NET) | 43U
Two points must be noted in the above definition of (b) depreciation of machinery
opportunity cost. Firstly, the opportunity cost of (c) expenses for building depreciation and repairs
anything is only the next-best alternative foregone. (d) expenses for land maintenance
That is to say, the opportunities cost of producing a good
is not any other alternative good that could be produced The variable costs include :
with the same factors, it is only the most valuable other (a) the raw materials
good which the same factors could produce. Second (b) the cost of direct labour
point worth nothing in the above definition is the (c) the running expenses of fixed capital, such as
addition of the qualification or “by an equivalent group fuel, as ordinary repairs and routine mainte-
of factors, costing the same amount of money.” The nance.
need for the addition of this qualification arises because
The total fixed cost is graphically denoted by a
all the factors used in the production of one good may straight line parallel to the output axis.
not be the same as are required for the production of the
next best alternative good. The total variable cost in the traditional theory
of the firm has broadly an inverse-S shape which reflects
In the words of Benham, “The opportunity cost of
anything is the next best alternative that could be the law of variable proportions. According to this law,
produced instead by the same factors or by an equivalent at the initial stages of production with a given plant, as
group of factors, costing the same amount of money”. more of the variable factor is employed, its productivity
increases and the average variable cost falls.
The concept of opportunity cost is explained
diagrammatically in figure with the help of production This continues unit the optimal combination of the
possibility curve PP 1 . At combination A on this curve, fixed and variable factors is reached. Beyond this point
the producer uses OL1 of labour and OK1 of capital. If as increased qualities of the variable factors are
he wants to use L1 L2 more labour, he will have to forgo combined with the fixed factor the productivity of the
K1K2 of capital. Thus the opportunity cost of L1 L2 variable factor declines (and the AVC rises). By adding
labour is K1K2 of capital. the TFC and TVC we obtain the TC of the firm. From
the total-cost curves we obtain average-cost curves.
The average fixed cost is found by dividing TFC by the
level of output. Thus
Opportunity Cost Total Fixed Cost Curve
The concept of opportunity cost has a wide Y TFC
application to economic problems. It is applicable to the
determination of factor prices and in international trade.
Cost
It can also be applied to consumption and public expen-
diture.
Short-run Costs of the Traditional O X
Theory Output
Total Variable Cost Curve
In the traditional theory of the firm total costs are
split into two groups : total fixed costs and total TFC
AFC =
variable costs. X
TC = TFC + TVC Graphically the AFC is a rectangular hyperbola,
showing at all its points the same magnitude, that is, the
where, TC = total cost level of TFC. Being rectangular hyperbola, AFC never
TFC = total fixed cost touches any axis. The average variable cost is similarly
TVC = total variable cost obtained by dividing the TVC with the corresponding
level of output :
The fixed costs include : TVC
AVC =
(a) salaries of administrative staff X
44U | Economics (NET)
TC, TVC and TFC
Average Total Cost
Average Fixed Cost Curve
Graphically the AVC at each level of output is
derived from the slopes of a line drawn form the origin Average Variable Cost
to the point on the TVC curve corresponding to the
particular level of output. For example, in figure the or
AVC at X1 is the slopes of the ray Oa, the AVC at X2 is
the slope of the ray Ob, and so on. It is clear from figure
that the slope of a ray
through the origin dec-
lines continuously until
the ray becomes tangent
to the TVC curve at C.
To the right of this point
the slope of rays through
the origin starts increa-
sing. Thus, the SAVC
Average Total Cost
curve falls initially as
the productivity of the Total Variable Cost
Marginal Cost
variable factor increases, reaches a minimum when the
plant is operated optimally and rises beyond that point. The marginal cost if defined as the change in TC
The ATC is obtained by dividing the TC by the which results from a unit change in output. In other
corresponding level of output words, marginal cost is the addition to the total cost of
producing n units instead of (n – 1) units, where n is say
TC
ATC = any given number. In symbols :
X
MC n = TCa – TCn – 1
TFC + TVC
= = AFC + AVC Mathematically the marginal cost is the first
X
derivative of the TC function. Denoting total cost by TC
Graphically the ATC curve is derived in the same and output by X we have
way as the SAVC. The ATC at any level of output is the
d TC
slope of the straight line from the origin to the point on MC =
the TC curve corresponding to that particular level of dX
output. The shape of the ATC is similar to that of the It is worth pointing out that marginal cost is
AVC (both being U-shaped). Initially the ATC declines, independent of the fixed cost. Since fixed costs do not
it reaches a minimum at the level of optimal operation of change with output, there are no marginal fixed costs
the plant (Xm) and subsequently rises again (figure 98). when output is increased in the short-run. It is only the
The U-shape of both the AVC and the ATC reflects the variable costs that vary with output in the short-run.
law of variable proportions or law of eventually Therefore, the marginal costs are infact due to the
decreasing returns to the variable factors of changes in variable costs, and whatever the amount of
production. fixed cost, the marginal cost if unaffected by it.
Economics (NET) | 45U
Thus, marginal cost of production is equal to the
reciprocal of the marginal product of the variable factor
multiplied by the price of variable factor. Therefore,
marginal cost varies inversely with the marginal product
of the variable factor.
Graphically the MC is the slope of the TC curve
(which of course is the same at any point as the slope of
the TVC). The slope of a curve at any one of its points is
the slope of the tangent at that point. With an inverse-S
Fig. Marginal Cost
shape of the TC (and TVC) the MC curve will be U-
The independence of the marginal cost from the shaped. In figure we observe that the slope of the
fixed cost can be proved algebraically as follows : tangent to the total-cost curve declines gradually, until it
MC n = TCn – TCn –1 becomes parallel to the X-axis (with its slope being
equal to zero at this point), and then starts rising.
= (TVCn + TFC) – (TVC n – 1 + TFC)
Accordingly we picture the MC curve in figure (on next
= TVCn + TFC – TVCn – 1 – TFC page) as U-shaped.
= TVCn – TVCn – 1
Hence, marginal cost is the addition to the total
variable costs when output is increased from n–1
units to n units of output. It follows therefore, that
the marginal cost is independent of the amount of the
fixed costs.
It should be noted that marginal cost of
production is intimately related to the marginal product
of the variable factor.
As noted above,
In Summary—the traditional theory of costs
dTC
MC = postulates that in the short-run the cost curves (AVC,
dX ATC and MC) are U-shaped, reflecting the law of
d(TVC) variable proportions. In the short-run with a fixed plant
or MC = …(1)
dX there is a phase of increasing productivity (falling unit
Since price of the variable factor, i.e., w is assumed costs) and a phase of decreasing productivity (increasing
to be constant, the change in total variable cost can unit costs) of the variable factor. Between these two
occur due to the change in the amount of the variable phases of plant operation there is a single point at which
factor. unit costs are at a minimum. When this point on the
SATC is reached the plant is utilised optimally, that is,
Therefore, with the optimal combination of fixed and variable
wdL factors.
MC =
dX
dL The Relationship between ATC and AVC
= w· ...(1)
dX The AVC is a part of the ATC, given ATC = AFC +
From above discussion we know that marginal AVC. Both AVC and ATC are U-shaped, reflecting the
product of the variable factor is the change in total law of variable proportions. However, the minimum
product as a result of the unit change in the variable point of the ATC occurs to the right of the minimum
factor. Thus point of the AVC. This is due to the fact that ATC
includes AFC, and the latter falls continuously with
dX 1
MPL = or increase in output. After the AVC has reached its lowest
dL MPL point and starts rising, its rise is over a certain range
dL offset by the fall in the AFC, so that the ATC continues
=
dX to fall (over that range) despite the increase in AVC.
Substituting for in equation (1), we get However, the rise in AVC eventually becomes greater
than the fall in the AFC so that the ATC starts
1 increasing. The AVC approaches the ATC
MC = w ·
MPL asymptotically as X (output) increases.
w In figure the minimum AVC is reached at X, while
or MC = …(2)
MPL the ATC is at its minimum at X 2 . Between X1 and X 2 the
46U | Economics (NET)
fall in AFC more than offsets the rise in AVC so that the Clearly, Z = f(X)
ATC continues to fall. Beyond X2 the increase in AVC dC d(XZ)
is not offset by the fall in AFC, so that ATC rises. The MC is =
dX d(X)
The Relationship between MC and ATC Applying the rule of differentiation of ‘a function
of a function’ (which states that if y = uv, where u =
The MC-curve cuts the ATC-curve and the AVC-
curve at their lowest points. We will establish this dY dY dU
f1 (X) and v = f2 (X), then = · ,
relation only for the ATC and MC, but the relation dX dU dX
between MC and AVC can be established on the same we obtain
lines of reasoning. dC
MC =
We said that the MC is the change in the TC for dX
producing an extra unit of output. Assume that we start dX dZ
from a level of n units of output. If we increase the = Z +X
dX dX
output by one unit the MC is the change in total cost
resulting from the production of the (n + l)th unit. or MC = AC + (X). (Slope of AC)
The AC at each level of output is found by dividing Given that AC > 0 and X > 0, the following results
TC by X (output). Thus, the AC at the level of Xn is emerges :
(a) If slope of AC < 0, then MC < AC.
TCn
ACn = (b) If slope of AC > 0, then MC > AC.
Xn
(c) If slope of AC = 0, then MC = AC.
and the AC at the level X n + 1 is
The slope of the AC becomes zero at the
minimum point of this curve (given that on the
theoretical grounds the AC curve is U-shaped).
Hence, MC = AC at the minimum point of the
average cost-curve.
Long-run Costs of the Traditional Theory :
The ‘Envelope’ Curve
In the long-run all factors are assumed to become
variable. We said that the long-run cost curve is a
planning curve, in the sense that it is a guide to the
ACn + 1 = TCn + 1/Xn + 1 entrepreneur in his decision to plan the future expansion
Clearly of his output.
TCn + 1 = TCn + MC The long-run average-cost is derived from short-run
cost curves. Each point on the LAC corresponds to a
Thus : point on a short-run cost curve, which is tangent to the
(a) If the MC of the (n + 1)th unit is less than ACn LAC at that point.
(the AC of the previous n units) the ACn + 1 will be Long-run average cost curve depicts the least
smaller than the ACn. possible average cost for producing all possible levels
(b) If the MC of the (n + 1)th unit is higher than of output. In order to understand how the long-run
ACn (the AC of the previous n units) the ACn + 1 will be average cost curve is derived, consider the three short-
run average cost curves as shown in figure. These short-
higher than the ACn.
run average cost curves are also called plant curves,
So long as the MC lies below the AC-curve, it pulls since in the short-run plant is fixed and each of the
the latter downwards, when the MC rises above the AC, short-run average cost curve corresponds to a particular
it pulls the latter upwards. In figure to the left of a the plants. In the short-run, the firm can be operating on any
MC lies below the AC curve, and hence the latter falls short-run average cost curve, given the size of plant.
downwards. To the right of a the MC-curve lie above Suppose that only these three are technically possible
the AC curve, so that AC rises. It follows that at point α, sizes of plants and that no other size of the plant can be
where the intersection of the MC and AC occurs, the AC built. Given the size of the plant or short-run average
has reached its minimum level. cost curve the firm will increase or decrease its output
The relationship between the MC and AC curves by varying the amount of the variable inputs. But in the
becomes clearer with the use of simple calculus. Given long-run, the firm can choose among the three possible
C = ZX sizes of plant as depicted by short-run average cost
curves SAC1 , SAC2 and SAC3 . In the long-run the firm
where, C = total cost will examine that with which size of plant or on which
Z = average cost short-run average cost curve it should operate to produce
X = output a given levels of output at the minimum possible cost.
Economics (NET) | 47U
It will be seen from figure that upto OB amount of called the ‘envelope curve’ because it ‘envelopes’ the
output, the firm will operate on the short-run average SRC-curve.
cost curve SAC1 , though it could also produce with
short-run average cost curve SAC2 , because upto OB
amount of output, production on SAC, curve entails
lower cost than on SAC2 . If the firm plans to produce an
output which is larger than OB (but less than OD), then
it will not be economical to produce on SAC1 . It will be
seen from figure that the outputs larger than OB (but less
than OD), can be produced at a lower cost per unit on
SAC2 than on SAC1. Thus, the output OC is produced
on SAC 2 costs CK per unit which is lower than CJ
which is the cost incurred when produced on SAC 1 .
Therefore, if the firm plants to produce between outputs Long Average Cost Curve
OB and OD, it will employ the plant corresponding to
short-run average cost curve SAC2 . If the firm has to An important fact about the long-run average cost
produce an output which exceeds OD, then the cost per curve is worth mentioning. It is that the long-run average
unit will be lower on SAC3 than on SAC2 . Therefore, for curve LAC is not tangent to the minimum point of the
outputs larger than OD, the firm will employ plant short-run average cost curves. When the long-run
corresponding to the short-run average cost curve SAC3. average cost curve is declining, that is, for output less
than OXm , it is tangent to the falling portions of the
short-run average cost curves.
On the other hand, when the long-run average cost
curve is rising, it will be tangent to the rising portions of
the short-run average cost curves.
Long-run Average Cost Curve in Cons-
tant Cost Case
If the production function is linear and homo-
Plant Curves geneous (that is, homogeneous of the first degree) and
also the prices of inputs remain constant, then the long-
It is thus clear that in the long-run the firm has a
run average cost will remain constant at all levels of
choice in the employment of a plant, and it will employ
output. Linear homogeneous production function implies
that plant which yields possible minimum unit cost for
constant returns to scale which means that when all
producing a given output. The long-run average cost-
inputs are increased in a certain proportion, the output
curve depicts the least possible average cost for
increases in the same proportion.
producing various levels of output when all factors
including the size of the plant have been adjusted. Therefore, with the given prices of inputs, when
Now, if we relax the assumption of the existence of returns to scale are constant, the cost per unit of output
only three plants and assume that the available remains the same. In this case, the long-run average
technology includes many plant sizes, each suitable for a cost-curve will be a horizontal straight cost curve will be
certain level of output, the point of intersection of a horizontal straight line as depicted in figure.
consecutive plants (which are the crucial points for the
decision of whether to switch to a larger plant) are more In such a case, the optimum size of the firm in
numerous. In the limits, If we assume that there is a very indeterminate, since all levels of output can be
large number (infinite number) of plants, we obtain a produced at the same long-run average cost which
continuous curve, which is the planning LAC-curve of represents the same minimum short-run average costs
the firm. Each point of this curve shows the minimum throughout.
(optimal) cost for producing the corresponding level of
output. The LAC-curve is the locus of points denoting
the least cost of producing the corresponding output.
It is a planning curve because on the basis of this curve
the firm decides what plant to set up in order to produce
optimally (at minimum cost) the expected level of
output. The firm chooses the short-run plant which
allows it to produce the anticipated (in the long-run)
output at the least possible cost. In the traditional theory Long-run Average Cost Curve : Constant Costs,
of the firm the LAC-curve is U-shaped and it is often Constant Returns
48U | Economics (NET)
optimum size. Thus, an optimum firm is that firm
which is producing optimum output (i.e., least-cost
output) with the optimum plant.
In our figure the firm is of optimum size if it
employs plant SAC7 and uses it to produce OXm. But the
point of minimum cost of the optimum plant (SAC7 )
coincides with the minimum point of the long-run
average cost-curve. Therefore, the optimum firm can
also be defined as one which produces at the minimum
Long-run Average Cost Curve : Decreasing Costs,
Increasing Returns point of the long-run average cost curve (LAC).
Explanation of the U-shape of the Long-
run Average Cost Curve
U-shape of the LAC reflects the laws of returns to
scale. According to these laws the unit costs of
production decrease as plant size increases, due to the
economies of scale which the larger plant sizes make
possible. The traditional theory of the firm assumes that
Long-run Average Cost Curve : Rising Costs, economies of scale exist only upto a certain size of
Decreasing Returns plant, which is known as the optimum plant size,
because with this plant size all possible economies of
Optimum Plant, Optimum Output and scale are fully exploited. If the plant increases further
Optimum Firm than this optimum size there are diseconomies of scale,
It is clear from figure that in the continuous long- arising from managerial inefficiencies. It is argued that
run average cost curve both for outputs less than OXm management becomes highly complex, managers are
and more than OX m no plant is used at its point of overworked and the decision-making process becomes
less efficient.
minimum cost. It is only the plant, the minimum point of
whose short-run average cost curve coincides with the We stress once more the optimally implied by the
minimum point of the long-run average cost-curve, LAC planning curve : each point represents the least unit
which is operated at the point of its minimum average cost for producing the corresponding level of output.
cost of production. In figure for producing output OX m, Any point above the LAC is inefficient in that it shows a
the plant of SAC7 is used at its minimum cost of higher cost for producing the corresponding level of
production X me. In other words, plant of SAC7 is being output. Any point below the LAC is economically
utilized to produce its optimum output, that is to say, it desirable because it implies a lower unit-cost, but it is
is being used at its capacity. not attainable in the current state of technology and with
the prevailing market prices of factors of production.
It should be noted that in figure the plant of SAC7 is
optimum plant, since its minimum cost of production is Long-run Marginal Cost Curve
the lowest of the minimum costs of all other plants.
The long-run marginal cost is derived from the
SRMC curves, but does not ‘envelope’ them. The
LRMC is formed from points of intersection of the
SRMC curves with vertical lines drawn from the points
of tangency of the corresponding SAC-curves and the
LRA cost-curve. The LMC must be equal to the SMC
for the output at which the corresponding SAC is
tangent to the LAC.
For levels of output to the left of tangency a the
SAC > LAC. At the point of tangency SAC = LAC. As
Optimum Plant, Optimum Output And
Optimum Firm
we move from point a′ to a, we actually move from a
position of inequality of SARC and LRAC to a position
If the size of the plant is increased beyond SAC7 it of equality. Hence, the change in total cost (i.e., the MC)
results in higher average cost of production. Similarly, if must be smaller for the short-run curve than for the long-
the size of the plant is smaller than SAC7 , average cost run curve. Thus, LMC > SMC to the left of a. For an
of production is higher. Further, the least-cost output or increase in output beyond X1 (e.g., X1′′) the SAC > LAC.
in other words the optimum output of the plant SAC7 is That is, we move from the position a of equality of the
OX m . Now, if the firm produces output OXm with the two costs to the position b where SAC is greater than
optimum plant SAC7 , it is said to have achieved the LAC. Hence, the addition to total cost (= MC) must be
Economics (NET) | 49U
larger for the short-run curve than for the long-run Empirical Evidence and L-shaped Long-
curve. Thus LMC < SMC to the right of a. run Average Cost Curve
Since to the left of a, LMC > SMC, and to the right Some economists argue on the basis of empirical
of a, LMC < SMC, it follows that at a, LMC = SMC. If evidence that the long-run average cost curve is L-
we draw a vertical line from a to the X-axis the point at shaped, rather than U-shaped, as in figure. The L-
which it interests the SMC (point A for SAC,) is a point shaped curve shows a rapid fall in the beginning but
of the LMC. after a point “the curve remains flat, or may slope gently
downwards, at its right-hand end.” The difference
If we repeat this procedure for all points of tangency
between L-shaped LAC and the U-shaped LAC is that
of SRAC and LAC curves to the left of the minimum there is no rising portion in the former. Figure shows a
point of the LAC, we obtain points of the section of the flat LAC curve and figure 110 depicts a gently sloping
LMC which lies below the LAC. At the minimum point downwards curve LAC at its right-hand end.
M the LMC intersects the LAC. To the right of M the
The following two explanations have been provided
LMC lies above the LAC curve. At point M we have
for the existence of L-shaped long-run average cost
SACm = SACm = LAC = LMC curve.
1. Technological Progress—One reason why
empirical studies do not find U-shaped long-run average
cost curve is that whereas economic theory assumes
that technology remains unchanged or there is no
technological progress, but, in the real word,
technological progress does take place over time. As a
result of technological progress in the real world, long-
run average cost curve will shift downwards over
time. The empirical investigations which are conducted
at different points of time would not find the rising
average cost in view of the existence of technological
progress.
Long-run Marginal Cost Curve
There are various mathematical forms which give
rise to U-shaped unit cost curves. The simplest total
cost function which would incorporate the law of
variable proportions is the Cubic Polynomial.
C = b0 + b1 X – b2 X 2 + b3 X 3
TC = TFC + TVC
The average variable cost is
TVC Flat LAC Curve
AVC =
X The L-shaped long-run average cost curve (LAC) is
= b1 – b 2 X + b3 X 2 explained in figure. Suppose the firm is producing OQ1
output on LAC1 curve at a per unit cost of OC1 . If there
The marginal cost is is an increase in demand for the firm product to OQ2,
dC with no change in technology, the firm will produce OQ2
MC =
dX output along the LAC1 curve at a per unit cost OC 4 . If,
= b1 – 2b2 X + 3b3 X2 however, there is technical progress in the firm, it will
install a new plant having LAC2 as the long-run average
The average total cost is
cost curve. On this plant, it produces OQ2 output as a
C lower cost OC2 per unit. Similarly, if the firm decides to
ATC =
X increase its output to OQ3 to meet further rise in
b demand, technical progress may have advanced to such
= 0 + b1 – b2 X +b3X2
X a level that it installs the plant with the LAC3 curve.
The TC curve is roughly S-shaped, while the Now, it produces OQ3 output at still lower cost OC3
ATC, the AVC and the MC are all U-shaped, the MC per unit. If the minimum points L, M and N of these U-
curve intersects the other two curves at their shaped long-run average cost curves LAC 1 , LAC 2 and
minimum points. LAC3 are joined by a line, it forms a gently sloping
50U | Economics (NET)
downwards curve LAC. Thus, in a given state of curves of each firm. Thus, when the industry expands
technology, the long-run average cost curves are U- and as a result of it certain external economies accrue to
shaped. But when there is technical progress, the long- the firms, the cost curves of a firm will shift down as is
run average cost curve is L-shaped. shown in figure. It should be noted that external
2. Learning by Doing—Learning by doing is economies will causes all types of firm's cost curves-
another factor which causes the long-run average cost to long-run average and marginal cost curves, short-run
slope downward throughout. It is now common average and marginal cost curves-to shift down. In
knowledge that a person learns while doing some figure, initially the long-run average cost curve is LAC1
productive work. The greater the amount of work he and as a result of the expansion of whole industry and
has done since the time he started doing a particular the creation of external economies it shifts down to a
work, the greater the experience he attains and with the new position LAC2 .
experience he learns to do thing in a better why than On the other hand, when the external
before. This tends to reduce the costs. diseconomies accrue to the firms as a result of the
expansion of the industry, cost curves of the firms will
shift upward as is depicted in figure. In the beginning,
the long-run average cost curve is LAC and with the
expansion of the industry output and consequent
emergence of external diseconomies cause the long-run
average cost curve (along with its short-run average and
marginal cost curves) to shift upward to a new position
LAC1 .
Downwards Sloping LAC Curve
External Economies and Diseconomies
and Cost Curves
We have explained above that the long-run average
cost curve falls downward in the beginning because of
economies of scale, namely, the use of greater degree of
division of labour and the specialised machinery at External Economies
higher levels of output. The uses of greater degree of
division of labour and the specialised machinery at
higher levels of output are the internal economies.
They are internal in the sense that they accrue to the
firm when its own output or scale increases. Besides
internal economies, Marshall introduce the concept of
external economies which play an important role in
Marshall's partial equilibrium theory of value, especially
in his analysis of equilibrium problem under conditions
of increasing returns or decreasing cost.
Costs of a firm depend not only on its output level
but also on the output level of the industry as a whole.
External economies and diseconomies are those
economies and diseconomies which accrue to the firms
as a result of the expansion in the output of the whole External Diseconomies
industry and they are not dependent oh the output level We noted above in the previous section that
of individual firms. They are external in the sense that internal economies and diseconomies of scale affect
they accrue to the firms not out of its internal situation the shape that the long-run average cost curve takes,
but from outside it i.e., the output of the industry. internal economies of scale cause the long-run average
External Economies accrue to the individual firms, cost to fall as output is increased in the initial stages and
if the increase in the output of industry lowers' the cost internal diseconomies of scale cause the long-run
curves of each firm in the industry. On the other hand, average cost curve to rise. On the other hand, external
external diseconomies accrue to the firms, when the economies and external diseconomies cause the long-run
expansion of the output of the industry raises the cost average cost curve to shift down or up, as the case may
Economics (NET) | 51U
be. Moreover, when we are considering the effect of dC Q dC Q
external economies and external diseconomies on the = × = ×
C dQ dQ C
cost curves, it is not only the long-run average cost dC C
curve, it is not only the long-run average cost curve but = ÷
dQ Q
all short-run and long-run cost curves, whether total,
average or marginal, shift together up or down as the MC Margina cost
= =
case may be. AC Average cost
Thus, cost elasticity (K) is equal to the ratio of
External Economies marginal cost (dC/dQ) to average cost (C/Q)—It
follows from this that
We explain below some of important external (a) If MC > AC, then K > 1
economies which accrue to the firms and reduce their (b) If MC = AC, then K = 1, and
costs of production.
(c) If MC < AC, then K < 1.
1. Cheaper Materials and Capital Equipment
Diagrammatically, when the MC curve is rising and
2. Technological External Economies is above the AC curve, K > 1, as shown by the area right
3. Development of Skilled Labour to point E in figure. It is the case of decreasing returns.
4. The Growth of Subsidiary and Correlated In the figure, it is the point E where, MC = AC. It is case
Industries of constant returns. When MC < AC, K < 1. It is
shown as the area to the left of point E in this figure,
5. Improved Transportation and Marketing Facilities where the MC curve is falling and is below the AC
6. Development of industry Information Services curve. It is the case of increasing returns.
External Diseconomies Elasticity of Average Cost
We have explained above the external economies dC Q
The elasticity of total cost is given by E(C) = ·
which accrue to the firms as a result of the growth of the dQ C
industry. But the expansion of an industry is also likely and average cost is C/Q. Therefore, replacing C by C/Q.
to generate external diseconomies which raise the cost Thus, elasticity of average cost
curves of the firms. The main example of external d(C/Q) Q d(C/Q) Q2
diseconomies is the rise in some factor prices when the E(C/Q) = · = ·
dQ C/Q dQ C
industry expands and its demand for various factors
⎛ Q· – C⎞
dC
Q2 ⎜⎜ dQ ⎟
needed by it increases. The expansion of an industry will
definitely raise the prices of those raw materials and = ⎟
C ⎝ Q2 ⎠
capital goods which are in short supply. Likewise, the
Q2 1
expansion of the industry is likely to raise the wages of
skilled labour, at least in the short-run, since it always
=
C Q2
· ( dC
Q· – C
dQ )
takes time for the labour to get training and acquire Q dC
specialised skill needed in a particular industry. = · –1
C dQ
Since the productive factors such as various types of = K – 1 (Q K = elasticity of total cost)
raw materials, cement, steal, various kinds of machinery The following results follows from this :
and tools and skilled labour are scarce, the increase in
(a) if K(the elasticity of total cost) is greater than,
demand for them resulting from the expansion in the
equal to or less than unity, the elasticity of average cost
industry is likely to push up their prices. In the contact
is greater than, equal to or less than zero, and
of scarcity of resources, an industry will expand by
snatching away the resources from other industries. For (b) the elasticity of total cost exceeds the elasticity
snatching away the scarce resources from other of average cost by unity, i.e.,
industries, it will bid up their prices. Thus, in the real
world of scarcity, an expanding industry will create
more external diseconomies than external economies.
Elasticity of Cost
If output (Q) is produced at a total cost (C), the cost
function is
C = f(Q).
The elasticity of total cost is the ratio of the
proportional change in total cost to the proportional
change in total output. It may be written as Cost Elasticity
dC/C E(C/Q) = K – 1
Cost Elasticity (K) =
dQ/Q or, K – E(C/Q) = 1
52U | Economics (NET)
Elasticity of Marginal Cost Different Risk Attitudes
As we know, the elasticity of total cost is given by People can be categorized into 3 distinct groups on
dC Q dC the basis of their attitudes towards risk based on the
K= · . Therefore, the marginal cost is . Thus,
dQ C dQ form of their respective Bernoulli utility functions. Let's
elasticity of MC illustrate this with a simple gamble based on a coin toss,
d(dC/dQ) Q which pays R 10 if the coin lands heads and R 20 if the
= · ...(1) coin lands tails. The expected value of this gamble is, of
dQ dC/dQ
course : (0·5 × 10) + (0·5 × 20) = R 15.
Since K is given by
1. Risk-Averse : If a person's utility of the expected
Q dC K·C dC
K = · or = …(2) value of a gamble is greater than their expected utility
C dQ Q dQ from the gamble itself, they are said to be risk-averse.
Substituting the value of (2) in (1), we get, This is a more precise definition of Bernoulli's idea.
Q2
E(MC) =
d
( )
dQ Q
C·K
·
C·K
Risk-averse behavior is captured by a concave Bernoulli
utility function, like a logarithmic function. For the
above gamble, a risk-averse person whose Bernoulli
Decision-Making Under Uncertainty utility function took the form u(w) = log(w), where w
Basic Concepts was the outcome, would have an expected utility over
An Introduction to Risk-Aversion the gamble of :
0·5 × log(10) + 0·5 × log (20) = 1·15, while their
According to the concept of an expected utility utility of the expected value of the gamble is log(15) =
function discussed, people maximize their expected 1·176.
utility when faced with a decision involving outcomes
with known probabilities. So an expected utility function u(w)
)
w
g(
over a gamble g takes the form :
lo
)=
u (g) = p1 u (a1 ) + p2 u (a2) + ... + pn u (an)
w
u(
where the utility function over the outcomes, i.e.
u (ai), is the Bernoulli utility function.
j
In Bernoulli's formulation, this function was a
logarithmic function, which is strictly concave, so that
the decision-maker's expected utility from a gamble is i
o w
less than its expected value. Bernoulli assumed this
would hold, since most people are risk-averse - they 2. Risk-loving : If a person's utility of the expected
prefer a more certain outcome to a less certain one. This value of a gamble is less than their expected utility from
does seem like a reasonable assumption at first glance. the gamble itself, they are said to be risk-loving. Note,
But is this always true? Most of the people buy however, that this does not capture normal gambling
insurance - for cars, homes, and pretty much anything behavior of the kind observed in casinos the world over.
which they consider valuable. The rationale is straight- By this definition, a truly risk-loving person ought to be
forward - even though the probability of losing or willing to stake all of their assets, everything they own,
damaging the item insured may be small, the potential on a single roll of dice. A convex Bernoulli utility
loss would be so huge, that most people would rather function captures risk-loving behaviour; for example, an
pay moderate amounts of money for certain, than lose a exponential function. For the above gamble, a risk-
large sum with a very small probability. loving person whose Bernoulli utility function took the
But there's another side to this - the insurance form u(w) = w2 would have an expected utility over the
companies. If it's logical for people to buy insurance, gamble of :
how come it's also logical to sell it? After all, insurance 0·5 × 102 + 0·5 × 202 = 250, while their utility of the
expected value of the gamble is 152 = 225.
companies are in the business to make a profit. If the
people as individuals are better off paying comparatively u(w)
w2
)=
small, fixed amounts at regular intervals (as an insurance
w
u(
premium) than risking a large loss, how is the insurance
company better off by accepting these small amounts,
and agreeing to risk a large loss? If buyers of insurance
are indeed risk-averse - what about those who sell it?
Obviously Bernoulli's assumption does not always j
hold. Using the von Neumann-Morgenstern framework, i
o w
we can define people's attitudes towards risk much more
precisely, without making any prior assumptions about 3. Risk-neutral : If a person's utility of the expected
their behavior. value of a gamble is exactly equal to their expected
Economics (NET) | 53U
utility from the gamble itself, they are said to be risk- results and the scope and variety of applications. As a
neutral. In practice, most financial institutions behave in recognition of the vitality of the field a total of 8 Nobel
a risk-neutral manner while investing. Risk-neutral Prizes were given in Economic Sciences for work
behavior is captured by a linear Bernoulli function. For primarily in game theory, with the first such recognition
the above gamble, a risk-neutral person whose Bernoulli given in 1994 to John Harsanyi, John Nash, and
utility function took the form u(w) = 2w would have an Reinhard Selten “for their pioneering analysis of
expected utility over the gamble of : equilibria in the theory of non-cooperative games.” The
(0·5 × 2 × 10) + (0·5 × 2 × 20) = 30, while their second set of Nobel Prizes in game theory went to
utility of the expected value of the gamble is 2 × 15 = Robert Aumann and Thomas Schelling in 2005, “for
30. having enhanced our understanding of conflict and
u(w) cooperation through game-theory analysis.” And the
most recent one was in 2007, recognizing Leonid
) Hurwicz, Eric Maskin, and Roger Myerson, “for having
(w
og
) =l laid the foundations of mechanism design theory.”
u(w There are two streams of Game theory : 1. Co-
operative games, and 2. Non-cooperative games.
Cooperative game theory exists, and is better suited to
j analyzing some economic settings, e.g. where the
i
structure of the game is unclear or unobservable, and it
o w is desired to make predictions that are robust to it. Co-
In the insurance example above, the insurance operative game theory assumes rationality, unlimited
company is risk-neutral, while buyers of insurance are communication, and unlimited ability to make
risk-averse. The insurance company earns profits since agreements. Its goal is to characterize the limits of the
the value of the premiums it receives is higher than the set of possible cooperative agreements that might
expected value of the loss. emerge from rational bargaining.
Game Theory- Non-Cooperative Games On the other hand Non-cooperative game theory
also assumes rationality. Non-cooperative game theory
Game theory is a latest branch of mathematical replaces co-operative game theory’s assumptions of
economics or the Econometrics. Game theory deals with unlimited communication and ability to make
strategic interactions among multiple decision makers, agreements with a fully detailed model of the situation
called players (and in some context agents), with each and a detailed model of how rational players will behave
player’s preference ordering among multiple alternatives in it. Its goal is to use rationality, augmented by the
captured in an objective function for that player, which “rational expectations” notion of Nash equilibrium, to
he either tries to maximize (in which case the objective predict or explain outcomes from the data of the
function is a utility function or benefit function) or situation. As a result, non-cooperative game theory is
minimize (in which case we refer to the objective used for normative purposes in some applications, such
function as a cost function or a loss function). For a non- as mechanism design.
trivial game, the objective function of a player depends
Some applications of non-cooperative game theory
on the choices (actions, or equivalently decision
involve predicting which settings are better for fostering
variable) of at least one other player, and generally of all
co-operation. This is done by making behavioral
the players, and hence a player cannot simply optimize
assumptions at the individual level (“methodological
her own objective function independent of the choices of
individualism”), thereby requiring cooperation to
the other players. This, thus, brings in a coupling
emerge (if at all) as the outcome of explicitly modeled,
between the actions of the players, and binds them
independent decisions by individuals in response to
together in decision making even in a non-cooperative
explicitly modeled institutions.
environment. If the players were able to enter into a
cooperative agreement so that the selection of actions or Key features of Non-Cooperative Game theory are
decisions is done collectively and with full trust, so that following :
all players would benefit to the extent possible, and no ● From the non-cooperative point of view, a game is a
inefficiency would arise, then we would be in the realm multi-person decision situation defined by its
of cooperative game theory, with issues of bargaining, structure, which includes :
coalition formation, excess utility distribution, etc. of ● Players : Independent decision makers.
relevance there; cooperative game theory will not be ● Rules : Which specify the order of players’
covered in this overview. decisions, their feasible decisions at each point
Game Theory has enjoyed over 65 years of they are called upon to make one, and the
scientific development, with the publication of the information they have at such points.
Theory of Games and Economic Behaviour by John von ● Outcome : How players’ decisions jointly
Neumann and Oskar Morgenstern generally acknow- determine the physical outcome.
ledged to kick start the field. It has experienced ● Preferences : players’ preferences over out-
incessant growth in both the number of theoretical comes.
54U | Economics (NET)
● Assume that the numbers of players, feasible Outcomes : If the two coins match, player X pays 1
decisions, and time periods are finite. rupee to player Y; otherwise,player Y pays 1 rupee to
● These can be relaxed, and it will be relaxed for player X.
decisions and time periods. Matching Coins (version D).
● Preferences over outcomes are modeled just as in Players : There are two players, denoted X and Y.
decision theory. Rules : Players flip a fair coin to decide who begins.
● Preferences can be extended to handle shared The looser puts a coin down, either heads up or tails up.
uncertainty about how players’ decisions determine Then, the winner puts a coin down, either heads up or
the outcome as in decision theory, by assigning von tails up.
Neumann-Morgenstern utilities, or payoffs, to Outcomes : If the two coins match, the looser pays 1
outcomes and assuming that players maximize rupee to player Y; otherwise, the winner pays 1 rupee to
expected payoff. player X.
● Assume for now that players face no uncertainty We are interested in Non-Cooperative Game Theory
about the structure other than shared uncertainty because it is very useful in modeling and understanding
about how their decisions determine the outcome, multi-personal economic problems characterized by
that players know that no player faces any other strategic interdependency. Consider, for instance, com-
uncertainty, that players know that they know, and petition between firms in a market. Perfect competition
so on; i.e., that the structure is common knowledge. and pure monopoly (not threatened by entry) are special
● It is essential that a player’s decisions be feasible non-realistic cases. It is more frequent in real life to find
independent of others’ decisions; e.g. “wrestle with industries with not many firms (or with a lot of firms but
player 2” may be not a well-defined decision, with just a few of them producing a large part of the
although “try to wrestle with player 2” can be well- total production). With few firms, competence between
defined. them is characterized by strategic considerations : each
● It is essential that specifying all of each player’s firm takes its decisions (price, output, advertising, etc.)
decisions should completely determine an outcome taking into account or conjecturing the behaviour of the
(or at least a shared probability distribution over others. Therefore, competition in an oligopoly can be
outcomes) in the game. If a specification of the seen as a non-cooperative game where the firms are the
structure of a game does not pass these tests, it must players. Many predictions or solution proposals arising
be modified until it does. from Game Theory prove very useful in understanding
Example : If you object to a game analysis is that competition between economic agents under strategic
players are not really required to participate in the interaction.
game, the (only!) remedy is to explicitly add a player’s Prisoner’s Dilemma under Co-operative game
decision whether to participate to the game, and then to theory and Non-cooperative game theory
insist that it be explained by the same principles of This type of game, where they reach a non-
behaviour the analysis uses to explain players’ other cooperative solution when they could co-operate, is
decisions. called Prisoner’s Dilemma. Prisoner’s Dilemma is
Matching Coins (version A). shown below :
Players : There are two players, denoted X andY2 . The Prisoner's Dilemma
Rules : Each player simultaneously puts a coin
down, either heads up or tails up. Mr. Ram
Outcomes : If the two coins match, player X pays 1 Confess Not
rupee to player Y; otherwise, player Y pays 1 rupee to confess
player X. Mr. Shyam Confess 6 0
Matching Coins (version B).
Players : There are two players, denoted X and Y.
Rules : Player X puts a coin down, either heads up 6 9
or tails up. Then, Player Y puts a coin down, either Not 9 1
heads up or tails up. confess
Outcomes : If the two coins match, player X pays 1
rupee to player Y; otherwise, player Y pays 1 rupee to 0 1
player X.
Matching Coins (version C). Two prisoners Mr. Ram and Mr. Shyam are arrested
Players : There are two players, denoted X and Y. for committing a crime and interrogated separately.
Rules : Player X puts a coin down, either heads up They are told the following :
or tails up, without letting player Y know his decision. (a) If both are claimed to be innocent, they will get
Player Y puts a penny down, either heads up or tails up. a light sentence that is 1 year in jail.
Economics (NET) | 55U
(b) If one confesses and the other does not, then strategy A, to receive R 1, or strategy B, to lose R 1.
who confesses will be released free and the other will Logically, both players choose strategy A and receive a
be punished for 9 year in jail, and payoff of R 1. If you revealed Shyam's strategy to Ram
(c) If both confess, then both of them will get a- and vice versa, you see that no player deviates from the
punishment of 6 years in jail. original choice. Knowing the other player's move means
little and doesn't change either player's behaviour. The
The payoff matrix presented in figure shows the
outcome A, A represents a Nash equilibrium.
dilemma of the prisoners about whether to confess or not
to confess. If none of them confess then both will get 1 Ram
year of jail, but if Ram confesses and Shyam does Shyam A B
not then Ram will be left free and Shyam will get 9 year
of imprisonment and the vise- versa. And if both of them A 1, 1 1, – 1
confess then both will get 6 years of imprisonment. Not B – 1, 1 0, 0
confessing is the best solution in this game (Pareto
efficient solution) but this leaves one always in
uncertainty. This solution is not a stable solution as one MARKET STRUCTURES
gets an imprisonment of 9 years if he/she does not The word market is derived from the Latin term
confess and the other does. Therefore, confession mercatus from the verb mercari which means “to trade”.
dominates in the mind of both the prisoners. If both of In simple term market is a place where goods are bought
them confess then they end up with 6 years jail for both. and sold. In economics market is defined as a complex
This kind of equilibrium is called Nash equilibrium. set of activities by which potential buyers and potential
From both the figures above it is clear that it they co- sellers are brought in close contact of the purchase and
operate then they will earn the maximum profit than if sale of commodity. In economics the term market has
they compete. different meaning. It does not refer to any public place
or private place, it does not mean shops or establish-
Nash Equilibrium ments. On the other hand, markets in economics refers
Nash equilibrium is a concept within game theory to certain conditions. They are as follows—
where the optimal outcome of a game is where there is (a) There should be a large number of buyers and
no incentive to deviate from their initial strategy. More sellers of a commodity.
specifically, the Nash equilibrium is a concept of game (b) There must be communication between buyers
theory where the optimal outcome of a game is one and sellers.
where no player has an incentive to deviate from his (c) There must be place or area where buyers and
chosen strategy after considering an opponent's choice. sellers interact with each other.
Overall, an individual can receive no incremental benefit (d) There must be a commodity which is being
from changing actions, assuming other players remain demanded and sold.
constant in their strategies. A game may have multiple (e) There must be freedom of entry or exit of the
Nash equilibria or none at all. firms. Different forms of markets are differen-
Nash equilibrium is named after its inventor, John tiated from each other in terms of the nature of
Nash, an American mathematician. It is considered one entry or exit.
of the most important concepts of game theory, which
attempts to determine mathematically and logically the Classification of Markets
actions that participants of a game should take to secure (1) Area Classification—Based on the area markets
the best outcomes for themselves. The reason why Nash are classified as
equilibrium is considered such an important concept of (a) Local Market, (b) Regional Market
game theory relates to its applicability. The Nash (c) National Market (d) International Markets
equilibrium can be incorporated into a wide range of
disciplines, from economics to the social sciences. (2) Classification According to Time—Markets
can be classified on the basis of the time taken by
The Nash equilibrium is the solution to a game in
which two or more players have a strategy, and with producers to adjust supply.
each participant considering an opponent’s choice, he (3) Functional Classification—According to the
has no incentive, nothing to gain, by switching his functions there are two types of markets—Generalised
strategy. In the Nash equilibrium, each player's strategy markets and Specialised market.
is optimal when considering the decisions of other
players. Every player wins because everyone gets the 1. PERFECT COMPETITION
outcome they desire. To quickly test if the Perfect competition is a market structure characte-
Nash equilibrium exists, reveal each player's strategy to rised by complete absence of rivalry among individual
the other players. If no one changes his strategy, then the firms. Perfect competition is defined as a market
Nash equilibrium is proven. structure in which there are large number of buyers and
For example, imagine a game between Ram and sellers of homogeneous commodity, for example,
Shyam. In this simple game, both players can choose agriculture.
56U | Economics (NET)
Features of Prefect Competition substitute and the seller takes the whole of the country
income all the time, it is called pure monopolist.
(1) Large Numbers of Buyers and Sellers—There
are so many buyers and sellers so that no individual (2) Simple Monopoly—Under this type of market
buyer or seller can influence the price of the commodity structure the monopolist cannot set a price to maximise
in the market. Any change in the output supplied by a his industry profit without attracting entry. But he may
single firm will not affect the total output of the set a lower profitable price at which entry will not be
industry. He can sell whatever output he produces at attracted.
the given price. An individual seller is a price-taker. (3) Discriminating Monopoly—This is a market
Similarly, individual buyer can not influence the price of structure where the monopolist charges different prices
the commodity by his decision to vary the amount, he from different consumers for the same good or services
would like to buy. He is a price taker having no bar- at the same time.
gaining powers in the market. The Degree of Monopoly Power
In a perfectly competitive market price of the
commodity is determined by the intersection of the By monopoly power we mean the amount of
market demand and supply curves of the commodity. discretion which a producer or seller possesses in regard
This occurs at point E where DD = SS. The perfectly to the framing of his price and output policy. There are
competitive firm is then a price taker and sell any mainly three measures of monopoly power which are
amount of the commodity at the established price. as follows :
(2) Homogeneous Product—Firms in the perfectly (i) Elasticity of Demand as a Measure of
competitive market produce homogenous products. Monopoly Power—A precise measure of monopoly
Homogeneity of a product implies that one unit of the power is given by the inverse of the elasticity of
product is a perfect substitute for another. demand. Thus,
(3) Free Entry or Exit of Firm—In a perfectly 1
Degree of monopoly power =
competitive market there are no barriers to entry or exit ep
of firms. where ep is the absolute value of price elasticity of
(4) Perfect Knowledge—All buyers and sellers demand.
have complete knowledge of the market conditions. The less the elasticity of demand, the greater the
(5) Perfect Mobility of Resources—The factors monopoly power and the greater the elasticity of
of production can move easily from one firm to another. demand, the less the degree of monopoly power.
(ii) Lerner’s Index of Monopoly Power—Lerner
2. MONOPOLY has given the following precise index of monopoly
Monopoly is a market structure in which there is a power :
single firm producing the output, for example—rail- P – MC
ways, post and telegraph. Being the sole supplier mono- 1 =
P
polist is thus in a position to fix up a price to his own Where, P denotes price and MC denotes
advantage.
marginal cost at the equilibrium level of output.
Features of Monopoly When competition is pure or perfect, price (P) is
(1) A Single Seller—The monopolist is the only equal to marginal cost and therefore, Lerner’s index of
producer of the good. So, the distinction between firm monopoly power is equal to zero indicating no
and industry disappears. There is only one seller or monopoly power at all.
producer of commodity. When MC is zero, I will be equal to unity. Thus,
(2) No Close Substitute—There are no close Lerner's index of monopoly power can vary from zero to
substitutes for the commodity produced by the unity.
monopolist. The monopolist produces all the output in a (iii) Cross Elasticity of Demand as a Measure of
particular market, thus he is a price maker. Monopoly Power—The concept of cross elasticity of
(3) Barriers to Entry—There are significant demand to measure the degree of monopoly power was
barriers to entry. It is characterised by closed entry to the first of all suggested by Kaldor, but it has been
prospective producers. emphasized and popularised by Robert Triffin in his
(4) Perfect Knowledge—Monopolist is assumed to well-known work ‘Value Theory and General
be having perfect knowledge about the market condi- Equilibrium Analysis’.
tions. The cross elasticity of demand points to the degree
of dependece of a firm’s product upon the prices of other
Types of Monopoly firms’ products. The smaller the extent of cross elasticity
(1) Pure Monopoly—When a single seller produces of demand for the product of a firm, the greater the
such a product which has neither a near nor a remote degree of monopoly power enjoyed by it and vice-versa.
Economics (NET) | 57U
3. MONOPOLISTIC COMPETITION (4) Mutual Interdependence—This is the only
OR IMPERFECT COMPETITION feature which sets oligopoly apart from other market
structures. It means that price and output decisions of
It is defined as a market structure in which there are
one firm affects the similar decisions of the other firms.
many firms selling closely related but unidentical
commodity, for examples detergents, automobiles, soft (5) Importance of Selling Cost— Selling cost are
drinks, T.V. sets. Monopolistic competition is the form incurred by firms to attract customers.
of market in which there are large number of sellers of a (6) Indeterminate Demand Curve of an
particular product, but each seller sells somewhat Oligopolist—An important feature of oligopoly is that
differentiated product. the demand curve faced by an oligopolist is indeter-
Features of Monopolistic Competition minate. A demand curve shows the amount of the
product a firm can sell at various prices. An oligopolist
(1) Large Number of Buyers and Sellers—In the cannot ignore the reaction of the rival firms in view of
monopolistic competition the number of sellers is large, interdependence of the firms in it. Any change in the
but it is not unusually large. The firm under mono- price by one firm may results in a change in prices by
polistic competition can reasonably assumes that any the rival firms. Therefore it is not definite, it is
action on its part will affect the rival firms so indeterminate.
insignificantly that it need not bother about the reactions PRICING UNDER MONOPOLY
of the rival firms, it can follow its independent price
The monopoly firm, like a competitive firm, reaches
policy.
its equilibrium when it maximises its total profits. Its
(2) Product Differentiation—The products of the profits are maximum when two conditions are fulfilled :
sellers are differentiated but are close substitutes of one
(1) The MC is equal to MR, and
another. Product differentiation can be real or artificial.
Its effect is that sellers can differentiate their products. (2) the slope of MC is greater than the slope of the
This gives the seller some degree of price-making MR at the point of intersection.
power, which he can exploit that is why firm faces an
elastic demand curve.
(3) Free Entry or Exit of Firms—Monopolistic
competition like perfect competition is characterized by
free entry and free exit. There are no restrictions to the
entry of new firms to produce the close substitutes. Free
entry would ensure that there are no abnormal profits.
Similarly free exit would ensure that no firm incurs
losses in the long run.
(4) Imperfect Knowledge—Buyers and sellers do
not have perfect or complete knowledge of market
conditions.
(5) Selling Cost—A firm under monopolistic
competition incurs selling cost to increase the demand
for its product. Examples of selling costs are adverti- The equilibrium of the monopolist is defined by the
sements, and window displays. point E, at which the MC intersects the MR curve from
below, thus both conditions for equilibrium are fulfilled.
4. OLIGOPOLY Price is P M and quantity is Xm. The monopolist realises
Oligopoly is defined as a market organisation in excess profits equal to the shaded area PM BCA. Here,
which there are a few sellers of the homogeneous or the price is higher than the AC.
differentiated products. The number of sellers depends
on the size of the market. Long-run Equilibrium of the Mono-
polist
Features of Oligopoly
In the long-run, the monopolist uses his existing
(1) Few Sellers—There are few dominant and large plant at any level which will maximise his profit since
firms each producing significant portion of the total the entry of new firms is totally blocked. It is not
output. necessary for the monopolist to reach an optimal scale.
(2) Homogeneous or Differentiated Products— The only necessary thing is that the monopolist will not
The output in an oligopolistic market may be either stay in business if he makes losses in the long-run. He
homogeneous or differentiated. will most probably continue to earn super normal profit
(3) Barriers to Entry—There are restrictions to even in the long-run because entry is barred. However,
entry of new firms. the size of the plant and the degree of utilisation of any
58U | Economics (NET)
given plant depend entirely on the market demand. Robinson, price discrimination is the act of selling the
When the market size is just large enough, it permits the same article produced under a single control at different
monopolist to build the optimal plant and use it at full prices to different customers.
capacity.
Forms of Price Discrimination
There can be different forms of price discrimination.
The important ones are the following :
(1) Personal Discrimination
When the monopolist simultaneously charges
different prices from different buyers, it is called
personal discrimination. The following factors make the
personal discriminations possible :
(i) Ignorance of the consumer.
(ii) Irrationality of the consumer.
(iii) Normal difference in price.
(iv) Nature of the commodity or service.
Pricing Under Monopoly in the Short-run
(2) Trade Discrimination
It is clear that the firm is running at its full capacity.
There is no certainty that in the long-run the monopolist When a monopolist charges different prices for the
different uses or from different occupations, it is called
will reach the optimal scale. In monopoly there are
trade discrimination. For example, an electricity
number of market forces similar to those in pure company may charge a high price for domestic
competition which lead the firms to operate at optimum consumption, and may charge low price for the industrial
plant size. use of electricity.
(3) Place Discrimination
When a monopolist charges different prices in
different market place, it is called place discrimination.
Conditions Essential for Price Discrimi-
nation
Price discrimination cannot be practised indiscrimi-
nately by a monopolist. It is possible under specific
conditions which are as follows :
(1) Existence of two or more than two markets.
(2) Existence of different elasticities of demand in
different markets.
(3) No possibility of resale.
Pricing Under Monopoly In The Long-Run (4) Full control over the supply.
Price Determination and Equilibrium Under
Discriminating Monopoly. Price Determination and Equilibrium
Discriminating Monopoly under Discriminating Monopoly
Every monopolist seeks to maximise his profits.
It means the monopolist producer charges different Accordingly, whenever he finds that it is not only
prices to different buyers for the same product with an possible to separate completely the markets for his
aim to earn maximum profits. The unique position and product, but also the elasticity of demand in these
control which the monopolist exercise for his supply or market is different, he indugles in price discrimination.
his price makes it possible for him to treat the various A monopolist under Price Discrimination policy will
customers on different markets in a diffrent manner. The sale less quantity at higher price in the market
idea is to get from each customer whatever revenue that having lesser elasticity while more quantity at lower
could be squeezed out of him depending on the purpose price will be sold in the market having lower elasti-
and intensity of demand. Price discrimination is a city.
technique by which the monopolist makes the customer Both the conditions can be explained diagramma-
pay according to his ability. According to Joan tically as in the following figure.
Economics (NET) | 59U
Price Determination and Equilibrium Under Discriminating Monopoly
Price Determination and Equilibrium 3. To reap the advantages of increasing returns.
Under Discriminating Monopoly 4. To create demand in foreign market.
5. To take advantage of differences in demand elastici-
In the market (A) ties.
MR 1 = MC The producer is a monopolist in the domestic
Price = E1 R and market and that he is not in the foreign market. The
foreign market is perfectly competitive. In market D, the
Quantity Sold = OQ1
domestic market, the producer is a monopolist. As such
In the market (B) his average revenue curve ARD slopes downward. MR D
When MR2 = MC is his corresponding marginal revenue curve. On the
contrary in the foreign market F, there prevails perfect
Price = R 1 E2 , and
competition so far as this particular commodity is
Quantity Sold = OQ2 concerned. ARF takes horizontal shape.
Total quantity sold in both of the market is
Bilateral Monopoly
OQ = OQ 1 + OQ2 and Price RE1 > R1 E 2 due to
It is a market consisting of single seller and single
different elasticity of demand. buyer. The equilibrium in such a market cannot be
Dumping—It means selling goods abroad at a determined by the traditional tools of demand and
lower price than is charged for them in the home market. supply. Economic analysis can only define the range
Dumping means selling in the foreign market at a price within which the price will eventually be settled. The
which is less than even the cost of production. The level of price and output however will ultimately be
dumped goods are mostly sold in foreign market below defined by non- economic factors such as the bargaining
average but above marginal cost of production. It is power skill and other strategies of the participant firms.
possible to sell dumped goods below the average but In bilateral monopoly let us assume that all postal
above the marginal cost of production. equipment is produced by a single firm and is bought by
a single buyer Indian post and telegraph department.
Both firms are assumed to aim at the maximisation of
their profit. The equilibrium of the producer monopolist
is defined by the intersection of his marginal revenue
and marginal cost curves.
He would maximise his profit if he were to produce
X1 quantity of equipment and sell it at the price P1 .
However, the producer can not attain the above profit
maximising position because he does not sell in a market
with many buyers each of whom would be unable to
affect the price by his purchases.
On the other hand, the monopolist buyer by
assuming that he has the full power to set the price and
in order to maximise his satisfaction he will equate his
The monopolist may resort to dumping as a result of Marginal Supply Price (MSP) with his marginal utility
anyone of the following motives : (or the price he is prepared to pay). Since demand curve
1. To get rid of surplus production. DD indicates his marginal utility, he will be maximising
2. To crush rivals in foreign market. satisfaction by purchasing OX2 at price OP2 . The price
60U | Economics (NET)
OP1 which the monopolist wants to set is higher than the point E in the following figure. At this price OP, AR >
price OP2 which the monopsonist wants to set. AC, the firm earns a profits of PQRS. The firm may earn
a profit or incurs loss or be at a no loss no profit position
depending upon the demand condition and the position
of the cost-curves;
Long-run Equilibrium under the Mono-
polistic Competition
Both the buyer and supplier think themselves to be
price makers and therefore act autonomously, they reach In the long-run, price cutting, expansion and
at different prices as well as at different quantities. They contraction of output and new entry are possible, i.e,
will negotiate and bargain with each other. The actual firms may compete with one another through price or
price which may be agreed upon as a result of non-price competition. The abnormal profit earned in the
negotiation and bargaining may be anywhere between short-run will attract new entries, therefore the amount
OP1 and OP2 . Since price can be set up anywhere sold at any given price will fall resulting in the shift of
between OP1 and OP2 , it is said to be indeterminate demand curve until the abnormal profits are wiped out.
within these limits. There is no profit no loss situation since the total cost
PRICING UNDER Monopolistic Compe- and the total revenue are equal.
tition (Imperpect Competition)
The concept of ‘Imperfect competition’ has been
elaborately analysed by Mrs. Joan Robinson, while the
concept of “monopolistic competition” has been
introduced by Chamberlin in economic literature. These
two concepts refers to two market situations which are
almost similar operationally excepting a few minor
differences. Operationally, both these market situations
imply that there is neither perfect competition nor pure
monopoly. In both the market situation, demand is not Long-run-Firm’s Equilibrium Under Monopolistic
perfectly elastic implying that the demand curve will be Competition
downward sloping although the slope may vary in Selling cost are costs necessary to persuade a buyer
accordance with changes in elasticity of demand of to buy one product rather than other or to buy from one
downward sloping demand curve (steeper or flatter). A seller rather than another.
downward sloping demand curve indicates that the MR
curve slopes below the AR and therefore, price is greater The cost incurred on advertising, publicity and
than MR unlike the case under perfect competition. In salesmanship are known as selling costs.
both the markets, firms may freely enter in the long run Advertisement is an unknown feature in perfect
to compete away the excess profit; enjoyed by each firm competition because homogeneous products do not
in the short-run but in no such market, can there be least- necessitate any advertising. On the other hand monopoly
cost combination and optimum output. High price and firms need not advertise because there is only one seller.
wastage of resources are the features of both of these Contrary to this, monopolistic competition is based on
markets. If there is no free entry of firms in an imperfect product differentiation, and hence selling cost is
market, each firm will continue to reach excess profit. required. Advertisement is not the only selling cost.
Selling cost was defined by Chamberlin as those cost
Short-run Equilibrium under the Mono- which are to be incurred in order to alter the position or
polistic Competition slope of the demand curve.
Firms under monopolistic competition attain Selling cost include a wide variety of expenses on
equilibrium when (1) MC = MR and (2) slope of MC > sales promotion such as window displays, showrooms,
slope of MR. The firm's equilibrium is defined at the advertisement in many forms, discount, quick
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delivery. Analysis of selling cost is mostly concerned close rivals. It is that form of imperfect competition
with advertisement since it is the dominant selling cost. where there are few firms in the market, producing
either a homogeneous product or producing products
Effect of Advertisement Costs on which are close but not perfect substitutes of each other.
Demand
An increase in advertising expenditure shifts the Classical Models of Oligopoly
demand curve. Cournot’s Duopoly Model—A model of oligopoly
Advertisement increases by a constant dose the (duopoly case) was first of all put forth by Cournot, a
demand curve shifts from D to D1 , D2 to D 3 when French economist, in 1838.
advertisement increases by M1 M2 first and M2 M3 latter. Assumptions of Cournot’s Model—Cournot's
model is based on the following assumptions :
1. There are only two firms producing identical
products.
2. The cost of production is zero (simplifying
assumption).
3. The duopolists fully know the market demand.
Moreover, the market demand for the product is
assumed to be linear.
4. Duopolists act independently, i.e., each duopolist
believes that regardless of his actions and their
effects upon market price of the product, the rival
firm will keep its output constant.
Equilibrium in the Cournot’s Model—Given that
Selling Costs and Equilibrium Output each seller assumed that other’s output is unaffected by
There are three possible methods of selling a large his own decision, they would adjust prices and output
output of which advertisement is only one. The other until a position of equilibrium was reached, somewhere
methods are lowering price and improving quality. between that reflected by the equations for monopoly
Selling costs add to the difficulty of determining the and that for unrestricted competition.
most profitable output. High selling cost are necessary to In Cournot’s model of duopoly, stable equilibrium
sell a larger ouput at the same prices. In order to is reached when total output produced is 2/3rd of the
ascertain the equilibrium output the following formula total demand and each producer is producing 1/3rd of
may be used. the total demand.
Bertrand's Duopoly Model
Joseph Bertrand, a French mathematician, criticised
Cournot's duopoly solution and put forth a substitute
model of duopoly.
Assumptions of Bertrand’s Model—Following
are the main assumptions of Bertrand's duopoly model :
1. The producers first set the price of the product
and then produce the output which is demanded at that
price. Thus, in Bertrand’s model adjusting variable is
price and not output.
2. Each producer believes that his rival will keep his
price constant at the present level whatever price he
Net return = (Price × Output) – (Production Cost + might himself set.
Selling Cost)
3. In Bertrand’s model, it is not very important that
AR is the average revenue curve and MR is the producer should know the correct market demand of
marginal revenue curve. PC is the average production their product or should have identical view about the
cost and the shaded area above it represents the selling market demand. It is enough for each producer to know
cost. By adding this to PC, we get ATUC (Average total that he can capture the whole market by undercutting his
unit cost). DP is the net return per unit of the output. rival.
Since OM = Ed thus DEFP indicates the maximum 4. There are only two producers producing and
net return in this case. selling homogeneous product and having identical costs.
Pricing under Oligopoly 5. Productive capacity of the producers is unlimited.
Oligopoly is that situation in which a firm basis its Equilibrium in the Bertrand’s Model—In
market policy in part on the expected behaviour of a few Bertrand’s model price war (i.e., the process of
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undercutting) will go on until the price falls to the level Chamberlin accepts that if firms do not recognise
of unit cost of production. Once the price has fallen to their interdependence, the industry will reach either the
the level of unit cost of production, neither of them will Cournot equilibruim if each firm acts independently on
like to cut the price further because in that case total the assumption that the rival keeps their output constant
costs would exceed total revenue. Thus, in Bertrand's or the Bertrands’ equilibrium if each firm acts
model equilibrium is achieved when market price is independently on the assumption that the rivals keep
equal to the average cost of production and the their prices constant.
combined equilibrium output of the two Duopolists is
equal to the competitive output. The market demand is a straight line with negative
slope and production is assumed cost-less for simplicity.
Edgeworth Duopoly Model If firm A is the first to start production it will produce
According to Edgeworth, no determinate equi- the profit maximising output OXM and sell it at the
librium would be reached in duopoly. monopoly price PM . Firm B under the Cournot’s
assumption that rival will retain his quantity unchanged
Assumptions of the Edgeworth's Model. Edge
considers that its demand curve is CD and will attempt
worth's duopoly model is based on the following
to maximise its profit by producing one half of this
assumptions :
demand. That is quantity XMB as a consequence the total
1. The productive capaity of each duopolist is industry output is OB and the price falls to P. Under the
limited so that neither duopolist can meet entire demand assumption of our example of equal cost the market will
at the lower price ranges. be shared equally between A and B.
2. The products of duopolists should not nece-
ssarilly be perfectly homogeneous. Sweezy’s Oligopoly Model (Kinked Demand
3. There are only two producers. Curve)
Equilibirum in the Edgeworth’s Model— It does not deal with the price and output
Edgeworth duopoly solution is one of perpetual determinations. Rather it seeks to establish that once a
disequilirbium, price constantly oscillating between the price and quantity combination is determined an
monopoly price and competitive price. Thus no oligopoly firm will not find it profitable to change its
determinate and unique equilibrium of duopoly is price even in response to the small changes in the cost of
suggested by Edgeworth's duopoly model. production. An Oligopolistic firm believes that if it
reduce the prices of its product, the rival firm would
Chamberlin’s Model of Oligopoly follow and neutralise the expected gain from price
Chamberlin develops his own model of oligopoly reduction but if it raises the price the firms would either
assuming interdependence between the competitors. maintain their prices or ever indulge in price cutting. So
Chamberlin suggests that each seller seeking to that the price raising firms stand to lose, a part of its
maximise his profits reflects well and looks into share in the market.
consequences of a seller’s move and consists of both its
direct and indirect effects.
Direct effects are those which results from a sellers
own action, rival sellers not reacting to his action.
The indirect effects are those which result from the
reaction of the rival sellers to the move made by a
sellers.
Chamberlin suggests in his model that if rival firms
are assumed to recognise their interdependence and act
accordingly a stable equilibium can be reached where
each firms charges monopoly price.
For price increases above P, the relevant demand
curve is the section DE of the DD' curve and for price
decreases below P, the relevant demand curve is the
section Ed. The upper segment of the demand curve
DEd' has a higher price elasticity than the lower segment.
Collusive Oligopoly
Collusion between oligopoly firms may take many
forms depending on their relative strength, their objective
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and whether collusion is legal or illegal. There are two price leadership by a dominant firm it is assumed that
types of collusion. They are given on overleaf— there exists a large size firm in the industry which
(i) Cartels; and supplies a large proportion of the total market. The
(ii) Price Leadership. dominance of the large firms is indicated by the fact that
it could possibly eliminate all its rival firm by price
(i) Cartels cutting. The dominant firm therefore compromise with
Cartel is a formal organisation of the oligopoly the existence of rival firms in the market. It uses its
firms in an industry. Cartels are the perfect form of dominance to set its price so as to maximise its profits.
collusion. Cartel may be in the form of open collusion or The smaller firm has no alternative but to accept the
secret collusion. Cartels in the broader sense of the term price set by the dominant firm. The smaller firms
exist in the form of trade associations, professional recognise their position and behave just like a firm in a
organisation. A cartel performs a variety of services for perfectly competitive market.
its member. (3) The Barometric Price Leadership—In this
(1) Fixing price for joint maximisation of industry form of price leadership a firm initiates well-publicised
profit, and changes in price that are generally followed by the rival
(2) Market sharing between its member firms in the industry. The price leader may not be the
largest firm in the industry. The barometric firm
(ii) Price Leadership supposed to have better knowledge of the prevailing
Price leadership is an informal position of a firm in market conditions. The firm having the qualification of
an oligopolistic selling to lead other firms in pricing. price leadership is regarded as barometer which reflects
This leadership may emerge spontaneously due to changes in business conditions and environment of the
technical reasons, or out of tacit or explicit agreements industry. The price changes announced by the
between the firms to assign leadership role to one of barometric firm serves as a barometer of changes in
them. demand and supply conditions in the market.
Price leadership serves as a means to price Average-cost or Full-cost Pricing Theory
discipline and price stabilisation. Price leadership can
exist when : Average-cost or full-cost pricing theory was
(1) Number of firms is small propounded by R.L Hall and C.J. Hitch.
(2) Entry to the industry restricted An alternative approach to profit maximisation and
(3) Products are by and large homogeneous marginal analysis is the average-cost pricing theory
(4) Demand for industry is inelastic which does not assume that rational firms seek to
(5) Firms have almost similar cost. maximize profits. Average-cost pricing theory has been
given several names. Average-cost pricing theory is also
Types of Price Leadership known as full-cost pricing theory, since in this theory
(1) Price Leadership by a Low Cost Firm—All price of a product is fixed on the basis of full-cost, i.e.,
firms face identical revenue curves as shown by AR = D all costs per unit of output which also includes normal
and MR. But the low cost firm has its cost curves as profit per unit of output. It is also called cost-plus
shown by AC1, and MC1 and all other rival firms' cost pricing, or mark-up pricing theory, since this theory
visualises that in order to fix price businessmen add a
curves as AC2 and MC2 .
mark-up to their average cost of production.
Hall and Hitch Version o f Average-cost Pri-
cing—According to Hall and Hitch, average cost price
includes :
(i) average variable cost (average direct cost),
(ii) average overhead cost, and
(iii) a normal or satisfactory margin of profit.
Average—cost pricing, according to Hall and
Hitch, is the result of (i) tacit or open collusion, (ii)
considerations of long-run demand and costs, (iii) moral
conviction of firms and (iv) uncertain effects of the
increases and decreases in price.
Output per time unit Hall and Hitch combine average-cost pricing with
The low cost firm find most profitable to fix the price at kinked demand curve analysis. Current price is fixed on
OP2 and sell qantity OQ 2 . the basis of average-cost pricing, and a kink in the
demand curve is formed at this price. Average-cost
(2) Price Leadership by Dominant Firm—It is pricing together with the kinked demand curve analysis
more common than by low cost firm. In the analysis of is illustrated in the following figure :
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We may suppose that on the basis of expected sales,
the firm decides to produce OM. With OM as the output,
firm then calculates the average overhead cost incurred Average cost curve AC is saucer-shaped. AC first
on capital equipment, etc. then the firm adds to it its falls, then remains constant for quite a large increase in
normal margin for profit. Addition of these three items output and then eventually rises. Corresponding to this,
yields full or average cost, which let us suppose is MK MC curves falls in the beginning and lies below AC,
in the figure. He will therefore, set the price OP which is then it coincides with AC curve and eventually MC lies
equal to MK. The kink in the demand curve dD is above AC.
formed at this price OP. Increases or decreases in In order to proceed to fix the price, besides average
demand will usually shift the kink to the right or left but direct cost, a business firm has to calculate the total
will leave the price unchanged. Hall and Hitch have fixed costs and also the amount of profits it wishes to
maintained the following two exceptions to this general earn. The total indirect costs plus the amount of profits
rule in which case price of the product changes : planned will yield a fixed sum of money which will
1. If there is a large decrease in demand, and the remain constant for fixation of price in the short-run.
demand remains at low level for some time, there is The ‘costing margin’ according to Andrews, is obtained
every likelihood that price will be reduced so as to from this fixed sum of money by dividing it by some
maintain output. The explanation for this reduction in chosen output.
price in the context of depressed demand is that one
entrepreneur may become panicky and his irrational
BOUMOL’S Sales Revenue Maximi-
behaviour forces the others to cut prices. zation Principle
2. If the average cost curves of all firms shift by Sales revenue maximisation principle of oligopoly
similar amounts on account of changes in factor prices, has been propounded by W.J. Boumol.
then this is likely to lead to a revaluation of the full cost Boumol argues that there is a minimum acceptable
price. level of profits which must be earned by the
management so as to finance future growth of the firm
Andrew’s Version of Average Cost Pricing—
through retained profits and also to induce the potential
Andrews’ average cost pricing theory may be summa-
shareholders for subscribing to the share capital of the
rised as follows :
company. An oligopolistic firm seeks to maximize sales
1. The price which will be fixed by a business firm revenue subject to this minimum profit constraint.
will equal the estimated average direct cost of production Price-Output Determination—Boumol’s sales
plus a costing margin. maximization principle can be explained graphically
2. Andrews assumes on the basis of empirical inves- with the help of following figure :
tigations that average variable cost remains constant
over a large range of output, provided the prices of
variable factors remain constant.
3. The costing margin will cover the cost per unit
incurred on the indirect factors of production and on the
normal rate of profit. Costing margin will vary as a
result of the permanent changes in the prices of fixed
factors. Andrews also visualises changes in the costing
margin in response to the competitive and market forces.
4. Given the prices of direct factors of production,
the price of the product will remain the same whatever
the level of output.
Andrews’ version of average-cost pricing theory is In the diagram TR and TC are total revenue and
illustrated in the following figure : total cost curves respectively. TP is the total profit curve.
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If the firm aims at maximising profits, it will control of a manager, the greater the status and prestige
produce OA output, because corresponding to OA of a manager.
output, the highest point of the profit curve TP lies. If According to Williamson, there is a close positive
the firm wants to maximize sales revenue, it will fix relationship between the number of staff and the
output at OC level which is greater than OA. At output manager’s salary, Williamson takes a single variable
OC, total revenue is CR2 which is maximum in the “monetary expenditure on the staff”.
diagram. At the output level of OC, firm’s total profit is 3. Management Slack—Management slack consists
CG. of those non-essential management per-requisites such
If OM is the minimum profit which a firm has to as lavishly furnished offices, luxurious company cars,
obtain to satisfy shareholders and for future growth, then large expenses accounts etc, which are not necessary for
ML is the minimum profit line. This minimum profit the efficient and effective operation of the firm.
line ML cuts the total profit curve TP at point E. 4. Discretionary investment expenditure—Utility
Therefore, if the firm wants total revenue maximisation derived by the manager from his job depends upon
subject to a profit constraint OM, then it will produce the magnitude of discretionary investment expenditure
and sell output OB. The firm can earn minimum profits by the manager. It is the amount of resources which the
OM even by producing ON output. But the total revenue manager can spend according to his discretion.
at output ON is much less that at output OB. Thus, utility of a manager in Williamson’s model is
Main Points of Boumol’s Model a function of the following three variables :
U = f(S,M,ID)
1. Sales revenue maximisation principle leads to a
greater output and lower price than does profit where, U denotes utility function
maximisation. M stands for management slack
2. Increase in advertising outlay always raises to ID stands for amount of discretionary investment
dR S stands for monetary expenditure on staff.
total revenue or sales, i.e., > O. As a result, it will
dA Main Points of Williamson’s Model—Follow-
always pay the sales maximiser to increase his ing conclusions can be drawn from the Williamson’s
advertising outlay until he is stopped by the profit managerial theory of firm :
constraint. This means that sales maximiser will 1. As compared to a profit-maximizing firm, utility-
normally advertise no less than, and usually more than, maximising firm has a higher staff expenditure and more
do profit maximizers. management slack.
3. Increase in overhead costs lowers the level of 2. If the profit–tax rate on the firm is increased,
output and raises price. there will be increase in the output and staff expenditure
4. Sales maximization makes for greater presump- of the firm. This is because now that profits have been
tion that the businessman will consider non-price made less attractive by the imposition of higher tax rate,
competition to be more advantageous alternative to price the manager will try to reduce the reported profits and
competition. for this they will increase the expenditure on staff and
expand output.
Williamson’s Managerial Theory 3. If a lump-sum tax is imposed on the firm,
According to Williamson, Managers are motivated Williamson’s model implies that the firm will reduce its
by their self-interest and they maximise their own utility expenditure, particularly on staff. This is because with
function. The objective of utility maximization by the the imposition of a lump-sum tax, minimum profit
managers is subject to the constraint that after-tax profits constraint is raised and to earn the higher profits, the
are large enough to pay acceptable dividends to the manager will try to expenditure.
shareholders and also to pay for economically
necessary investments.
Theory of Limit Pricing
Utility maximisation is possible only in a corporate The proponents of the theory of Limit Pricing are
form of business organisation where there exists J.S. Bain, Sylos, Modigliani and Jagdish Bhagwati. It
separation between ownership and management. has been argued by these economists that price –output
decisions of the existing firms in oligopolistic markets
Managerial Utility Function—According to
are affected not only by the actual entry but also by the
Williamson, utility function of the self-seeking
potential entry of firms. Another important issue is that
managers depends on the following factors :
oligopolistic firms do not maximise short-run profits.
1. Salary and other Monetary Compensation— Instead, they take a longer view of the situation and seek
This is a major factor determining the utility of the to maximize profits over the long-run.
managers since salary and other monetary rewards
received by the manager from the firm determine his Bain’s Theory of Limit Pricing
private expenditure and standard of living. Bain’s theory of limit pricing relates to the case of
2. The Number of Staff under the Control of a collusive oligopoly. The central idea of his theory is the
Manager—The greater the number of staff under the notion of limit price.
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According to Bain, limit price is the highest price P L – PC
which the existing firms believe they can charge without E =
PC
attracting entry of new firms. Thus, limit price is the where E is the condition of entry i.e., the margin by
entry preventing price. which the established firms can raise price above the
Assumptions of Bain’s Theory—Bain’s theory competitive level, Pc stands for perfectly competitive
of limit price is based on following assumptions. price, and PL stands for limit price.
1. Products of the firms, both already established in Above equation can be written as
the industry and the potential ones, are homogeneous. P L = P C (1 + E)
2. The collusive oligopolists seek to maximise long- Bain has mentioned four barriers to entry which are
run profits. as follow :
3. There is a given determinate demand curve for 1. Cost Advantage—The established firms have
the industry product which remains unaltered and stable some cost advantage over the potential rivals. Thus,
during price adjustments by the existing firms or change potential rivals can not compete with already existing
in price as a result of entry of new firms. firms.
Explanation of the Bain’s Theory—Following 2. Product Differentiation—The new entrants
figure illustrates the essential features of limit pricing cannot produce the same identical product, as produced
theory. by the established firms which may have earned a lot of
In the figure, dd' is the market demand and MR is goodwill for their products. This acts as a barrier to the
the corresponding revenue curve. LACEF is the long-run entry.
average cost of the existing firms. Since LACE F is 3. Large Initial Capital—To set up a new enter-
constant, hence LMC will be equal to it. prise, a large amount of initial capital is required which
If the collusive oligopolist wishes to maximise may be difficult for the new firms to mobilise.
short-run profits it will set the price corresponding to the 4. Benefits of Large Scale—Large scale production
intersection of LACEF with the MR. This short run profit has several benefits like real and pecuniary economies of
maximising price is equal to Pm. This short-run profit scale. Economies of scale act as an important barrier to
maximising price Pm is greater than the long-run the entry of new firms.
average cost LAC P E of the potential entrants.
Consequently, the price Pm will attract entry of new Sylos Model of Limit Pricing
firms in the industry. Sylos-Labini further modified and developed the
limit pricing theory. Sylos theory is based on following
assumptions :
1. Market demand curve has a unit price elasticity.
2. The product is homogeneous and is being
produced by few firms with a price leader.
3. Economies of scale accrue as the size of plant
increases. Straight line average cost curve is
assumed, i.e, the larger the plant size, the lower
the average cost.
Sylos Postulate—The established firms expect
that the new firm will not enter the industry if it
estimates that with its entry price will fall below his
average cost of production. Secondly, the new entrant
expects that on his entry the established firms would
If oligopolists set price PL which is equal to the keep their output constant at the preentry level so that
long-run average cost curve of the potential entrants the increase in quantity demanded of the product caused
(LACPE), they will sell quantity Q2 of the product. The by the decline in its price due to its entry accrues
established oligopolists will still earn profits as price PL entirely to new firms.
is greater than their long-run average cost LACEF. It will Fixation of Limit Price—Minimum acceptable
not be profitable for potential entrants to enter the price must cover the average cost as well as the normal
industry as the price PL equals their average cost of rate of profits. Thus,
production. P = ATC (1 + p)
The Condition of Entry in Bain’s Model— where, P is the minimum acceptable price to the firm,
According to Bain, limit price is set above the ATC is average total cost and p is normal rate of profit.
competitive price because of the existence of barriers to
Sylos theory of limit pricing can be illustrated with
entry. Bain has put forward a concept which he calls ‘the
the help of given ahead diagram.
condition of entry’ which describes a margin by which
the established oligopoly firms are able to raise their In the diagram, dd1 represents the market demand
price above the perfectly-competitive price level curve. AC1, AC2 and AC3 are the average cost curves of
persistently without inducing entry. The condition of the large size, medium size, and small size plants res-
entry has been written as : pectively.
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In view of various firms having different plant sizes Equilibrium of the Firm in the Short-
with differential costs, the price leader which is the most run : By Curves of Total Revenue and
efficient firm with lowest average cost AC1 will set a Total Cost
price which is acceptable to the least efficient firms
having higher average cost AC3 . Accordingly, the most The firm is in equilibrium when it maximises its
efficient firm will set a price above average cost AC3 of profit (π), defined as the difference between the total
cost and total revenue.
the firms operating least efficient plant-size.
π = TR – TC
At price P3 which is equal to AC3 , the quantity
demanded is OQ. Given that the new firm can enter the
industry with a plant size equivalent to AC3 and with
productive capacity equal to OQs. Then, QL = Q - Qs
provides the quantity of output corresponding to which
price will be set. It is clear from the above figure that
quantity QL of output can be sold at price PL. According
to Sylos PL is the limit price which will deter the entry
of new firms.
Perfect Competition
Given that the normal rate of profit is included in
the cost items of the firm, π is the profit above the
normal rate of return on capital and the remuneration for
the risk-bearing function of the entrepreneur. The firm is
in equilibrium when it produces the output that
maximises that difference between total receipt and total
costs. The equilibrium of the firm may be shown
graphically in two ways. Either by using the TR and TC
curves, or the MR and MC curves.
Perfect Competition
In figure we show the total revenue and total cost
Perfect competition is a market structure characte- curves of a firm in a perfectly competitive market. The
rised by a complete absence of rivalry among the total revenue curve is a straight line through the origin,
individual firms. In other words, perfect competition Showing that the price is constant at all levels of output.
implies no rivalry among firms. The firm is a price-taker and can sell any amount of
output at the going market price, with its TR increasing
Assumptions proportionately with its sales. The slope of the TR curve
The model of perfect competition is based on the is the marginal revenue. It is constant and equal to the
following assumptions : prevailing market price, since all units are sold at the
same price. Thus in pure competition MR = AR = P.
1. There are a large number of firms producing
and selling a product.
2. The product of all firms is homogeneous.
The assumptions of large numbers of sellers and of
product homogeneity imply that the individual firm in
perfect competition is a price-taker : Its demand curve
is infinitely elastic, indicating that the firm can sell any
amount of output at the prevailing market price. The
demand curve of the individual firm is also its average
revenue curve and its marginal revenue curve.
3. Both the sellers and buyers have perfect
information about the prevailing price in the market. Profit-Maximising Output : Equilibrium of the Firm
4. Entry into and exit from the industry is free for The shape of the total-cost curve reflects the U
the firms. shape of the average-cost curve, that is, the law of
5. No government regulation. variable proportions. The firm maximises its profit at the
6. Perfect mobility of factors of production. output, X e, where the distance between the TR and TC
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curves is the greatest. At lower and higher levels of But the fulfilment of the above two conditions does
output total profits is not maximized : at levels smaller not guarantee that the profits will be earned by the firm.
than XA and larger than XB the firm has losses. Whether the firm makes excess profits or losses depends
on the level of the ATC at the short-run equilibrium. If
Equilibrium of the Firm : By Curves of the ATC is below the price at equilibrium the firm earns
Marginal Revenue and Marginal Cost excess profits (equal to the area PABE). If, however, the
(Identical Cost Conditions) ATC is above the price the firm makes a loss (equal to
the area FPEC). In the latter case the firm will continue
Identical cost conditions imply that all firms are
to produce only if it covers its variable costs. Other-
facing same cost conditions, that is, their average and
wise, it will close down, since by discontinuing its
marginal cost curves are of the same level and shapes.
operations the firm is better off : it minimises its losses.
In figure we show the average and marginal-cost The point at which the firm covers its variable costs is
curves of the firm together with its demand curve. called ‘the closing-down point.’
In order to decide about its equilibrium output,
the firm will compare marginal cost with marginal
revenue. It will be in equilibrium at the level of output at
which marginal cost equals marginal revenue and
marginal cost curve is curing marginal revenue curve
from below. At this level it will be maximising its
profits. Consider figure in which price OP is prevailing
in the market. PL would then be the demand curve or the
average and marginal revenue curve of the firm. It will
be seen from figure that MC curve cuts average and
marginal revenue curve at two different points, F and E.
F cannot be the position of equilibrium, since at F
second order condition of firm’s equilibrium, namely, Short-run Equilibrium with losses
that the marginal cost curve must cut marginal revenue
curve from below at the point of equilibrium, is not
satisfied. The firm will be increasing its profits by
increasing production beyond F because marginal
revenue is greater than marginal cost. The firm will be in
equilibrium at point E or output OM since at E marginal
cost equals marginal revenue as well as marginal cost
curve is cutting marginal revenue curve from below. As
under perfect competition MR curve is a horizontal
straight line, the MC curve must be rising so as to cut
the marginal revenue curve from below. Therefore, in
case of perfect competition the second order condition
of firm’s equilibrium requires that MC curve must be Short-run Equilibrium with Profit
rising at the point of equilibrium. Hence the twin con-
ditions of firms equilibrium under perfect competition Shut-down Point for the Perfectly Com-
are : petitive Firm
1. MC = MR = Price In figure the closing-down point of the firm is
2. (Slope of MC) > (Slope of MR) denoted by point M. If price falls below P the firm does
not cover its variable costs and is better off his closes
down.
Firm’s Equilibrium Under Perfect Competition
Economics (NET) | 69U
Mathematical Derivation of the Equili- zero, hence the second-order condition is simplified as
brium of the Firm follows :
The firm aims at the maximisation of its profits d 2C
0 <
dX2
π = R–C
Hence, the MC curve must have a positive slope or
where,
the MC must be rising.
p = profit Long-run Equilibrium of the Firm (Identical
R = total revenue Costs)
C = total cost It is assumed that all entrepreneurs are of equal
Clearly, R = f1 (X) and C = f2(X), given the price P. efficiency. All factors are homogeneous and are available
at constant and uniform prices, so that the cost curves of
(a) The first-order condition for the maximisation the firms are identical.
of a function is that its first derivative (with respect to X
in our case) be equal to zero. Differentially the total- In the long-run firms are in equilibrium when they
profit function and equality to zero we obtain have adjusted their plant so as to produce at the
minimum point of their long-run AC curve, which is
dπ dR dC tangent (at this point) to the demand curve defined by
= – =0
dX dX dX the market price. In the long-run the firms will be
earning just normal profits, which are included in the
dR dC
or = LAC. If they are making excess profits new firms will
dX dX be attracted in the industry, this will lead to a fall in
The term dR/dX is the slope of the total revenue price and an upward shift of the cost curves due to
dC increase of the prices of factors as the industry expands.
curve, that is, the marginal revenue. The term is the These changes will continue until the LAC is tangent to
dX
slope of the total cost curve, or the marginal cost. Thus the demand curve defined by the market price. If the
the first-order condition for profit maximisation is MR = firms male losses in the long run they will leave the
MC industry, price will raise and costs may fall as the
industry contracts, until the remaining firms in the
Given that MC > 0, MR must also be positive at industry cover their total costs inclusive of the normal
equilibrium. Since MR = P the first-order condition may rate of profit.
be written as Figure represents long-run equilibrium of firm
MC = P under perfect competition. The firm cannot be in the
long-run equilibrium at a price greater than OP in figure.
(b) The Second-order condition for a maximum
Since if price is greater than OP, then the price line
requires that the second derivative of the function be (demand curve) would lie somewhere above the
negative (implying that after its highest point the curve minimum point of the average cost curve so that
turns downwards). The second derivative of the total- marginal cost and price will be equal where the firm is
profit function is earning abnormal profits. Since there will be tendency
d 2π d 2R d 2C for new firms to enter and compete away these abnormal
2 = – profits the form cannot be in equilibrium at any price
dX dX2 dX2
higher than OP. Likewise, the firm cannot be in long-run
This must be negative if the function has been equilibrium at a price lower than OP in figure under
maximised, that is which yields the condition perfect competition.
d 2R d 2C
– < 0
dX2 dX2
d 2R d 2C
–
dX2 dX2
d 2R
But is the slope of the MR curve and is the
dX2
slope of the MC curve. Hence, the second-order
condition may verbally be written as follows :
(Slope of MR) > (Slope of MC)
Thus the MC must have a steeper slope than the
MR curve or the MC must cut the MR curve from
below. In perfect competition the slope of MR curve is Long-run Equilibrium of the firm
70U | Economics (NET)
If price is lower than OP, the demand curve will lie equilibrium output, but firm A in equilibrium is making
below the average cost curve so that the marginal cost super-normal profits, B is earning only normal profits
and price will be equal at the point where the firm is and C is making losses. This is so because cost
making losses. Therefore, there will be tendency for conditions are different for the three firms.
some of the firms in the industry to go out with the result
that price will rise and the firms left in the field make Thus, under conditions of different costs and in
normal profits. We therefore conclude that firm can be short-run equilibrium, some firms in the industry may be
in long-run equilibrium under perfect competition only earning super-normal profits. Some may be making only
when price is at such a level that the horizontal demand normal profits, and some others may be incurring losses.
curve is tangent to the AC curve, so the price equals In such a situation the industry cannot be in
average cost and firm makes only normal profits. full equilibrium.
Therefore, the condition for long-run equilibrium of firm
can be written as : Firm A
SMC = SAC = LMC = LAC = MR = Price
It should be noted that a horizontal demand line can
be tangent to a U-shaped average cost curve only at the
latter’s minimum point. Since at the minimum point of
the average cost curve the marginal cost and average
cost are equal, price in long-run equilibrium is equal to
both MC and AC. In other words, double condition of
long-run equilibrium is fulfilled at the minimum point of
the average cost curve.
It is clear from above that long-run equilibrium of
the firm under perfect competition is established at
the minimum point of the long-run average cost
curve. Operating at the minimum point of the long-run
average cost curve signifies that the firm is of optimum
size, that is, it is producing output at the lowest possible
cost. The fact that the firm, working under conditions of
perfect competition, tends to be of optimum size in the
long run is beneficial from the social point of view in
two ways. Firstly, working at optimum size implies that
the resources of the society are being utilized in the most
efficient way. Secondly, it signifies that the consumers
are getting the goods at the lowest possible price.
Short-run Equilibrium of the Firm :
Differential Cost Conditions Firm C
If entrepreneurs differ in efficiency the cost curves
of the firms vary from each other. Firms with more
efficient entrepreneurs will, be able to produce at lower
costs than the others. Thus different firms selling the
same product at one price will be producing different
quantities at different costs. More efficient firms
employing better resources will have lower cost curves
than others. For the sake of convenience we divide the
firms having differential cost conditions into three
categories A, B and C whose cost curves are shown
in figure that represents differential cost conditions.
If price in market is OP, then the firm of every
category will adjust output where price OP equals its Long-run Equilibrium of Firms : Diffe-
marginal cost. Firm A will be in equilibrium at E and
will be producing OM output, firm B will be in
rential Cost Conditions
equilibrium at L and will be producing ON, form C will In case the entrepreneurs are of different efficiency,
be in equilibrium at K and will be producing OT. While the cost curves of the firms will also differ. A firm with
for all the firms, price equals their marginal cost at a superior entrepreneur than the others will be able to
Economics (NET) | 71U
produce the same output at lower costs. Such a firm will individual firms and the number of firms in the industry
be earning supernormal profits even in the long-run as is so adjusted that the following two conditions must be
compared to the other firms which may be earning only satisfied :
normal profits. The firm which earns supernormal
profits is the ‘intra-marginal firm’ as distinct from the 1. Price = MC of all firms,
‘marginal firm’ which just earns normal profits. In other 2. Price = AC of the marginal firm.
words, a marginal firm is one which will be the first to From above it follows that in long-run competitive
leave the industry if price falls. The marginal firm is the equilibrium under differential cost conditions
highest-cost firm which earns only normal profits. Since Firm A
the marginal firm is the highest-cost firm making only
normal profits, it will be first to quit the industry if the
price falls as with the fall in price its profits sink below
normal.
Figure represents long-run equilibrium of firms,
which are of three categories in respect of cost
conditions. The price prevailing in the long-run is OP
which equals marginal cost of firm A at output OQ and
marginal cost of firm B at output OS. For firms of
category B price is equal to average cost, therefore they
make only normal profits. Thus, firms of category B are
marginal firms which will go out of the industry if the
price falls below the present price OP. But price OP is
greater than average cost at equilibrium output of intra-
marginal firm A and therefore this firm make super-
normal profits. The price being equal to average cost of
the marginal firm guarantees that the marginal firm will
be making only normal profits and therefore there will
be no tendency for new firms to enter or for some of the
existing firms to leave the industry.
If price in the long-run falls below OP in figure, the
firms of category B will go out of the industry and some
previous intra-marginal firms for which new price is
equal to average cost firm will become marginal firms. only the marginal firm will be of optimum size,
We therefore conclude that in long-run competitive because the equilibrium of only marginal firm will be
equilibrium under different cost conditions the output of established at the minimum point of the average cost
A Classification of Market Forms
Price Elasticity of Demand Degree of Control
Forms of Market Structure Number of Firms
for and Individual Firms Over Price
(a) Perfect Competition A large number of firms Infinite None
(b) Imperfect Competition A large number of firms Large Some
(i) Monopolistic Competition — Large Some
(ii) Pure Oligopoly Few firms Small Some
(Oligopoly without Product
Differentiation)
(iii) Differentiated Oligopoly
(Oligopoly without Product Few firms Small Some
Differentiation)
(c) Monopoly
One Very Small Considerable
72U | Economics (NET)
curve. The intra-marginal firms will be of more than efficiency of the businessman, which is traditionally
optimum size, as is clear from figure. considered as a random attribute.
Thus, in the long-run where cost curves are not
identical some firms may be earning supernormal
profits. The industry will be in full equilibrium only by
accident.
The Supply Curve of the Firm and the
Industry
The supply curve of the firm may be derived by the
points of intersection of its MC curve with successive
demand curves. Assume that the market price increases
gradually. This causes an upward shift of the demand
curve of the firm. Given the positive slope of the MC
curve, each higher demand curve cuts the (given) MC Short-run Supply Curve of a Firm
curve to a point which lies to the right of the previous
intersection. This implies that the quantity supplied by
the firm increases as price rises. The firm, given its cost
structure, will not supply any quantity if the price falls
below P, because at a lower price the firm does not
cover its variable costs (fig). If we plot the successive
points of intersection of MC and the demand curves on a
separate graph we observe that the supply curve of the
individual firm is identical to its MC curve to the right
of the closing-down point (above AVC) M.
Short-run Industry Supply Curve
Short-run Equilibrium of the Industry
Given the market demand and the market supply the
industry is in equilibrium at that price at which the
quantity demanded is equal to the quantity supplied. In
figure the industry is in equilibrium at price P, at
which the quantity demanded and supplied is Q.
However, this will be a short-run equilibrium, if at the
prevailing price firms are making excess profits or
losses.
Below P the quantity supplied by the firm is zero.
As price rises above P the quantity supplied increases.
The supply curve of the firm is shown in figure.
The Industry-supply curve is the horizontal
summation of the supply curves of the individual firms.
It is assumed that the factor prices and the technology
are given and that the number of firms is very large.
Under these conditions the total quantity supplied in the
market at each price is the sum of the quantities supplied
by all firms at that price. In figure we show the industry
supply as a straight line with a positive slope. It should,
however, be noted that the particular shape of the Short-run Industry Equilibrium
market-supply curve depends on the technology and on In the long-run, firms that make losses and cannot
factors prices, as well as the size distribution of the read just their plant will close down. Those that make
firms in the industry. All firms are not usually of excess profits will expand their capacity, while excess
the same size. The particular size of each firm in profits will also attract new firms into the industry. Entry
perfect competition depends on the entrepreneurial exit and readjustment of the remaining firms in the
Economics (NET) | 73U
industry will lead to a long-run equilibrium in which affects the MC of the firm. The MC curve, which is also
forms will just be earning normal profits and there will the supply curve of the firm, will shift upwards to the
be no entry or exit from the industry. left, and the amount produced at the going price will be
reduced.
Optimal Resource Allocation The market-supply curve will shift upwards to the
In perfect competition the market mechanism leads left and price will rise. The important question here is by
to an optimal allocation of resources. The optimality is how much will the price increase : Will the increase in P
shown by the following conditions which prevail in the be smaller, equal, or greater than the specific tax ? This
long-run equilibrium of the industry : is an important question because it relates to who is
(a) The output is produced at the minimum feasible going to bear the specific sales tax : the consumer-
cost. buyer, the firm, or both?
The answer to this question is that the burden of the
(b) Consumers pay the minimum possible price
specific tax that will be borne by the consumer (buyer)
which just covers the marginal cost of the product, that
depends on the price elasticity of supply, given the
is, price = opportunity cost.
market demand. In general, the most elastic the market
(c) Plants are used at full capacity in the long run, so supply the higher the proportion of the tax that the
that there is no waste of resources. consumer will bear and the less the burden of the firm
(d) Firms only earn normal profits. from the specific tax.
In the long-run these conditions prevail in all So long as the market supply has a positive slope
markets, so that resources are optimally allocated in the the specific tax will be paid partly by the buyer and
economy as a whole. partly by the firm. The burden to the firm will be smaller
the greater the elasticity of supply. In other words, the
Effect of Imposition of A Tax (Perfect firm will be able to pass on to the consumer more of the
Competition) specific tax, the more elastic the market supply. This is
We will examine the effects of the imposition by the illustrated in figure. The demand curve is identical in
government of a lump-sum tax, a profits tax, and a both figures and. the initial (pre-tax) price is the same,
specific tax, that is, a tax per unit of output. but the supply curve in figure is more elastic. Imposition
of a specific tax equal to ab raises the price by AP in
Imposition of a Lump-Sum Tax (Per figure and by AP, in figure. Clearly AP; > AP, that is,
Period) the tax burden to the consumer is greater in the case of a
more elastic supply curve (given the market demand).
In the short-run the lump-sum tax will not affect the
MC cost curve and the firm will continue to produce
the same output as before the imposition of the tax.
However, if the firm was earning just normal profits
prior to the tax, it will not be covering its ATC at the
going market price and will close down in the long-run.
Thus in the long run the market-supply curve will shift
to the left as firms leave the industry, the output will be
lower and the price higher as compared with the pre-tax
equilibrium.
Imposition of Profits Tax
This tax takes the form of a percentage on the net
profit of the firm. The effects of a profits tax are the Burden of a Sales Tax : Less Elastic Supply Curve
same with those of a lump-sum tax. The profits tax,
while reducing the profits, will not affect its MC. Hence
in the short-run the equilibrium of the firm and the
industry will not change.
However, in the long-run, exit of firms will be
inevitable if in the pre-tax period firms were earning just
normal profits. In the long-run the supply in the market
would shift to the left and a new equilibrium would be
reached with a higher price, a lower quantity produced
and a smaller number of firms.
Imposition of a Specific Sales Tax
This takes the form of a given amount of money
(e.g., R 2) per unit of output produced. Such a tax clearly Burden of a Sales Tax : More Elastic Supply Curve
74U | Economics (NET)
In the limiting case of a market-supply curve with because it always takes time for the supply to adjust
infinite elasticity the increase in price is equal to the fully to the changed conditions of demand.
specific tax and the whole tax burden is force by the Marshall divided time into following three periods
consumer. In figure the demand is the same as in figure, on the basic of response of supply to a given and
but the supply curve is parallel to the horizontal axis, permanent change in demand :
showing infinite price elasticity. The imposition of a
1. Market Period—The market period is very short
specific tax equal to ab leads to an equal increase in the
period in which the supply is fixed, that is, no
price : ΔP2 = ab.
adjustment can take place in supply conditions. In this
period more good cannot be produced in response to an
increase in demand. This market period may be a day or
a few days or even a few weeks depending upon the
nature of the good, for instance, in case of perishable
goods, like fish, the market period may be a day and for
a cotton cloth, it may be a few weeks.
2. Short-run—Short run is a period in which
supply can be adjusted to a limited extent. During the
short period the firms can expand output with given
equipment by changing the amounts of variable factors
employed. Output can be expanded by making intensive
use of given plant or capital equipment by varying the
amount of variable factors.
Burden of a Sales Tax : Infinite Elastic Supply Curve 3. Long-run—The long run is a period long enough
to permit the firms to build new plants or abandon old
ones. Further, in the long run, new firms can enter the
industry and old ones can leave it. Since in the long run
all factors are subject to variation, none is a fixed factor.
From above, it is clear that because of the varying
response of supply over a period of time to a sudden and
once for all increase in demand that Marshall found if
necessary and useful to study the pricing process in—(a)
the market period, (b) the short-run, and (c) the long-run
depending respectively upon whether the supply
conditions have time to make—(i) no adjustment (ii)
some adjustment of labour and other variable factors,
and (iii) adjustment of all factors and all costs.
Burden of a Sales Tax : Supply is Negatively Sloping Therefore, Marshall explained how the equilibrium
If the supply curve has a negative slope the between demand and supply was established in three
imposition of a specific tax results in an increase in the time periods which consequently determine market
price which is greater than the tax. In figure the demand price, short-run price and long-run price.
is identical as in the above-examined cases but the
supply curve is negatively sloping (with its slope smaller Price Discrimination
than the slope of the DD curve). Under these conditions Price discrimination refers to the practice of a seller
a specific tax of ab leads to an increase in the market of selling the same good at different prices to different
price equal to DP3 , which is obviously larger than the buyers.
unit tax.
Degrees of Price Discrimination
Marshall’s Time Analysis and Price
Prof. A.C. Pigou has distinguished between the
Marshall, who propounded the theory that price is
following three types of price discrimination on another
determined by both demand and supply, also gave a
ground :
great importance to the time element in the determination
of price. Time element is of great relevance in the theory 1. Price discrimination of the first degree,
of value, since one of the two determinants of price, 2. Price discrimination of the second degree, and
namely supply, depends on the time allowed to: it for 3. Price discrimination of the third degree.
adjustment. It is worth mentioning that Marshall divided
time into different periods from the view point of supply Price Discrimination of the First Degree
and not from the view point of demand. Time is short or Price discrimination of the first degree is also
long according to the extent to which supply can adjust known as perfect price discrimination because this
itself. Marshall felt it necessary to divide time into involves maximum possible exploitation of each buyer
different periods on the basis of response of supply in the interest of a seller’s profits. Price discrimination
Economics (NET) | 75U
of the first degree is said to occur when the monopolist markets or groups and charges a different price in each
is able to sell each separate unit of the output at a sub-market. In this case monopolist will receive the
different price. entire consumer’s surplus, First-degree price discrimi-
nation is also known as ‘take-it-or-leave-it’ price
discrimination, because in negotiating with each buyer
the monopolist charges him the maximum price he is
willing to pay under threat of denying the selling of any
quantity to him : he offers each buyer a ‘take-it-or-leave-
it’ choice. In this case the demand curve also becomes
the MR curve of the monopolist.
When is Price Discrimination Possible ?
The necessary conditions, which must be fulfilled
for the implementation of price discrimination are the
following :
1. The market must be divided into sub-markets
Fig. : Third-degree Price Discrimination with different price elasticities.
2. There must be effective separation of the sub-
markets, so that no reselling can take place from a low-
price market to a high-price market.
Equilibrium under Price Discrimination
The reason for a monopolist to apply price
discrimination is to obtain an increase in his total
revenue and his profits. By selling the quantity defined
by the equalisation of his MC and his MR at different
prices the monopolist realises a higher total revenue
and hence higher profits as compared with the revenues
he would receive by charging a uniform price. The
Fig. : Different Groups under Price Discrimination of the monopolist can divide his total market into several sub-
Second Degree markets according as there are differences in demand
elasticity, but for the sake of making our analysis simple
we shall explain the case when the total market is
divided into two sub-market.
In order to reach the equilibrium position, the
discriminating monopolist has to take two decisions :
1. how much total output should be produce, and
2. how the total output should be shared between the
two sub-markets and what prices he should charge in the
two sub-markets.
It is assumed that the monopolist will sell his
product in two sub-markets, each of them having a
demand curve with different elasticity. In figure the
Fig. : Price Discriminating Monopolist of the First Degrees demand curve D1 has a higher price elasticity than D2 at
Extracts all the Consumer’s Surplus from the Buyers. any given price. The total-demand curve D is found by
the horizontal summation of D 1 and D2. The aggregate
Price Discrimination of the Second marginal revenue (MR) is the horizontal summation of
Degree the marginal-revenue curves MR1 and MR 2 . The
In price discrimination of the second degree buyers marginal-cost curve is depicted by the curve MC.
are divided into different groups and from each group a The total quantity to be produced is defined by the
different price is charged which is the lowest demand point of intersection of the MC and the aggregate MR
price of that group. curves of the monopolist. In figure the two curves
intersect at point E, this defining a total output OX
Price Discrimination of the Third Degree which must be produced. If the monopolist were to
Price discrimination of the third degree is said to charge a uniform price this would be P, and his total
occur when the seller divides his buyers into two sub- revenue would be OXAP.
76U | Economics (NET)
and in the second market the monopolist will sell OX2 at
the price P2 .
Clearly, OX1 + OX2 = OX
From figure it is obvious that the total revenue from
price discrimination is larger than the revenue OXAP
which would be received by charging a uniform price P.
With price discrimination the total revenue is
P 1 .OX1 + P2.OX2 = OP1FX1 + OP2EX2
Comparing this revenue with the revenue from the
unique price P we find the following :
Fixation of Total Output and Different Prices in the two
Sub-markets by the Discriminating Monopolist Total revenue from price P :
His profit would be the difference between this TR1 = OXAP
revenue and the cost for producing OX. However,
the monopolist can achieve a higher profit by charging TR1 = OX2DP + X 2 XBC + CBAD …(1)
different prices in the two markets. The price and the Total revenue from P1 and P2 :
quantity in each market is defined in such a way as to
maximise profit in each market. Thus in each market he TR2 = OX1FP1 + OX2 EP 2
must equate the MR with the MC. However, the MC is But OX1FP1 = X2XBC
the same for the whole quantity produced, irrespective
of the market in which it is going to be sold. The MR in and OX2EP 2 = OX2DP + PDEP2
each market differs due to the difference in the elasticity Therefore,
of the two demand curves. The profit in each market is TR2 = X2XBC + OX 2 DP + PDEP2 …(2)
maximised by equating MC to the corresponding MR :
Subtracting (1) from (2) we find
In the first market profit is maximised when
TR2 – TR1 = [X 2 XBC + OX 2 DP + PDEP2 ] –
MR 1 = MC
[OX2 DP + X 2 XBC + CBAD] = PDEP2 – CBAD
In the second market profit is maximised when
Since CBAD < PDEP2 , it is obvious that
MR 2 = MC TR2 > TR1
Clearly the total profit is maximised when the Note that PDEP2 is the additional revenue from
monopolist equates the common MC to the individual selling OX2 at price P 2 which is higher than P, while
revenue CBAD is the loss in revenue from selling OX1 at price
MC = MR 1 = MR2 P 1 which is lower than P. The additional revenue from
Hence, the following two conditions are required for selling OX2 at a higher price more than offsets the loss
the equilibrium of a discriminating monopolist : of revenue from selling OX 1 at a lower price, so that
total revenue from discrimination is larger. Since the
1. Aggregate Marginal Revenue (AMR) = Marginal cost of producing OX is the same irrespective of the
Cost (MC) of the total output. price at which it will be sold, the profits from price
2. MR 1 = MR 2 = MC. discrimination are larger as compared with those that
would be obtained from selling all the output at the
If MR in one market were larger, the monopolist uniform price P.
would sell more in that market and less in the other, until
The above case has been called third-degree price
the above condition was fulfilled. Graphically the
discrimination by the British economist Pigou. The
determination of the prices and quantities in the two increase in total revenue is achieved by taking away part
markets is defined as follows : of the consumer’s surplus.
From the equilibrium point E we draw a line
perpendicular to the price axis. This line cuts the MR1 at Price Discrimination and the Price Elasti-
point E, and the MR2 at point E2. Clearly at these point city of Demand
we have the required equality : We know that
MC = MR 1 = MR2
From E1 and E2 we drop vertical lines to the X axis, MR = P 1 –( 1e)
and we extend them upwards until they meet the demand
curves D1 and D 2 respectively. These vertical lines In case of price discrimination we have
define the output and price in each market. Thus in the
first market the monopolist will sell OX1 at a price P 1 , ( )
MR 1 = P 1 –
1
e1
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dπ d(TR1 ) dC
MR 2 = (1 – e1 )
2
(a)
dX1
=
dX1
–
dX1
=0
and MR 1 = MR 2 dπ d(TR2 ) dC
and = – =0
Therefore, dX2 dX2 dX2
d(TR1 ) dC
( e1 ) = P (1 – e1 )
P1 1 –
1
2
2
(b)
dX1
=
dX1
or MR 1 = MC 1
or
P
=
( 1– )
1 e
1
1 and
d(TR2 )
=
dC
dX2 dX2
P
(1 – e1 )
2
2 = MR 2 = MC2
where, dC
But MC 1 = MC 2 = MC =
dX
e1 = elasticity of D 1
Therefore,
e2 = elasticity of D 2
MC = MR 1 = MR2
If e 1 = e2 the ration of prices is equal to unity : The second-order condition for profit maximisation
P1 requires
= 1
P2 d2 (TR 1 ) d c
1 < 22
that is, P1 = P2 dx 2 dx
This means that when elasticities are the same d2 (TR 1 ) d2 c
and 2 <
price discrimination is not profitable. The monopolist dx 2 dx2
will charge a uniform price for his product.
Equilibrium under Price Discrimination
If price elasticities differ price will be higher in the
market whose demand is less elastic. in the Dumping Case
This is obvious from the equality of MR’s A special case of price discrimination is met when a
producer is selling in two markets, one in which he faces
P1 1 –( )1
e1
= P2 1 – ( )1
e2 perfect competition, while in the other the he has a
monopoly. The demand curve for the product will be
if |e1| > |e2| then perfectly elastic for him in the market in which he faces
perfect competition, while the demand curve will be
(1 – e1 ) = (1 – e1 )
1 2 sloping downwards in the market in which he enjoys
Thus for the equality of MR’s to be fulfilled that is, monopoly position. Such situation might occur when a
the market with the higher elasticity will have the lower producer sells his product in his home country in which
price. he has a monopoly and also in the world market which is
P1 < P2 perfectly competitive. Equilibrium in this situation is
depicted in figure. In the home market in which the
Mathematical Derivation of the Equili-
producer has a monopoly power, demand curve or the
brium of the Price-Discriminating Mono- average revenue cure ARH is sloping downward. So
polist does the MR curve MRH. In the world market in which
Given the total of the monopolist he faces perfect competition the demand for his product
P = f(X) is perfectly elastic. The AR curve ARW of the producer
Assume that the demand curves of the sub-markets in the world market is therefore a horizontal straight line
are and MRW curve coincide with it. MC is the marginal
P 1 = f1 (X 1 ) cost curve of output. Aggregate marginal revenue curve
and P 2 = f2 (X 2 ) in this case is the composite curve BFED which is the
The cost of the firm is lateral summation of MRH and MRW . The MC curve
C = f (X) = f (X1 + X2) intersects the aggregate marginal revenue curve BFED at
The firm aims at the maximisation of its profit point E and equilibrium output OM is determined. The
π = TR1 + TR2 – C total output OM is to be distributed between the home
The first order condition for profit maximisation market and the world market in such a way that marginal
requires revenue in each market is equal to each other and to the
dπ dπ marginal cost ME. Thus, out of total output OM, amount
= 0 and =0
dX1 dX2 OR will be sold in the home market. From the curve
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ARH , it is clear that price OPH will be charged in the where,
home market. Rest of the amount RM will be sold in the MPL = marginal productivity of labour
world market at price OPW .
Area CEFB represents the total profits earned by the MPK = marginal productivity of capital
producer from both the markets. Price in the world dX = change in output
market OP W is lower than the price OP H in the home dL = change in labour
market. When a producer charges a lower price in the dK = change in capital.
world market than in the home market, he is said to
be dumping in the world market. Marginal Revenue Product (MRP)
Marginal Revenue Product is the increment in the
total value product caused by employing an additional
unit of a factor, the expenditure on other factors
remaining unchanged. In other words, marginal revenue
product is the marginal physical product of the factor
multiplied by the marginal revenue.
MRP = MPP × MR
Value of Marginal Product (VMP)
It means the marginal physical product of the factor
multiplied by the price of the product (i.e., average
revenue).
VMP = MPP × Price (or AR)
Equilibrium of the Discriminating Monopolist When he
has a monopoly in the home-market and faces perfect Since under perfect competition the demand curve
competition in the world market. of the product facing an individual firm is perfectly
elastic and therefore price and marginal revenue are
FACTOR PRICING ANALYSIS equal, the value of marginal product and marginal
Theory of factor pricing or the theory of distribution revenue product are equal to each other as is shown in
is concerned with analysis of how and in what manner Figure. But since in monopoly or imperfect competition
the factors of production get remuneration for their average revenue (or demand curve) is falling downward
contribution to the production process as the production and MR curve lies below the average revenue curve,
of goods and services in an economy is the result of the price is not equal to marginal revenue. Therefore, in
joint efforts of factors of production. Though like the monopoly or in others forms of imperfect competition,
pricing of goods, the factor pricing is also based on MRP will not be equal to the value of marginal product
market demand and supply, the essential difference (VMP). Since price is higher than marginal revenue
between these two lies in the force operating behind under monopoly or monopolistic competition in the
demand and supply of these factors. How much will be product market, the value of marginal product (VMP)
the demand for a factor depend upon the quantity of will be larger than the marginal revenue product (MRP)
goods that it helps to produce and the extent of demand and the marginal revenue product (MRP) curve will lie
for these goods in the market. Thus, the demand for a below the value of marginal product (VMP) curve as is
factor of production depends upon the demand for its shown in figure. Thus, in perfect competition MRP
products in the market. This type of demand is known as and VMP have identical meanings but in imperfect
derived demand. competition they diverge.
Concepts of Productivity
Average Physical Productivity is the total production
divided by the number of units of a factor employed.
Average productivity of a factor
Total Output
=
Total Number of units of a factor
Marginal physical productivity of a factor is the
increase in total output caused by employing an
additional unit of the factor, quantity of other factors
remaining fixed.
dX dX VMP and MRP under perfect competition in the Product
MPL = and MPK =
dL dK Market
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factor service is upward sloping from left to right, i.e., it
has a positive slope.
Under a perfectly competitive factor market there
are many buyers of a productive service so that a single
firm purchases only a small portion of the total factor
service and in no way influences its market price. It
takes the price of the factor service as given and
employs as many units as it needs at that price. Thus the
supply of a factor service to the firm is perfectly elastic
in the long-run at the given market price. As a result, for
a firm working under perfect competition in the factor
market, the extra cost of hiring an extra unit of the factor
will be equal to the price of the factor which remains
unchanged. Thus, marginal factor cost under perfect
VMP and MRP under Imperfect Competition in the competition in the factor market is equal to the price of
Product Market the factor (Pf = MFC). This is shown in figure. In this
Factor Prices under Perfect Competition figure, ruling price-of the factor in the market is OP,
which the firm has to accept as given and constant.
According to the modern theory of pricing of factors Supply curve of the factor (or AFC curve) is horizontal
of production, under condition of perfect competition it straight line and MFC curve coincides with it.
is the forces of demand for and supply of factors which
determine their prices. The demand for a factor service Determination of Factor Price
is derived demand which is derived from the demand
for the product that it helps to produce. Thus the demand Given the demand and supply conditions of the
for a factor ultimately depends upon the demands for factor service as enumerated above the firm will
goods it helps to produce. The greater the demand for continue to employ more units of a particular factor
goods a particular type of factor helps to make, the service so long as the additional revenue obtained from
greater the demand for that type of factor. Just as an additional unit of the factor service (MRP) exceeds
demand for a good depends upon its utility, the the extra cost of employing it (MFC). It will be earning
demand for a factor depends upon the marginal maximum profits at the point at which the MRP equals
revenue productivity of the factor. In fact, under the MFC. If the firm employs less than this, MRP would
perfect competition in the factor market downward be higher than MFC and it would be to its advantage to
sloping part of the marginal revenue productivity curve hire more units of the factor service because they would
of the factor is the demand curve for that factor. add to revenue more than costs. In case the firm-decides
to hire beyond the point of equality of MRP and MFC, it
Assumptions would be a loser because costs would rise more than
The analysis of factor pricing under perfect revenue. Thus in a perfectly competitive factor market
competition is based on the following assumptions : the firm will be in equilibrium when MRP ≥ MFC which
1. There is perfect competition in the product implies two conditions.
market and the factor market. 1. MRP must equal MFC.
2. The number of buyers and sellers of factor 2. The MRP curve must cut the MFC curve from
services is large. above at the equilibrium point.
3. All units of a factor are homogeneous.
4. Factors of production are perfectly mobile.
5. There is perfect substitutability between factors
and their units.
6. All factor-units are divisible.
7. Buyers and sellers of factor services have
complete knowledge about market conditions.
8. Buyers and sellers of factor services have
complete freedom to enter and leave the market.
The supply of a factor service means the number of
units which a resource owner sells at a particular price.
There is a direct relationship between price and the
supply of a factor service. This is in the short-run when
the supply of productive service is not perfectly elastic.
More of it will be supplied at a higher price and less at a Employment of a factor by a Firm Under Conditions of
lower price. Thus the shape of the supply curve of a Perfect Competition
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The pricing of a factor service as stated above can (a) When the factor market is perfectly competitive
be explained diagrammatically. In Figure, VMP = MRP and the product market is imperfectly competitive or
is the demand curve and AFC = MFC is the supply monopolistic.
curve of the factor service. Since the price of the factor (b) When there is monopsony in the factor market
service is given and constant at OP for the firm, the and perfect competition in the product market.
MRP curve cuts the MFC curve at E from above. This is (c) When there is monopsony in the factor market
the equilibrium point for the firm at which it employees and monopoly in the product market.
OQ units of the factor service. The MRP curve also cuts
We discuss these variants of factor pricing under
the MFC curve at R. But this cannot be the equilibrium
imperfect competition.
point because MRP cuts MFC from below. It is not the
point of maximum profit for the firm because MRP is A. Factor Market Perfectly Competitive
higher than MFC beyond this point R. Thus E is the and Product Market Imperfectly
point of equilibrium in a perfectly competitive factor
market when
Competitive or Monopolistic
In a perfectly competitive factor market, the price of
MRP = VMP = MFC = AFC = Price the factor service is given for the firm and does not
Under perfect competition in both factor and affect the volume of its purchases. The supply curve or
product markets, a firm may be at a profit or at a loss in the cost curve is horizontal to the X – axis (AFC =
the short-run. But in the long-run it must earn normal MFC). But because there is imperfect or monopoly in
profits.
the product market, the MRP curve will lie below the
VMP curve. Since we know that under imperfect
Formal Derivation of the Equilibrium competition or monopoly in the product market marginal
of the Firm in Perfectly Competitive revenue is less than the price (AR) of the product,
Markets therefore the MRP will be less than the value of
marginal product (VMP). Symbolically,
The production function is
X = f(L)— MRP < VMP
K
Q MR < P (Under imperfect competition both AR
The total cost consists of the variable cost —
w ·L and
the fixed cost F and MR curves slope downward)
The firm will be in equilibrium where MRP equals
C = — w ·L + F MFC, the price of the factor under perfect competition.
— This is shown in figure by point E where the firms
where, w = wage rate
employs OQ units of factor service at OP price. Hence
L = quantity of labour the MRP of employing OQ units is QE which is less
The revenue of the firm is than QA the value of its marginal product. Thus the
– factor service gets less than the value of its marginal
R = Px · X product by EA amount. This means that when the firms
– have monopolistic power the factor is paid its MRP
= Px · [f(L)]
which is smaller than the VMP. This effect has been
The firm wants to maximise its profit called monopolistic exploitation by Joan Robinson.
π = R–C
–
π = Px · [f(L)] – (—
w ·L + F)
Setting the first derivative of the profit function with
respect to labour equal to zero we obtain
–
dπ
dL
= Px · (dX
dL )
–—
w
Rearranging
–
Px · (MPPL) = —
w (give dLdX = MPP )L
or VMP L = —
w
Factor Pricing under Imperfect Compe-
When the firm equates MRP with MFC it employs
tition less units of the factor service because of imperfect
Factor pricing under imperfect competition or competition in the product market than what is would
monopoly is studied under three categories : have had there been perfect competition. Thus it employs
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OQ units of the factor, as compared with OQ1 units than its marginal revenue product. For OQ units the
(where VMP = MFC) that a competitive product seller factor is being paid QA (= OP) price whereas its
would employ consequently. Under imperfectly com- marginal revenue product is QE. The difference between
petitive product market, the demand for the factor will the MRP and the price paid to the factor is AE (QE –
be less by Q1 Q. QA) which measures monopsonistic exploitation per
According to Joan Robinson a productive factor is unit of the factor employed.
exploited if it is paid a price less than the value of its
marginal product (VMP). We saw that a profit maximiser
will employ a factor until the point where an additional
unit adds precisely the same amount to total cost and
total revenue.
For a perfectly competitive firm
VMP L = MRPL
Because :
VMP L = MPPL.MRX
But P X = MR X
So that VMP L = MRPX
Thus when the commodity market is perfectly
competitive the profit maximising behaviour of firms
leads to the payment of factor prices which are equal to C. Monopsony in the Factor Market and
the value of the marginal product (VMP) of the factors. Monopoly in the Product Market
However, the condition of equilibrium of a When there is monopsony in the factor market and
monopolistic firm is monopoly in the product market, MRP < VMP and the
MRPL = MPPL.MRX = w MFC > AFC. This implies that the MRP curve will lie
and MRx < Px , so that factors are paid less than the below the VMP curve and MFC curve will lie above the
value of their marginal product. The difference AE in AFC curve, as shown in figure.
figure shows that profit maximising behaviour of
imperfectly competitive firms causes the factor price to
be less than the value of its marginal product.
B. Monopsony in the Factor Market and
Perfect Competition in the Product
Market
A monopsonist firm is a single buyer of a particular
factor in the market. Since the firm is the market for the
factor in this case, the supply of factor service to the
monopsonist is identical to its supply to the market.
Thus the supply curve to the firm (AFC) is positively
sloping from left to right upward. The firm can employ
more units of the factor service by offering a higher
price per unit. The MFC curve to this AFC curve will As usual, the firm is in equilibrium at point E where
also be sloping upward and will be above the AFC curve the MRP curve cuts the MFC curve from above and
throughout its length. equals it. The firm employs OQ units of the factors
service at QP price which is less than QE the marginal
Since we are assuming perfect competition in the revenue product of the factor. Thus due to its
product market, the value of the marginal product will monopsonistic position in the factor market, the firm
be equal to the marginal revenue product (VMP = exploits the factor units used to the extent of PE (QE –
MRP). The firm can sell any amount without affecting QP). On the other hand, due to its monopolistic position
the price of the product and the value of the marginal in the product market, the MRP of the factor is less than
product (VMP) therefore coincides with the marginal its VMP and the firm exploits the factor units employed
revenue product (MRP), as shown in figure. further to the extent of EA amount. We may conclude
The firm is in equilibrium at point E in figure that in the case of monopsony in the factor market and
where the MRP curve cuts the MFC curve from above monopoly in the product market, the factor used in
and equals it at that point. The firm employs OQ units of production by the firm is doubly exploited : first, due to
the factor service by paying OP (= QA) price for them. the excess of MRP over the price of the factor, and
In this case, there is monopsonistic exploitation of the second, due to the excess of the VMP over the marginal
factor because the factor service is being paid less revenue product of the factor.
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Role of Collective Bargaining by Trade derivatives. Thus, the marginal product of labour can
Unions in Raising Wages dX dX
be expressed as , and the marginal of capital as ,
dL dK
First—If the firm-buyers have no monopsonistic then for the adding-up problem to be fulfilled, the
power, labour unions can attain an increase in the following equation must hold good :
wage rate at the expense of a lower employment.
Whether this result is beneficial to all the members of dX dX
X = L· + K·
the union depends on the elasticity of demand for labour dL dK
and the distribution policies of the union. Where represents share of the total product going to
labour.
Second—If the firm-buyers have monopsonistic
power, the union’s actions can eliminate one part of dX
K· represents share of the total product going to
the monopsonistic exploitation, namely the part that is dK
solely attributable to the monopsonistic power of the capital.
firms. However, the other portion of the monopsonistic Now, Euler’s Theorem states that if X is a
exploitation, that which is due to the monopoly power of homogenous function of the first degree, that is, if in X
firms in the product market, cannot be eliminated by = f(L, K) for any given increase in the variables L and K
trade union action. by the amount n the output X will also increase by n.
Thus homogeneous function of the first degree or
Third—If the firm-buyers have monopsonistic linearly homogeneous function is of the following form :
power, trade unions can increase the total wage bill in
nX = f(n.L, n.K)
cases, by either increasing employment, or the wage
rate, or both. Only if the demand for labour is elastic Now according to Euler’s theorem for this linearly
can the union harm its members, if it sets the wage rate homogeneous function :
above the maximum level for the initial (pre-union) level dX dX
X = L· + K·
of employment. dL dK
Thus, if production function is homogeneous of the
The ‘Adding-Up’ Problem : ‘Product first degree, then according to Euler’s Theorem the total
Exhaustion’ Theorems product,
As soon as it was propounded that the factors of dX dX
X = L· + K·
production are paid equal to their marginal products, a dL dK
perplexing problem cropped up over which there was a dX dX
serious debate among the famous economists at that Where , are partial derivatives of the
dL dK
time. The perplexing problem which was posed was that production function and therefore represent the marginal
if all factors were paid rewards equal to their marginal products of labour and capital respectively. It follows
products, would the total product be just exactly therefore that if production function is homogeneous of
exhausted? In other words, If each factor is rewarded the first degree (that is, where there are constant
equal to its marginal product, the total product should be returns to scale), then, according to Euler’s Theorem, if
disposed of without any surplus or deficit. The problem the various factors, L and K are paid rewards equal to
of proving that the total product will be just exhausted if their marginal products, the total products will be just
all factors are paid rewards equal to their marginal exhausted, with no surplus or deficit.
products has been called “Adding-up-Problem” or In the above way, Wicksteed assuming constant
Product Exhaustion Problem. returns to scale and applying Euler’s Theorem, proved
the adding-up problem, that is, demonstrated that if all
Wicksteed’s Solution of Product Exhaus- factors are paid equal to their marginal products, the
tion Problem total product will be just exactly exhausted.
Philip Wicksteed was one of the first economists Wicksteed’s solution was criticized by Walras,
who posed this problem and provided a solution for it. Barone Edgeworth and Pareto. It has been asserted by
Wicksteed applied a mathematical proposition called these writers that production function is not homoge-
Euler’s Theorem to prove that the total product will be neous of the first degree, that is, returns to scale are not
just exhausted if all the factors are paid equal to their constant in the actual world. Critics pointed out that
marginal products. Let X stand for the total output of the production function is such that it yields a U-shaped
product, L stand for the labour and K stand for the long run average cost curve. The U-shape of the long-
capital. Then, the adding-up problem implies that, run average cost curve implies that up to a point
increasing returns to scale occur and after it diminishing
X = MPL.L + MPK.K
returns to scale are found. In case a firm is still working
That is, the marginal product of labour (MPL) under increasing returns to scale, then if all factors are
multiplied by the amount of labour (L) plus the marginal paid equal to their marginal products, the total factor
product of capital (MPK ) multiplied by the amount of rewards would exceed the total product. On the other
capital (K) equals the total product of the firm. Marginal hand, if a firm is working under diminishing returns to
products of various factors can be expressed as partial scale, and all factors are paid equal to their marginal
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products the total factor rewards would not fully exhaust
the total product and will therefore leave a surplus. It
follows that Euler’s Theorem does not apply and
therefore the adding-up problem does not hold good
when either there are increasing returns to scale or
decreasing returns to scale.
Another drawback pointed out in Wicksteed’s
solution is that when there is constant returns to scale,
the long run average cost curve of the firm is a
horizontal straight line which is incompatible with
perfect competition. (Under horizontal long-run average
cost curve, the firm cannot have a determinate
equilibrium position). But competition was essential to
the marginal productivity theory and therefore to
Wicksteed’s solution. Thus Wicksteed solution leads us
to two contradictory things. Fig. : Stable Equilibrium : Downward sloping demand
curve and upward sloping supply curve
Wicksell, Walras and Barone’s Solution
of Production Exhaustion Problem Stability Conditions of Equilibrium-
After Wicksteed, Wicksell, Walras, Barone, each Walras Vs. Marshall
independently, advanced more satisfactory solution to There are two different approaches of stability
the problem that marginally determined factor rewards conditions of equilibrium one by Marshall and the other
would just exhaust the total product. These authors by Walras. Marshall’s approach is the price-dependent
assumed that the typical production function was not approach which depends on quantity movements;
homogeneous of the first degree, but was such that while Walra’s approach is quantity dependent
yielded U-shape long-run average cost curve. They approach which depends on price movements to reach
pointed out that in the long-run under perfect equilibrium level. The Marshallian stability condition is
competition, the firm was in equilibrium at the minimum based on the assumption that when the excess demand
point of the long-run average cost curve. At the price is positive, producers will increase the supply of
minimum point of the LAC-Curve, the returns to scale the product, and reduce it when it is negative. In figure
are momentarily constant, that is, returns to scale are A at OQ1 level, when the excess demand price is
constant within the range of small variations of output. positive, d1 Q1 > SQ1, (the demand prices is greater than
Thus the condition required for the marginally the supply price) it means that the consumers are
determined rewards to exhaust the total product, that is, offering a higher price than S being charged by the
the operation of constant returns to scale, was fulfilled at producers who will increase the supply When supply
the minimum point of the long-run average cost curve, increases, price falls which will increase demand and
where a perfectly competitive firm is in long-run equilibrium will be restored at OQ level. Similar
equilibrium. Thus in the case of perfectly long-run reasoning holds for the converse case when at OQ2 the
equilibrium if the factors are paid rewards equal to their excess demand price is negative, dQ 2 < S1 Q2 It will
marginal products, the total product would be just
induce producers to reduce the quantity supplied. When
exactly exhausted.
supply falls, price increases which will reduce the
demand and equilibrium will be restored at OQ.
GENERAL EQUILIBRIUM
ANALYSIS
The main types of equilibrium are as follows :
Stable, Neutral and Unstable Equili-
brium
A system is in stable equilibrium if, when any
small disturbance takes place, forces come into play to
re-establish the initial position; It is in neutral
equilibrium if, when such a disturbance takes place, no
reestablishing forces and no further disturbing forces are
evoked, so that the system remains at rest in the position
to which it has moved; it is in unstable equilibrium if the
small disturbance calls forth further disturbing forces
which act in a cumulative manner to drive the system Unstable Equilibrium: Upward sloping demand curve and
from its initial position. downward sloping supply curve
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supply from Q1 to Q. Price will rise, demand will fall
and equilibrium will be restored at E. However, in the
other case price OP1 the excess demand dS1 being
negative P1 d < P1 S 1 , it will induce sellers to reduce the
price of their product still further. Price and quantity will
move farther away from the equilibrium point E.
Equilibrium is unstable.
Figure C illustrates Marshall’s unstable and
Walras’s stable equilibrium. At the price OP1 the excess
demand price dS 1 is positive, dQ 1 > S1 Q1. Since the
consumer’s are prepared to pay more than the actual
price, producer will tend to increase the supply but the
excess demand price also increases. Thus, both price and
quantity continue to move farther away from the
Neutral Equilibrium over a given range equilibrium level. In the Walrasian sense, at the price
On the other hand, the Walrasian stability condition OP1 , the excess demand S1 d1 is positive, P1 d1 > P1 S.
is based on the assumption that when excess demand is Demand being more than the supply, competition among
positive, buyers will raise the price and if it is negative, buyers will raise the price to the equilibrium level OP.
the sellers will lower the price. In figure when the excess Equilibrium is stable.
demand is positive P 2 d > P2 S (the quantity demanded is It follows from the above discussion that
greater than the quantity supplied), the buyers will bid geometrically equilibrium is stable in the Marshallian
the price upwards. When price rises, demand falls and sense if the demand curve is steeper than the supply
supply increases and equilibrium is restored at E. curve and unstable if it is less than the letter. The same
Contrariwise, in case of negative excess demand, P1 d1 < reasoning holds for the converse Walrasian case.
P 1 S 1 , supply being in excess of demand, It will induce Stable Equilibrium in the Marshallian Sense and
sellers to lower the price of the product. When price falls Unstable in the Walrarsian Sense
supply declines and demand increases till the
equilibrium is reached at E.
Fig. B
Stable Equilibrium in the Walrasian Sense and Unstable
Fig. A Equilibrium in the Marshallian Sense
Thus, both the Marshallian and Walrasian
stability conditions are satisfied when demand curve
has negative slope and the supply curve has a positive
slope (in figure A).
If however, the supply curve has a negative slope,
the Marshallian and Walrasian conditions cannot be
fulfilled simultaneously. Both the conditions will hold in
opposite directions. When equilibrium is stable in the
Marshallian sense, it will be unstable in the Walrasian
sense, and vice- versa. Let us first study these stability
conditions with the help of straight line curves.
Figure B illustrates stable equilibrium in the
Marshallian sense and unstable in the Walrasian sense.
At the price OP1 the excess demand price S2 d is
negative, dQ1 < S2 Q1 the demand price being less than
the supply price, it will induce producers to reduce their Fig. C
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Partial Equilibrium forward to the market only at some time in future. Thus
Partial equilibrium analysis is the study of the supply reacts to price changes with at time lag. The
equilibrium position of an individual, a firm, an industry simplest possible time lag in one year and it is this
or group of industries. It is a market process for the period that we consider in our example below.
determination of product prices and factor prices in Let us suppose that our commodity is produced
which one or two variables are discussed, keeping all in an annual crop, say wheat. Once the crop is planted,
others constant. The partial equilibrium approach is also the supply may be taken as more or less fixed for the
known as ‘Marshallian approach’ after Alfred year, if we neglect the effects of the weather and other
Marshall, who used it as his basic method of analysis in uncertain factors. A change in price will, accordingly,
his Principles of Economics. have no effect on the magnitude of this year’s total
Partial equilibrium analysis is concerned with two supply. It will, however, effect next year’s supply since
types of economic problems. First, those pertaining to a low price may induce farmers to plant less for the next
only particular aspects of the economic behaviour of a year as they would expect low price to continue in the
certain individual, firm or industry. Second, it studies next year as well. On the other hand, a high price this
only the first-order consequences of the economic year will induce farmers to produce more next year as
events. they would expect high price to continue in the next year
as well. Thus output in year 2 is a response to price in
In summary, the basic characteristic of a partial year 1, output in year 3 is a response to price in year 2,
equilibrium approach is the determination of the price and so on. Thus supply in period t would be in response
and quantity in each market by demand and supply to price in year (t – 1).
curves drawn on the ceteris paribus clause. Each market
in the Marshallian methodology is regarded indepen- This gives the supply function as
dently of the others. S t = f(Pt – 1)
General Equilibrium As against this, the demand function is Dt = f(Pt)
The most ambitious general equilibrium model was indicating that demand in period t depends on the price
developed by the French economist Leon Walras. In his in the same period.
Elements of Pure Economics Walras argued that all There are three possibilities in the Cobweb model—
prices quantities in all markets are determined simulta-
neously through their interaction with one another. (a) Perpetual Oscillation
Walras used a system of simultaneous equations to (b) Damped Oscillation
describe the interaction of individual sellers and buyers (c) Explosive Oscillation
in all markets, and he maintained that all the relevant
magnitudes (prices and quantities of all commodities Perpetual Oscillation
and all factor services) can be determined simultaneously
Below Figure gives the case of perpetual oscillation.
by the solution of this system.
Dt = f(Pt) is the demand curve for wheat in period t
General equilibrium analysis is an extensive study while St = f (Pt – 1 ) is the supply curve of wheat in
of a number of economic variables, their interrelations period t.
and interdependences, for under-standing the working of
the economic system as a whole. It brings together the
cause and effect sequences of changes in the prices and
quantities of commodities and services in relation to the
entire economy. An economy can be in general
equilibrium only if all consumers, all firms, all industries
and all factor-services are in equilibrium simultaneously
and they are interlinked through commodity and factor
prices.
The Cobweb Theorem
Prices and outputs of many commodities show
pronounced cyclical movements over long periods of
time. Their prices rise and fall in a continued wavelike
pattern over a period of time while their production Cobweb Model-Perpetual Oscillation
moves up and down in counterwaves. Thus the price
and quantity movements of these commodities trace a Let us suppose that price in 1 period OP1 . In
cobweb like pattern. Such examples are frequently found response to this price the farmers produce an output of
in agriculture where supply coming on to the market at OQ2 in period 2. But according to the demand curve,
any one time is the result of decisions taken in the past, output OQ2 can be sold only at a low price OP 2 . Thus
while decisions taken about production in the present the price in period 2 becomes OP2 . In response to this
will have their effect on the actual supply coming low price, farmers bring forth a lower supply of wheat in
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period 3 equal to OQ3 . This small quantity in period 3
will fetch a higher price OP1 . Hence, the price in period
3 is the same as the price in year 1. Thus the price and
quantity perpetually oscillate round and round as the
arrows in the figure indicate. In this example, the odd-
numbered years have high prices and low outputs while
the even numbered years have low prices and high
outputs. Perpetual oscillation takes place when the
slopes of the demand curve and the supply curve are
equal. Damped Oscillation.
Let us now consider the case of damped oscillation.
Consider Below figure. In this figure the demand curve
is Dt and the ‘lagged’ supply curve of wheat is St.
The price in period 1 is OP1 . In response to this
price, the farmers produce an output of OQ2 in period 2.
Cobweb Model : Explosive Oscillation
However, this output in period 2 can be sold at a price
OP2 . Due to this low price, the farmers will plant less As earlier, the price the period 1 is OP1 . In response
crop resulting in a low supply of OQ3 of wheat in period to this price, the farmers produce an output of OQ2 in
3. According to the demand curve, this low output will period 2. However, this output in period 2 can be sold
fetch a high price of OP3 in period 3. As a result, the only at a price OP2 . Due to this low price, the farmers
supply of wheat will expand to OQ4 in period 4. This will plant less crop resulting in a low supply of OQ3 of
will fetch a price of OP4 in period 4. And so on. Thus wheat in period 3. This low output will fetch a high price
of OP3 in period 3. As a result, the supply of wheat will
the path of the annual price quantity positions is traced
expand to OQ4 in period 4. This will fetch a price of OP4
by the thick cobweb like line connecting them.
in period 4. And so on. As can be seen, the cobweb line
Since oscillations around the equilibrium price- keeps moving further and further away from the point of
quantity become smaller and smaller, this is a case of equilibrium E.
damped oscillations.
WELFARE ECONOMICS
Welfare economics is concerned with the evaluation
of alternative economic situations from the point of view
of the society’s well-being.
To evaluate alternative economic situations we need
some criterion of social well-being or welfare. The
measurement of social welfare requires some ethical
standard and interpersonal comparisons both of which
involve subjective value judgements.
According to Prof. J.K. Mehta, if we compare the
two periods of time then a given man has greater welfare
in that period in which larger number of his wants have
been satisfied. The smaller the number of wants that
remain unsatisfied the greater is the welfare.
Cobweb Model : Damped Oscillation
Welfare Economics has been defined by Scitovsky
In this case equilibrium at point E is stable. This as that part of the general body of economic theory
always happens in the case where the slope of the which is concerned primarily with policy.
supply curve is greater than that of the demand As we know that general welfare refers to all
curve. economic and non-economic goods and services that
provide utilities or satisfaction to individuals living in a
Explosive Oscillation community.
If the slope of demand of the demand curve is
greater than that of the supply curve, the cobweb line Pigou defined welfare economics as that part of
keeps moving further and further away from the point of general welfare which can be brought directly or
equilibrium. Thus the oscillations are explosive and indirectly into relation with measuring rod of money.
equilibrium unstable. To illustrate this case consider According to Pigou an individual’s welfare resides
below figure where, once again, the demand curve is Dt in his state of mind or consciousness which is made up
= f(Pt) and supply curve is S t = f(Pt – 1). of his satisfaction. An individual welfare is said to have
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increased when he is better off. As a hypothesis, social income is not adversely affected, opening of international
welfare implies the aggregation of the satisfaction or trade will increase welfare.
utility of all individual in a society. The cardinalist
(3) Rationing : From the point of view of maximum
approach to welfare has serious flaws. It assures that all
welfare, price rationing is better than fixed rationing
individuals have identical utility functions for money. So
which permits a consumer to buy only a fixed quantity
that with an equal income distribution all would have the
of each commodity.
same marginal utility of money.
(4) Taxation : When a government has to resort to
Positive Economics and Normative Eco- taxation to raise resources, welfare will be increased if
nomics or Welfare Economics the revenue is sought to be raised through direct
taxation, rather than indirect taxation.
Positive Economics is concerned with explaining
what is, that is, it describes theories and laws to explain (5) Monopoly Versus Competition : The welfare
observed economic phenomena. A positive science may economics is opposed to monopoly since it stands in the
be defused as a body of systematized knowledge. way of optimum conditions of production and exchange.
Concerning the objective of positive science it is the There is, therefore, strong support for perfect competition
establishment of uniformities. Thus in positive on welfare grounds.
economics we derive propositions, theories and laws (6) National Income : The welfare economics is
following certain rules or logic. able to demonstrate the intimate relation between
In positive economics we are concerned with national income and welfare. Increase in national
explaining the determination of relative prices and the income or favourable redistribution is found to increase
allocation of resources between different commodities. the welfare in the community.
In positive economics we are concerned with how Above are given a few illustrations which show that
the level of prices are determined. In these parts of welfare economics has a strong say in shaping vital
positive economics we do not deal with what should be economic policies.
the prices and what should be the saving rate, what
should be the allocation of resource. Old Welfare Economics
Normative Economics is concerned with what Pigou’s Analysis
should be or what ought to be the things. Normative
economics involves value judgements or what are The Pigouvian welfare economics can be conve-
simply known as values. By value judgements or values niently divided into :
we mean the conceptions of the people about what is (1) The meaning of welfare
good or bad. (2) The welfare conditions and
Difference between Welfare and Positive Econo- (3) The analysis of the divergence between mar-
mics : The laws of positive economics are derived from ginal private and marginal social costs and
a set of axioms. Whereas the propositions or laws so returns.
derived are capable of being tested and verified by (1) Meaning of Welfare : According to Pigou,
observations of the facts in the real world, the proposi- welfare resides in a man’s state of mind or consciousness
tion of welfare economics cannot be so tested and which is made up of his satisfaction or utilities. The
verified because we cannot know whether welfare has basis of welfare, therefore, is necessarily the extent to
actually increased or not. This is because welfare is not which an individual desires are met. Social welfare is
an absolute quantity like prices or quantities of goods. regarded as the summation of all individual’s welfare in
the society.
Applications of Welfare Economics
(2) Pigouvian Welfare Conditions : Pigou regards
We know that welfare economic analysis is intended economic welfare and national income as essentially
to enable the economist to make policy recommendations coordinate. It is on this basis that he lays down two
so that social welfare is maximised. Such recommenda- conditions for maximisation of welfare.
tions may cover the diverse fields of the economy.
Hence, policy implications of welfare economics can be The first condition states that welfare is said to
numerous. We shall just pick up a few prominent ones : increase when national income increases. Given the
same taste and income distribution, an increase in the
(1) Pricing Policy of Public Undertakings : The national income represents an increase in welfare.
price and output policy of such undertakings must be Second, for welfare maximisation distribution of the
such as to maximise welfare. national income is equally important. If national income
remains constant, transfers of income from rich to the
(2) International Trade : There is no doubt that poor would improve welfare. Thus welfare conditions
trade policies, free trade or protectionist, have welfare are based on the dual Pigouvian postulates of equal
implications. If the post-trade position is actually better capacity for satisfaction and diminishing marginal utility
than the pre-trade position; and if the distribution of real of income.
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Assumptions of Pigouvian Conditions : the distribution implied by b increases the utility of A
without reducing the utility of B. Thus all the points
(1) Each individual tries to maximise his satisfac- from a to b represent improvements in social welfare in
tion from his expenditure on different goods and comparison to the distribution at Z.
services.
The marginal condition for a Pareto Optimal or
(2) It is further assumed that satisfactions are com- efficient distribution of commodities among consumers
parable both intrapersonally and interpersonally. requires that the MRS between two goods be equal for
(3) It is assumed that the law of diminishing marginal all consumers.
utility of income applies. MRSAAx, y = MRSBx, y .
(4) Another assumption is that of equal capacity for
satisfaction.
Given these assumptions, it is possible to satisfy the
Pigouvian conditions of maximum social welfare on the
basis of his dual criterion.
Its Criticism :
(1) The notion of maximisation is not clear.
(2) Pigou measures welfare cardinally.
(3) National income is not an accurate measure of
welfare.
(4) Pigou does not clarify the ethical relation of
welfare.
These drawbacks in the Pigouvian analysis have led
modern economists to propound the compensation (b) Efficiency of Allocation of Factors among
principle and the social welfare function. Producers : Efficiency in Production—To derive the
marginal condition for a Pareto Optimal allocation of
EFFICIENCY CRITERIA factors among producers we use an argument closely
analogous to the one used for the derivation of the
Pareto Optimality Criterion marginal condition for optimal distribution of commo-
dities among consumers.
According to this criterion any change that makes at
least one individual better off and no one worse off is an
improvement in social welfare.
The criterion can be stated in a different way–a
situation in which it is impossible to make any one better
off without making some one worse off is said to be
Pareto optimal or Pareto efficient.
For Pareto Optimality three conditions must be
satisfied which are known as marginal conditions.
(a) Efficiency of distribution of commodities
among consumers.
(b) Efficiency of allocation of factors among
firms. The marginal condition for a Pareto Optimal alloca-
(c) Efficiency in the allocation of factors among tion of factors requires that the MRTS between labour
commodity. and capital be equal for all commodities produced by
(a) Efficiency of Distribution of Commodities different firms.
among Consumer : Efficiency in Exchange—Applying MRTSAxLK = MRTSyLK
the Pareto Optimality criterion to the case of distribution
Pareto optimality condition for efficiency in produc-
of commodities X and Y between two consumers, A and
tion fullfiled only on production contract curve as shown
B, it will be efficient if it is impossible by redistribution
in the figure. Production contract curve can be found by
of these goods to increase the utility of one individual
joining the tangency points of isoquants X and Y.
without reducing the utility of the other. Only points on
the Edgeworth contract curve will satisfy the Pareto (c) Efficiency in the Composition of Out-put—
optimality condition. Any other distribution off the The third possible way of increasing social welfare is a
contract curve is inefficient. For example, point Z is change in the product mix. The marginal condition for a
inefficient since a redistribution of the commodities such Pareto Optimal or efficient composition of output
as to reach any point between A and B increases the requires that the MRPT between any two commodities
utility of both consumers. A movement to a increases the be equal to the MRS between the same two goods.
utility of B without reducing the utility of A. Similarly, MRPTx, y = MRSAx, y = MRSBx, y
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MRPT shows the rate at which a good can be points R, G and S. This means that by mere redistribution
transformed into another. of income between the two individuals, that is, if
individual B gives some compensation to individual A
Kaldor-Hicks Compensation Principle for the loss suffered, they can move from position T to
Economists like Kaldor and Hicks have made efforts the position R. It is evident from the figure that at
to evaluate the changes in social welfare resulting from position R individual A is as well off as at the position Q
any economic reorganisation which harms somebody but individual B is still better off as compared to the
and benefits the other. These economists have sought to position Q. Therefore, social welfare increases with the
remove indeterminacy in the analysis of Pareto Optima- movement from position Q to position T.
lity. They have put forward a criterion known as the
‘Compensation Principle’.
Assumptions :
(1) The satisfaction of an individual is independent of
the others.
(2) There exist no externalities of consumption and
production .
(3) The tastes of the individuals remain constant.
(4) Utility can be measured ordinally and interpersonal
comparisons of utilities are not possible.
(5) The problems of production and exchange can be
separated from the problem of distribution.
Kaldor was the first economist to give a welfare
criterion based on compensating payments. According to
Kaldor, if a certain change in economic organisation or Kaldor—Hicks Criterion Explained with Utility
policy makes some people better off and others worse Possibility Curve
off, then that change will increase social welfare if those Criticism
who gain from the change could compensate the losers
and still be better off than before. (1) This theory involves interpersonal comparisons
which new welfare economics wanted to avoid.
According to Hick, if A is made so much better by
the change that he could compensate B for his loss and (2) The principle would work only if the compensation
still have something left over, then the reorganisation is is actually paid by the gainers.
unequivocal improvement. (3) The payment of compensation creates its own
Kaldor—Hicks criterion can be explained with the difficulties.
help of the utility possibility curve. In the following (4) There is a problem of “the external effects”.
figure, ordinal utility of two individual A and B is (5) This theory isolated production and exchange from
shown on X and Y axis respectively. DE is utility possi- distribution and thus ignores distribution.
bility curve which represents the various combinations
Scitovsky Paradox—Scitovsky pointed out an
of utilities obtained by individuals A and B. As we move
important limitation of Kaldor Hicks criterion that it
downward on the curve DE, utility of A increases while
might lead to contradictory results. He showed that if in
that of B falls. On the other hand, if we move up on the
some situation position B is shown to be an improvement
utility curve ED, utility of B increases while that of A
over position A on Kaldor – Hicks criterion it may be
falls.
possible that position A is shown to be an improvement
Suppose the utilities obtained by A and B from over position B on the same criterion.
the distribution of income are represented by point Q. As
a result of some change in economic policy, the two
individuals move from point Q to point T on the utility
possibility curve DE. as a result of this movement,
utility of individual B has increased while the utility of
A has declined, that is, B has been become better off and
A has become worse off than before. Therefore, this
movement from point Q to point T cannot be evaluated
by means of Pareto criterion. We have to see whether the
individual B who gains with the movement from
position Q to position T could compensate the individual
A who is loser and still be better off than before. In the
figure the utility possibility curve DE passes through
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According to Scitovsky, Kaldor-Hicks criterion particular the value of the welfare index increases
involves such contradictory and inconsistent result. whenever the utility level of one individual is increased
Since Scitovsky was the first to point out this paradoxical without lowering that of the other individuals.
result in Kaldor-Hicks criterion, it is known as Scitovsky The social welfare function is explained diagra-
Paradox. mmatically in terms of the figure.
In this figure, FF1 is the Utility Frontier curve,
which presents the boundary of all utility combinations
Scitovsky’s Double Criterion of Welfare— possible with the given resources of the economy. W,
Scitovsky formulated a double criterion which requires W1 and W2 form the family of curves representing the
the fulfilment of Kaldor Hicks test and also the
fulfilment of the reversal test. It means that a change is social welfare functions. The welfare curve W1 depicts a
an improvement if the gainers in the changed situation higher level of social welfare than curve W and W3
are able to persuade the losers to accept the change and higher level than W2 . The point of maximum social
simultaneously losers are not able to persuade the welfare or optimum position is one where the utility
gainers to remain in the original situation. frontier curve FF1 is tangent to the welfare curve. In the
Thus, when the two utility possibility curves are figure, point “E” clearly represents the situation of
non intersecting and change involves movement maximum social welfare within the constraints of given
from a position on a lower utility possibility curve to technology and fixed quantities of inputs. Of all the
a position on a higher utility possibility curve. The welfare combinations open to society, E has the highest
change raises social welfare on the basis of Kaldor – social value. Point L is at a lower welfare curve and
Hicks-Scitovsky criterion. represents a lower levels of social welfare. Whereas
point C on the W2 curve is beyond the utility frontier
The Social Welfare Function
FF1 of the society. Thus point E represents maximum
The social welfare function represents another new
social welfare.
approach to welfare economics. This system of welfare
economics was first worked out by Prof. Bergson in his Assumptions
article “A Reformulation of Certain Aspects of Welfare The Bergson social welfare function is based on
Economics”. It has been endorsed and further developed certain assumptions :
by Prof. Samuelson and Tinter. The concept of social
welfare is an attempt at providing a scientifically (a) It assumes that social welfare depends on each
normative study of welfare economics. individual’s wealth and income and on the
A social welfare function shows the factors on distribution of welfare among the members of
which the welfare of a society supposed to depend. the society.
Bergson defines it “as a function either of the welfare of (b) It assumes the presence of external economies
each member of the community or of the quantities of and diseconomies with their consequent effects.
product consumed and services rendered by each (c) It is based on ordinal ranking of combinations
member of the community”. Thus the social welfare of those variables which influence individual’s
function is an ordinal index of society’s welfare and is a welfare.
function of individual utilities. It is expressed as : (d) Interpersonal comparisons of utility involving
W = F (U 1 , U2 … Un). value judgements are freely permissible.
Where W is the social economic welfare, F is for Main Features of Social Welfare Functions—
function, and U1, U2 … Un are the levels of utilities of 1, Following are the main features of the Bergson-
2 …… n individuals. W is an increasing function of Samuelson Social Welfare Function :
these utilities. 1. Social welfare function is based on explicit
The general properties of the social welfare function value judgements and involves interpersonal
are similar to those of an individual utility function. In comparisons of utility in ordinal terms.
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2. The maximum social welfare position is Compensation principle accepts the level of social
completely determined as a result of the welfare to be a function of the level of production. Thus
introduction of value judgements regarding it ignores the effects of a change in distribution on social
distribution of welfare among individuals welfare.
3. It is not based on any unique value judge- (e) Utility can be measured ordinally and inter-
ments. Instead, any set of value judgement personal comparisons of utilities are not possible.
can be used by a welfare economist to construct
a social welfare function. Thus, it is not any Scitovsky Paradox
unique function but changes with the change in
value judgements. Scitovsky pointed out an important limitation of
Kaldor-Hicks criterion that it might lead to contradictory
4. Once the social welfare function has been
results. He showed that if in some situation position A
decided upon by value judgements, the maximi-
on Kaldor-Hicks criterion, it may be possible that
sation technique is used to obtain the maximum
position A is also shown to be an improvement over B
social welfare position at which allocation of
on the basis of some criterion. For getting consistent
resources is Pareto optimum and also the
results when position B has been revealed to be
distribution of goods and services is equitable.
preferred to position A on the basis of a welfare
5. Used along with the Pareto optimality analysis criterion, then position A must not be preferred to
the concept of social welfare function enables position B on the same criterion. According to
us to find a unique optimum solution, generally Scitovsky, Kaldor-Hicks criterion involves such
called the point of bliss. contradictory and inconsistent results. Since Scitovsky
Its Criticism—There are following limitations of was the first to point out this paradoxical result in
this criterion : Kaldor-Hicks criterion, it is known as ‘Scitovsky-
(1) The social welfare function is analogous to the Paradox’. How kaldor-Hicks criterion may lead to
individual consumer’s utility function. contradictory results in some situations is depicted in
(2) Another difficulty arises with regard to the figure. In this figure JK and JH are the two utility
construction and shape of the welfare function. possibility curves which intersect each other. Now
suppose that the initial position is at point C on JK.
(3) The representation of the social welfare
Further suppose that due to a certain policy change,
function in terms of either equations or social
utility possibility curve changes and takes the position
indifference curves does not help to solve the
GH and the two individuals find themselves at position
problem, because individual welfare functions
D. Position C is superior to position D on Kaldor-Hicks
cannot be known.
criterion because from position D movement can b e
(4) According to Little, the maximum is a concept made through mere redistribution to position F at which
without any possible empirical significance; both individuals are better off as compared to the
and therefore it seems preferable not to use it. original position C. Thus movement from position C to
(5) Prof. Arrow points out that the construction of a position D satisfies Kaldor-Hicks criterion. But, as has
social welfare function on the basis of ordinal been pointed out by Scitovsky, reverse movement from
preferences leads to contradictory results. position D on the new utility possibility curve GH to the
position C on the old utility possibility curve JK also
The Compensation Criteria or New Wel- represents an improvement on Kaldor-Hicks criterion,
fare Economics that is, C is socially better than D on Kaldor-Hicks
The compensation criteria also known as the New criterion. This is because from position C movement can
Welfare Economics, have been formulated by Hicks, be made by mere redistribution of income to position E
Kaldor and Scitovsky. Accepting Pareto’s ordinal as the utility possibility curve JK on which position C
measurement of utility and the impossibility of its lies also passes through the position E.
interpersonal comparisons, they tried to show that social
welfare could be increased without making value
judgements.
Assumptions—The various compensation criteria
are based on the following assumptions :
(a) Each individual’s satisfactions are independent
from the others so that he is the best Judge of his
welfare.
(b) There is the absence of external effects in
production and consumption.
(c) The tastes of the individuals remain constant.
(d) The problems of production and exchange can
be separated from the problems of distribution. Scitovsky Paradox
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And, as will be observed from figure, at position E However, Bergson and Samuelson did not deal with
both the individuals are better off than at D. We thus see the question as to how to get these value Judgements or
that the movement from position C to the position D due what these value Judgements could be for constructing a
to a policy change is passed by the Kaldor-Hicks social welfare function. It was this problem left
criterion and also the movement back from position D to untouched by Samuelson and Bergson, which was
position C is also passed by the Kaldor-Hicks criterion. explored by Arrow in his path breaking work “Social
This implies that D is socially better than C on this Choice and Individual Values”. K.J. Arrow in his
criterion and C is also socially better than D on the same social choice and Individual values has demonstrated the
criterion. So Kaldor-Hicks criterion leads us to impossibility of obtaining the social welfare function
contradictory and inconsistent results. It is mention even if individual preferences are consistent. He suggests
worthy that these contradictory results are obtained by five minimum conditions or criteria which social choices
Kaldor-Hicks criterion when following a policy change must satisfy in order to reflect preferences of individuals.
new utility possibility curve intersects the former utility They are as follows :
possibility curve. After bringing out the possibility of 1. Collective Rationality
contradictory results in Kaldor-Hicks criterion which is 2. Responsiveness to Individual Preferences
generally known as Scitovsky’s Double Criterion. 3. Non-imposition
Its Criticism 4. Non dictatorship
The compensation principle has been bitterly 5. Independence of Irrelevant Alternatives Arrow
criticised by the various welfare economists. demonstrates that it is not possible to satisfy all these
1. The Kaldor-Hicks compensation principle, five conditions and obtain a transitive social choice for
according to Dr. Little, is merely a definition and each set of individual preferences without violating at
not a test of increase in welfare because it ignores least one condition. In other words, social choice is
income distribution. inconsistent or undemocratic because no voting system
2. Compensation principle is not free from value allows these five conditions to satisfied. This has come
Judgements as is claimed by its propounders. It involves to be known as the Arrow Impossibility Theorem.
implicit value Judgements. Its Criticism Arrow’s general impossibility theorem
has been criticised by Samuelson, Little and other
3. Kaldor and Hicks think that the level of
welfare economists.
production is the main determinant of social welfare and
the distribution a secondary one. But this is quite According to Little, Arrow’s negative conclusions
untenable. This is because welfare has dual aspect : have no relevance in welfare economics. His impo-
absolute and relative. People are dissatisfied not only ssibility theorem relates to a decision making process
because they are poor but more because other peoples and not to a social welfare function.
are very rich. If all the people would have been poor Baumol shows that “Arrow’s requirements are more
they would not have been dissatisfied very much. Thus a strict than they seem at first view and that inconsistent or
lower total output equitably distributed is preferred to “undemocratic” social choice making is not really the
larger output, inequitably distributed, from the point of only alternative.
view of social welfare. Moreover, the Arrow theorem is based on the
4. This criterion does not take into consideration the assumption of a majority voting pattern which does not
payment of actual compensation. It recognises only take into consideration the possibility of a voting system
potential compensation with which actual increase in that requires unanimity and permits buying and selling
welfare cannot be measured. of votes.
5. Compensation principle does not take into Asymmetric Information : Adverse
account the external effects on consumption and Selection and Moral Hazards
production. The exponents of compensation principle Asymmetric information, also called information
are of the opinion that an individual’s welfare depends failure, happens when one party to a transaction has
solely upon his own level of production and greater material knowledge than the other party.
consumption and is not effected by the production and Typically, the more knowledgeable party is the seller.
consumption activities of the others. But this is not a Symmetric information is when both parties have equal
realistic assumption because a person’s level of knowledge. Asymmetric information, as the adjective
satisfaction (or dissatisfaction) depends to a large extent indicates, refers to situations, in which some agent in a
upon the consumption of goods and seryices by other trade possesses information while other agents involved
persons. in the same trade do not. This rather self-evident premise
Arrow’s Social Choice and Individual has nevertheless revolutionized modern economic
thought since the 1970s. The first major breakthrough in
Values relation to asymmetric information was the first
Bergson and Samuelson made significant contri- fundamental theorem of welfare economics and the
bution to welfare economics by introducing explicit second was Modigliani-Miller theorem. The first
value Judgements in the form of social welfare function. welfare theorem states that in a competitive economy
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with no externalities, prices would adjust so that the exchange, the insurance covers all the costs due to any
allocation of resources would be optimal in the Pareto traffic accident. In this hypothetical world of perfect
optimality. A key assumption for the theorem to hold is information, such contract would be optimal in that it
that the characteristics of all products traded on the transfers all uncertainty from risk-averse drivers on to
market should be equally observed by all agents. When risk- neutral insurance companies. However, putting a
such assumption fails to hold, i.e., when information is camera in every car is not (yet) feasible. If insurers keep
asymmetric, prices are distorted and do not achieve offering the same contract, drivers are fully insured
optimality in the allocation of resources. Standard against risks that are independent of their driving but
government interventions such as regulation of also against risks arising from their own misbehavior.
monopolies to replicate a competitive environment, or This would lead to a less careful driving, an increase in
fiscal policy to alleviate the effects of externalities, are the number of accidents and a larger risk-premium. In
no more sufficient to restore optimality. The Modigliani- this situation, drivers are the first to be harmed by such
Miller theorem concluded that the value of a firm is outcome. Thus, a departure from full coverage is
independent of its financial structure. The desirable to create the incentives to drive carefully. In
acknowledgment of asymmetric information within short, an optimal contract in an environment with moral
organizations shifted the debate on optimal financial hazard must tradeoff insurance and the provision of
structure from fiscal considerations, to the provision of incentives. The application of deductibles, and the
incentives to align the interests of managers and workers prospects of increased insurance premiums following
with the interests of stakeholders. repeated accidents are examples of measures to induce
Moral Hazard careful driving. Holmström (1979) and Grossman and
Hart (1983) made determinant methodological
Moral hazard occurs when a party that has agreed to contributions to the understanding and analysis of the
a transaction provides misleading information or principal-agent paradigm.
changes their behavior because they believe that they
won't have to face any consequences for their actions. It Adverse Selection
is the risk that one party has not entered into the contract
in good faith or has provided false details about its Adverse selection describes a situation in which one
assets, liabilities or credit capacity. In addition, moral party that has agreed to a deal have more accurate and
hazard may also mean a party has an incentive to take different information than the other party. The party
unusual risks in a desperate attempt to earn a profit with less information is at a disadvantage to the party
before the contract settles. with more information. The asymmetry causes a lack of
The case in which the information asymmetry efficiency in the price and quantity of goods and
occurs after an agreement is obtained between services. Most information in a market economy is
individuals, is called moral hazard. The framework often transferred through prices, which means that adverse
used to analyze moral hazard situations is the principal- selection tends to result from ineffective price signals.
agent problem, whereby one individual – the principal – The literature on adverse selection then investigates
wants to hire another individual – the agent – to perform arrangements that allow segmentation of the market
a given task. However, once the contract has been according to unobserved quality, i.e., how insurance
signed, the agent can either take an action that is non- companies and banks screen their customers with the use
observable for the principal (hidden action), or obtain of deductibles and collateral requirements , sellers signal
information about some characteristics of the the quality of their products by offering product-
environment that the principal cannot acquire (hidden warranties to customers, or workers signal their ability
information). As opposed to the previous case, in which by getting academic degrees.. It is important to
agents were offered a menu of contracts, moral hazard emphasize that market segmentation does not primarily
situations imply that every agent is given the same come from some information inherent to, say, warranties
contract; the contract must therefore take into account or deductibles, but rather from a menu of contracts
future information asymmetries, and hence address the offered to agents that leads to self-selection, revealing
incentives problem. Mirrlees (1999), Holmström (1979) their private information. In the examples mentioned
and Grossman and Hart (1983) were key contributions to above, such menus would be of the form (low insurance
this literature. To illustrate this phenomenon, let’s premium; high deductible) or (high insurance premium;
consider the car insurance market developed in Mirrlees low deductible), and in the product market example, of
(1999): a driver – the agent – wants to buy insurance the form (low price, no warranty) or (high price, one-
from an insurance company – the principal. The source year warranty). Such menus then induce careful drivers
of concern is that once the insurance contract is signed, to opt for a (low premium; high deductible) contract,
the insurance company cannot observe whether the while less careful drivers prefer to pay a high premium
driver is careful enough. Suppose that the insurance and face a low deductible in case of accident. Similarly,
company can put in every single car a camera to monitor sellers of high quality goods will want to charge a high
how the driver behaves. Then, it could convene with the price but offer in exchange a one-year warranty to
driver that she would henceforth drive carefully (after customers; a policy that low-quality-good sellers are not
agreeing on the definition of what “carefully” means). In willing to mimic.
94U | Economics (NET)
Moral Hazard vs. Adverse Selection between the individual who smokes and doesn't exercise
Example and the other person.
For an example of moral hazard, consider the The insurance company asks the individuals to fill
implications of buying insurance. Let's assume a out questionnaires to distinguish them. However, the
homeowner does not have homeowners insurance or individual that smokes and doesn't exercise knows that
flood insurance and lives in a flood zone. The answering truthfully means higher insurance premiums,
homeowner is very careful and subscribes to a home so he lies and says he doesn't smoke and exercises daily.
security system that helps prevent burglaries. When This leads to adverse selection, where the life insurance
there are storms, he prepares for floods by clearing the company is at a disadvantage and then charges the same
drains and moving furniture to prevent damage. premium to both individuals. However, insurance is
However, the homeowner is tired of always having to more valuable to the non-exercising smoker than the
worry about potential burglaries and preparing for exercising non-smoker because one party has more to
floods, so he buys the home and flood insurance. After gain. The non-exercising smoker needs health insurance
his house is insured, his behavior changes and he is less more and benefits from the lower premium.
attentive, he leaves his doors unlocked, cancels the home Key features of the asymmetric information and
security system subscription and does not prepare for moral hazards are the following :
floods. In this case, the insurance company is faced with ● Both moral hazard and adverse selection are terms
the risks of floods and burglaries and their consequences, used in economics, risk management, and insurance
and the problem of moral hazard arises. to describe situations where one party is at a
Life insurance premiums can be a way of disadvantage to another.
looking at an example of adverse selection. Let's assume
there are two sets of people in the population, those who ● Moral hazard is the risk that one party has not
smoke and do not exercise, and those who do not smoke entered into the contract in good faith or has
and do exercise. It is common knowledge that those who changed their behaviour after a deal is struck
smoke and don't exercise have shorter life because they believe that they won't have to
expectancies than those who don't smoke and do face any consequences.
exercise. Suppose there are two individuals who are ● Adverse selection is when sellers have information
looking to buy life insurance—one who smokes and that buyers do not have, or vice versa, about some
does not exercise— and one who doesn't smoke and aspect of product quality. It is also the tendency of
exercises daily. However, the insurance company, those in dangerous jobs or high-risk lifestyles to
without further information, cannot differentiate purchase life insurance.
Economics (NET) | 95U
Objective Questions
1. A high value of cross-elasticity indicates that the (C) Utility first increases and after that diminishes
two commodities are— at every point
(A) Very good substitutes (D) The additional benefit which a person derives
(B) Poor substitutes from a given increase of his stock of a thing
(C) Good complements diminishes with every increase in stock that he
already has
(D) Poor complements
9. Marginal utility (MU) curve is always—
2. The vertical demand curve for a commodity shows
that its demand is— (A) Rising (B) Falling
(A) Highly elastic (B) Perfectly elastic (C) Parallel to x-axis (D) Parallel to y-axis
(C) Fairly elastic (D) Moderately elastic 10. The total utility is maximum when—
3. Utility may be defined as— (A) M.U. is zero
(A) The power of a commodity to satisfy wants (B) A.U. is the highest
(B) The usefulness of a commodity (C) M.U. is the highest
(C) The level of satisfaction given by a commodity (D) M.U. is equal to A.U.
(D) The desire for a commodity 11. The falling part of a TU curve show—
4. The economically relevant range of the total utility (A) Increasing marginal utility
curve is the portion over which— (B) Decreasing marginal utility
(A) The total utility is rising at a declining rate (C) Zero marginal utility
(B) The total utility is rising at an increasing rate (D) Negative marginal utility
(C) The total utility is maximum and constant 12. MU of nth unit is found by the following formula—
(D) The total utility is declining TU
(A) (B)TU n
5. After reaching the saturation point, consumption of n
additional units of the commodity cause— (C) TUn – TU(m – 1) (D)TU + n
(A) Total utility to fall and marginal utility to 13. Total utility curve is—
increase (A) Concave to x-axis
(B) Total utility and marginal utility both to (B) Convex to x-axis
increase
(C) Concave or convex depending on situations
(C) Total utility to fall and marginal utility to
(D) Concave to y-axis
become negative
(D) Total utility to become negative and marginal 14. ‘Utils’ is a term used—
utility to fall (A) By Marshall in Demand theory
6. Which of the following concepts are most closely (B) By Walras to measure cardinal utility
associated with Alfred Marshall ? (C) To mean Marginal utility
(A) Marginal utility theory (D) None of the above
(B) Price mechanism under monopoly 15. Given below is the MU schedule for commodities x
(C) Modern theory of wage and y—
(D) Interest theory
MUx 11 10 9 8 7 6
7. The law of Equi-Marginal utility states—
MUy 9 17 15 13 12 10
(A) MUx · P x = MUy · P y = MUz · Pz
MUx MUy MUz If price is Re. 1 permit in each case the consumer
(B) = = = MUm
Px Py Pz will spend his 10th rupee on—
MUx MUy MUz (A) Commodity x
(C) = = > MUm
Px Py Pz (B) Commodity y
MUx MUy MUz
(D) < = < MUm (C) Commodity x and y
Px Py Pz
(D) Save from both
8. Law of diminishing Marginal utility states—
(A) Total utility diminishes with the consump- 16. A consumer will be in equilibrium if he consumes
tion of every additional unit three commodities when—
(B) Utility always diminishes whether something Price of x Price of y Price of y
(A) = = =K
is consumed or not Price of y Price of x Price of x
96U | Economics (NET)
MUx MUy MUz (C) Any departure from the equilibrium position
(B) < = K calls into play forces which end to restore that
Px Py Pz
position
(C) P x = Py = Pz = Z
(D) There are endless oscillations
(D) MUz = MUx = MUy
24. Put into chronological order on the basis of
17. A consumer will be maximizing his utility if he development—
allocated his money income so that— 1. Law of demand
(A) The marginal utility of the last unit of each 2. Law of indifference
product consumed is equal 3. Law of diminishing marginal utility
(B) The marginal utility from he last rupee spent 4. Revealed preference curve
on each purchased product is the same 5. Indifference curve
(C) Elasticity of demand is the same for all (A) 1 2 3 4 5
purchased products (B) 1 5 3 4 2
(D) Total utility gained from each product consu- (C) 1 3 2 5 4
med is the same (D) 1 3 4 2 5
18. Adam Smith spoke about the famous diamond 25. Match the following :
water paradox to show that— List-I
(A) Utility is related to supply (a) Principles of Economics
(b) Diamond water paradox
(B) Utility is related to demand
(c) Value and Capital
(C) Utility could be the cause of value (d) Asian Drama
(D) Utility could not be the cause of value (e) Language of Economics
19. The area which lies under the demand curve for a List-II
given good measures—
1. Gunnar Myrdal 2. J.K. Galbraith
(A) Marginal utility 3. Alfred Marshall 4. J. R. Hicks
(B) Total utility 5. Adam Smith
(C) Disutility Codes :
(D) Marginal cost of production (a) (b) (c) (d) (e)
20. A consumer reaches equilibrium at the point (A) 1 2 3 5 4
where— (B) 2 4 3 5 1
(A) MU = P (B) MU < P (C) 5 2 3 1 4
(C) MU > P (D) TU = P (D) 3 5 4 1 2
(E) 4 5 3 2 1
21. Which of the following is most closely connected
with Paul A. Samuelson ? 26. The price which a consumer would be willing to
(A) Indifference curve analysis pay for a commodity equals to his—
(B) Marginal utility analysis (A) Total utility
(C) Revealed preference theory (B) Marginal utility
(D) Liquidity preference theory (C) Average utility
(D) Does not have any relation to any one of these
22. After reaching the saturation point additional unit of
the commodity causes— 27. The concept of indifference curves analysis was
(A) Total utility to fall and marginal utility to given scientific touch by—
become negative (A) Irving Fisher in 1982
(B) Total utility and marginal utility both to (B) F.Y. Edgeworth in 1881
increase (C) Slutsky in 1915
(C) Total utility and marginal utility both to (D) Alfred Marshall in 1921
decrease 28. Other things remaining the same, when a consumer’s
(D) Total utility become negative and marginal income increases, his equilibrium point moves to—
utility to fall (A) A higher indifference curve
23. A stable equilibrium position is one in which— (B) A lower indifference curve
(A) There are never any departures from the (C) Remains unchanged on the same indifference
equilibrium position curve
(B) There are only two forces influencing equili- (D) Moves to the left-hand side on the same
brium indifference curve
Economics (NET) | 97U
29. The general equation of the budget constraint line 36. The amount of a commodity that the consumer
is— would purchase per unit of time at various levels of
(A) P y . Qx + Py . Qy = M his income is shown by—
Px (A) Contract curve (B) Lorenz curve
(B) = Qx (C) Engel curve (D) Indifference curve
M
(C) Qx . Px = M + Py 37. All the points on a budget line represent—
(D) P x + Py = O (A) Increasing total expenditure
30. Goods X and Y are perfect substitutes. A consu- (B) Decreasing total expenditure
mers’s indifference curve for these commodities (C) The same total expenditure
is represented by a— (D) None of the above
(A) Upward sloping straight line MUx MUx
(B) Upward sloping curve which is convex from 38. If the for individual A is greater than the
MUy MUy
below
for individual B it is possible for individual A to
(C) Downward sloping straight line
gain by giving up—
(D) Downward sloping curve which is convex to
origin (A) Y in exchange for more X from B
(B) Y in exchange for more X from A itself
31. The indifference curve which is ‘L’ shape
represents— (C) Y in exchange for less X from B
(A) Perfect complementarity (D) X in exchange for less Y from A
(B) Perfect substitutability 39. For perfect substitutability between x and y—
(C) Non-substitutability (A) MRSxy will be constant
(D) Non-complementarity (B) MRSxy will be decreasing
32. “We are much better off when drawing purely (C) MRSxy will be increasing
imaginary indifference curves than we are when
(D) None of the above
speaking of purely imaginary utility functions.”
This is remarked by— 40. Match the following —
(A) J. R. Hicks (B) Allen List-I
(C) Schumpeter (D) Paul A. Samuelson
(a) Various combinations that a consumer can
33. When the price of one commodity in a combination purchase.
of commodities falls in such a way that the (b) Various combinations of two Commodities
consumer’s real income changes but he remains on that give consumer equal satisfaction.
the same level of satisfaction as before, It is known
as— (c) A set of indifference curves.
(A) Income effect (d) Point of tangency of a budget line and an
(B) Variation effect indifference curve.
(C) Price effect List-II
(D) Compensating variation in income 1. Indifference map
34. If two goods are perfect substitutes for each other, it 2. Indifference curve
necessarily follows that— 3. Budget line
(A) An indifference curve relating the two goods 4. Consumer’s equilibrium
will be curvilinear
Codes :
(B) An indifference curve relating the two goods
will be linear (a) (b) (c) (d)
(C) An indifference curve relating the two goods (A) 1 2 4 3
will be divided into two segments which meet (B) 4 3 1 2
at a right angle (C) 2 3 4 1
(D) An indifference curve relating the two goods (D) 3 2 1 4
will be convex to the origin
41. Match the following —
35. MRS xy and MRSyx both will be zero where the
commodity x and y are— List-I
(A) Complement to each other (a) Cardinal approach
(B) Substitutes to each other (b) Ordinal approach
(C) Perfect complementarity (c) Hicks-Allen approach
(D) Imperfect complementarity (d) Consumer’s surplus
98U | Economics (NET)
List-II (C) Is equal to the substitution effect
1. Marginal utility (D) More than offsets the substitution effect
2. Alfred Marshall 46. The substitution effect works to encourage a
consumer to purchase more of a product when the
3. J.R. Hicks price of that goods is falling because—
4. Indifference curve (A) The consumer’s real income has increased
5. Revealed preference theory (B) The consumer’s real income has decreased
Codes : (C) The product is now relatively less expensive
(a) (b) (c) (d) the before
(A) 1 2 3 4 (D) Other products are now less expensive than
(B) 1 5 4 2 before
(C) 1 3 4 2 47. The total effect of a price change of a commodity
is—
(D) 1 3 2 4
(A) Substitution effect + Price effect
42. Price effect in indifference curve analysis arises— (B) Substitution effect + Income effect
(A) When the consumer becomes either better off or
(C) Substitution effect + Demonstration effect
worse off because price change is not
compensated income change (D) Substitution effect – Income effect
(B) When income and price change 48. In the following diagram, consumer’s surplus is
(C) When the consumer is better off due to a shown by—
change in income and price
(D) None of the above
Directions : Followings two Questions are based on
the following figure—
(A) OPEX (B) ODEX
(C) PDE (D) None of these
49. Average product of labour is defined as—
ΔQ Q
(A) (B)
ΔL L
dQ L
(C) (D)
dL Q
43. If curve IC2 represents the income consumption 50. In the following diagram, when price of the
curve, then we can conclude that— commodity decreases from p1 to p 2 , the gain in
(A) X only is an inferior good consumer surplus is equal to—
(B) Y only is an inferior good
(C) Both X and Y are inferior good
(D) X only is a superior good
44. If we assume that curve IC, is the income
consumption curve, it can be concluded that—
(A) Only Y is an inferior good
(B) Neither Y nor X is an inferior good
(C) Only X is an inferior good
(D) X is inferior but Y is a superior good
45. In the case of an inferior good, the income effect—
(A) Partially offsets the substitution effect (A) A P1 B (B) A P2 C
(B) Reinforces die substitution effect (C) P 1 P2 C B (D) B S C
Economics (NET) | 99U
51. Total product will be maximum when— 56. An isoquant for perfect substitutes would be—
(A) M P is maximum (B) A P is maximum (A) Right angled shape
(C) M P is zero (D) M P negative (B) Negatively sloped straight line
52. Match List-I to List-II and choose correct code— (C) Straight line parallel to the x – axis
List-I (D) Straight line parallel to the y – axis
(a) Cardinal utility Analyses 57.
(b) Ordinal Utility Analyses
(c) Strong Ordering
(d) Law of equi marginal utility
List-II
1. Marshall 2. Hicks and Allen
3. Samuelson 4. Gossen
Codes :
(a) (b) (c) (d)
(A) 1 2 3 4
(B) 2 3 4 1
(C) 1 3 2 4 Isoquants shown in the above diagram exhibit.
(D) 4 3 2 1 1. Perfect substitutability of factors.
53. Which of the following is not a reason of dimi- 2. Perfect complementarily of factors.
nishing returns to a factor ? 3. Fixed proportion production function.
(A) Scarcity of fixed factor 4. Variable proportions production function.
(A) 1 and 2 only (B) 1 and 3 only
(B) Scarcity of variable factor
(C) 3 and 4 only (D) 2 and 3 only
(C) Indivisibility of the fixed factor
(D) Imperfect substitutability of factor 58. When there is constant returns to scale, then the
production function is described as—
54. Match list-I and List-II and choose the correct
(A) Linearly homogeneous production function
code—
(B) Homogeneous production function of degree
List-I
two
(a) Consumer surplus (C) Non-homogeneous production function
(b) Concept of compensating variation (D) None of these
(c) Utility Index Number
59. In Cobb-Douglas production function elasticity of
(d) Input–output model
factor substitution is equal to—
List-II (A) Zero (B) Infinity
1. Leontief (C) One (D) 0 < es < 1
2. Newman Morgenstern
60. In Cobb – Douglas production function Q = ALa K1-a
3. Hick the share of labour in total production is—
4. Marshall (A) a (B) 1 - a
Codes : (C) A (D) a . L
(a) (b) (c) (d) 61. A change in the relative price of the two goods with
(A) 1 2 3 4 the levels of satisfaction remaining same is related
(B) 4 3 2 1 to—
(C) 4 2 3 1 (A) Income effect (B) Substitution effect
(D) 1 4 3 2 (C) Price effect (D) None of these
55. Which of the following is not true about 62. If an increase in real income, ceteris paribus, causes
isoquants ? of reduction in the demand for potatoes and a rise in
the demand for meat, then which of the following is
(A) An isoquant slopes downward to the origin correct ?
(B) Isoquants are concave to the origin (A) Potatoes is a inferior good
(C) Isoquants are convex to the origin (B) The income elasticity of demand for potato is
(D) Isoquants cannot intersect each other positive
100U | Economics (NET)
(C) The income elasticity of demand for meat is
negative
(D) All of the above
(C)
63. If all inputs are increased in the same proportion,
then it is the case of—
1. Short-run production function.
2. Long-run production function.
3. Laws of variable proportion.
4. Laws of returns to scale. (D)
(A) 1 and 2 only (B) 2 and 3 only
(C) 1 and 4 only (D) 2 and 4 only
64. Which of the following is not the reason for
increasing returns to scale ? 67. Following symbols are given—
(A) Indivisibility of the factors K → Capital, L → labour, W → wage rate R → rate
of interest, C → cost of production The slope of the
(B) Fuller utilization of fixed factors iso-cost line is given by—
(C) Greater specialization of factors C C w
(D) Dimensional economies (A) (B) – · L
w r r
65. Match List-I with List-II and select correct code— w
(C) (D) None of these
r
List-I
68. Iso-cost line shows—
(a) Input–output isoquant
(A) Various combinations of two factors that the
(b) CES production function
firm can buy with a given outlay
(c) Duopoly model
(B) Various combinations which are capable of
(d) Kinked demand curve producing the same level of output
List-II (C) Various combination of two commodities
1. Arrow and chenery 2. Leontief which given equal satisfaction
(D) Various combinations of two commodities that
3. P. Sweezy 4. Cournot
can be purchased that can be purchased with
Codes : given income
(a) (b) (c) (d) 69. Condition for the producer’s equilibrium is—
(A) 1 3 2 4 MPL w MPL MPK
1. = 2. =
(B) 2 1 4 3 MPK r w r
(C) 1 2 3 4 3. Isoquant should be tangent to the iso-cost line.
(D) 2 1 3 4 4. Isoquent should be convex to the origin at the
point of tangency.
66. Which of the following figures shows increasing (A) 1 and 2 only (B) 2 and 3 only
returns to scale ? (C) 1, 2 and 3 only (D) 1, 2, 3 and 4
70. An increase in supply of a commodity causes—
(A) A increase in equilibrium price and increase
in equilibrium quantity
(A)
(B) A decrease in equilibrium price and increase in
equilibrium quantity
(C) A increase in equilibrium price and decrease in
equilibrium quantity
(D) A decrease in equilibrium price and decrease
in equilibrium quantity
71. Economic cost consists of—
(B) 1. implicit cost 2. explicit cost
3. normal profit
(A) 1 and 2 only (B) 2 and 3 only
(C) 1 and 3 only (D) 1, 2 and 3
Economics (NET) | 101U
72. Opportunity cost refers to— 79. The marginal product curve is above the average
(A) Money expenses incurred on factors product curve when the average product is—
(B) The imputed value of the inputs owned by the (A) Increasing (B) Decreasing
firms (C) Constant (D) None of these
(C) The next best alternative 80. When the output produced is maximum for the
(D) None of these given level of inputs the firms achieve—
73. The efforts and sacrifices made by the owners of (A) Maximum profits
factors of production used in the production of a (B) Technical efficiency
commodity is known as— (C) Economic efficiency
(A) Opportunity cost (B) Implicit cost (D) None of these
(C) Explicit cost (D) Real cost 81. The social costs are the sum of the private costs
74. Which of the following is correct regarding long run and—
cost ? (A) The net of economic damages inflicted on
1. It is least cost of producing each level of others
output. (B) The imputed value of the inputs owned by the
2. LAC curve is envelope of SAC curves. firm
3. LAC is U-shaped (C) Sacrifices made by the owners of factors of
Choose the right code— production
(A) 1 and 2 only (B) 2 and 3 only (D) Payments charge made by the entrepreneur
(C) 1 and 3 only (D) 1, 2 and 3 82. “The more nearly perfect a market is, the stronger is
75. Point of inflexion is the point at which— the tendency for the same price to be paid for the
same thing at the same time in all parts of the
(A) Marginal product increases market”, is the definition of perfect competition
(B) Marginal product decreased by—
(C) Marginal product is at its maximum (A) Prof. Benham (B) J.S. Mill
(D) Marginal product becomes zero (C) Jevons (D) Prof. Marshall
76. Under the law of variable proportion, stage I is 83. For a unitary elasticity of demand curve, the amount
known as the stage of increasing returns because— spent by a consumer on a good—
(A) Marginal product of the variable factor (A) Remains constant when price changes
increases throughout this stage (B) Increases when price changes
(B) Average product of the variable factor (C) Decreases when price increases
increases throughout this stage (D) Decreases when price decreases
(C) Marginal product increases at the increasing
rate throughout this stage 84. MC = MR and MR = AR means—
(A) The equilibrium position of a firm in the long
(D) Total product increases at the increasing rate
period
throughout this stage
(B) The equilibrium point of a firm under imperfect
77. In the second stage of the law of variable propor- competition in the short period
tion— (C) The equilibrium point of a firm under perfect
(A) Marginal product diminishes and average competition
product increases (D) A short period equilibrium of a firm under
(B) Average product diminishes but marginal perfect competition
product increases 85. Which of the following statements is not correct ?
(C) Both marginal product and average product (A) In the short-run, the monopolist makes a profit
diminish (B) The impositions of maximum price at the point
(D) Both marginal product and average product where the monopolist’s SMC curve intersects
increase his D curve, that causes monopolist to make
profit
78. I n CES production function elasticity of factor (C) Under price discrmination, demand elas-
substitution is— ticities are different in different markets
(A) Unity (D) None of these
(B) Zero 86. In the case of monopolistic competition—
(C) Infinite (A) The long-run supply curve can be defined
(D) Can take any positive constant value (B) The long-run supply curve can’t be defined
102U | Economics (NET)
(C) The short-run supply curve can’t be defined 2. A profit maximising monopolist in separate
(D) The short-run supply curve can be defined markets will not adjust his sales.
87. Which of the following statements is correct ? 3. A profit maximising monopolist in separate
markets will adjust his sales in the two markets
1. One way the government can induce a so that his MR in each market will greater than
monopolist to expand his output is by imposing MC.
a price ceiling that make the monopolist lower 4. A profit maximising firm in separate markets
his price. will adjust his sales in each market so that his
2. MC = MR = AC = AR shows the equilibrium MR is less than MC.
position of the competitive firm. 5. All of these
3. One way the government can induce a mono- (A) 1 and 4 only (B) 1 only
polist to expand his output by imposing a price (C) 5 only (D) 1 and 3 only
floor that makes the monopolist raise his price.
4. One way the government can induce a mono-
polist to expand his output by imposing a
specific tax on the monopolist output.
(A) 1 and 2 only (B) 3 and 4 only
(C) 2 only (D) 1, 2 and 3 only
88. Marginal cost is equal to marginal revenue, average
cost is equal to average revenue, average revenue is
equal to marginal revenue and average cost is equal,
to marginal cost This is the condition of—
1. Long period equilibrium for a firm under Output (A) Output (B)
monopoly. The question 92 to 95 are based on above diagram.
2. Short period equilibrium for a firm under 92. The figure A represents—
oligopoly. (A) The equilibrium position of an industry
3. Long period equilibrium. (B) The equilibrium position of a firm
4. Long period equilibrium for a firm under (C) The equilibrium position of a perfectly
perfect competitions. competitive industry
5. Short period equilibrium for a firm under (D) The equilibrium position of a perfectly
perfect competitions. competitive firm in the long-run
(A) 1 and 5 only (B) 3 and 4 only
93. The figure B represents—
(C) 3 and 1 only (D) 2 only
(A) The equilibrium of a firm
89. At a particular price level, there are no forces (B) The equilibrium of a long-run perfectly
tending to move it either up or down means— competitive firm
1. The firm is in equilibrium. (C) The equilibrium of a short-run competitive
2. The price is in equilibrium. firm
3. The equilibrium price of the firm. (D) None of the above
4. The equilibrium price and quantity of a firm. 94. In figure B, A, B, C, represents—
(A) 1 and 4 only (B) 1, 2 and 4 only
(A) SMC, SAC and STC
(C) 1 and 3 only (D) 4 only
(B) LMC, SAC and AR = AC
90. Under perfect competition : which of the following (C) LMC, LAC, and AR = AC
equation is/are true ? (D) LMC, LAC and AR = MR
1. MC = P 2. MC > P
95. This figure represents—
3. MC < P 4. None of these
(A) Short-run equilibrium under perfect compe-
(A) 1 and 3 only (B) 4 only tition in the industry and firm
(C) 1 only (D) 3 only (B) Long-run equilibrium under Perfect compe-
91. Which of the following statements is correct ? tition in both industry and firm
1. A profit maximising monopolist in different (C) Long-run equilibrium under imperfect compe-
markets will adjust his sales in the two markets tition in the industry and firm
so that his MR in each market just equals his (D) Long-run equilibrium under oligopolistic com-
MC. petition in the industry only
Economics (NET) | 103U
96. P/MC is the same for all products at equilibrium 102. If the monopoly profits were to add to costs so that
level, then the level of output may be known as— costs equalled revenue, even if the average cost
(A) ‘Optimum’ level curve exclusive of profits was rising, the average
(B) ‘Ideal’ level cost curve obtained from the first operation is—
(C) Equilibrium level (A) Necessarily decreasing at the equilibrium
(D) Profit maximising level output
(B) Necessarily increasing at the equilibrium output
97. Which one of the following statements is not
correct ? (C) Necessarily increasing at the equilibrium price
1. In perfect competition there is a large number (D) Necessarily decreasing at the equilibrium price
of independent sellers each too small to affect 103. Which of the following is not correct ?
the commodity price.
1. Monopoly form of market organisation may be
2. In perfect competition the product of all firms the result of increasing returns to scale.
are homogenous or identical.
3. In perfect competition the firm can easily enter 2. Monopoly form of market organisation may be
or leave the industry. the result of patent or government decision.
4. In perfect competition the product of all firms 3. Monopoly form of market organisation may be
are different. the result of control over the supply of raw
(A) 1 and 2 only (B) 3 and 4 only materials.
(C) 4 only (D) 3 only 4. Monopoly form of market organisation may be
the result of control over the demand for raw
98. ‘Each duopolists assumes that other keep their materials.
prices constant’. This is correct in the case of—
(A) Lorentz’s curve (B) Phillip’s curve (A) 1 only (B) 2 only
(C) Edgeworth model (D) Contract curve (C) 1 and 3 only (D) 4 only
99. Equilibrium condition of a profit maximising firm 104. Average revenue curve should be kinked in—
is— (A) Duopoly
1. Supply equals to demand (B) Monopoly
2. MR equals to AC (C) Collusive Oligopoly
3. MR equals to MC (D) Non-collusive Oligopoly
4. LMR equals LAC
105. The excess of TR over the TC is greatest at a point
(A) 1 and 2 only (B) 2 and 3 only where a competitive firm will maximise—
(C) 3 and 4 only (D) 3 only (A) Profits
100. ‘How producers would respond to different prices if (B) Profits of the output
they had time to make appropriate adjustments in (C) Production of the output
their capital stock’, can be explained with the help
(D) Availability of raw materials
of ?
(A) Long-run supply curve of a perfectly 106. The demand curve of consumers for the firm's
competitive market product, is indicated by—
(B) Long-run supply curve of a monopolistic (A) The average cost curve of a firm
market (B) The average cost curve of an industry
(C) Long-run supply curve of an oligopolistic mar- (C) The average revenue curve of a firm
ket (D) The average revenue curve of an industry
(D) Long-run supply curve of a perfectly
competitive industry 107. Which one of the following statements is correct
in connection with monopolistic competitions ?
101. Which of the following statements is not
correct ? (A) Paucity of firms
1. Prices ration goods among different uses and (B) Comparatively easy entry
users. (C) Standardized product
2. Prices tend to force producers into low cost (D) All of the above
operations, specially in competitive industry.
108. When the D curve is elastic MR is—
3. Prices tend to force producers into higher cost
operation specially in competitive industries. (A) Negative
4. Prices reflect in competitive industries. (B) Positive
(A) 1 and 4 only (B) 2 only (C) Neither positive nor negative
(C) 3 only (D) 4 only (D) Unity
104U | Economics (NET)
109. When the TR and STC curves are parallel, it shows 118. Each seller determines his price on the assumption
the point where the monopolist reaches the— that his rival will keep his price constant, under—
(A) Best level of profit only (A) Bertrand’s model
(B) Best level of output (B) Cournot’s duopoly model
(C) Best level of rivals price (C) Edgeworth’s model
(D) All of the above (D) Price leadership
110. In the long-run, due to blocked entry pure profits 119. ‘The equilibrium prices of duopoly model are
can be made by— obtained at the intersections of their reaction
(A) Pure oligopolist (B) Pure monopolist curves’. It is correct in the case of—
(C) Pure duopolist (D) None of these (A) Edgeworth’s model
111. The monopolists shift up the SAC and SMC curve, (B) Chamberlin’s model
because of the imposition of— (C) Bertrand’s duopoly model
(A) A per unit tax (D) None of the above
(B) A per unit price 120. “If an oligopolist decreases his price the rivals will
(C) A per unit tax like a variable cost follow.” This is the basic assumption of—
(D) A per unit excise duty (A) The kinked supply curve
112. Price control is one of the monopoly regulations (B) The oligopolistic demand curve
which is most advantageous for— (C) The kinked demand curve
(A) The producer (B) The consumer (D) The demand curve
(C) The government (D) The seller
121. Which of the following assumptions is correct in
113. The AR curve and industry demand curve are connection with oligopoly ?
same— 1. If an oligopolist increase his price his rivals
(A) In case of monopoly will follow.
(B) In case of oligopoly 2. If an oligopolist increase his pride his rivals
(C) In case of perfect competition will not follow.
(D) None of the above 3. If an oligopolist increase his price his rivals
will lower their price.
114. Which of the following statements is correct ? 4. If an oligopolist decrease his price his rivals
1. Posts and Telegraph is an example of will not react.
Monopoly in India. (A) 1 only (B) 2 only
2. Posts and Telegraph is an example of Oligopoly (C) 3 only (D) 4 only
in India.
3. Posts and Telegraph is an example of Perfect 122. The upper portion of the kinked demand curve is
competition in India. relatively—
4. Posts and Telegraph is not suited to any market (A) More inelastic (B) More elastic
situation. (C) Less elastic (D) Inelastic
(A) 1 and 2 only (B) 1 and 3 only 123. Each seller ultimately supplies one-third of the
(C) 4 only (D) 1 only market and charges the same prices. This is the
conclusion of—
115. The hypothesis that the firms seek to maximise their
sales revenue owes its origin to— (A) Bertrand’s duopoly model
(A) W.J. Baumol (B) J.S. Baumol (B) Edgeworth’s duopoly model
(C) W.J. Hicks (D) J.W. Baumol (C) Cournot’s duopoly model
(D) Collusive duopoly model
116. ‘Each sellers assumes his rival’s price as being
constant’ under the— 124. His competitor will keep his output constant even if
(A) Bertrand’s model (B) Edgeworth model he changes his own, is the assumption of—
(C) Duopoly model (D) Price leadership model (A) Bertrand’s model of collusive oligopoly
117. The equilibrium is unstable and indeterminate (B) Edgeworth model of non-collusive oligopoly
under— (C) Cournot’s model of duopoly
(A) Edgeworth’s duopoly model (D) None of the above
(B) Chamberlin’s oligopoly model 125. Which of the following does not have a uniform
(C) Bertrand’s model elasticity of demand at all points ?
(D) Pareto model (A) A downward sloping demand curve
Economics (NET) | 105U
(B) A vertical demand curve 132. The demand for pepper is likely to have a low price
(C) A rectangular hyperbola demand curve elasticity because it—
(D) A horizontal demand curve 1. Involves only a small proportion of consumers
expenditure.
126. Match the following—
2. It is single-use goods.
List-I
3. Has no close substitutes.
(a) For a given 10 per cent change in price, 4. Can readily be foregone.
demand changes by zero per cent.
(A) 1 and 2 only (B) 1 and 3 only
(b) For a given 10 per cent change in price,
(C) 2 and 3 only (D) 2 and 4 only
demand changes by 5 per cent.
(E) 2, 3 and 4 only
(c) For a given 10 per cent change in price,
demand changes by 10 per cent. 133. In measuring price-elasticity—
(d) For a given 10 per cent change in price, (A) Price is a dependent variable and quantity is an
demand changes by 20 per cent. independent variable
List-II (B) Price is a independent variable and quantity is
a dependent variable
1. e > 1 2. e = 1
(C) Price and quantity both are independent varia-
3. e < 1 4. e = 0
bles
Codes : (D) Price and quantity both are dependent variables
(a) (b) (c) (d)
134. Giffen goods are those goods—
(A) 3 1 2 4
(A) For which demand increases as price increases
(B) 4 3 2 1
(B) Which have a high income elasticity of demand
(C) 1 2 3 4
(C) Which are in very short supply
(D) 2 3 1 4
(D) None of the above
127. One common definition of luxury goods is goods
135. A negative income elasticity of demand for a
with an income elasticity—
commodity indicates that as income falls the amount
(A) Greater than one of the commodity purchased—
(B) Equal to one (A) Rises
(C) Less than one but more than zero (B) Falls
(D) None of the above (C) Remains unchanged
128. Cross elasticity of complementary goods is— (D) Any of the above
(A) Negative (B) Zero
136. If total consumer expenditure on a good falls as its
(C) High (D) Infinite
price falls this indicates that—
129. Income-elasticity of demand will be zero when a (A) eP < 1 (B) eP > 1
given change in income brings about—
(C) eP = 1 (D) eP = ∞
(A) A less than proportionate change in quantity
demanded 137. When the demand curve is a rectangular hyperbola,
(B) A more than proportionate change in quantity it represents—
demanded (A) Unitary elastic demand
(C) The same proportionate change in demand (B) Perfectly elastic demand
(D) No change in demand (C) Perfectly inelastic demand
130. When with a change in price the total outlay on a (D) Relatively elastic demand
commodity remains constant, it is a case of—
138. To calculate the elasticity of demand which of the
(A) Perfect elasticity following formula is used ?
(B) Perfect inelasticity Percentage Change in Demand
(C) Unit elasticity (A)
Original Demand
(D) Zero elasticity Proportionate Change in Demand
(B)
131. Consider a demand curve which takes the form of a Proportionate Change in Price
straight line cutting both axis. Elasticity at the mid Change in Demand Original Demand
(C) ÷
point of the line would be— Change in Price Original Price
(A) 0 (B) 1·0 Change in Demand
(D)
(C) 1·5 (D) 2·0 Change in Price
106U | Economics (NET)
139. In the case of Giffen good like bajra, a fall in its 146. Match the following —
price tends to—
List-I
(A) Make the demand remain constant
(B) Reduce the demand (a) Responsiveness of demand to change in price.
(C) Increase the demand (b) Responsiveness of demand to change in tastes.
(D) Change demand in an abnormal way (c) Responsiveness of demand to change in
income.
140. When an individual’s income falls (while everything (d) Responsiveness of demand to change in price
else remains the same), his demand for an inferior of related goods.
goods—
(A) Increases List-II
(B) Decreases 1. Income elasticity of demand
(C) Remains unchanged 2. Price elasticity of demand
(D) We cannot say without additional information 3. Cross elasticity of demand
141. When there is decrease in demand the demand 4. Taste elasticity of demand
curve— Codes :
(A) Moves downwards towards the axis
(a) (b) (c) (d)
(B) Moves upwards away from the axis
(A) 1 2 3 4
(C) Remains unchanged
(B) 4 3 1 2
(D) None of the above
(C) 3 4 2 1
142. Which one of the following is true increase of (D) 2 4 1 3
normal goods ?
147. A monopolist charging high price operates on—
(A) When Price increases, demand decreases
(B) When Price increases, demand also increases (A) The elastic part of a demand curve
(C) When Price remains constant, demand falls (B) The inelastic part of a demand curve
down (C) The constant elastic part of a demand curve
(D) When Price falls down, demand remains (D) Ignores elasticity of demand altogether
constant
148. Elasticity of demand in the following figure at point
143. Which of the following could provide an example of Q, is—
exceptional demand curves ?
1. Demand for “Giffen goods”.
2. Demand based on fears of a future rise in
prices.
3. Demand for second-hand clothes.
4. Demand for daily newspapers.
(A) 1 only (B) 1 and 2
(C) 2 and 3 (D) 1, 2, 3 and 4
144. ‘Ceteris paribus’ clause in the Law of Demand does
not mean—
(A) The price of the commodity does not change
(B) The price of its substitutes does not change
(C) The income of the consumer does not change RQ1 Q1 N1
(A) (B)
SQ1 OS
(D) The price of complementary goods does not
change QF QF
(C) 1 (D) 1
RQ1 RQ1
145. If the percentage increase in the quantity of a
commodity demanded is smaller than the percentage 149. Which of the following statement is correct—
fall in its price, the coefficient of price elasticity of (A) When the slope of the demand curve is zero,
demand is— demand is infinitely elastic and when the slope
(A) Greater than 1 is infinite, elasticity is zero
(B) Equal to 1 (B) When the slope of the demand curve is zero,
(C) Less than 1 elasticity is also zero and when the slope is
(D) Zero infinite, elasticity is also infinite
Economics (NET) | 107U
(C) When the slope of the demand curve is zero, When price falls from R 5 to R 4, elasticity of
elasticity is unity and also when the slope is demand can be expressed numerically as—
infinite, elasticity is unity (A) 1·0 (B) 2·5
(D) None of the above (C) 3·3 (D) 3·75
150. Income elasticity of demand is expressed as— 157. Consider the following statements :
Percentage Change in Quantity Demanded The equivalence between the effects of a tariff and a
(A)
Percentage Change in Income quota which limits imports by the same amount
Percentage Change in Income depends on the assumption that—
(B)
Change in Quantity Demanded 1. There are competitive conditions prevailing
(C) Change in Quantity Demanded abroad.
Change in Marginal Income 2. There is perfect competition among quota
×
100 holders.
Change in Income 3. There is free competition within the domestic
(D)
100 × Change in Quantity Demanded import competing industry. Of these state-
151. In the case of an inferior commodity, the income ments—
elasticity of demand is— (A) 1 alone is correct
(A) Positive (B) Unitary (B) 1 and 2 are correct
(C) Negative (D) Infinity (C) 1, 2 and 3 are correct
152. Income elasticity of demand will be zero when a (D) 2 and 3 are correct
given change in income brings about—
(A) A less than proportionate change in quantity 158. If the total cost curve is plotted, marginal cost can
demanded be illustrated by—
(B) A more than proportionate change in quantity (A) A U-shaped curve cutting the total cost curve
demanded at its lowest point
(C) The same proportionate change in demand (B) The slope of a tangent to the curve at any
(D) No change in demand given output
(C) A straight line from the origin to the mid-point
153. The degree of price elasticity of demand used for of the curve
goods is influenced by whether—
(D) A straight line cutting the curve at its lowest
1. It has close substitutes. point
2. Its output is easily altered.
159. “The price which is necessary to retain a given unit
3. It account for a small input.
of a factor in a certain industry may be called its
4. It is a durable use or single use goods. transfer earnings or transfer price.” Defined by—
(A) 1, 3 and 4 only (B) 1 and 2 only (A) Prof. Lipsey (B) Alfred Marshall
(C) 2 and 3 only (D) 2, 3 and 4 only
(C) Robertson (D) Joan Robinson
154. Pick out the correct formula for arc elasticity—
160. “The opportunity cost of using any factor is what is
Δq P 1 + P2 ΔP ΔP 1 + P2 currently forgone by using it.” This definition of
(A) · (B) ·
Δq q1 + q2 q1 q1 + q2 opportunity cost is given by—
ΔP 100 Δq × 100 (A) Joan Robinson (B) Prof. Lipsey
(C) · (D)
Δq q1 + P1 P (C) Marshall (D) Paul A. Samuelson
155. A country is advised to devalue (reduce external 161. A loss bearing firm will continue to produce
value of) its currency only when its exports face— in the short run so long as the price at least covers—
(A) Inelastic demand in foreign markets
(A) Average variable costs
(B) Elastic demand in foreign markets
(B) Average fixed costs
(C) Unit elastic demand in foreign markets
(C) AVC + AFC
(D) None of the above
(D) Marginal costs
156. Consider the following demand schedule—
162. The optimum output is the one which is produced—
Price per unit (R ) Quantity demanded (000)
(A) By the optimum firm
6 3
(B) At the maximum average cost
5 9
4 15 (C) At the minimum average cost
3 20 (D) At zero marginal cost
108U | Economics (NET)
163. To maximise profits during short run, a firm should (B) The marginal product of the variable factors is
produce the output that will— at a maximum
(A) Minimize marginal cost (C) The factors are combined in their best possible
(B) Yield maximum total revenue proportion
(C) Maximize marginal revenue (D) The average product of the variable factors is
(D) Equate marginal revenue with marginal cost at a maximum
164. The prime cost may be considered as— 170. The MP of a factor—
(A) Variable cost (B) Direct cost (A) Is always positive
(C) Sunk cost (D) Fixed cost (B) Is always either positive or zero
165. Why the average fixed cost curve does not touch the (C) Can be positive, negative or zero
output axis ? (D) Is always negative
171. The LAC curve is tangent to the lowest point on the
SAC curves when the LAC curve is—
(A) Falling (B) Rising
(C) At its minimum (D) None of these
172. The lowest point of the TC curve is—
(A) The left of the lowest point of the AVC curve
(B) The right of the lowest point of the AVC curve
(C) The same as the lowest point of AVC curve
(D) None of the above
173. The supply curve for the short-run competitive firm
(A) Because AFC cannot be negative is the same as—
(B) Because AFC cannot be zero (A) Marginal cost curve
(C) Because AFC cannot be less than one (B) Average variable cost curve
(D) None of the above (C) That part of the MC curve which equals or is
166. An Iso-cost line represents— greater than AVC
(A) Combinations of two inputs which yield the (D) Average total cost curve
same amount of output 174. Average fixed cost can be obtained through—
(B) Combinations of two inputs which cost the TFC
same amount to a firm (A) AFC =
TC
(C) Combinations of two inputs which yields
varying amounts of output TFC
(B) AFC =
(D) Combinations of two inputs which cost MC
different amounts of outlay to a firm (C) AFC = TC + TVC
167. A firm may be considered to be of optimum size (D) AFC = MC + TVC
when— 175. When the law of diminishing returns begins to
(A) Its fixed and average costs are equal operate the TVC curve begins to—
(B) Its average cost is at a minimum (A) Fall at an increasing rate
(C) Its total cost and total revenue curve coincide (B) Rise at a decreasing rate
(D) It is faced with a horizontal demand curve
(C) Fall at a decreasing rate
168. Which of the following market situations explains (D) Rise at an increasing rate
marginal cost equal to price for attaining equili-
brium ? 176. The advertisement cost is included in—
(A) Perfect competition (A) Fixed cost
(B) Monopoly and imperfect competition (B) Sometimes in fixed cost sometimes in variable,
(C) Oligopoly cost
(D) Monopoly only (C) Always in variable cost
(D) Never included in variable cost
169. Minimum marginal cost occurs at the output
where— 177. Where the leading firms in an industry combine to
(A) The total product is at a maximum pursue a common policy in their interests, but retain
Economics (NET) | 109U
their separate identities, such a combination is (B) Marginal return is negative
generally known as— (C) Marginal return is zero
(A) Trust (D) Marginal cost is zero
(B) Cartel
187. With the expansion of output, the short-run average
(C) Joint-stock company cost curve, beyond a point, starts rising because—
(D) Holding company (A) Average fixed cost increases sharply
178. MC is given by— (B) More production yields lower per unit price
(A) The slope of the TFC curve (C) The law of variable proportions applies to
(B) The slope of the TVC curve but not by the short-run production
slope of the TC curve (D) Sales expenses become much larger
(C) The slope of the TC curve but not by the slope 188. The cost, ‘what has to be paid to retain it in its
of TVC curve present use’ is called—
(D) Either the slope of the TVC curve or the slope
(A) Normal cost
of the TC curve
(B) Social cost of a factors of production
179. If marginal cost is above average variable cost at a
(C) Opportunity cost of a factors
time when output is rising, then—
(D) Economic cost of a factors of production
(A) Average total cost is falling
(B) Average variable cost is rising 189. Minimum marginal cost occurs at the output
(C) Average variable cost is falling where—
(D) Average total revenue is rising (A) The total product is at a maximum
(B) The marginal product of the variable factor is
180. Normal profits are considered as— at a maximum
(A) Explicit costs (B) Implicit costs (C) The factors are combined in their best possible
(C) Social costs (D) Private costs proportions
181. Opportunity costs are also known as— (D) The average product of the variable factors is
(A) Spill-over costs (B) Money costs at a maximum
(C) Alternative costs (D) External costs 190. Empirical evidence has shown, that due to tech-
182. The slope of the TVC or total cost curve indicates nological change and people fear by doing’ trends—
the— (A) Changed the shape of LAC curve to be ‘U’
(A) Marginal revenue (B) Average cost shaped rather than ‘L’
(C) Marginal cost (D) Variable cost (B) Changed the shapes of LAC curve to be ‘L’
shaped rather than ‘U’
183. The general average curve is also known as—
(A) Total unit cost curve (C) Changed the shape of SAC curve to ‘U’
shaped rather than ‘L’
(B) Average total unit cost curve
(C) Total marginal unit cost curve (D) None the above
(D) Total variable unit cost curve 191. If the long run average cost curves are ‘L’ shaped
184. Even if costs increase, the MC remains unaffected, rather than ‘U’ shaped. Due to technological change
the cost is— take place and, people by doing so the long run
curve will flatter in—
(A) Variable cost (B) Fixed cost
(C) Total fixed cost (D) Average cost (A) Heavy industries only
(B) Both Heavy and agricultural industries
185. The law of diminishing returns or increasing cost
will operate at an earlier level in agriculture than in (C) Agricultural industries only
industry because— (D) Iron and steel industry only
(A) Agriculture is an industry where land is used 192. The point on which the average cost is minimum in
extensively a firm short-run average cost curve will also be the
(B) More labour is used in agriculture minimum cost point on the firm’s long run average
(C) Less mechanisation is applicable to agriculture cost curve. This is true—
(D) None of the above (A) Always
186. Generally the profits are maximised in the short- run (B) Never
at the point at which— (C) When LAC is falling
(A) Marginal cost of production is equal to the (D) Only at that level of output when LAC is at its
marginal return minimum
110U | Economics (NET)
193. MR n = TR n – TRn – 1 is the algebraic expre- 201. Consider the diagram below which shows a demand
ssion of— curve (d)—
(A) The addition to TR earned by selling n units of
product instead of (n – 1) units
(B) Marginal Revenue, the addition to TR earned
by selling n units of product instead of (n – 1)
units
(C) Information is insufficient
(D) None of the above
194. In general, if the average revenue curve is a straight
line, the marginal revenue curve will be—
(A) U-shaped (B) A straight line Total expenditure on a commodity is represented by
(C) C-shaped (D) Bell-shaped the area TUVW. Consumer’s surplus is represented
195. Assume that a firm’s total revenue curve takes the by—
form of a straight line which passes through the (A) The area MWV (B) The area XTWV
origin. We may deduce that— XW TU
(C) (D)
(A) Price exceeds marginal revenue XT UV
(B) Price and marginal revenue equal 202. Consumer’s surplus is the highest in the case of—
(C) Total costs and total revenue are equal (A) Necessities
(D) Elasticity of demand for the product is unity (B) Comforts
196. Which of the following formula explain the term (C) Luxuries
average revenue ? (D) Conventional necessities
Total units produced
(A) AR = 203. While analysing Marshall’s measure of Consumer’s
Total Revenue surplus one assumes—
Total Revenue (A) Imperfect competition
(B) AR =
Number of units produced (B) Perfect competition
(C) AR = MR × No. of units produced (C) Monopoly
(D) AR = TR – MR (D) Monopsony
197. The Engel curve passes through the tangency point 204. Who demonstrated the abnormal shape of demand
of— curve for diamonds through the doctrine of conspi-
(A) Budget line and indifference curve cuous consumption ?
(B) Price line and iso cost line (A) Thorstein Veblen (B) Robert Giffen
(C) Iso-quant and budget line (C) David Ricardo (D) Alfred Marshall
(D) None the above
205. We can separate the income effect from the
198. In the case of a normal good, the income effect— substitution effect of the price fall of reducing the
(A) Is always equal to the substitution effect consumers—
(B) Completely offsets the substitution effect (A) Money income sufficiently to keep his real
(C) Partially offset the substitution effect income constant
(D) Reinforces the substitution effect (B) Money income to make his real income higher
199. The Doctrine of consumer’s surplus is based on— (C) Money income to make his real income lower
(A) Indifference curve analysis (D) None the above
(B) Revealed preference theory
206. What was Robert Giffen’s observation in relating to
(C) Law of substitution
price and quantity demanded ?
(D) The law of diminishing marginal utility
(A) A commodity whose price and quantity
200. The Revealed Preference Theory was formulated demanded vary in different direction
by— (B) A commodity whose price and quantity
(A) Lionel Robbins demanded vary in same direction
(B) Paul Samuelson (C) A commodity whose price and quantity
(C) Joan Robinson demanded is always constant
(D) Alfred Marshall (D) Both (A) and (B) are correct
Economics (NET) | 111U
207. External economies are witnessed in— 215. When average product increases, the marginal
(A) A rising supply curve product is—
(B) A rising demand curve (A) Less than the average product
(B) More than the average product
(C) A falling supply curve
(C) Equal to the average product
(D) A falling demand curve
(D) None of the above
208. Any straight line supply curve which cuts the x-axis 216. Increasing returns to scale can be explained in terms
will have— of—
(A) An elasticity greater than one (A) Fixed scale of plant
(B) Unitary elasticity of supply (B) Optimum factor proportions
(C) An elasticity less than one (C) External and internal economics
(D) Zero elasticity of supply (D) Labour productivity
209. In general, most of the production functions 217. Imagine a graph showing production possibilities.
measure— What does an outward shift of the production
possibilities curve indicate ?
(A) The productivity of factors of production
(A) Inflation (B) Over production
(B) The relation between the factors of production (C) Economic growth (D) Over full employment
(C) The economies of scale 218. The expansion path of production theory is analo-
(D) The relations between change in physical gous in consumption theory to the—
inputs and physical output (A) Price consumption line
210. A set of all possible production combinations while (B) Engel curve
producing two commodities is— (C) Income consumption line
(A) Isoquant map (D) Budget constraint line
(B) Iso cost line 219. The Law of variable proportions comes into being
(C) Production possibility curve when—
(D) Production functions (A) There are only two variable factors
(B) There is a fixed factor and a variable factor
211. Economies of scale means— (C) All factors are variable
(A) Reductions in unit cost of production (D) Variable factors yield less
(B) Reductions in unit cost of distribution
220. Which of the stages is relevant for a firm which
(C) Addition to the unit cost of production
aims at maximum economic efficiency in the
(D) Reduction in the total cost of production following diagram ?
212. Marginal product is—
(A) What is produced when all factors of
production are employed at optimum efficiency
(B) The extra output obtained from employing an
additional unit of a factor
(C) What is left to the entrepreneur after he has
paid all his expenses
(D) Annual output of the most efficient firm in the
industry
213. Marginal product becomes negative—
(A) In no circumstances
(B) When total output turns down
(A) Stage I (B) Stage II
(C) When total output grows swiftly
(C) Stage III (D) Stage IV
(D) When total output ceases to grow swiftly
221. From the above figure in stage III the MP curve
214. When the average product is at its maximum the becomes negative because of—
equality can be reached between— (A) Fixed factor quantity exceed variable factor
(A) The marginal product and total product (B) Variable factor quantity exceed fixed factor
(B) The marginal product and average product (C) Both the factors are used at the highest propor-
(C) The marginal product and primary product tion
(D) The marginal product and final product (D) None of the above
112U | Economics (NET)
222. A long run Analysis of production is called— 232. The output elasticity with respect to labour input is
(A) Economies of scale measured by—
(B) Law of variable proportion (a) β (b) A
(C) Law of increasing returns (c) α (d) β.A
(D) Law of Returns to scale 233. The factor intensity is measured by—
223. The elasticity of substitution between two inputs in α α
(A) (B)
CES production function— A β
(A) Decrease continuously (C) A + B (D) α + β
(B) Increase continuously 234. Written in this form, the CES constant Elasticity
(C) Remains constant of substitution production function exhibits—
(D) None of the above (A) Increasing returns to scale
224. “The increasing returns to scale occurs because (B) Constant returns to scale
larger scale provides greater specialisation to various (C) Decreasing returns to scale
factors.” According to— (D) None of the above
(A) Joan Robinson (B) Alfred Marshall 235. Increasing returns to scale can be explained in terms
(C) Chamberlin (D) Paul. A. Samuelson of—
225. Isoquant refers to— (A) External diseconomies and internal economies
(A) Another name of indifference curve (B) External and internal economies
(B) The production Indifference curve (C) External and internal diseconomies
(C) An equal quantity curve of a consumer (D) Optimum factor combination
(D) An equal cost curve of a producer 236. Which of the following is the correct statement ?
226. If, by increasing the quantity of labour used by one 1. The slope of the Isoquants represents the
unit, the firm can give up 2 units of capital and still MRTS.
produce the same output, then the MRTSLK is— MPx
1 2. The MRTS of the inputs x and y = .
(A) (B) 2 MPy
2 3. The elasticity of substitution between two
(C) 1 (D) 4 inputs x and y is proportionate change in the
Directions : Following seven questions are based ratio two inputs divided by proportionate
on Cobb-Douglas Production Function— change in the MRTS.
Q = A.L α .Kβ 4. If degree of homogeneity is greater than one,
227. The elasticity substitution between the two inputs the production function is increasing returns to
is— fixed factor.
α (A) 1, 2, 3 and 4 (B) 1, 3 and 4
(A) Zero (B)
β (C) 2, 3 and 4 (D) 1, 2 and 3
(C) Infinite (D) Unity
237. The point which shows the maximum marginal
228. The returns to scale are measure by— product in the total product curve represents—
(A) α + β (B) α – β
(A) Least cost combination
α
(C) α . β (D) (B) Producer’s equilibrium
β
(C) Expansion path
229. The efficiency parameter indicating the state of
technology is given by— (D) Point of inflexion
(A) A (B) K 238. If the MRTSLK equals 2, then the MPK/MPL is—
(C) L (D) α
(A) 2 (B) 1
230. The MRTS of capital for labour is given by— 1
α α+β (C) (D) 4
(A) (B) 2
β K+L
α L K 239. The isoquants are convex to origin because of—
(C) · (D)
β K L (A) Diminishing MRTS
231. The efficiency of production is measured by— (B) Increasing MRTS
(A) A(α + β) (B) A (C) Increasing returns to scale
(C) α.β (D) A . α (D) Decreasing returns to scale
Economics (NET) | 113U
240. In the short run Analysis, MP = O at the level in 246. All money costs can be regarded as—
which— (A) Social costs (B) Opportunity costs
(A) Marginal product is maximum (C) Explicit costs (D) Real costs
(B) Average product is maximum
(C) Total product is maximum 247. The cost assigned to factors of productions that the
firm neither hires nor purchases is called—
(D) Total profit is maximum
(A) Social cost (B) Opportunity cost
241. The law of Diminishing Returns is applied to all (C) Economic cost (D) Imputed cost
fields of production was stated by—
(A) Walras (B) A.C. Pigou 248. The average profit is equal to the difference
(C) Alfred Marshall (D) David Ricardo between—
242. At the point of producers equilibrium— (A) AC and TC (B) AC and VC
(A) The isoquant is tangent to the iso cost (C) AC and AR (D) AC and TR
P 249. Average fixed costs—
(B) The MRTSLK equals L
PK (A) Remain the same whatever the level of output
MPL MPK (B) Increase as output increases
(C) = (C) Diminish output increases
PL PK
(D) All of the above (D) Do not show any uniform pattern
243. Which of the following is incorrect in connection 250. The firm producing at the minimum point of the AC
with Ridge line ? curve is said to be—
1. Two ridge lines can be drawn on a particular (A) Operating under diminishing cost
isoquant map (B) Making Optimum use of plant capacity
2. The production techniques are technically (C) Operating at excess capacity
efficient between the two ridge lines (D) Operating under increasing costs
3. The upper ridge line is the locus points on
isoquants where the MRTS of input is taken on 251. Rectangular hyperbola is the shape of—
x-axis for input taken on y-axis is infinite. (A) TFC (B) AFC
4. The upper ridge line is the locus of points on (C) FC (D) MC
isoquants where the marginal product of input
252. Which is the best definition of the marginal firm ?
taken on y-axis is zero.
5. The lower ridge line is the locus of points on (A) The firm with the largest profit
isoquants where the marginal product of input (B) The firm with lowest costs
taken on x-axis is negative. (C) The firm which makes only normal profit
(A) 5 only (B) 1, 2, 3, 4, 5 (D) The firm which equates its marginal costs with
(C) 1, 2, 3 and 5 (D) 4 only marginal revenue
244. The elasticity of technical substitution is measured 253. In short-run, a firm would remain in business as
by— long as which one of the following of costs is
(A) The slope of the isoquant covered ?
(B) The change in the slope of the isoquant (A) Total costs (B) Fixed costs
(C) The ratio of factor inputs (C) Variable costs (D) Constant costs
(D) None of the above 254. Each short-run average cost curves coincides with
245. The following Table shows the various com- long run cost curves—
binations of labour (L) and capital (K) and the (A) At upper point (B) At lower point
resulting outputs— (C) At middle point (D) No permanent position
Combination Output (Units) 255. The MC curve cuts the AVC and ATC curves—
1L + 1K 200 (A) At the falling parts of each
2L + 2K 400 (B) At different points
3L + 3K 600 (C) At their respective minimas
4L + 4K 800 (D) At the rising parts of each
5L + 5K 1000 256. Marginal cost curve always cuts the average cost
This Table shows the— curve—
(A) Constant returns to scale (A) From below on the falling portion of the AC
(B) Diminishing returns to scale curve
(C) Increasing returns to scale (B) From below on the rising portion of the AC
(D) None of the above curve
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(C) From below at the minimum point of the AC (C) Market sharing cartels
curve (D) Oligopoly with dominant firm as leader
(D) From below at any point on the AC curve
265. Price control is one of the monopoly regulations
257. The economies and diseconomies of large scale which is most advantageous for—
production is determined by— (A) The producer (B) The consumer
(A) The long run MC curve (C) The government (D) The seller
(B) The long run AC curve
266. Pure Monopoly exists—
(C) The normal long run AC curve
(A) When there is a single producer
(D) The normal long run TC curve
(B) When there is a single producer without any
258. An entrepreneur will stay in business in the long run close substitutes
as long as he meets— (C) When there is a single producer with close
(A) His domestic expenditure substitutes
(B) All costs of production (D) When a few producers control the industry
(C) Fixed costs of production
267. Under monopoly the supply curve is absent
(D) Variable costs of production because—
259. Which of the following is an implicit cost of (A) The monopolist always makes profit
production ? (B) There is no entry for others
(A) Wages of the labour
(C) Equilibrium involves MC = MR and MR
(B) Charges for electricity <P
(C) Interest on owned money capital (D) The monopolist controls the supply
(D) Payment for raw materials
268. If a single monopolist enjoying internal economies
260. If the individual firm’s demand curve is coincident of scale is replaced by a large number of producers
with the market demand curve then— operating under perfect competition, it may be said
(A) The firm is price-taker that—
(B) The firm is a monopolist (A) Price will increase and output will fall
(C) The firm can set any price it wants without (B) Both price and output will rise
limitation (C) Price will increase but the effect on output
(D) Marginal revenue is equal to average revenue will be indeterminate
261. Even in the long run equilibrium, the pure mono- (D) Output will fall but the effect on price will be
polist (as opposed to the perfectly competitive firm) indeterminate
can make abnormal profits because of—
269. The degree of monopoly power can be measured by
(A) Blocked entry the formula—
(B) High price he charges P – MC AR
(A) (B)
(C) His low LAC P AR – MR
(D) Advertising MR MR
(C) (D)
262. Price discrimination is possible— AR – MR AR – MR
(A) Only under monopoly situation 270. Bilateral monopoly means—
(B) Under any market form (A) Two rival sellers only
(C) Only under monopolistic competition (B) Two rival buyers only
(D) Only under perfect competition (C) A monopoly seller buying his input from many
263. The imposition of a ceiling on a monopolist’s price suppliers
will effect his— (D) A monopolist facing a monopsonist
(A) Profits only 271. A monopolist who is selling in two markets in
(B) Average revenue in the short-run only which demand is not identical will be unable to
(C) Equilibrium output only maximise his profits unless he—
(D) Equilibrium output and profits (A) Sells below costs of production in both markets
264. Which one of the following is identical with (B) Practices price discrimination
multiplant monopolist ? (C) Equates the volume of sales in both markets
(A) Cartel aiming at joint profit maximisation (D) Equates marginal costs with marginal revenue
(B) Oligopoly with low-cost firm as leader in one market only
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272. Under bilateral monopoly the price is higher if— 280. Clark-Wicksteed product exhaustion theorem says
(A) The monopolist has his way that—
(B) The monopolist acts as a competitor (A) Given a linearly homogenous production
(C) The monopsonist has his way function, the product is exhausted
(D) The monopsonist sells his own product in a (B) Total product is exhausted only under
monopoly market conditions of monopoly
273. One equates price and MC to maximise profit, the (C) In long-run competitive equilibrium, the total
other one equates MC and MR for the same purpose product will be exhausted in rewarding the
they are— factors
(A) Monopolist and perfect competitor (D) Total product is exhausted only under laissez-
(B) Monopsonist and perfect competitor faire
(C) Oligopolist and monopolist 281. Under monopoly and imperfect competition MC
(D) Perfect competitor and duopolist is—
274. The equilibrium level of output for the pure mono- (A) More than the price (B) Less than the price
polist is where— (C) Equal to the price (D) Any one of the above
(A) MR = MC (B) MR > MC 282. The limit to the long-run growth of a firm under
(C) MR < MC (D) P < AC imperfectly competitive conditions is set by—
275. Given the cost conditions— (A) Fear of falling demand
(A) Monopoly output and price will be higher than (B) Fear of prices falling more than costs
under pure competition
(C) Fear of rising costs
(B) Monopoly output will be lower and price
higher than under pure competition (D) Fear of external diseconomies
(C) Monopoly output will be higher and prices 283. Which form of monopoly regulation is most
lower than under pure competition advantageous for the consumer ?
(D) Monopoly output and price will be lower than (A) Price control
under pure competition
(B) Per unit tax
276. A monopolist will fix the equilibrium output of his (C) Lump sum tax
product where the elasticity of his AR curve is—
(D) All of the above three form are equally
(A) Greater than or equal to one advantageous
(B) Equal to or less than one
284. If V is the elasticity of demand for the product of a
(C) Less than one but more than zero
e
(D) Zero monopolist than is the—
e–1
277. If a commodity sold under monopoly is got free of P P
cost, MC curve will be— (A) Ratio (B) Ratio
MR AR
(A) Identical with the x-axis
(B) Identical with the MR q Q
(C) Ratio (D) Ratio
(C) A horizontal straight line above x-axis AR AR
(D) Identical with y-axis 285. It does not exceed super normal profit, will reduce
excess profit of a monopolist; i.e.,—
278. A monopolist has control over the price he charges
(A) The imposition of income tax
for his product. He will be able to maximise his
profit by— (B) The imposition of price control
(A) Lowering the price, if the demand curve is (C) The imposition of lump sum tax price period
elastic (D) The imposition of jump sum tax once in a year
(B) Lowering the price, if the demand curve is 286. With which of the following economists would
inelastic you associate “the model of Managerial enterprise”?
(C) Raising the price, if the demand curve is elastic
(A) R.A. Gordan (B) R. Marris
(D) None of the above is applicable
(C) Baumol (D) Scitovsky
279. A monopoly producer usually earns—
287. The imposition of a maximum price at the point
(A) Abnormal profits where the monopolist’s MC curve intersects his AR
(B) Only normal profits curve cause the monopolist to—
(C) Neither profits nor losses (A) Break even (B) Incur losses
(D) Profits and losses which are uncertain (C) Make profits (D) Any of the above
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288. The firms are under severe pressure to keep their 295. The least cost criterion for the monopsonist is
costs low, a situation characterised by— expressed as—
(A) Strong competition with perfect competition MPL P L MPL MPK
(A) = (B) =
(B) Strong competition MPK P K MC L MC K
(C) Oligopolist competition MPL P MC L MPL
(C) = L (D) =
(D) Monopolist competition P K MPK MPK MC K
289. Dumping means selling at— 296. The figure below explains price and employment
(A) A higher price in home market and a lower determination under—
price in foreign market
(B) A lower price in the home market and a higher
price in foreign market
(C) The same price in the home and the foreign
market
(D) None of the above
290. Consideration of the external effect of a fall in the
factor price will make the market demand curve of
the factor—
(A) Less elastic than otherwise
(B) More elastic than otherwise
(C) Vertical
(A) Pure Monopoly Market
(D) Will have no effect on the elasticity of the
(B) Monopolistic Market
market demand curve for the factor
(C) Monopsony Market
291. Which one of the following statements is not true
with respect to a FIRM in circumstances of (D) Oligopoly Market
imperfect competition ? 297. Price discrimination is undertaken with the aim of—
(A) Advertising will improve its profit (A) Increasing sales and maximising profits
(B) There is no perfect substitute for the product it (B) Reducing sales and raising prices
sells (C) Minimising cost and maximising revenue
(C) MR is equal to price at all output levels (D) Serving the markets without earning profits
(D) Its demand curve is inelastic at some point
within its entire range 298. Modern theories of imperfect competition were
inspired by—
292. Which of the following economists said that the (A) Joan Robinson (B) Sraffa
problem of bilateral monopoly has a solution if the
(C) Cournot (D) Chamberlin
Monopsony buyer of the factor sells his own
product in a monopoly ? 299. The strength of a monopolist may be assessed by—
(A) Hicks (B) Cournot (A) The size of his total revenue
(C) Marshall (D) Kaldor (B) The gap between AR and MR
293. Monopsonistic exploitation occurs when— (C) The size of consumer’s surplus accruing to him
(A) The factor market is monopsonistic (D) The long-term price of his product
(B) The factor market is competitive 300. The theory of monopolistic competitions is develo-
(C) The product market is competitive ped by—
(D) The product market is monopolistic (A) E.H. Chamberlin
294. Which of the following represents the AR curve of a (B) H.E. Chamberlin
firm ? (C) Mrs. John Robinson
(A) The curve representing the cost per unit of (D) Joan Robinson
output 301. Which of the following conditions are met in the
(B) The demand curve of consumers for the firm’s long-run equilibrium in monopolistic competition
product where the firm is earning only normal profits ?
(C) Total receipts realized by the firm (A) MC = AC (B) P = ATC
(D) All of the above (C) P = MR (D) P = MC
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302. Chamberlin’s concepts of ‘product group’ may be (C) The gap between TR and TC is maximum and
defined as— TR curve lies above TC curve
(A) Products that have infinite cross elasticity of (D) TR = TC curve
demand
310. On a less than perfectly elastic demand curve, the
(B) Products that are close technological and MR for a given price and output is equal to price
economic substitutes multiplied by—
(C) Homogenous products with different brand
names
(D) Product that have infinite elasticity of
( )
(A) 1 –
1
e ( )
(B) e –
1
e
substitution
303. Under monopolistic competition there can be
(C) ( ) 1
e
–1 (D)( ) 1
e
–e
freedom of entry in the sense of a freedom to 311. If a demand curve exhibits unit elasticity for all
produce— prices the MR curve—
(A) Close substitutes (A) Is identical with it
(B) Perfect substitutes (B) Lies below the demand curve
(C) Complementary goods (C) Is identical with the x-axis
(D) Perfect complementary goods (D) Is identical with the y-axis
304. In the case of monopolistic competition— 312. In perfect completion in long run a firm maximise
(A) The long-run supply curve can be defined its profit. Where ?
(B) The long-run supply curve cannot be defined (A) AFC = Opportunity cost
(C) The short-run supply curve cannot be defined (B) MC = Price
(D) The short run supply curve can be defined
(C) Sunk costs are zero
305. If there is effective price competition in the market, (D) MVC = MR
the monopolistic competition does not create excess
capacity. According to— 313. If AR curve is a falling straight line, MR curve
(A) Joan Robbinson (B) Robertson will lie below it in such a way that any line drawn
from a point from y-axis parallel to x-axis to meet
(C) Paul A. Samuelson (D) Chamberlin the AR curve is intersected by the MR curve—
306. Chamberlin’s measure of excess capacity is— (A) Mid-way
(A) More than what is normally understood an (B) More than half-way
excess capacity (C) Less than half-way
(B) The same as what is normally understood an (D) Any where
excess capacity
(C) Less than what is normally understood an 314. In general, profit will be at a maximum where—
excess capacity (A) MC = MR (B) MC > MR
(D) Zero (C) MC < MR (D) MC = MR = 1
307. The name of the economist who first defined the 315. Which of the following persons is engaged in
concept of shadow prices is— “secondary production” ?
(A) Rosenstein-Rodan (B) H.Leibenstein 1. A bricklayer
(C) J. Tinbergen (D) G. Myrdal 2. An automobile assembly-line worker
3. An accountant
308. The relationship between elasticity of demand (E).
Average Revenue (AR) and Marginal Revenue 4. A cinema projectionist
(MR) is shown by the following formula— (A) 1 only (B) 1 and 2 only
AR MR (C) 2 and 3 only (D) 1, 2, 3 and 4
(A) e = (B) e =
AR – MR AR – MR 316. An increase in a firm’s fixed costs will—
TR AR (A) Change marginal costs but not total costs
(C) e = (D) e =
AR – MR MR
(B) Change both marginal and total costs
309. Using Total Revenue and total cost curves, the level (C) Change variable costs but not marginal costs
of output that gives maximum profits will be one
(D) Change total costs but not marginal costs
where—
(A) TR and TC curves intersect 317. The LAC curve—
(B) The gap between TR and TC is maximum and (A) Falls when the LMC curve falls
TR curve lies below TC curve (B) Rises when the LMC curve rises
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(C) Goes through the lowest point of the LMC 325. In the following diagram of a competitive firm T
curve point include—
(D) Falls when LMC < LAC and rises when LMC
> LAC
318. Which of the following occupations should be
included under the heading of “Primary produc-
tion”?
1. Quarrying 2. Fishing
3. Farming 4. Coal mining
(A) 1 only (B) 1 and 2
(C) 1 and 3 (D) 1, 2, 3 and 4
319. Thomas Malthus believed—
(A) The population of a country will always
increase
(B) Production cannot keep on increasing (A) No profit (B)Abnormal profit
(C) Food supplies place a limit to the growth of (C) Normal profit (D)Heavy loss
population
326. By “normal profits” is meant—
(D) Population increase leads to a fall in output
(A) The profit made by the marginal entrepre-
320. Which of the following statements is correct or neur in a normal year
more nearly correct ?
(B) The payment made to the marginal entrepre-
(A) An increase in the price of commodity
neur for his abilities
represent a fall in its value
(B) Value has nothing to do with price (C) The surplus profit made by the least efficient
firms
(C) If the price of a commodity falls, its value
relative to other goods does not change (D) The payment needed to keep an entrepreneur in
(D) The price of a good is its value measured in an industry
terms of money 327. The change in TR resulting from the sale of the one
321. The MC curve reaches its minimum point before unit more of output, means—
the AVC curve and the AC curve. In addition the (A) MR from a given input
MC curve intersects the AVC curve and the AC (B) MR from a given output
curve at their lowest point. The above statement are (C) AR from a given output
both true—
(D) MR from MC
(A) Always (B) Never
(C) Often (D) Sometimes 328. Under the perfect competition the transportation
cost—
322. A rise in the price of a commodity will generally
call forth a bigger supply and this will be brought (A) Is considered to be negligible and thus, ignored
about partly by existing firms expanding their (B) Is considered to be vital for the calculation of
output and partly by— total cost
(A) The general expansion of the market (C) Is charged along with the price of the commo-
(B) New firms being attracted into the industry dity
(C) The discovery of new sources of raw materials (D) Excluded from the prime cost
(D) Changes in the general level of consumer’s 329. Match the following—
incomes List-I List-II
323. Under perfect competition a firm will be in equili- (a) Increasing cost 1. Horizontal long
brium if— industry run supply Curve
(A) MC = MR (b) Decreasing cost 2. Positively sloped long
(B) MC cuts the MR from below
industry run supply curve
(C) MC rises when it cuts the MR
(c) Constant cost 3. Negatively sloped
(D) All the above three conditions are fulfilled
industry long run supply curve
324. When the perfectly competitive firm and industry
are both in long run equilibrium— (a) (b) (c)
(A) P = MR = SAC = LAC (A) 1 2 3
(B) D = MR = SMC = LMC (B) 3 2 1
(C) P = MR = Lowest point on the LAC curve (C) 2 3 1
(D) All of the above (D) 2 1 3
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330. Price taker firms— 337. Under competitive conditions the industry will be in
(A) Advertise to increase the demand for their equilibrium—
product (A) When each firm is in equilibrium equating MC
(B) Do not advertise, because most advertising is with MR
wasteful (B) When all the firms are earning only normal
(C) Do not advertise because they can sell as much profits
as they want at the current price
(C) When firms outside have no tendency to enter
(D) Who advertise will get more profits than those
the industry and those within, have no tendency
who do not
to leave the industry
331. If factor prices and factor quantities move in the (D) When all the three conditions are fulfilled
same direction we have—
(A) A constant cost industry 338. In the long run competitive equilibrium the theory
(B) A decreasing cost industry predicts that—
(C) An increasing cost industry (A) TC = TR and MC = MR
(D) Inadequate data to tell precisely what will (B) Firms operate at a minimum average total
happen cost
332. In conditions of pure competition, in which the (C) There is no incentive for entry or exit of firms
demand for a firm’s product is infinitely elastic, the (D) All these conditions exist
firm’s average revenue curve will be—
339. One would expect a firm to close down rather than
(A) A vertical straight line continue producing in the short period if—
(B) A horizontal straight line
(A) Total revenue were more than total variable
(C) A U-shaped cost
(D) A straight line at 45° to the horizontal axis (B) Total revenue were less than total variable
333. “The more nearly perfect a market is, the stronger is cost
the tendency for the same price to be paid for the (C) Variable costs were to fall below fixed costs
same thing at the same in all parts of the market,”
(D) Variable costs were to rise above fixed costs
is the definition of perfect competition by—
(A) Prof. Benham (B) J.S. Mill 340. Under perfect competition, a firm will be in
(C) Jevons (D) Prof. Marshall equilibrium when its AC is—
(A) At a maximum
334. With increasing returns to scale, the equilibrium in a
market is incomplete. This is— (B) At a minimum
(A) Only in the case of perfectly competitive (C) Covering only prime costs of production
market (D) Covering wages and salaries only
(B) Only in the case of imperfectly competitive 341. Expanding output till the rising marginal cost is less
market than price, is the nature of—
(C) Only in the case of monopolistic market
(A) Imperfectly competitive market
situations
(D) None of the above (B) Perfectly competitive market
(C) Perfectly competitive firm
335. In finding equilibrium position of a profit maximi-
sing firm, which technique is most convenient— (D) Perfectly competitive industry
(A) Total revenue and total cost technique 342. At the shut-down point—
(B) Marginal revenue and marginal cost technique (A) P = AVC
(C) Demand and supply technique (B) TR = TVC
(D) None of the above (C) The total losses of the firm equal TFC
336. In the case of consumer’s demand curve, determi- (D) All of the above
ned the price but in the case of producer— 343. Which of the following statement is correct in
1. AR curve determined the price. connection with the below diagram ?
2. AR curve determined the price and income. 1. The firm is styled as price taker as contrasted to
3. MR curve determined the price. price maker industry.
4. MR curve and AR curve are determined the 2. The firm is styled as price maker as contrasted
price. to price taker industry.
(A) 1 only (B) 2 only 3. The firm is styled as price taker as same in
(C) 3 only (D) 4 only price maker industry.
120U | Economics (NET)
349. The imposition of a per unit tax causes the
monopolist’s—
(A) Average cost curve to shift up
(B) Average cost and marginal cost curves to shift
up, because the per unit tax is like a fixed cost
(C) Average cost and marginal cost curves to shift
up, because the per unit tax is like a variable
cost
(D) All of the above
350. One way the government can induce a monopolist
to expand his output is by imposing—
(A) 1 only (B) 1 and 2 only (A) A specific tax on the monopolist’s output
(C) 3 only (D) 2 only (B) A price ceiling that make the monopolist lower
his price
344. If more firms enter a competitive industry the theory
(C) A price floor that make the monopolist raise his
predicts that—
price
(A) Both marginal and average cost curves rises
(D) A heavy tax on the monopolist’s profits
(B) The industry short-run supply curves shifts
upwards to the right 351. A firm practising price discrimination will be—
(C) Output of every firm increases (A) Charging different prices for different qualities
(D) The price of the product rises of a product
345. From the resource allocation view point, perfect (B) Buying in the cheapest and selling in the dearest
competition is preferable because— markets
(A) The firms operate at excess capacity levels (C) Charging different prices in different markets
for a product
(B) There is a whole variety of output produced
(C) There is no restriction on entry and exit of (D) Buying only from firms selling in bulk at a
firms distance
(D) There is no idle capacity 352. Equilibrium of a discriminating monopolist requires
the fulfilment of which one of the following
346. A profit-maximising monopolist in two separate conditions—
markets will—
(A) It must be profitable for him to sell output
(A) Charge the same price in both markets in more than one market
(B) Always charge a higher price in the market (B) MR in both markets must be the same
where he sells more
(C) MR in both markets must also be equal to the
(C) Always charge a higher price in the market marginal cost of producing the monopolist’s
where he sells less aggregate output
(D) Adjust his sales in the two markets so that his (D) All the above
MR in each market just equals his aggregate,
marginal cost Directions : Following two Questions are based on
the following diagram showing a firm’s cost and
347. Equilibrium of monopolist will never lie below the revenue curves
middle point of the average revenue curve because
below the middle point— MC = Marginal cost
(A) Elasticity of demand is less than one MR = Marginal Revenue
(B) MR is negative AC = Average cost
(C) Both (A) and (B) AR = Average Revenue
(D) Market laws cease to be operate
348. Price discrimination is possible—
(A) When elasticities of demand in different
markets are the same at the ruling price
(B) When elasticities of demand are different in
different markets at the ruling price
(C) When elasticities cannot be known
(D) None of the above
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353. The most profitable output for the firm to produce (B) Both Assertion and Reason are true but Reason
is— is not a correct explanation of A
(A) OS (B) OV (C) Assertion is true but Reason is false
(C) OK (D) OA (D) Assertion is false but Reason is true
354. The amount of profits will be shown by— 360. Assertion : Consumer’s surplus is the difference
(A) INQ (B) TICH between the potential price and the actual price.
Reason : There exists an inverse relationship
(C) ACH (D) Either AEH or BTIN
between the price and the consumer’s surplus.
355. The difference between monopoly equilibrium (A) Both Assertion and Reason are true and Reason
and competitive equilibrium is— is the correct explanation of Assertion
(A) The MC should rise at the point of equilibrium (B) Both Assertion and Reason are true and Reason
under perfect competition whereas under is not a correct explanation of Assertion
monopoly it can rise, fall or remain constant (C) Assertion is true but Reason is false
(B) There is no difference at all (D) Assertion is false but Reason is true
(C) Under perfect competition the MC = MR 361. Assertion : The long-run cost curve is L-shaped
whereas under monopolistic conditions this rather than U-shaped.
need not be the case Reason : The new techniques of production of large
(D) None of the above plants reduce the total costs per unit of output.
356. If a monopolist is producing under decreasing cost (A) Both Assertion and Reason are true and Reason
conditions, increase in demand is beneficial to the is the correct explanation of Assertion
society because— (B) Both Assertion and Reason are true and Reason
(A) Consumers get better quality goods is not a correct explanation of Assertion
(C) Assertion is true but Reason is false
(B) Cost of production falls and hence price will
follow (D) Assertion is false but Reason is true
(C) Goods will be sold in many markets 362. Assertion : The imposition of a per unit tax causes
(D) None of the above answers is correct the monopolists average cost and marginal cost
curves to shift up.
357. The hypothesis that the firms seek to maximise their Reason : The per unit tax is like a variable cost.
sales revenue own its origin to— (A) Both Assertion and Reason are true and Reason
(A) W.J. Baumol (B) J.S. Baumol is the correct explanation of Assertion
(C) W.J. Hicks (D) J.W. Baumol (B) Both Assertion and Reason are true but Reason
358. A consumer spends all his income of R 500 equally is not a correct explanation of Assertion
on two goods x and y by purchasing 50 units of x at (C) Assertion is true but Reason is false
R 5 per unit and 25 units of y at R 10 per unit. (D) Assertion is false but Reason is true
Because of recession, prices of x and y fall by 50% 363. Suppose that output (Y) is a function of capital (K);
and his employer reduces his salary from R 500 to then the capital-elasticity of output is given by—
R 250. In this situation he is expected to—
MPk APk
(A) Increase the purchase of both x an y as they are (A) (B)
now cheaper AP k MP K
(B) Decrease the purchase of both x and y as his Y
(C) (D) None of these
income goes down K
(C) Leave the purchase basket unaltered at 50 of x 364. Assume a production function y = Lα K1 – α
and 25 of y (Y = output, L = labour and K = capital) for a firm
(D) Alter his purchase in an uncertain way in a purely competitive market. Which one of the
following would measure the share of labour in
359. Assertion (A) : If the monopolist faces identical output ?
demand curves for his commodity in two separate
(A) α (B) L(α)
markets, by practising third degree price discrimina-
α
tion, he cannot increase his TR and total profits. (C) Lα (D)
L
Reason (R) : As the marginal revenue curves are
identical when the demand curves in the two 365. A supply curve will have a price-elasticity equal to
markets are the same, the monopolist will not 1 only when it is—
charge different prices in each market to maximise (A) A straight line with a positive intercept
profits. (B) A straight line with a negative intercept
(A) Both Assertion and Reason are true and Reason (C) A straight line passing through the origin
is the correct explanation of Assertion (D) Horizontal
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366. Under perfect competition (when input prices are 373. If in a purely competitive market with down
fixed and there are no external economies or wardsloping demand and upward-sloping supply
diseconomies), the industry supply curve is derived curves, a specific excise tax per unit of output is
by— imposed, then—
(A) Vertically adding the average cost curves
(A) Price rises by the amount of the tax
(B) Horizontally adding the average cost curves
(B) The price-rise is less than the amount of the tax
(C) Vertically adding the marginal cost curves
(D) Horizontally adding the marginal cost curves (C) The price-rise is greater than the amount of the
tax
367. Starting from a monopoly equilibrium without any (D) The price remains the same
policy intervention, market efficiency can be
improved by imposing a— 374. Market failure may not arise in the case of—
(A) Per-unit production tax (A) Increasing returns to scale
(B) Per-unit sales tax (B) Public goods
(C) Profit tax (C) The consumption externalities
(D) Price ceiling below the existing equilibrium (D) Income inequalities
price
375. A given economic state is Pareto-optimum if a
368. Application of the ‘Marginal-cost pricing’ principle policy-change can—
in a decreasing cost industry would lead to—
(A) Make everyone better off
(A) Surpluses
(B) Make someone better off and some one worse
(B) Losses needing subsidies
off
(C) Neither surpluses nor losses
(C) Make someone better off and all others worse
(D) A decline in output
off
369. In monopolistic competition, a firm is in long-run (D) Not make anyone better off without making
equilibrium— someone worse off
(A) At the minimum point of the long-run average
cost curve 376. The theory of Distribution analysis the principles
which explain—
(B) In the declining segment of the long-run
average cost curve (A) The distribution of goods among consumers
(C) In the rising segment of the long-run average (B) The allocation of resources in different sectors
cost curve of the economy
(D) When the price is equal to marginal cost (C) The distribution of income amount factors of
production
370. Income inequalities in a country can be measured (D) The distribution of profits among share holders
by—
377. While analysing the marginal productivity theory of
(A) Lorenz curve
distribution, Clark gave more emphasis to—
(B) Gini coefficient
(A) Demand for labour
(C) Proportion of income received by different size
(B) Supply of labour
groups
(C) Both demand as well as supply of labour
(D) All of the above
(D) Profit maximisation
371. The Adding Up Theorem under constant returns to 378. We say of the demand for a factor that it is a
scale holds when the factors of production are paid “derived demand”, because—
according to their— (A) It is derived from the entrepreneur’s need for
(A) Marginal productivities profit
(B) Average productivities (B) It stems from government policy relating to
(C) Total productivities labour
(D) Ration of marginal productivities to average (C) It emerges from the demand for the final
productivities product
372. Rent earned by a factor of production equals— (D) It is derived from long period expectations
(A) What this factor can earn in its next best use 379. Who suggested that the price of a factor or
(B) The sum of what this factor earns in its current production is determined by the demand and supply
use and what is can earn in its next best use forces ?
(C) Its current earnings (A) Marshall and Hicks
(D) The difference between what this factor is (B) Clark and Allen
currently earning and what it can earn in its (C) Lipsey and Samuelson
next best use (D) Jevons and Walras
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380. In practice the reward paid to a factor depends (B) Total product is at a maximum when marginal
upon— product is falling
(A) Its productivity and the price of the product it (C) Total product is at a minimum when marginal
makes product is zero
(B) Value of its output minus profit tax (D) Total product increases when marginal product
(C) General directives of the government is zero
(D) Its cost and the price of the product it makes 388. For a competitive firm, the demand curve is also—
381. Marginal physical product and marginal revenue (A) The total revenue curve
product change exactly similarly only when— (B) The average revenue curve
(A) The price of the product remains constant (C) The marginal revenue curve
(B) The product remains unchanged (D) Both (B) and (C)
(C) The price of the product falls regularly 389. The slope of the iso-cost line measures—
(D) None of the above (A) The marginal rate of technical substitution
(B) The marginal rate of substitution
382. The price elasticity of demand in demand function q
b
= ap is— (C) The ratio of input prices
(A) a (B) 1 (D) Optimal combination inputs
(C) b (D) ab 390. In a general competitive equilibrium, the slope of
the production possibility frontier equals—
383. A fall in the price offish will have comparatively
(A) The slope of the iso cost line of a firm
little effect on demand for meat, whereas a fall in
the price of chicken will have a far greater effect on (B) The slope of a consumer’s budget line
the demand for mutton, because— (C) The input price ratio
(A) Chicken is a much better substitute for mutton (D) The ratio of marginal products
than fish for meat 391. Efficiency in the distribution of products among
(B) Chicken and fish are complementary goods consumers occurs when—
(C) Meat and fish are substitutes (A) Marginal rate of technical substitution are
(D) Meat is a better substitute to fish than to equal
chicken (B) Consumer’s marginal rate of substitution are
equal
384. If the price elasticity of demand is 0·5, a 10 per cent
increase in price leads to— (C) P = MC
(A) 5% increase in demand (D) P x = MUx
(B) 5% decrease in demand 392. In order to get a Pareto-optimal distribution the
(C) 0·5 units decrease in demand goods must be distributed in a fashion such that—
(D) 0·5 units increase in demand (A) MRS between any two goods is different for
385. An upward sloping supply curve implies that— different individuals
(A) The producer will cut back on production when (B) MRS between any two goods of individual is
price rises because he can sell a smaller amount greater than those of others
and obtain the same total profit (C) MRS between any two goods is the same for all
(B) The producer will increase output when price individuals
rises in an attempt to increase profits even (D) MRS between any two goods of one individual
more is less than those of others
(C) The producer is not responsive to the true 393. Frank H. Kinght regards profits as—
needs of consumers
(A) Payments received by an entrepreneur who is
(D) Consumers will buy more of the product when seeking to maximise his profits and faces a
its price rises downward sloping demand curve for the
386. Diminishing returns refers to an eventual fall in— produce which he is selling
(A) The average product of he variable factor (B) A chance of distribution of income among
(B) The marginal product of the fixed factor entrepreneurs
(C) The total product (C) The payments received by entrepreneurs who
take highly risky projects involving bold inno-
(D) The marginal product of the variable factor
vations
387. Which one of the following is true ? (D) The payments received by an entrepreneur for
(A) Total product is at a maximum when marginal his risk-taking and activities in which some
product has fallen to zero elements of uncertainty are involved
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394. In Schumpeter’s view an entrepreneur is— (C) Reward of marginal and sub marginal units of a
(A) An individual participating in activities in factor
which any risk uncertainty or speculation exists (D) All of these
(B) The individual who furnishes the money capital 404. First of all the term ‘Quasi-rent’ was used by—
to finance any enterprise and thus bears the risk (A) Marshall (B) Adam Smith
(C) An innovator of new products and processes (C) John Robinson (D) None of these
(D) The person responsible for decisions concerning
operations of an enterprise 405. Quasi-rent is a—
(A) Short-period phenomenon
395. ‘Interest is a reward for parting with liquidity’,
according to— (B) Long-period phenomenon
(A) J.M. Keynes (B) Alfred Marshall (C) Time phenomenon
(C) G. Von Haberler (D) Bertil Ohlin (D) None of the above
396. The advocate of the Loanable Fund Theory of 406. Quasi-rent is—
Interest is— (A) Price-AVC (B) Price-AFC
(A) Keynes (B) Lionel Robbins (C) Price-ATC (D) Price-MC
(C) Robertson (D) Paul Samuelson
407. The Modern Theory of Rent has been developed
397. The Loanable funds theory lays emphasis on the by—
interplay of— (A) J.M. Kynes (B) Alfred Marshall
(A) Monetary factors
(C) Joan Robinson (D) D.H. Robertson
(B) Real factors
(C) Both monetary as well as real factors 408. A factor will not earn rent if—
(D) Liquidity preference (A) Its supply is elastic
398. Which theory is called as the Neo-classical theory (B) Its supply is inelastic
of Rate of interest ? (C) Its supply cannot be varied
(A) The Keynesian Theory (D) Its supply is perfectly elastic for all amount
(B) Liquidity Preference Theory 409. ‘In a sense all rents are scarcity rents, and all rents
(C) The Time Preference Theory are differential rents’ are words of—
(D) Loanable Funds Theory (A) Ricardo (B) Adam Smith
399. Interest is “Price paid for the use of capital in any (C) K.F. Boulding (D) Marshall
market.” This view of interest has been expressed 410. That the rent of land is a return for the use of the
by— “original and indestructible powers of the soil” was
(A) S.E. Harris (B) Lipsey the essence of the theory proposed by—
(C) Fisher (D) Marshall (A) Adam Smith (B) Ricardo
400. The Ricardian Theory and the Modern Theory of (C) John Stuart Mill (D) Alfred Marshall
rent are— 411. In the Ricardian theory of economic rent, transfer
(A) Similar earnings of land are presumed to be—
(B) Same (A) Equal to rent (B) Negative
(C) Altogether different (C) Positive (D) Zero
(D) Slightly different 412. Transfer earnings are—
401. If the supply of a factor cannot be increased in the (A) The maximum payment necessary to retain
short period and demand for it increases it will— the factor in its employment
(A) Earn an economic rent (B) The level of earnings required to tempt factors
(B) Earn a quasi-rent to take up less remunerative employment
(C) That part of a factor’s earnings classed as
(C) Earn a windfall profit
Economic Rent
(D) Increase its transfer earnings (D) Payments made to labour during periods of
402. According to the Modern Theory, rent arises on— retraining
(A) Labour only (B) Land only 413. Consider the following statements :
(C) Capital only (D) All factors Unanticipated inflation is likely to benefit—
403. According to the Modern theory, rent is the I. Debtors.
difference between— II. Life Insurance policy-holders.
(A) Actual earning and transfer earning III. Persons having fixed deposits with companies.
(B) A land’s produce and B land’s produce IV. Persons having fixed deposits with banks
Economics (NET) | 125U
Of these statements— 421. In collusive oligopoly for joint profit maximisa-
(A) I alone is correct tion—
(A) The highest cost firm makes the highest profit
(B) I and II are correct
(B) The lowest cost firm makes the highest profit
(C) I, II and III are correct
(C) The lowest cost firm produces the largest
(D) II III and IV are correct output
414. The term ‘group equilibrium’ is related to— (D) None of the above is true
(A) Analysis of Monopolistic competition 422. ‘If an oligopolist decreases his price the rivals will
(B) Analysis of Chamberlin follow’. This is the basic assumption of—
(C) Analysis of Monopolistic competition by E.H. (A) The kinked supply curve
Chamberlin (B) The oligopolistic demand curve
(D) Analysis of Monopolistic competition by (C) The kinked demand curve
Robinson (D) The demand curve
415. Monopolistic competition differs from perfect 423. Each seller determines his price on the assumption
competition due to— that his rival will keep his price constant, under—
(A) Large number of firms and heterogeneous pro- (A) Bertrand’s Model (B) Samuelson’s Model
duct (C) Edge worth Model (D) Price leadership
(B) Large number of firms and homogeneous pro- 424. Duopoly is a market situation when—
duct
(A) There is only one producer of a given product
(C) Small number of firms and differentiated
(B) There are two producers of a given product
products
(C) There are more than two producers
(D) Only a few firms and similar products
(D) There are a few producers
416. In an oligopoly, a firm while deciding about its own
price and output policy has— 425. ‘The equilibrium prices of duopoly model are
(A) To take account of the likely reactions of the obtained at the intersections of their reaction
other firms curves’. It is correct in the case of—
(B) Has not to bother about other firms (A) Edgeworth Model
(C) Assume that others will not react (B) Bertrand’s Model
(D) To act independently of the others (C) Bertrand’s Duopoly Model
(D) None of the above
417. A firm with the highest cost of production is not
plausible in the case of— 426. Which of the following used the kinked demand
(A) Price leadership under oligopoly curve only to explain why oligopoly prices are
‘sticky’?
(B) Price leadership under monopoly
(A) P.M. Sweezy (B) Chamberlin
(C) Price leadership under bilateral monopoly
(C) Hall and Hitch (D) Stigler
(D) Price leadership u n d e r monopolistic com-
petition 427. With reference to the Cournot’s model, determine
which of the following statements is false ?
418. The dominant firm price leader’s market share
is— (A) The solution is stable
(B) Each duopolist assumes the others will keep its
(A) Lower, the higher the follower’s costs
price constant
(B) Higher, the lower the follower’s costs (C) The duopolists do not recognise their inter-
(C) Lower, the lower the follower’s costs dependence
(D) Invariant with the follower’s costs (D) Each duopolist assumes the other will keep its
419. In the case of price leadership by the dominant firm, quantity constant
when all the firms in the purely oligopolistic 428. With reference to the Edgeworth Model, determine
industry will produce their best level of output ? which of the following statements are correct ?
(A) Always (B) Often (A) It explains price rigidity
(C) Never (D) None of these (B) The duopolists recognised their inter-depen-
dence
420. Joint profits are maximised in the model cartel, (C) Each duopolist assumes the other keeps its
which is a model of— price constant
(A) Duopoly (B) Duopsony (D) Each duopolist assumes the other keeps its
(C) Oligospony (D) Oligopoly quantity constant
126U | Economics (NET)
429. Each seller ultimately supplies one third of the 435. Which type of equilibrium is shown in the following
market and charges the same prices. This is the function for a commodity, where S is supply, D is
conclusion of— demand, P is price and t refers to time ?
(A) Bertrand’s duopoly model S t = f(Pt)
(B) Edgeworth’s duopoly model Dt = f(Pt)
(C) Cournot’s duopoly model S x = Dx
(D) Collusive duopoly model
(A) Partial equilibrium
430. The equilibrium is unstable and indeterminate (B) Static equilibrium
under—
(C) Partial and static equilibrium
(A) Edgeworth duopoly model
(B) Edgeworth oligopoly model (D) Dynamic equilibrium
(C) Edgeworth model 436. In bilateral monopoly there—
(D) Edgeworth and Pareto model (A) Is a single buyer and large number of sellers
431. The kinked-demand curve is appropriate when— (B) Is a single seller and large number of buyers
(A) Inter-firm knowledge is low (C) Is a single seller and a single buyer
(B) There is a general depression (D) Are a large number of buyers and a large
(C) Inter-firm knowledge is high number of sellers
(D) There is a general prosperity 437. Where two factors of production are perfectly
432. The lower portion of the kinked-demand curve, is complementary, the shape of the equal product curve
noted for bringing in just a few new consumers. So is—
it is— (A) Convex to the origin
(A) Relatively elastic (B) Concave to the origin
(B) Relatively in elastic
(C) Right angled
(C) Relatively no response
(D) None of the above
(D) None of the above
438. In case of monopoly, which of the following
433. In the following diagram the total consumer’s
relations is true ?
surplus is measured by—
(A) MR = AR 1 – ( 1
e)
(B) MR = AR 1 + ( )
1
e
(C) AR = MR 1 – ( 1
e)
(D) AR = MR 1 + ( )
1
e
where MR = marginal revenue
AR = average revenue
e = elasticity of demand
439. Lerner’s index of monopoly power is indicated
by—
(A) CF (B) PC P – MC P – MC
(C) CFTE (D) PKE (A) (B)
P MC
434. Which of the following statements are true regarding P – AC P – MR
the Cobb-Douglas production function ? (C) (D)
AC P
1. It is long period production function. 440. In Edgeworth’s box diagram, the curve showing the
2. It is short period production function. equilibrium of two consumers is known as—
3. It assumes increasing returns to scale. (A) Income-consumption curve
4. Out-put elasticities with respect to factors are (B) Ridge lines
constant.
(C) Expansion path
Choose the correct answer from the code given
below— (D) Contract curve
(A) 1 and 3 (B) 1 and 4 441. As a result of increase in the price of tea from R 40
(C) 2 and 3 (D) 3 and 4 to R 50 per pound, the demand for coffee increases
Economics (NET) | 127U
from 600 pound to 720 pounds. The cross elasticity 449. The revealed preference approach can be described
of demand is— by—
1 2 (A) Strong ordering and lexicographic preference
(A) (B)
2 3 pattern
3 4 (B) Rationality, Consistency and Transitivity
(C) (D) (C) Rationality and Weak ordering
4 5
(D) Transitivity and Weak ordering
442. Taking capital as constant, if we go on increasing
the quantity of labour average product of labour will 450. If capital ‘K’ is plotted on the vertical axis and
be maximum in— labour ‘L’ on the horizontal axis, then the slope of
(A) The middle of the second stage the straight line iso-cost curve will be—
(B) The end of the 1st stage P P
(A) K (B) L
P PK
(C) The end of the second stage L
(D) The end of third stage P P
(C) – L (D) – K
PK PL
443. Who among the following Economists propounded
the innovation theory of profit ? 451. Quasi rent is—
(A) Karl Marx (B) F.H. Kinght (A) Equal to the firm’s total profits
(C) J. Schumpeter (D) A. Marshall (B) Greater than firm’s total profits
(C) Smaller than firm’s total profits
444. The validity of kinked demand curve was empi-
rically tested and questioned by— (D) Not related to firm’s profits
(A) D.S. Watson (B) Hall and Hitch 452. The backward-bending supply curve for labour
exists—
(C) G.J. Stigler (D) F. Maeklap
(A) Only in inflationary conditions
445. In Cobb-Douglas production function, (B) Wherever income effect overcomes substitu-
Q = Akα Lβ, α and β measure— tion effect
(A) Elasticity of substitution (C) Only in labour intensive industry
(B) Input shares (D) Only in a high cost industry
(C) Output elasticities of inputs 453. An ethical or value Judgement must be made in
(D) Technological condition order to derive the—
(A) Transformation curve
446. The product transformation curve is derived from—
(B) Grand utility possibility
(A) The contract curve related to consumption
(C) Consumption contract curve
(B) The utility possibility curve (D) Social welfare function
(C) The social welfare function
454. According to the Kaldor-Hicks compensation
(D) The production contract curve criterion, a change in economic policy leads to an
447. In case of Giffen goods— improvement in social welfare, if—
(A) Price effect and income effect are positive, (A) The gainers can just compensate the losers
substitution effect is negative (B) The losers can profitably bribe the gainers to
(B) Price effect, income effect and substitution induce them to stay in the old position
effects are negative (C) The gainers can compensate the losers for their
(C) Price effect, income effect and substitution loss and still remain better-off themselves than
effect are positive before
(D) Price effect is negative while income effect (D) The losers do not oppose the change
and substitution effect are positive 455. Match List-I with List-II a n d select t h e correct
448. Which one of the following statements is an apt answer using the codes given below the lists—
reflection of J. R. Hick’s Indifference curve Analysis List-I (Curves) List-II (Ideas)
of demand ?
(a) Offer curve 1. Market segmentation
(A) Pareto’s theory with Marshall’s method (b) Laffer curve 2. Sticky price
(B) Pareto’s theory with Marshall’s method (c) Lorenz curve 3. Reciprocal demand
(C) Marshall’s theory with Pareto’s method (d) Kinked curve 4. Inequalities
(D) Marshall’s theory with Marshall’s method 5. Public revenue
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Codes : 460. In the context of cost minimisation by a competitive
(a) (b) (c) (d) producer, which one of the following is not correct ?
(A) 1 4 5 3 (A) Marginal rate of technical substitution of the
factors equals relative factor price ratio
(B) 3 5 4 2
(B) Ratio of marginal physical productivities of the
(C) 1 5 3 2 factors equals the ratio of factor prices
(D) 4 2 3 1 (C) Slope of the isoquent in question equals slope
456. When both the demand and the supply curves slope of the budget line
downwards and the demand curve is steeper than (D) Marginal rate of technical substitution of
the supply curve, the equilibrium is— factors of production divided by relative factor
price ration is zero
(A) Stable in both Marshallian and Walrasian sense
461. In the short-run, the supply curve of a competitive
(B) Unstable in both Marshallian and Walrasian
firm is—
sense
(A) The rising portion of the marginal cost curve
(C) Stable in the Marshallian sense but unstable lying above the minimum point of the average
in the Walrasian sense variable cost curve
(D) Unstable in the Marshallian sense but stable in (B) The falling portion of the MC-curve lying
the Walrasian sense before the minimum point of the average
457. Consider the following combinations of inputs variable cost curve
and outputs— (C) The rising portion of the MC-curve after the
Labour Capital Output highest point of total cost curve
5 10 1 (D) None of the above
6 12 2 462. Suppose, there is a situation where two individuals
7 14 3 are engaged in exchange and if individual 1 is a
8 16 4 price-maker and individual 2 is a price-taker,
9 18 5 equilibrium—
10 20 6 (A) Takes place on the offer curve of individual 1
This production technology satisfies— (B) Takes place on the offer curve of individuals 2
(A) Increasing returns to scale (C) Takes place at the intersection point of the two
offer curves
(B) Diminishing returns to scale
(D) Is indeterminate
(C) Constant returns to scale
(D) Increasing returns initially, followed by 463. In the long run, the market price of a commodity is
decreasing returns to scale equal to its minimum average cost of production, if
there is—
458. On the expansion path of the firm operating with (A) Perfect competition
homogeneous production function, which among the (B) Monopoly
following remain constant ?
(C) Oligopoly
1. Input ratio.
(D) Monopolistic competition
2. Price ratio of inputs.
3. Marginal rate of technical substitution between 464. In the linearly homogeneous Cobb-Douglas produc-
the factors. tion function with two inputs, the elasticity of
4. Elasticity of substitution. substitution between the inputs is—
Select the correct answer using the codes given (A) Zero (B) Greater than one
below— (C) One (D) Less than one
(A) 1 and 4 (B) 2 and 1
465. Suppose that there are two goods, x and y, facing a
(C) 2, 3 and 4 (D) 1, 2, 3 and 4 consumer. The price are P = R 4 and P = R 5. He
x y
459. Rent earned by factor of production equals— has R 110 to spend on these goods. Suppose, he is
(A) What this factor earn in its next best use currently buying 15 units of good x (with marginal
(B) The sum of what this factor earns in its current utility equal to 40) and 10 units of good y (with
use and what it can earn in its next best use marginal utility equal to 45). In the above context,
(C) Its transfer earnings which one of the following statements is correct ?
(D) The difference between what this factor is (A) His total utility will increase if he reallocates
currently earning and what it can earn in its his spending towards more of good x and less
next best use of good y
Economics (NET) | 129U
(B) His total utility will increase if he spends more 471. When there is monopsony in the labour market
on good y and less on good x and monopoly in the product market, total of
(C) His total utility will increase if he spends less monopsonistic and monopolistic exploitation is the
on both the goods difference between—
(D) His total utility is being maximized subject to (A) VMP and AW (B) VMP and MW
the budget constraint he is facing (C) MRP and MW (D) ARP and AW
466. If an individual is observed to work less in response 472. A trade-union entering a perfectly competitive
to an increase in the wage rate for his services, this labour market can raise the wage above the free
implies that— market level—
(A) For this individual, leisure is a normal good (A) Along with an increase in employment
(B) For this individual, leisure is an inferior good (B) Keeping the employment at the existing level
(C) The individual is irrational (C) Only at the cost of lowering the amount of
employment
(D) Leisure could be a Giffen good
(D) Either (A) or (C) depending upon the relative
20 elasticities of demand and supply curves of the
467. Given the demand function Q = , where P = Price
P commodity being produced
of product and Q = Quantity of product, the 473. A negatively sloped supply curve of labour of an
elasticity of demand at P = 10 would be— individual indicates that the substitution effect of an
(A) 0 (B) –1 increase in the wage rate is—
(C) – 2 (D) ∞ (A) Equal to income effect
468. Match List-I (MRSxy) with List-II (The shape of (B) Weaker than income effect
Indifference Curve IC) and select the correct answer (C) Stronger than income effect
using the codes given below the lists— (D) Either (B) or (C) depending upon his income
List-I level
(a) MRSxy = Zero 474. Under condition of Monopsony in the labour
(b) MRSxy = Constant but non-zero market, the trade unions can succeed in achieving
(c) Decreasing MRS xy higher wage rates—
(d) Increasing MRSxy (A) Without decreasing employment
List-II (B) With increasing employment
1. Right angled (C) Without unemployment
2. Straight line with negative slope (D) All of the above
3. IC is concave to the origin 475. Income effect results in—
4. IC is convex to the origin (A) Upward sloping supply curve of labour
Codes : (B) Downwards sloping supply curve of labour
(a) (b) (c) (d) (C) Backward sloping supply curve of labour
(A) 1 2 4 3 (D) Zero slope of supply curve of labour
(B) 3 4 2 1 476. Which of the following statements is not true ? A
(C) 1 4 2 3 trade union is likely to be successful in obtaining a
(D) 3 2 4 1 wage increase when—
469. Where there is perfect competition in the labour (A) The demand for the product made by the labour
market as well as the product market, labour will be is inelastic
subjected to— (B) There is full employment
(A) Monopolistic exploitation (C) The supply of labour saving equipment is
(B) Non exploitation elastic
(C) Monopsonistic exploitation (D) Labour costs form a small proportion of total
(D) Both (A) and (B) cost
470. With perfect competition in the labour market and 477. When there is monopsony in labour market and
monopoly in the product market the monopolistic perfect competition in product market, the mono-
exploitation of labour is equal to the difference psonistic exploitation in the equilibrium situation is
between— the difference between—
(A) MU and AW (B) MRP and AW (A) VMP and MRP (B) ARP and MRP
(C) VMP and MRP (D) MRP and ARP (C) MW and AW (D) MW and MRP
130U | Economics (NET)
478. The demand curve for labour is also its— 486. When there is monopsony in labour market and
(A) Average revenue productivity curve monopoly in product market, the total exploitation
(B) Marginal revenue productivity curve in the equilibrium situation is the difference
between—
(C) Total revenue productivity curve
(A) VMP and MRP (B) VMP and AW
(D) Total utility curve
(C) MRP and MW (D) MRP and AW
479. Wage-offer curve shows the relationship between—
487. An employer will continue to hire units of a variable
(A) Wage offered by two competing firms
factor until MRP—
(B) Wage rate and general price level
(A) Equals its AW (B) More than AW
(C) Money income and real income
(C) Less than MW (D) Equals its MW
(D) Money income of an individual and the work
effort that he is ready to put in 488. Assertion (A) : Long run equilibrium of the
industry in a perfectly competitive market occurs at
480. The backward-bending supply curve for labour the point where price equals minimum long run
exists— average cost.
(A) Only in inflationary conditions Reason (R) : In this position of zero economic
(B) Wherever income effect overcomes substitution profit, there is no tendency on the part of any
effect existing firm to stage on exit, and no potential
(C) Only in labour intensive industry entrant wants to enter the industry.
(D) Only in a high cost industry (A) Both A and R are individually true and R is the
correct explanation of A
481. According to the subsistence theory of wages, the
long run supply curve of labour is— (B) Both A and R are individually true but R is not
the correct explanation of A
(A) Perfectly elastic
(C) A is true but R is false
(B) Perfectly inelastic
(D) A is false but R is true
(C) A straight line sloping up towards right passing
through the origin 489. Assertion (A) : In perfect competition a firm is
(D) A straight line sloping up towards right cutting price-taker and the industry is price-maker.
and intercept on y-axis Reason (R) : No individual firm can influence the
price.
482. Which one of the following is not true in the wage
(A) Both A and R are individually true and R is the
fund theory ?
correct explanation of A
(A) Wages depend upon the wage-fund set aside
for the purchase of labour (B) Both A and R are individually true but R is not
the correct explanation of A
(B) Wages depend upon the number of workers
seeking employment (C) A is true but R is false
(C) Wage could rise only by a reduction in the (D) A is false but R is true
number of workers 490. Assertion (A) : Monopolistic competition is a
(D) Trade unions and collective bargaining can market situation where there is product differen-
raise the wages for labour class as a whole tiation.
483. Collective bargaining refers to— Reason (R) : Product differentiation is also a
characteristic of monopoly market.
(A) Inter-union discussions aimed at resolving an
industrial dispute (A) Both A and R are individually true and R is the
correct explanation of A
(B) Negotiation between employer’s associations
and worker’s unions (B) Both A and R are individually true but R is not
the correct explanation of A
(C) The determination of factor prices in a
collective economy (C) A is true but R is false
(D) Government trade union decisions on industrial (D) A is false but R is rue
legislation 491. Assertion (A) : The average fixed cost curve is
484. Wages Fund Theory was formulated by— rectangular hyperbola.
Reason (R) : The rate of increase in average
(A) Physiocrats (B) J. S. Mill
variable cost is higher than the rate of decrease
(C) Walker (D) Marshall in the average fixed cost.
485. For the equilibrium level of employment of a factor (A) Both A and R are individually true and R is the
of production the necessary condition is— correct explanation of A
(A) MRP = ARP (B) ARP = AFC (B) Both A and R are individually true but R is not
(C) MRP = MFC (D) MRP = VMP the correct explanation of A
Economics (NET) | 131U
(C) A is true but R is false 497. Which of the following is not a component of Engel
(D) A is false but R is true – Blackwell – Kollat Model of consumer beha-
viour ?
492. Assertion (A) : For inferior goods, the income
(A) Information Processing
elasticity of demand is negative.
(B) Personal Traits of the consumer
Reason (R) : As income rises, goods on which
spending grows relatively faster than income will (C) Decision process
occupy a rising share of income. (D) Environmental influences
(A) Both A and R are individually true and R is the 498. According to Family Decision Model of consumer
correct explanation of A behaviour, different consumption roles are played
(B) Both A and R are individually true but R is not by various members of the family. These roles are
the correct explanation of A …………
(C) A is true but R is false I. Influencers
(D) A is false but R is true II. Gate keepers
III. Deciders
493. Which of the following models is/are associated
with the concept of consumer behaviour ? IV. Buyers
I. Pavlovian Model Correct code is—
II. Howarth- Sheth Model (A) Only I, II & III (B) I, III & IV
III. Engel – Blackwell – Kollat Model (C) II, III & IV (D) I, II, III & IV
IV. Nicosia Model 499. Which of the following statement is correct about
Bernoulli utility function ?
Correct code is—
I. Bernoulli's formulation is strictly a concave
(A) Only I (B) Only I & II
II. Decision-maker's expected utility from a
(C) Only I, II & III (D) I, II, III & IV gamble is less than its expected value
494. Which of the following pair is not matched III. Decision-maker's expected utility from a
correctly ? gamble is greater than its expected value
(A) The psychoanalytical model of consumer beha- IV. Decision-maker's expected utility from a
viour- Freudian psychology gamble is equal to its expected value
(B) Learning model of consumer behaviour- Correct code is—
Stimulation-Response (A) I & II (B) I & III
(C) Social Welfare Function- Cardinal approach of (C) I & IV (D) None of these
utility maximization
500. Von Neumann-Morgenstern framework is used to
(D) Liquidity Preference Theory- Precautionary analyze…………..
motive
(A) To define people's attitudes towards risk
495. According to Pavlovian Model of consumer (B) To determine the profit function of a firm
behaviour, the learning process consists of ……. under monopolistic competition
I. Drive (C) To determine the flow of currency under infla-
II. Triggering Cues tionary condition
III. Reinforcement (D) To determine the level of uncertainty under
Correct code is— oligopoly
(A) I & II only (B) II & III only 501. People can be categorized into ……………. distinct
(C) I & III only (D) I, II & III groups on the basis of their attitudes towards risk
based on the form of their respective Bernoulli
496. Which of the following factors influence the utility functions.
consumer indirectly and vary from one consumer to
another ? (A) Two (B) Three
I. Individual’s own personality traits, (C) Four (D) Five
II. Social class, 502. Which of the following academecians is said to be
III. Importance of purchase the original developer of game theory ?
IV. Financial status. (A) John von Neumann
Correct code is— (B) Oskar Morgenstern
(A) Only II (B) III & IV only (C) John Harsanyi
(C) I & IV only (D) I, II, III & IV (D) Both (A) & (B)
132U | Economics (NET)
503. Which of the following pair is not matched IV. Probability distributions for movements made
correctly ? by nature.
(A) Reinhard Selten- Analysis of equilibria in the Correct code is—
theory of non-cooperative games (A) Only I, II & III are correct
(B) Robert Aumann- Understanding of conflict and (B) Only II, III & IV are correct
cooperation through game-theory analysis (C) Only I, III & IV are correct
(C) Roger Myerson- Mechanism design theory (D) I, II, III & IV are correct
(D) John Forbes Nash Jr– Market equilibrium under 509. Which of the following is/are associated with the
conflict conditions concept of moral hazards ?
504. Co-operative game theory assumes— I. Mirrlees
I. Rationality, II. Holmström
II. Unlimited communication III. Grossman and Hart
III. Unlimited ability to make agreements Correct code is—
(A) Only III (B) Only I & II
Correct code is—
(C) Only II & III (D) I, II, III
(A) I, II & III are correct
(B) Only I & II are correct 510. Which of the following is/are related to asymmetric
information ?
(C) Only III is correct
I. Moral Hazards
(D) Only II&III are correct
II. Adverse Selection
505. Non-cooperative theory assumes that the………… (A) Only I (B) Only II
(A) Numbers of players are finite (C) Both I & II (D) Neither I nor II
(B) Feasible decisions are infinite
(C) Time periods are infinite
Answers
(D) All are the assumptions 1. (A) 2. (B) 3. (A) 4. (A) 5. (C)
6. (A) 7. (B) 8. (D) 9. (B) 10. (A)
506. Non-Cooperative Game Theory is very useful
11. (D) 12. (C) 13. (A) 14. (B) 15. (A)
in………
16. (B) 17. (B) 18. (B) 19. (B) 20. (A)
I. Modeling in Consumer behaviour
21. (C) 22. (A) 23. (C) 24. (C) 25. (D)
II. Understanding multi-personal economic pro-
blems characterized by strategic interdepen- 26. (D) 27. (B) 28. (A) 29. (A) 30. (C)
dency 31. (A) 32. (C) 33. (D) 34. (B) 35. (C)
Correct code is— 36. (C) 37. (C) 38. (B) 39. (A) 40. (D)
(A) Only I is correct 41. (B) 42. (A) 43. (A) 44. (A) 45. (A)
(B) Only II is correct 46. (C) 47. (B) 48. (C) 49. (B) 50. (C)
(C) I & II both are correct 51. (C) 52. (A) 53. (B) 54. (B) 55. (B)
(D) Neither I nor II is correct 56. (B) 57. (D) 58. (A) 59. (C) 60. (A)
61. (B) 62. (A) 63. (D) 64. (B) 65. (B)
507. Which of the following is / are special non-realistic
cases ? 66. (B) 67. (C) 68. (A) 69. (D) 70. (B)
I. Perfect competition 71. (D) 72. (C) 73. (D) 74. (D) 75. (C)
76. (B) 77. (C) 78. (D) 79. (A) 80. (B)
II. Pure Monopoly (not threatened by entry)
81. (A) 82. (D) 83. (A) 84. (C) 85. (D)
III. Monopolistic Competition
86. (C) 87. (A) 88. (B) 89. (D) 90. (C)
IV. Duopoly
91. (C) 92. (C) 93. (B) 94. (D) 95. (B)
(A) Only I & II (B) Only II & III 96. (B) 97. (C) 98. (C) 99. (D) 100. (A)
(C) Only I & III (D) I, II, III & IV 101. (C) 102. (A) 103. (D) 104. (C) 105. (B)
508. An extensive form game under game theory speci- 106. (C) 107. (A) 108. (A) 109. (B) 110. (B)
fies……….. 111. (A) 112. (B) 113. (A) 114. (D) 115. (A)
I. The choices available to each player at each
116. (B) 117. (A) 118. (A) 119. (C) 120. (C)
turn of play (at each decision node).
II. The information held by each player at each 121. (B) 122. (B) 123. (C) 124. (C) 125. (C)
turn of play (at each decision node). 126. (B) 127. (A) 128. (A) 129. (D) 130. (C)
III. The payoffs of each player as a function of the 131. (B) 132. (C) 133. (B) 134. (B) 135. (A)
movements selected. 136. (A) 137. (A) 138. (B) 139. (B) 140. (A)
Economics (NET) | 133U
141. (A) 142. (A) 143. (B) 144. (A) 145. (C) 326. (A) 327. (B) 328. (A) 329. (C) 330. (C)
146. (D) 147. (B) 148. (A) 149. (A) 150. (A) 331. (C) 332. (B) 333. (D) 334. (A) 335. (B)
151. (C) 152. (D) 153. (A) 154. (A) 155. (B) 336. (A) 337. (D) 338. (D) 339. (B) 340. (B)
156. (C) 157. (B) 158. (B) 159. (B) 160. (B) 341. (C) 342. (D) 343. (A) 344. (B) 345. (D)
161. (A) 162. (C) 163. (D) 164. (D) 165. (B) 346. (D) 347. (C) 348. (B) 349. (C) 350. (B)
166. (B) 167. (B) 168. (A) 169. (B) 170. (C) 351. (C) 352. (D) 353. (C) 354. (D) 355. (A)
171. (C) 172. (B) 173. (C) 174. (A) 175. (D) 356. (B) 357. (A) 358. (C) 359. (A) 360. (A)
176. (D) 177. (B) 178. (D) 179. (B) 180. (B) 361. (A) 362. (A) 363. (A) 364. (A) 365. (C)
181. (C) 182. (C) 183. (B) 184. (B) 185. (A) 366. (D) 367. (A) 368. (A) 369. (B) 370. (D)
186. (A) 187. (C) 188. (C) 189. (A) 190. (B) 371. (A) 372. (D) 373. (B) 374. (C) 375. (D)
191. (D) 192. (C) 193. (B) 194. (B) 195. (B) 376. (C) 377. (A) 378. (C) 379. (A) 380. (A)
196. (B) 197. (A) 198. (D) 199. (D) 200. (B) 381. (A) 382. (C) 383. (A) 384. (B) 385. (B)
201. (A) 202. (A) 203. (B) 204. (A) 205. (A) 386. (D) 387. (C) 388. (D) 389. (C) 390. (B)
206. (B) 207. (C) 208. (D) 209. (D) 210. (C) 391. (B) 392. (C) 393. (C) 394. (C) 395. (A)
211. (A) 212. (B) 213. (B) 214. (B) 215. (A) 396. (C) 397. (C) 398. (D) 399. (D) 400. (C)
216. (C) 217. (C) 218. (C) 219. (B) 220. (B) 401. (B) 402. (D) 403. (A) 404. (A) 405. (A)
221. (B) 222. (D) 223. (C) 224. (C) 225. (B) 406. (A) 407. (C) 408. (D) 409. (D) 410. (B)
226. (B) 227. (D) 228. (D) 229. (A) 230. (C) 411. (D) 412. (A) 413. (A) 414. (C) 415. (C)
231. (C) 232. (A) 233. (B) 234. (B) 235. (B) 416. (A) 417. (A) 418. (C) 419. (A) 420. (D)
236. (D) 237. (D) 238. (C) 239. (A) 240. (A) 421. (C) 422. (C) 423. (A) 424. (B) 425. (C)
241. (C) 242. (D) 243. (A) 244. (D) 245. (A) 426. (C) 427. (B) 428. (C) 429. (C) 430. (A)
246. (C) 247. (D) 248. (C) 249. (C) 250. (B) 431. (A) 432. (B) 433. (A) 434. (B) 435. (C)
251. (B) 252. (C) 253. (C) 254. (B) 255. (C) 436. (C) 437. (C) 438. (A) 439. (A) 440. (D)
256. (C) 257. (C) 258. (B) 259. (C) 260. (B) 441. (D) 442. (B) 443. (C) 444. (C) 445. (C)
261. (B) 262. (A) 263. (D) 264. (A) 265. (B) 446. (D) 447. (B) 448. (C) 449. (B) 450. (B)
266. (B) 267. (C) 268. (C) 269. (A) 270. (D) 451. (A) 452. (B) 453. (D) 454. (C) 455. (B)
271. (B) 272. (A) 273. (A) 274. (A) 275. (B) 456. (C) 457. (C) 458. (A) 459. (D) 460. (D)
276. (C) 277. (A) 278. (A) 279. (A) 280. (A) 461. (A) 462. (A) 463. (A) 464. (C) 465. (D)
281. (B) 282. (B) 283. (A) 284. (A) 285. (C) 466. (A) 467. (B) 468. (A) 469. (B) 470. (C)
286. (B) 287. (D) 288. (B) 289. (A) 290. (B) 471. (A) 472. (C) 473. (B) 474. (D) 475. (C)
291. (C) 292. (B) 293. (A) 294. (B) 295. (B) 476. (C) 477. (C) 478. (B) 479. (D) 480. (B)
296. (C) 297. (A) 298. (B) 299. (B) 300. (A) 481. (A) 482. (D) 483. (B) 484. (B) 485. (C)
301. (B) 302. (B) 303. (A) 304. (C) 305. (D) 486. (B) 487. (D) 488. (A) 489. (A) 490. (C)
306. (A) 307. (C) 308. (A) 309. (C) 310. (A) 491. (B) 492. (C) 493. (D) 494. (C) 495. (D)
311. (C) 312. (B) 313. (A) 314. (A) 315. (B) 496. (D) 497. (B) 498. (D) 499. (A) 500. (A)
316. (B) 317. (D) 318. (D) 319. (C) 320. (C) 501. (B) 502. (D) 503. (D) 504. (A) 505. (A)
321. (A) 322. (B) 323. (D) 324. (C) 325. (C) 506. (C) 507. (A) 508. (D) 509. (D) 510. (C)
●●
UNIT-2
Macro-Economics
The term macro is derived from the Greek word quantities, not with individual incomes but with national
‘makros’ which means large. Most of the modern income, not with individual prices but with price levels,
economics is now macro-economics. It has become not with individual outputs but with the national output.”
popular only after the publication of Keynes ‘General Further, Gardner Ackley says : “Macro economics deals
Theory of Employment, Interest and Money’ in 1936. K. with economic affairs in large. It concerns the overall
Boulding has rightly remarked, “The modern develop- dimensions of economic life…… It studies the character
ments in macro economics … are most closely associated of forest, independently of trees which compose it.”
with the work of Mr. J.M. Keynes”. In a nutshell, macro-economics examines and
Besides Keynes, Robert Malthus (a classical econo- explains the determination of the level of composition,
mist and an important forerunner of macro-economics), fluctuations (cycles) and trends (growth) in the over all
Karl Marx, Leon Walras, Knut Wicksell and Irving economic activity, i.e., national income, output and
Fisher were among the prominent economists, who employment. Further, here full employment is not
contributed to the development of macro-economic assumed. We merely study the determinants of full
analysis. Theory of economic growth has further made employment and see how the fullest possible employ-
its use indispensable. ment can be achieved.
Macro-economics, also called income theory is Various aspects of macro-economics can be shown
concerned with the analysis of the economy as a whole in the following Chart-1.
and its large aggregates or averages such as total
national income and output, total employment, aggregate Importance of Macro-Economics
demand and supply and the general price level. The analysis of the macro-economics has acquired
Macro-economics studies the entire economic system or great significance in recent years particularly for
its major components such as households, business and understanding economic problems like unemployment,
Government. It deals with total private consumption poverty, inflation, depression, underdevelopment, etc.
expenditure, total private investment, total Government The study of the macro-economics is useful in many
expenditure, and total imports and exports of goods as ways.
well as services. It seeks the causes and cures for (a) Formulation and Execution of Economic
unemployment, inflation and balance of payment Policies—Government’s intervention in the economic
deficits. activities has been increasing day by day. The
Thus, macroeconomics is not concerned with a Government, however, can not deal with a particular
particular decision making unit, but with all such units individual or with small groups. Hence, the study of
combined together. It presents a complete picture of the the macro-economics becomes very important while
economic system. That is why, macro-economics is formulating and executing economic policies. The
termed as aggregative economics. In the words of economic policies for the removal of the poverty,
Kenneth E. Boulding. “Macro-economics deals not the unemployment and the price instability are based
with individual quantities but with aggregate of these upon aggregative requirements.
Chart-1
Economics (NET) | 135U
(b) Functioning of Economy—The macro-econo- Classical Theory of Employment
mics helps us to get an idea of how a complex economic
The classical theory starts with the assumption that
system functions. It is very difficult to interpret the
an economy functions at full employment and produces
functioning of an economy in terms of micro-economics
an output and income corresponding to the level of full
as there are numerous decision making units in the
employment. Any lapse from full employment will not
economy. We can understand the complex econo-mic
last long. There is a built in mechanism in the economy
system through the study of national aggregates like
that makes it operate at full employment. A long period
income, output, expenditure, saving and investment.
unemployment can persist only due to interference of the
(c) Helps to Understand Micro-Economics free play of market forces by the Government or by the
Better—The study of the macro-economics makes the private monopoly. The classical thinkers, thus, do not
understanding of the micro-economics better. Almost normally examine the level of employment at which the
every micro-economic law is based on macro-economic economy actually operates.
study. For instance, the law of diminishing marginal The assumption of the normal condition of ‘full
utility (a fundamental law of consumption) has been employment’ by the classical economists is based on the
framed by observing the behaviour of many consumers following two factors :
in the society. (i) Wage rates are flexible in nature and the
( d ) Study of Economic Development—Macro- operation of the free competition and price mechanism
economic developments have led to the study of the automatically removes unemployment by forcing the
economic growth. This has enabled us to study and wage down.
understand the problems of under developed countries. (ii) Increase in production increases not only the
By analysing such problems, it has become possible for supply of goods, but also creates the demand for these
us to promote the development of the under developed goods by virtue of factor price payments. This is the
countries. The macro economic analysis helps us to essence of Say’s Law.
study the process of the income generation and to
determine the factors accelerating the economic Say’s Law of Market
efficiency. The classical theory of employment is based upon
the ideas, broadly incorporated in Say’s Law of Market
(e) Study of Welfare—It is not possible to measure believed to have given by J.B. Say, a French economist
the size of material welfare in terms of the micro- of the 19th century. According to this law, ‘supply
economics. The importance of macro-economics is creates its own demand’. In other words, production
enhanced, as the main objectives of the study of and supply of a product creates an equivalent demand
Economics is the welfare of society. for the product, so that there can never be a problem of
(f) Theory of Inflation and Deflation—In these over production. The demand comes from income
days, the problem o f inflation has assumed serious carried by various factors of production. For example,
dimensions in both the developed and the under- the producer of a product organises the factors of
production and generates the purchasing power into the
developed countries. It is the result of excessive
economy by paying remuneration to these factors to
aggregate demand, as explained by Keynes. The theory enable them to purchase the product. This can, in
of inflation is an important subject of macro-economics. general, be explained with the help of a Chart-2.
In contrast, deflation is associated with a steady and
sustained fall in the price level. The inflation as well as Chart-2
the deflation are explained in terms of aggregative
economic variables like aggregate demand, output and
money supply, which explain the general price level.
The steps for curing these maladies are also based on the
aggregative approach.
(g) International Comparisons—Macro-econo-
mics facilitates international comparisons by providing
information about aggregate demand, national income,
consumption and saving for different countries. It is clear from this chart that the production of
Business environment needs macro-economic goods worth R 10 crores, on one hand, creates an income
analysis before decisions are taken by the firms. Macro- worth R 10 crores. On the other hand, the goods worth
economic analysis as it exists today has been evolved R 10 crores are supplied (offered for sale). Further, the
through ages with contributions made by economists income of R 10 crores generated during this process will
from different schools of thought. This analysis will help be used to demand the goods, which are supplied in the
in evaluating the plans and policies towards the business market. Therefore, every supply creates its own demand.
firm. Here, there will neither be over production nor
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deficiency of demand. Unemployed men or materials, if investment, the rate of interest goes up to equalise
any, will automatically be employed, as the employment savings and investment.
of unutilised productive resources would create the (iv) The mechanism of wage flexibility brings about
necessary income to lift and additional goods produced full employment. Unemployment disappears, when
by them. As an increase in supply leads to a workers accept a wage rate equal to their marginal
simultaneous expansion of market demand by an amount product. As production is usually done under conditions
equal to the income generated, J.B. Say concluded that of diminishing returns, the marginal product falls, as
aggregate demand is equal to aggregate supply. more labour is employed. This unique relationship
between the real wage rate and employment expands
Assumptions of Say’s Law employment with reduction in wage rate.
Say’s Law is based upon the following assumptions : We observe that the classical theory of employment
rules out the possibility of deficient demand and hence
(i) Whatever income the economy generates is involuntary unemployment. Moreover, the assumption
instantaneously spent either on consumption or on of competition in product, factor and money markets is
capital goods. That is, income not consumed is enough to restore full employment equilibrium through
automatically invested. There is, thus a continuous flow flexibility in interest, wages and prices. Whenever
of income, income becoming expenditure; expenditure imbalances crop up in the economy, this process of
creating income; and so on. adjustment will be instant and automatic without
(ii) There is perfect competition in product, factor interference of the government of any external stimulus.
and money markets.
Classical Theory of Employment and Its
(iii) There is no Government Interference in the Assumptions
functioning of the economy. The classical theory assumes the existence of full
employment without inflation. Given wage-price flexibility,
(iv) The amount of labour and capital can be raised there are automatic forces in the economic system that tend
to any extent in a free enterprise economy based on price to maintain full employment, and produce output at that
mechanism. level. Thus full employment is regarded as a normal
(v) New entrants have easy access into the market situation and any deviation from this level is something
without dislocating the existing ones. They are also free abnormal which automatically tends towards full employ-
ment. The classical theory of output and employment is
to withdraw. Hence, the size of the market is expandable. based on the following assumptions :
(vi) Economy is closed, which implies absence of 1. There is the existence of full employment without
trade or financial relationship with other economies. inflation.
2. There is perfect competition in labour and product
Implications of Say’s Law markets.
3. There is a closed laissez faire capitalist economy
It is important to understand the implications of without foreign trade.
Say’s Law, as these are important features of the 4. Labour is homogenous.
classical theory of income and employment : 5. Total output of the economy is divided between
consumption and investment expenditures.
(i) The economy under consideration is a two sector 6. The quantity of money is given.
economy. Whatever is produced by firms is consumed 7. Wages and prices are flexible.
by households. As there is automatic adjustment bet- 8. Money wages and real wages are directly related and
ween production (supply) and consumption (demand), proportional.
there is no need for the Government to interfere in the 9. Capital stock and technological knowledge are given in
functioning of this economic system. The Government the short run.
interference will simply create imbalances and disequili-
brium in the economy. Say’s Law and Classical Theory
According to the classical theory propounded by
(ii) As long as there exist unemployed resources Ricardo and Adam Smith, levels of income and
in the economy, it is profitable to employ them, because employment are governed by fixed capital stock on the
they will pay in their own way. Hence, the economy will one hand and wage-goods fund on the other. In fact, the
operate at the level of full employment. wage goods surpluses are also called by them as capital
(iii) Savings are only a form of investment. Thus, and have been given the name of circulating capital or
whatever is saved is automatically invested. The equality liquid capital in contrast to the fixed capital consisting of
between savings and investment is brought about machines, plants, factory buildings, irrigation works, etc.
through the rate of interest. If savings exceed investment, It may be noted in the beginning that the classical theory
the supply of funds will become more than their believes in full employment or near full employment
demand for investment. So, the rate of interest comes prevailing in the economy. This belief of classical theory
down, savings will be reduced and investment will regarding the existence of full employment in the
increase. Consequently, savings will be made equal to economy is based on Say’s Law put forward by a
investment. Similarly, when savings are less then Frenchy economist J. B. Say. According to J. B. Say’s
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law, “Supply creates its own demand”. This implies Q = f(K, T, N)
that every increase in production made possible by the where, Q = total output
increase in the productive capacity or the stock of fixed K = capital stock
capital will be sold in the market and there will be no
T = technological knowledge
problem of lack of demand.
N = number of workers
Thus, classical economists rule out the possibility of
This production function shows that in the short run
overproduction; there being no problem in selling the
the total output is an increasing function of the number
output produced. Thus, deficiency in demand being no
of workers given the capital stock and technological
problem, the process of capital accumulation and
knowledge.
expansion of productive capacity will continue till all
people are employed and there is no reason why the Keynes’s Criticism of Classical Theory
productive capacity created remains unutilized or
Keynes in his renowned book “General Theory”
underutilized.
severely criticised the classical theory of employment.
According to this theory, the income which is not Keynes attacked the classical theory on the following
spent on consumer goods and thus saved will be counts.
automatically invested. Indeed, in classical theory, 1. Keynes rejected the fundamental classical
saving and investment are two factors of the same assumption of full employment equilibrium in the
phenomenon i.e., an act of saving is an act of investment economy. He considered it as unrealistic. He regarded
itself. Thus, the leakage caused by the saving in the full employment as a special situation. The general
income flow is made up by the investment expenditure. situation in a capitalist economy is one of underemploy-
In this way, a given productive capacity continue to be ment.
fully utilized and no problem of deficiency of demand
2. Keynes refuted Say’s law of markets that supply
arises.
always created its own demand. He maintained that all
Classical economists thought that if price income earned by the factor owners would not be spent
mechanism in a capitalist economy is allowed to work in buying products which they helped to produce. A part
freely without any interference by the Government, then of the income is saved and is not automatically invested
there is always a tendency to full employment in it. Of because saving and investment are distinct functions, so
course, they admitted that in an advanced capitalist when all earned income is not spent on consumption
economy often certain circumstances arise due to which goods and a portion of it is saved, there results a
economy is not in a full-employment equilibrium. But deficiency of aggregate demand. This leads to general
they firmly believed that there was always a tendency to over production because all that is produced is not sold.
full employment in the economy and certain economic This, in turn, leads to general unemployment.
forces automatically operate so as to move the economy
3. The classicists believed that saving and
towards full employment. Therefore, according to the
investment were equal at the full employment level and
classical economists when ever there are lapses from full
in case of any divergence the equality was brought about
employment level, then these are removed automatically
by the mechanism of rate of interest. Keynes held that
by the working of free price mechanism.
the level of saving depended upon the level of income
Price Flexibility and Employment and not on the rate of interest. Similarly investment is
In the classical model of employment, chan-ges in determined not only by rate of interest but by the
money wages and real wages are directly related and are marginal efficiency of capital. A low rate of interest
proportional. When there is a cut in the money wage, the cannot increase investment if business expectations are
real wage is also reduced to the some extent which low.
reduces unemployment and ultimately brings full 4. Keynes did not agree with the classical view that
employment in the economy. This relationship is based the laissezfaire policy was essential for an automatic and
on the assumption that prices are proportional to the self-adjusting process of full employment equilibrium.
quantity of money. It is argued that in a competitive He pointed out that the capitalist system was not
economy a reaction in the money wage reduces the cost automatic and self-adjusting because of the non-
of production and prices of products thereby raising their egalitarian structure of its society. Keynes, therefore,
demand. In order to meet the increased demand for the advocated state intervention for adjusting supply and
products, more workers are employed to produce them. demand within the economy through fiscal and
As employment increases, total output also monetary measures.
increases till full employment is reached. But when the 5. The classical economists regarded money as
economy is at the full employment level, total output neutral. Therefore they excluded the theory of output,
becomes stable. Thus, given the stocks of capital, employment and interest rate from the monetary theory.
technological knowledge and resources, a precise According to them, the level of output and employment,
relation exists between total output and the amount of and the equilibrium rate of interest were determined by
employment. Total output is an increasing function of real forces. Keynes criticised the classical view that the
the number of workers. monetary theory was separate from the value theory. He
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integrated monetary theory with value theory, and Keynesian Theory of Employment
brought the theory of interest in the domain of monetary
theory. Concept of Effective Demand
6. Kenes refuted the Pigovian formulation that a cut The principle of ‘effective demand’ is basic to
in money wage could achieve full employment in the Keynes analysis of income, output and employment.
economy. The greatest fallacy in Pigou’s analysis was Prior to Keynes no satisfactory explanation was given of
that he extended the argument to the economy which the factors determining the level of employment in the
economy. The economists mostly assumed the
was applicable to a particular industry.
prevalence of the state of full employment believing in
Keynes also did not accept the classical view that Say’s Law of Markets. T. R. Malthus tried hard to
there was a direct proportionate relationship between convince Ricardo that demand in general might fall short
money wages and real wages. According, to him, there of supply in general and the deficiency of aggregate
is an inverse relation between the two. When money demand might cause general over production and hence
wages fall, real wages rise and vice-versa. general unemployment. But Malthus failed to explain
how effective demand could be deficient or excessive. It
7. The classicists believed in the long-run full was Keynes, who for the first time, put forward a
employment equilibrium through a self-adjusting systematic and convincing theory of employment based
process. Keynes had no patience to wait for the on the “Principle of Effective Demand.”
long period for he believed that “In the long-run we are
all dead.” Meaning of Effective Demand
Effective demand represents the money actually
Conclusion spent by people on the products of industry. Keynes
We have discussed above classical theory of used the term ‘effective demand’ to denote the total
employment. In brief this law states that supply creates demand for goods and services at various levels of
its own demand. From this, it has been concluded that in employment. Different levels of employment represent
a free enterprise capitalist economy, there is always a different levels of aggregate demand. But there can be
tendency towards full employment. If at sometimes a level of employment where aggregate demand equals
unemployment appears in the economy, then wages aggregate supply. This is the point of effective demand.
would decline, the rate of interest and price would also
fall and as a result of this employment of labour would Determinants of Effective Demands
increase and unemployment will be automatically Fro an understanding of Keynes theory of employ-
removed, provided the economy is allowed to work ment and how an equilibrium level of employment is
freely without any interference by Government and trade established in the economy, we must know the
unions. Hence a state of full employment will be determinants of effective demand—the aggregate
established. In this way due to the flexibility of wages, demand function and the aggregate supply function and
prices and interest rate, there can neither be general over their interrelationship.
production, nor unemployment in the economy for a
long time. Therefore, classical and neo-classical econo- Aggregate Supply
mists thought that there is always a tendency towards When entrepreneurs employ some people they
full-employment provided ho restrictions are placed in incur some cost of production. If the proceeds obtained
the working of free and perfect competition. But keynes from the sale of output produced by a certain number of
proved this as invalid not only theoretically but also people employed is greater than the cost of production
practically. Keynes put forward a new theory of income incurred, then it will be worthwhile to employ them.
and employment which is the correct explanation of the This cost of production incurred on the employment of a
phenomenon in a developed capitalist economy. For this certain number of labourers must be received by the
purpose, keynes invented new concepts such as entrepreneur, otherwise they will not produce and
propensity to consume, marginal efficiency of capital, provide employment to labour. At any given level of
liquidity preference which effect the level of income and employment of labour, aggregate supply price is the
employment in the economy. Keynes also proved that a total amount of money which all the entrepreneurs in
cut in wages will not cure depression and unemployment the economy taken together must expect to receive
but will worsen them. Following Keynesian revolution from the sale of the output produced by the given
in economic theory and the recognition of the fact that number of labourers employed. In other words, the
economic fluctuations or lapses from fullemployment aggregate supply price is the total cost of production
will not be automatically corrected, it is now almost incurred by employing a certain given number of
universally believed that Government should play an labourers. It is obvious that if the cost of production
active and important role to promote economic stability incurred by the entrepreneur in employing a certain
at the level of full employment by taking appropriate number of labourers is not covered, they will reduce the
fiscal and monetary measures. Laissez faire policy amount of employment offered. As the amount of
cannot, therefore, be followed by the Government in the employment of labour increases, the total cost of
modern world. production will also increase. Therefore, aggregate
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supply price will rise as more labour is employed to and at different income levels, consumption demand
produce goods and services. Thus we can construct would be different. Therefore, we can construct a
a schedule and curve of aggregate supply showing schedule or curve of aggregate demand price showing
aggregate supply price at different levels of employment. different aggregate demand price at different levels of
The curve of aggregate supply price is represented by employment. The curve of aggregate demand is shown
AS in figure A. This curve of aggregate supply price by the curve AD in figure A. The aggregate demand
starts from the point of origin and slopes upward to the price curve also rises from left to right. It will be seen in
right. In the beginning aggregate supply price curve AS figure A that when ON1 number of men are employed,
rises slowly, afterwards it rises rapidly. This curve AS the aggregate demand price is OH and when ON2 men
shows that as the number of men employed is increased, are employed, aggregate demand price is OM.
the aggregate supply price rises slowly in the beginning
and rapidly afterwards. This is because cost of Determination of the Equilibrium Level
production rises as more people are employed and of Employment by Effective Demand
further due to the operations of law of diminishing In figure A we have shown together aggregate suply
returns total cost of production increases at an increasing curve and aggregate demand curve. The amount of
rate. Once all the men willing to get employment are employment is measured along the x-axis and the
employed, then we have a state of full employment. receipts or proceeds obtained at various levels of
When the state of full employment is reached further employment are measured along the y-axis. As said
increases in aggregate demand or monetary expenditure above, aggregate supply curve shows the revenue or
will be unable to increase employment further since receipts which must be received by the entrepreneurs so
output of goods and services cannot be increased further as to provide employment to a given number of men.
as no more labour is available for production after Whereas aggregate demand curve shows proceeds or
full employment level is reached. Therefore, aggregate receipts which entrepreneurs actually expect to receive
supply curve assumes a vertical shape after full at different levels of employment and production. These
employment is reached. In figure A, ONF is the level of aggregate demand and the aggregate supply curves
full employment at which aggregate supply price determine the level of employment in the economy.
assumes a vertical shape. Given that the perfect competition prevails in the
economy, then so long as opportunities to earn profits or
Aggregate Demand make money exist, the entrepreneurs will increase the
It is the aggregate demand which plays a more level of employment. The opportunities to make profits
important role in the determination of employment. exist if aggregate demand price is greater than the
Aggregate demand price at any level of employment is aggregate supply price for a given number of
the amount of total money or price (proceeds) which all employment. Therefore, so long as, aggregate demand
the firms or entrepreneurs in the economy actually price exceeds aggregate supply price, the entrepreneurs
expect to receive from the sale of output produced by a will go on employing the extra men. When at a level of
given number of men employed. In other words, aggre- employment aggregate demand price becomes equal to
gate demand price represents the amount of aggregate supply price, then after this it will be no more
expenditure expected by the entrepreneurs when a given profitable to employ men. Since beyond this point
number of men are employed to produce goods and aggregate supply price will exceed aggregate demand
services. Like the aggregate supply price, aggregate price, the cost of production incurred on employing a
demand price also varies at different levels of certain number of people will not be covered. Therefore,
when aggregate demand price falls short of aggregate
supply price, employment of labour will fall. Equilibrium
level of employment is determined by the intersection of
aggregate demand curve and the aggregate supply curve,
where the amount of money which the entrepreneurs
actually expect to receive from employing a certain
number of men is equal to the amount of money which
they must receive. In other worlds, the employment of
labour will be in equilibrium at the level at which
aggregate demand price equals aggregate supply price. It
will be seen in figure that aggregate supply curve and
aggregate demand curve intersect at point E and
therefore ON2 level of employment is determined.
However, it will be seen from figure B that in the
situation of equilibrium at the employment level ON2,
Fig. A : Determination of Employment : Keynesian Theory N2NF persons remain unemployed. Thus equilibrium at
employment. This is because at different levels of E represent an under-employment equilibrium. It is
employment different income levels would be generated important to note that N2F 2 , persons are involuntarily
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unemployed, they are willing to work at the existing According to Keynes, aggregate demand and
wages but are unable to find jobs. It is important to aggregate supply will be equal at full employment only
remember that, according to Keynes, this unemployment if investment demand is sufficient to cover the gap
is due to deficiency of aggregate demand. between the aggregate supply price corresponding to full
employment and the consumption expenditure out of
income at the full employment level. The view of
Keynes is that investment demand generally falls short
of this gap between full-employment income and
consumption. According to him, when inducement to
invest in capitalist countries declines due to the fall in
marginal efficiency of capital, aggregate demand falls so
that equilibrium is established at less than full
employment level. As a result, output and income of the
community also fall.
Determination of National Income :
Keynesian Theory
We explained earlier the Keynesian theory with
special reference to the determination of employment. It
Number of Persons Employed
is worth noting here that the Keynesian theory is
Fig. B
relevant in the context of the short run only since the
This unemployment will be removed and full stock of capital, techniques of production, efficiency of
employment equilibrium will be reached if through labour, the size of population, forms of business
increase in investment demand or increase in consum- organisation have been assumed to remain constant in
ption, or increase in both aggregate demand curve shifts this theory. Therefore, in the Keynesian theory which
upward so that it intersects the aggregate supply curve at deals with the short run, the level of income of the
point R as depicted in figure B. It will be seen that country will change as a result of changes in the level of
with the intersection of aggregate demand and aggregate labour employment. Thus, in an advanced capitalist
supply curves at point R, equilibrium is established economy in the short-run, income is a function of
at full employment level ONF. employment. Infact, both income and employment go
It is thus clear that employment in the economy in together. The higher the level of employment; the higher
the short-run is determined by effective demand. The the level of income. As level of employment is
higher the level of effective demand, the greater is the determined by aggregate demand and aggregate supply,
volume of employment and vice versa. Unemployment the level of income is also determined by aggregate
is due to the deficiency of effective demand and the demand and aggregate supply.
basic remedy to remove this unemployment is to raise Aggregate Supply
the level of effective demand. The classical economists
believed that effective demand was always large enough Equilibrium level of national income in the short
to ensure full employment. But Keynes proved that it run depends upon aggregate demand and aggregate
was not so and that is why the phenomenon of supply. The aggregate supply depends on physical or
unemployment is common in free market capitalist technical conditions of production which do not change
economies. in the short-run. Since Keynes assumes the aggregate
supply to be stable, he concentrates his entire attention
Equilibrium Not Necessarily At Full upon the aggregate demand to fight depression and
Employment unemployment.
It is not necessary that the equilibrium levels of Aggregate Demand
employment is always at full employment. Equality Aggregate demand is determined by consumption
between aggregate demand and aggregate supply does demand and investment demand. Therefore,
not necessarily indicate the full employment level. The
Aggregate Demand = Consumption Demand
economy can be in equilibrium at less than full
employment or, in other words, an under employment + Investment Demand
equilibrium can exist. The classical economists denied AD = C + I
that there could be equilibrium at less then full where, AD = aggregate demand
employment, because they believed that supply would C = consumption demand
always create its own demand and therefore no problem
of deficiency of aggregate effective demand would b e I = investment demand
experienced. Keynes demolished the classical thesis of Consumption Demand—As for consumption
full employment both on theoretical grounds and by demand, it depends upon the propensity to consume of
illustrations from real life. the community and the level of national income. Given
Economics (NET) | 141U
the propensity to consume, as income will increase short-run. Therefore, the fluctuations in the level of
consumption demand will also increase. In other words, investment demand chiefly depend upon the changes in
given the propensity to consume, consumption demand the marginal efficiency of capital. The MEC means the
is a function of income. Consider figure C. in which expected rate of profit which the business community
income is measured along the x-axis and consumption hopes to get from the investment in capital assets. MEC
demand (C) and investment (I) are shown on the y-axis. depends upon the replacement cost of the capital goods
In this figure, a straight line OZ which makes 45° angle on the one hand and profit expectations of entrepreneur
with the x-axis has been drawn. This straight line OZ on the other.
with 45° angle with the x-axis represents the aggregate In Keynesian theory of income determination,
supply curve of the economy. This is also often called investment is not taken to be function of income. In
income line. In this figure a curve C has also been drawn actual practice when the level of income rises, the
which shows the propensity to consume slopes upward demand for goods will also rise and this will favourably
from left to right, which shows that as income increases effect the expectations of the entrepreneurs regarding
the amount of consumption demand also increases. The making of profits. Rise in the profit expectations will
gap between propensity to consume curve C and the raise the MEC which in turn will increase the level of
income line OZ represents the saving of the community. investment. But it is quite clear that investment demand
The reason for this is that a part of the income is does not directly depend upon income; It is only effected
consumed and a part is saved, i.e., indirectly by changes in income.
National Income = Consumption + Saving Therefore, in our figure we have taken a given level
or Y = C+S of investment demand independent of the level of
where, income. The distance between the C curve and the C + I
Y = income curve is parallel to the C - curve throughout which
C = consumption indicates that the level of investment is constant and
S = saving does not change with the change in income.
It will be seen from the figure that the gap between Equilibrium Level of Income : Equality
the propensity to consume curve C and the income line of Aggregate Demand and Aggregate
OZ goes on increasing as income increases. In other
words, the amount of saving or saving gap increases as
Supply
income increases. It is worth mentioning that in the short The equilibrium level of national income is
run propensity to consume does not change. This is determined at a point where the aggregate demand
because the propensity to consume, that is, the whole function intersects the aggregate supply function. The
propensity to consume curve C depends upon the tastes, aggregate demand function is represented by C + I in the
preferences, the income distribution in the society, the figure C. It is drawn by adding to the consumption
population level, etc. which do not undergo any change function C and the investment demand I. The 45° line
in the short-run. represents the aggregate supply function (Y = C + S).
Investment Demand The aggregate demand function C + I intersects the
aggregate supply function Y = C + S at point E and the
The other constituent of the aggregate demand is equilibrium level of income OY is determined.
investment which is a crucial factor in the determination
of equilibrium level of national income. Investment Therefore, E is the equilibrium point and OY
demand depends upon two factors : represents the equilibrium level of national income.
Now, income cannot be in equilibrium at levels smaller
1. Marginal efficiency of capital (MEC) than OY.
2. Rate of interest This is because at any level of income smaller than
OY, aggregate demand exceeds aggregate supply of
output-since C + I curve lie above 45° line which depicts
Z
aggregate supply of output. This excess demand will
lead to the decline in inventories of goods below the
desired levels. This unintended fall in inventories will
induce the firms to expand their output of goods and
services to meet the extra demand for them and keep
their inventories of goods at the desired level. Thus
when at a given level of national income, aggregate
expenditure (i.e. aggregate demand) exceeds aggregate
supply of output, national income will increase. With
this increase in national income or output, employment
of labour will also rise to produce the increment in
Fig. C : Equilibrium Level of National Income
output. This process of expansion in output under the
Of these two factors, rate of interest is compa- pressure of excess demand will continue till national
ratively stable and does not frequently change in the income OY is reached.
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On the contrary, the level of national income cannot an element of dynamism in his theory through the
be greater than OY because at any level greater than OY, ‘expecta-tions’. But his analysis was concerned with the
aggregate expenditure or demand (C + I) falls short of level of employment at any time. It is a log less analysis.
aggregate supply of output. This will cause the increase
in inventories of goods with the firms beyond the National Income : Concepts and
desired levels. To this situation of the unintended Measurement
increase in inventories of goods, the firms will respond
by cutting down production to keep their inventories at Different Terms Associated with National
the desired levels. Thus, deficiency in aggregate demand Income
relative to the aggregate supply of output will lead to the (i) Monetary Expression—National income is
fall in national income and output until the level OY is always expressed in monetary terms. It adds
reached where aggregate demand (C + I) is equal to the together the value of all final goods and services
value of aggregate supply. Thus OY is the equilibrium produced in a country during a year. Since we
level of national income. cannot add together unlike items, such as apples
Criticism of Keynesian Theory and oranges, services of doctors and barbers, they
are expressed by assigning monetary value of
1. Closed Economy—The Keynesian theory is these services.
based on the assumption of a closed economy which (ii) Final Goods and Intermediate Goods—Final
excludes the impact of foreign trade on the level of goods are those goods which are sold to the final
employment and income. This makes Keyne’s analysis users during the year. Final users may be
unrealistic because all economies are open economies, consumers or producers. Intermediate goods are
and foreign trade has an important impact on their level those goods which are used by the producers as
of employment. Thus, Keyne’s neglect of the reper- inputs into a further stage of production.
cussions of foreign trade on the volume of employment
is a serious defect in his theory. Some Important Relations Relating to National
2. Perfect Competition—Another weakness of the Income Aggregates
Keynesian theory is that it is based on the unrealistic 1. Domestic Income and National Income—Domestic
assumption of perfect competition. This makes his income is defined as the value of all final goods and
theory inapplicable to socialist or communist societies services produced by all the enterprises located within
where the entire economy is regulated by the state. the territory of a country. National income refers to the
amount of final goods and services produced by the
3. General Theory—Keynes considered his theory nationals of a country. So while the concept of domestic
as a “general theory.” But as is clear from the above product is geographical in character, that of national
points, it is not a general theory but a special theory product relates to nationals of a country.
which is applicable only under static conditions in a Thus,
perfectly competitive closed economy. Moreover, it fails National Product = Domestic Product + Net Factor
to solve the problems of underdeveloped countries. Income from Abroad
4. Problem of Unemployment—Keynes has been 2. National Income at Market Prices and National
criticised for tackling only cyclical unemployment, and Income at Factor Cost—National income at market
prices is the value of final goods and services produced
neglecting other types of unemployment to be found in in the economy calculated at their market prices. But
capitalist economies. National income at factor cost expresses national
5. Short-run Economics—Another criticism of the product as the sum of all factor payments (wages,
Keynisian economics is that it is applicable to the short- interest, rent, profits etc.).
run. Keynes himself remarked, “In the long-run, we Thus,
are all dead.” He, therefore, assumed a given stock of National Product at Factor Cost = National Product at
Market Prices – Indirect Taxes + Subsidies
capital equipment, existing technique, tastes and habits 3. Gross Domestic Income and Net Domestic Income—
of the people, organisation, size of population, etc. But The domestic income can be measured either on a gross
all these factors change during the short-run. This makes basis or on a net basis. There is a distinction between
Keynes’s analysis unrealistic. Moreover, economics is gross or net product according to whether investment is
an incomplete study without concentrating on the long- taken in gross or net terms i.e., whether depreciation is
included or not.
run effects of these forces on the economy.
Thus,
6. Expectations—Keynes has been criticised for his Net Domestic Product = Gross Domestic Product
over emphasis on expectations. Expectations breed – Depreciation.
uncertainly. Though Keynes gave a dominant role to National Income at Current Prices and at Constant
expectations in influencing the marginal efficiency of Prices—National income at current prices is the money
capital, yet he failed to formulate a precise theory of value of all final goods and services produced in a
expectations. country during a particular year expressed at market
prices prevailing in that year. National Income at
7. Dynamic Theory—Keynes regarded his theory constant prices, on the other hand, measures the final
dynamic and called it “the theory of shifting equili- goods and services constituting the national income at
brium.” Even his foremost pupil Roy Harrod calls him market prices prevailing in a particular year, which
“the father of dynamic economics.” Keynes introduced becomes the base year.
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(iii) Flow—National income is a flow concept. It is the According to A.C. Pigou—National income is that
flow of goods and services. A flow is a quantity part of the objective income of the community,
which is measured over a period of time. National including of course income derived from abroad, which
income is a very important flow variable in can be measured in money.
economics. Conventionally, national income is According to Marshall—“The labour and Capital
expressed over an year. of a country acting on its national resources produce
(iv) Current Output—National income measures the annually a certain net aggregate of commodities, material
value of currently produced goods and services. It and immaterial including services of all kinds. This is
excludes ‘pure exchanges’ transactions such as the true net annual income or revenue of the country or
sale and purchase of second hand goods since national dividend . In this definition, the word ‘net’
such sales do not reflect the current production refers to deductions from the gross national income in
whereas national income relates to current produc- respect of depreciation and wearing out of machines.
tion only. And to this must be added income from abroad.
(v) Residents and Domestic Territory—Normal Fisher made a significant departure and adopted
residents are those persons who ordinarily reside the flow of satisfaction instead of flow of goods as the
in a country and whose economic interests lies in index of measurement.
that country. Domestic Territory refers to the
geographical or political boundary of a country According to Fisher, “The national income consists
excluding foreign embassies and international safely of services as received by ultimate consumers,
institutions (e.g. WHO, UN etc.) located within whether from their material or from their human
the geographical territory. National income is environments. Thus, a piano, or an overcoat made for
defined as the value of final goods and services me this year is not a part of this year’s income, but an
produced by the normal residents of a country. addition to the capital. Only the services rendered to me
during this year by these things are income.”
Meaning of National Income
These definitions bring out the following features
National income is the total of all incomes earned in
about national income :
a nation during a specific period–usually a year. The
concepts of national income and product are most (1) National income refers to the income of a
significant in macro-economic accounting. Both these country.
macro-economic concepts are used to measure the (2) Its measurement refers to a specified period of
economic performance of an economy both over the time.
short and long period. (3) It includes all types of goods and services.
National Income/National Product is a single (4) It is expressed in monetary terms. It adds
measure (in monetary terms) of the total amount of together the value of all final goods and
goods and services produced by the normal residents of
services produced in a country during a year.
a country during a given period.
NP/NI is a flow concept. Production is a process (5) National income reflects the value of final
which generates goods and services over a period of goods and services.
time. Without time period there can not be any produc- (6) National income measures the values of
tion. currently produced goods and services. It
NP/NI measures goods and services which accrue to exclude ‘pure exchange’ transactions such as
a country only as a result of its production efforts and it sale and purchase of second hand goods or used
excludes all goods and services received other wise. goods, purchase and sale of securities and
Circular flow of income can be viewed from two transfer payments.
different angles : Keynes Approach to National Income
(i) Real Flows : It consists of factor services
from the owner of factor services to the Keynes, suggested three approaches to national
producers and flow of goods and services from income.
the producers to the buyers of those goods and (a) Aggregate Expenditure Approach—Income
services. Thus the real flow consists of flow of
factor services and flow of goods and services is the result of expenditure. Unless somebody spends,
among different sectors of the economy. nobody will earn any income. Income can be measured
by taking into account of all final exenditures in the
(ii) Money Flows : In the modern monetized
economy. These expenditures are classified into
economies, economic transactions involve the
following types : (i) private consumption expenditure
use of money. Flow of factor services generate
(C), (ii) investment expenditure (I), and (iii) government
factor income in the form of money. Money
purchases of goods and services (G).
flows consist of flow of money income for
factor services, such as money wages, rent etc. (b) Factor Income Approach—factors of produc-
and money expenditure incurred on the tion, called inputs, earn income when a good is
purchase of goods and services. produced. These are called Land, Labour, Capital and
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Entrepreneur. Each type of factor income has a different 2. Factor payments by firms = factor incomes
name – wages, salaries for labour, rent for land, interest of household sector.
as return on capital. By aggregating these factors income 3. Consumption expenditure of household sector
we can find national income. = Income of household sector.
(c) Sales Minus Cost Approach—Keynes, third 4. Real flows of production and consumption of
approach to national income is based on aggregate sales firms and households = Money flows of income
minus cost. He states that national income lies between and expenditure of firms and households.
the GNP and NNP. Introduction of Capital Market (Financial
Circular Flow of Income System)—Financial institutions are intermediaries
between savers and investors. All lending and
Circular flow of Income and expenditure refers to
borrowings are channelled through capital market.
the process whereby the national income and expenditure
Whatever is earned by the households is not spent on
of an economy flow in a circular manner continuously
consumption goods. A part of earning is saved and
through time. The various components of national
deposited in the capital market. Leading to money flow
income and expenditure such as saving, investment,
from household to the capital market. A firm also saves
taxation, government expenditure, exports and imports
with the aim of meeting cost of depreciation and
are shown in form of currents and cross currents in
expanding in production capacity. Thus savings of firms
such a manner that national income equals national
expenditure.
The structure of macro economy is given by
circular flows of income and output. In fact national
income accounting has its foundation in the model of
circular flows which can be depicted in two sector, three
sector, and four sector economy.
Circular Flow of Income in two Sector Fig. : Circular Flow of Income in a Two Sector
Economy with Capital Market
Economy
going to the capital market and borrowing by the firms
In a simple model involving two sectors namely,
from the latter also create money flows. It should be
household and firm sector assuming there is no
kept in mind that savings by households and firms
government sector. The economy is a closed one having
constitute a leakages from the circular flow of income
no exports or imports and there is no saving by the
whereas borrowings by the firms for investment purpose
household, who spend all what they earn and no
become injection.
investments by firms. Under these presumptions the firm
sector hires from house-hold, the services of factors of Introduction of Government Sector :
production for producing goods and services and pays (Circular Flows of Income in a Three
them reward in the form of money for rendering the Sector Economy)
productive services. For the factors of production these
are factor income known as rent, wages, interest and We move further by introducing government sector
profit which have been generated in production process. which purchase goods from firms and factor services
Thus money income flows from firm sector to the from households. Between house-holds and the govern-
households. The firms, in turn, sell goods and services ment money flows from government to the household
thus produced to the household sector for its when the government makes transfer payments. Like old
consumption. Therefore, whatever the firms produce, is age pension, scholarship and factor payments to the
consumed by the household. households. Money flows back to the government when
it collects direct taxes from the households. Similarly,
there are flows of money between the government sector
and the firm sector when government realises corporate
taxes from the firms, grants them the subsidies and
makes payment for the goods purchased by it.
Fig. : Circular Flow of Income in a Two Sector Economy
Now we can derive the following conclusions in the
case of two sector economy :
1. Total production of goods and services by firms
= Total consumption of goods and services by
household sector. Fig. : The Circular Flow of Income in a Three-sector Economy
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Introduction of External Sector : (Circular GNP at Market Prices—When we multiply the
Flow of Income in a Four Sector Economy) total output produced in one year by their market price
prevalent during that year in a country, we get the Gross
Our model will remain incomplete without National Product at market price. Thus GNP at market
converting the closed economy into an open economy
prices means the Gross Value of final Goods and
where imports and exports are made. One country
Services produced annually in a country plus net income
exports are other country’s imports. In case of a
form abroad.
country’s imports money flows to the rest of the world.
Whereas in case of exports, money flow in from rest of GNP at Factor Cost—GNP at factor cost is the
the world. There is a trade surplus for an economy when sum of the money value of the income produced by and
it exports exceed imports but the economy suffers trade accruing to the various factors of production in one year
deficit when imports exceed exports. Imports are in a country.
leakages and exports are injections into the circular GNP at Factor Cost = GNP at Market Prices –
flow of income in an economy. Indirect Taxes + Subsidies
Y = C + I + G + (X – M) 2. Net National Product (NNP)
where,
The difference between Gross National Product and
Y = Income or output, depreciation is called NNP.
C = Private consumption expenditure
NNP at Market Prices—It is the net production
I = Investment expenditure of goods and services in an economy during the year. It
G = Government purchases and is the GNP minus the value of capital consumed or
X – M = Exports minus Imports. depreciated during the year.
NNPMP = GNPMP – Depreciation
NNP at Factor Cost—Net National Product at
factor cost is the net output evaluated at factor prices. It
includes income earned by factors of production through
participation in the production process, such as wages
and salaries, rents, profits etc. It is also called National
Income. This measure differs from NNP at market prices
in that indirect taxes are deducted and subsidies are
added to NNP at market prices in order to arrive at NNP
at factor cost.
Thus NNP at factor cost = NNP at market prices –
Indirect Taxes + subsidies = National Income.
Normally, NNP at market prices is higher than NNP
Fig. : Circular Flow of Income in Four Sector Economy at factor cost.
Related Aggregates of National Income 3. Domestic Income or Product
We study below the important concepts of national Income generated or earned by the factors of
income viz., the Gross National Product, Net National production within the country from its own resources is
Product, National Income, Personal Income, Disposable called domestic income or domestic product. It is defined
Income etc. as the value of all final goods and sevices produced by
1. GROSS NATIONAL PRODUCT (GNP) all the enterprises located within the territory of a
Gross National Product is defined as the total country.
market value of all final goods and services produced Domestic income includes
in a year including net income from abroad. GNP (I) Wages and salaries
includes four types of final goods and services; (II) Rents, including imputed house rents
(1) Consumer’s goods and services to satisfy the (III) Interest
immediate wants of the people.
(IV) Dividends
(2) Gross private domestic investment in capital
goods consisting of fixed capital formation, (V) Undistributed corporate profits including sur-
residential construction and inventories of plus of public sector undertakings.
finished and unfinished goods. (VI) Mixed incomes consisting of profits of incor-
(3) Goods and services produced by the Govern- porated forms, self-employed persons etc. and
ment and. direct tax.
(4) Net exports of goods and services, i.e., the Since domestic income does not include income
difference between value of export and imports earned from abroad, it can also be shown as :
of goods and services known as net export from Domestic Income = National Income – Net Income
abroad. earned from abroad.
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GDP at Market Prices (GDPMP)—Goss domestic Though per capita income is more reliable than
product at market prices is the value of all final goods GNP for many practical purposes, this also does not
and services at prices prevailing in the market produced reveal the existence of income inequalities like GNP.
in the domestic territory of a country during a given
year. Being gross, it is inclusive of depreciation. It can 6. National Disposable Income (NDI)
be obtained by deducting net factor income from abroad It is the income from all sources to the residents of a
from GNP at market prices. Thus, nation for spending on consumption as well as saving
GDPMP = GNPMP – Net Factor Income from Abroad during a year.
GDP at Factor Cost (GDPFd)—Gross domestic NDI = NNPMP + other current transfers from the
product at factor cost is the sum total of earnings rest of the world.
received by various factors of production in terms of Current transfers from the rest of the world may
wages, interest, rent, profits, etc. within the domestic
include gifts, cash, consumer goods and even military
territory of a country during a year. If we deduct net
indirect taxes from gross domestic product at market equipment.
prices, we get gross domestic product at factor cost. National disposable income for a country is what
Thus, the personal disposable income is for an individual.
GDPFC = GDP MP – Net Indirect Taxes
7. Private Income (PI)
4. Net Domestic Product (NDP) Private income refers to the current income received
GDP does not makes allowances of depreciation in from all sources of private sector consisting of private
the estimation of domestic product. But the net domestic enterprises and factor owners. It is the total of factor
product makes allowances of depreciation. income (including retained profits of the corporations)
NDP = GDP – Depreciation from all sources and current transfers from the
NDP at Market Prices (NDPM P)—Net domestic government and rest of the world accruing to the private
product at market prices is the value of all final goods sector.
and services at prices prevailing in the market produced PI = National Income – Income of Government
in the domestic territory of a country during a given
companies – Savings of Non-Departmental
year after making allowances for depreciation.
enterprises + Interest on national debt + Net
NDPMP = GDPMP – Depreciation
current transfers from Govt. + Net current
NDP at Factor Cost (NDPFC )—Net domestic
transfers from abroad.
product at factor cost is the estimate of the domestic
product interms of earnings of factors of production 8. Personal Income
within the domestic territory of a country in a year. Personal income is defined as the sum total of all
NDPFC = GDP FC – Depreciation current incomes received by persons or households from
5. National Income or Product all sources. It is the income actually received by persons
from all sources in the form of factor incomes and
National Product or Income refers to the amount of
current transfer payments. Thus,
final goods and services produced by the nationals of a
country. While the concept of domestic product is Personal Income = Private income – Undistri-
geographical in character, the concept of national buted profits of enterprises –
proudct relates to nationals or citizens of a country. The Corporate profits tax –
difference between the factor income received from Retained earnings of foreign
abroad and the factor income accruing to foreigners is companies.
the net factor income from abroad. Thus, Personal Disposable Income (PDI)—Personal
National Product = Domestic Product + Net Factor disposable income is that part of personal income which
Income from Abroad. is available to the individuals to be used the way they
like. In other words, it is the income which the
Real Income—Real income is national income
households can spend on consumption or can save as
expressed in terms of a general level of prices of a
they desire.
particular year taken as base.
Current year NNP PDI = Personal income – Personal income taxes–
Real NNP = × 100 Miscellaneous Receipts of the Government
Current year Index
Per Capita Income—The average income of the administrative departments.
people of a country in a particular year is called per 9. National Income at Current Prices and at
capita income for that year. So, it is national income Constant Prices
divided by population i.e., per capita income for the year National income at current prices is the money
2011-2012 value of all final goods and services produced in a
National Income of 2012 country during a particular year expressed at market
=
Population in 2012 prices prevailing in that year.
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National income at constant prices, on the other (3) Estimating net value added of each industrial
hand, measures the final goods and services constituting sector by summing up net value added at FC of all
the national income at the market prices prevailing producing units falling in each industrial sector.
in a particular year, which becomes the base year. (4) Computing domestic income by adding up NVA
at FC of all industrial sectors.
Important National Income Aggregates : (5) Estimating net factor income from abroad which
Summary is added to domestic income for deriving national
GNPMP = Value of all final goods and services income.
produced in the economy + Net factor income
from abroad. Precautions
NNPMP = GNPMP – Depreciation. (1) Imputed rent of owner occupied houses are
GNPMP = GNPMP – Net factor income from abroad. included.
NDPMP = GDPMP – Depreciation = NNPMP – Net factor (2) Imputed value of goods and services produced
income from abroad. for self consumption are included.
GNPFC = GNPMP – Net indirect taxes. (3) Value of own account production of fixed assets
NNPFC = GNPFC – Depreciation = NNP M P – Net by enterprises, government and the house-holds.
indirect taxes = National income. Thus according to value added method,
GDPFC = GDPMP – Net indirect taxes. GNP = (value of output in primary sector –
NDPFC = GDPFC – Depreciation. intermediate consumption) + (Value of
output in secondary sector – intermediate
The Methods of Measuring National Pro- consumption) + (Value of output in
duct tertiary sector – intermediate consumption)
The three methods of measuring national product + Net factor income from abroad.
are : (2) Income Method
(1) Product method, (2) Income method, (3) Income Method measures national income from the
Expenditure method side of payments made to the primary factors of
production for their productive services in an accounting
(1) Product Method year. Thus according to income method, national income
In this method two approaches-final product is calculated by summing up of factor incomes of all the
approach and value added approach are adopted. normal residents of a country earned within and outside
Final Product Approach—It is expressed as GDP. the country during a period of one year and income
According to final product approach, sum total of generated is nothing but the net value added at FC by
market value of all final goods and services produced by factors of production which is distributed in the form of
all productive units in the domestic economy in an money income among them. Thus if factor incomes of
accounting year is estimated by multiplying the gross all the producing units generated within the domestic
product with market prices. economy are added up, the resulting total will be
domestic income or net domestic product at factor cost
Being gross it includes depreciation, being at market (NDPFC)by adding net factor income from abroad to
price, it includes net indirect taxes and being domestic, it
domestic income we get NNPFC.
includes production by all production units within
domestic territory of a country. It includes value of only GNP is the addition of all factor incomes generated
final goods and services. in production of goods and services. While measuring
GDP we must include only those income flows that
Value Added Approach—This method measures
originate with the production of the goods and services
contribution of each producing enterprise to production
within the particular time period. The components of
in the domestic territory of a country in an accounting
factor income are: (i) Employees’ Compensation, (ii)
year. According to this method net value added at factor
Profits, (iii) Rent (iv) Interest, (v) Mixed Income, and
cost by all the producing units during an accounting
(vi) Royalty. Profit, rent, interest and other mixed
year within the domestic territory is summed up. This
income are jointly known as operating surplus. Thus,
gives us value of net domestic product at factor cost or
national income = compensation of employees +
domestic income.
operating surplus.
Steps Involved
(1) Identifying all the producing units in the
Steps Involved
domestic economy and classifying them into the (1) Identifying enterprises which employ factors of
industrial sectors such as primary, secondary, tertiary production (labour, capital and entrepreneur)
sector on the basis of similarity of activities. (2) Classifying various types of factor payments
(2) Estimating net value added at factor cost by each like rent, interest, profit and mixed income.
producing unit deducting intermediate consumption, (3) Estimating amount of factor payments made by
depreciation and net indirect taxes from value of output. each enterprise.
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(4) Summing up of all factors payments within Conceptual Difficulties
domestic territory to get domestic income. (1) Ignoring goods and services not amenable to
(5) Estimating net factor income from abroad many measurement.
which is added to the domestic income to (2) Ignoring income from illegal activities.
derive national income.
(3) The existence of a large non-monetary sector in
Precautions the Indian economy makes it difficult to
(1) Sale and purchase of second hand goods are measure the value of a large part of the national
excluded. product. A considerable volume of output in
(2) Imputed rent of owner occupied houses and this country does not at all enter into the market
production for self-consumption are included. and is not exchanged for money. It is either
(3) Incomes from illegal activities are not included. consumed by the producers or bartered for
(4) Direct taxes such as Income tax are paid by other commodities. These three difficulties
employees from their salaries are included. under-estimate national income.
(3) Expenditure Method Statistical Difficulties
GDP can be measured by taking into account all (1) Non-availability of statistics or inaccurate data
final expenditures in the economy. There are three overestimate national income.
distinct types of expenditures as they are committed by (2) Absence of standard method to calculate capital
households, firms and Government respectively. These consumption.
expenditures are classified into following types : (3) Many enterprises are engaged in more than one
(i) Private consumption expenditure (C) functional enterprise.
(ii) Government expenditure (Government pur- (4) Listing final goods and services to avoid double
chases of goods and services) (G) counting. In order to avoid the double counting,
(iii) Investment expenditure (I) the value of raw materials and hal-ffinished
(iv) Net exports (X – M) goods produced and used up in production
during the year has to be omitted from produc-
Thus, GDP = C + I + G + (X – M) tion. Sometimes, the same commodity is partly
Steps Involved used as raw material and partly as final product.
(1) Identification of economic units incurring final (5) Problems posed by transfer payments like
expenditure unemployment allowances and interest on
(2) Classification of final expenditure into public borrowings.
following components : Significance of National Income in
(a) Private final consumption expenditure Modern Economic Analysis
(b) Government final consumption expenditure (1) Measurement of Inflationary and Defla-
(c) Gross final capital formation tionary Gap—The Inflationary and deflationary gap are
(d) Change in stocks the results of inconsistencies in certain subtotals relating
to the national product and expenditure aggregates.
(e) Net exports.
(2) Economic Forecasting—The aggregates of
(3) Measurement of final expenditure on the above income and product are of strategic significance in
components.
forecasting the general level of business activity, the
(4) Estimation of net factor income from abroad anticipation regarding government expenditure, fiscal
which is added to NDPFC . and monetary policies.
Precautions (3) Importance in International Field—National
(1) Avoid double counting of goods. Income data is useful in the international field also for
the allocation of quota towards international monetary
(2) Expenditure on purchase of second hand goods
institution like IMF and IBRD.
is excluded.
(4) Measure of Material Welfare—The data of
(3) Expenditure on purchase of old share is national income are used as principal measure of
excluded. economic growth and development. High level of
(4) Government expenditure on all transfer pay- national income is considered as the high level of
ment is excluded. welfare.
(5) Promotion of Research—The analysis of
Difficulties in the Measurement of national income focuses attention o n inter industry
National Income relationship in the economy and the computation of
There are various difficulties on estimating national national ncome and output is made through the
income. The important difficulties are : aggregation of output in all industries.
Economics (NET) | 149U
Outline of the Methodology of National Income Estimation in India
Sector Nature of Available Data Description of the Method of Estimation
Category A—Agriculture, Forestry Annual figures of commodity-wise
Product Approach—Aggregation of commodity
and Logging, Fishing, Mining and output and prices and value of
wise price-output multiplications yield gross value
Quarrying. Registered Manufac- different types of inputs or input-
of output from which total value of input is
turing, and Construction (urban) output proportion. deducted to arrive at the estimates of value-added.
Category B—Electricity, Railways, The actual figures of all types of
Income Approach— The actual figures of
Air Transport, Organised Road and factor earnings reported in the
employee compensation, interest, rent and operating
Water Transport, Communications, annual accounts of different com-
surplus or profits relating to different enterprises/
Banking and Insurance, Real Estate, panies or undertakings published on
organizations in each sector are aggregated to arrive
Public Administration and Defence. a more or less regular basis.
at the estimates of value-added.
Category C—Unregistered Manu- The estimates of working force
Income Approach—Decennial estimates of working
facturing, Gas and Water Supply, derived from the decennial popula-
force interpolated or extrapolated, and the periodical
Unorganised Road and Water tion census data and estimates of
estimates of average productivity are carried
Transport, Storage, Trade, Hotels forward or backward by using certain indicators.
average productivity of labour
and Restaurants, Ownership of The year-to-year estimates of workers and their
derived from the data shown by
Dwellings, and Other Services. periodical sample surveys. average productivity so derived are then multiplied
to arrive at the estimates of values added.
Category D—Construction (Rural) NSSO estimates form the basis of Expenditure Approach—The expenditure method
estimating value of output. of national income estimation combines
consumption, investment, government spending and
net exports. It is the most common way to estimate
GDP, and it says everything that the private sector,
including consumers and private firms, and public
expenditure within the boundaries of a particular
country, must addup to the total value of all finished
goods and services produced over a certain period
of time. This method gives the value of nominal
GDP, which must then be adjusted for inflation to
find out the real GDP.
Method Adopted in India—The National Income Δc
b = = marginal propensity to consume
Committee employed a combination of the ‘Product Δy
Method’ and the ‘Income Method’. First the total Now suppose that investment demand equals I. This
working force (self-supporting persons plus earning investment I is autonomous because this does not
dependents) and its occupational distribution were taken depend on income. Thus we get the following three
into account. The ‘product method’ was then applied to equations for the determination of the equilibrium level
as many sectors as possible. For the remaining sectors, of national income
the ‘income method’ was applied. In a few cases, e.g.,
small enterprises, the income was estimated by both Y = C+I …(i)
methods. But the results obtained by the income C = a + by …(ii)
methods were considered more satisfactory and adopted. I = Ia …(iii)
Determination of Equilibrium Level of Substituting the value of C and I in equation (i) we
have
National Income : Algebraic Analysis
Y = a + by + Ia …(iv)
A study of how the level of national income is
determined will become more clear by using simple Y – by = a + Ia
mathematics. As has been explained above, the level of Y [1 – b] = a + Ia
national income is in equilibrium at which aggregate 1
demand equals aggregate supply of output. In a simple Y = (a + Ib) …(v)
1–b
model of income determination in which we do not The equation (v) shows the equilibrium level of
consider the impact of Government expenditure and national income when aggregated demand equals
taxation and also exports and imports, the national aggregate supply. The equation (v) reveals that
income is the sum of consumption demand (C) and autonomous consumption and autonomous investment (a
investment demand (I), that is, + Ia) generates so much expenditure or demand that
Y = C+I becomes equal to the income generated by the production
Suppose the consumption function is of the of goods and services. From the equation (v) it also
following form— follows that the equilibrium level of national income
C = a + by can be known from multiplying the elements of
where, autonomous expenditure (that is, a + Ia) by the term
c = consumption 1
a = autonomous consumption expenditure which is equal to the value of multiplier.
1–b
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Equilibrium Level of National Income when national income and therefore it should also be included
there is no Autonomous Element (a) in the Consump- in the analysis of income determination. We assume that
tion Function and Autonomous Investment Equals Ia Government spends on goods and services keeping taxes
When there is no autonomous element (that is, the unchanged. We denote Government expenditure by G.
intercept term) in the consumption function, the Thus when we take into account the income generating
consumption function takes the following form : effects of Government expenditure, we get the following
c = bY equation for the equilibrium level of National Income.
As matter of fact, empirical studies reveal that the Y = C+I+G
long-run consumption function actually takes the form where Y is national income or output and C + I + G
c = by in which there is no constant element in represents the level of aggregate demand including
consumption function. Thus, when autonomous con- Government expenditure, G.
sumption is zero and autonomous investment equals la Since consumption function is
the equilibrium level of income can be obtained as C = a + bY
under— where,
Y = C+I b = mpc
Y = by + Ia a = autonomous consumption expenditure
Y – by = Ia We can rewrite the equilibrium level of national
Y [1 – b] = Ia income as under :
Y = ( )1–b
1
Ia
Y = a + by + Ia + G
Y – by = a + Ia + G
Thus we find that in this situation the equilibrium Y[1– b] = a + Ia + G
level of national income is equal to autonomous l
Y = (a + Ia + G)
investment (Ia) multiplied by the value of multiplier (1 – b)
where b stands for marginal propensity to consume. Thus it is clear that the equilibrium level of income
Illustration of Equilibrium Level of Income with (when impact of Government expenditure is also
a Numerical Example considered) is equal to the sum of three types of fixed
Let us take an example. Suppose in an economy, autonomous expenditure, namely, autonomous consum-
autonomous investment (Ia) equals R 600 crores and the ption, autonomous investment and Government
following consumption function is given— expenditure (a + I + G) multiplied by the value of the
C = 200 + 0.8 Y
Given the above we are required to find the
multiplier( )l–b
l
.
equilibrium level of income. Taxes and Equilibrium Income
Solution :
In our above analysis of impact of Government
Y = C + Ia expenditure on national income we have ignored the
C = 200 + 0.8Y effect of taxes. We assumed that increase in Government
Ia = 600 expenditure was financed by borrowing by the Govern-
The equilibrium level of income is ment. The equilibrium level of income is
l Y = C + Ia + G
Y = (a + Ia)
(1 – b) Q C = a + bYd
4
Q MPC (b) = 0·8 = where Ya = disposable income
5 Since disposable personal income is less than net
and autonomous investment (a) = R 200 national income (product) by the amount of taxes.
1 Therefore
∴ Y = × (200 + 600)
1–4 Yd = Y – T
5 The consumption function becomes
= ( ) 1
1/5
× (800) C = a + b (Y – T) [where T = tax]
With this consumption function, with investment
= 5 × 800 = 4000 assumed to be entirely autonomous (Ia) and with fixed
Government Expenditure and National amounts of government purchases and tax receipts
Income assumed per time period, the equilibrium level of
income is given by
In our above analysis we have not taken into
account the rate of Government expenditure in the Y = a + b (Y – T) + Ia + G
determination of national income. However, in all Y – b.Y = a – b × T + Ia + G
economies today including the free market capitalist Y[1 – b] = a – b × T + Ia + G
economies the Government expenditure on goods and 1
services plays an important role in the determination of Y = (a – b·T + Ia + G)
1–b
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In this form, it may be seen that a change in any When we include net exports in our analysis we get
single value within the parentheses will produce a the following equation for the equilibrium level of
change in income equal to the change in that value times income
l Y = C + I + G + (X – M)
the ordinary multiplier, .
l–b Since C = a + b·Y
If now, for example, we assume a change in G, the Y = a + b·Y + I + G + (X – M)
other values remaining unchanged, the new equilibrium or Y – b·Y = a + I + G + (X – M)
level of Y is equal to the original level of Y plus the Y [l – b] = a + I + G + (X – M)
change in Y :
l
Y = [a + I + G + (X – M)]
Y + ΔY = ( ) l
l–b
(a – b.T + Ia + G) +( ) l
l–b
ΔG l–b
Thus, the equilibrium level of income is the sum of
subtracting Y from both sides, there remains all fixed autonomous expenditures [i.e. a + 1 + G +
ΔY =
l
1–b
ΔG or,
Δy
=
ΔG 1 – b
l (X – M)] times the value of multiplier ( )1
1–b
.
= Government Expenditure Multiplier
where, b = marginal propensity to consume
In the same, we will find that
–b
ΔY = ·ΔT
l–b
= Tax Multiplier
It is clear from above that a change in T of the same
size as the change in G will produce a smaller change in
Y and the change will be in the opposite direction.
Foreign Trade And National Income Fig. : Determination of National Income
with Foreign Trade
Foreign trade, that is, volume of exports and imports
of a country also affects the level of national income Graphic Illustration
of the country. We now extend the Keynesian model of In figure D we have depicted the determination of
determination of national income by including the effect national income when there are positive net exports (i.e.
of exports and imports of a country on the generation of (X – M) > O). To obtain the aggregate demand curve
income. For example, the exports of India represent the incorporating the positive net exports we add the
foreign demand and generates income for the Indian amounts of net exports to (C + I + G) to get the higher
people. On the other hand, imports represent the demand aggregate demand curve [C + I + G + (X – M)] which
for foreign goods by the Indians and generate incomes intersects the 45° line at point R and determines a higher
for the people of other countries therefore, imports tend level of income OY. If the net exports (X – M) were
to reduce the aggregate expenditure. It therefore follows negative, that is, imports exceed exports, (X – M) < O,
that national income will depend on the net exports, that the aggregate demand curve incorporating net exports
is, exports minus imports (X – M, where X-stands for would lie at a lower level than C + I + G + X – M curve
exports and M for imports). The exports and imports of and determine a lower level of income than OY.
a country depend to a great indent on the level of
economic activity. Thus, when the growth of industrial New GDP measurement in India
output in India is rapid, it will generate greater demand The Central Statistical Office of India has upgraded
for imported materials. On the other hand, the higher the National Income Accounting Standards by
industrial growth would also cause our exports to rise introducing some notable changes in 2015. This has
provided there is demand for our goods abroad. resulted in increased GDP for the country for many
However, in the Keynesian model of income years and it became a notable issue globally. These
determination, exports and imports are considered as changes have been made in conformity with globally
autonomous, that is, independent of income, being accepted norms of national income accounting.
determined outside the model. Further, as mentioned Globally, most accepted and followed national income
above, the increase or decrease in aggregate expenditure accounting format is the System of National
or demand due to exports and imports depends on the Accounting (SNA), prepared by the UN and ratified by
net exports, that is, (X – M). If net exports are positive, the IMF, World Bank, OECD and EC. The SNA
there will be addition to the aggregate demand or describes a coherent, consistent and integrated set of
expenditure of a country. On the other hand, if the net measures in the context of internationally agreed
exports are negatives there will be decrease in aggregate concepts, definitions, classifications and accounting
expenditure. rules.
152U | Economics (NET)
Globally accepted standard : The SNA calculate Gross Value Added in a particular sector at
basic prices.
The SNA was launched in 1992 and upgraded in
2008. Because of these globally accepted norms and Gross value added at basic prices = CE + OS/MI +
their refinement, GDP estimation methods have to be CFC + Production taxes less production – subsidies
changed in India as well. Besides, the CSO has adopted CE – Compensation of Employees
a new base year of 2011-12, instead of the previous one OS – Operating Surpluses
– 2004-05. This change in base year is a normal exercise MI – Mixed Income
as Base year is changed in every ten years. Three types CFC – Consumption of fixed capital
of changes were made by the CSO in the GDP Taxes are out of the effort (production) of the
estimation procedure. producer. Actually, it is brought out of his income. On
Methodological changes the other hand, subsidies are not his income, it is accrued
from outside. Subsidies are not out the contribution of
● Change in the base year
the concerned firm. So, taxes to be added and subsidies
● Giving comprehensive coverage to all sectors. should be reduced to estimate the GVA of the concerned
Of these changes, the most important is the firm/sector.
methodological changes in the form of a shift to GDP in The above identity says that GVA is the sum of
market prices from factor costs. Globally there is a payment made to labour, surplus of the business entity
consensus that GDP in Market Prices is more powerful (profit), income of the self-employed people etc. (Mixed
and useful than GDP in factor cost. Income) and the money we keeps to replace the existing
Methodological Changes machineries (CFC). This is also known as the
Specifically, there are two methodological changes depreciation. These are the expenditure item for a firm,
adopted by the CSO in its new estimates and both are industry etc.
highly interrelated. Now, what is unique about Basic price is that it
● Gross Domestic Product (GDP) of the country is to measures the GVA by adding production taxes and
be estimated in terms of Market Price. deducting production subsidies. GVA, thus, calculated
● Gross Value Added (GVA) from different sectors is for individual sectors are cumulate to get the GDP. The
being calculated at basic prices. important thing is that GDP is measured now at Market
Actually, estimation of GVA at basic prices is a step Prices instead of at factor cost.
to measure the GDP at market prices. That is why both GDP at Market Prices
of these changes are interrelated. The new methodology measures GDP at Market
Gross Value Added (GVA) Prices compared to the previous factor cost estimation.
GDP at Market Prices has a standard format that it is
As a national income estimation identity, Gross
measured by adding product taxes and deducting
Value Added GVA) measures the contribution of an
product subsidies.
economy, producer, sector or region. GVA provides the
GDP at Market Prices is calculated as the total (or
rupee value of the amount of goods and services that
sigma ∑) of the GVAs.
have been produced, less the cost of all inputs and raw
The important thing is that from the cumulated or
materials while producing these goods and services.
total GVAs, product taxes are added and product
There can be GVA for a firm, industry, sector or the
subsidies are deducted to get the GDP at Market Prices.
entire economy.
To estimate the GVA for the entire economy, GVA Change in the base year
for all sectors of the economy is to be cumulated. The base year for national income estimation in the
Hence, first the GVA of each sector is calculated in country has changed to 2011-12 from 2004-05. Usually
a prescribed format. Here, the SNA and the new a base year change is done periodically to accommodate
methodology adopted in India calculate sectoral GVA at the changes in the economy. Here, 2011-12 is considered
basic prices. to be a stable year among the available options.
When using production or income approaches to More coverage
estimate national income are adopted, the contribution to The coverage has been enhanced with greater
an economy of a particular industry or sector is representation of manufacturing and financial sectors
measured using GVA. and this became a notable change that caused an upward
Gross Value Added at basic prices revision of GDP for few years. Comprehensive coverage
(sectoral GVA) of the financial sector including that of stock brokers,
coverage of activities of local bodies etc marks a
Gross Value Added (GVA) for a sector is the sum deviation that seems to have caused the increase in GDP
of expenditure made in that sector. figures.
As have been mentioned above, the new metho-
dology measures Gross value added at basic prices Some Key Concepts
instead of at factor costs. The following identity reveals Basic price—Basic price is the amount receivable
what all expenditure items are considered when we by the producer from the purchaser for a unit of a good
Economics (NET) | 153U
or service produced as output minus any tax payable, CONSUMPTION FUNCTION
and plus any subsidy receivable, by the producer as a
consequence of its production. Consumption function can be defined as the
Production tax and production subsidies— schedule detailing the relationship between aggregate
Production taxes are paid by the producer independent consumption expenditures and income, Therefore
of the quantity of production. Meaning is that the C = f (Y)
production tax is not per unit tax imposed on a where, C is consumption, Y is income, and f is the
commodity. Rather it is a general tax. Examples are land functional relationship.
revenue and stamp duty. The same is applicable for
production subsidy. It is not the subsidy availed in terms Thus the consumption function indicates a
of per unit of production. functional relationship between C and Y, where C is the
Product taxes and Product subsidies—Product dependent and Y is the independent variable. This
taxes or subsidies are paid or received on per unit of the relationship is based on the ceteris paribus (other things
product. Examples for product tax are excise duties, being equal) assumption, as such only income-
sales tax etc. Food, fertilizer and fuel subsidies which consumption relationship is considered and all possible
are provided per unit are product subsidies. influences on consumption are held constant.
The consumption function has two technical
Acronyms Used in the New Methodology of
National Income Estimation attributes or properties :
GDP : Gross Domestic Product 1. The average propensity to consume
GVA : Gross Value Added 2. The marginal propensity to consume
GNI : Gross National Income
NDP : Net Domestic Product The Average Propensity to Consume
NNI : Net National Income
GNDI : Gross National Disposable Income
Average propensity to consume is the ratio of the
PFCE : Private Final Consumption Expenditure amount of consumption to total income. Therefore,
GFCE : Government Final Consumption Expenditure average propensity to consume is calculated by dividing
CFC : Consumption of Fixed Capital the amount of consumption by the total income. Thus,
GFCF : Gross Fixed Capital Formation C
CIS : Changes in Stock
APC =
Y
CE : Compensation of Employees where,
OS : Operating Surplus
MI : Mixed Income
APC = average propensity to consume
ROW : Rest of the World C = amount of consumption
Formulae of National Income Y = level of income
1. GVA at basic prices = CE + OS/MI + CFC + Production Diagrammatically, the average propensity to
taxes less Production subsidies consume is any one point on the consumption curve. In
2. GVA at factor cost (earlier referred to as GDP at factor figure A, point R measures the APC of the CC curve
cost) = GVA at basic prices – Production taxes less which is OC′/OY′.
Production subsidies
3. GDP = ÂGVA at basic prices + Product taxes - Product
subsidies
4. NDP/NNI = GDP/GNI - CFC
5. GNI = GDP + Net primary income from ROW
(Receipts less payments)
6. Primary Incomes = CE + Property and Entrepreneurial
Income
7. NNDI = NNI + other current transfers from ROW, net
(Receipts less payments)
8. GNDI = NNDI + CFC = GNI + other current transfers
from ROW, net (Receipts less payments)
9. Gross Capital Formation= Gross Savings + Net Capital
Inflow from ROW
10. GCF = GFCF + CIS + Valuables + “Errors and
Fig. A
Omissions”
11. Gross Disposable Income of Govt. = GFCE + Gross If with the increase in income, average propensity to
Saving of GG consume remains constant, the consumption function
12. Gross Disposable Income of Households = GNDI – curve or propensity to consume curve will be linear or
GDI of Govt. – Gross Savings of All Corporations straight line as is shown by the curve CC in figure B.
154U | Economics (NET)
Marginal Propensity to Consume
The marginal propensity to consume (MPC)
measures the change in consumption resulting from a
change in income. In other words, marginal propensity
to consume may be defined as the ratio of the change in
consumption to the change in income or as the rate of
change in the average propensity to consume as income
changes. Thus,
ΔC
MPC =
ΔY
where,
MPC = marginal propensity to consume
Fig. B : Linear Consumption Function DC = change in consumption
DY = change in income
When with the increase in income, average
propensity to consume declines, then the curve of Significance of MPC
consumption function is not a straight line passing Marginal propensity to consume needs to be
through the origin and has a shape as shown in figure C. carefully distinguished from average propensity to
From any point on the propensity to consume curve CC consume. Whereas average propensity to consume is the
C
we can find out average propensity to consume by ratio of total consumption to total income, i.e. the
Y
joining that point with the point of origin by a straight
marginal propensity to consume is the ratio of change in
line whose slope will measure the average propensity to ΔC
consume. In figure C, if we have to find out average consumption to the change in income, i.e. .
ΔY
propensity to consume at point A on the propensity When income increase, the MPC falls but more than
to consume curve CC, we connect point A with the the APC. Contrariwise, when income falls, the MPC
origin by a straight line. Now, the slope of the line OA rises and the APC also rises but at a slower rate than
AY1 former. Such changes are only possible during cyclical
i.e., will indicate the average propensity to
OY1 fluctuations whereas in the short-run there is no change
consume. Similarly, at point B of the given consumption in the MPC and MPC < APC. In the long-run MPC =
APC.
It is worth noting that when average propensity to
consume remains constant, marginal propensity to
consume is equal to it. Marginal propensity to consume
can be estimated by drawing the tangent at a point on the
consumption function.
When marginal propensity to consume declines with
the increase in income, consumption curve is non-linear
whose slope declines as income rises. But if consumption
curve is a straight line i.e., the slope of the consumption
curve remains constant then MPC which is given by the
slope of the propensity to consume curve (consumption
curve) remains constant. It is worth noting that marginal
propensity to consume is neither zero nor equal to one. It
has been found by empirical studies that marginal
propensity to consume varies between zero and unity. If
Fig. C : Non-Linear Consumption Function : Average the MPC was zero, then the whole of the increment in
Propensity to Consume income would have been saved and the consumption
curve would have a horizontal shape. On the other hand,
curve CC, the average propensity to consume will be if the MPC was equal to unity, then the whole of the
AY2 increment in income would be consumed and in that
given by the slope of the line OB which is equal to .
OY2 case consumption curve would have coincided with 45°
The glance at the figure will show that the slope of the line.
line OB is smaller than the slope of the line OA.
Therefore, average propensity to consume at point B or Propensity To Save
at income level OY 2 is less than that at point A or the We will now explain what happens to saving when
income level OY1. income increases. Saving is defined as that part of
Economics (NET) | 155U
income which is not consumed because disposable Consumption Function (Keynes’ Psycho-
income is either consumed or saved. Thus, logical Law of Consumption)
Yd = C + S
The consumption function is the relationship
or S = Yd – C between consumption and income. Before the 1930s
where, most economists stressed the relationship between
Yd = disposable income consumption and the interest. Keynes postulated that
C = consumption consumption depends mainly on income. In regard to the
S = saving relationship, he argued that consumption increases as
income increases but by an amount less than the increase
Average Propensity to Save (APS) in income.
An important relationship between income and This Law Consists Essentially of Three Related
saving is described by the concept of average propensity Propositions :
to save (APS). Average propensity to save is the (a) When aggregate income increases, consump-
proportion of disposable income that is saved. Thus, tion expenditure also increases but by a somewhat
Saving S smaller amount. The reason is that as income increases,
APS = =
Income Y more and more of our wants get satisfied and therefore,
Like the average propensity to consume (APC) lesser and lesser amounts are spent out of subsequent
average propensity to save also varies as income increases in income.
increases. As seen above, average propensity to consume (b) The second proposition is that when income
falls as income increases. This implies that average increases, the increment of income will be divided i n
propensity to save will increase as income rises. certain proportion between consumption spending and
Let us derive an important relationship between saving. This follows from the first proposition because
average propensity to consume and average propensity what is not spent is saved.
to save. Restating below the relation that income is (c) The third proposition is that as income
either consumed or saved : C + S = Y. increases both consumption spending and saving will go
Dividing both sides by disposable income Y we have up.
C S Y C S Assumptions of the Law
+ = or + = 1
Y Y Y Y Y Keynes’ Psychological law of consumption is based
C S on the following three assumptions :
Since is average propensity to consume and is (a) It is assumed that habits of people regarding
Y Y
average propensity to save, we have spending do not change or that the propensity to
consume remains the same.
APC + APS = 1 or APS = 1 – APC
(b) The second assumption is that the conditions
Marginal Propensity to Save (MPS) are normal in the economic system.
Whereas average propensity to save indicates the (c) The third assumption is that of the existence of
proportion of income that is saved, marginal propensity capitalistic laissez faire of economy.
to save represents how much of the additional disposable Explanation of the Law
income is devoted to saving. The marginal propensity to Consumption (C) is therefore, according to
save is therefore change in savings induced by a change Keynesian analysis, a function of income (Y). This
in the disposable income. Thus, relationship is often algebraically expressed as
ΔS C = f(Y)
MPS =
ΔY where, C stands for consumption, f - function and Y
Since the additional income is either consumed or for income. Keynes has made use of four concepts in
saved, the sum of marginal propensity to consume and analysing consumption-income relationship. These are :
marginal propensity to save is equal to one. (1) Average propensity to consume
MPC + MPS = 1 (2) Marginal propensity to consume
This can be mathematically proved as under. (3) Average propensity to save; and
From C + S = Y, it follows that any change in (4) Marginal propensity to save
income (ΔY) must induce either change in consumption (1) Average Propensity to Consume (APC)—It is
(ΔC) or change in saving (ΔS). Thus the ratio of total consumption to total income.
ΔC + ΔS = ΔY Symbolically :
Dividing both sides by DY we have C
APC =
ΔC ΔS ΔY Y
+ =
ΔY ΔY ΔY C = aggregate consumption
MPC + MPS = 1 Y = aggregate income
156U | Economics (NET)
(2) Marginal Propensity to Consume (MPC)— Determinants of Propensity to Consume—
The marginal propensity to consume is the ratio of the Income is the principal determinant of propensity to
change in total consumption to the change in total consume. Propensity to consume is, however, also
income, symbolically. determined by other factors. These are :
ΔC (i) Rate of Interest—The classical economists
MPc =
ΔY assumed that consumption was a function of the rate of
where, interest. A rise in interest rate tends to discourage the
propensity to consume and vice-vresa.
ΔC is the change in consumption
ΔY is the change in income (ii) Wealth—Wealth has also been regarded as
most important determinant of consumption. The larger
(3) Average Propensity to Save (APS)—We may the wealth possessed by a person, the higher will be the
define APS as the ratio of total saving to total income. consumption.
The sum of the APC and the APS will be equal to 1,
because income can either be consumed or saved. If (iii) Liquid Assets—If people hold larger liquid
we take the ratio of consumption to income, we get assets they will have a tendency to spend more out of
APC; and the ratio of saving to income gives APS. their current income and the propensity to consume
Therefore the two will add up to 1 and we express them will move upward, and vice-versa.
in percentage, they will equal 100%. (iv) Capital Gains—A sudden and unexpected
S gains increase the individuals, net worth, and thereby
MPC = induce additional consumption.
Y
Or, APC + APS = 1 (v) Consumer Expectations—Current spending on
consumer goods is influenced by expectations regarding
Since income is either consumed or saved.
future movements in income and price.
C+S = Y
(vi) Stock of Consumer Durable—People’s stock
C S Y of durable consumer goods reduces their desire to use a
+ = = 1
Y Y Y portion of their actual income to make additional
APC + APS = 1 purchase since they already have them.
(4) The Marginal Propensity to Save (MPS)— (vii) Consumer Credit—The avail of consumer
Another way of measuring the relationship between credit on easy instalments consumer credit raises the
income and saving is to concentrate on the relative propensity to consume in the economy because the
changes in the two variables replacement of durable consumer goods rises and
ΔC ΔS because instalment purchasing, partly, takes place at the
MPC = and MPS = expense of saving.
ΔY ΔY
and MPC + MPS = 1 (viii) Distribution of Income—If there are large
disparities in income distribution between the rich and
We know that
the poor, consumption function is low. If through
Y = C+S progressive taxation and other fiscal measures the
or ΔY = ΔC + ΔS inequalities of income and wealth are reduced, the
ΔY ΔC ΔS consumption function will shift upward.
= +
ΔY ΔY ΔY (ix) Taxation Policy—Heavy taxation adversely
1 = MPC + MPS affect the consumption function by reducing the
disposable income. On the other hand, the policy of pro-
1 – MPC = MPS gressive taxation along with that of public expenditure
Determination of Consumption and Invest- on welfare programmes tends to shift the consumption
function upward by altering the distribution of income.
ment
(x) Other Factors—There are other factors that
In the following figure we observe that the influence consumption expenditure. These includes
consumption line intersects the Y axis at a point above age, education, occupation, family composition and
zero and slope of the line (ΔC/ΔY ) is also constant. It rural-urban distribution of people in the country.
means that the consumption increases as the income
increases. Theory of Consumption
The APC (C/Y), consumption-income ratio declines
ΔC
1. The Absolute Income Hypothesis
as the level of income increases while the, MPC =
ΔY (AIH)
the ratio of change in consumption to change in income, The absolute income hypothesis is propounded by
is constant. This type of consumption function shows a Prof. Keynes. Keynes gave primary importance to dispo-
non-proportional income-consumption relationship. sable income as the chief determinant of consumption.
Economics (NET) | 157U
The basic tenet of the AIH is that the individual Advocates of AIH argue that the basic relationship
consumer determines the fraction of current income he is non-proportional with the data that show the long-run
will devote to consumption on the basis of the absolute relationship to be proportional is through an upward
level of that income. Consumption as a proportion of shift in the basic, non-proportional consumption
income (the APC), other things being constant, is function as a result of changes in factors other than
assumed to decline as income rises. The first statement
income like shifts of population from rural to urban
of this hypothesis is probably made by Keynes in the
General Theory. Its subsequent development is primarily areas, the age and composition of population etc. Shift in
associated with James Tobin and Arthur Smithies. the non-proportional consumption function is shown in
The basic form of early Keynesian consumption the figure I and II.
function is that current consumption depends on current Shifting of consumption function from C1 to C2 is
income. due to change in factors other than income. These
C t = a + bYt factors have caused the consumption function to shift
The hypothesis that consumption is a function of upward by roughly the amount necessary to produce a
current income, whether the relationship is linear or non- proportional relationship between C and Y over the
linear, is known as absolute income hypothesis. long-run.
Main Features of AIH
1. Above equation is a linear consumption function
since ‘b’, the MPC, is constant.
2. Another feature of this consumption function is
C a
that it is non-proportional, i.e., the APC = + b
y y
declines as Y increases (since a/y term falls).
A linear non-proportional consumption function, C
= a + bY, is graphed in figure (I) below. If the MPC falls
Fig. III
as income rises, then the consumption function is non-
linear as shown in figure (II). 2. Relative Income Hypothesis (RIH)
Cross-Section and Time Series Analysis of AIH— An answer to the apparent inconsistency of AIH is
Cross-section data are provided by sampling household provided by J.S. Duessenberry in his relative income
to obtain information for a particular time period on hypothesis (RIH).
their consumption expenditure. Such budget studies The RIH argues that the fraction of a family’s
shows that the apc does decline with rise in income and income devoted to consumption depends on the level of
typically that low income households dissave. There is its income relative to the income of other families with
also evidence that consumption functions fitted to which it identifies rather than on the absolute level of its
budget study data tend to be non-linear. income. Duessenberry develops the proposition that the
ratio of income consumed by an individual does not
depend on his absolute income, instead it depends upon
his relative income–upon his percentile position in the
total income distribution.
Individual Consumption Function—If a family’s
income rises but its relative position on the income scale
remains unchanged because the incomes of other
Fig. I Fig. II
families with whom it identifies have risen at the same
The short-term time series data produced linear non- rate, its division of income between consumption and
proportional consumption functions. saving will remain unchanged. The family’s absolute
Kuznets published long-run time series data for income has risen, so its absolute consumption and
USA which showed that the long-run APC had not saving will also rise, but the fraction of income devoted
fallen as national income had increased, but was on the to consumption will be the same as it was at the lower
whole quite stable. From Kuznets’ data is obtained a level. On the other hand, if a family’s income remains
long-run consumption function such that the long-run unchanged but the incomes of these other families rise,
apc and mpc are both constant and equal to k. This type its income position relative to that of the other families
of consumption function is known as a proportional one has then changed. According to RIH, the deterioration in
and is written as the relative position of this family would lead to a rise in
C = ky the fraction of its income devoted to consumption
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despite the fact that there has been no change in its does not follow the SR curves to the right but instead
absolute income. Duessenberry calls it as ‘demonstration shifts over to follow the LR-lines. Because income is
effect’. now rising to levels not previously attained. Consumers
feel free to consume a larger fraction of this income than
Studies have shown that black families with an
they consumed of the below peak income of the
income of, say $ 15,000 will, on the average, spend less preceding recession. As income grows to ever higher
than white families with an equal income, because the peaks, consumption increases proportionally, the APC
black family will probably live in a neighbourhood in and APS remain unchanged.
which $ 15,000 is a relatively high income, whereas the
Duessenberry refers to the tendency for the new and
white family will probably live in a neighborhood in higher level of consumption purchasing associated with
which this income is farther down the scale of incomes. a previously exceeded level of income as the ratchet
Aggregate Consumer Behaviour—When this effect. It explains the tendency for an economy’s
hypothesis is extended from individual consumer consumption purchasing not to fall back to earlier levels
behaviour to aggregate behaviour (time-series analysis), when its income does.
the ratio of consumption to incomes dependent on the
ratio of the current income level to the peak income 3. The Permanent Income Hypothesis
level previously attained. In developing the peak income (PIH)
argument of RIH, Duessenberry taken as his point of The best known exposition of the PIH is developed
departure the known fact that income does not grow at by Prof. Milton Friedman.
an even pace over the long-run but instead displays The permanent income hypothesis holds that the
cyclical ups and downs. These short-run income basic relationship between aggregate consumption and
fluctuations push the economy off the LR curve and aggregate income is proportional, but the relationship
onto the successive SR curves in an unbroken series here is expressed in terms of permanent income and
over time. permanent consumption.
Permanent, Measured and Transitory Income. In
a world of certainty, permanent income is the return on
the household’s human and non-human wealth. The
households’ wealth is the present value of the future
flow of income, which is expected by the household to
be variable from year to year. The household’s wealth is
given by the following equation :
∞ Yt
W = ∑ t
t = 1(l + i)
The same level of wealth could be attained by
receiving a constant annual annuity, A. Then
∞ Yt
Fig. IV W = ∑ t
According to Duessenberry, as income falls over the t = 1(l + i)
course of the recession, consumers as a group will ∞ A
attempt to maintain the consumption level they enjoyed = ∑ (l + ti)t
t=1
when income was at its peak but will gradually cut back
their expenditures as their aggregate income falls Assuming an infinite time horizon, permanent
consequently, consumption falls, but not proportionally income, A, is the stock of wealth multiplied by the
with the fall in income. This behaviour is depicted in the interest rate, i.e.
figure IV. limit A = i w
As the economy moves down the SR curves (as in N→ ∝
the figure) the apc rises and the aps falls. This reflects Thus permanent income is the amount that can be
the fact that in an attempt to maintain the previously consumed annually while leaving the stock of wealth
established highest standard of living, consumers will intact.
cut down their saving more than proportionally. Then as
recovery succeeds recession and the income level begins But measured income is different from permanent
its move back toward its previous peak, consumption income. Over a lifetime measured income ought to
rises but less than proportionally with the rise in income. coincide with permanent income, in any period (year),
Consequently, the APC falls. but measured income as a result of cyclical fluctuations
As the level of income rises to its previous peak and because of other random changes may depart from
and pushes on to higher ground, the consumption permanent income.
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The difference between measured and permanent
income, which may be + ve or – ve, is called by
Friedman transitory income. Thus,
Ym = Yp + Y t
Friedman assumes that consumption is planned on
the basis of permanent income and that the relationship
between the two variables is proportional, i.e.,
C = k Yp
Friedman divides measured (actual) consumption
into permanent and transitory components. A family’s
measured consumption in any particular period may be
larger or smaller than its permanent consumption.
C m = C p + Ct
A related result follows from a cyclical decline in
The coefficient of proportionality, k, which is the
income during a year that carries income to OY1 from
true underlying mpc and apc, is assumed to depend on
the initial level at Y = Yp . In this case, part of the decline
those factors which affect the household’s saving
in income will be –ve transitory income. With
decision. These factors are house-hold preferences, the consumption out of transitory income equal to zero, the
nature of the uncertainties facing the household, the rate result will be consumptions, say, at point E and a rise in
of interest and the ratio of human to non-human wealth. the APC. The decline in permanent income is that from
The higher the ratio of human to non-human wealth, the Y = Yp to Yp 1 . T h e decrease in consumption corre-
greater is the incentive to save and acquire non-human sponding to this decrease in permanent income takes us
wealth. from point H to point E.
Any change in measured income will only affect Assumptions of PIH—Friedman gives a series
current consumption if they cause the household to alter of assumptions concerning the relationships between
its estimate of permanent income. permanent and transitory components of income and
Friedman found, excluding the war years, the consumptions.
relationship for 1905-51 is C = 0.88 Yp. The apc equals 1. There is no correlation between permanent and
mpc and the function corresponds to line like LRC is the transitory consumption.
figure. The PIH argues that the economy departs from 2. There is no correlation between transitory and
this long-run growth path in the short-run as it is permanent incomes.
affected by the business cycles. 3. There is no correlation between transitory
The essential idea of the PIH is shown with the help consumption and transitory income.
of the following diagram. 4. Only differences in permanent income affect
consumption systematically.
In an initial year the income level is indicated by Y
= Y P, i.e., aggregate measured income and aggregate Cross-section and Time-Series Analysis of PIH.
permanent income are equal. This average year is The cross sectional results of PIH give a linear and
followed, say, by an above average year during which proportional consumption function.
measured income rises to Y2 . The long run data trace out a proportional relation
between income and consumption. But studies relating
According to Friedman, 33 per cent of the increase
to short-run oscillations of income around a long-run
in measured income for the year in question is an equilibrium path generally reveal a non-proportional
increase in permanent income, the balance is transitory relationship. The non-proportional relationship between
income. Since consumption out of transitory income consumption and measured income found in the short-
equal to zero, the apc at Y2 will be smaller than the 0.88 run is based on the + ve and – ve transitory income
value of the APC at the original income level of y = yp. components that appear respectively in the aggregate
Because, the MPC out of permanent income is 0.88 measured income of above and below average years.
and the increase in permanent income is 33 per cent of 4. Life Cycle Hypothesis (LCH)
the increase in measured income, the increase in
This hypothesis has been developed by Franco
consumption is also 0.88 × 33 % of increase in measured
Modigliani, Richard E. Brumberg, and Albert Ando.
income. This is shown by point B, which lies above the Given that the household has a known life span and
new level of income, Yp 2 . Relative to consumption intends to leave no legacies, and also given certainty, the
indicated by point H, this is the same increase motive for saving is to rearrange life time consumption
consumption shown by point A, which lies above the in relation to the expected future income stream.
new level of measured income Y2 . According to this theory, consumption is a function of
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lifetime expected income of the consumer. The con-
sumption of the individual consumer depends on the
resources available to him, the rate of return on capital,
the spending plan, and the age at which the plan is made.
The present value of his income (or resources) includes
income from assets or property and from current and
expected labour income.
Assumptions of the LCH—Following are the main
assumptions of the life cycles hypothesis :
1. There is no change in the price level during the
life of the consumer. Time-Series Analysis—The short-run consumption
2. The rate of interest remains stable. function, given by LCH is non-proportional, the
3. The consumer does not inherit any assets and intercept term being given by a 3 At-1. As net wealth
his net assets are the result of his own savings. increases in growing economy, so that short-run
consumption function shifts up over time as shown by
Explanation of the LCH—The typical time profile the dashed lines in the figure.
of a lifetime income stream is one that rises in the early
working years, reaches a plateau in middle years and is The LR function shows a constant ratio of
followed by a sudden decline upon retirement. To even consumption and income as income reaches successively
out the time profile of lifetime consumption a typical higher levels in the long-run.
house-hold will dissave or save very little when young, The aggregate APC is given by
save in the middle years and dissave upon retirement. Ct A
The consumption function for each age group is = a + a3 t – 1
Yt Yt
assumed to be
and is constant, if over time, the net wealth and income
C tT = kT (VtT) ratio remains constant. Statistical data, shows that the
Here Vt is the total resources (value in year t of ratio of property assets to income has indeed been fairly
aggregate current plus expected income of future years). stable.
T indicates the age group. VtT may be written Ando and Modigliani estimated that in the long-run
VtT = f(ytT, VTE At-1T) APC = MPC = 0.92.
Where yt is the current income, Y E is the present DEMAND FOR MONEY
value of future expected labour income, and At-1 is asset.
The demand for money arises from two important
Thus consumption function may now be written as functions of money. The first is that money act as a
C t T = a1 T YtT + a2 T YTE + a3T At-1T medium of exchange and the second is that it is a store
Aggregate consumption will be a weighted average of value. This individuals and businesses wish to hold
of the various age groups’ consumption levels. Thus money partly in cash and partly in the form of assets.
C t = a1 Yt + a2 YE + a3 At-1 There are three approaches to the demand for money :
Ando and Modigliani assume that average expected 1. The Classical Approach
labour income is equal to current labour income 2. The Keynesian Approach
multiplied by a scale factor, or 3. The post-Keynesian Approach
YtE = BYt The Classical Approach
B is some +ve fraction. Now consumption function The classical economists did not explicitly formulate
becomes demand for money theory but their views are inherent in
C t = (a1 + B a2) Yt + a3 At-1 the quantity theory of money. They emphasized the
or C t = aYt + a3 At-1 transactions demand for money in terms of the velocity
of circulation of money. This is because money acts as a
where a = a1 + B a2 medium of exchange and facilitates the exchange of
In this form, the coefficients of A t-1 and Yt can be goods and services. In Fisher’s “Equation of Exchange”,
estimated. On the basis of annual US data, Ando and MV = PT
Modigliani found where,
C t = 0·06At + 0·7 Yt M = total quantity of money
V = circulation velocity of money
Cross-section Analysis—Cross-section regression
of current consumption on current income produces non- P = price level
proportional consumption function, i.e., the APC T = total amount of goods and services
declines with the rise in household’s income. exchanged form money
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The right hand side of this equation PT represents The Key Feature of the Cambridge equation is that
the demand for money which, in fact, “depends upon the it makes the demand for money a function of money
value of the transaction to be undertaken in the income.
economy, and is equal to a constant fraction of those Cambridge equation is the simplest demand
transaction.” MV represents the supply of money which function for money. It has played a very important role.
is given and in equilibrium equals the demand for
money. Thus the equations becomes The Keynesian Approach : Liquidity
Md = PT Preference
This transactions demand for money, in turn, is What is known as the Keynesian theory of the
demand for money was first formulated by Keynes in
determined by the level of full employment income.
his well-known book, The General Theory of Employ-
This is because the classicists believed in Say’s Law ment, Interest and Money (1936). It has been developed
whereby supply created its own demand, assuming the further by other economists of Keynesian persuasion.
full employment level of income. Thus the demand for Keynes suggested three motives which led to the
money in Fisher’s approach is a constant proportion of demand for money in an economy :
the level of transactions, which in turn, bears a constant 1. The Transactions Demand
rela-tionship to the level of national income.
2. The Precautionary Demand
The Neoclassical Theory 3. The Speculative Demand
The neoclassical theory of the demand for money The Transactions Demand for Money
was put forward by the Cambridge economists Marshall The transactions demand for money arises from
and Pigou. The Cambridge demand equation for money the medium of exchange function of money in making
is regular payments for goods and services. According to
Md = K.Y ...(1) Keynes, it relates to “the need of cash for the current
where, transactions of personal and business exchange.” In
Md = amount of money demanded other words people hold money or cash balances for
transactions purposes, because receipt of money and
Y = money value of national income payments do no coincide. Most of the people receive
K = Constant their incomes weekly or monthly while the expenditure
Since, by definition, Y = P.y, where P is the general goes on day by day. A certain amount of ready money,
price level and y real national income, equation (1) can therefore, is kept in hand to make current payments.
This amount will depend upon the size of the individual’s
be written alternatively in its equivalent form as
income, the interval at which the income is received and
Md = K.Py ...(2) the methods of payments prevailing in the society.
K is the fraction of the real money income (Py) Given these factors, the transactions demand for
which people wish to hold in cash and demand deposits. money is direct proportional and positive function of the
level of income, and is expressed as
We may illustrate equation (1) diagrammatically as
in Figure D2. Md is shown to be a linear function of Y. It Lt = K.Y
goes through the origin. The tangent of the angle which where Lt is the transactions demand for money, K is the
it makes with the horizontal axis = Md /Y = K proportional of income which is kept for transactions
purposes, and Y is the income.
This equation is illustrated in Figure D3 , where
the line KY represents a linear and proportional relation
between transactions demand and the level of income.
Md
Fig. D2 : The Cambridge Demand for Money Function Fig. D3
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Interest Rate and Transaction Demand to the desire to provide for contingencies requiring
sudden expenditures and for unforeseen opportunities.
Regarding the rate of interest as the determinant of
the transactions demand for money, Keynes made the Lt The precautionary demand for money depends upon
function interest inelastic. But he pointed out that the the level of income and business activity, opportunities
“demand for money in the active circulation is also to for unexpected profitable deals, availability of cash, the
some extent a function of the rate of interest, since a cost of holding liquid assets, etc.
higher rate of interest may lead to a more economical According to Kenyes, precautionary demand for
use of active balances. In recent years, two post- money, like transactions demand, is a function of the
Keynesian economists W. J. Baumol and James Tobin level of income.
have shown that the rate of interest is an important M P = f (Y)
determinant to transactions demand for money. They d
have also pointed out that the relationship between According to Keynes, demand for money for
transactions demand for money and income is not linear transactions and precautionary motives are functions of
and proportional. Rather changes in income lead to the level of income, therefore we can sum up both the
proportionately smaller changes in transactions demand. demand for money in a single equations as
The modern view is that the transactions demand for M T = f (Y)
money is a function of both income and interest rates d
which can be expressed as The Speculative (Asset) Demand for Money—
Lt = f(Y, r) Money is also demanded as an asset. The speculative or
asset demand for money is for securing profit from
Reasons to Hold Transactions Balances—It is the knowing better than the market what the future will
lack of synchronisation between money inflow and bring forth. Money held for speculative purposes is a
money outflow both for individuals and business firms liquid store of value which can be invested at an
that compel them to hold money in cash for meeting day opportune moment in interest-bearing bonds or
to day transactions. securities.
The higher is the rate of interest, the larger is the
Md = ky return on bonds and the greater the opportunity cost of
holding money rather than an interest-bearing asset. The
speculative demand for money is therefore hypothesised
to vary inversely with the rate of interest. Expectations
about the future returns likely to be yielded by the
various types of assets will also affect the demand for
them, including money. An additional determinant of the
demand to hold money for speculative motive is the
Determinants of Transactions Demand—The
determinants of transactions demand for money are :
(1) Level of Income—The quantity of transaction
balances demanded depends directly upon the level of i
income of an economy. At higher level of income, the s
size of money holdings transaction would be larger, for d f (i)
example the size of money holdings for transaction
purposes at the level of national income of R 800 crores
will certainly be larger than at the income level of R 450 s
d
crores.
total stock of wealth to be allocated between money and
(2) Pattern of Income Payments and Expendi- bonds. The demand for money will rise with increased
ture—The intervals at which incomes are paid in the wealth.
economy and the patterns of expenditure also influence The demand for money under speculative motive is
the demand for money. The same income paid out a function of the current rate of interests increasing as
weekly would necessitate use of a smaller amount of the interest rate falls and decreasing as the interest rate
money than paid out monthly. rises. Thus, demand for money under this motive is a
decreasing function of the rate of interest. This is shown
(3) Use of Credit—Use of credit makes it possible in Figure D4 . Along OX is represented the speculative
for a given volume of transactions to be carried out with demand for money and along OY the current rate of
a smaller amount of money. interest. The liquidity preference curve LP is a
The Precautionary Demand for Money—Both downward sloping towards the right signifying the
individuals and business firms keep cash in reserve to higher the rate of interest, the lower the demand for
meet unexpected needs. The precautionary motive relates money for speculative motive, and vice-versa.
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speculative demand for money. It can be expressed
algebraically as
LS = f(r)
where LS is the speculative demand for money and r is
the rate of interest.
The Total Demand for Money
According to Keynes, money held for transactions
and precautionary purposes is primarily a function of the
level of income, L T = f(Y), and the speculative demand
for money is a function of the rate of interest, LS = f(r).
Thus the total demand for money is a function of both
Fig. D4 : Demand for Money for Speculative Motive
income and the interest rate :
Thus at the high current rate of interest Or, a very
small amount OM is held for speculative motive. This is
because at a high current rate of interest much money
would have been lent out or used for buying bonds and
therefore less money would be kept as inactive balances.
If the rate of interest falls to Or′, then a greater amount L = Lr + Ls
OM′ is held under speculative motive. With the further
fall in the rate of interest to Or”. Money held under
speculative motive increases to OM”.
Liquidity Trap
At very low rate of interest, such as r” in Figure D4, Fig. Total Demand for Money
the LP curve becomes perfectly elastic and the LT + LS = f(Y) + f(r)
speculative demand for money is infinitely elastic. This or, L = f(Y) + f(r)
perfectly elastic portion of liquidity preference curve or, L = f(Y, r)
indicates the position of absolute liquidity preference of where, L represents the total demand for money.
the people. That is, at a very low rate of interest people
Thus the total demand for money curve can be
will hold with them as inactive balances any amount of
derived by the lateral summation of the demand function
money they come to have. This portion of liquidity pre- for transactions and precautionary purposes and the
ference curve with absolute liquidity preference is called demand function for speculative purposes as illustrated
liquidity trap by the economists because expansion in in Figure.
money supply gets trapped in the sphere of liquidity trap
and therefore cannot affect rate of interest and therefore The Post-Keynesian Approaches
the level of investment. According to Keynes, it is Keynes believed that the transactions demand for
because of the existence of liquidity trap that monetary money was primarily interest inelastic. Prof. Baumol
policy becomes ineffective to tide over economic has analysed the interest elasticity of the transactions
depression. demand for money on the basis of his inventory
The phenomenon of liquidity trap possesses certain theoretical approach. Further, in the Keynesian analysis
important implications. the speculative demand for money is analysed in relation
to uncertainty in the market. Prof. Tobin has given an
First, the monetary authority cannot influence the alternative theory which explains liquidity preference
rate of interest even by following a cheap money policy. as behaviour towards rist. The third important post-
An increase in the quantity of money cannot lead to a Keynesian development has been Friedman’s formula-
further decline in the rate of interest in a liquidity-trap tion that the demand for money is not merely a function
situation. of income and the rate of interest, but also of the total
Second, the rate of interest cannot fall to zero. wealth.
Third, the policy of a general wage cut cannot be
efficacious in the face of a perfectly elastic liquidity Baumol’s Inventory Theoretic Approach
preference curves, such as LP in Figure D4 . The inventory theoretic approach to the demand for
Thus the speculative demand for money is a money is associated with the name of W. Baumol.’ The
decreasing function of the rate of interest. The higher the most famous result of Baumol is the Square-root-law of
rate of interest, the lower the speculative demand for the demand for money. William Baumol has made an
money, and the lower the rate of interest, the higher the important addition to the Keynesian transactions demand
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for money. Keynes regarded transactions demand for Baumol’s theory also has the merit of demons-
money as a function of the level of income, and the rela- trating the interest elasticity of the transactions demand
tionship between transactions demand and income as for money as against the Keynesian view that it is
linear and proportional. Baumol shows that the relation interest inelastic.
between transactions demand and income is neither Further, Baumol analyses the transactions demand
linear nor proportional. Rather, changes in income lead for real balances thereby emphasising the absence of
to less than proportionate changes in the transactions money illusion.
demand for money. Further, Keynes considered
transactions demand as primarily interest inelastic. But Again, Baumol’s inventory theoretic approach is
Baumol analyses the interest elasticity of the superior to both the classical and Keynesian approaches
transactions demand for money. because it integrates the transactions demand for money
with the capital-theory approach by taking assets and
Baumol’s analysis is based on the holding of an their interest and non-interest costs into account.
optimum inventory of money for transactions purposes
by a firm or an individual. He writes : “A Firm’s cash Tobin’s Portfolio Selection Model : The
balance can usually be interpreted as an inventory of
money which its holder stands ready to exchange against Risk Aversion Theory of Liquidity Pre-
purchases of labour, raw materials, etc.” Cash balances ference
are held because income and expenditure do not take James Tobin in his famous article “Liquidity
place simultaneously. “But it is expensive to tie up large Preference as Behaviour Towards Risk” formulated the
amounts of capital in the form of cash balances. For that risk aversion theory of liquidity preference based on
money could otherwise be used profitably elsewhere in portfolio selection. This theory removes two major
the Firm… it could be invested profitably in securities.” defects of the Keynesian theory of liquidity preference.
Thus the alternative to holding cash balances is bonds One, Keynes’s liquidity preference function depends on
which earn interest. A Firm would always try to the inelasticity of expectations of future interest rates;
keep minimum transactions balances in order to earn and two, individuals hold either money or bonds. Tobin
maximum interest from its assets. The higher the interest has removed both the defects. His theory does not
rate on bonds, the lesser the transactions balances which depend on the elasticity of expectations of future interest
a Firm holds. rates but proceeds on the assumption that the expected
In this inventory theory of the demand for money, value of capital gain or loss from holding interest
Baumol also emphasises that the demand for money is a -bearing assets is always zero.
demand for real balances. Therefore demand for real Moreover, it explains that an individual’s portfolio
balances for transactions purposes becomes. holds both money and bonds rather than only one at a
time.
1 2b·Y
Md = ·P Tobin starts his portfolio selection model of liquidity
2 r
preference with this presumption that an individual asset
where, Md = demand for money holder has a portfolio of money and bonds. Money
P = price level neither brings any returns nor imposes any risk on him.
But bonds yield interest and also bring income.
This equation shows that the demand for real However, income from bonds is uncertain because it
transactions balances “is proportional to the square involves a risk of capital losses or gains.
root of the volume of transactions and inversely
Optimal decision making requires the help of
proportional to the square root of the rate of interest.” It
means that the relationship between changes in the conventional indifference curve analysis and suggests
price level and the transactions demand for money that normally the individual will hold both bonds and
is direct and proportional. speculative balances.
In order to find out risk averter’s preference
Its Superiority Over the Classical and between risk and expected return, Tobin uses indi-
Keynesian Approaches fference curves having +ve slopes indicating that the risk
Baumol’s inventory theoretic approach to the averter demands more expected returns in order to take
transactions demand for money is an improvement over more risk. This is illustrated in the Figure.
the classical and Keynesian approaches. The lower portion of the figure shows the allocation
The cash balance quantity theory of money assumed of total asset between idle cash holdings and bonds,
the relationship between the transactions demand and while the upper part shows the trade off between risk
the level of income as linear and proportional. Baumol measured on the horizontal axis and expected returns,
has shown that this relationship is not accurate. No measured on the vertical axis. The initial rate of interest
doubt it is true the transactions demand increases with in is i1. The optimal combination will be OX of risk
income but it increases less than proportionately because combined with OZ of expected return, showing an
of the economies of scale in cash management. investment of OA in bonds and retention of YB in cash.
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Supposing the interest rate increases to i2 , raising the Friedman’s Theory
expected return associated with any degree of risk. A Friedman, in his essay “ The Quantity Theory of
rise in the interest rate will incorporate an income effect, Money—A Restatement” published in 1956, set down a
allowing the investor to take less risk, while also particular model of quantity theory of money.
producing a substitution effect, in favour of more risk
because the cost of holding idle balance has increased. In his reformulation of the quantity theory, Friedman
asserts that “money does matter.” He points out that his
i quantity theory is a theory of the demand for money. It is
not a theory of output, money incomes or prices.
i
Friedman’s theory of the demand for money is
partly Keynesian and partly non-Keynesian. Instead, for
identifying the key determinants of the demand for
money, he classifies the holders of money as between (a)
ultimately wealth-holders and (b) business enterprises.
All the essentials of his theory have been set out in
respect of the former, and comparatively much less
about the latter. He emphasises the role of money as an
asset and in this he generalises Keynes’s analysis of the
speculative demand for money by treating the total
demand for money as part of capital or wealth theory,
concerned with the composition of the balance sheet or
If substitution effect is stronger as shown in the portfolio of assets.
figure, the investor will increases his risk and reduce his According to Friedman, the analysis of the demand
holdings of asset cash. The degree of risk increases to for money on the part of the ultimate wealth owning
OR and the expected return become OE, investment in units is formally identical with that of the demand for
bonds is shown as OC and speculative money balances any durable consumer good. The demand for money
fall to YS. depends upon three major sets of factors :
This analysis of the demand for money shows that (a) the total wealth to be held in various forms
the real demand for money will vary inversely with the (b) the price and return on this form of wealth and
rate of interest and positively with the level of output. alternate forms
Its Superiority Over Keynesian Theory (c) the tastes and preferences of the wealth-owing
Tobin’s risk aversion theory of portfolio selection units.
is superior to the Keynesian liquidity preference theory He, therefore, regards the amount of real cash
of speculative demand for money. First, Tobin’s balances (M/P) as a commodity which is demanded
theory does not depend on inelasticity of expectations of because it yields services to the person who holds it.
future interest rates, but proceeds from the assumption Thus money is an asset or capital good. Hence the
that the expected value of capital gain or loss from demand for money forms part of capital or wealth
holding interest bearing assets is always zero. In this theory.
respect, Tobin regards his theory as a logically more Friedman’s theory of the demand function for
satisfactory foundation for liquidity preference than the money for an individual wealth-holder is summed up
Keynesian theory. symbolically below :
Second, this theory is superior to Keynes’s theory in Md = f(Y, P, rb , re, pe, w, u) …(1)
that it explains that individuals hold diversified portfolios where,
of bonds and money rather than either bonds or money.
Md = total stock of money demanded
Third, like Keynes, Tobin regards the demand for
money as closely dependent on interest rates and Y = total permanent income
inversely related to interest rates. But he is more realistic P = price level
than Keynes in not discussing the perfect elasticity of rb = yield on bonds
demand for money (the liquidity trap) at very low rates re = yield of equities
of interest.
pe = expected rate of change of prices of
Fourth, the real importance of the portfolio theory goods and hence the expected rate of
lies in “not what it tells directly about the aggregate return on teal assets
economy, but rather it represents an interesting approach
to the existence of uncertainty, and approach that w = ratio of non-human to human wealth
probably has scope for considerable development in the u = tastes and preferences and ail other
future.” relevant variables.
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The aggregate demand function for money is the Fisher points out that the price level (P) varies
summation of individual demand functions. So equation directly as the quantity of money (M + M′). Provided the
(1) being the demand function of an individual wealth volume of trade (T) and velocity of circulation (V, V′)
holder also represents the aggregate demand function remain unchanged.
of all wealth holders in the community. Assumptions of the Theory
The Quantity Theory of Money Fisher’s theory is based on the following
For generations economists have been engaged in assumptions :
answering the question : What causes changes in the 1. V and V′ are assumed to be constant and are
price level or the value of money ? Right from independent of changes in M and M′.
Davanzatti and Jean Bodin in the 16 century to David 2. The proportion of M′ to M remains constant.
Hume (1752) in the 18th century, to Simon Newcomb 3. T also remains constant and is independent of
(1886), and Knut Wicksell (1898) in the 19th century to other factors such as M, M′, V and V′.
Irving Fisher (1911), Alfred Marshall (1923), A.C. 4. P is a passive factor in the equation of exchange
Pigou (1917), Keynes (1930 and 1936), Patinkin (1948) which is affected by the other factors.
and Friedman (1957) in the 20th Century, economists 5. It is assumed that the demand for money is
believed that the quantity theory of money explains the proportional to the value of transactions.
causes of changes in the price level or the value of 6. The supply of money is assumed as an
money. Before we study the views of some of the exogenously determined constant.
economists on the relationship between money and
7. The theory is applicable in the long run.
prices it is essential to know the relation between the
price level and the value of money. 8. It is based on the assumption of existence of full
employment in the economy.
By value of money is meant the purchasing power
Fisher’s quantity theory of money is explained with
of money over goods and services within a country. The
the help of a numerical example. Suppose the quantity of
relation between value of money and the price level is an
money is R 5,00,000 in an economy, the velocity of
inverse one. When the price level rises, the value of
circulation of money (V) is 5; and the total output to be
money falls, and vice versa. The various versions of the
transacted (T) is 2,50,000 units, the price level (P) will
quantity theory of money are attempts at explaining the
be :
causes of changes in the value of money.
MV
Fisher’s Cash Transactions Approach P =
T
In the words of Fisher, “Other things remaining 500000 × 5
unchanged, as the quantity of money in circulation =
250000
increases, the price level also increases in direct
proportional and the value of money decreases and vice- = R 10 per unit
versa.” If the quantity of money is doubled, the price If now, other things remaining the same, the quantity
level will also double and the value of money will be of money is doubled, i.e., increased to R 1000000 then:
one half. On the other hand, if the quantity of money is 10000 × 5
reduced by one half, the price level will also be reduced P = = R 20 per unit
250000
by one half and the value of money will be twice.
We thus see that according to the Fisher’s quantity
Fisher has explained his theory in terms of his theory of money, price level varies in direct proportion
equation of exchange : to the quantity of money.
PT = MV + M′V′
where, The Cambridge Cash Balances Approach
P = price level of 1/P = the value of money; As an alternative to Fisher’s quantity theory of
M = the total quantity of legal tender money; money, Cambridge economists Marshall, Pigou,
V = the velocity of circulation of M; Robertson and Keynes presented the quantity theory of
M′ = the total quantity of credit money; money as a cash balance approach theory, they regarded
the determination of value of money in terms of supply
V′ = the velocity of circulation of M; and demand.
T = the total amount of goods and services The supply of money is exogenously determined at
exchanged for money or transactions a point of time by the banking system. Therefore, the
performed by money. concept of velocity of circulation is altogether discarded
This equation equates the demand for money (PT) in the cash balances approach because it ‘obscures the
to the supply of money (MV + M′V′). In order to find motives and decisions of people behind it.’ On the other
out the effect to the quantity of money on the price level hand, the concept of demand for money plays the major
or the value of money, we write the equation as role in determining the value of money. The demand for
MV + M′V′ money is the demand to hold cash balances for
P = transactions and precautionary motives.
T
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Thus the cash balances approach considers the (1 – c) = the proportion kept in bank notes and
demand for money not as a medium of exchange but bank balances;
as a store of value. The Cambridge equations show that h = the proportion of actual legal tender that
given the supply of money at a point of time, the value bankers keep against the notes and
of money is determined by the demand for cash balances held by their customers.
balances. When the demand for money increases, people Pigou points out that when K, R, C and h are taken
will reduce their expenditure on goods and services in as constants then the two equations give the demand
order to have larger cash holdings. Reduced demand for curve for legal tender as a rectangular hyperbola. This
goods and services will bring down the price level and implies that the demand curve for money has a uniform
raise the value of money. On the contrary, fall in the unitary elasticity. This is shown in Figure D 5 where DD1
demand for money will raise the price level and lower is the demand curve for money and Q1 M1 , Q2 M2 and
the value of money.
Q3M3 are the supply curves of money drawn on the
The Cambridge cash balances equations of Marshall, assumption that the supply of money is fixed at a point
Pigou, Robertson and Keynes are discussed below. of time. The value of money or Pigou’s purchasing
Marshall’s Equation power of money P is taken on the vertical axis. The
Figure shows that when the supply of money increases
Marshall’s equation can be stated as : from OM 1 to OM2 the value of money is, reduced from
M = K.PY OP1 to OP2 . The fall in the value of money by P1 P 2
where, exactly equals.
M = the exogenously determined supply of
money;
K = the fraction of the real money income
(P Y) which people wish to hold in cash
and demand deposits;
P = the price level;
Y = the aggregate real income of the
community
Thus, the price level P = or the value of money (the
1
reciprocal of price level) is p = .
P
Pigou’s Equation
Pigou was the first Cambridge economist to express
the cash balances approach in the form of an equation : Fig. D5
KR the increase in the supply of money by M1 M2 . If the
P =
M supply of money increases three times from OM1 to
where, OM3 , the value of money is reduced by exactly one-third
P = the purchasing power of money or the from OP 1 to OP 3 . Thus the demand curve for money
value of money; DD1 is a rectangular hyperbola because it shows changes
K = the proportion of total real resources or in the value of money exactly in reverse proportion to
income (R) which people wish to hold the supply of money.
in the form of titles to legal tender;
R = the total resources or real income;
Robertson’s Equation
M = the number of actual units of legal To determine the value of money or its reciprocal
tender money the price level, Robertson formulated an equation similar
to that of Pigou. The only difference between the two
The demand for money, according to Pigou,
being that instead of Pigou’s total real resources R,
consists not only of legal money or cash but also bank
Robertson gave the volume of total transactions T. The
notes and bank balances. In order to include bank notes
Robertsonian equation is
and bank balances in the demand for money, Pigou
notifies his equation as M
M = PKT or P =
KR KT
P = [c + h (1 – c)] where,
M
where, P = the price level;
c = the proportion of total real income M = the total quantity of money;
actually held by people in legal tender K = the proportion of the total amount of
including token coins; goods and services (T) which people
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wish to hold in the form of cash determines the value of money. But in the transactions
balances; approach, the determination of value of money is
T = the total volume of goods and services artificially divorced from the theory of value.
purchased during a year by the The cash balances approach is superior to the
community. transactions approach because it altogether discards
the concepts of velocity of circulation of money which
Keynes’s Equation ‘Obscures the motives and decisions of people behind
Keynes in his A Tract on Monetary Reforms (1923) it.’
gave his Real Balances Quantity Equation as an Again the cash balances version is more rea-listic
improvement over the other Cambridge equations. than the transactions version of the quantity theory,
According to him, people always want to have some because it is related to the short period while the latter is
purchasing power to finance their day to day related to the long period.
transactions. The amount of purchasing power (or In the cash balances equation, transactions relating
demand for money) depends partly on their tastes and to final goods only are included where P refers to the
habits, and partly on their wealth. Given the tastes, price level of final goods. On the other hand, in the
habits and wealth of the people, their desire to hold transactions equation P includes all types of transactions.
money is given. This demand for money is measured by This creates difficulties in determining the true price
consumption units. A consumption unit is expressed level. Thus the former equation is simpler and realistic
as a basket of standard articles of consumption or other than the latter.
objects of expenditure.
If K is the number of consumption units in the form
Relationship between Money and Prices :
of cash, n is the total currency in circulation, and p is the Friedman and Other Monetarist’s View
price for consumption units then the equation is The relation between money and prices put forward
n = pK by crude quantity theory of money was based on two
assumptions, namely, (1) the velocity of money (V) is
If K is constant, a proportionate increase in n
constant, and (2) the real national product (Y) remains
(quantity of money) will lead to a proportionate increase
fixed at the full-employment level. But both these
in p (price level.)
assumptions are questionable. Monetarists led by Milton
This equation can be expanded by taking into Friedman have restated and modified the quantity theory
account bank deposits. Let K′ the number of consump- of money and have presented a more sophisticated
tion units in the form of bank deposits, and r the cash version of it. These monetarists continue to assume that
reserve ratio of banks, then the expanded equation is velocity of money (V) remains constant but they
n = p (K + rK′) recognise that in the short-run the economy is often at
Again, if K, K′ and r are constant, p will change in less than full employment level and as a result the real
exact proportion to the change in n. national output (Y) may change considerably. They
Keynes’ regarded his equation superior to other restate their quantity theory of money in the following
cash balances equations. The other equation fail to point way :
how the price level (p) can be regulated. Since the cash MV = PT
balances (K) held by the people are outside the control where,
of the monetary authority, p can be regulated by M = Money supply
controlling n and r. It is also possible to regulated bank V = Velocity of circulation of money
deposits K′ by appropriate changes in the bank rate. So p PY = Nominal national product or national
can be controlled by making appropriate changes in n, r income in money form; P is the price
and K′ so as offset changes in K. level and Y is the real national product.
Cash Balances Approach Versus Tran- It follows from the above equation that given the
sactions Approach constant velocity of money (V), the nominal national
product (PY) would be proportional to the money
The Cambridge cash balances approach to the supply. The increase in money supply will lead to
quantity theory of money is superior to Fisher’s increase in expenditure on purchase of final goods and
transactions approach in many respects. They are services. That is, increase in money supply directly
discussed as under. causes increase in aggregate demand for final goods and
The cash balances approach emphasises the services. To the extent the real national product (Y)
importance of holding cash balances rather than the which consists of final goods and services increases, the
supply to money which is given at a point to time. It thus effect on price level (P) is less. Thus, when their is slack
led Keynes to propound his theory of liquidity preference in the economy, that is, there exist a lot of idle
and of the rate of interest, and to the integration of productive capacity or capital stock and a large
monetary theory with the theory of value and output. magnitude of unemployment of labour, as it happens
The cash balances version of quantity theory is during period of recession, the real aggregate output will
superior to the transactions version because the former increase considerably with relatively little effect on the
Economics (NET) | 169U
price level. But when the economy is at full employment reformulated quantity theory of money stresses the
level of output, the expansion of money supply will have point that with increase in the quantity of money
its full effect on raising the rice level, the real national prices rise only when the level of full employment is
Product (Y) remaining constant. reached, and not before this.
Keynes’s Reformulated Quantity Theory
of Money
The Keynesian reformulated quantity theory of
money is based on the following assumptions :
1. All factors of production are in perfectly elastic
supply so long as there is any unemploy-ment.
2. All unemployed factors are homogeneous,
perfectly divisible and inter changeable.
3. There are constant returns to scale so that prices
do not rise or fall as output increases. f
4. Effective demand and quantity of money change Fig. (A) Fig. (B)
in the same proportion so long as there are any The reformulated quantity theory of money is
unemployed resources. illustrated in figure (A) and (B) where OTC is the PRC
Given these assumptions, the Keynesian chain of is the price curve relating to the quantity of money.
causation between changes in the quantity of money and Panel A of the figure shows that as the quantity of
in prices is an indirect one through the rate of interest. money increases from O to M, the level of output also
How the increase in money supply can lead to the rise in rises along the OT portion of the OTC curve. As the
aggregate expenditure and price level can be represented quantity of money reaches OM level, full employment
by the following scheme : output OQ f is being produced. But after point cannot
Ms↑ → r↑ → I↑ → AD↑ → Y↑ raise output beyond the full employment level OQf.
where, Ms stands for supply of money, r, I, AD, and Panel B of the figure shows the relationship
Y stand for rate of interest, investment, aggregate between quantity of money and prices. So long as mere
demand and income respectively. is Unemployment, prices remain constant whatever the
According to this, when the quantity of money is increase in the quantity of money. Prices start rising only
increased, its first impact is on the rate of interest which after the full employment level is reached. In the figure,
tends to fall. Given the marginal efficiency of capital, a the price level OP remains constant at the OM quantity
fall in the rate of interest will increase the volume of of money corresponding to the full employment level of
investment. The increased investment will raise output OQ f But an increase in the quantity of money
effective demand through the multiplier effect there by above OM raise prices in the same proportion as the
increasing income output and employment. Since the quantity of money. This is shown by the RC portion of
supply curve of factors of production is perfectly elastic the price curve PRC.
in a situation of unemployment, wage and non wage
factors are available at constant rate of remuneration. Superiority of the Keynesian Theory
There being constant returns to scale, prices do not rise over the Traditional Quantity Theory of
with the increase in output so long as there is any Money
unemployment.
The Keynesian theory of money and prices is
Under these circumstances, output and employment superior to the traditional quantity theory of money for
will increase in the same proportion as effective the following reasons :
demand, and the effective demand will increase in the
same proportion as the quantity of money. But “Once 1. Keynes’s reformulated quantity theory of money
full employment is reached, output ceases to respond at is superior to the traditional approach in that he discards
all to changes in the supply of money and so in the old view that the relationship between the quantity of
effective demand”. The elasticity of supply of output in money and prices is direct and proportion. Instead, he
response to changes in the supply, which was infinite as establishes an indirect and non-proportional relationship
long as there was unemployment falls to zero. The entire between quantity of money and prices.
effect changes in the supply of money is exerted on 2. In establishing such a relationship, Keynes
prices, which rise in exact proportion with the increase brought about a transition from a pure monetary theory
in effective demand. of prices to a monetary theory of output and employ-
Thus so long as there is unemployment, output ment. In so doing, he integrates monetary theory with
will change in the same proportion as the quantity of value theory. He integtates monetary theory of output
money, and there will be no change in prices; and when and employment through the rate of interest. The
there is full employment, prices will change in the same Keynesian theory is, therefore, superior to the traditional
proportion as the quantity of money. Therefore, the quantity theory of money because it does not keep the
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real and compartments with ‘no doors or windows Thus the demand for a commodity depends upon
between the theory of value and theory of money and real balance as well as relative prices. Now if the price
prices. level rises, this will reduce the real balance (purchasing
3. The traditional quantity theory is based on the power) of the people who will spend less than before.
unrealistic assumption of full employment of resources. This implies a fall in the demand for goods and the
Under this assumption, a given increases in the quantity consequent fall in the price level. Contrariwise, a fall in
of money always leads to a proportionate increase in the the price level increases the real balances thereby
price level. Keynes, or the other hand, believes that full increasing the demand for goods and the price level. In
employment is an exception. Patinkin’s words : “This is the crucial point. The
4. Further, the Keynesian theory is superior to the dynamic grouping of the absolute price level towards its
traditional quantity theory of money in that it emphasises equilibrium value will—through the real balance effect
important policy implications. The traditional theory reaction the commodity markets and hence on relative
believes that every increases in the quantity of money prices.” Thus absolute prices play a crucial role not only
leads to inflation. Keynes on the other hand, establishes in the money market but also in the real sector of the
that so long as there is unemployment, the rise in prices economy. Patinkin further points out that “once the real
is gradual and there is no danger of inflation. and monetary data of an economy with outside money
are specified, the equilibrium values of relative prices,
Patinkin’s Intergation of Monetary and the rate of interest, and the absolute price level are
simultaneously determined by all the markets of the
Value Theory : The Real Balance Effect economy.” In this way Patinkin also introduces the real
Don Patinkin in his monumental work Money, balance effect in the general equilibrium analysis.
Interest and Prices criticised the cambridge economists Besides removing the classical dichotomy and the
for the homogeneity postulate and the dichotomisation homogeneity postulate and integrating the monetary and
of goods and money markets and reconciles the two value theory through the real balance effect, Patinkin
markets through the real balance effect. also validates the quantity theory conclusion. According
The homogeneity postulate states that the demand to Patinkin, the real balance implies that people do not
and supply of goods are affected only by relative prices. suffer from “money illusion.” They are interested only
It means that a doubling of money prices will have no in the real value of their cash holdings. In other words,
effect on the demand and supply of goods. they hold money for ‘what it will buy.’ This means that
Mathematically, the demand and supply functions for a doubling of the quantity of money will lead to a
goods are homogenous of degree zero in prices alone. doubling of the price level, but relative prices and the
Thus, this homogeneity postulate precludes the price real balances will remain constant and the equilibrium of
level from market. Patinkin criticises this postulate for the economy will not be changed.
its failure to have any determinate theory of money and
prices.
Another closely related assumption which Patinkin
criticises is the dichotomisation of the goods and many
markets in the neo-classical analysis. This
dichotomisation means that the relative price level is
determined by the demand and supply of goods, and the
absolute price level is determined by the demand and
supply of money. Like the homogeneity postulate,
this assumption also implies that the price level has
absolutely no effect on the monetary sector of the
economy, and the level of monetary prices, in turn, has
no effect on the real sector of the economy.
After condemning the neo-classical assumptions
outlined above, Patinkin integrates the money market
f
and the goods market of the economy which depends
not only on relative prices the real purchasing power of The Patinkin analysis is illustrated diagrammatically
the stock of cash holding of the people. in figure by using the IS and LM curves because the IS
When the price level changes, it affects the curve represents the goods sector and the LM cutve
purchasing power of people’s cash holdings which in represents the monetary sector of the economy. To begin
turn, affects the demand and supply of goods. This is the with we take a situation when the economy is in
real balance effect. Patinkin denies the existences of the equilibrium at OYf level of income when the IS and LM
homogeneity postulate and the dichotomisation curves intersect at point A and the rate of intersect is
assumption through this effect. For this, Patinkin OR. Thus OYf is the full employment level of income.
introduces the stock of real balance (M/P) held by Suppose at this level the quantity of money is increased,
community as an influence on their demand for goods. given the same rate of interest OR. The increased money
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supply, shown by LM1 curve, leads to increased demand country, other things remaining the same, the higher
and the consequent rise in the price level. Further, this shall be the velocity of circulation of money in that
increased money supply raises the demand for bonds country because people tend to spend major portion of
thereby lowering the rate of interest to OR1 . The fall in their income on consuption.
the rate of interest encourages investment and income (5) Distribution of Income—If income is
which further increase the price level in goods market. distributed in a country in such a manner that a major
The rise in the price level is implicit in the increase in portion of it is held by the richer section then the
income from OYf to OY1, at the new equilibrium point B. velocity of circulation of money will be low because this
At this stage, Patinkin’s real balance effect starts section is inclined to hold larger cash balances with
operating to restore the full employment equilibrium itself.
level OQf. With the rise in the price level, the real Components of Money Supply
balance of the people are reduced who accordingly start
spending less than before. This leads to a fall in the The main components of the supply of money are as
demand for goods and consequent fall in the prices level. follows
On the other hand, to maintain the same real balances, Currency Component—Consisting of coins and
people increase the demands for money and consequently currency notes issused by the central government, and
the rate of interest rises. These are shown by the upward Deposit Component—Consisting of deposits of
shifting of the LM1 curve to its original position as the general public with the commercial banks.
LM curve and of the rate of interest to OR from OR1 (I) Coins : The metallic coins are issued by the
respectively. Thus the full employment equilibrium is country’s monetary authority. There are two system of
reestablished at OQf level through the real balance effect. coinage :
(a) Free Coinage : Under this system anybody
Supply of Money could take a fixed quantity of the metal and get it minted
The supply of money with the people or the volume at the mint. The mint, in other words, is open to the
of money in circulation refers to the volume of money public. Free minted at the mint may be gratuitous or non
held by the people in the country by individuals and gratuitious.
business houses. We include only the amount of money (i) Gratuitous Coinage is that where no fee is
held by the public and used by the public for transactions charged for mintage of a coin.
and for making payments and for settlement of debt and (ii) Non-gratuitious Coinage is that where a fee is
we exclude money held by the government in its charged for mintage. Non-gratuitous coinage are of two
treasures and money lying with the commercial banking types :
system. (1) Brassage—When the government charges a fee
The quantity of money in existence at particular equal to the cost of minting coins it is called Brassage.
time-or the supply of money in a spendable form consists The government makes no profit in this type of coinage.
of two important items. (2) Seigniorage—When the government charges a
Velocity of Money fee which is higher than the cost of minting it is known
as seigniorage. The government makes some profit in
The average number of times money is transferred this type of coinage.
from one person to another in given period of time is
(b) Limited Coinage—Coinage is said to be limited
known as the velocity of circulation of money. In other
when coinage is done on government account only.
words, velocity of circulation is the average number of
Under this system the government enjoys the monopoly
times that each unit of money is spent for purchases of
of minting coins. The government itself buying metals
goods and services.
and converts them into coins.
The velocity of circulation of money depends upon (II) Paper Currency—The most important part of
certain factors. the money supply is the paper currency which is
(1) Quantity of Money—Velocity of circulation of obligation of Central Bank. The paper currency in
money depends upon the supply of money in the country is regulated in accordance with the system laid
economy. If the supply of money in the economy is less down by the monetary authority.
than its requirements the velocity of circulation goes up.
(2) Frequency of Cash Transactions—Greater the
Standard System of Note Issue
frequency of cash transaction in the economy the Following are the main systems of currency issue :
higher shall be the velocity of circulation. (1) Simple Deposit System—Under this system,
(3) Credit Facilities—If the people in the country the monetary authority is required to keep hundred per
are given credit facilities on large scale the velocity of cent of the bullion (gold or silver) for every note issued.
circulation goes up. That is why it is also known as the Full Reserve System.
(4) Size of Propensity to Consume—According to (2) Fixed Fiduciary System—Under this system
Keynes, the higher the propensity to consume in a the Central Bank of a country is permitted to issue a
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fixed amount of notes without keeping any metallic the sum of currency in the hands of the public (C) and
reserves. This portion is called fiduciary system. But all reserves of commercial banks (R) Cash holdings and
notes issued above this amount must be converted by 100 deposits at the central bank.
per cent metallic reseserves. (2) The Level of Bank Reserves—The actual
(3) Maximum Fiduciary System—Under this reserve ratio of commercial banks (R/D) which is the
system, there is a maximum limit up to which the central ratio of their reserves to their deposit liabilities.
bank is authorised to issue notes without any gold (3) Public’s Desire to Hold Currency and
reserves. But there has to be full backing of gold Deposits : The currency ratio of the public (C/M) which
reserves beyond this limit. is the ratio of the currency that they hold to their total
(4) Proportional Reserve System—Under this money holding (M).
system the Central Bank is required to keep a certain
percentage of gold against the note issue and the Money Multiplier Theory of Money
remainder of their note issue is covered by securuties. Supply
(5) The Minimum Reserve System—Under this In its simplest form the theory says that the supply
system the Central Bank is permitted to issue notes to of money (M) is highly stable increasing function of
any extent provided a fixed minimum reserves is high powered money (H). In other words its says that.
maintained in gold and foreign securities. (a) as H changes M also changes in the same
direction.
Measures of Money Supply
(b) the most of the change in M is due to change in
Meaning of Money Supply—The supply of money H.
is a stock at a particular point of time, though it conveys
High-powered money H is the sum of commercial
the idea of a flow over time. The term supply of money banks’ reserves and currency (notes and coins) held by
at any moment is the total amount of money in the the public. High-powered money is the base for the
economy. It is synonymous with such terms as ‘money expansion of bank deposits and creation of the money
stock’ and ‘quantity of money’. supply. The use of high-powered money consists of the
There are three alternative views regarding the demand of commercial banks for the legal limit or
definition or measures of money supply. The most required reserves with the central bank and excess
common view is associated with the traditional and reserves, and the demand of the public for currency.
Keynesian thinking. According to this view, money Thus,
supply is defined as currency with the public and H = C+R+E
demand deposits with commercial banks. Demand where, C represents currency, R the required
deposits with commercial banks plus currency with the reserves and E the excess reserves.
public are together denoted as M1 . This is regarded as a
For simplification we may assume excess reserve to
narrower definition of the money supply. be zero. Thus
The second view is associated with Friedman. Prof. H = C+R
Friedman defines the money supply at any moment of
Algebraical Derivation of Money Multiplier—We
time as “literally the number of dollars people are have defined money (M) as currency (C) Plus demand
carrying around in their pocket, the number of dollars deposits.
they have to their credit at banks or dollars they have to
M = C+D …(1)
their credit at banks in the form of demand deposits, and
also commercial bank’s time deposits.” This definition H = C+R …(2)
includes M1 plus time deposits of commercial bank in The only difference between M and H is that where
the supply of money. This wider definition is characte- as the former includes demand deposits the latter
rised as M2 in America and M3 in Britain and India. It includes reserves of Banks.
stresses the store of value function of money. If we devide equation (2) by M we get
The third definition is the broadest and is associated H C+R C R
with Gurley and Shaw. They include in the supply of = = + …(3)
M M M M
money, M2 plus deposits of savings banks, building
societies, deposits of other credit and financial institu- Since
tions. R R D M C D
= × , M ≡ C + D, ≡ × …(4)
M D M M M M
Determinants of Money Supply
There are basically three determinants of money
supply :
1 ≡
C D
M M ( )
+ , 1–
C
D ( )D
≡ , 1–
M
C
D
≡ + , (1 – ) ≡
(1) The Required Reserve Ratio—The monetary R R R C R
base or the Stock of High Powered Money, H, which is M D D D M
Economics (NET) | 173U
Rewriting equation (4) Thus, there is no change in the calculation of money
supply with the public (M1 )
H
M
≡
C R
M D
+ ( )
1–
C M
M H
,
2. M2 = M1 + Time liabilities portion of Savings
1 Deposits with banks + Certificate of
≡ Deposits (CDs) issued by banks +
C R
+
M D
1–( )
C
M Term Deposits, maturing within a year.
1 3. M3 = M2 + term deposits with banks with
M ≡ × H or M = m H maturity of over one year + call/term
C R C
+ 1– borrowing of the banking system.
M D M
where, The new M3 can be designated as broad money and
1 will be the significant monetary measure.
m = ≡ …(5) Liquid Resources in India are :
C R
+
M D ( )1–
C
M (i) L1 = New M3 + All Deposits of Post Office
In equation (5) m is called the money multiplier H is Savings Banks excluding National
called high powered money, (C/M) is the currency ratio Savings Certificates (NSCs).
and (R/D) is the actual reserve ratio of commercial (ii) L2 = L1 + Term Deposits with term lending
bank. This money multiplier identity M = mH shows the Institutions and Refinancing Institutions
mechanical dependence of the money supply on the + Term borrowing by Financial Institu-
stock of high powered money, H, and on the money tions (FIs)
multiplier, m, which is determined by actual reserve (iii) L3 = L2 + public deposits of non-banking
ratio of commercial banks (R/D) and by the currency
financial companies (NBFCs)
ratio of the general public (C/M).
The revised monetary aggregates consider only
Measures of Money Supply in India bank deposits and bank borrowings, liquidity aggregate
Till March, 1968, the RBI published only one consider also term deposits with and borrowings by FIs
measure of the money supply, M, defined as currency and NBFCs.
and demand deposits with the public. From April 1968,
the RBI also started publishing another measure of the Multiplier and Accelerator
money supply which it called Aggregate Monetary
Resources (AMR). This included M1 plus time deposits Money Supply and Its Determinants
of bank held by the public. Since April 1977, the RBI Rearranging money multiplier equation (3), we can
has been publishing data on four measures of the money know the determinants of money supply in the economy.
supply which are discussed as under: Thus
M1 = currency with public (C) + demand M l+K
=
deposits of the public (DD) + other H r+K
deposits (OD) or, M = H.m
Thus,
M1 = C + DD + OD
M = H ( ) l+K
r+K
...(4)
M2 = M1 + savings deposits with post office It follows from (4) that money supply in an
savings banks economy is determined by-
M3 = M1 + time deposits of the public with (a) Supply of high—powered money (H)
banks (b) The value of money multiplier (m)
M3 is known as broad money While the Central Bank of a country can control the
M4 = M3 + Total post office deposits supply the supply of high powered money, the value of
New Monetary Equations. RBI working group on multiplier is determined by two behaviour ratios,
Money Supply has now redefined its parameters for currency deposit ratio (K) of the public and desired
measuring money supply. Saving bank deposits of post reserve deposit ratio (r) of banks.
offices, included previously in M 2 , and also all deposits From the equation (4) expressing the determinants
with post offices, included in M4 have now been of money, it follows that money supply will increase :
dropped. Accordingly, there are now only three monetary 1. When the supply high powered money H
aggregates – M1 , M2 and M3 . RBI working group has increases;
introduced a new concept of liquid resources in India. 2. When the currency- deposit ratio decreases;
Revised Monetary Measures are : 3. When the reserve-deposit ratio falls.
1. M1 = Currency + Demand Deposits + Other The relation between the money supply and high-
Deposits with RBI powered money is illustrated in figure A. The horizontal
174U | Economics (NET)
curve H shows the given supply of high powered money. Factors Determining Money Supply in
The curve Hs shows the demand for high-powered India
money. The slope of the Hd curve is equal to the term
Reserve Bank of India classifies factors determining
( )
r+K
l+K
. Given r, k and H s, the equilibrium money money supply into the four following categories :
A. Government borrowing from She banking
supply is OM. If the money supply is larger than this,
system;
say OM1 , there will be excess demand of high-powered
money. On the contrary, a less than OM money supply B. Borrowing of the private or commercial sector
will mean less demand for high-powered money. from the banking system;
C. Changes in net foreign assets held by the Reserve
Bank of India caused by changes in balance of payments
position; and
D. Government’s currency liabilities to the public.
The Creation of Credit
The creation of credit or deposits is one of the most
important functions of commercial banks. Like other
corporations, banks aim at earning profits. For this
purpose, they accept cash in demand deposits and
advance a loan on credit to customers. When a bank
advances a loan, it does not pay the amount in cash. But
it opens a current account in his name and allows him to
withdraw the required sum by cheques. In this way, the
bank creates credit or deposits.
Fig. A Demand deposits arise in two ways : One, when
customers deposits currency with commercial banks,
If there is an increase in any one of the ratios r and and two, when banks advance loans, discount bills,
k, there would be an increase in the demand for high- provide overdraft facilities, and make investments
powered money. This is shown by the H′ d curve in figure through bonds and securities. The first type of demand
A where the increase in the demand for high-powered deposits are called “Primary deposits.” Banks of
money leads to decline in the money supply to OM. demand deposits are called “derivative deposits.”
The supply of money varies directly with changes in Banks actively create such deposits.
the high-powered money. This is shown in figure B. An Banks know by experience that all depositors do not
increase in the supply of high-powered money by ΔH withdraw their money simultaneously. Some withdraw
shifts the Hs. curve upward to Hs. At E, the demand and money while others deposit on the same day. So by
supply of high-powered money is in equilibrium and keeping a small cash in reserve for dayto-day
money supply is OM. With the increase in the supply of transactions, the bank is able to advance loans on the
high-powered money to Hs the supply of money also basis of excess reserves. When the bank advances a loan
it opens an account in the name of the customer. The
bank knows by experience that the customer will
withdraw money by cheques Which will be deposited
by his creditors in this bank or some other bank, where
they have their accounts. Settlements of all such cheques
are made in the clearing house. The same procedure is
followed in other banks. Thus banks are able to create
credit or deposits by keeping a small cash in reserves
and lending the remaining amount.
The bank provides overdraft facility to a customer
on the basis of some security. It enters the amount of the
overdraft in the existing account of the customer and
allows him to draw cheques for the overdraft amount
agreed upon. It thus creates a deposit.
Fig. B The Process of Credit Creation
increases to OM1 at the new equilibrium point E1 . Let us explain the actual process of credit creation.
Further B reveals the operation of the money multiplier. We have seen above that the ability of banks to create
With the increase in the high-powered money by ΔH, the credit depends on the fact that banks need only a small
money supply increases by m. ΔH = ΔM Where m is the percentage of cash to deposits. If banks kept 100 per
money multiplier. cent cash against deposits, there would be no credit
Economics (NET) | 175U
creation. Modern banks do not keep 100 per cent cash 3. Banking Habits of the People—The banking
reserves. They are legally required to keep a fixed habits of the people also govern the power of credit
percentage of their deposits in cash say 10, 15, or 20 per creation on the part of banks. If people are not in the
cent. They lend and/or invest the remaining amount. habit of using cheques, the grant of loans will lead to the
Thus it is the required cash reserve ratio that becomes withdrawal of cash from the credit creation stream of the
the basis of credit creation. The smaller the required banking system. This reduces the power of banks to
cash reserve ratio the larger the expansion of deposits or create credit to the desired level.
credit. Thus total deposits created by banking system is 4. Minimum Legal Reserve Ratio—The minimum
l legal reserve ration of cash to deposits fixed by the
= ·D
r central bank is an important factor which determines the
where, power of banks to create credit. The higher this ratio (r),
D = Deposits of the bank the lower the power of banks to create credit; and the
lower the ratio, the higher the power of banks to create
r = required cash reserve ratio
credit.
l
In the above equation, is called the deposit 5. Behaviour of Other Banks—The power of
r credit creation is further limited by the behaviour of
multiplier with determines the limits to deposit other banks. If some of the banks do not advance loans
expansion by a bank. If a bank has R 1000 in deposits to the extent required of the banking system, the chain of
and its legal minimum ratio or the required cash credit expansion will be broken.
reserves ratio (r) is 20 per cent; it can create credit to the
extent of R 5000. 6. Economic Climate—Banks cannot continue to
create credit limitlessly. Their power to create credit
l l depends upon the economic climate in the country.
= ·D= · 100
r 0·20 7. Credit Control Policy of the Central Bank—
= 5000 The power of commercial banks of create credit is also
The bank is “loaned up” to the limit of R 5000 and it limited by the credit control policy of the central bank.
cannot create more deposits till its reserves increase The central bank influences the amount of cash reserves
further. with banks by open market operations, discount rate
We are now a position to state how much deposits policy and varying margin requirements. Accordingly,
have been created by the banking system out of the it affects the credit expansion or contraction by
currency deposits of R 1000. commercial banks.
Total Deposits = R 5000 The Concept of Multiplier
Out of the total deposits of R 5000, the deposits of The concept of multiplier was first developed by
R 1000 in cash was made in the bank system. The Richard F. Kahn in 1931. Kahn’s multiplier was the
remaining deposits have been created by the banking ‘employment multiplier.’ Keynes took the idea from
system itself. Kahn and developed the Investment Multiplier. The
Deposits Created by the Banking System concept of Investment Multiplier constitutes an
= R 5000 – R 1000 – R 4000 important pillar in the whole edifice of the Keynesian
theory of income and employment. The concept of
Limitations on the Power of Banks to multiplier is closely connected with the MPS.
Create Credit The multiplier expresses a relationship between an
We have been above how the banking system as a initial investment and the final increment in aggregate
whole can create credit. But it does not mean that banks income. To be more accurate, the multiplier is the ratio
have unlimited powers to create credit. In fact, they have of the change in income to the change in investment. It
to function under certain restrictions. The following are shows by how many times the effect of an initial change
the limitations on the power of commercial banks to in investment is multiplied by causing changes in
create credit. consumption and finally in the aggregate income.
1. Amount of Cash—The credit creation power of According to Keynes, the multiplier establishes “a
banks depends upon the amount of cash they posses. The precise relationship between aggregate employment,
larger the cash, the larger the amount of credit that can income and the rate of investment given the propensity
be created by banks. The amount of cash that a bank has
to consume. Whenever an investment is made in the
in its vaults cannot be determined by it. It depends upon
the primary deposits with the bank. economy, the effect is to increase aggregate income not
only by the amount of original investment, but by
2. Proper Securities—An important factor that
something much more than that.
limits the power of bank to create credit is the
availability of adequate securities. Of proper securities There is, thus, a precise relationship between the
are not available with the public, a bank cannot create initial investment and the ultimate increase in income.
credit. This relationship Keynes designates as ‘K’.
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In the words of Alvin H. Hansen, Keynes’s 1 1
K = or K =
investment multiplier is the coefficient relating an 1 – MPC MPC
increment of investment to an increment in income. The The multiplier is derived as follows :
multiplier is the number by which an initial change in DY = K · ΔI
aggregate monetary demand must be multiplied to find
out the eventual change in income. It is the ratio of the ΔY
K =
change in one of the components of aggregate demand, ΔI
viz. Planned investment, consumption expenditure, ΔI is increased investment and Δ Y is increased
export receipts or governmental expenditure, to the total income. Aggregate saving S is equal to aggregate
change in national income. The general form of the investment I. By the same argument increased saving ΔS
1 must be equal to increased investment ΔI.
multiplier is . In the multiplier theory, the
1 – MPC Saving is the difference between income (Y) and
important element is the multiplier coefficient ‘K’, consumption (C) so that
which refers to the power by which an initial investment S = Y – C.
expenditure is multiplied to obtain a final increase in By the same reasoning
income. The value of the multiplier is determined by the
ΔS = ΔY – ΔC
MPS. The higher the MPC, the higher the value of the
multiplier and vice versa. Since Δ S = Δ I, we can substitute Δ Y – ΔC
for ΔI.
Assumptions of Multiplier Substituting Δ – ΔC for ΔI we have
The Keynesian theory of Multiplier requires specific ΔY
K =
conditions under which it operates. Some assumptions ΔY – ΔC
are necessary for its smooth movement. They are as Dividing both the numerator and the denominator
follows— by ΔY we get,
1. There is a change in investment. ΔY
2. Marginal propensity to consume is constant. ΔY 1
K = or K =
3. Consumption is a function of current income. ΔY ΔC ΔC
– 1–
4. There are no time lags in the multiplier process. ΔY ΔY ΔY
An increase (decrease) in investment instantaneously ΔC
leads to a multiple increase (decrease) in income. (
The denominator 1 –
ΔY) is 1 – MPC which is
5. The new level of investment is maintained the MPS. So, multiplier K is the reciprocal of the
steadily for the completion of the multiplier process. 1
6. There is net increase in investment. fraction saved, that is, .
MPS
7. Consumer goods are available in response to ΔC
If MPC = is deducted from 1 we get the MPC.
effective demand for them. ΔY
8. There is a surplus capacity in consumer goods So that MPS = 1 – MPC.
industries to meet the increased demand for consumer 1
goods in response to a rise in income following ∴ K =
MPS
increased investment.
9. Other resources of production are also easily MPC and Multiplier
available within the economy. Multiplier varies directly with the MPC and
10. There is an industrialised economy in which the inversely with the MPS. Since the MPC is always
multiplier process operates. greater than zero and less than one (i.e., O < MPC < 1),
11. There is a closed economy unaffected by foreign the multiplier is always between one and infinity (i.e., 1
influences. < K < ∞).
12. There are no changes in prices. 1. The MPC is very rarely zero. If it is zero, the
multiplier is 1. What this means is that nothing is spent
13. The accelerator effect of consumption on by consumers out of increased income. The whole
investment is ignored. increased income is saved, with the result that the
14. There is less than full employment level in the multiplier is one. Suppose there is a new investment of R
economy. 10 crore in public works and the MPC is zero. It means
Derivation of the Multiplier that the whole of R 10 crore is saved. The multiplier is
one. The aggregate income increase by R 10 crore.
The size of the multiplier depends upon the size of
2. The other limiting case is when MPC is 1.
the MPC. The two are closely related. Given the MPC,
the multiplier can be easily derived. Keynes has What this implies is that the consumers spend the
expressed it by the symbol K. ‘K’ can be found out from whole of the increment of their incomes on consumption
the formula and nothing is saved; and the MPS is zero. The result
Economics (NET) | 177U
in such a case is highly “explosive.” Suppose R 10 effort to save more by all in a society will lower the
crore is invested in public works. The workers who aggregate demand for goods and services resulting in a
receive R 10 crore shall spend the whole of it on drop in the level of national income. At the lower level
consumption. Others who receive increased incomes of national income the savings fall to I original level but
shall also spend the whole of them. In this way, R 10 consumption will be less than before which implies that
crore shall emerge and re-emerge and result in an the people would become worse off.
infinite increase in income. It will soon lead to full
employment in the economy and then create a limitless Dynamic or Period Multiplier
inflationary spiral. Keynes’s logical theory of the multiplier is an
Both these cases are rare. Actually the multiplier instantaneous process without time lag. It is a timeless
can never be 1 or infinity It generally varies between 1 static equilibrium analysis in which the total effect of a
and infinity. change in investment on income is instantaneous so that
consumption goods are produced simultaneously and
Leakages of Multiplier consumption expenditure is also incurred instan-
taneously. But this is not borne out by facts because a
Leakages are the potential diversions from the
time lag is always involved between the receipt of
income stream which tend to weaken the multiplier
income and its expenditure on consumption goods and
effect of new investment. Given the marginal propensity
also in producing consumption goods. Thus “the
to consume, the increase in income in each round
timeless multiplier analysis disregards the transition and
declines due to leakages in the income stream and
deals only with the new equilibrium income level” and
ultimately the process of income propagation “peters
is, therefore, unrealistic.
out.” The following are the important leakages :
1. Saving Table : Dynamic Multiplier
2. Strong Liquidity Preference (R Crores)
3. Purchase of old stocks and securities Period Δ I (Increment Δ C = 0.5 ΔY ΔY
in in) (Increment in (Increment
4. Debt cancellation Months Investment) consumption) in Income)
5. Price Inflation
0 0 0 0
6. Net Imports
t+1 100 0 100
7. Undistributed Profits t+2 100 50 100 + 50
8. Taxation t+3 100 25 150 + 25
9. Excess Stocks of Consumption Goods. — — — —
— — — —
The Paradox of Thrift t+n 100 100 200
An interesting paradox arises when all people in a
society try to save more but in fact they are unable to do The dynamic multiplier relates to the time lags in
so. According to this paradox of thrift, the attempt by the the process of income generation. The series of
people as a whole to save more for hard times such as adjustments in income and consumption may take
impending period of recession or unemployment may months or even years for the multiplier process to
not materialise and in their bid to save more the society complete, depending upon the assumption made about
in fact may not only end up with the same savings (or, the period involved. This is explained in Table where if
even lower savings) but also in the process cause their each round is of one month and it takes seventeen
consumption or standard of living to decline. According rounds for an initial investment of R 100 crores to
to classical economists, savings determine investment generate an income of R 200 crores, given the value of
which plays a crucial role in accelerating the rate of MPC to be 0.5, then the multiplier process will take 17
economic growth. However, the paradox of thrift shows months to complete.
that the efforts to save more, especially at times of The Table shows that if the MPC remains constant
depression, may actually deepen the economic crisis and at 0.5 throughout, an initial increase of R 100 crores of
cause output to fall and unemployment to increase. It investment will first raise income by 100 crores in the
goes to the credit of Keynes that with his multiplier first month. Out of this R 50 crores will be spent on
theory he has been able to resolve the paradox of thrift. consumption. This will raise income in the second
According to the Keynesian theory, the saying month to R 50 crores, and out of this R 25 crores will be
“penny saved is penny earned” is quite inappropriate for spent on consumption. This will go to increase income
the economy as a whole when it is working at under- in the third month by R 25 crores, and successive
employment equilibrium, that is, when there prevails increments in income get smaller and smaller in each
recession or depression. Keynes has showed that if all period till in the seven-tenth month the income increases
people in a society decide to save more, they may by R 0.001 crore. This can also be explained alge-
actually fail to do so but nevertheless reduce their braically as :
consumption. This is because according to Keynes, the ΔY = ΔI + ΔI·C + ΔI·C2 + …ΔICn + 1 [C is MPC]
178U | Economics (NET)
ΔY = 100 + 100 (0·5) + 100 (0·5) 2 +…+ 100 (0·5)n – 1 original income E0. But at Y0 level total demand rises
100 from Y0 f0 to Y0 t. There is now an excess of demand
ΔY = = 200 crores over supply equal to t0t. In period t consumption rises
1 – 0·5
due to the rise in demand to Y0 t. Now investment
It is now easy to generalise. Let the MPC be
increases income still higher to OY1 in period t + 1 and
denoted by the symbol C and let the upward shift in the
investment function be denoted as ΔI. On the first day to increase in consumption from t to E1. But at this level
income rises by ΔI; on the second day by and additional total
C ΔI; on the third day by yet another C2 ΔI and on any
arbitrary day n by the additional Cn–1ΔI. Therefore, by
day n the increase in income over its initial level will be
given by the geometric series
ΔY = ΔI + C. ΔI + C2. ΔI + C3 . ΔI + … + Cn – 1 × ΔI
…(1)
which can be written as
ΔY = ΔI (1 + C + C2 + C3 +…+Cn – 1) …(2)
There is an easy way for simplifying a geometric
series. Multiply both sides of equation (2) by the term C.
Both sides of any equation can always be multiplied by
some constant. If we do this, we get
C·ΔY = ΔI (C + C2 + C3 + C4 + …+Cn – 1 + Cn ) Fig. 4.2 : Dynamic Multiplier
…(3)
demand is Y1 E1 which exceeds total supply by AE1 .
If we subtract equation (3) from equation (2) we are
This will further tend to raise income to OY2 in period t
left with
+ 2 and to increase in consumption to E1 E2 . This leads
ΔY – C. ΔY = ΔI (1 – Cn ) to a rise in demand to Y2 E2 , leading to an excess of total
Solving for ΔY we get demand over total supply by BE2 . This process of
ΔY (1 – C) = ΔI (1 – Cn ) income generation will continue till the aggregate
ΔI (1 – Cn ) demand function C + I + ΔI equals the aggregate supply
∴ ΔY = …(4) function 45° line at En in the nth period, and the
(1 – C)
If the multiplier process is permitted to go on long new equilibrium level of income is determined at OY n .
enough we can let n become as large as we like. Since C The curved steps E0 to E n is the path of income
is a fraction, the term C n will approach zero as n tends to propagation showing the dynamic process of multiplier.
infinity, and when that happens equation (4) reduces to The Principle of Acceleration
ΔI
ΔY = The term “acceleration principle” was first intro-
1–C duced into economics by J.M. Clark in 1917. It was
This expression predicts the change in the further developed by Hicks, Samuelson, and Harrod in
equilibrium level of income. If we divide both sides of relation to the business cycles.
the expression by DI. we get the multiplier which equals The principle of acceleration is based on the fact
the reciprocal of MPS. that the demand for capital goods is derived from the
ΔY 1 1 demand for consumer goods which the former help to
= =
ΔI 1 – C 1 – MPC produce. The acceleration principle explains the process
This process of dynamic income propagation by which an increase (or decrease) in the demand for
assumes that there is a consumption lag and no consumption goods leads to an increase (or decrease) in
investment lag so that consumption is a function of the investment on capital goods.
income of the preceding period i.e., C t = f ( Y t–1) and Symbolically,
investment is a function of time (t) and of constant ΔI
β = or ΔI = β ΔC
autonomous investment ΔI, i-e. It = f(ΔI). In figure 4.2, ΔC
C + I is the aggregate demand function and the 45° line where,
is the aggregate supply function. If we begin in period to β = accelerator coefficient
where with an equilibrium level of OY0 income, ΔI = net change in investment
investment is increased by ΔI. then in period t income ΔC = net change in consumption expenditure This
rises by the amount of the increased investment (from t0 version of the acceleration principle has been more
to t). The increased investment is shown by the new broadly interpreted by Hicks as the ratio of induced
aggregate demand function C + I + ΔI. But in period t0 investment to changes in output it calls forth. Thus,
consumption lags behind, and is still equal to the ΔI = γΔY
Economics (NET) | 179U
where, 1 1
or KS = =
γ = accelerator 1–C–γ S–γ
It shows that the demand for capital goods is not where
derived from consumer goods alone but from any direct Ks = super multiplier
demand of national output. C = marginal propensity to consume
There is little difference between Δ I = γ Δ Y, as γ = marginal propensity to invest
defined by Hicks and ΔI = β ΔC, as defined by
Samuelson and others. The accelerator γ and β are the S = marginal propensity to save
same. Hicks takes the increase in final output (ΔY) while The super-multiplier tells us that if there is an initial
Samuelson takes the increase in the demand for increase in autonomous investment, income will increase
consumer goods (AC). In Hicks’s model net investment by Ks times the autonomous investment. So the super-
equals Int = γ (Yt – Yt – 1) while in Samuelson’s model multiplier in general form will be
Int = β (Ct – C t – 1). 1
ΔY = = KS. ΔIa
1–C–γ
Assumptions
The acceleration principle is based upon the IS-LM Approach
following assumptions.
The term IS is the shorthand expression of the
1. The acceleration principle assumes a constant
capital-output ratio. equality of investment and saving which represents the
product market equilibrium. On the other hand, the term
2. It assumes that resources are easily available.
LM is the shorthand expression of the equality of money
3. The acceleration principle assumes that there is
demand and money supply and represently the money
no excess or idle capacity in plants.
market equilibrium.
4. It is assumed that the increased demand is
permanent. The Product Market
5. The acceleration principle also assumes that there The product market is in equilibrium when saving
is elastic supply of credit and capital.
and investment are equal. Saving is a direct function of
6. It further assumes that an increase in output the level of income,
immediately leads to a rise in net investment.
S = f(y) …(1)
Super Multiplier Investment is a decreasing function of the interest
In order to measure the total effect of initial rate,
investment on income, Hicks has combined the I = f(r) ....(2)
multiplier and the accelerator mathematically and given In case of equilibrium, S = I
it the name of the super-multiplier. The combined
effect of the multiplier and the accelerator is also The IS Schedule reflects the equilibrium of the
called the leverage effect which may lead the economy product market. It shows the combinations of interest
to very high or low level of income propagation. rates and income levels where saving-investment
equality takes place so that the product market of the
The super-multiplier is worked out by combining
economy is in equilibrium. It is also known as “real”
both induced consumption (C·Y) and induced invest-
equilibrium.
ment (γ ·Y). Hicks divides the investment component
into autonomous investment and induced investment so
that investment I = Ia + γ ·Y,
The Slope of the IS Curve
Figure shows that the IS curve slopes downward
where
from left to right. This negative slope reflects the
Ia = autonomous investment increase in investment and income as the rate of interest
γ ·Y = induced investment falls. The IS curve may be Flat or steep depending on
Since the sensitiveness of investment to changes in the rate of
Y = C+I interest, and also on the size of the multiplier.
Therefore
ΔY = C· ΔY + ΔI a + γ. ΔY
ΔY – C· ΔY – γ · ΔY = ΔIa
ΔY [1 – C – γ] = ΔIa
ΔY 1
=
ΔIa 1–C–γ
ΔY 1
=
ΔIa S–γ
180U | Economics (NET)
If investment is very sensitive to the rate of interest, LM curve is vertical that is, it is perfectly inelastic. This
the IS curve is very flat. On the other hand, if investment is shown in figure as the portion from T above on the
is not very sensitive to the rate of interest, the IS curve is LM curve. In this case, a large change in the interest rate
relatively steep. is accompanied by almost no change in the level of
income to maintain money market equilibrium. If the
The shape of the IS curve also depends upon the
demand for money is very sensitive to the rate of
size of the multiplier. If the size of the multiplier is interest, the LM curve is horizontal that is, It is a
large, income is more sensitive to changes in the interest perfectly elastic. In this case, a small change in the
rate and the IS curve is flatter. interest rate is accompanied by a large change in the
A few more properties of the IS curve may be level of income to maintain the money market
noted. First, the IS curve shifts to the right or left as a equilibrium.
result of an increase or decrease in autonomous or Shifts in the LM Curve
government investment. Second, any point to the right of The LM curve shifts downward to the right when
a given IS curve shows excess supply in the product the stock of money supply is increased and it shifts
market and any point to the left of an IS curve shows upward to the left if the stock of money supply is
excess demand in the product market. reduced.
The Money Market The LM curve shifts upward to the left if there is an
increase in the money demand function which raises the
The money market is in equilibrium when the quantity of money demanded at the given interest rate
demand and supply of money are equal. Denoting L for and income level. On the other hand, the LM curve
money demand and M for money supply, in equilibrium shifts downward to the left if there is a decrease in the
L = M. The demand for money L = Lt + Ls, where, Lt is money demand function which lowers the amount of
the transactions demand for money which is a direct money demanded at given levels of interest rate and
function of the level of income, Lt = f (y). Ls is the income.
speculative demand for money which is a decreasing Another important property of the LM curve is that
function of the rate of interest, Ls = f (r). Thus in on any point to the right of the LM curve, there is excess
money market equilibrium, demand for money in the money market, and on any
M = Lt (y) + Ls (r) point to the left of the LM curve, there is excess supply
of money in the money market.
The Slope of the LM Curve General Equilibrium of Product and
The LM curve slopes upward from left to right Money Market
because given the supply of money, an increase in the
level of income increases the demand for money which Now we study how these markets are brought into
leads to higher rate of interest. This, in turn, reduces the simultaneous equilibrium. It is only when the equilibrium
demand for money and thus keeps the demand for pairs of interest rate and income of the IS curve equal
money equal to the supply of money. The smaller the the equilibrium pairs of interest rate and income of the
responsiveness of the demand for money to income, LM curve that the general equilibrium is established. In
and the larger the responsiveness of the demand for other words, when there is a single pair of interest rate
money to the rate of interest, the flatter will be the LM and income level in the product and money markets that
curve. This means that a given change in income has a the two markets are in equilibrium.
smaller effect on the interest rate. Such an equilibrium position is shown in figure
where the IS and LM curves intersect each other at point
E relating Y level of income to R interest rate. This pair
of income level and interest rate leads to simultaneous
equilibrium in the real or goods (saving investment)
market and the money (demand and supply of money)
market.
The LM curve is steeper, if a given change in
income has a larger effect on the rate of interest. In this
situation, the responsiveness of the demand for money to
income is larger and is smaller for the interest rate. If the
demand for money is insensitive to the interest rate, the
Economics (NET) | 181U
This general equilibrium position persists at a point given the demand for money or due to the decrease in
of time, given the price level. If there is any deviation the demand for money, given the supply of money.
from this equilibrium position, certain forces will act
and react in such a manner that the equilibrium will be
restored.
Shifts in the IS and LM Functions :
Changes in General Equilibrium
The general equilibrium combination of Y income
level and R rate of interest may change either due to a
shift in the IS function or the LM function, or by both
the functions shifting simultaneously. The IS function
may shift due to changes in the saving function or the
investment function and the shifts in the LM function This is depicted in figure. With the increase in the
may be caused by changes in the money supply or money supply the LM curve shifts to the right as LM1
liquidity preference. which moves the economy to a new equilibrium point E1
Shifts in the IS Function. The IS function shifts to where the IS curve intersects the LM1 curve. The
the right with a reduction in saving. The IS function also increase in the money supply bring down the interest
shifts to the right by an autonomous increase in invest- rate to R1 in the money market. This, in turn, increases
ment. investment there by raising the level of income to Y1.
The shifting of the IS curve to the right and the Thus the effect of the increase in money supply is to
consequent equilibrium with the given LM curve is shift the LM function to the right and a new equilibrium
illustrated in figure. With the increase in the autonomous is established at a lower interest rate and higher income
investment (or reduction in saving), the IS curve moves level.
from IS to IS1 and the new equilibrium is established at Contrariwise a decrease in the money supply, or an
point E1 which indicates a higher level of income Y1 at a increase in the demand for money will shift the LM
higher interest rate R1 . If the interest rate had not function to the left such that a new equilibrium is
established at a higher interest rate and lower income
increased but remained at R level, the increase in
level.
investment would have raised income from Y to Y2
level. Effectiveness of Monetary and Fiscal
But this much increase in income would not take Policies
place. This is because with the increase in income the
demand for money for transactions purposes will raise The relative effectiveness of monetary and fiscal
the interest rate to R1 level where the IS and LM policy has been the subject of controversy among
functions intersect at point E1 . Thus the expansionary economists. The monetarists regard monetary policy
affect of increase in investment is dampened by the rise more effective than fiscal policy for economic stabili-
in the interest rate and the income rises by less than the sation. On the other hand, the keynesians hold the
full multiplier. opposite view. In between there two extreme views,
there are the synthesists who advocate the middle path.
Modern economists explain these three views in terms of
the elasticities of the IS-LM curves. The IS curve
represents fiscal policy and the LM curve represents
monetary policy.
The IS-LM technique explains the effectiveness of
monetary and fiscal policies in relation to the keynesian,
monetarist and synthesist views in terms of the
elasticities of the IS-LM curve. The LM curve slopes
upward to the right and has three segments, as shown in
figure. Starting from the left it is perfectly elastic. This
segment is known as “the keynesian range”. AT the
other extreme to the right, the LM curve is perfectly
In the opposite case when investment falls or saving
inelastic. This segment of the curve is known as “the
increases, the IS function will shift to the left and the classical range.” In between these two segments of the
equilibrium will be established at a lower level of curve is “the intermediate range.” The keynesian range
income and interest rate. represents the fiscalist or Keynesian view, the classical
Shifts in the LM Function—The LM function range the monetarist view, and the intermediate range
shifts to the right with the increase in the money supply, the synthesist view.
182U | Economics (NET)
Monetary Policy—Monetary policy is explained Y2Y3 is less than that in the classical range Y4 Y5 This is
in figure where the three-range LM curves LM 1 and because in classical case the entire increase in the money
LM2 are shown with three IS curves. The LM2 curve supply is absorbed for transactions purposes. But in the
emerges after an increase in the money supply. intermediate case, the increase money supply is partly
absorbed for speculative purposes and partly for
transactions purposes. That which is held for speculative
purposes is not invested by wealth holders and remains
with them in the turn of idle balances. This has the effect
of raising the income level by less than the increase in
the money supply. Thus in the intermediate range
monetary policy is less effective than in the classical
range.
Fiscal Policy—Fiscal policy is explained in terms
of figure in which the three range LM Curve is taken
along with six IS curves that rise after increase in
government expenditure in the case of the Keynesian,
First consider the Keynesian range where the LM intermediate and classical ranges.
curve is perfectly elastic. This is the Keynesian liquidity Consider first the keynesian range when the initial
trap situation in which the LM curve is horizontal, and equilibrium is at A where the IS1 curve intersects the
the interest rate cannot full below OR1 . An increase in
LM curve. Suppose the government expenditure is
the money supply shifts the LM curve from LM1 to increased. This brings about new equilibrium at B where
LM2 . This shift in the curve has no effect on the rate of the IS2 curve cuts the LM curve. Consequently the
interest. Consequently, investment is not affected at all income level rises from OY1 to OY 2 with the interest
so that the level of income remains unchanged at OY2. rate unchanged at OR. The increase in income in the
Thus under the Keynesian assumption of the liquidity keynesian case is equal to the full multiplier times the
trap, the horizontal portion of the LM curve is not increase in government expenditure. Thus, in the
affected by an increase in the money supply. This IS Keynessian range, the fiscal policy is very effective.
curve intersects the LM curve in the flat rangeat A with
little effect on the interest rate, and consequently on In the classical range, the LM curve is perfectly
investment and income. Monetary policy is therefore, inelastic and the IS5 curve intersects it at E so that the
totally ineffective in the Keynesian range. interest rate is OR3 and the income level is OY5 . When
the government expenditure increases for an expansio-
In the classical range, the system is in equilibrium nary fiscal policy, the IS5 curve shifts upward to IS6 . As
at D where the IS 3 curve intersects the LM1 curve and
a result, the IS6 curve crosses the LM curve at F and the
the interest rate is OR5 and income level OY4 . An
interest rate rises to OR4 with income remaining
increase in money supply shifts the LM1 curve to the
unchanged at OY 5 . This is became the classical case
right to LM2 position. As a result, the income level
relates to a fully employed economy where the increase
increases from OY4 to OY5 , and the interest rate falls in government expenditure has the effect of raising the
from OR5 to OR7 when the IS3 curve crosses the LM2 interest rate which reduces private investment. Since the
curve at E. The increase in the income level and fall in increase in government expenditure exactly equals the
the interest rate as a result of the increase in the money reduction in the private investment, there is no effect on
supply is based on the classical assumption that money the level of income which remaining constant at OY 5 .
is primarily a medium of exchange. Thus the monetary Thus, fiscal policy is not at all effective in the classical
policy is highly effective in the classical range when the range.
economy is at high levels of income and interest rate and
utilises the entire increase in the money supply for
transactions purposes the rely raising national income by
the full increase in the money supply.
Now consider the intermediate range when the
initial equilibrium is at B where the IS2 curve intersects
the LM1 curve, and the income level is OY2 and the
interest rate is OR3. The increase in the money supply
shifts the LM7 curve to LM2 position. As a result, the
new equilibrium is established at point C where the IS2
curve crosses the LM2 curve. It shows that with the
increase in the money supply the rate of interest falls
from OR3 to OR2 and the income level rises from OY 2 to In the intermediate range, the initial equilibrium is
OY3. In the intermediate range the increase in income by at C where the 1S3 curve intersects the LM curve. Here
Economics (NET) | 183U
OR1 is the interest rate with OY 3 the level of income output. As, Hicks remarks : “Public investment, invest-
with the increase in the government expenditure, the IS3 ment which occurs in direct response to inventions and
curve shifts upwards to the right from IS3 to IS 4 and the much of the long range investment which is only
new equilibrium is established at point D. As a result, expected to pay for itself over a long period, all of these
the increase in government expenditure raises the can be regarded as autonomous investments.”
income level from OY3 to OY4 and the interest rate from Autonomous investment is not sensitive to changes
OR1 to OR 2 . The increase in both the income level and in income. It is independent of income changes and is
the interest rate in the intermediate range is due to not guided or induced by profit motive. Autonomous
two reasons. First, the increase in income resulting from investments are made primarily by the Government and
a rise in government expenditure occurs because are not based on considerations of profit. Autonomous
additional money balances are available for transactions investments are a peculiar feature of a war or a planned
purposes. economy, for example, expenditures on arms and
equipment to strengthen the defence of a country may be
Second, given a fixed money supply, a part of
called autonomous investment as it is incurred
available transactions are held as idle balances by wealth
irrespective of the level of income or profits. Prof.
holders which raise the interest rate. As a result of the
Hansen explained that autonomous investment is
rise in the interest rate, investment falls and the fiscal
generally associated with such factors as introduction of
policy is not so effective as in the Keynesian range.
new production techniques, products, development of
Conclusion new resources or growth of population. Simultaneously,
public expenditure on the creation of infrastructure, such
The relative effectiveness of monetary and fiscal
as the construction of roads and highways bridges,
policy depends upon the shape of the IS and LM curves
railways, ports, airports, warehouses, schools – colleges
and the economy’s initial position. If the economy is in
–universities, hospitals etc. is also called the autonomous
the Keynesian range, monetary policy is in effective and
investment. Autonomous investment is independent of
fiscal policy is highly effective. On the other hand, in the
the level of income and is thus income inelastic. It is
classical range, monetary policy is effective and fiscal
influenced by exogenous factors like innovations,
policy is ineffective. But in the intermediate range both
inventions, growth of population and labour force,
monetary and fiscal policies are effective. In fact, in the
researches, social and legal institutions, weather
intermediate range, the effectiveness of monetary and
changes, war, revolution, etc. But it is not influenced by
fiscal policies depends largely on the elasticities of the
changes in demand. Rather, it influences the demand.
IS curve. If the IS curve is inelastic, fiscal policy is more
Investment in economic and social overheads whether
effective than monetary policy. On the other hand, if the
made by the government or the private enterprise is
IS curve is elastic, monetary policy is more effective
autonomous.
than fiscal policy.
I
Investment Function
Investment
Income (Y) in an economy has two components,
namely the Consumption ( C ) and the investment (I). It I I'
can be expressed in the following manner—
Y = C+S …(1)
When the savings (s) are invested to raise the capital
stock of a business than they become investment i.e., I. O Income Y
In simple words investment is expenditure on Fig. A. : Autonomous Investment
capital goods – for example, new machines, offices, new
technology. Investment is a component of Aggregate On the other hand, Induced investment is profit or
Demand (AD) and also influences the capital stock and income motivated. Factors like prices, wages and
productive capacity of the economy (long-run aggregate interest changes which affect profits influence induced
supply) investment. Similarly demand also influences induced
investment. With the rise in income, consumption
Types of Investment demand also increases and, investment increases to meet
Investment can be categorized in the following out the increase in demand. Induced investment is a
manner : function of income i.e., I = f (Y). It is income elastic,
● Private Investment and public investment means induced invest increases with the increase in
● Autonomous investment and induced investment income.
● Gross and Net Investment In figure B, I 1 I1 is the investment curve which
● Long term investment and short term investment shows induced investment at various levels of income.
According to Hicks, investment is of two types, Induced investment is zero at OY1 income. When income
induced investment and autonomous investment . rises to OY 3 induced investment is I3Yy. A fall in income
Autonomous investment is independent of variations in to OY2 also reduces induced investment to I2Y2.
184U | Economics (NET)
yields or the series of expected annual returns from the
I1 capital asset in the years, 1, 2… and n, i is the rate of
Investment
I3 discount which makes the capital asset exactly equal to
the present value of the expected yield from it. This i is
I2
a the MEC or the rate of discount which equates the two
sides of the equation. If the supply price of a new capital
asset is R 100,000 and its life is two years, it is expected
O I Y1 Y2 Y3 to yield R 5500 in the first year and R 6050 in the second
1
Income year. Its MEC is 10 per cent which equates the supply
Fig. B : Induced Investment price to the expected yields of this capital asset.
Induced investment may be further divided into Thus
(i) the average propensity to invest, and (ii) the marginal (SP) R10000 = 5500/(1.10) + (6050)/(1.10)2
propensity to invest— = R 5000 + 5000
(i) The average propensity to invest is the ratio of In equation (2), the term R1 /(1 + i) is the present
investment to income, I/Y. If the income is R 500 crores value (PV) of the capital asset. The present value is “the
and investment is R 50 crores, I/Y = 50/500 = 0.1. In value of payments to be received in the future.” It
terms of the above figure, the average propensity to depends on the rate of interest at which it is discounted.
invest at OY 3 income level is I3 Y3/ OY3 . Suppose we expect to receive R 1000 from a
machine in a year’s time and the rate of interest is 5 per
(ii) The marginal propensity to invest is the ratio of
cent. The present value of this machine is
change in investment to the change in income, i.e.,
R 1 / (1+ i) = 1000/(1.05) = R 952.38
ΔI /ΔY. If the change in investment, ΔI = R 5 crores and
the change in income, ΔY = R 25 crores, then ΔI/? Y = If we expect R 1000 from the machine after two
5/25=0.2 In Figure A, ΔI/ΔY =I3 a/Y2 Y3. years then its present value is 1000/ (1.05) 2 = R 907.03.
The present value of a capital asset is inversely related to
Determinants of the Level of Investment the rate of interest. The lower the rate of interest, the
The following factors determine the level of invest- higher is the present value, and vice versa. For instance,
ment : if the rate of interest is 5 per cent, PV of an asset of
R 1000 for one year will be R 952.38; at 7 per cent
● The cost of the capital asset,
interest rate, it will be R 934.5; and at 10 per cent
● The expected rate of return from it during its interest rate, it will be R 909.1.
lifetime, and
The relation between the present value and the rate
● The market rate of interest. of interest is shown in Figure C. If the current rate of
Prof J. M. Keynes sums up these factors in the interest is i the present value of the project is P1 On the
concept of the marginal efficiency of capital (MEC). other hand, a higher rate of interest (i2 ) will lead to a
Marginal Efficiency of Capital lower present value (P2 ) when the present value curve
(PR) cuts the horizontal axis at point (Z), the net present
Marginal efficiency of capital (MEC) is the discount value becomes zero.
rate at which the present value of the future yields from
a capital asset are equal to its cost of acquisition. MEC
determines how much additional output (profits) an
Present Value (P)
P
investment yields. Marginal productivity of capital,
natural interest rate, net capital productivity and rate of P1 A
return over cost are other names for MEC. If the supply
price of a capital asset is R 1,00,000 and its annual yield
P2 B
is R 10,000, the marginal efficiency of this asset is
10000/100000 × 100/1 = 10.00 per cent. Thus the
marginal efficiency of capital is the percentage of profit O I1 I2 Z R
expected from a given investment on a capital asset. Interest Rate (I)
Prof. J.M.Keynes defines the MEC as “equal to the Fig. C
rate of discount which would make the present value of
the series of annuities given by the returns expected As a matter of fact, the MEC is the expected rate of
from the capital assets during its life just equal to its return over cost of a new capital asset. If the present
supply price.” value of a capital asset exceeds its cost of buying, it pays
to buy it. On the contrary, if its present value is less than
It can be expressed as—
its cost, it is not worthwhile investing in this capital
S P = R 1 / (1 + i) + R 2 (1 + i)2 + Rn /(1+i)n …(2) asset.
Where SP is the supply price or the cost of the If the MEC is higher than the rate of interest, there
capital asset, R1 , R 2 , R 3 … and Rn are the prospective will be a tendency to borrow funds in order to invest in
Economics (NET) | 185U
new capital assets. If the MEC is lower than the rate of FISCAL POLICY
interest, no firm will borrow to invest in capital assets.
The term fiscal policy generally refers to the use of
Thus the equilibrium condition for a firm to hold the
taxation, government expenditure and debt term to
optimum capital stock is where the MEC equals the
regulate the aggregate level of economic activity. It is a
interest rate.
policy which affects certain macro economic variables
The Marginal Efficiency of Investment such as output, employment, saving, investment etc.
(MEI) through budgetary manipulations.
A number of economists have defined fiscal policy
Marginal efficiency of investment, in economics, differently.
expected rates of return on investment as additional
(1) Harvey and Johnson define Fiscal Policy as
units of investment are made under specified conditions
changes in government expenditure and taxation
and over a stated period of time. A comparison of these
designed to influence the pattern and level of economic
rates with the going rate of interest may be used to
activity.
indicate the profitability of investment. The marginal
efficiency of investment is the rate of return expected (2) Ecksten defines fiscal policy as changes in taxes
from a given investment on a capital asset after covering and expenditure which aim at short run goals of full
all its costs, except the rate of interest. Like the MEC, it employment and price level stability.
is the rate which equates the supply price of a capital (3) G.K. Shaw defines fiscal policy to encompass
asset to its prospective yield. The investment on an asset any decision to change the level, composition or living
will be made depending upon the interest rate involved of government expenditure or to vary the burden, the
in getting funds from the market. If the rate of interest is structure or frequency of the tax payment.
high, investment is at a low level. Fiscal policy makes (a) Taxes, (b) Public spending
A low rate of interest leads to an increase in in- (c) Public borrowing. It also includes the use of the
vestment. Thus the MEI relates the investment to the budget. A skillful management of the budget can go a
rate of interest. The MEI schedule shows the amount of long way in maintaining economic stability and assuring
investment demanded at various rates of interest. That is higher rates of economic growth. Taxes are important
why, it is also called the investment demand schedule or not only because the government can secure revenues
curve which has a negative slope, as shown in Fig. D. At through this instrument but also because they can
Or1 rate of interest, investment is OF. As the rate of very effectively cut down disposable income of the
people and have a decisive impact on the level of
interest falls to Or2 , investment increases to OI".
aggregate spending. Changes in the rates and structure
Rate of Interest, MEI
(A) (B) on taxes promote or restrict private spending on
consumption and investment and can thus give desired
r1 orientation to economic system.
r2 Theory of Fiscal Policy
MEI MEI' The theory of fiscal policy is a deviation from the
general framework o f national income analysis. In the
O I' I" O I1 I2 words of Arthur Smithies fiscal policy is a policy under
Investment which the government uses its expenditure and revenue
Fig. D programmes to produce desirable effects and avoid
undesirable effects on the national income, production
To what extent the fall in the interest rate will
and employment.’
increase investment depends upon the elasticity of the
investment demand curve or the MEI curve. The less Fiscal Policy Implication of National Income Analysis
elastic is the MEI curve, the lower is the increase in can be Expressed as a Series of Propositions
investment as a result of fall in the rate of interest, and (a) An increase in government expenditure raises
vice versa. GNP. Multiplier determines the size of this
increase.
The higher marginal efficiency of investment
(b) An increase in taxes reduces GNP.
implies that the MEI curve shifts to the right. When the
existing capital assets wear out, they are replaced by (c) Suppose that both public expenditure and taxes
new ones and level of investment increases. increase by the same amount. This balanced
increase in the level of budget changes the level
Concluding; of GNP. The equilibrium level of gross national
● If Marginal Efficiency of the capital > Rate of product (GNP) is determined at the point where
Interest, it is advisable to increase the investment. C + I = y.
● If Marginal Efficiency of the capital < Rate of Inte-
rest, it is not advisable to increase the investment. India’s Fiscal Policy
● If Marginal Efficiency of the capital = Rate of India’s fiscal policy has a multidimensional role. It
Interest, consider the other factors of the market, particularly aims at improving the growth performance
such as the market risks and future expectations. of the economy and ensuring social justice to the people.
186U | Economics (NET)
Objectives and Approach of India’s Fiscal Meaning and Objectives of Monetary Policy—
Policy—Following are the main objectives of fiscal Monetary policy, was known as the credit policy
policy in India : statements till 1992—the year which marked the
1. Resource mobilisation—Important aspects of initiation of financial sector reforms. With the move
resource mobilisation are tax revenue, non-tax revenue, towards a more market oriented financial system and
restricting of current government expenditure and operating procedures for monetary policy, the policy
raising of surpluses of public sector enterprises. was renamed as Monetary and Credit Policy concerns
itself with the supply of money as also of credit to the
The approach towards the tax-system is to so
economy. This is a statement, announced twice in a year
designed that it becomes growth elastic and gets in line
(October. for October to March, and April, for April to
with the tax systems of other fast growing and
developed countries. To ensure better compliance and September, to coincide with the busy and the lean
less incentive for tax evasion, the government has seasons respectively of agriculture) till (1998-99). With
lowered the tax-rates both in respect of direct taxes and the decline in the share of agricultural credit, and a rise
indirect taxes. During the last few years tax-GDP ratio in that of the industrial credit, the RBI has started
has risen to 14.5 percent. For a poor country like India making an annual policy statement in April, with a
which started its development effort with a very low per review of the same in October. Beginning with 1999-
capita income, this record in mobilising tax revenue is 2000, the RBI has decided that the policy announcement
good by any standard. will be an annual affair.
The policy-statement gives an overview of the
In India, fiscal policy has been used for providing working of the economy. In this light, it specifies the
both special incentives for private savings and measures that the RBI intends to make influence on
encouraging investment in specified areas like housing. such key factors as money supply, interest rates, and
As a result of these policies in case of the last three Five inflation, so as to ensure price stability. It also lays down
Year Plans, the actual private savings rate has exceeded norms for financial institutions (like banks, finance
the plan target. companies etc.) governed by the RBI. These pertain to
2. Fiscal Equilibrium—One of the major objectives such matters as cash reserve ratio, capital adequacy etc.
of fiscal policy in India has been to attain a match In short, it is a sort of blue-print containing a description
between the revenue receipts and revenue expenditure. of aims and means.
Toward this objective, three types of measures have Two sets of objectives have been pursued for long.
been taken. One is controlled expansion of money. It sought to
(i) The effort has been to slow down the growth achieve the twin objectives of meeting in full the needs
rate in expenditure. The non-plan expenditure of production and trade, and at the same time moderating
is sought to be cuts substantially through the growth of money supply to contain the inflationary
pressures in the economy. Second is sectoral deployment
reduction in expenditure on such items as
of funds. Depending upon the priorities laid down in the
subsidies. plans, the RBI has determined the allocation of funds, as
(ii) The second measure is to increase tax revenue. also the interest-rates, among the different sectors. The
(iii) The government has made efforts to raise sectors which have received special attention are : core
profits of the public sector undertakings. A industries (coal, iron, steel and engineering etc.);
part of equity capital of some enterprises is foodgrains (rice, wheat etc.); priority sectors (agriculture
being sold to the public and thereby impart an small-scale industry etc.); and weaker sections of
element of market accountability and effi- population.
ciency. Implementing Measures—The objectives, listed
above, have been sought to be achieved through various
3. Equity and Socially Desirable Activities—The
monetary instruments, as also by selective controls.
government, in its fiscal policy, has also provided large Their use has, however, varied from time to time,
expenditure, tax concessions and other incentives for the depending upon circumstances.
expansion of socially important sectors. Several means, at the disposal of RBI, have been
To achieve social justice and equity, direct taxation used to influence the three aspects of money, namely,
in India, to some extent, has been made progressive. the rate of interest or price of money, the quantity or
During 1990s share of direct taxes in total tax revenue supply of money, and the access to or demand for
has risen. money. One principal instrument used has been the
Bank Rate or Discount Rate i.e., the rate at which the
Monetary Policy RBI lends to the banking system (through the rediscount
The Reserve Bank of India, being primarily concer- of eligible papers). Through changes in it, the RBI
ned with money matters, so organizes currency and affects the short-term interest rates in the money market,
credit that it subserves the broad economic objectives of and through it the long-term rates, and through it the
the country. In the performance of this task, it level of economic activity in the economy. It also
formulates and executes a monetary policy with clear- influences the international capital movements: higher
cut goals and tools to be used for this. rates attract capital inflows, and vice-versa.
Economics (NET) | 187U
Monetary
Instruments
Another important instrument is the open market priority sectors. Similarly structure of interest rates has
operations. The operations involve the sale or purchase been so used to provide low-interest loans to certain
of Government securities. Through the sale of securities sectors like agriculture and export. Weaker sections of
the RBI withdraws a part of the deposit resources of the population too have been helped through loans at low
banking sector, there-by reducing resources available interest. Selective credit controls have also been
with the banks for lending. The opposite happens when introduced from time to time to ease or tighten the
the RBI purchases securities. The stock of securities conditions of access to credit in respect of certain
with the seller banks is reduced and the cash with them commodities. This instrument of administered/dif-
expands. This augments credit-creating capacity of the ferential interest rate will, however, decline in
banks. Another device to influence money supply is the importance with the market-orientation of the economy.
Cash Reserve Ratio (CRR). It is the ratio of a bank’s Lags of Monetary Policy
cash holdings to its total deposit liabilities. A higher
ratio means that the amount of cash available for Changes in monetary policy do not have a direct
creating credit is reduced, and vice-versa. In addition, Linkage with the changes in aggregate spending. The
the government imposes an obligation on the banks to important links between the two are the supply of money
use a proportion of cash to buy government securities cost and availability of money. This is because of lags
known as Statutory Liquidity Ratio (SLR). This device which are involved between the time when the monetary
has been used for long by the Government to get bank policy is variaed. The longer the time taken by the
funds against its securities carrying low rates of interest. commercial banks in effecting adjustment the longer
Now with the market-orientation of the economy, one the lags in monetary policy.
government securities have become attractive on The Lag can be Split up into several components :
commercial consideration. As such the SLR is becoming (1) Recognition Lag—It involves some time to
redundant as far as the Central Government is concerned. recognise that the economy has changed in existing
However, since the State Governments depend on this policy.
source, the SLR is not to be eliminated. It has, however, (2) Action Lag—Once the need for a policy changes
been brought down to 25 per cent of bank deposits with is recognised, sometimes must elapse before there are
effect from 1996-97. suitable adjustments or alternative in the policy. The
Various measures have also been adopted by the duration of action lag is conditioned by number of
RBI to achieve the objective of sectoral deployment of factors.
credit. For this a certain percentage of credit has been (i) Sometime is likely to be taken for working
earmarked for the purpose. For example, 40 per cent of out details for change.
the total net bank credit has been earmarked to the (ii) Disagreements among the policy makers.
188U | Economics (NET)
(iii) The action may be delayed because of political cause inflationary pressure in the economy. The govern-
pressure. ment intervention in open market operation, statutory
(iv) The action may be delayed due to the desirable reduce the power of RBI and that may restricted the
change in monetary policy. scope of monetary policy.
Whatever would be the limitations, India's monetary
policy help much to maintain economic stability and at
the same time the economy needs more modernisation in
the fields of money market, banking and non-banking
institutional fields etc, to work and implement monetary
policy effectively.
Monetary Policy Committee
Constituted
The Reserve Bank of India Act, 1934 (RBI Act) has
(3) Inside Lag—The sum of recognition lag and been amended by the Finance Act, 2016, to provide for
action lag is referred to as inside lag. The duration is not a statutory and institutionalised framework for a
only determined by the ability of the policy makers to Monetary Policy Committee, for maintaining price
recognise and respond to some economic changes, its stability, while keeping in mind the objective of growth.
length depends also upon what is used as a basis for The Monetary Policy Committee would be entrusted
measurement and in what way this base is related to with the task of fixing the benchmark policy rate (repo
changes in other condition that influence policy decisions. rate) required to contain inflation within the specified
target level. A Committee-based approach for deter-
(4) Outside Lag—Once policy is changed some mining the Monetary Policy will add lot of value and
additional time must elapse before these changes will transparency to monetary policy decisions. The meetings
work their way through the system and affect aggregate of the Monetary Policy Committee shall be held at least
spending and income. 4 times a year and it shall publish its decisions after each
Limitations of Monetary Policy such meeting.
The provisions of the RBI Act relating to Monetary
Restricted scope of policy—For an effective of the Policy have been brought into force through a
monetary policy to fight inflation, a much large policy- Notification in the Gazette of India Extraordinary on
profile is necessary. According to I.G. Patel, the role of 27.6.2016. The factors constituting failure to meet
monetary policy in combating inflation in our country is inflation target under the Monetary Policy Committee
strictly limited and that monetary policy can be effective Framework have also been notified in the Gazette on
only if it is a part of an overall frame work of policy 27.6.2016. The Government, in consultation with RBI,
which includes not only fiscal and foreign exchange has notified the inflation target in the Gazette of India
policy but also what is described as income policy. Extraordinary dated 5th August 2016 for the period
Predominance of Currency—In India Limitations beginning from the date of publication of this notifica-
on the effective use of monetary policy arises from the tion and ending on the March 31, 2021, as under :
predominance of currency in the total money supply. Inflation Target : Four per cent.
This fact inhibits the credit creating capacity of the Upper tolerance level : Six per cent.
banking system. Lower tolerance level : Two per cent.
Underdeveloped Money Market—Another weak- As per the provisions of the RBI Act, out of the six
ness of Indian economy is the weak money market. This Members of Monetary Policy Committee, three Mem-
is not organised. The monetary policy is effective only if bers are from the RBI and the other three Members of
the money market is organised one, consisting of Reserve MPC are appointed by the Central Government. In
Bank, the State Bank, foreign banks, the Indian joint exercise of the powers conferred by section 45ZB of the
stock banks etc. And the non banking institution provide Reserve Bank of India Act, 1934, the Central Govern-
a considerable proportion of total credit and link between ment has accordingly constituted, through a Gazette
the two sectors are not well developed. Notification dated 29th Sept 2016, the Monetary Policy
Existance of Black Money—The major obstacle of Committee of RBI, with the following composition,
the efficient working of monetary policy is the circula- namely :
tion of large amount of money in the black market. So (a) The Governor of the Bank—Chairperson, ex-
the supply and demand of money do not remain desired officio;
by RBI. This means that a significant part of money eco- (b) Deputy Governor of the Bank, in charge of
nomy remain outside the orbit of RBI’s monetary policy. Monetary Policy—Member, ex-officio;
Government Policies—The scope of monetary (c) One officer of the Bank to be nominated by the
policy is further restricted because the RBI could not Central Board—Member, ex-officio;
persue independent line in monetary affairs. The crea- (d) Shri Chetan Ghate, Professor, Indian Statistical
tion of new money to meet government deficits will Institute (ISI) —Member
Economics (NET) | 189U
(e) Professor Pami Dua, Director, Delhi School of available 24/7, it is expected to revolutionise the
Economics (DSE) — Member retail payments system in India. NEFT system will
(f) Dr. Ravindra H. Dholakia, Professor, Indian be available on a 24 × 7 basis from December 2019.
Institute of Management (IIM), Ahmedabad— INFLATION
Member A change in the value of money is associated with
The Members of the Monetary Policy Committee the change in the general price level. These changes are
appointed by the Central Government shall hold office generally described in two forms :
for a period of four years, with immediate effect or until (i) Inflation (ii) Deflation
further orders, whichever is earlier. Inflation in the simplest manner can be defined
Third Bi-monthly Review of Monetary as a chronic and sustained rise in prices caused by an
Policy 2019-20 increase in the supply of money. It is the situation where
amount of money in the country is an excess of the
For the fourth straight time in a row, the Reserve volume of goods available so that too much money is
Bank of India (RBI) on August 7, 2019 cut its chasing too few goods.
benchmark Repo rate, this time by a more than expected
Inflation is a situation in which the general price
margin of 35 basis points. The announcement was made
level rises or it is the same thing as saying that the value
after the third bi-monthly policy review by the Monetary
of money falls.
Policy Committee (MPC), led by RBI Governor
Shaktikanta Das, for 2019-20. The benchmark rate is Problems Associated with the Definition
now at the lowest since April 2010. Four members, Dr. of Inflation
Ravindra H. Dholakia, Dr. Michael Debabrata, Patra, Some people who do not regard inflation as an
Bibhu Prasad Kanungo and Shaktikanta Das, voted to economic evil believe that a price level rising at a rate of
reduce the policy repo rate by 35 basis points, while two around 1.5 per cent is so gradual that it assists in achiev-
members (Dr. Chetan Ghate and Dr. Pami Dua) voted to ing and maintaining full employment and a satisfactory
reduce the policy repo rate by 25 basis points. The cut in rate of economic growth. Such people would apply the
repo rate is likely to result in lower EMIs for home and term inflation only to what they regard as an unhealthy
buyers. The impact of monetary policy easing since or excessive rise in the price level. Other people agree
February 2019 is also expected to support economic that inflation is an economic evil, but they go further and
activity, going forward. label any rise in the price level as inflation.
● The Monetary Policy Committee (MPC) at its Another definitional problem is associated with the
meeting today decided to reduce the policy repo rate time dimension. A 2 per cent rise in the GNP deflator
under the liquidity adjustment facility (LAF) by 35 over any one quarter would, if sustained, amount to more
basis points (bps) from 5·75% to 5·40% with than an 8 per cent rise over a full year. An 8 per cent rise
immediate effect. in a year would be regarded by almost everyone as an
● Reverse Repo rate under the LAF stands revised to appreciable and therefore inflationary rise in the price
5·15%, and the marginal standing facility (MSF) level. But 2 per cent rise in a quarter is controversial.
rate and bank rate to 5·65%. In short, as long as we define inflation in terms of
Policy Ratio/Ratio as on August 7, 2019 (In view price level changes, no fully satisfactory definition is
of Third Bi-monthly review of Monetary available.
Policy 2019-20) Measures of Inflation
● Repo Rate : 5·40%
● Reverse Repo Rate : 5·15% There are four measures of Inflation: The consumer
● Marginal Standing Facility Rate : 5·65% price index, wholesale price index the GNP implicit
● Bank Rate : 5·65% price deflator, the personal consumption expenditures
● CRR : 4·0% (PCE) implicit price deflator.
● SLR : 18·75% The Consumer Price Index (CPI)—This index is
● Real GDP growth for 2019-20 revised from 7% to designed to reflect changes in the prices of a “market
6·9%. basket” of consumer goods and services purchased by all
● CPI inflation is projected at 3·1% for Q2 2019-20 urban consumers. A single index is calculated for all
and 3·5-3·7% for H2 2019-20. the goods and services in the basket as well as separate
● To help NBFCs, the RBI has announced harmoni- indices for groups of items like food, housing, apparel
sation of single counterparty exposure limit for and upkeep, and transportation. In addition to an index
banks’ exposure to single NBFCs with the general for the country as a whole, the data for different cities
single counterparty exposure limit. permits the preparation of price indices for certain large
● The RBI has decided to set a Central Payment Fraud cities.
Registry to track frauds in the payment systems. Each of the goods and services in the basket is
● Currently, NEFT as a retail payment system is weighted according to its importance in consumer’s
available for customers from 8 am to 7 pm on all budgets. This index is also known as cost of living Index.
working days of the week (except 2nd and 4th Wholesale Price Index (WPI)—It is also known as
Saturdays of the month). Once the NEFT becomes the producer price Index (PPI). It is similar to the CPI
190U | Economics (NET)
in construction. It, however, measures the prices of some inflation, sectoral theory of inflation, structural theory of
over 2,000 commodities at level of their first commercial inflation and Mark-up inflation.
transaction. (I) Demand Pull Inflation or Monetary
The GNP Implicit Price Deflator—It is called
implicit because it is not obtained directly as are the CPI
Theory of Inflation
and PPI, instead, it is calculated by dividing current It occurs when there exists an excess demand over
GNP by constant GNP. Unlike the CPI and or WPI, the the available supplies at the existing prices. In this type
GNP implicit price deflator is not based on a fixed of situation the aggregate demand function shifts upward
market basket. to the right while no shift in the supply function.
The PCE Implicit Price Deflator—It is an index
of price change for all of the goods and services
included in the personal consumption expenditure (PCE)
component of the GNP, and is derived as is the implicit
price deflator for GNP as a whole.
Like the GNP deflator, the PCE deflator is not a
fixed weight price index.
Types of Inflation
We can divide different types of inflation based
on the rate of inflation and the degree of control.
On the Basis of the Rate, there are Four Types of
Inflation.
(1) Creeping Inflation—It is known as mild
inflation. Creeping inflation, according to some Fig. 1
economists, is not of much consequence specially in an In this figure OF is the level of output at full
economy where national income is rising. employment. Output is assumed not to exceed of O F
(2) Walking or Trotting Inflation—When prices level. Beyond OF, increase in prices does not result in
rise moderately and the annual inflation rate is a single increased output, therefore the supply curve becomes a
digit. In other words, the rate of rise in prices is in the straight vertical line. It will be seen that as demand
intermediate range of 3 to 7 per cent per annum or less progressively increases from D1 to D2 , D 3 , D 4 , D 5 the
than 10 per cent. Inflation at this rate is a warning signal price level also rises from P1 to P 2 , P 3 , P 4 and P5
for the government to control it before it turns into respectively.
running inflation.
(3) Galloping Inflation—If mild inflation is not Factors on Demand Side Inflation
checked and if it is allowed to go uncontrolled it may (1) Money Supply—The major source of inflation
assume the character of the galloping inflation. It may is increase in money supply in the economy. Increase in
have adverse effect on the saving and thus may affect money supply results from an increase in demand
the long term investment projections in the economy. deposits and expansions of loans and investment by
(4) Hyper Inflation—A final stage of inflation is commercial banks.
hyper inflation. It occurs when the price line goes out of (2) Disposable Income—It refers to income
control and the monetary authorities find it beyond payments to factors after personal taxes have been paid.
their resources to impose any check on it. An increase in disposable income results in an increase
On The Basis of The Degree of Control Exercised in the absolute amount of consumption expenditure in
Over Inflation, We Can Distinguish Two Types of the economy. Increase in consumption expenditure is
Inflation. inflationary in character.
(1) Open Inflation—It occurs when prices rise (3) Increase in Business Outlays—The increase
without any control and checks. It refers to “an infla- in business outlays or capital expansion taken on a
tionary process in which prices are permitted to rise speculative character during an inflationary boom.
without being suppressed by government price control. (4) Increased Foreign Demand—Another factor
(2) Suppressed Inflation—It is not characterised responsible for increased demand is foreign expenditure
by a price rise. In this type of situation prices are held for domestic goods and services. This factor is parti-
stable through different means like application of control cularly significant if a country maintains an export
by the government rationing etc. surplus on its balance of trade.
Theories (Causes) of Inflation (II) Cost Push Inflation
There are various theories explaining the causes of The second major cause of inflation is seen as
inflation such as theory of demand-pull inflation, cost- increase in the cost of production. When the cost of
push inflation, mixed demand pull and cost-push production increases, aggregate supply schedule shifts
Economics (NET) | 191U
to the left indicating that a lesser quantity is supplied either of the two forces, but the inflationary process can
at the prevailing prices. With the aggregate demand not be sustained in the absence of the other forces.
schedule remaining unchanged, a fall in supply pushes We may consider an inflationary process begins
the price level upward. Downward shift of the supply with excess demand with no cost push forces at work.
curve from S1 to S2 , S3, S4 results in progressive increase Excess demand will raise prices which will in due
in the price level. course pull up money wages. But the rise in money
wages is not the result of cost-push forces. Such a mixed
Factors on Cost (Supply) Side Inflation inflation will lead to sustained rise in prices. When
(1) Higher Wage Rates—A modern economy is prices rise, producers are encouraged to increase output
characterised by the presence of organised trade union as their profits rise with increased aggregate demand.
activity. Whenever the producers are forced to grant They therefore, raise the demand for labour thereby
higher wage rates, they find it easier to shift the burden increasing money wages which further lead to increase
on the consumers by charging higher prices for the in demand for goods and services. So long as the
commodities. demand for output continues to raise money incomes,
inflationary pressure will continue.
(2) Higher Taxes—A further source of cost push
inflation is the various types of taxes imposed by the Now, supposing an inflationary process that begins
state authorities specially indirect taxes like excise from the supply side due to increase in money wage
duties. The producers have a tendency to shift the higher rates. The cost push inflationary process will be self
burden of taxes to the consumers by hiking prices by the sustaining only if every wage-push is accompanied by a
amount of tax. corresponding increase in aggregate demand. Since
every cost – push is accompanied by a fall in output and
employment along with a price increase, it is likely that
the government will adopt expansionary monetary and
fiscal policies in order to check the fall in output and
employment. In this way, cost-push will lead to a
sustained inflationary process because the government
will try to achieve full employment by raising aggregate
demand which will, in turn, lead to further wage-push
and so on.
(IV) Sectoral or Demand–Shift Inflation
Sectoral or demand-shift inflation is associated with
the name of Charles Schultz who opined out that the
price increase in America between 1955-57 were caused
by neither demand-pull nor cost-push but by sectoral
shifts in demand. Schultz advanced his theory with
reference to the American economy but it has now been
generalised in the case of modern industrial economies.
Fig. 2
Prices and wages are flexible upward in response to
(3) Fall in the Availability of Basic Inputs—A fall excess demand but they are rigid downward. If the
in the supply of raw material of cement, iron and steel, aggregate demand is not excessive, excess demand in
cotton, jute would raise their costs, which would go in to some sectors of the economy and deficient demand in
raise the prices at which the manufactured goods will other sectors, will still lead to a rise in the general price
sell in the market. level. This is because prices do not fall in the deficient
(4) Higher Profits Margin—Higher profit margins demand sectors, there being downward rigidity of prices.
fixed by producers is one of the main causes of cost- But prices rise in the excess demand sectors and remain
push inflation. This happens specially when the constant in other sectors. The net effect is an overall rise
producers are faced with the situation of sellers market. in the price level.
In this type of situation demand exceeds supply, prices Increase in prices in excess-demand sectors can
tend to rise under the impact of high demand to the spread to deficient – demand sectors through the prices
advantage of the producer. of intermediate goods. Not only this, wages will also be
bid up in excess demand sectors, and wages in demand
(III) Mixed Demand-Pull Cost-Push deficient industries will follow the rising trend.
Inflation Thus, demand-shift inflationary process arises
According to this theory, actual inflationary process initially out of excess demand in particular sectors. But
contains some elements of both, demand pull and cost- it results in a general price rise only because of the
push inflation. In fact, excess demand and cost-push downward rigidities and cost-oriented nature of prices
forces operate simultaneously and interdependently in and wages. It is not characterised by an autonomous
an inflationary process. Price increases may start with upward push of costs nor by an aggregate excess
192U | Economics (NET)
demand. Indeed its basic nature is that it can not be Stagflation
understood in terms of aggregate alone. Such inflation is
The word “Stagflation” is the combination of stag
the necessary result of sharp changes in the composition
plus flation, taking ‘stag’ from stagnation and ‘flation’
of demand, given the structure of prices and wages in
from inflation. Thus it is a paradoxical situation where
the economy.
the economy experiences stagnation or unemployment
(V) Structural Theory of Inflation along with a high rate of inflation. It is, therefore, also
called inflationary recession. In other words, the
The structural school of South America stresses stagflation refers to a situation when a high rate of
structural rigidities as the principal cause of inflation in inflation occurs simultaneously with a high rate of
developing countries. unemployment.
According to this school, as economy develops, One of the principal causes of stagflation has been
rigidities arise which lead to structural inflation. In the restriction in the aggregate supply. When aggregate
initial phase, there are increases in non-agricultural supply is reduced, there is a fall in output and
incomes accompanied by high growth rate of population employment, and the price level rises. A reduction in
that tend to increase the demand for goods. In fact, the aggregate supply may be due to a restriction in labour
pressure of population growth and rising urban incomes supply. The restriction in labour supply, in turn, may be
would tend to raise through a chain reaction mechanism, caused by a rise in money wages on account of strong
first the prices of agricultural goods, second, the general unions or by a rise in the legal minimum wage rate, or
price level, and third wages. by increased tax rates which reduce work effort on the
Another cause of structural inflation is that the rate part of workers.
of export growth in a developing economy is slow and When wages rise, firms are forced to reduce
unstable which is inadequate to support the required production and employment. Consequently, there is a
growth rate of the economy. The sluggish growth rate of fall in real income and consumer expenditure. Since the
exports and the foreign exchange constraint lead to the decline in consumption will be less than the fall in real
adoption of the policy of industrialisation based on income, there will be excess demand in the commodity
import substitution. This policy leads to a cost-push rise market which will push up the price level.
in prices because of the rise in prices of imported The rise in the price level, in turn, reduces output
materials and equipment, and protective measures. The and employment in the following three ways :
policy of import substitution also tends to be inflationary
because of the relative inefficiency of the new industries (a) It reduces the real quantity of money, raises
during the learning period. interest rates and brings a fall in investment expenditure.
(b) The rise in the price level reduces the real value
Thus structural inflation may result from supply
of cash balances with the government and the private
inelasticities leading to rise in agricultural prices, costs
sector via the pigou effect which reduces their
of import substitutes, deterioration of the terms of trade
consumption expenditure.
and exchange rate devaluation.
(c) The rise in prices of domestic goods makes
(VI) Markup Inflation exports dearer to foreigners and makes exports goods
relatively more attractive to domestic output and
This analysis is based on the assumption that both employment :
wages and prices are administered and are settled by
Restriction on aggregate supply may also be caused
workers and business firms. Firms fix administrative
by external factors such as rise in the world prices of
prices for their goods by adding to their direct material
foods grains and crude aid prices. In all these cases, the
and labour costs some standard markup which covers
domestic price level is raised by outside forces. When
profit. Labour also seeks wages on the basis of a fixed
international prices of food grains and crude oil rise,
markup over its cost of living.
they lead to the outflow of purchasing power away from
If either firms or workers use a percentage markup, domestic consumers. They accentuate inflation, raise
the inflation will progress faster than if either or both fix wages and prices. As a result, the real quantity of money
the markup in money terms. If each participant fixes declines, interest rates rise and investment declines, via
prices on the basis of prices he pays, the inflation will be the pigou effect, and making exports dearer and imports
high and of long duration. attractive, domestic output and employment decline.
The size of the markup applied by firms and They lead to Stagflation.
workers is a function of the pressure of demand felt in The phenomenon of stagflation is illustrated in
the economy. When the demand is moderate, the figure 3, where employment is measured on the
markups may be applied to historically experienced horizontal axis and the price level on the vertical axis.
costs and prices, and the price rise may be slow. But The initial equilibrium is at E where aggregate
when demand is intense, the markups are based on demand curve AD intersects the aggregate supply curve
anticipations of future costs and prices rise rapidly. Thus AS and the price level is OP and the employment level
there can be no inflation without some change in the size is ON. When the aggregate supply is reduced due to any
of the mark up. of the factors mentioned above, the aggregate supply
Economics (NET) | 193U
cent, that is, equal to OM. Since the growth rate of
money wages equals the rate of labour productivity, the
price level remains constant. If now aggregate demand is
increased, this lowers the unemployment rate to OT
(2%) and raises the wages rate to OS (4%) per year. If
lower productivity continues to grow at 2% per annum,
the price level will also rise at the rate of 2 per cent per
annum at OS in the figure 4.
Thus a money wage rate increase which in excess of
labour productivity leads to inflation. To keep wage
increase to the level of labour productivity (OM) in
order to avoid inflation, ON rate of unemployment will
have to be tolerated.
Samuelson and Solow extended the Phillip’s
Fig. 3. : Stagflation analysis to the trade off between the level of unem-
ployment and the rate of change in the level of prices.
curve S shifts to the left at AS1 . The new equilibrium is
Thus, the Phillips curve suggests that unemployment
at E1 where AS1 intersects the AD curve. Now the price can always be reduced by having more inflation and
level rises from OP to OP1 and the level of employment that the inflation rate can also be reduced by having
declines from ON to ON1 . more unemployment.
Phillips Curve Criticism of Philips Curve
Professor Phillips urged there was a close link Economists have criticised the phillips curve. They
between the level of unemployment and the rate of wage argue that the phillips curve relates to the short run and
increase. Phillips curve expresses an inverse relationship it does not remain stable. It shifts with changes in
between the rate of unemployment and the rate of expectations of inflation. In the long run, there is no
increase in money wages. trade off between inflation and employment. These
views have been expounded by friedman and phelps in
what has come to be known as the “accelerationist”
hypothesis.
According to friedman, the long run phillips curve
is vertical.
Tobin’s View—James Tobin in his presidential
address before the American Economic Association in
1971 proposed a compromise between the negatively
sloping and vertical phillips curve. Tobin believes that
them is a phillips curve within limits, but as the
economy expands and employment grows, the curve
becomes even more fragile and vanishes until it becomes
vertical at some critically low rate of unemployment.
Thus Tobin’s Phillips curve is kinked-shaped, a part like
Fig. 4. : Phillips Curve
a normal phillips curve and the rest vertical, as shown in
Prof. Phillips studied the relationship between figture 5. In the figure 5 is the critical rate of
unemployment and changes in money wages in the U.K. unemployment at which the philips curve becomes
over the period 1862-1957. As a result of this study, he vertical where there is no trade off between
seems to have discovered a stable and inverse unemployment and inflation. According to Tobin, the
relationship over the whole period between the rate of vertical portion of the curve is not due to increase in the
wage increase and the per cent of unemployment.
LPC
The Phillips curve depicts the trade off between
unemployment and money wages. It relates percentage
change in money wages on the vertical axis with
percentage of labour force unemployment on the
horizontal axis, as shown in figure. The curve is convex
to the origin which shows the percentage change in
money wages rises with decrease in the unemployment
rate.
Suppose that ON rate of unemployment (3%) is Ue
associated with OM growth rate of money wages (2%).
Suppose also that the rate of labour productivity is 2 per Fig. 5 : Tabin’s Philips Curve
194U | Economics (NET)
demand for more wages but emerges from imperfections about the nature of monetary and fiscal policies to be
of the labour market. At the Uc level, it is not possible to adopted. For instance if the authorities find that the
provide more employment because the job seekers have inflation rate P 2 is in compatible with the unemployment
rate U1 of figure, they would adopt such monetary and
wrong skills or wrong age or sex or are in the wrong fiscal policies as to shift the phillips curve PC to the left
place. in the position of PC1 curve. This will give a better
Regarding the normal portion of the phillips curve trade-off between a lower inflation rate P 1 with the same
which is negatively sloping, wages are sticky downward level of unemployment U1.
because labourers resist decline in their relative wages. Inflationary Gap
Solow’s View—Like Tobin Robert Solow does not Inflationary gap arises when consumption and
believe that the phillips curve is vertical at all rate of investment spending together is greater than the full
inflation. According to him, the curve is vertical at employment GNP level. This means that people are
positive rates of inflation and is horizontal at negative demanding more goods and services than can be
rates of inflation as shown in figure. produced. In other words, the amount by which the
actual aggregate demand exceeds the level of national
income corresponding to full employment is known as
inflationary gap because this excess in aggregate
demand causes inflation or rise in prices in the country.
Diagramatically, the inflationary gap EE′ is shown
in figure. YF is the full employment level of income
which is arrived at by the equality of aggregate
consumption and investment expenditure line C + 1 + G
and the 45° line representing aggregate supply of goods
at point E. At the full employment level, there is excess
demand because consumers, firms and government
Fig. 6 expenditure more than the available output at current
Policy Implications of the Phillips Curve
The phillips curve has important policy im-
plications. It suggests the extent to which monetary and
fiscal policies can be used to control inflation without
high levels of unemployment. In other words, it provides
a guide line to the authorities about the rate of inflation
which can be tolerated with a given level of
unemployment. For this purpose, it is important to know
the exact position of the phillips curve. If the curve is
PC1 as in figure, where there labour productivity and the
wage rate are equal at point E, both full employment and
price stability would be possible. Again a curve to the Fig. 8. : Inflationary Gap
left of point E suggests full employment and price
prices by EE’ amount. This increased demand or
stability as consistent policy objectives. It implies that a
expenditure shifts the C + I + G curve upward to C + I +
lower level of inflation can be traded-off for a low level
G′ position. This intersects the 45° line at E 1 so that the
of unemployment. If, on the other hand, the phillips
curve is PC as in the figure 7. It suggests that the total expenditure is E1 Y1 while the available output is
authorities will have to choose between price stability EYF Thus E1 A = EE′ is the inflationary gap.
and more unemployment. Thus by observing the The inflationary gap can be wiped out by increase in
position of the phillips curve the authorities can decide saving so that aggregate demand is reduced. Another
solution is to raise the value of available output to match
the disposable income. But output cannot be increased
during the short run. Private investment cannot be
reduced while the government expenditure is auto-
nomous. So both cannot be reduced during the short run.
Thus the only alternatives left to the government are to
increase taxation and induce saving.
Deflationary Gap
Deflationary gap represents the difference between
the actual aggregate demand and the aggregate demand
which is required to establish the equilibrium at full
Fig. 7 employment level of income.
Economics (NET) | 195U
The concept of deflationary gap is illustrated in and employment will not only be equal to the
figure in which along the X-axis national income is deflationary gap EH but it will be much greater than
measured and long the Y-axis expenditure is measured. this. The decline in national income is determined by the
Suppose national income at the equilibrium level of full value of the multiplier. In figure when aggregate demand
employment is equal to OYf Now the equilibrium level is YF H i.e, deflationary gap is equal to EH, then the
of income and employment would be established at OY f aggregate demand curve is C + I + G′ which cuts the 45°
when aggregate demand (C + I + G) is equal to YfE line at point Q as a result of which equilibrium is
(which is equal to national income OYf). But in the real established at OY1 level of national income. It will be
world if aggregate demand is less than the full seen from figure that OY1 is less than full employment
employment level of income OYf or it is less than Y fE level of income OYf.
then the problem of deficiency of aggregate demand will
arise. Therefore, EH in figure 9 represents deflationary
Effects of Inflation
gap. In an economy in which the prices of everything,
including the prices of assets and debt instruments,
changed proportionally with the price level, no body
would be hurt by or benefit from changes in the price
level, unless those changes affected the economy’s
H output and the rate at which that output grew. However,
in the real economy, all prices do not change at the same
rate. Consequently, inflation does provide gains to some
and losses to others, apart from any effect on the output
level and its growth rate.
(1) Effects on the Distribution of Income
U1 Y and Wealth
Fig. 9. : Deflationary Gap There are two ways to measure the effects of
It should be carefully understood that due to inflation on the redistribution of income and wealth in a
deflationary gap E, the level of national income and society : (i) on the basis of the change in the real value
employment will decline. The decline in national income of such factor incomes as wages, salaries, rents, interest,
Base Year of Wholesale Price Index Changed to 2011-12
The new series of Wholesale Price Index (WPI) with 2011-12 as its base year has replaced the series with base year 2004-
05 with effect from May 12, 2017. The number of commodities included in the new series stands at 697 while it was only 676 in
old series with base year 2004-05. In total included 697 commodities, the members of primary articles, fuel and power and
manufactured products stand at 117, 16 and 564 respectively.
Base Year for Wholesale Price Index shifts to 2011-12, number of commodities and price quotations
increased, and relative weights in index undergo minor change
The base year for the Wholesale Price Index has been moved from 2004-05 to 2011-12. The basket of commodities has
been increased from 676 to 697 with the number of price quotations substantially stepped up from 5,482 to 8,331. Relative
weights in the index for the various components has also changed marginally. WPI for April 2012 released recently is based on
the new series index WPI series in India has undergone six revisions in 1952-53, 1961-62, 1970-71, 1981-82, 1993-94 and
2004-05 so far. The current series is seventh.
Base Year → 1970-71 1981-82 1993-94 2004-05 2011-12
Number of Commodities
Primary Articles 80 93 98 102 117
Fuel and Power 10 20 19 19 16
Manufactured Products 270 334 318 555 564
All Commodities 360 447 435 676 697
Number of Price Quotations
Primary Articles 411 519 455 579 983
Fuel and Power 30 73 72 72 442
Manufactured Products 854 1779 1391 4831 6906
All Commodities 1295 2371 1918 5482 8331
Relative Weight in WPI
Primary Articles 41·667 32·295 22·025 20·118 22·62
Fuel and Power 8·459 10·663 14·226 14·910 13·15
Manufactured Products 49·874 57·042 63·749 64·972 64·23
All Commodities 100 100 100 100 100·00
O/o Economic Adviser, Deptt. of Ind. Policy and Promotion.
196U | Economics (NET)
dividends and profits. Here, income is narrowly defined, Thus inflation bring about a redistribution of real wealth
(ii) on the basis of the size distribution of income over in favour debtors.
time as a result of inflation. The change in a household’s (ii) Salaried Class—During rising prices, salaried
net worth from one date to another is the difference persons lose because their salaries are slow to adjust
between the changes in the amounts of its assets and when prices are rising.
liabilities. Conceptually this is a broader definition of (iii) Fixed Income Class—The recipients of transfer
income. payments such as pensions, unemployment insurance,
In terms of the narrow definition, inflation affects social security, etc. and recipients of interest and rent
the distribution of income only to the degree that it alters live on fixed incomes. All such persons lose because
the way that the flow of total income is distributed by they receive fixed payments, while the value of money
income class. If this remains unchanged despite continues to fall with rising prices.
inflation, then by definition inflation does not affect (iv) Investors—There are two types of investors:
distribution of income. However, by the broad definition, first, who invest in shares or stocks of companies and
inflation may leave the flow covered by the narrow second who invest in fixed interest bearing bonds.
definition unchanged, but still significantly alter the Investors of first group gain because when prices are
distribution of income by causing changes in the dist- rising, business activities expand which increase profit
ribution of networth of household by income class. of companies.
The effects of inflation on redistribution of income As profits increase, dividends on equities also
can be understand by knowing the effect of inflation on increase at a faster rate than prices. But investor of
different group of societies which are as follows : second type lose during inflation because they receive a
(i) Debtor and Creditors—During inflation, debtors fixed sum while the purchasing power is declining.
return the same amount of money, but they pay less in (v) Farmer—Landlord lose during rising prices
terms of goods and services. Thus, the burden of the because they get fixed rents. But peasant proprietors
debt is reduced and debtors gain. On the other hand, who own and cultivate their farms gain. The landless
creditors lose because they receive less in real terms. agricultural workers are hit hard by rising prices.
(2) The Effects of Inflation on Output, Employment and the Growth Rate
For an economy producing below potential, many economists maintain that inflation of the creeping or crawling
variety will have a tonic effect on output and employment. In the event of unanticipated inflation, prices rise faster
than money wage rates, and the resulting reduction in the real wage rate gives business the profit incentive to hire
more workers and expand output. Consequently, a rise in the inflation rate, if unanticipated, may lead to a
reduction in the unemployment rate.
Given an inflation in which wages lag behind prices, the wage share of total income shrinks and the fraction of
total income saved expands. This follows from the fact that a larger portion of the total income goes to profits and
other non-wage income, the recipients of which are typically upper income groups with a relatively high propensity
to save. That a greater saving will occur under the conditions here specified is well established.
Comparison of Weighing Diagrams of Old and Revised Series of Consumer Price Index
Old Series of CPI (Base CES 2004-05) Revised Series of CPI (Base CES 2011-12)
Groups
Rural Urban Combined Rural Urban Combined
Food and Beverages 56·59 35·81 47·58 54·18 36·29 45·86
Pan, Tobacco and Intoxicants 2·72 1·34 2·13 3·26 1·36 2·38
Clothing and Footwear 5·36 3·91 4·73 7·36 5·57 6·53
Housing — 22·54 9·77 — 21·67 10·07
Fuel and Light 10·42 8·40 9·49 7·94 5·58 6·84
Miscellaneous 24·91 28·00 26·31 27·26 29·53 28·32
Total 100·00 100·00 100·00 100·00 100·00 100·00
When one compares the rate of inflation and the rate of growth of real gross national product in major
industrialized countries over the period since World War II, one finds no clear pattern. West Germany (with the
lowest rate of inflation) has shown one of the highest rates of growth and Japan (with a high rate of inflation) has
shown by far the highest rate of growth. The U.K. (with the lowest rate of growth) is among the highest in terms of
the rate of inflation. There are problems of interpretation here due to the impact of World War II.
(3) Other Effects of Inflation
Inflation leads to a numebr of other effects which are discussed as under—
(i) Government—The government gains under inflation for rising wages and profits spread an illusion of
prosperity within the country.
Economics (NET) | 197U
(ii) Balance of Payments—During inflation, OUTPUT (GDP)
domestic products become costlier compared to foreign
products. This tends to increase imports and reduce Actual Growth
exports, thereby making the balance of payments peak
expansion
unfavourable for the country. But there is no adverse
impact on the balance of payments if the country is on Growth
the flexible exchange rate system. Trend
contraction
Business Cycle trough
The business cycle describes the rise and fall in
production output of goods and services in an economy.
TIME
Business cycles are generally measured using the rise
and fall in real gross domestic product (GDP) or GDP Fig. 10
adjusted for inflation. The business cycle is also known Theories of Business Cycles
as the economic cycle or trade cycle.
Business cycles are fluctuations in economic 1. The Purely Monetary Theory : R. G. Hawtrey
activity that an economy experiences over a period of described the business cycle as a purely monetary
time. Actual fluctuations in real GDP, however, are far phenomenon. According to Howtery all the business
from consistent. These fluctuations include output from activities in an economy are the reflections of changes in
all sectors including households, non-profit activities, the flow of money.
governments, as well as business output. "Output ● The fluctuations in the supply of money and the
cycle" is, therefore, a better description of what is bank credit are the main causal factor of a cyclical
measured. process.
The business cycle is characterized by expansion ● With an increased supply of money, the prices rise,
and contraction. During expansion, the economy profit increases, total output increases and thus
experiences growth, while a contraction is a period of overall growth takes place. On the other hand, if the
economic decline. Contractions are also called supply of money falls, then the price fall, profits
recessions. decline, total output falls as production activities
become sluggish, and the economy enters into the
Stages of a Business Cycle depression phase.
All business cycles are characterized by following ● The principle factor behind the supply of money is
stages : the credit created by the banking system.
Expansion—When expansion occurs, there is an ● The economy observes the upswing with the
increase in employment, incomes, production, and sales. expansion of bank credit and continues to expand as
People generally pay their debts on time. The economy long as the banks create the credit.
has a steady flow in the money supply and investment is
booming. ● Till the process of credit expansion continues, the
general level of price increases as after a certain
Peak—The reached at peak when the economy hits limit, the rate of increase in the demand will be
a snag, having reached the maximum level of growth. more than the supply rate. The supply increases at a
Prices hit their highest level, and economic indicators lower rate because of limited production capacity
stop growing. Many people start to restructure as the and the gestation period of new investments. Thus,
economy's growth starts to reverse. credit expansion helps in accelerating the economy
Recession—These are periods of contraction. and at the same time helps in the price rise. The
During a recession, unemployment rises, production economy observes the upswing and enters into the
slows down, sales start to drop because of a decline in expansion phase.
demand, and incomes become stagnant or decline. ● With the contraction of credit, the businessmen can
Depression—Economic growth continues to decline no longer obtain bank credit for furthering their
while unemployment rises and production plummets. business activities. As a result of this, the expansion
Consumers and businesses find it hard to secure credit, slows down and marks the beginning of the
trade is reduced, and bankruptcies start to increase. downswing.
Consumer confidence and investment levels also drop. 2. Investment Theory—Investment theory of busi-
Trough—This period marks the end of the depre- ness cycle was propounded by Austrian economist
ssion, leading an economy into the next step : recovery. Hayak. It centres on the analysis of equilibrium between
Recovery—In this stage, the economy starts to turn production of capital goods and consumer goods.
around. Low prices spur an increase in demand, employ- According to Hayak cyclical fluctuations in the eco-
ment and production start to rise, and lenders start to nomy are the result of the shortening and strengthening
open up their credit coffers. This stage marks the end of of the process of production that are brought by an
one business cycle. expansion in money supply, causing the market rate of
198U | Economics (NET)
interest to fall below the natural or equilibrium rate of significant role in the Schumpetererian theory of
interest. A fall in the interest rate leads to changes in the business cycle. Interventions and entrepreneurs are two
structure of production. The failure of the banking strategic factors in this theory. Cyclical upswing begins
system to keep the supply of money neutral causes when entrepreneurs start investing in the commercial
business cycle. And, therefore the correct remedy to end applications of their innovative ideas. It gives
business cycle is to have a ‘neutral money policy’. commercial advantage to them in terms of higher return.
3. The Psychological Theory—This theory was High influx in the industry results into the saturation in
developed by A.C. Pigou. According to Pigou, the main profit maximization. The era of downfall starts.
cause for business cycle is optimism and pessimism 7. Hicks’s Theory of Business cycle—Professor
among business people and bankers. During the period J.R. Hicks has analyzes the concept of business cycle in
of good trade, entrepreneurs become optimistic which his book ‘A Contribution to the Theory of the Trade
would lead to increase in production. The feeling of Cycle’. He shows that accelerator is responsible for
optimism encourages other to enter into the business or fluctuations. Hicks’ model of the business cycle
increase the production. Hence investments are represents an important step towards integrating a theory
increased beyond limits and there is over production, of cyclical fluctuations with the factors of economic
which ultimately results in losses. Entrepreneurs become expansion. According to Hicks, “the theory of the
pessimistic and reduce their investment and production. acceleration and the theory of multiplier are the two
4. Over-investment Theory—This theory was sides of the theory of the fluctuations, just as the theory
developed by Arthur Spiethoff and D.H. Robertson. This of demand and the theory of supply are the two sides of
theory is basically based on the ‘Say’s Law of markets. the theory of value.”
Spiethoff has pointed out that over investment is the A distinction is made between autonomous invest-
cause for trade cycle. Over investment is due to ment and induced investment—the latter is a function of
indivisibility of investment and excess supply of bank changes in the level of output and the former a function
credit. Over investment and overproduction are of the current levels of output. Under autonomous
encouraged by monetary factors. If the banking system investment Hicks includes “public investment, invest-
places more money in the hands of entrepreneurs, prices ment which occurs in direct response to inventions and
will increase. The rise in prices may induce the much of the ‘long range’ investment which is only
entrepreneurs to increase their investments leading to expected to pay for itself over a long period.”
over-investment. Thus Prof. Robertson has successfully According to Hicks, business cycle is an explanation
combined real and monetary factors to explain business in real terms of a mechanical technological sort in which
cycle. monetary factors are left out or admitted as a modifying
5. Over-Saving or Under Consumption Theory— factor and where, apparently, human judgment or varying
This theory was postulated by Malthus, Sismondi, Carl business expectations and decisions play little or no part.
Marx and Hobson. According to this theory, depression Investment plays the leading role but is based on
is due to over-saving. In the modern society, there are formula, not judgment. This would appear as the most
great inequalities of income. Rich people have large serious limitations of such a theory.
income but their marginal propensity to consume is less. In the upswing of business cycle income rises as a
Hence they save and invest which results in an increase result of the combined action of the multiplier and
in the volume of goods. This causes a general glut in the accelerator. A super cumulative process of income
market. At the same time, as majority of the people are propagation and investment expansion based on the
poor, they have low propensity to consume. Therefore, ‘interaction’ of the multiplier and accelerator is attained
consumption will not increase. Increase in the supply of in the economy called ‘leverage effects’. This pheno-
goods and decline in the demand create under consump- menon continues till the economy touches the ‘full
tion and hence over production. employment ceiling point’. In a dynamic economy, there
6. Innovation Theory—This theory of business will be an expanding or rising ceiling and, therefore, it
cycle was developed by J.A . Schumpeter. Innovation in may take much longer than in a static set up to reach the
business leads to development of new products, new ceiling but once the ceiling is touched the cycle takes the
production processes, new markets, discoveries of new downward swing.
raw material, changes in the market structures-such as The upper turning point of income is determined by
the creation of monopolies, formation of cartels, entry the availability of resources like population, technology,
and exit of firms etc. It encourages entrepreneurs to capital stock, etc. The process of expansion hits against
enhance business activities. When the new product the ceiling and turns down or in some cases when the
becomes successful, other entrepreneurs will also interaction of the multiplier and accelerator is not strong
produce similar products. This will result in cumulative enough, the downswing starts even before the ceiling is
expansion and prosperity. When the innovation is touched. The decline in investment in the downswing
adopted by many, supernormal profits will be competed also operates cumulatively but the decline cannot
away. Firms incurring losses will go out of business. continue indefinitely because of the lower limit which
Employment, output and income fall resulting in depends upon the fact that gross investment cannot fall
depression. Money, capital, and bank credit play a below zero.
Economics (NET) | 199U
At the lower level, some essential and basic is short lived and may be over and autonomous
investment for replacing inventories and equipment investment falls back to its old level, yet on account
becomes inevitable; the autonomous investment starts of explosive S and I coefficients the multiplier and
asserting itself once more at this stage and is higher than acceleration interaction takes the economy from
the amount of disinvestment. The increment of net P 0 to P1.
investment causes an upturn of aggregate income and ● However, the upward expansion cannot continue
takes the economy along an upward phase. Hicks has indefinitely and must finally reach the ceiling FF at
expressed the opinion that while the upswing is the some point as P1 . As soon as the expansion of
result of the interaction of multiplier and accelerator, the output hits the point P1 the cycle reaches the top of
downswing is largely a product of the multiplier (the the boom and the output hits the hump. It has got to
accelerator remaining inoperative for the most part). come down but it does not fall with a crash
Thus, the lower turning point during depression is immediately but creeps along the ceiling for some
caused when the amount of disinvestment turns out to be time on account of lagged effects and adjustments
less than the amount of autonomous investment, so that, of induced investments.
there is increase in net investment turning the cycle on a ● After creeping along for a while and it will creep as
path to prosperity. Hicks theory of the cycle is shown in long as the lagged effects of induced investments
the following Figure. are there; afterwards it moves down and the
F downward trend of cycle begins. But once the output
Y
starts falling it can no longer remain even along the
P1
Q1 E equilibrium path EE.
IT
LIM ● Once a fall starts it is interesting to note that it does
PER L
UP P2 not halt at the equilibrium level on account of the
Q2
F
A
effects of past investments and because current
P0 q investments are below the level at which output can
E 'g' be maintained at equilibrium level, hence the fall
NT doesn’t stop at equilibrium level and it moves down.
ME
V EST
L S IN 8. J. M. Keynes’s theory of Business Cycle—Prof.
OU J.M. Keynes never propagated theory of business cycle
N OM
TO as such, however, he witnessed the ‘great depression of
A AU
thirties’ very closely and suggested various measures to
overcome the situations like depression or the recession
in the economy. According to Keynes, a business cycle
TIME
occurs due to the fluctuations in the rate of changes in
Fig. 11 the marginal Efficiency of Capital (MEC).
In the above figure 11— During the era of high value of MEC, investment
● Line AA shows autonomous investment, which is increases by leaps and bounds which results into the rise
assumed to be growing at a constant rate ‘g’. in income and employment. Through the activation of
● EE shows the equilibrium path of output which multiplier effect, there would be multiple increase in
depends upon AA and is deduced by applying ‘super income in relation to each increase in investment. Thus,
multiplier’ to it. a cumulative rising trend occurs during expansionary
● LL represents the lower equilibrium path of output phase. Businessmen are optimistic about future during
or floor or bottom or lower limit. this phase , expecting higher profits.
● FF represents the full employment ceiling showing As the economy enters the boom stage through
maximum expansion when scarcity of resources expansion , certain economic forces come into operation
occurs. It is supposed to be above the equilibrium which tend to lower the MEC. It happens because of two
path EE and is assumed to grow at the same rate at reasons—
which AA is growing. I. As more built up in the capital goods investment
● Up to P0 the economy moves along equilibrium path occurs, the supply, prices of capital goods increase.
of output and employment EE. Suppose at P 0 there II. The yields on the capital goods tend to fall below
is a burst of autonomous investment following, say, the expectation level as more and more capital
an invention. This will cause a disturbance and the goods are build up.
path of output moves steadily away from EE to FF. The collapse in the MEC is the predominant cause
This happens despite the fact that although the burst of the business crisis.
200U | Economics (NET)
Objective Questions
1. When the intrinsic value of money and its face 7. The speculative demand for money, according to
value are equal, it is called— Keynes, is a function of—
(A) Token money (B) Full-bodied money (A) Rate of interest (B) Level of income
(C) Quasi-money (D) Fiat money (C) Level of savings (D) Level of output
2. Which one of the following according to Miltan 8. Anticipation of an increase in the rate of inflation
Friedman is not a key determinant of the demand will—
for money ? (A) Cause the short run Phillips curve to shift
(A) Aggregate wealth upward to the right
(B) Precautionary motive (B) Cause an increase in the real rate of interest
(C) Relative rates of return obtainable on different (C) Reduce the normal rate of unemployment in the
forms of assists long run
(D) Physical non-human capital goods and human (D) Cause the rate of inflation to slow down, other
capital things remaining constant
3. Which one of the following factors affects velocity 9. Fisher’s quantity theory of money has mainly been
of circulation of money ? criticised because—
(A) Time unit of income receipts (A) It does not tell us as to how the change in the
(B) Frequency of transaction quantity of money influence the price level
(C) Liquidity preference (B) It over emphasises the demand for money by
(D) All of the above assuming supply of money as being constant
4. Which one of the following statements is correct (C) It analyses short term variations in the value of
is respect of equation of exchange M V = PT ? money
(D) It emphasises too much on the price level
(A) If M i s doubled, leaving V and T unaffected,
then P must double 10. Gresham’s law explains that—
(B) If M is doubled, leaving V unaffected, then P (A) Two grams of silver is equal to half gram gold
will be halved for conversion
(C) If M and T are doubled, leaving V unaffected, (B) Good money chases bad money out
then P will be halved (C) Velocity of circulation of money fluctuates
(D) If M is doubled, V is halved, leaving T rapidly
unaffected, then P gets multiplied 3 times (D) Bad money drives good money out of circu-
5. Match List-I (Name of the Economist) with List-II lation
(Concept /Theory) and select the correct answer 11. Match List-I (Economists) with List-II (Concepts)
using the codes given below the Lists— and select the correct answer using the codes given
List-I below the lists—
(a) A.W. Phillips (b) Findlay Shirras List-I List-II
(c) J.M. Keynes (d) R.S. Sayers (a) Keynes 1. Money illusion
List-II (b) Modigliani 2. IS-curve
1. Central Bank (c) Hicks 3. Life cycle hypothesis
2. Trade-off between wage a n d unemployment (d) Pigou 4. Liquidity trap
rate Codes :
3. Theory of profit (a) (b) (c) (d)
4. Taxable capacity (A) 4 1 2 3
5. Liquidity trap (B) 2 3 4 1
Codes : (C) 4 3 2 1
(a) (b) (c) (d) (D) 2 1 4 3
(A) 5 4 1 2
12.
(B) 2 3 5 1
(C) 5 3 1 2
(D) 2 4 5 1
6. To which one of the following, does the liquidity
trap correspond ?
(A) Consumption function
(B) Production function
(C) Money demand function
(D) Labour demand function
Economics (NET) | 201U
In respect of the diagram given above, consider the 20. Match List-I with List-II and select the correct
following statements— answer using the codes given below the lists—
1. Saving (S) is autonomous. List-I
2. Investment (I) is autonomous. (a) A continuous increase in general price level.
3. Saving is determined by income (Y). (b) Raising prices deliberately to relieve depre-
4. Investment (I) is not autonomous. ssion.
Which of these statements are correct? (c) Fall in prices without a decline in the existing
(A) 2 and 3 (B) 3 and 4 level of employment, out put and income.
(C) 1 and 4 (D) 1 and 2
(d) Recession accumpanied by inflation.
13. Assume consumption function of an economy to be
C = R 30 Crore + 0·8 Y. Investment is R 40 Crore. List-I
Then, the equilibrium level of income is— 1. Hyper inflation 2. Disinflation
(A) R 150 crore (B) R 350 crore 3. Stagflation 4. Reflation
(C) R 55 crore (D) R 10 crore Codes :
14. M2 , money supply measure in India, constitutes— (a) (b) (c) (d)
(A) M1 + all post-office deposits (A) 5 1 2 4
(B) M1 + time deposits of commercial banks (B) 1 3 2 5
(C) M1 + post-office saving deposits (C) 1 4 5 3
(D) 5 4 2 3
(D) M3 + all post-office deposits
21. Consider the following types of assets held by a
15. Consider the following items— commercial bank—
1. Currency with the public. 1. Money at call and short notice
2. Cash with banks. 2. Government securities
3. Post-office saving bank deposits. 3. Advances
4. Time deposits with the banks Reserve money 4. Cash
includes. The correct DECREASING order (highest to
(A) 1, 2 and 3 (B) 2, 3 and 4 lowest) of liquidity of the given assents is—
(C) 1 and 2 (D) 1, 2, 3 and 4 (A) 4, 1, 3, 2 (B) 1, 4, 3, 2
16. According to Keynes, transaction demand for (C) 1, 4, 2, 3 (D) 4, 1, 2, 3
money L can be stated as (symbols have the usual 22. In the given diagram, LK represents—
meaning)—
(A) L = K(y) (B) L = I(r)
(C) L = K(y) + I(r) (D) L=Y – I
17. Supply of money remaining the same, when there is
an increase in demand for money, there will be—
(A) A fall in the level of prices
(B) An increase in the rate of interest
(C) A decrease in the rate of interest
(D) An increase in the level of income and
employment
18. Fisher’s equation of exchange establishes—
(A) Direct relationship between money and prices (A) Deficiency of demand
(B) Inverse relationship between money and prices (B) Excess demand
(C) Direct and proportionate relationship between (C) Deficiency of supply
money and prices (D) Excess supply
(D) Inverse and proportionate relationship between 23. Assuming that : change in investment Δ I = 25
money and prices marginal propensity to save (MPS) = 0·5 marginal
19. Consider the following statements— propensity to investment (MPI) = 0 the change in
A rise in the general level of prices may be caused income Δy will equal to—
by— (A) 25 (B) 50
1. An increase in the money supply. (C) 200 (D) 100
2. A decrease in the aggregate level of out-put.
3. An increase in the effective demand. 24. Given the total investment expenditure an increase
Of these statements— in the propensity to save will lead to a—
(A) 1 alone is correct (B) 1 and 2 are correct (A) Fall in the rate of interest
(C) 2 and 3 are correct (D) 1, 2 and 3 are correct (B) Fall in income
202U | Economics (NET)
(C) Rise in the rate of interest 30. In the given diagram, speculative demand for
(D) Rise in income money curve l (r) has four regions R1 , R2 , R3 , and
25. Investment multiplier can be obtained from R 4 . Liquidity trap is indicated by the regions—
(symbols have the usual meaning)—
1 1
(A) (B)
Δc Δc
1– 1–
Δs Δy
1 1
(C) (D)
Δc Δc
1+ 1+
Δs Δy
26. If there is an expectation of a rise in the price level,
investment will be encouraged because—
(A) There will be an increase in the production of
capital goods
(B) There will be a rise in the prospective return (A) R 1 alone (C) R 1 and R4
from capital
(B) R 3 and R4 (D) R 4 alone
(C) People will save more and the interest rate will
fall 31. According to Keynes, marginal propensity to
(D) The cost of production of capital goods will fall consume—
27. The aggregate demand curves slopes downwards (A) Can never exceed unity
because an increase in price level leads to— (B) May exceed unity when disserving occurs
(A) Reduction in real balances and increase in (C) Can never exceed the average propensity to
interest rate consume
(B) Increase in the interest rate and reduction in (D) Is the reciprocal of the marginal propensity to
aggregate spending save
(C) Reduction in real balances alone
(D) Reduction in real balances, increase in interest 32. Super multiplier refers to—
rate and reduction in aggregate spending (A) Interaction of the Multiplier and the Accelerator
28. According to permanent income hypothesis, the— (B) Reciprocal of the marginal propensity to con-
(A) Long-run aggregate Average propensity to sume
consume (APC) equals long-run aggregate (C) Capital output ratio
Marginal Propensity to consume (MPC) (D) Budget multiplier
(B) Long-run aggregate APC is greater than the 33. A Production Possibility Frontier (PPF) is shown in
long run aggregate MPC
the given diagram. A Less Developed Country
(C) Long-run aggregate APC is less than the long-
(LDC) will be—
run aggregate MPC
(D) APC of every individual is equal irrespective of
different levels of income of families
29. Match List-I with List-Il and select the correct
answer using the codes given below the lists—
List-I
(a) Supply creates its own demand.
(b) Choice reveals preference.
(c) Division of labour is limited by the extent of
the market.
(A) Inside the PPF
(d) Corn in high not because Samuelson rent is
paid, but rent is paid because corn is high. (B) En the PPF
List-II (C) Above the PPF
1. J.B. Say 2. Adam Smith (D) At a point which coincides with the origin
3. Ricardo 4. Keynes 34. Consider the following :
Codes : 1. Money supply M1 .
(a) (b) (c) (d)
(A) 1 4 2 3 2. Saving deposits with Post Office saving banks.
(B) 1 4 3 2 3. Net time deposits of banks.
(C) 4 1 3 2 4. Total deposits of the Post Office saving banks
(D) 4 1 2 3 excluding NSC.
Economics (NET) | 203U
The measure of money supply, M3 would include— List-II
(A) 1, 2 and 3 (B) 1 and 3 1. IS relation 2. Relation
(C) 1 and 4 (D) 3 and 4 3. Investment relation 4. LM relation
35. The correct sequence of the stage through which a Codes :
trade cycle in an economy passes is— (a) (b) (c) (d)
(A) Depression, Inflation, Reflation, Disinflation (A) 4 3 2 1
(B) Reflation, Disinflation, Inflation, Depression (B) 4 3 1 2
(C) Depression, Reflation, Inflation, Disinflation (C) 2 4 3 1
(D) Inflation, Depression, Disinflation, Reflation (D) 2 4 1 3
36. The credit multiplier is based on which of the 41. Excess of exante savings over exante investment
following assumptions ? means that—
1. The cash reserve ratio remains constant. (A) income will fall
2. The banks maintain a fixed relationship bet- (B) income will rise
ween deposit liabilities and cash reserves. (C) income will remain the same
3. People prefer higher cash holding. (D) price will rise and inventories will accumulate
4. People have well developed banking habits. 42. Which one of the following consumption func-
tions corresponds to the income multiplier, R = 4 ?
Select the correct answer using the codes given (A) c = 24 + 0·5y (B) c = 240 + 0·25y
below—
(C) c = 24 + 0·55y (D) c = 240 + 0·75y
Codes :
43. Consider the following statements—
(A) 1, 2 and 3 (B) 2, 3 and 4
1. Points to the left of the IS curve indicate excess
(C) 1, 3 and 4 (D) 1, 2 and 4
supply of goods.
37. If cash reserve ratio is 40% and the commercial 2. Points to the right of the LM curve indicate
banks get a fresh cash of R 15 crores as a result of excess demand for money.
government spending then the increase in loans 3. Points to the right of the IS curve indicate
advanced by the commercial banks will be— excess supply of money.
(A) R 37·5 crores (B) R 40 crores 4. Points to the right of the IS curve indicate
(C) R 5 crores (D) R 30·5 crores excess supply of goods.
38. Liquidity preference refers to— Of these statements—
(A) The extent to which investors prefer to keep (A) 2 and 4 are correct
their assets in money (B) 1 and 3 are correct
(B) RBI’s share holdings in other financial insti- (C) 2 and 3 are correct
tutions (D) 1, 2 and 3 are correct
(C) Community’s preference for gold
44. Suppose, MPC falls. The IS curve shifts to the left.
(D) Community’s effective demand for capital Then what happens ceteris paribus ?
goods
(A) The level of equilibrium becomes lower
39. Consider the following statements : (B) The level of equilibrium becomes higher
Intersection of the IS and LM curves corresponds
(C) There is no change in equilibrium
to—
1. Equilibrium in the real sector. (D) Only the rate of interest becomes lower
2. Equilibrium in the monetary sector. 45. Match List-I with List-II and select the correct
3. Liquidity trap necessarily. answer using then codes given below the Lists—
4. Walrasian general equilibrium. List-I
Of these statements— (a) Life Cycle Hypothesis
(A) 1 and 3 are correct (b) Permanent Income Hypothesis
(B) 1 and 2 are correct (c) Absolute Income Hypothesis
(C) 2, 3 and 4 are correct (d) Relative income Hypothesis
(D) 1, 2, 3 and 4 are correct
List-II
40. Match List-1 with List-II and select the correct
answer using the codes given below the lists— 1. Keynes 2. Duesen berry
List-I 3. Friedman 4. Ando-Modigliani
(a) c = 9 + 0·1y Codes :
(b) 0·25y – 20i – 193 = 0 Consumption (a) (b) (c) (d)
(c) 0·06y + 29i – 500 = 0 (A) 4 3 1 2
(d) I = 50 – 10i (B) 4 3 2 1
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(C) 3 2 1 4 (B) An increase in the quantity of money demanded
(D) 3 2 4 1 and an increase in the rate of interest
46. The author of employment multiplier is— (C) A decrease in the quantity of money demanded
and a decrease in the rate of interest
(A) Lord Beveridge (B) Keynes
(D) An increase in the quantity of money demanded
(C) R.F. Kahn (D) J.R. Hicks and a decrease in the rate of interest
47. In a two sector economy, the saving and investment 56. Portfolio theory of the demand for money assumes
functions are as follows— that the individual—
S = –10 + 0·2Y (A) Disregards risk (B) Is risk neutral
I = –3 + 0·1Y (C) Is risk lover (D) Is risk averse
what will be the equilibrium level of income?
57. If the rate of interest increases, people holding
(A) 15 (B) 80
bonds will—
(C) 90 (D) 100
(A) Experience a capital gain on the bonds
48. The IS-LM model has been formulated by— (B) Experience a capital loss on the bonds
(A) J.R. Hicks (B) F. Modigliane (C) Not be able to find a buyer should they decide
(C) P.A. Samuelson (D J.M. Keynes to sale
49. The speculative demand for money is— (D) Experience neither capital gains nor a capital
(A) Interest determining loss
(B) Interest determined 58. When the demand for money is infinitely interest
(C) Income determining elastic, the effectiveness of an expansionary
(D) Income determined monetary policy is—
50. Which one of the following is represented by M3 ? (A) The highest (B) Mode rate
(A) M1 + post office savings bank deposits (C) Very low (D) Nil
(B) Currency with the public + demand deposits 59. Assertion (A) : Real rate of interest is better
(C) M1 + time deposits with bank indicator of returns on savings than nominal rate of
interest.
(D) None of these
Reason (R) : The real rate of interest is estimated
51. In an economy where people always consume half after removing the effect of the expected rate of
of any additional income and save the other half, an inflation.
additional Govt, expenditure of R 20,000 can create (A) Both A and R are true and R is the correct
an additional income of— explanation of A
(A) R 10,000 (B) R 40,000 (B) Both A and R are true but R is not a correct
(C) Zero (D) R 20,000 explanation of A
52. When a linear consumption function undergoes a (C) A is true but R is false
parallel shift down wards, the investment multiplier (D) A is false but R is true
will— 60. Assertion (A) : If the government expenditure and
(A) Fall (B) Rise marginally taxation are increased by an equal amount, the
(C) Remain as before (D) Become double equilibrium income of the economy will remain
53. If the consumption function passes through the the same, ceteris paribus.
origin, then APC = MPC it must be— Reason (R) : A given change in the government
(A) Linear without any intercept expenditure affects aggregate spending more than
(B) Non-linear without any intercept an equal amount of tax.
(C) Linear with a negative intercept on the income (A) Both A and R are true and R is the correct
axis explanation of A
(D) Linear with a positive intercept on the (B) Both A and R are true but R is not a correct
consumption axis explanation of A
54. Given the consumption function— (C) A is true but R is false
c = 205 + 0·9y (D) A is false but R is true
what is the multiplier ? 61. Assertion (A) : In India, monetary policy alone
(A) 0·09 (B) 10·0 cannot eliminate inflation.
(C) 0·9 (D) 9·00 Reason (R) : There are structure factors which
55. Suppose that the money supply in an economy is make prices rigid in the downward direction but
constant and the demand for money is a function of flexible in the upward direction.
income and interest rate, then if the level of income (A) Both A and R are true and R is the correct
increases, there will be— explanation of A
(A) A decrease in the quantity of money demanded (B) Both A and R are true but R is not a correct
and an increase in the rate of interest explanation of A
Economics (NET) | 205U
(C) A is true but R is false 68. If GNP is 16% higher than the last year’s and the
(D) A is false but R is true rate of inflation is 9%, production in the economy
62. Assertion (A) : Keynes pointed out that during has grown by—
depression, private investment is not induced. (A) 4% (B) 5%
Reason (R) : The marginal productivity of capital is (C) 6% (D) 7%
high in depression. 69. Which of the following is a transfer payment ?
Choose the correct answer from the code given (A) Payment made to housewife
below— (B) Pocket allowance to children
(A) Both A and R are true and R is the correct (C) Maintenance allowance to old parents
explanation of A
(D) All of the above
(B) Both A and R are true and R is not the correct
explanation of A 70. The difference between gross domestic product
(C) A is true but R is false and net domestic product equals—
(D) A is false but R is true (A) Transfer payments (B) Depreciation cost
63. Assertion (A) : Money is a link between the present (C) Indirect taxes (D) Subsidies
and the future. 71. Which of the following is not correct regarding IS-
Reason (R) : Money is a store of value. LM model ?
(A) Both A and R are true and R is the correct (A) Saving is the increasing function of income
explanation of A (B) Investment is the function of both the rate of
(B) Both A and R are true but R i s not a interest and the level of income
correct explanation of A (C) IS curve and LM curve show the equilibrium
(C) A is true but R is false in the money market and in the goods market
(D) A is false but R is true respectively
64. Assertion (A) : According to Baumol, the tran- (D) The interaction of IS and LM schedules shows
sactions demand for cash varies with respect to the the simultaneous equilibrium in the goods
square-root of the volume of transactions. market and in the money market
Reason (R) : Transaction demand for money is a
function of income. 72. In the IS-LM model, supply of money is assumed
(A) Both A and R are true and R is the correct as—
explanation of A (A) An increasing function of the rate of interest
(B) Both A and R are true but R is not a correct (B) A function of the level of income
explanation of A (C) A decreasing function of the rate of interest
(C) A is true but R is false (D) Exogenously given
(D) A is false but is true 73. In the IS-LM model, the demand for liquidity is
65. Assertion (A) : There would be no trade-off assumed as—
between inflation and unemployment even in the (A) A function of the rate of interest
short run if people’s expectations are rational. (B) A function of the level of income
Reason (R) : Rational expectations imply fore- (C) Both (A) and (B)
casting the future correctly. (D) None of these
(A) Both A and R are true and R is the correct 74. If we consider the goods market in isolation, then a
explanation of A situation in which C + I > Y will lead to—
(B) Both A and R are true but R is not a correct (A) A rise in income
explanation of A (B) A fall in the interest rate
(C) A is true but R is false (C) A fall in income
(D) A is false but R is true (D) An increase in money supply
66. Assertion (A) : The major distinguishing feature of 75. The Keynesian ISLM model—
a commercial bank is its ability to create money. (A) Is an entirely demand oriented theory
Reason (R) : It has a legal power to do so. (B) Is an entirely supply-oriented theory
(A) Both A and R are true and R is the correct
(C) Applies to the long run determination of output
explanation of A
(B) Both A and R are true but R is not a correct (D) Assumes perfectly inelastic supply of output
explanation of A function up to the full-employment level
(C) A is true but R is false 76. In the neo-classical version of the IS-LM model—
(D) A is false but R is true (A) Prices are assumed to be endogenous
67. Which of the following is not, by definition, equal (B) Costs are assumed to be exogenous
to National Income ? (C) Real output is determined endogenously
(A) National output (B) National expenditure (D) Goods market establishes the equilibrium price
(C) National product (D) National wealth level
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77. If the marginal propensity to save falls, then— (C) The price level will rise in the neo-classical IS-
(A) IS curve will shift up to the right but its slope LM model
will remain unchanged (D) Real output will increase in the neo-classical
(B) IS curve will shift to the left and its slope will IS-LM model
also be changed 86. The fiscal policy multiplier is larger in the
(C) IS curve will shift to the right and its slope will Keynesian IS-LM model if—
also be altered (A) The more interest elastic is the demand for
(D) IS curve will shift to the left but its slope will money
remain unaltered
(B) The more interest elastic is the demand for
78. If the money supply were reduced, then— investment goods
(A) The IS curve would shift up to the left (C) The less interest elastic is the demand for
(B) The IS-curve would shift up to the right money
(C) The LM curve would shift up to the right (D) LM curve is vertical
(D) The LM curve would shift up to the left
87. The size of the money multiplier is larger in the
79. A fall in the demand for money would cause— Keynessian IS-LM model if—
(A) A rightward shift in the IS function (A) The more interest elastic is the demand for
(B) A leftward shift in the IS function money
(C) A rightward shift in the LM function (B) The more interest elastic is the demand for
(D) A leftward shift in the LM function investment goods
80. In the ISLM model, saving function is defined (C) The less interest elastic is the demand for
as S = – a + sY, where ‘a’ is constant and s is investment goods
marginal propensity to save. An increase in ‘a’ (D) The demand for investment goods is perfectly
shifts— inelastic
(A) The IS function up to the right 88. Which of the following is not correct regarding
(B) The IS function down to the left Keynessian IS-LM model ?
(C) The LM function up to the left (A) The fiscal policy multiplier will be larger if the
(D) The LM function down to the right demand for money is more interest elastic
(B) The fiscal policy multiplier will be larger the
81. An increase in the tax rate will cause—
demand for investment goods is less interest
(A) IS curve to shift up to the right elastic
(B) IS curve to shift down to the left (C) The money multiplier will be larger if the
(C) LM curve to shift up to the left demand for money is more interest elastic
(D) LM curve to shift down to the right (D) The money multiplier will be larger if the
82. An equal initial increase in government demand for capital goods is more interest
expenditure and taxation will— elastic
(A) Shift the IS curve down to the left 89. In the neo-classical ISLM model change in the
(B) Leave the IS curve unchanged money supply—
(C) Shift the IS curve up to the right (A) Will change the equilibrium level of output
(D) Only alter the slope of the IS curve (B) Will change the rate of interest
83. Which of the following is not correct ? (C) Will affect the equlibrium price level
(A) There is an inverse relationship between the (D) Will affect the investment function
price of bonds and the rate of interest 90. In the neoclassical IS-LM model fiscal policy
(B) IS curve slopes downward to the right affects—
(C) LM curve slopes upward to the right 1. The price level.
(D) An increase in the money supply will shift the 2. The interest rate.
LM curve up to the left 3. The real national output.
84. An increase in investment will shift— (A) Only 1 and 2 (B) 2 and 3
(A) The IS curve upwards to the right (C) Only 1 and 3 (D) 1, 2 and 3
(B) The IS curve downward to the left 91. In the estimation of national income which of the
(C) The LM curve upward to the left following is not included ?
(D) The LM curve downward to the right (A) Rent (B) Interest
85. Which of the following is not correct about the (C) Dividends (D) Transfer payments
consequences of an increase in the investment ? 92. National product at factor cost used for studying
(A) IS curve will shift upward to the right the—
(B) Interest rate will increase in the Keynesian (A) Final products by the origin of industry
IS-LM model (B) Expenditure by commodity groups
Economics (NET) | 207U
(C) Payments to factor owners (C) Adding net factor income from abroad
(D) Consumer goods and services (D) Subtracting net factor income from abroad
93. National income is less than NNP at market price by 103. If we know the GNP, then we calculate GDP by—
the amount of— (A) Adding net indirect taxes
(A) Transfer payments (B) Direct taxes (B) Subtracting net indirect taxes
(C) Net indirect taxes (D) Depreciation (C) Adding net factor income from abroad
94. Interaction of the multiplier and acceleration is (D) Subtracting net factor income from abroad
known as— 104. NNP for a given year can be defined as—
(A) Investment multiplier (A) The profits of manufacturing units after
(B) Employment multiplier deducting taxes
(C) Super multiplier (B) The real value of final and intermediate goods
(D) Dynamic multiplier (C) The market value of all the final goods and
services
95. Which one of the following items is excluded in
(D) The total profits of all the entrepreneurs
calculating national income ?
(A) Unemployment allowance 105. Which of the following is not included in disposable
(B) Paid household job income ?
(C) Profit of public sector undertakings (A) International transfer payments
(B) Unemployment allowances
(D) Royalty
(C) Direct taxes
96. Which of the following is not to be included in (D) Corporate dividends
national product ?
106. If the consumption function is given by C = 20 +
(A) Wheat produced by the farmer and consumed 3/4 Y, then the value of multiplier will be—
by him (A) 4/3 (B) 1/4
(B) house built by the owner himself (C) 4 (D) 20
(C) Income from the sale of old car
107. If the saving function is given by S = –25 + 1/4 Y,
(D) Machine made by firm A and sold to B
then what will be the value of marginal propensity
97. Depreciation means— to consume ?
(A) Destruction of a plant in a fire accident (A) 1/4 (B) 25
(B) Loss of equipment and machines over time due (C) 3/4 (D) 4
to normal wear and tear 108. If the consumption function is given by C = 25 + y,
(C) Closure of the firm due to lockout then what are the values of autonomous consumption
(D) Unanticipated loss and total consumption when income is 300 ?
98. The difference between GNP and GDP is equal to— (A) 2/3 and 200 (B) 25 and 200
(A) Gross foreign investment (C) 25 and 295 (D) 2/3 and 225
(B) Net foreign investment 109. On the basis of above example, what is the value of
(C) Net export total saving ?
(D) Net factor income from abroad (A) 100 (B) 125
99. National product at current prices is higher than (C) 75 (D) cannot be determined
national product at constant prices during a period 110. Which of the following is a flow concept ?
of— (A) Wealth (B) Money
(A) Rising prices (B) Falling prices (C) Total saving (D) Income
(C) Stable prices (D) Changing costs
111. Which of the following is not correct ?
100. The difference between GNP and NNP is— (A) In measuring GNP, all kinds of goods and
(A) Indirect taxes services produced in a country during a
(B) Direct taxes year are measured in terms of money
(C) Depreciation (B) In estimating GNP, only the final products are
(D) Net factor income from abroad taken into account
(C) The sale and purchase of shares of existing
101. Y = C + I + G + (X – M) is— companies are included in GNP
(A) An equation (B) An identity (D) The income earned through illegal activities
(C) A formula (D) A function is not included in the GNP
102. If we know the GNP at market prices we calculate 112. Which of the following is not included in the
GNP at factor cost by— estimation of NNP by income method ?
(A) Adding net indirect taxes (A) Interest
(B) Subtracting net indirect taxes (B) Dividends
208U | Economics (NET)
(C) Undistributed profits (C) NNP at market price
(D) Depreciation (D) NNP at factor cost
113. GNP, according to expenditure method, exclude— 122. The difference between GNP and NNP is—
(A) Private consumption expenditure (A) Net indirect taxes
(B) Gross domestic private investment (B) Net factor income from abroad
(C) Net foreign investment (C) Depreciation
(D) Government expenditure (D) Personal income taxes
(E) None of these 123. National income expressed in terms of a general
114. The term ‘social accounting’ was first introduced level of prices of a particular year taken as base is
into economics by— known as—
(A) Marshall (B) Hicks (A) NNP at market price
(C) Keynes (D) Cooper (B) NNP at factor cost
115. NNP is equal to— (C) NNP at current prices
(A) GNP – depreciation (D) Real income
(B) GNP + depreciation 124. Classical theory of employment is based on some
(C) GNP – net export assumptions. Which of the following is not a n
(D) GNP + net export assumption of the classical theory of employment ?
(A) Perfect competition
116. The total income received by the individuals of a
country from all sources before deducting direct (B) Full employment
taxes is known as— (C) Money wages and real wages are directly
(A) Private income related
(B) Personal income (D) Wages and price are fixed
(C) Personal disposable income 125. According to classical, full employment in the
(D) None of these labour market is restored through—
(A) The manipulation of prices
117. GNP includes—
(B) The manipulation of wages
1. Consumer goods and services.
(C) Government intervention
2. Gross private domestic investment.
3. Goods and services produced by government. (D) Monopolistic behaviour of labour unions
4. Net exports. 126. In the real sector, the equality between saving and
(A) 1, 2 and 3 only (B) 2, 3 and 4 only investment, according to classical economics, is
(C) 1, 3 and 4 only (D) 1, 2, 3 and 4 brought out by—
118. NNP according to income method includes— (A) Price mechanism
1. Wages and salaries (B) Manipulation in wage rates
2. Royalty (C) The adjustment of the rate of interest
3. Net indirect taxes (D) The adjustment of real income
4. Depreciation 127. The point of interaction of aggregate supply curve
(A) 1, 2 and 3 only (B) 2, 3 and 4 only and aggregate demand curve is known as the point
(C) 1 and 2 only (D) 2 and 3 only of—
119. GNP at market prices minus depreciation minus (A) Excess demand (B) Deficient demand
indirect taxes + subsidies is equal to— (C) Effective demand (D) Aggregate demand
(A) NNP at market price
128. Which of the following is not correct regarding
(B) GNP at factor cost
Keynes’ psychological law of consumption ?
(C) National income
(D) NDP at factor cost (A) When income increases, consumption also
increases but by a smaller amount
120. The sum of money value of the income produced by (B) The increased income will be divided in some
and accruing to the various factors of production in proportion between consumption and saving
one year in a country is known as— (C) Increase income always leads to an increase in
(A) GNP at market price both consumption and saving
(B) GNP at factor cost
(D) As income increases APC also increases
(C) NNP at market price
(D) NNP at factor cost 129. Which of the following is not correctly matched ?
121. The net value of final goods and services evaluated (A) Absolute Income Hypothesis— Keynes
at current prices is known as— (B) Relative Income Hypothesis—Duesenberry
(A) GNP at market price (C) Permanent Income Hypothesis—Friedman
(B) GNP at factor cost (D) Life Cycle Hypothesis—Baumol and Tobin
Economics (NET) | 209U
130. Which of the following is not correct ? 137. The life cycle hypothesis of consumption function is
(A) O < MPC < 1 (B) O < MPS < 1 propounded by—
(C) MPC > 1 (D) MPC + MPS = 1 (A) M. Friedman (B) Duesenberry
131. The short-run consumption function ratchets (C) Keynes (D) Ando and Modigliani
upwards when income increases in the long-run but 138. Which of the following is not a part of investment ?
it does not shift down to the earlier level when (A) New plant
income declines. It is called— (B) Construction of public works
(A) Demonstration effect
(C) Purchase of existing share and bonds
(B) Ratchet effect
(D) Net foreign investment
(C) Pigou effect
(D) Keynes’ effect 139. The ratio of change in investment to the change
in income is called—
132. Match list-I to list-II— (A) Multiplier
List-I (B) Average propensity to invest
(a) Demonstration effect (C) Marginal propensity to invest
(b) Wealth effect (D) Accelerator
(c) Interest rate effect
140. Autonomous investment is influenced by—
List-II
(A) The level of income
1. Keynes 2. Duesenberry
(B) The rate of interest
3. Pigou
(C) Both (A) and (B)
Codes :
(D) Neither (A) nor (B)
(a) (b) (c)
(A) 1 2 3 141. Which of the following is not a determinant of
(B) 2 3 1 investment ?
(C) 3 2 1 (A) The cost of capital asset
(D) 3 1 2 (B) The expected rate of returns
133. Which of the following is not correctly matched ? (C) The market rate of interest
(A) Wealth effect—Pigou (D) The rate of inflation
(B) Acceleration principle—Clark 142. The rate which equates the supply price of a capital
(C) Permanent Income—Duesenberry Hypothesis asset to its prospective yield is called—
(D) Super Multiplier—Hicks (A) Marginal efficiency of investment
134. If measured income is greater than permanent (B) Marginal efficiency of capital
income, then— (C) Marginal productivity of capital
(A) Transitory income will be less than permanent (D) The market rate of interest
income 143. If the long-run consumption function is propor-
(B) Transitory income will be zero tional, then—
(C) Transitory income is positive (A) MPC < APC (B) MPC > APC
(D) Transitory income is negative (B) MPC = APC (D) MPC = APC = 1
135. Which of the following is not correct regarding 144. The excess of income over consumption, according
permanent income hypothesis ? to Keynes, is termed as—
(A) There is no correlation between permanent (A) Savings (B) Investment
income and transitory income (C) Both (A) and (B) (D) None of these
(B) There is no correlation between transitory 145. Gross investment is equal to—
income and measured income
(A) Net investment + capital consumption
(C) There is no correlation between permanent and
(B) Net investment + depreciation
transitory consumption
(C) Net investment + replacement investment
(D) There is no correlation between transitory
(D) All of the above
income and transistory consumption
146. An entrepreneur expands his investment up to the
136. The cross sectional results of Friedman’s permanent point where—
income hypothesis give—
(A) The marginal efficiency of capital (MEC) is
(A) A non-linear consumption functions
equal to the market rate of interest
(B) Linear but non-proportional consumption
function (B) The MEC is equal to the prospective yield
(C) Linear and proportional consumption function (C) The MEC is equal to the cost of the capital
(D) A non-linear and non-proportional consump- (D) The cost of the capital is equal to the market
tion function rate of interest
210U | Economics (NET)
147. The Keynesian consumption function is assumed to (C) M = X
be— (D) Any of the above is possible
(A) Non-proportional 156. Investment can be increased by—
(B) Stable in the short-run (A) A fall in the rate of interest
(C) Stable in the long-run (B) A rise in the MEC
(D) All of the above (C) Either (A) or (B) or the combination of both
148. Suppose MPC = 0.5, MPI (marginal propensity to (D) Neither (A) nor (B)
invest) = 0.4 and autonomous investment = R 100
crore. The increase in aggregate income will be (in 157. Unemployment results from—
R crore)— (A) The deficiency of effective demand
(A) 1000 (B) 200 (B) The excess of effective demand
(C) 250 (D) 300 (C) The deficiency of supply
149. Leverage effect is associated with— (D) The excess of supply
(A) Multiplier 158. Frictional unemployment exists due to—
(B) Accelerator (A) Lack of adjustment between demand and
(C) Consumption function supply of labour
(D) Super multiplier (B) Lag between losing one job and finding
150. Financial theory of investment is propounded by— another
(A) Hicks (B) Koyak (C) Lack of necessary skills for a particular job
(C) Duesenberry (D) Jorgenson (D) All of the above
151. Match list-I with list-II— 159. Cyclical unemployment arises due to—
List-I (A) Seasonal fluctuations in demand
(a) Neo-classical theory of investment (B) Depression phase of business cycle
(b) Leverage Effect (C) Labour immobility
(c) Financial theory of Investment (D) Breakdowns of machinery
(d) Acceleration Principle 160. Structural unemployment arises due to—
List–II
(A) Deficiency in effective demand
1. Clark 2. Duesenberry
(B) Structural rigidities
3. Hicks 4. Jorgenson
Codes : (C) Structural changes in particular area, industry
(a) (b) (c) (d) and occupation
(A) 1 2 3 4 (D) All of the above
(B) 2 3 4 1 161. According to Keynes, full employment means—
(C) 3 4 1 2 (A) A situation where there were more vacant jobs
(D) 4 3 2 1 than employed men
152. According to Swedish approach, which of the (B) Zero unemployment
following is correct ? (C) A situation in which employment cannot be
(A) Ex-ante saving and ex-ante investment are increased by an increase effective demand and
always equal unemployment does not exceed the minimum
(B) Ex-post saving and export investment are allowances that must be made for the effects
always equal of frictional and seasonal factors
(C) Ex-ante saving equals ex-post investment (D) The absence of involuntary unemployment
(D) Ex-post saving equals ex-ante investment 162. Lower turning point in a business cycle refers to—
153. In a two sector economy, equilibrium output is (A) Recession (B) Expansion
determined where— (C) Downswing (D) Recovery
(A) Saving equals investment 163. Total sum of money or proceeds, which is expected
(B) Expenditure equals income from the sale of the output at a particular level of
(C) C + S = C + I employment is known as—
(D) All of the above are correct (A) Aggregate demand price
154. Y > C + I implies— (B) Aggregate supply price
(A) S = I (B) S > I (C) Effective demand rice
(C) S < I (D) None of these (D) None of these
155. If in an open economy Y > E, then 164. Aggregate supply price refers to—
(A) X > M (A) proceeds necessary from the sale of output
(B) M > X (B) expected proceeds from the sale of output
Economics (NET) | 211U
(C) the level of employment 169. In the following diagram, at the y1 level of income,
(D) the level of full employment saving is equal to—
165.
(A) CC1 (B) ee1
(C) e1e2 (D) y1e1
170. The slope of the consumption function is known
In the given diagram, effective demand has been as—
represented by the point— (A) The aggregate consumption
(A) e1 (B) C (B) The average propensity to consume
(C) r (D) NF (C) The marginal propensity to consume
166. Match list-I with list-II— (D) None of these
List-I 171. Which of the following is correct for a given
(a) Expected sale proceeds consumption function C = Ca + cY ?
(b) Necessary sale proceeds C
(A) APC = a + C and MPC = c
(c) Interaction of aggregate supply and aggre- y
gate c
(B) APC = Ca + and MPC = c
(d) Change in total consumption due to small y
change in income C
List-II (C) APC = c and MPC = a + c
y
1. Aggregate supply price Ca
2. Aggregate demand price (D) APC = + c and MPC = Ca + c
y
3. Marginal propensity to consume demand func- 172. In the consumption function, C = C + cY, C
a a
tions represents—
4. Effective demand (A) APC
Codes : (B) MPC
(a) (b) (c) (d)
(C) Consumption at income zero
(A) 1 2 3 4
(D) Consumption at previous peak income
(B) 2 1 4 3
(C) 2 1 3 4 173. In the consumption function, C = C a + cY, c
(D) 1 2 4 3 represents—
(A) APC
167. In the following diagram, the average propensity
to consume at the level of income ‘y’ is indicated (B) MPC
by— (C) Consumption at income zero
(D) Consumption at previous peak income
174. Following informations are given :
C = 20 + 3/4 Y, and Y = 80
What is the value of APC ?
(A) 0 (B) 1
(C) 0·5 (D) 0·075
(A) OC/OY (B) OY/OC 175. On the basis of the above example (Q. No. 154) the
(C) CR/RY (D) All of these value of MPC will be—
168. Which of the following is not correct ? (A) 0 (B) 1
ΔC ΔC (C) 05 (D) 0.75
(A) APC = (B) MPC =
ΔY ΔY 176. Which of the following is not correct ?
C (A) When income increases, the MPC and APC
(C) APC = (D) APC + APS = 1
Y both fall
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(B) When income falls, the MPC and APC both 183. Assuming life cycle hypothesis, let a person starts
increase working when he is 20 years old, works, until the
(C) When income increases, the MPC falls and age of 60 and expects to die at the age of 70. If this
APC increases person earns, say R 1·50 lac annually when he is
(D) When income increases, the MPC falls but 20-30 years, R 2 lac annually when he is 30–45
more than the APC years, and R 3 lac annually when he is 40–60 years,
then his life time average propensity to consume
177. In the following diagram, when the income increases is—
from 120 to 180, then what is the value of MPC ? (A) 0·60 (B) 0·70
(C) 0·80 (D) 0·90
184. Match list-I with list-II—
List-I
(a) Absolute Income Hypothesis
(b) Relative Income Hypothesis
(c) Permanent Income Hypothesis
(d) Life cycle hypothesis
List-II
(A) 0.83 (B) 0.17 1. Duesenberry 2. Friedman
(C) 1.17 (D) 0.67 3. Keynes 4. Ando and Modigliani
178. Which of the following is not correct ? Codes :
(A) 0 < MPC < 1 (B) MPC + MPS = 0 (a) (b) (c) (d)
(C) APC + APS = 1 (D) MPC + MPS = 1 (A) 1 2 3 4
179. If APC > MPC at all levels of income, it follows (B) 2 1 3 4
that— (C) 3 1 2 4
(A) MPS > APS at all levels of income (D) 3 1 4 2
(B) MPS = APS at all levels of income 185. According to absolute income hypothesis consump-
(C) MPS < APS at all levels of income tion function is—
(D) APC + APS > 1 (A) Non-linear
180. If C= 20 + 0.90 Y, then— (B) Linear but non-proportional
(A) Average propensity to consume is 20 (C) Proportional
(B) Marginal propensity to consume is 20 (D) Linear and proportional
(C) Average propensity to save is 80 186. A rise in absolute income, ceteris paribus, will led
(D) Autonomous consumption is 20 to a—
(A) Decrease in the fraction of that income
181. Equilibrium condition S for a two sector economy
devoted to consumption
requires—
(B) Increase in the fraction of that income devoted
(A) C = S (B) S = I to consumption
(C) Y = S + 1 (D) C + S = S + I (C) Decrease in fraction of that income devoted to
182. saving
c (D) Increased proportion of both consumption and
saving
187. Shift in the consumption function is caused by—
b d (A) The change in absolute income
(B) The change in permanent income
f (y)
e (C) The change in factors other than income
(D) The change in relative income
a
188. The long-run consumption function is—
(A) Proportional
(B) Non-proportional
(C) Not related to income
(D) Determined by the factors other than income
On the basis of above diagram, the equilibrium level 189. The relative income hypothesis of consumption
of output is equal to— function is propounded by—
(A) OY1 (B) OY2 (A) Keynes (B) Duesenberry
(C) OY3 (D) None of these (C) Friedman (D) Ando and Modigliani
Economics (NET) | 213U
190. The permanent income hypothesis of consumption 196. According to Duesenberry’s relative income hypo-
function is propounded by— thesis, as the level of income rises to its previous
(A) Keynes peak and pushes on to higher ground consumption
(B) Dusenberry will follow—
(C) Friedman (A) The short-run consumption curve
(D) Ando and Modigliani (B) The long-run consumption curve
191. The life cycle hypothesis of consumption function is (C) Either (A) or (B)
propounded by— (D) Both (A) and (B)
(A) Keynes (B) Duesenberry 197. Consider the following equation :
(C) Friedman (D) Ando and Modigliani
C = Y (b – c) + cy
192. Absolute income hypothesis was developed by— Where, Y is the peak level of income and y is the
(A) Duesenberry (B) Tobin and Smithies current level of income.
(C) Friedman (D) Harrod If income is steadily attaining new peaks during
193. Match list-I and list-II— prosperity, then the above consumption will
List-I become—
(A) Proportional (B) Non-proportional
(a) Employment multiplier
(C) Non-linear (D) Any of these
(b) Ratchet Effect
(c) Real Balance effect 198. “A family with any given level of income will
typically spend more on consumption if it lives in a
(d) Psychological Law of consumption
community in which that income is relatively low
List-II than if it lives in a community in which that income
1. Keynes 2. Kahn is relatively high.” This phenomenon is described
3. Patinkin 4. Duesenberry by Duesenberry as—
Codes : (A) Wealth effect
(a) (b) (c) (d) (B) Demonstration effect
(A) 1 2 3 4 (C) Ratchet effect
(B) 2 3 4 1 (D) Income effect
(C) 3 4 1 2 199. “As income falls, consumption declines but pro-
(D) 2 4 3 1 portionately less than the decrease in income
because the consumer dissave to sustain previous
194. The concept of “previous peak level of consump- standard of living”. This is called—
tion and income” is given by—
(A) Wealth effect
(A) Keynes (B) Duesenberry
(B) Demonstration effect
(C) Friendman (D) Ando and Modigliani
(C) Ratched effect
195. On the basis of following, according to relative (D) Income effect
income hypothesis, if income decreases from Y3 to
Y2 then the consumption will be equal to— 200. With reference to demand for money, match List-I
with List-II—
List-I
e c (a) Demand for money is stable
(b) Liquidity preference as behaviour towards risk
f (c) Inventory Theoretic Approach
d b
(d) No portfolio diversification
List-II
1. J. M. Keynes 2. W. Baumol
a
3. James Tobin 4. Milton Friedman
Codes :
(a) (b) (c) (d)
(A) 4 3 1 2
(B) 3 4 1 2
(A) Y3C (B) Y2b (C) 2 1 3 4
(C) Y2 (D) Y3f (D) 4 3 2 1
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201. Permanent consumption is a function of— 2. The expected rate of return of capital during its
1. The rate of interest. life time.
2. The ratio of property and non-property income 3. The market rate of interest.
to total wealth. (A) 1 and 2 only (B) 1, 2 and 3
3. The consumer’s propensity to consume. (C) 2 and 3 only (D) 1 and 3 only
(A) only 2 (B) only 1 and 2 208. As capital stock increases, the MEC—
(C) only 2 and 3 (D) 1, 2 and 3 (A) Decreases (B) Increases
(C) Remains constant (D) None of these
202. Which of the following is/are not correct regarding
Friedman’s permanent income hypothesis ? 209. The marginal efficiency of capital (MEC) is defined
1. There is no correlation between transitory and as the rate of discount which equates—
permanent incomes. (A) The cost of the capital to the market rate of
2. There is no correlation between permanent and interest
transitory consumption. (B) The market rate of interest to the natural rate
3. There is no correlation between transitory of interest
consumption and transitory income. (C) The supply price of the capital asset to the
4. Only differences in permanent income affect prospective yield of the capital asset
consumption systematically. (D) The market rate of interest to the prospective
yield of the capital asset
(A) 1 and 2 only (B) 3 and 4 only
(C) 2 only (D) None of these 210. MEC is the ratio between—
(A) The market rate of interest and the prospective
203. If transitory income is positive, then—
yield of the capital asset
(A) Measured income will exceed permanent
(B) Prospective yield of the capital asset and the
income
market rate of interest
(B) Permanent income will exceed measured (C) The market rate of interest and the supply price
income of the capital asset
(C) Measured consumption will be proportional (D) The prospective yield of the capital asset and
(D) Permanent income will be equal to measured the supply price of the capital asset
income
211. It will pay to invest in new capital asset if—
204. According to life cycle hypothesis, the consumption (A) MEC is greater than the market rate of interest
of the individual consumer depend on the—
(B) MEC is lower than the market rate of interest
1. Resources available to him.
(C) MEC is equal to the market rate of interest
2. The rate of return on capital.
3. The spending plan. (D) MEC is equal to the prospective yield of the
capital asset
4. The age at which the plan is made.
(A) 1, 2 and 3 only 212. Which of the following is not correct ?
(B) 2, 3 and 4 only (A) If the MEC is higher than the market rate of
(C) 1, 3 and 4 only interest, it pays to purchase capital asset.
(D) 1, 2, 3 and 4 (B) If the MEC is equal to the market rate of
interest, the firm is said to possess the
205. Which of the following is not correct ? optimum capital stock
(A) Induced investment is profit motivated (C) If the MEC is lower than the rate of interest,
(B) Induced investment is a positive function of no firm will borrow to invest in capital assets
income (D) If the firm possesses more than the optimum
(C) Prices, wages, interest changes influence indu- capital stock, then the equilibrium can be
ced investment established by increasing the market rate of
(D) Induced investment is income inelastic interest
213. The negative relationship between the gap between
206. Autonomous investment curve is—
actual GDP and its trend value and the difference
(A) A horizontal line parallel to income axis between actual unemployment rate and its equili-
(B) A vertical line brium value is called—
(C) Positively related with income (A) The Aggregate Supply Curve
(D) Negatively related with the rate of interest (B) The Phillips Curve
207. Which of the following, according to Keynes, is/are (C) The Natural Rate of Unemployment Hypo-
determinant(s) of investment ? thesis
1. The cost of capital asset. (D) Okun’s Law
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214. It is often true that as the economy begins to recover 221. Which one of the following is not included in
from a recession, the unemployment rate rises calculating gross national product of an economy ?
because— (A) Wages and salaries before tax
(A) As the economy initially recovers from a (B) Depreciation allowances
recession the demand for goods and services (C) Indirect taxes
falls, so the demand for workers falls (D) Subsidies
(B) As the economy begins to recover from a
recession, workers who were previously 222. For the study of the long term growth of the
discouraged about their chances of finding a economy we use—
job begin to look for work again (A) Real GNP (B) Transfer payments
(C) As the economy begins to recover from a (C) Per capita income (D) Disposable income
recession because of the errors in the way the 223. Interest on the national debt is included in—
data are collected (A) NNP (B) GNP
(D) As the economy initially recovers from a (C) Personal income (D) National income
recession, firms do not immediately increase
224. Double counting has the effect of—
the number of workers they hire. Firms wait to
hire more individuals until they are convinced (A) Underestimating national product
that the recovery is strong (B) Overestimating national product
(C) Distorting national product
215. Net foreign investment is equal to— (D) Misleading conclusions about national income
(A) Total amount of foreign investment in a
country 225. The Government sector’s contribution to GNP is
measured by—
(B) Investment by foreigners during a particular
year (A) Government purchases of goods and services
(C) Investment by local resident in a foreign (B) Wages and salaries paid by the government
country (C) Inter-governmental surplus
(D) Investment by the foreigners in this country (D) The size of the government surplus
minus investment by residents of this country 226. A certain part of corporate business income gets
in foreign countries during a given time period into the calculation of personal income. Which is
216. “Disposable income” does not include— that ?
(A) Government transfer payments
(A) Business transfer payments
(B) Social security payment made by firms
(B) Social security benefits
(C) Dividends
(C) Corporate dividends (D) None of the above
(D) Personal income taxes
227. Depreciation means—
217. Circular flow of income in a two sector model (A) Destruction of a plant in a fire accident
implies— (B) loss of equipment over time due to wear and
(A) Payments from households to firms and back tear
again
(B) Payments from firms to firms (C) Closure of the plant due to raw material
(C) Payments from households to households problem
(D) Payments from households to firms (D) Closure of the plant due to lockout
218. Which one of the following is not a Transfer 228. Which of the following is not a method of estimating
Payment in National Income accounting ? GNP ?
(A) Interest on government bonds held by Indians (A) The value added approach
(B) Drought relief payments (B) Product approach
(C) Unemployment benefits (C) Income approach
(D) Salaries of Supreme Court judges (D) The financial approach
219. Which one of the following is a transfer income ? 229. Depreciation is the loss of value of—
(A) The salary of an M.P. (A) Capital assets (B) Stocks
(B) Company dividends to share holders (C) Intermediate goods (D) Final goods
(C) Rents from house property 230. If value added at different stages are added, the total
(D) Unemployment allowance will—
220. The smallest national income accounting aggregate (A) Equal the value of the final product
is usually— (B) Underestimate the value of the final product
(A) PI (B) GNP (C) Overestimate the value of the final product
(C) DPI (D) NI (D) Misrepresent the value of the final product
216U | Economics (NET)
231. GNP is R 600 crores and NNP is R 475 crores: 238. The important leakages in the circular flow of
therefore depreciation is— income are as follows except one which ?
(A) R 100 (B) R 175 (A) Saving
(C) R 50 (D) R 125 (B) Imports
(C) Government expenditure
232. Which of the following is not true ?
(D) Taxes
(A) GNP – Depreciation = NNP
(B) GNP = GDP + Net income from abroad 239. Which of the following formula could be used for
calculating the per capita income of a country ?
(C) NNPFC = NNP MP + Subsidies – Indirect taxes
Total family income
(D) GNP = NNP – Depreciation (A)
Number of family members
233. NNP at market prices and NNP at factor costs will National Income
be equal when there is— (B)
Total Population
(A) No direct tax Total income of various industries
(B) No indirect tax (C)
Total number of industrial workers
(C) No subsidy
Total government revenue
(D) No indirect tax and no subsidy (D)
Total population
234. Gross domestic product at factor cost plus net
income from abroad minus capital consumption is 240. Per capita income increases when—
equal to— (A) GNP increases at the same rate as population
(A) Gross domestic product at market prices (B) GNP increases slower than population
(B) Gross national product at factor cost (C) GNP increases faster than population
(C) Net national product at market prices (D) GNP does not increase and population increases
(D) Net national product at factor cost slowly
235. When additional government expenditure is 241. This year, if national product at factor cost is R 600
financed by selling government securities, then crores, indirect taxes R 200 crores and subsidies R
what will be the nature of crowding out effect, 75 crores, national product at market prices is—
given in List-I in the context of the situation given (A) R 750 crores (B) R 725 crores
in List-II ? (C) R 500 crores (D) R 250 crores
List-I (Crowding out effect) 242. Which one of the following measures does not
(a) Full include final goods and services ?
(b) Partial (A) GNP
(c) Nil (B) NNP
List-II (Situation) (C) Disposable income
1. Keynesian Range (D) National income
2. Classical Range 243. Match items given in List-I with those in List-II—
3. Intermediate Range List-I
Codes : (a) Equation of Exchange
(a) (b) (c) (b) Cash Balances Approach
(A) 2 3 1 (c) Regressive Expectation Model of Demand for
(B) 3 1 2 Money
(C) 1 3 2 (d) Square Root Formula of Demand for Money
(D) 1 2 3 List-II
236. National product at factor cost by the amount of— 1. J.M. Keynes
(A) Subsidies 2. Irving Fisher
(B) Indirect taxes 3. W.J. Baumol
(C) Indirect taxes plus subsides 4. A.C. Pigou and Alfred Marshall
(D) Indirect taxes minus subsidies Codes :
237. Net exports are negative when— (a) (b) (c) (d)
(A) Net investment is positive (A) 2 4 1 3
(B) Exports are exceeded by imports (B) 3 2 4 1
(C) Exports exceed private transfer to foreigners (C) 4 3 1 2
(D) Imports are exceeded by exports (D) 1 3 2 4
Economics (NET) | 217U
244. IS-LM model is used to determine ……… in the (B) II, III and IV are correct
economy. (C) I, III and IV are correct
(A) Interest Rate (D) II and IV are correct
(B) Saving Rate
(C) Consumption Level 251. Income velocity of money depends upon—
(D) Inflation Rate (A) Frequency of spending money income by the
people
245. When less output is consumed than produced during
(B) Frequency of earning and spending of money
a given income period, national wealth—
(C) The speed with which money stock moves
(A) Increases
from income earners to the producers of final
(B) Remains unchanged as there is no relationship goods
(C) Decreases (D) Liquidity preference of cash by the people for
(D) May increase or decrease the purchase of final goods
246. National product at current prices is higher than 252. Match List-I (Types of Banks/Banking) with List-II
national product at constants prices during a period (Functions/Characteristics) and select the correct
of— answer using the codes given below the lists—
(A) Rising prices (B) Falling prices List-I
(C) Stable prices (D) Changing costs
I. Investment Banks
247. Which of the following items are not included in II. Group Banking
estimating National income or NNPFC ?
III. Chain Banks
(A) Salary income of artists, dancers and singers
IV. Correspondent Banking
(B) Income of smugglers
List-II
(C) Payments to form workers in food grains
(D) Payments of bank interest for capital borrowed (a) Two or more separately incorporated banks
brought under the control of a holding
248. National product is not affected by which of the company.
following ? (b) Provide credit on long-term basis.
(A) Sale of a second hand automobile by A (c) Banks linked together through deposits by
to B smaller banks of some of their cash reserves
(B) Sale of a new car by an automobile dealer with bigger banks.
(C) Sale of a new car by an automobile company (d) Branches of the banks linked together for better
(D) Sale of a new car on hire purchase mobilisation ofdeposits.
249. Managed currency is said to be the— (e) Banks brought under-common control by a
device other than the holding company.
(A) Currency, the exchange rate of which can be
managed easily Codes :
(B) Currency, the intrinsic value of which can be I II III IV
managed by increasing or decreasing its supply (A) (a) (c) (d) (e)
(C) Currency to be managed if the government of (B) (b) (e) (d) (a)
the country intervenes in some way or the other (C) (b) (a) (c) (e)
to influence the prevailing rate of exchange
(D) (b) (a) (e) (c)
(D) Quota of currency to be managed by the
Central Bank at times of deflation 253. Assertion (A) : It is possible to control either the
money supply or the rate of interest but not both.
250. Consider the following statements : Money supply
in India can be increased if— Reason (R) : Other things remaining the same, the
demand for money depends inversely on the rate of
I. RBI puts out more paper money for circulation.
interest.
II. The commercial banks expand their credit
operations. Codes :
III. The Central Government gives more grants to (A) Both A and R are true, and R is the correct
the states. explanation of A
IV. The Government of India borrows from the (B) Both A and R are true, but R is not a correct
RBI. explanation of A
Of these statements— (C) A is true, and R is false
(A) I, II and III are correct (D) A is false, and R is true
218U | Economics (NET)
254. Which of the following pairs are correctly matched? (C) Price level would be rising
I. Interest rate is a real pheno- — Neoclassical (D) Price level would be constantly rising or falling
menon economists 260. Inflation benefits—
II. Interest rate is a monetary — Marshall (I) salary earners (II) pensioners
phenomenon (III) equity holders (IV) debtors
III. Interest rate does not — Cambridge Codes :
determine the level of saving school (A) I, II and III (B) I and II only
IV. Reduced interest rates always — Bohm (C) I, III and IV (D) III and IV
bring with them production Bawerk 261. Regular changes in interest rates the most sensitive
processes which are more money market is the—
roundabout (A) Bill market
(A) I, II and III (B) I, III and IV (B) Unorganised money market
(C) I, II and IV (D) III and IV (C) Call money market
(D) Collateral loan market
255. Which of the following would help to control
inflation ? 262. According to Friedman, the QTM is primarily a—
1. Discontinuation of the system of adhoc (A) Theory of determination of real output
treasury bills. (B) Theory of determination of the price level
2. Increase in the production and supply of (C) Theory of the demand for money
foodgrains. (D) Theory of natural rate of unemployment
3. Reducing SLR.
263. The equation of exchange version of the QTM is—
Select the correct one—
(A) True by definition
Codes :
(B) Only true if V is held constant
(A) I and II (B) I and III
(C) Only true if M is held constant
(C) II and III (D) I, II and III
(D) Only true if the economy is in full employ-
256. If the economy is operating at potential GDP, an ment
increase in money supply will lead to—
(A) Stagflation 264. The fiat money refers to—
(B) Structural inflation (A) Legal money (B) Illegal money
(C) Deposit money (D) Full bodied money
(C) Demand-side inflation
(D) Supply-side inflation 265. Which of the following would have the greatest
degree of moneyness but still not be considered
257. Which of the following is true in case of the
functional money ?
orthodox (early) Keynesians ?
(A) Currency (B) A house
1. Interest elasticity of demand for money is (C) Business inventories (D) Time deposits
extremely high.
2. Interest elasticity of demand for money is low. 266. Which of the following attributes would not increase
3. Changes in the quantity of money do not have the liquidity of an asset ?
important predictable effects on the level of (A) An organised market for sale of an asset
economic activity. (B) A growing economy
4. Demand for money is unstable. (C) A more stabilized value relative to money
(A) 1, 2, 3 (B) 1, 3, 4 (D) None of the above
(C) 1, 2, 4 (D) 2, 3, 4 267. Large increases in price levels will not—
258. Which of the following is very sensitive to changes (A) Increase the turnover of money
in interest rates ? (B) Maintain the value of money
(A) The speculative demand for money (C) Lower the purchasing power of money
(B) The transaction demand for money (D) Depreciate the value of money
(C) The precautionary demand for money
268. Representative full-bodied money—
(D) The supply of bank money
(A) Is usually made of paper
259. If the growth rate of money is kept constant and (B) Is in effect a circulating warehouse receipt for
output is growing— full-bodied coins or their equivalent in bullion
(A) Price level would be falling (C) Itself has no significant value as a commodity
(B) Price level would be constant (D) All of these
Economics (NET) | 219U
269. People tend to demand money for the so-called (B) Money is an asset that provides its owner with
“precautionary motive” because— liquidity
(A) They wish to keep cash for their day-to-day (C) In modern advanced economies money supply
purchases is composed largely of credit money
(B) They wish to make some provision against (D) In every country money supply has full gold
unforeseen contingencies backing
(C) They bear a severe fall in the rate of interest 276. The financial system helps production, capital
accumulation and growth by—
(D) They believe that the price of bonds may rise
suddenly (A) Actual savings
(B) Encouraging savings
270. Under a ‘bimetallic standard’, a nation—
(C) Mobilizing savings
(A) Uses equal amounts of gold and silver coins
(D) Allocating them among various common uses
(B) Stabilises its monetary unit in terms of silver
(C) Stabilises its monetary unit simultaneously in 277. Which of the following is very sensitive to changes
terms of gold and silver in interest rates ?
(D) (A) and (B) only (A) The speculative demand for money
(B) The precautionary demand for money
271. Keynes terms ‘active balances’ as the money held
for— (C) The transactions demand for money
(A) The speculative motive only (D) The supply of money
(B) The transactions and precautionary motives 278. Fisher’s quantity theory is explained by his famous
(C) The transactions motive only equation of exchange given as—
(D) The precautionary motive only (A) MV = PT (C) MP = VT
(C) MT = PV (D) None of these
272. Which of the following statement is false ?
(A) The IS curve is flatter, lower the value of the 279. The transactions version of the quantity theory of
Keynesian multiplier and lower the interest money was put forward by—
resistiveness of investment (A) Fisher (B) Pigou
(B) The IS curve is steeper lower the value of the (C) Marshal (D) Keynes
Keynesian multiplier and lower the interest 280. Which of the following could originate as a
resistiveness of investment demand-pull inflation ?
(C) The position of LM curve depends negatively (A) The general level of prices
on the price level and the resistiveness of the
money demand to the changes in income (B) Increase in rate of interest
(D) The LM curve is flatter, the larger the interest (C) The demand for money
resistiveness of the money demand and the (D) Increase in aggregate demand
lower the income resistiveness of the money 281. According to Friedman which of the following is
demand not a key determinant of demand for money ?
273. The fact that money that has value in a non- (A) Total wealth
monetary use tends to move, if possible, to the use (B) Division of wealth between human and non
in which its value is higher may be referred to as— human forms
(A) Gossen’s law (C) Expected rates of return on money and other
(B) Gresham’s law assets
(C) Pigou effect (D) Precautionary demand
(D) Quantity Theory of Money 282. Of the items given below which can cause demand
274. In the money supply the relative importance of cash pull inflation ?
component— (A) Increase in interest rates
(A) Goes up with economic development (B) Increase in investment
(B) Goes down with economic development (C) Increase in money supply
(C) Remains unchanged with economic develop- (D) Increased cost of materials
ment
283. Which one of the following statement is not correct
(D) None of these regarding the Friedman's theory of demand for
275. Which of the following statement is incorrect ? money ?
(A) Money is an asset used in the exchange of (A) It is based on Keynes classification of three
goods and services motives for holding money
220U | Economics (NET)
(B) It classified the holders of money as ultimate (3) Life cycle hypothesis
wealth holders and business enterprises (4) Relative increase hypothesis
(C) It generalises Keynes’ analysis of the Codes :
speculative demand for money
(A) 1, 3, 4, 2 (B) 1, 2, 4, 3
(D) It treats total demand for money as part of
capital or wealth theory (C) 1, 4, 3, 2 (D) 1, 3, 2, 4
284. If on a particular day, the volume of currency was R 292. Assume a model of income determination of the
200 crores, demand deposits R 50 crores, bonds and following type :
securities R 25 crores and gold worth R 25 crores. C = a + b·Yd
The supply of money would be, thus— Yd = Y – T
(A) R 300 crores (B) R 275 crores T = T0 + t1·Y
(C) R 250 crores (D) R 225 crores –
I = I
285. In the Fisher’s equation of exchange M V = PT, V —
denotes— G = G
(A) Value of money in real terms Y = C+I+G
(B) Rate of growth of economy where, C = Consumption expenditure; Y = income;
(C) Average number of times a unit of money Yd = disposable income; T = taxes; T0 = Tan, when
changes hands to facilitate transactions Y = 0; t1 = marginal tax rate; I = investment
(D) Value of inventories in money terms expenditure; G = Government expenditure; and bar
‘–’ as the variable indicates that these autonomous
286. The liquidity trap condition occurs at— variables. Then the tax multiples with respect to T0
(A) A very low rate of interest is—
(B) A very high rate of interest 1 –b
(C) At ‘normal’ rate of interest (A) (B)
1 – b + bt1 1 – b + bt1
(D) Either (B) or (C) 1–b 1
(C) (D)
287. Maintaining a cash reserve ratio of 20% with 1 – b – bt1 1 – b – bt1
primary deposits of R 1000, the total derivative 293. Which of the following components of aggregate
deposits created by banks would be— demand is self-terminating and self-financing ?
(A) R 5000 (B) R 1000 (A) Investment expenditure
(C) R 4000 (D) None of these (B) Durable consumption expenditure
288. Inflation results from an excess demand over the (C) Non-durable consumption expenditure
available supply is known as— (D) Government expenditure
(A) Cost-push inflation
294. Arrange all the four concepts of money supply M 1 ,
(B) Demand-pull inflation
M2 , M3 and M 4 in the ascending order in terms of
(C) Either (A) or (B) their liquidity—
(D) None of these
(A) M3 , M2 , M1 and M4
289. Inflation is the result of increases in the cost of (B) M1 , M2 , M3 and M4
production. This kind of inflation is known as—
(C) M4 , M2 , M3 and M1
(A) Cost-push inflation
(D) M4 , M3 , M2 and M1
(B) Demand-pull inflation
(C) Either (A) or (B) 295. ‘Bandwagon effect’ is found in—
(D) None of these (A) Relative Income Hypothesis
(B) Permanent Income Hypothesis
290. Deflation is—
(C) Life Cycle Hypothesis
(A) A situation of falling prices
(D) Absolute Income Hypothesis
(B) A situation of rising prices
(C) A situation of constant prices 296. Let the consumption function in life cycle
(D) None of these
291. Arrange in ascending chronological order the
hypothesis be represented as C =
w
w+e
y–( )
following consumption hypothesis in which they where, e = number of post retirement years of
appeared in the economics literature— living.
(1) Absolute increase hypothesis –
y = average annual income during the
(2) Permanent increase hypothesis working period
Economics (NET) | 221U
Then Marginal Propensity to Consume (MPC) is (B) T remains unchanged
represented by the equation— (C) Short-run change in V be predicted
⎛ – ⎞ (D) There is no change in interest rates
(A)
1
(Σy) ( )
(B)
w
⎜ ∂y ⎟
w+e w + e ⎝ ∂y ⎠ 302. Reflation may be defined as—
⎛y ⎞
– (A) Recovery from business cycle operation
(C) ( ) w
⎜ ⎟
w + e ⎝y ⎠
(D) None of these (B) Deflation deliberately undertaken to relieve an
inflation
297. Complete the statements given in List-I with there (C) Inflation deliberately undertaken to relieve
given in List-II— a depression
List-I (D) None of the above
(a) Instantaneous adjustment of income with 303. An active deposit is one lies with—
investment spending occurs in (A) The bank (B) The depositor
(b) Consumption lags income by one period in (C) The government (D) The central bank
(c) Value investment multiplier zero when 304. In the IS-LM model of income determination, an
(d) Major portion of multiplier is realized in fewer increase in the propensity to save leads to a—
periods when (A) Right ward shift of the LM curve
List-II (B) Right ward shift of the IS curve
1. MPC is smaller (C) Left ward shift of the LM curve
2. increase in investment expenditure is once-for- (D) Left ward shift of the IS curve
all
305. Under the Keynesian system, a fall in money wage
3. state multiplier rate will lead to a/am—
4. dynamic multiplier (A) Increase in employment
Codes : (B) Fall in the price level
(a) (b) (c) (d) (C) Fall in the interest rate
(A) 3 4 1 2 (D) Fall in the quantity of money
(B) 3 4 2 1
306. If there is to be large oscillation in the path of
(C) 4 3 1 2 income through the intraction of multiplier and
(D) 2 3 1 4 accelerator then the—
298. 'The Veil of money' indicate that— (A) Value of marginal propensity to save must be
(A) Money is only lubricant, enabling the economic less than the value of accelerator
machine to function continuously and smoothly, (B) Value of marginal propensity to save must
which cannot affect any real variables be greater than the value of accelerator
(B) Money is a lubricant that helps the smooth (C) Value of accelerator must be greater than one
functioning of economy and affects real (D) Sum of the value of marginal propensity to
variables save and accelerator must be greater than one
(C) Money is a lubricant that helps the smooth 307. Match List-I with List-II a n d select t h e correct
functioning of economy which affects both real answer using the codes given below the lists—
and money variables List-I
(D) None of the above (a) C = 4 + 0.6Y
299. Monetization refers to— (b) I = 80 – 5i
(A) Nullification of barter (c) 0·3y – 20i – 150 = 0
(B) Accentuation of barter (d) 0·3y + 20i – 150 = 0
(C) Minting of coins List-II
(D) Proliferation of NBFI 1. LM function
2. IS function
300. Which of the following is the equation of 3. Consumption function
exchange ?
4. Investment function
MV + M′ V′ MV
(A) P = (B) P = Codes :
T T (a) (b) (c) (d)
(C) MV = PT (D) All of these (A) 3 4 1 2
301. For the equation PT = MV to explain short-run price (B) 4 3 1 2
behaviour, it is necessary that— (C) 3 4 2 1
(A) P varies inversely with M (D) 4 1 2 3
222U | Economics (NET)
308. Neutrality of money implies that a given increase in 316. Which of the following is consistent with the cross-
the money supply will— sectional consumption function ?
(A) Increase all prices in the same proportion (A) APC = MPC (B) MPC = 0
(B) Increase all prices in different proportions (C) APC > MPC (D) APC = 0
(C) Decrease all prices in the same proportion
317. The speculative demand for money depends on—
(D) Not change prices at all
(A) Interest rate (B) Income
309. The theory that the transactions demand for money (C) Profit (D) Output
also depends on the rate of interests, was put
forward by— 318. Consider the following statements—
(A) Keynes and Pigou (B) Bumal and Tobin Classical economists believed that unemployment in
(C) Hicks and Solow (D) Samuelson and Meada an economy would persist because of—
310. Where M is money-supply, is rate of interest and I 1. Labour-saving technical progress.
is investment, the correct likely sequence would 2. Deficiency in demand for goods.
be— 3. Government intervention in the free working
(A) M decreases, i goes down, I goes down, GNP of the economy.
goes down Which of the above statements is/are correct ?
(B) M decreases, i goes up, I goes down, GNP goes (A) 1, 2 and 3 (B) 1 and 2
down
(C) 2 and 3 (D) 3 alone
(C) M decreases, i goes up, I goes up, GNP goes up
(D) M goes up, i goes up, I goes up, GNP goes up 319. Liquidity preference curve slopes downward to right
because—
311. The quantity theory of money implies that an
(A) As rate of interest rises, the opportunity cost of
increase in the price level will be associated with—
holding money falls
(A) An increase in out put
(B) As rate of interest rises, the opportunity cost of
(B) An increase in money supply holding money rises
(C) A decrease in money supply
(C) As rate of interest falls, the opportunity cost of
(D) Both (A) and (B) holding money does not change
312. High powered money is— (D) When the rate of interest is low, the central
(A) Bank’s reserves at the Central Bank banks reduces the supply of money
(B) All loans and advances of banks 320. Quantity theory of money should be regarded as a
(C) Money held by banks theory of demand for money. This view has been
(D) Currency held by public and reserves with the given by—
Central Bank (A) D.H. Robertson (B) J.M. Keynes
313. Which one of the following pair is not correctly (C) Pigou (D) M. Friedman
matched ? 321. Inflation is unjust and deflation is inexpedient, of
(A) Inflationary Gap : Keynes the two, deflation is worse. Who made this state-
ment—
(B) Cash Balance Approach : Pigou
(A) J.M. Keynes (B) G. Crowther
(C) Accelerator-Multiplier : Hicks Analysis (C) A. Marshall (D) A.H. Hansen
(D) Equation of Exchange : Marshall
322. The quantity theory of money was first propoun-
314. Given the total investment expenditure, an increase ded by—
in the propensity to save will lead to a— (A) D. Ricardo (B) Davanzatti
(A) Rise in income (C) D. Hume (D) J. Mill
(B) Rise in the rate of interest 323. Money is an asset. Its demand is determined along
(C) Fall in savings with the demand for all the other assets. This view
has been held by—
(D) Fall in income
(A) Marshal (B) J. Tobin
315. If the investment multiplier is 4, the relevant (C) M. Friedman (D) H. Johnson
consumption function is given by—
324. Who among the following Economists, was the first
(A) c = 28 + 0·75y to mention effective demand as a determinant of the
(B) c = – 28 + 0·78y level of economic activity ?
(C) c = 28 + 0·15y (A) D. Ricardo (B) T.R. Malthus
(D) c = 28 + 0·40y (C) A. Marshall (D) J.M. Keynes
Economics (NET) | 223U
325. In classical theory of employment what ensures the (B) Negative relationship between unemployment
perfect clearing of the labour market— and real gross domestic product
(A) Flexibility of interest rate (C) Positive relationship between money supply
(B) Flexibility of wage rate and price level
(C) Flexibility of prices of the commodity (D) Negative relationship between money supply
(D) Classical assumption of perfect competition in and rate of interest
the product market 333. Which of the curves shown in the diagram below
326. When a linear consumption function undergoes a truly represent Keynes saving function ?
parallel shift down wards, the investment multi- (A) AA (B) OB
plier— (C) DD (D) CC
(A) Falls (B) Rises
(C) Doubles (D) Does not change
327. A direct increase in initial employment leads to a
multiple increase in total employment. This
relationship was propounded by—
(A) J.M. Keynes (B) R.F. Kahn
(C) A.C. Pigou (D) J. Robertson
328. Who among the following Economists introduced
the concept of permanent income as a determination
of consumption function—
(A) M. Friedman (B) J.M. Keynes
(C) J.S. Duesenberry (D) N. Kaldor 334. Before full employment, if price level falls, aggre-
329. An increase in money supply leads to— gate demand will increase which will lead to rise in
employment and income. This relationship between
(A) Rightward shift of IS curve
price level and aggregate demand has been called—
(B) Leftward shift of IS curve
(A) Real balance effect (B) Income effect
(C) Leftward shift of LM curve
(C) Price effect (D) Employment effect
(D) Rightward shift of LM curve
335. In which of the following situations will an increase
330. Consider the following statements in relation to in money supply have no effect on equilibrium
Accelerator and choose the correct answer from the effect ?
code given below—
(A) LM is steeply sloped and IS is relatively flat
1. It depends on the rate of growth of demand.
(B) LM is vertical and IS is steeply sloped
2. It works when there is no idle capacity in the
economy. (C) LM is steeply sloped and IS is vertical
3. It increases with increase in the rate of (D) LM is relatively flat as is IS
depreciation. 336. Assertion (A) : Keynes pointed out that during
4. It depends on the level of demand. depression private investment is not induced.
Codes : Reason (R) : The marginal productivity of capital is
(A) 1 and 2 are correct high in depression.
(B) 2 and 3 are correct Choose the correct answer from the code given
(C) 3 and 4 are correct below—
(D) 2, 3 and 4 are correct (A) Both A and R are true and R i s the correct
explanation of A
331. According to the IS-LM model, given by Hicks-
Hansen there is simultaneous equilibrium bet- (B) Both A and R are true and R is not the correct
ween— explanation of A
(A) Income level and rate of interest (C) A is true but R is false
(B) Income level and consumption (D) A is false but R is true
(C) Inflation and unemployment 337. Keynes was most concerned with—
(D) Demand and supply of money (A) Demand-pull inflation
332. Okun’s law postulates a— (B) Cost-push inflation
(A) Positive relationship between unemployment (C) Structural inflation
and real gross domestic product (D) Stagflation
224U | Economics (NET)
338. The speculative demand for money depends only on 344. Which one of the following saving functions
the expected prices of bonds. This view has been corresponds to the investment multiplier of 5 ?
held by— (A) S = – 28 + 0·25y (B) S = – 40 + 0.75y
(A) J.M. Keynes (B) K. Wickscell
(C) S = – 5 + 0·20y (D) S = – 75 + 0·5y
(C) D.H. Robertson (D) M. Friedman
339. Money multiplier is the ratio between— 345. When investment is negatively related to the rate of
interest, the equilibrium output in the goods market
(A) Quantity of total money and money national is—
income
(A) Unrelated to the rate of interest
(B) Quantity of primary money and quantity of
secondary money (B) Inversely related to the rate of interest
(C) Quantity of primary money and quantity of (C) Positively related to the rate of interest
total money (D) Indeterminate
(D) Quantity of money and aggregate investment 346. Consider the following statements denoting the
340. According to the quantity theory of money, the relationship between marginal propensity to con-
price level rises if— sume and value of multiplier—
(A) There is a decrease in money supply 1. Higher the marginal propensity to consume,
(B) The velocity of circulation of money rises higher is the multiplier.
(C) The aggregate volume of transactions increases 2. Higher the marginal propensity to consume
(D) The real demand for money rises lower is the multiplier.
–
341. Let I = 5 + 0·2y; S = –15 + 0.3y andG = 5 (where I 3. When the marginal propensity to consume is
= Investment, y = National Income, S = Saving and one, multiplier takes the value of infinity.
G = Government spending). What is the equilibrium Which of the above statements is/are correct?
level of yI (A) 1 alone (B) 2 and 3
(A) 200 (B) 100 (C) 1, 2 and 3 (D) 1 and 3
(C) 250 (D) 300
347. An increase in fiscal spending leads to—
342. Consider the following statements—
(A) A shift of the Phillips curve to the right
1. Absolute Income Hypothesis is associated with
Keynes. (B) A shift of the Phillips curve to the left
2. S = – 20 + 0·4y and C = 20 + 0.6 >> yield the (C) Movement along the Phillips curve such that
same investment multiplier. unemployment rises and inflation falls
3. Investment multiplier rises when ever income (D) Movement along the Phillips curve such that
tax is introduced in the system. unemployment falls and inflation rises
4. Bond price and interest rates are directly 348. Consider the following statements—
related.
1. According to the accelerator modeles, invest-
Which of the above statements is/are correct ? ment demand is proportional to the change in
(A) 1 alone (B) 2 and 3 GNP.
(C) 3 and 4 (D) 1 and 2 2. The real rate of interest is the nominal rate of
343. Consider the following statements relating to interest plus the inflation rate.
classical theory of employment— 3. The higher the real interest rate, the higher is
1. Classical theory is based on the assumption of the rental cost of capital.
full employment. 4. Investment is a stock concept.
2. Classical version of full employment is a situa- Which of the above statements are correct ?
tion where involuntary unemployment is (A) 2 and 3 (B) 1 and 2
present.
(C) 1 and 3 (D) 1, 2, 3 and 4
3. Classical version of full employment is
consistent with seasonal unemployment and 349. ‘The propensity to consume of an individual with
frictional unemployment. respect to his disposable income and wealth depends
on his age.’ The statement refers to the—
4. Classical economists advocated wage cuts to
reduce the unemployment level. (A) Relative income hypothesis
Which of the above statements are correct ? (B) Permanent income hypothesis
(A) 1, 2 and 3 (B) 2, 3 and 4 (C) Life-cycle hypothesis
(C) 1, 3 and 4 (D) 1 and 2 (D) Absolute income hypothesis
Economics (NET) | 225U
350. Consider the following statements— 357. Consider the following statements :
1. If Government expenditure increases the IS The study of national income accounts is of great
curve shifts to the right. importance because it—
2. If the taxes increase the IS curve shifts to the 1. Reveals the change in the size and com-
right. position of the national product.
3. If the price level increases the LM curve shifts 2. Provides us with information about the
to the left. distribution of national income in the society
4. The more interest elastic the investment among various groups.
function, the more interest elastic will be the IS 3. Reveals the manner in which national ex-
curve. penditure is divided between consumtion and
Which of the above statements is/are correct ? investment.
(A) 2, 3 and 4 (B) 1, 3 and 4 (A) 1 and 2 are correct (B) 2 and 3 are correct
(C) 1 and 2 (D) 2 alone (C) 1 and 3 are correct (D) 1, 2 and 3 are correct
351. Stagflation refers to situation which is characterised 358. Consider the following types of income :
by— 1. Personal income
(A) Deflation and rising unemployment 2. Private income
(B) Inflation and rising employment 3. Disposable income
(C) Inflation and rising unemployment 4. National income
(D) Stagnant employment and deflation The correct sequence in descending order of their
magnitude is—
352. The elasticity in respect of speculative demand for
money under the liquidity trap condition is— (A) 4, 2, 1, 3 (B) 4, 2, 3, 1
(A) Zero (B) One (C) 2, 4, 3, 1 (D) 2, 4, 1, 3
(C) Greater than one (D) Infinite 359. The national income of a country for a given period
is equal to the—
353. The purchase of a new home is included in the GNP
as a part of— (A) Total value of goods and services produced by
(A) Capital consumption allowance the nationals
(B) Personal consumption expenditures (B) Sum of total consumption and investment
expenditure
(C) Investment
(D) Personal saving (C) Sum of personal income of all individuals
(D) Money value of final goods and services pro-
354. Expenditure on defence is an item of— duced
(A) Private investment
360. Gross National savings measure the—
(B) public investment
(A) Amount of GNP not consumed
(C) Private consumption (B) Excess of income over consumption plus the
(D) Public consumption net taxes
355. GNP at market prices is R 200 : net property income (C) Sum of retained earnings and depreciation
form from abroad is R 20 and indirect tanes are amounts
R 20 and subsidies are R 20 GDP factor cost is— (D) Excess of disposable income over consumption
(A) R 160 (B) R 180 361. Social accounting system in India is classified into
(C) R 200 (D) R 250 which one of the following sets of sectors ?
(A) Enterprise, households and government
356. National income at constant prices can be found out
by— (B) Assets, liabilities and debt position
Price index number (C) Public sector, private sector and joint sector
(A) ×0 (D) Income, production and expenditure
N.I. at current prices
N.I. at current prices 362. For a closed economy having no foreign trade
(B) ×0 which one of the following is correct ?
Price index number
N.I. at market prices (A) GDP = GNP
(C) ×0
Price index number (B) GDP > GNP
N.I. at factor cost (C) GDP < GNP
(D) ×0
Price index number (D) None of the above
226U | Economics (NET)
363. Which of the following statements explain the 368. Value added means value of—
difference between NNP (Net National Product) and (A) Output at market prices
NMP (Net Material Product) ? (B) Goods and services less depreciation
1. NNP includes services. (C) Goods and services less cost of intermediate
2. NNP excludes services. goods and services
3. NMP includes services. (D) Output at factor cost
4. NMP excludes services. 369. Which one of the following statements is correct?
Select the correct answer using the codes given (A) Gross national product includes depreciation
below— (B) Value added includes transfer payments
Codes : (C) Personal income includes undistributed profits
(A) 1 and 4 (B) 2 and 4 (D) Disposable income includes personal taxes
(C) 1 and 3 (D) 2 and 3 370. The GNP at market prices for 1983-84 was
364. A : Y = C + 1 (where Y = National Income, R 192866 crores and the GNP at factor cost was
C = Consumption, I = Investment)
R 17201 crores. The government p a i d at R 5107
crores as subsidies during the year. The amount of
R : C and I are important determinants of national indirect taxes in crores for the year should work out
income. to—
(A) Both A and R a r e true and R is n o t correct (A) R 31879 (B) R 26772
explanation of A (C) R 21665 (D) R 16558
(B) Both A and R are true but R is not correct
explanation of A 371. GNP exceeds NNP by—
(C) A is true but R is false (A) The amount of total taxes
(D) A is false but R is true (B) Government expenditure
365. The GNP gap is the gap between— (C) Transfer payments
(A) GNP and NNP (D) The difference between gross investment and
net investment
(B) GNP and depreciation
372. National Income total reveals :
(C) GNP and GDP
1. Production side of the economy.
(D) Potential and actual GNP 2. Distribution side of the economy.
366. Which one of the following is the most important 3. Expenditure side of the economy.
limitation of the per capita GNP as the Measure of Choose your answer from—
welfare ? (A) 1 only (B) 2 only
(A) The increase in the per capita GNP may not (C) 1, 2 and 3 (D) 3 only
always raise the real standard of living of the 373. National Income is the—
masses (A) Net National Product at market price
(B) This measure does not take into account the (B) Net National Product at factor cost
increase in the population (C) Net Domestic Product at market price
(C) This measure does not take into account the (D) Net Domestic Product at factor cost
employment aspect
374. Improvement in the standard of living in a country
(D) This measure does not take into consideration are best reflected be increase in—
government expenditure (A) GNP at constant prices
367. The ‘Hindu rate of growth’— (B) Per capita income at constant prices
(A) Refers to growth of Hindu population (C) Per capita income at current prices
(B) Is the term used by Raj Krishna to represent (D) GNP at current prices
the nature of the growth of the Indian economy 375. Which one of the following statements is not
at around 3.5 per cent per year correct?
(C) Is the term used by Amartya Sen to represent (A) Compensation of employees plus operating
the nature of the growth of the Indian economy surplus plus mixed income of self employed
at around 3.5 per cent per year plus consumption of fixed capital equals GDP
(D) Is the term used by V.K.R.V. Rao to decide the at factor cost
nature of the growth of the Indian economy at (B) GDP at factor cost plus indirect taxes minus
around 4 per cent subsidies equals GDP at market prices
Economics (NET) | 227U
(C) GDP at factor cost minus depreciation equals 381. Consider the following statements regarding saving
net domestic product at factor cost different sectors of an economy :
(D) GDP at market prices minus net receipts from 1. Savings of private corporate sector constitute
abroad plus indirect taxes minus subsidies undistributed profits.
equals net national product 2. Saving of private corporate sector constitute
excess of income over expenditure.
376. Which one of the following constitutes government
consumption expenditure ? 3. Saving of government sector constitute excess
of revenue receipts over revenue expenditure.
(A) Compensation to employees plus net purchases
4. Saving of government sector constitute excess
from business enterprises
of total revenue over total expenditure.
(B) Wages and salaries of government employees Of the above statements—
(C) Government expenditure on defence (A) 2 and 3 are correct
(D) Transfer payments to individuals and state (B) 3 and 4 are correct
governments (C) 1 and 3 are correct
377. Which one of the following denotes net state (D) 2 and 4 are correct
domestic product ?
382. The implicit national income deflator represents a
(A) Money value of final goods and services price index number of the type known as—
produced within the boundary of a state plus
net inflow of income from outside the state (A) Laspeyre’s index number
(B) Money value of final goods and services (B) Fisher’s index number
produced within the boundary of a state minus (C) Paasche’s index number
depreciation plus indirect taxes of fixed assets (D) Marshall-Edgeworth’s index number
(C) Money value of final goods and service 383. Human Development Index (HDI) is a composite
produced with the boundary of a state minus index of—
depreciation plus indirect taxes
(A) Health, literacy and employment
(D) Money value of goods and services consumed
within the boundary of a state plus net income (B) National income, size of population and the
from outside the state general price level
(C) National income, per capita income and per
378. Which one of the following equals the value of
capita consumption
output of a factory ?
(A) Total value added by factors (D) Physical resources, monetary resources and
population size
(B) Value of all non-factor inputs plus indirect
taxes 384. Which one of the following agencies in India is
(C) Payments for factor inputs and non factor responsible for computation of national income ?
inputs (A) N.C.A.E.R. (B) C.S.O.
(D) Payments for non-factor inputs plus wages (C) N.S.S. (D) R.B.I.
379. Which one of the following items is excluded in 385. Which one of the following represents the saving in
calculating national income ? the private corporate sector ?
(A) Service of a rental TV set (A) Total profits of a company
(B) R 10,000/- won in a lottery (B) Undistributed profits
(C) Rented residences (C) Excess of income over expenditure
(D) Paid house work (D) Dividends paid to share holders
380. In which of the following sectors, is product method 386. An economy’s Net National Income is $ 20,000
used in computing national income in India ? million, indirect taxes are $ 2000 million, subsidies
1. Agriculture and allied activities. are $ 1000 million and its population 150 million.
2. Mining and quarrying. What will be the National Income at factor cost ?
3. Registered manufacturing. (A) $ 21000 million (B) $ 19000 million
4. Unregistered manufacturing. (C) $ 23000 million (D) $ 22000 million
Select the correct answer using the codes given 387. Given are the following information about an
below— economy :
Codes : Consumption = R 5000
(A) 2, 3 and 4 (B) 1, 2 and 3 Gross Investment = R 1000
(C) 1 and 3 (D) 1, 3 and 4 Govt. Purchases = R 800
228U | Economics (NET)
Exports = R 600 392. Which of the following prevents national income
Imports = R 800 from falling to zero when gross investment falls to
Depreciation = R 250 zero ?
What is the GNP at market prices ? (A) Consumption (B) Multiplier
(C) Accelerator (D) None of these
(A) R 7100 (B) R 6850
(C) R 6600 (D) R 6350 393. In India, the main source of national income is—
(A) Primary sector
388. Consider the following statements :
(B) Secondary sector
1. In an economy where productive capacities are
(C) Tertiary sector
increasing, gross private domestic investment
exceed depreciation. (D) Foreign sector
2. Interest on the public debt is not a part of 394. The GNP of an economy at market prices is R1000.
national in copies but is included in personal Net factor income from abroad is R 1000, indirect
income. taxes R 800, subsidies R 500 and depreciation
3. Disinvestment occurs when inventories expand. R1000. What is the GDP at market prices ?
(A) R 9000 (B) R 7700
4. The purchase of new home is included in the
GNP as a part of investment. (C) R 11000 (D) R 13300
Which of the above statements are correct ? 395. Consider the following statements—
(A) 1 and 2 (B) 3 and 4 1. At the time of rising prices, NNP at current
(C) I, 2 and 4 (D) 1, 3 and 4 prices is less than NNP at constant prices.
2. At the time of rising prices, NNP at current
389. Assertion (A) : Per capita income figures are Poor prices is higher than NNP at constant prices.
tools of ordinal ranking of countries with respect to 3. NNP at current prices and NNP at constant
the real well being. prices are always same irrespective of changes
Reason (R) : A good portion of the national income in prices.
in poor countries is unreported. 4. NNP at current prices is equal to NNP at
Codes : constant prices at the time of stable prices.
(A) Both A and R are true and R i s the correct Which of these statements are correct ?
explanation of A (A) 1 and 2 (B) 1 and 3
(B) Both A and R are true but R is not a correct (C) 2 and 3 (D) 2 and 4
explanation of A
(C) A is true but R is false 396. Match List-I with List-II and select the correct
answer using the codes given below the lists—
(D) A is false but R is true
List-I
390. Estimate gross national product from the data given
below : (a) Capital consumption allowances
Value of consumer goods R 20000 crore and (b) Subsidies
services (c) Personal taxes
Value of capital goods R 10000 crore and services (d) Personal savings
Value of exports R 4000 crore List-II
Value of Imports R 2600 crore 1. Are included in estimating National Income at
Total depreciation R 1600 crore factor cost.
Which one of the following is correct ? 2. Are excluded while calculating disposable
income.
(A) R 3400 crore (B) R 38600 crore
3. Are excluded in calculating personal out-lays.
(C) R 29800 crore (D) R 29200 crore
4. Are excluded in estimating Net National Pro-
391. National income at market price is equal to— duct.
(A) The sum of wages, interest, rent and profits Codes :
earned
(a) (b) (c) (d)
(B) National income at factor cost plus indirect
taxes minus subsidies (A) 3 1 2 4
(C) The sum of earnings of all the factors plus (B) 4 1 2 3
direct tax minus subsidies (C) 3 2 1 4
(D) Total quantity of goods and services produced (D) 4 2 1 3
Economics (NET) | 229U
397. Assume that between 1985 and 1995, GNP increased 403. National income at market price rises due to—
from R 1000 crore to R 1500 crore and the index of (A) Taxes
prices increased from 100 to 200. Which one of the (B) Additional supply of goods from imports
following expresses GNP for 1995 in terms of 1985
prices ? (C) Subsidies
(A) R 1000 crore (B) R 750 crore (D) Savings on account of keeping many govern-
(C) R 1500 crore (D) R 500 crore ment posts vacant
398. Which one of the following statements relating to 404. If consumer price index in city A is 200 and in city
transfer payments, capital gains and illegal activities B is 250, per capita income of R 4000 in both cities
is correct ? is in fact equal to—
(A) Market transactions such as transfer pay-ments, (A) R 5000 for A and R 4000 for B
capital gains are included and illegal activities (B) R 3200 for A and R 4000 for B
are omitted in national product (C) R 4000 for A and R 3000 for B
(B) Market transactions such as transfer payments, (D) Nothing can be said on this basis
capital gains and illegal activities are omitted in
national product 405. In the accounting of the state domestic products—
(C) Market transactions such as transfer payments (A) Transfer payments like pension, scholarships
are included but capital gains and illegal etc. are included
activities are omitted in national product (B) Indirect taxes are not included but direct taxes
(D) All the three market transactions should be are
included in national product (C) Direct taxes are not included but indirect taxes
399. National income will be higher than net national are
product because— (D) Supra-regional incomes, as allocated by the
(A) There being no depreciation CSO are included
(B) Inclusion of services 406. For a study of the long term growth of the economy
(C) Inclusion of profits we use—
(D) Net inflow of unilateral transfers from abroad (A) Real GNP
400. Social accounting of national income addresses to (B) Money GNP
the issue of— (C) Per capita income
(A) Public expenditure on social infrastructure (D) Property of the individual
(B) Revenue receipts from and public expenditure 407. Assertion (A) : Transfer earnings are not to be
on social services included in the national income estimation.
(C) Estimating what is being produced, where, Reason (R) : Transfer earnings are not payments
how much and how and who consumes what for factor services.
and how much (A) Both A and R are true but R is the correct
(D) Share of national income going to the socially explanation of A
backward groups (B) Both A and R are true but R is not a correct
explanation of A
401. Gross Domestic Product is the monetary value of—
(C) A is true but R is false
(A) Stock of goods and services
(D) A is false but R is true
(B) All final goods and services produced in a year
408. Assertion (A) : Continuous increase in Real
(C) Goods produced for the market only National Income is an indication of economic
(D) Goods produced for the market and for self growth.
consumption Reason (R) : Increase in National Income does not
402. As the country develops, we should find that the— necessarily reflect increase in per capita income.
(A) Relative percentage share of the primary sector (A) Both A and R are true and R is the correct
in the national income goes down explanation of A
(B) Absolute share of the agricultural sector in the (B) Both A and R are true but R is not a correct
national income goes down explanation of A
(C) Better redistribution of national income is (C) A is true but R is false
ensured by the market only (D) A is false but R is true
(D) Absolute share of the primary sector in the 409. Assertion (A) : The GNP is the value of all goods
national income goes down and services produced annually in the nation.
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Reason (R) : The most comprehensive measure of 416. “National income as the aggregate net product of,
national output is the GNP. and the sole source of, payment for all the agents of
(A) Both A and R are individually true and R is the production” has been defined by—
correct explanation of A (A) A.C. Pigou (B) Alfred Marshall
(B) Both A and R are individually true but R is not (C) Robbins (D) Dusenbery
the correct explanation of A 417. Assertion (A) : The individual speculative demand
(C) A is true but R is false for money is a discontinuous one.
(D) A is false but R is true Reason (R) : Because the aggregate speculative
demand for money function is smooth downward
410. Assertion (A) : Banking sector’s contribution to sloping with liquidity trap at extremely low interest
national income is zero. rates.
Reason (R) : By the usual methods of calculation, Codes :
the net factor payments in the banking sector (A) Both (A) and (R) are correct and (R) is the
amounts to zero. correct explanation of (A)
(A) Both A and R are individually true and R is the (B) Both (A) and (R) are correct, but (R) is not the
correct explanation of A correct explanation of (A)
(B) Both A and R are individually true but R is not (C) (A) is correct, but (R) is incorrect
the correct explanation of A (D) (A) is incorrect, but (R) is correct
(C) A is true but R is false
418. The total income earned in any given year by the
(D) A is false but R is true owners of productive resources is measured by—
411. The best method of computing national income (A) Personal income
is— (B) Disposable Income
(A) Product Method (C) Gross national product
(B) Income Method (D) National income
(C) Expenditure Method
419. In calculating a country’s GNP at market prices one
(D) Combination of income and production method of the following is not included—
412. Which of the following will directly increase the (A) Wages and salaries before tax
GNP ? (B) Indirect taxes
(A) A rise in the market price (C) Bonds to the employes
(B) A surplus in budget (D) Depreciation allowances
(C) An increase in investment
420. An example of double counting in national income
(D) A deficit in budget would be—
413. “National dividend is that part of objective income (A) Wages of bus and train drivers
of the community, including of course the income (B) Cotton output and cotton cloth output
derived from abroad which can be measured in
money.” This is the remark of— (C) Electricity output and water output
(A) Marshall (B) J.R. Hicks (D) Tax receipts and earnings of inland revenue
officials
(C) David Ricardo (D) A.C. Pigou
421. Double counting must be avoided when calculating
414. While calculating personal income, we have to national income. This means that there must be a
deduct the following from private income— deduction of the value of—
(A) Saving of private corporate sector and corpora- (A) Food subsidies
tion tax (B) Personal consumption of alcoholic drinks
(B) Consumption of fixed capital (C) Transfer payments
(C) Direct taxes paid by households (D) Net interest from abroad
(D) All of the above
422. Which of the following is counted in determining
415. The National income is equal to— GNP ?
(A) GNP – Subsides – Taxes (A) A do it yourself roof repair job
(B) NNP – Indirect Taxes + Subsidies (B) A housewife’s work at home
(C) NNP – Direct Taxes + Subsides (C) An operation performed in a hospital
(D) GNP – Subsidies + Taxes (D) Vegetables grown by a farmer for his own use
Economics (NET) | 231U
423. Among these statements which one clearly explains 429. Given that the increment in aggregate demand (Y)
the meaning of “Subsidies”— per unit of time, t, is given by the equation
(A) Payment by Government for purchase of goods ∂Y ∂I
and services
(B) Payment by business enterprises to factors of
[ ] =
1
∂t d 1 – MPC ∂t []
production and the increment in supply of output is represented
(C) Payment by companies to shareholders by the equation
∂Y ∂k
(D) Payment by Government to business enterprises
without buying any goods and services [ ]
∂t s
=σ
∂t
424. The difference between Gross National Product and ∂I
Where MPC = Marginal Propensity to Consume,
Gross Domestic Product is equal to— ∂t
(A) Gross Domestic investment ∂k
& are change in investment & capital stock
(B) Net Foreign Investment ∂t
respectively, per unit of time, then the capacity
(C) Net imports
creating effect or Domar effect of investment
(D) Net factor income from abroad following goods market equilibrium equals—
425. Net domestic product at factor cost equals net
domestic product at market prices— (A) σ (1 – MPC) (
(B) σ
1
)
1 – MPC
(A) Plus subsidies – indirect taxes 1 1 1
(B) Minus subsidies + indirect taxes (C) (1 – MPC) (D) ·
σ σ 1 – MPC
(C) Minus subsidies
430. Base year for the estimation of national income is—
(D) Plus indirect taxes
(A) 2010-11 (B) 2011-12
426. Transaction Cost is also called—
(C) 2012-13 (D) 2013-14
(A) Shoe Leather Cost
(B) Menu Cost 431. Methodology of estimation of national income in
India changed from the year—
(C) Opportunity Cost of holding cash
(D) All of the above (A) 2012-13 (B) 2013-14
(C) 2014-15 (D) 2015-16
427. Given the consumption function, C = 0·8 Y, and the
investment function I = 102 – 0·2i, then the IS-curve 432. The current national income accounting format is
is— the System of National Accounting (SNA), prepared
(A) Y = 500 – 10i (B) Y = 450 – i by—
(C) Y = 510 – i (D) Y = 505 – 2i (A) The United Nations
428. Match the premise given in List-I with that in (B) The International Monetary Fund
List-II— (C) World Bank
List-I (D) Organisation for Economic Cooperation and
(a) Price expectations are static Development (OECD) and European
(b) Price expectations are adaptive Community
(c) People do not make systematic errors 433. Consider the following statements and choose the
(d) Deviations of output from its natural rate is correct code given below—
inversely ralated to the deviation of unemploy- I. The current national income accounting format
ment rate from its natural level is the System of National Accounting (SNA).
List-II II. SNA has been prepared by the United Nations
1. Okun’s law and ratified by the IMF, World Bank, OECD
2. Phillips Curve and EC.
3. Natural Rate of unemployment hypothesis (A) Only I is correct
4. Rational expectations hypothesis (B) Only II is correct
Codes : (C) I & II both are correct
(a) (b) (c) (d) (D) Neither I nor II is correct
(A) 2 3 4 1 434. Which of the following statement is correct about
(B) 4 3 2 1 the estimation of national income in India ?
(C) 1 3 4 2 (A) Gross Domestic Product (GDP) at Market Price
(D) 4 2 1 3 is estimated now
232U | Economics (NET)
(B) Gross Domestic Product (GDP) at Factor Cost 440. Consider the following statements about product
is estimated now taxes and choose the correct code given below—
(C) Gross Domestic Product (GDP) at Basic Price I. Product taxes are paid by the producer and they
is estimated now are dependent of the quantity of production.
(D) Gross Domestic Product (GDP) at Real Price is II. Production tax is per unit tax imposed on a
estimated now commodity.
Correct code is—
435. Which of the following is the correct formula used
for the estimation of Gross Domestic Product at (A) Only I is correct
Market Price ? (B) Only II is correct
(A) GDP at MP = GVA at Base Prices + Product (C) I & II both are correct
Taxes – Product Subsidies (D) Neither I nor II is correct
(B) GDP at MP = GVA at MP + Product Taxes – 441. In simple words which of the following measure is
Subsidies termed as the National Income of a country ?
(C) GDP at MP = GVA at Base Prices + (A) Net National Product at Factor Cost (NNP at
Production Taxes – Production Subsidies FC)
(D) GDP at MP = GVA at Base Prices – Product (B) Net National Product at Market Price (NNP at
Taxes + Product Subsidies MP)
(C) Gross National Income at Factor cost (GNI at
436. Which of the following is/are the part of Gross
FC)
Value Added at Basic Prices?
(D) Net Domestic Product at Market Price (NDP at
I. Compensation of Employees (CE) MP)
II. Operating Surpluses (OS)
442. Which of the following is the correct measurement
III. Mixed Income (MI)of self-employed people of National Income?
IV. Consumption of Fixed Capital (CFC) (A) NNP at market prices + (Indirect taxes –
V. Production Taxes Less Subsidies Subsidies)
Correct code is— (B) NNP at market prices – (Indirect taxes –
(A) Only I, II & III (B) Only I & II Subsidies)
(C) Only II, III & V (D) I, II, III, IV & V (C) NNP at market prices – (direct taxes –
Subsidies)
437. Which of the following is not a production tax ? (D) NNP at market prices – (Indirect taxes +
(A) Registration fees (B) Land revenue Subsidies)
(C) Import Duties (D) Stamp duties 443. Which of the following is the correct measurement
438. Which of the following is/are Product Tax ? of National Disposable Income ?
I. Goods and Services Tax (A) National Disposable Income = Gross National
II. Excise Duties Product at market prices + Other current
transfers from the rest of the world
III. Customs Duties
IV. Sales Tax (B) National Disposable Income = Net Domestic
Product at market prices + Other current
Correct code is transfers from the rest of the world
(A) Only I, II & III (C) National Disposable Income = Net National
(B) Only I, III & IV Product at market prices + Other current
(C) Only II, III & IV transfers from the rest of the world
(D) I, II, III & IV (D) National Disposable Income = Gross National
439. Consider the following statements about production Product at Factor Cost + Other current transfers
from the rest of the world
taxes and choose the correct code given below—
I. Production taxes are paid by the producer 444. Estimation of national income in India is done by—
independent of the quantity of production. (A) Reserve Bank of India
II. Production tax is not per unit tax imposed on a (B) Office of Economic Adviser, Department for
commodity. Rather it is a general tax Promotion of Industry and Internal Trade,
(A) Only I is correct Ministry of Commerce and Industry, GoI
(B) Only II is correct (C) Central Statistics Office, Ministry of Statistics
(C) I & II both are correct and Programme Implementation, GoI
(D) Neither I nor II is correct (D) Chief Economic Advisor, GoI
Economics (NET) | 233U
445. As per the Second Advanced Estimates of National 451. Consider the list I (Economist) and List II (Theory
Income for the year 2018-19, value of which of the of Business Cycle) and choose the correct code
following estimate is highest ? given below—
(A) Gross Domestic Product at Constant Prices List I
(Base year 2011-12) (a) J.R. Hicks (b) R.G. Hawtrey
(B) Gross National Income at Constant Prices (c) F.A. Hayek (d) J.A. Schumpeter
(Base year 2011-12)
List II
(C) Gross Value Added at Basic Prices at Constant
Prices (Base year 2011-12) 1. Pure Monetary Phenomenon
(D) Net National Income at Constant Prices (Base 2. Innovation Theory
year 2011-12) 3. Working of acceleration and multiplier theory
4. Monetary over-Investment theory
446. Which of the following is regarded a better
measurement of economic development? Correct code is—
(A) National Income (A) A-3; b-1; c-4; d-2
(B) A-1; b-3; c-4; d-2
(B) National Disposable Income
(C) A-2; b-3; c-4; d-1
(C) Per Capita Income
(D) A-4; b-3; c-2; d-1
(D) Private Disposable Income
452. Who among the following economist said the
447. According to J M Keynes the volume of investment business cycle is a purely monetary phenomenon?
(I), undertaken by private entrepreneurs in the
economy depends upon— (A) Milton Freidman
(A) Marginal Efficiency of capital (B) R.G. Hawtrey
(B) Rate of Interest (C) J.M. Keynes
(C) National income (D) A.C. Pigue
(D) Both (A) & (B) 453. Which of the following economist never propounded
any theory of business cycle but discussed it at
448. Expected rate of profit is measured in terms of— length and suggested measures to overcome the
(A) Marginal Efficiency of capital recession and depression ?
(B) Rate of Interest (A) J.R. Hicks (B) Karl Marx
(C) Quantum of capital invested (C) J.M. Keynes (D) J.S. Mill
(D) Credit policy of the central bank
Answers
449. Which of the following statement is correct ?
1. (B) 2. (B) 3. (D) 4. (A) 5. (D)
(A) Marginal Efficiency of capital will always
increases as investment in that asset increases 6. (C) 7. (A) 8. (B) 9. (A) 10. (D)
(B) Marginal Efficiency of capital will always 11. (C) 12. (A) 13. (B) 14. (C) 15. (A)
diminishes as investment in that asset increases16. (A) 17. (B) 18. (C) 19. (D) 20. (D)
(C) Marginal Efficiency of capital will always 21. (D) 22. (B) 23. (B) 24. (B) 25. (B)
diminishes as investment in that asset decreases26. (B) 27. (D) 28. (A) 29. (A) 30. (D)
(D) Marginal Efficiency of capital will remain 31. (A) 32. (A) 33. (A) 34. (B) 35. (C)
unaffected with the increase or decrease in 36. (D) 37. (A) 38. (A) 39. (B) 40. (D)
investment in that asset 41. (A) 42. (D) 43. (A) 44. (A) 45. (A)
450. Which of the following factors affect the marginal 46. (C) 47. (A) 48. (A) 49. (B) 50. (C)
efficiency of capital? 51. (B) 52. (C) 53. (A) 54. (B) 55. (B)
I. Business optimism and pessimism 56. (C) 57. (B) 58. (D) 59. (A) 60. (D)
II. Changes in income 61. (A) 62. (C) 63. (A) 64. (B) 65. (A)
III. Propensity to consume 66. (C) 67. (D) 68. (D) 69. (D) 70. (B)
IV. Population growth 71. (C) 72. (D) 73. (C) 74. (A) 75. (A)
V. Technological advancement 76. (A) 77. (C) 78. (D) 79. (C) 80. (A)
Correct code is— 81. (B) 82. (C) 83. (D) 84. (A) 85. (D)
(A) I, II & III only 86. (A) 87. (B) 88. (C) 89. (C) 90. (A)
(B) III, IV & V only 91. (D) 92. (C) 93. (C) 94. (C) 95. (A)
(C) I, II, III, IV & V 96. (C) 97. (B) 98. (D) 99. (A) 100. (C)
(D) II, III & IV only 101. (B) 102. (B) 103. (D) 104. (C) 105. (C)
234U | Economics (NET)
106. (C) 107. (C) 108. (C) 109. (C) 110. (D) 281. (D) 282. (B) 283. (A) 284. (C) 285. (C)
111. (C) 112. (D) 113. (E) 114. (B) 115. (A) 286. (A) 287. (C) 288. (B) 289. (A) 290. (A)
116. (B) 117. (D) 118. (A) 119. (C) 120. (B) 291. (C) 292. (B) 293. (B) 294. (D) 295. (A)
121. (C) 122. (B) 123. (D) 124. (D) 125. (B) 296. (B) 297. (B) 298. (A) 299. (B) 300. (D)
126. (C) 127. (C) 128. (D) 129. (D) 130. (C) 301. (C) 302. (C) 303. (A) 304. (D) 305. (C)
306. (A) 307. (A) 308. (D) 309. (B) 310. (B)
131. (B) 132. (B) 133. (C) 134. (C) 135. (B)
311. (B) 312. (D) 313. (D) 314. (D) 315. (A)
136. (C) 137. (D) 138. (C) 139. (C) 140. (D)
316. (A) 317. (A) 318. (D) 319. (B) 320. (D)
141. (D) 142. (B) 143. (C) 144. (C) 145. (D)
321. (A) 322. (B) 323. (C) 324. (B) 325. (B)
146. (A) 147. (D) 148. (A) 149. (D) 150. (C)
326. (D) 327. (B) 328. (A) 329. (D) 330. (D)
151. (D) 152. (B) 153. (D) 154. (B) 155. (B)
331. (A) 332. (B) 333. (D) 334. (A) 335. (D)
156. (C) 157. (A) 158. (D) 159. (B) 160. (D)
336. (A) 337. (A) 338. (A) 339. (B) 340. (B)
161. (D) 162. (D) 163. (A) 164. (A) 165. (A)
341. (A) 342. (D) 343. (C) 344. (C) 345. (B)
166. (B) 167. (A) 168. (A) 169. (C) 170. (C)
346. (D) 347. (D) 348. (C) 349. (C) 350. (B)
171. (A) 172. (C) 173. (B) 174. (B) 175. (C)
351. (C) 352. (D) 353. (C) 354. (D) 355. (B)
176. (C) 177. (A) 178. (B) 179. (A) 180. (D)
356. (B) 357. (D) 358. (A) 359. (D) 360. (C)
181. (B) 182. (B) 183. (C) 184. (C) 185. (B)
361. (D) 362. (A) 363. (A) 364. (A) 365. (D)
186. (A) 187. (C) 188. (A) 189. (B) 190. (C)
366. (A) 367. (B) 368. (C) 369. (A) 370. (D)
191. (D) 192. (B) 193. (D) 194. (B) 195. (C) 371. (D) 372. (C) 373. (B) 374. (B) 375. (A)
196. (B) 197. (A) 198. (B) 199. (C) 200. (D)
376. (A) 377. (C) 378. (C) 379. (B) 380. (B)
201. (D) 202. (D) 203. (A) 204. (D) 205. (D)
381. (D) 382. (A) 383. (A) 384. (B) 385. (B)
206. (A) 207. (B) 208. (A) 209. (C) 210. (D)
386. (B) 387. (C) 388. (A) 389. (A) 390. (A)
211. (A) 212. (D) 213. (D) 214. (B) 215. (D)
391. (B) 392. (A) 393. (C) 394. (A) 395. (D)
216. (D) 217. (A) 218. (D) 219. (D) 220. (C)
396. (B) 397. (A) 398. (B) 399. (B) 400. (C)
221. (B) 222. (A) 223. (C) 224. (B) 225. (A)
401. (B) 402. (A) 403. (A) 404. (A) 405. (C)
226. (C) 227. (B) 228. (D) 229. (A) 230. (A)
406. (A) 407. (A) 408. (B) 409. (C) 410. (D)
231. (D) 232. (D) 233. (D) 234. (D) 235. (A)
411. (D) 412. (C) 413. (D) 414. (A) 415. (B)
236. (D) 237. (D) 238. (C) 239. (B) 240. (C)
416. (B) 417. (B) 418. (D) 419. (D) 420. (B)
241. (B) 242. (C) 243. (A) 244. (A) 245. (A)
421. (C) 422. (C) 423. (D) 424. (D) 425. (A)
246. (A) 247. (B) 248. (A) 249. (C) 250. (D)
426. (A) 427. (C) 428. (A) 429. (A) 430. (B)
251. (C) 252. (C) 253. (B) 254. (B) 255. (A)
431. (C) 432. (A) 433. (C) 434. (A) 435. (A)
256. (C) 257. (B) 258. (C) 259. (A) 260. (D)
261. (D) 262. (C) 263. (D) 264. (A) 265. (D) 436. (D) 437. (C) 438. (D) 439. (C) 440. (C)
266. (D) 267. (B) 268. (D) 269. (B) 270. (C) 441. (A) 442. (B) 443. (C) 444. (C) 445. (A)
271. (B) 272. (A) 273. (B) 274. (B) 275. (D) 446. (C) 447. (D) 448. (A) 449. (B) 450. (C)
276. (A) 277. (A) 278. (A) 279. (A) 280. (D) 451. (A) 452. (B) 453. (C)
●●
UNIT-3
Statistics and Econometrics
Probability Theory Mathematical Definition
Concept of Probability If there are n mutually exclusive and equally likely
cases and of these n cases, there are p cases favourable
In every day life we talk about probability of and q cases unfavourable to some event, then the
occurrence of various events. Whenever there is an probability of occurence of the event is denoted by
element of uncertainly about the occurrence of some p
event one makes a probability statement. For example, P=
n
the probability that India will win a cricket much against
West Indies is 30% or 0·30; the probability that it will The probability of non-occurence of the event is
rain tonight is 80% or 0·80, etc. denoted by
q
The concept of probability originally developed in Q=
n
the 17th century with the games of chance, line games of
cards, tossing of coins and dies etc. where P = Chances of success
Q = Chance of failure
Let us illustrate the concept of probability with the
help of the classical example of coin tossing experiment. Examples—1. A uniform die is thrown at random.
Suppose a coin is tossed, what is the probability that it Find the probability that the number on it is 5.
1 Solution—As we known a die has six sides with 1,
will turn up head? Perhaps the immediate answer it ,
2 2, 3, 4, 5 and 6 written on them. Since it is an ideal die
provided it is an ideal coin and it is not worn out or all the six sides are equally likely to turn up. Also, only
biased in any way. The argument will be that there are one of the sides will turn up at a time and thus the six
only two possible ways in which the coin can be tossed possible ways are mutually exclusive. The number 5 can
(either head or tail will turn up), and the coin being an turn up in only one possible way. Therefore, the required
ideal one both head and tail are equally likely. 1
probability is .
Therefore, the odds are fifty – fifty, i.e., the probability 6
1
of getting head is and so is the probability of getting 2. Suppose an ideal die is tossed twice. What is the
2 probability that 6 will appear on both occasions ?
tail. This is, in fact, the classical approach to obtaining
the probability of occurrence of an event. Solution—There are 36 (= 6 × 6) possible ways in
which the die can be thrown twice we may get 1 in the
According of La Place–“Probability is the ratio of first toss and also 1 in the second, or 1 in the first and 2
favourable events to the total number of equally likely in the second, or, 1 in the first and 3 in the second and so
events.” on. Let us list the number of possible outcomes as
Symbolically follows :
Number of favourable cases (1, 1) (1, 2) (1, 3) (1, 4) (1, 5) (1, 6)
P=
Total number of equally likely cases (2, 1) (2, 2) (2, 3) (2, 4) (2, 5) (2, 6)
Similarly, (3, 1) (3, 2) (3, 3) (3, 4) (3, 5) (3, 6)
Number of cases not favourable (4, 1) (4, 2) (4, 3) (4, 4) (4, 5) (4, 6)
q=
Total number of equally likely cases (5, 1) (5, 2) (5, 3) (5, 4) (5, 5) (5, 6)
In simple words, probability can be defined in the (6, 1) (6, 2) (6, 3) (6, 4) (6, 5) (6, 6)
following manner.
All these ways are equally likely and mutually
The probability of the happening of any one of the exclusive. There is only one possible way in which we
several equally likely events is the ratio of the number of get 6 in both the first and the second toss. Therefore, the
cases favourable to it to the total number of possible 1
required probability is ,
cases. 36
236U | Economics (NET)
3. In the above example, what is the probability of preference to other. Thus, in tossing of a coin, all the out
getting a sum of 10 ? comes, namely, H and T are equally likely if the coin is
Solution—What is required is that the sum of the unbiased.
two numbers shown on the die in two tosses should be Independent Events
10. This is possible in only three ways.
Events are said to be independent of each there if
Either we get 5 in the Ist toss and 5 in the 2nd. or, happening of any one of there is not affected by and
we get 4 in the Ist toss and 6 in the 2nd. we get 6 in the does not affect the happening of any one of others.
Ist toss and 4 in the second.
For example, in tossing of a die repeatedly the event
Thus the required probability is of getting ‘5’ in Ist throw is independent of getting ‘5’ in
3 1 second, third or subsequent throws.
= =
36 12
4. If a coin is tossed two times, what is the Remark
probability of getting head at least once? The two events A and B are said to be disjoint or
mutually exclusive if they cannot happen simultaneously
Solution—The total number of equally likely and
i.e., if their intersection is a null set. Thus if A and B are
mutually exclusive ways is, now, 4 :
disjoint event, there
(H, H) (H, T) (T, H) (T, T) A ∩ B = φ ⇒ P (A ∩ B) = P(φ) = 0
and the number of favourable way (i.e., the number Thus P(A ∩ B) = 0, provides us with a criterion for
of ways in which head appears at least once) is 3. finding if A and B are mutually exclusive.
3
Therefore, the required probability is . Addition Rule of Probability
4
5. What is the chance of drawing a queen in a draw The probability of occurrence of at least one of the
from a pack of 52 cards ? two events A and B is give by :
Solution—Total number of cases = 52 P (A ∪ B) = P (A) + P (B) – P (A ∩ B)
Total number of queen = 4 where
P (A) = Probability of occurrence of an event A
∴ The probability of drawing a queen is
P (B) = Probability of occurrence of an event B
4 1
= = P (A ∩ B) = Probability of simultaneous occurrence
52 13 of A and B
6. A bag contains 10 black and 20 white balls. What P (A ∪ B) = Probability of occurrence of at least
is the probability of drawing : one of the two event A and B
a. a black ball, and
Addition Rule of Probability for Mu-
b. a white ball.
tually Exclusive Events
Solution—Total number of balls = 10 + 20 = 30
If two events A and B are mutually exclusive (i.e.,
a. Probability of drawing a black ball is only one of them can occur at a time) and P (A) and P
Number of Black Balls (B) are the probabilities of occurrence of A and B,
P =
Total Numbers of Ball respectively; then
10 1 P (A ∪ B) = P (A) + P (B)
= =
30 3
Multiplication Rule of Probability
b. Probability of drawing a white ball is
Number of White Balls The probability of simultaneous happening of two
P = events A and B is given by :
Total Number of Balls
P (A ∩ B) = P (A). P (B/A); P (A) ≠ 0
20 2
=
30 3
= P (B ∩ A) = P (B). P (A/B); P (B) ≠ 0
where P (B/A) is the conditional probability of
Mutually Exclusive Events happening of B under the condition that A has happened
Two or more events are said to be mutually exclu- and P (A/B) is the conditional probability of happening
sive if the happening of any one of them excludes the of A under the condition that B has happened.
happening of all others in the same experiment. Remark
For example, in toss of a coin the events ‘head’ and
Multiplicative Rule for Independent Events.
‘tail’ are mutually exclusive because if head comes, we
cannot get tail and if tail comes we cannot get head. If A and B are independent so that the probability of
occurrence or non-occurrence of A is not affected by
Equally Likely Cases the occurrence or non-occurrence of B, we have
The outcomes are said to be equally likely or P (A/B) = P (A) and P (B/A) = P (B)
equally probable if none of them is expected to occur in Hence P (A ∩ B) = P (A) . P (B)
Economics (NET) | 237U
Thus, the probability of simultaneous happening of There is only one case favourable to the event
two independent events is equal to the product of their A ∩ B, namely, king of diamond. Hence
individual probabilities. 1
P(A ∩ B) =
Generalisation 52
Substituting in (i), we get
The multiplication law of probability can be exten-
ded to more than two events. Thus, for three events A, B 1 1 1 13 + 4 – 1
P (A ∪ B) = + – =
and C we have 4 13 52 52
P (A ∩ B ∩ C) = P(A). P(B/A) P(C/A ∩ B) =
16 4
=
In particular, if A, B and C are independent events 52 13
there Example 2. In a certain college, the students engage
P (A ∩ B ∩ C) = P (A). P(B). P(C) in various sports in the following proportions :
i.e., the probability of the simultaneous happening Football (F) : 60% of all students
of n independent events is equal to the product of their Basket ball (B) : 50% of all students
individual probabilities. Both Football and Basketball : 30% of all students.
Theorem If a student is selected at random, what is the
probability that he will :
–
P(A) = 1 – P(A) (i) play football or basketball?
where (ii) play neither sports?
– Solution—Let A denote the event that the student is
P(A) = Probability of event A does not happen engaged in Football and B denote the event that he is
P(A) = Probability of event A happens engaged in Basketball. Then we are given;
Theorem : P(A) = 0·60
– P(B) = 0·50
(i) P(A ∩ B) = P (B) – P (A ∩ B)
where and P (A ∩ B) = 0·30
– (i) The probability that a student selected at random
P(A ∩ B) = Probability of A does not happen but B plays Football or Basketball is given by :
happens P(A ∪ B) P(A) + P(B) – P(A ∩ B)
– = 0·60 + 0·50 – 0·30 = 0·80
(ii) P( A ∩ B) = P (A) – P (A ∩ B)
– (ii) The probability that the student plays neither
(iii) P(A ∩ B) = 1 – P (A ∪ B) Football nor Basketball is given by :
= 1 – [P (A) + P (B) – P (A ∩ B)] – –
= 1 – P (A) – P (B) + P (A ∩ B)] P (A ∩ B) 1 – P [the plays at least one of the two
where A and B are independent event. games
Q P(A ∩ B) = P (A). P (B) = 1 – 0·80 = 0·20
Example 3. Probability that a man will be alive 25
–
∴ P(A ∩ B) = 1 – P (A) – P (B) + P (A). P(B) years hence is 0·3 and the probability that his wife will
= 1 – P (A) – P (B) [1 – P (A)] be alive 25 years hence is 0·4. Find the probability that
25 years hence.
– –
= [1 – P (A)] [1 – P (B)] = P(A)·P(B) (i) both will be alive.
Example 1. A card is drawn from a will shuffled (ii) only the man will be alive
pack of playing cards. Find the probability that it is either (iii) only the woman will be alive
a diamond or a king.
(iv) at least one of there will be alive
Solution—Let A denote t h e event of drawing a
diamond and B denote the event of drawing a king from Solution—Let us define the following events :
a pach of cards. A : The man will be alive 25 years hence,
Then we have B : His wife will be alive 25 years hence,
13 1 we are given
P(A) = =
52 4 P (A) = 0·3
4 1 and P(B) = 0·4
and P (B) = =
52 13 (i) The probability that 25 years hence both man and
and we want P(A ∪ B) his wife will be alive is
Now P (A ∪ B) = P(A) + P(B) – P(A ∩ B) P (A ∩ B) = P (A). P (B)
1 1 (∴ A and B are independent)
= + – (A ∩ B) ...(i)
4 3 = 0·3 × 0·4 = 0·12
238U | Economics (NET)
(ii) The probability that 25 years hence only the Solution—Let A denote the event of drawing a
man will be alive is white ball and B denote the event of drawing a red ball.
– – – Balls drawn with replacement–If the drawn ball is
P(A ∩ B) = P(A)·P(B) replaced before the 2nd drew is not affected by the result
= P(A).[1 – P (B)] of the 2nd draw. In other words, A and B are
= 0·3 × (1 – 0·4) = 0·3 × 0·6 = 0·18 independent events and hence the probability of drawing
(iii) The probability that only the woman will be a white ball and then a red ball in that order is given by :
alive 25 years hence is P(A ∩ B) = P(A). P (B)
– – – – 5 7 35
P(A ∩ B) = P(A) × P(B) = × =
12 12 144
= [1 – P (A)] × P(B) Balls drawn without replacement–If the drawn
= (1 – 0·3) × 0·4 = 0·7 × 0·4 = 0·28. ball is not replaced before the 2nd draw, then the events
(iv) The probability ‘P’ that 25 years hence at least A and B are not independent.
one of them will be alive’s ∴ P (A ∩ B) = P (A). P (B) …(i)
P = 1 – (None will be alive) For the 2nd draw, the total number of balls left in
the bag is 12 – 1 = 11 and
– –
= 1 – P (A ∩ B)
– –
= 1 – P (A ) × P ( B)
∴P () B
A
= (drawing a red ball when there are 4
white and 7 red balls)
= 1 – (1 – 0·3) × (1 – 0·4) 7
=
= 1 – 0·7 × 0·6 = 1 – 0·4 = 0·58 11
Example 4. The probability that a person stopping Hence from (1)
to a petrol pump will get his tyres checked is 0·12, the P(A ∩ B) = P(A) · P(B/A)
probability that he will get his oil checked is 0·29, and 5 7 35
the probability that he will get both checked is 0·07. = · =
12 11 132
(i) What is the probability that a person stopping at
this pump will have neither his tyres nor oil checked ? Mathematical Expectation
(ii) Find the probability that a person who has his oil If x is a random variable which can assume any one
checked will also have his tyres checked. of the values x1, x 2 ,….xn with respective probabilities p1 ,
Solution—Let A denote the event that a person p2 ….. pn there the mathematical expectation of x usually
stopping at a petrol pump will have his tyres checked, called that expected value of x and denoted by E (X) is
and B denote the event that he will get his oil checked. defined as :
There we are given : E(x) = p1 x1 + p2 x2 +….+ pn xn = Σp.x
P (A) = 0·12 where Σpi = p1 + p2 + ...pn = 1
P (B) = 0·29 More precisely, if x is a random variable with
P (A ∩ B) = 0·07 probability distribution {x, p(x)}, Hence
(i) The probability that a person stopping at this E(x) = Σx. p(x)
pump will have neither his tyres nor oil checked is given
by :
Remark
– – Mathematical expectation of a random variable
P(A ∩ B) = 1 – P (A ∪ B) is nothing but its arithmetic mean.
= 1 – [P(A) + P(B) – P(A ∩ B)] Theorems of Expectation
= 1 – (0·12 + 0·29 – 0·07) Theorem – 1
E(c) = C
= 1 – 0·34 = 0·66
where c is a constant
(ii) Required probability = P (A/B)
Proof—We have
P(A ∩ B)
= E(c) = Mean of c
P(B)
c + c + c + ... + c nc
0·07 = = =c
= = 0·24 n n
0·29
Theorem-2
Example 5. There are 5 white and 7 red balls in a
bag. A ball is drawn and then replaced. What is the E(cx) = CE (x)]
probability that a white and a red ball are drawn in that where c is a are constants.
order ? Theorem-3
What would be the probability if the balls drawn E(ax × b) = a E (x) + b
were not put back into the bag ? where a and b are constants.
Economics (NET) | 239U
Theorem-4. Addition Rule of Expectation where
If X and Y are random variables then p = probability of success in a single trial.
E (X + Y) = E(X) + E(Y) Q = probability of failure in a single trial.
i.e., Expected value of the sum of two random and p + q = 1
variable is equal to sum of their expected values
Remark
Corollary.
Putting x = 0, 1, 2,…..n in above equation we get the
E (ax – by) = AE (X) + bE (Y)
probabilities of 0, 1, 2, 3,…..n successes respectively in
when a and b are constants n trials, which are tabulated ahead :
Theorem–5 (Multiplication Rule of Expectation)
The Binomial Distribution
If X and Y are independent random variables, then
Number of
E (XY) = E (X). E(Y) successes x Probability
i.e., the expected value of the product of two 0 qn
independent random variables is equal to the product of
1 nqn – 1
their expected values.
2 n(n – 1) n – 2 2
q p
Distribution 2–1
M M
Binomial Distribution M
Suppose the variable under study is measured in x n (n – 1)...(n – x + 1) n – x x
q p
such away that each observation can be classified into x (x – 1) ... 3·2·1
two categories. For example, if a coin is tossed, the M MM
result of each throw can be either a head or a tail.
Similarly, if a die is thrown we may call getting 5 or 6 a n pn
‘success’ and getting 1, 2, 3 or 4 a ‘failure’. If data on Total Ι
income of households are collected, we may classify
each household as ‘poor’ or ‘Not–Poor’ on the basis of It should be noted that
its income. For example, if the household monthly 1. The variable x (number of success) is discrete it
income is less than or equal to R 500/- it may be can take only the integral values 0, 1, 2,…, n.
classified as ‘Poor’ and if it is more than R 500/- we may 2. The probabilities specified above
call it ‘Not – Poor’.
qn , nqn-1 p,…pn
In Binomial Distribution it is necessary that each
observation is classified into only two categories. are in fact successive terms in the Binomial
Expansion of (q + p)n.
For the sake of convenience we name there two
categories as ‘success’ and ‘failure’. 3. The sum of binomial coefficient is 2 n .
In binomial distribution it is necessary that the 4. For n trials the binomial probability distribution
probability of success (failure) remains the same for consists of (n + 1) terms.
each observations or in each trial. Thus the probability For Binomial Distribution
of getting head (or tail) must remain the same in each
toss; similarly, in case of the die throwing experiment 1. Mean = n p
the probability of success (i.e., getting 5 or 6) must 2. Variance = (s.d.)2 = npq
remain the same in each throw. 3. Third moments μ3 = npq (q – p)
If the probability of success (or failure) changes 4. Fourth moments μ4 = npq [1 + 3pq (n – 2)]
from trial to trial or if the results of each trial are
classified into more than two categories, then the 5. Moment coefficient of Skewness is
Binomial distribution cannot be used. (q – p)2
β1 =
Another condition underlying the Binomial distri- npq
bution is that the trials (or individual observations) 1 – 6pq
should be independent of each other. 6. Coefficient of Kurtosis is β2 = 3 +
npq
If n independent observations (or n independent Remarks
trials) are made, the result of each trial is classified into
1. Since q is the probability (of failure), we always
two categories called ‘success’ and ‘failure’ and the
have 0 < q < 1.
probability of success is the same for each observation
or in each trial, then the probability of getting x ∴ Variance = np × q < np (Q 0 < q < 1)
successes in n trials is equal to ⇒ Variance < Mean
n! Hence for the Binomial distribution variance is less
px qn – x
x ! (n – x) ! than mean
240U | Economics (NET)
2. Binomial distribution is symmetrical if p = q 0·5 (i) n, the number of trials is indefinitely large
1 (ii) p, the constant probability of success for each
= . It is positively Skewed if p < 0·5 and negatively
2 trial is indefinitely small i.e., p → 0.
Skewed if p > 0·5. (iii) np = m is finite
Examples—1. Comment on the following : Under the conditions gives above the probability of
For a binomial distribution, mean = 7 and variance getting x successes is
= 11 e–n · mx
...(i)
Solution—For a binomial distribution with para- x!
meters n and p, where x = 0, 1, 2, 3…..
Mean = np = 7 …(1) m = mean = np
and variance = npq = 11 …(2) e = 2·71828
Dividing (2) by (1), we get and x! = x (x – 1) x (x – 2)… × 3 × 2 × 1.
q=
11
= 1·6 Remarks
7 1. Poisson distribution is a discrete probability dis-
which is impossible, since q being the probability tribution, since the variable can take only integral value
must lie between 0 and 1. Hence, the given statement is 0, 1, 2,…∞
wrong. 2. Putting x = 0, 1, 2, 3….in (i) we obtain the
2. If the probability of a defective bolt is 1/10, find probabilities of 0, 1, 2, 3…, successes respectively,
(i) the mean; (ii) variance; (iii) moment coefficient of which are tabulated ahead :
Skewness; (iv) Kurtosis, for the distribution of defective
bolts in a total of 400. Poisson Distribution
Solution—In the usual notations, we have No. of Successes Probability
1 (x) p(x)
n = 400, p = = 0·1, 0 e-m
10
-m
q = 1 – p = 0·9 1 e ·m
1!
According to Binomial Probability law : 2 e–m · m2
(i) Mean = np, = 400 × 0·1 = 40 2!
(ii) Variance = npq = 400 × 0·1 × 0·9 M M
(iii) The moment coefficient of Skewness 3 e · m3
–m
(q – p) 2 3!
β1 = x e–m · mx
npq
x!
(0·8)2 0·64
= = = 0·1777 = 0·018 Total 1
36 36
+ 3. If we known m, all the probabilities of the poisson
√⎯β1 = ⎯√⎯⎯⎯
∴ γ1 = ⎯ 0·018 = 0·134
distribution can be obtained, m is, therefore, called
(iv) Coefficient of Kurtosis is given by : the parameter of the Poisson distribution.
1 – 6pq Constants of Poisson Distribution
β2 = 3 +
npq The mean of poisson distribution
1 – 6 × 0·1 × 0·9 Mean = m = np
=3+ and the Variance = m = mean
36
i.e., mean and variance are equal, each being equal
0·46
=3+ = 3 + 0·013 = 3·013 to the parameter m.
36
Other Constants
Remarks The moments (about mean) of the poisson distribu-
Since β1 ≠ 0, the distribution is not symmetrical. But tion are :
since it is nearly zero, it is moderately symmetrical. β2>3 μ1 = 0
implies that the distribution is platy Kurtic. μ2 = Variance = m
μ3 = m
Poisson Distribution
μ4 = m + 3m2
(As a Limiting Case of Binomial Hence,
Distribution) (μ )2 m2 1
Poisson distribution was derive in 1837 by siman D. β1 = 3 3 = 3 =
(μ2 ) m m
Poisson. Poisson distribution may be obtained as a
μ4 m + 3m2 1
limiting case of Binomial probability distribution under and β2 = 2 = =3+
the following conditions : μ2 m2 m
Economics (NET) | 241U
Remarks Normal Curve
1. As m → ∞, β1 → 0 and β 2 → 3 1 (x – m)2
1 –
2 σ2
2. Since μ 3 = m > 0, From above equation we The y = e
σ⎯√⎯2π
observe that B1 > 0. This means that Poisson distribution
is called the Normal Curve.
is a positively Skewed distribution. As the value of the
parameter m increases, β1 decreases and thus Skewness where
is reduced for increasing values of m. In particular as m = Mean
m → ∞ (large value of m), β1 → 0 and consequently the σ2 = Standard deviation
distribution tends to be symmetrical for large m. As a special case, we may write m = 0 and
σ2 = 1 there
Mode of Poisson Distribution 1 –2 x
1 2
The poisson distribution has mode at X = x, if P (x) y= e
> P (x – 1) and P (x) > P (x + 1) ⎯⎯2π
√
is the Standard Normal Curve (S.N.C.)
Case 1. When m is an integer—If m is an integer,
equal to K, (say), then the Poisson distribution is Remark
bimodal, the two modes being at the points X = k an X = If X is a random variable following normal dis-
k – 1. tribution with mean m and standard deviation σ, then the
Case 2. When m is not an integer—If m is not an random variable Z defined as follows :
integer than the distribution is unimodal, the unique X – E(X) X – m
Z= =
modal value being the integral part of m. For example, if σx σ
m = 5·6, then mode is 5, the integral part of 5·6. is called the Standard Normal Variate (S.N.V.),
we have
Utility or Importance of Poisson Distri-
bution E(Z) = E ( ) X–m
σ
The conditions under which Poisson distribution is 1
obtained as a limiting case of the Binomial distribution = E(X – m) [Q E(cx) = CE(x)]
σ
and also the conditions for the general model underlying.
[Q E(x) = E(x)]
Poisson distribution suggest that Poisson distribution can
be used to explain the behaviour of the discrete random 1
= E(x) – E(m)
variables where the probability of occurrence of the σ
event is very small and the total number of possible 1
cases is sufficiently large. We give below some practical = [m – m] = 0
σ
situations where Poisson distribution can be used :
(i) Number of accidents taking place per day on a
busy road.
Var (Z) = Var (x –σ m)
(ii) The number of suicides reported in a particular 1
= Var (x – m) [Q Var (cx) = c 2 Var (x)]
day or the number of casualties due to a rare disease σ2
such as heart attack or cancer or snake bit in a year. 1
= 2 · Var(x)
(iii) The number of defective material in a packing σ
manufactured by a good concern. because variance is independent of the change of
(iv) To count the number of radioactive disinte- origine.
grations of a radioactive element per unit of time. 1
∴ Var (Z) = 2 · σ2 = 1
Example—1. Comment on the following : σ
For a Poisson distribution, Therefore, the standard normal variate (S.N.V.) Z
Mean = 8 and Variance = 7 has mean 0 and standard deviation 1.
Solution—The given statement is wrong, since for a Properties of Normal Distribution
Poisson distribution mean an variance are equal. 1. If the parameters m and σ 2 of the normal curve
are specified, the normal curve is fully determined and
Normal Distribution we can draw it by obtaining the value of (y) corres-
Normal distribution is one of the most important ponding to different values of x – the abscissa.
continuous theoretical distributions in statistics. Most of we not that the normal curve
the data relating to economic and business statistics or 1 (x – m)2
1 –
2 σ2
even in social and physical sciences confirm to this y= e
distribution. σ⎯
√⎯2π
242U | Economics (NET)
is bell-shaped and it is symmetric about the Straight Areas Under Normal Curve
line x = m.
Importance of Normal Distribution
Normal distribution has occupied a very important
role in statistics. We enumerate below some of its
2. The normal curve tends to touch the X – axis only important applications.
at infinity, i.e., the X – axis is an ‘asymptote’ to the
normal curve. It is a continuous curve stretching from 1. Most of the discrete probability distributions (i.e.,
–∞ to + ∞. Binomial distribution, Poisson distribution) tend to
normal distribution as n the number of trials increases.
3. Since the distribution is symmetrical, mean, For large values of n, computation of probability for
median and mode coincide. Thus, discrete distributions becomes quite tedious and time
Mean = Median = Mode = m consuming. In such cases, normal distribution can be
4. Since Mean = Median = m, the ordinate at x = m, used with great ease and convenience.
divides the whole area into two equal parts. Further, 2. Almost all the exact sampling distributions e.g.,
since total area under normal curve is 1, the area to the student’s t-distribution, snedecor’s F-distribution,
right of te ordinate as well as to the left of the ordinate at Fisher’s Z-distribution and the Chi square distribution
x = m is 0·5. conform to normal distribution for large degree of
5. Also, by virtue of symmetry the quartile are freedom (i.e., as n → ∞).
equidistant from median (m) i.e., 3. The whole theory of exact sample (small sample)
Q3 – Md = M d – Q1 ⇒ Q1 + Q3 = 2M d = 2M tests, namely, t , F, φ 2 tests, etc, is based on the
6. Since the distribution is symmetrical, the moment fundamental assumption that the parent population from
coefficient of Skewness is given by : β 1 = 0 which the samples have been drawn follows Normal
distribution.
7. The coefficient of Kurtosis is given by : β2 = 3
4. Perhaps, one of the most important applications
8. No portion of the curve lies below the X – axis.
of the Normal distribution is inherent in one of the most
9. Theoretically, the range of the distribution is from fundamental theorems in the theory of statistics, namely,
–∞ to ∞. But practically, Range = σσ. the Central Limit Theorem.
10. Since the distribution is symmetrical, all 5. If X is a normal Variate with mean m and
moments of odd order about the mean are zero. Thus variance σ2, then we have proved that
μ1 = μ3 = μ5 = …= 0 P(m – 3σ < × < m + 3σ) = P(–3 < z < 3) = 0·9973
11. X-axis is an asymptote to the curve, i.e., for ⇒ P[|z| > 3] = 1 – 0·9973 = 0·0027
numerically large value of x (on either side of the point
Thus, the probability of standard normal variate
X = m), the curve becomes parallel, to the X-axis and is
going outside the limits ± 3 is practically zero. In other
supposed to meet it is infinity.
words, in all probability we should expect a standard
12. Points of inflexion of the normal curve are at normal variate to lie between the limits ± 3. This
X = mσ and x = m – σ. property of the normal distribution forms the basis of
At the point of inflexion the tangent changes entire large sample theory.
its sign. 6. Normal distribution is used in Statistical Quality
13. Area Property—One of the most fundamental Control in Industry for the setting of control limits.
properties of the normal probability curve is the area
property. The area under the normal curve between the Moments
ordinates at x = m – σ and x = m + σ is 0·6826. In other According to Frederick Mills, “Moment is a familiar
words, the range m ± σ covers 68·26% of the mechanical term for the measure of a force with
observations. reference to its tendency to produce rotation. The
The area under the normal probability curve strength of this tendency depends, obviously, upon the
between the ordinates at x = m – 3σ and x = m + 3σ is amount of the force and the distance from the origin of
0·9973 i.e., the range m ± 3σ covers 99·73% of the the point at which the force is exerted.”
observations. Hence, for practical purposes, the range m Moment is a term generally used in physics,
± 3σ covers the entire area, which is 1. mechanics and refers to the turning effect or rotating
Economics (NET) | 243U
effect of a force. When it is applied in statistics, it 3. The third moment about mean measures skew-
describes the various’ characteristics of frequency ness—
distribution, viz., central tendency, dispersion, skewness If μ 3 > 0, the given distribution is positively
and kurtosis. Moments can be defined as the arithmetic skewed.
mean of various powers of deviations taken from the
If μ3 < 0, the given distribution is negatively
mean of a distribution.
skewed.
Moments about Mean or Central If μ3 = 0, the given distribution is symmetrical.
Moments 4. All odd moments (in a symmetrical distribution) are
For a frequency distribution, the first moment about zero
the arithmetic mean is defined as the mean of deviations ∴ μ1 = μ3 = μ5 = μ7…
of items taken from their arithmetic mean. The first four 5. The fourth moment about mean measures kurtosis.
moments about arithmetic mean or central moments are μ
defined below— β1 = 42
μ2
Individual series Discrete series Moments about Arbitrary Origin or
First moment
∑(X – X)
– –
∑d ∑f (X – X) ∑fd
Raw Moments
about the mean μ1 = =
N N N N If the mean is a fractional value, then it becomes a
=0 difficult task to work out the moments. In such cases, we
can calculate moments about a working origin and then
Second moment – – change it into moments about the actual mean.
about the mean μ2 ∑(X – X)2 ∑f (X – X)2
∑
N N Discrete
∑d2 ∑fd2 Individual series distribution
= = σ2 = = σ2
N N First moment ∑(X –A) ∑d ∑f (X –A) ∑fd
Third moment – – = =
about arbitrary N N N N
about the mean μ3 (X – X)3 ∑f (X – X)3
∑ origin (μ′1)
N N
Second moment ∑(X –A)2 ∑d2 ∑f(X –A) 2 ∑fd2
∑d 3 ∑fd3 about arbitrary = =
= = N N N N
N N origin (μ′2)
Fourth moment – 4 – Third moment ∑(X –A)3 ∑d3 ∑f(X –A) 3 ∑fd3
about the mean μ4 ∑(X – X) ∑f (X – X)4 = =
about arbitrary N N N N
N N origin (μ′3)
fd4 fd4
=∑ =∑ Fourth moment ∑(X –A)4 ∑d4 ∑f(X –A) 4 ∑fd4
N N = =
about arbitrary N N N N
μ is a Greek letter, pronounced as ‘mu’. origin (μ′4)
The sum of deviation of items from arithmetic mean d = deviations from arbitrary origin i.e., assumed
is always zero. Therefore, μ1 would always be zero. mean.
μ 2 = σ2 Relations between the moments from arithmetic
mean and moments from a working origin (i.e.,
σ = √ ⎯⎯μ2 conversion of moments from assumed mean into the
Two important constants of a distribution are moments about actual mean) are given below—
calculated from μ2 , μ3 and μ4 . They are—
2
μ1 = μ' – μ' = 0
1 1
μ3 2
(i) β1 = 3 μ2 = μ'2 – μ1'
μ2
3
μ μ3 = μ'3 – 3μ'1 μ'2 + 2μ1'
(ii) β2 = 42
μ2
μ4 = μ'4 – 4μ'1 μ'3 + 6μ2' (μ'1 )2 – 3 (μ1' )4
β1 measures skewness and β2 kurtosis.
Moments about Zero
Properties of Central Moments The moments about zero are often denoted by V 1 ,
1. The first moment about mean is always zero, i.e., V2, V3 and V 4 are obtained as follows—
μ1 = 0. ∑fX ∑fX2
V1 = V2 =
2. The second moment about mean measures variance. N N
∑fX3 ∑fX4
That is, μ2 = σ2 or σ = ± ⎯ V3 = V4 =
√⎯μ2. N N
244U | Economics (NET)
1
Also, the first moment about zero or V1 = A + μ1 or An interesting thing about CLT is that it does not
mean matter what the distribution of the Xi’s. The Xi’s can be
The second moment about zero or discrete, continuous, or mixed random variables. To get
a feeling for the CLT, let us look at some examples.
V2 = μ2 + (V1 )2 Let’s assume that Xi’s are Bernoulli (P). Then EXi = p,
The third moment about zero or variance (Xi) = p (1 – p). Also,
3
V3 = μ3 + 3V1 V2 – 2V1 Yn = X1 + X2 + …… + X n has Binomial (n, p)
The fourth moment about zero or distribution.
2 4
V4 = μ4 + 4V1 V3 – 6V1 V2 + 3V1 Yn – np
Thus, Zn = ,
Sheppard’s Correction for Moments ⎯⎯⎯⎯⎯⎯⎯
√ np (1 – p)
When Y n ~ Binomial (n, p). Fig. 1 shows that
In case of grouped frequency distribution, while
calculating moments we assume that the frequencies are Probability Mass Function (PMF) of Zn for different
concentrated at the centre (or middle point) of the class values of n. It is clear in the fig. 1. that the shape of the
intervals. However, the assumption is not true in practice PMF gets closer to a normal Probability Distribution
and some error called the grouping error creeps into the Function (PDF) curve as n increases. Here, Zn is a
calculation of the moments. discrete random variable, so mathematically speaking it
μ2 (corrected) = μ2 (incorrected) – i2 /12 has a PMF not a PDF. That is why the CLT states that
the CDF (not the PDF) of Zn converges to the standard
μ3 (corrected) = μ3
normal CDF Nevertheless, since PMF and PDF are
1 7 4
μ4 (corrected) = μ4 (uncorrected) – i2 μ2 + i conceptually similar, the figure is useful in visualising
2 240 the convergence to normal distribution.
Where i is the width of the class interval.
Assumptions—
The first and third moments need no correction.
1. X1, X2……are iid Bernoulli (p).
Central Limit Theorem X1 + X2 + …… + Xn – np
2. Zn =
The Central Limit Theorem (CLT) is one of the ⎯⎯⎯⎯⎯⎯⎯
√ np (1 – p)
most important results in probability theory, the CLT
states, that, under certain conditions, the sum of a large 1
We choose p = .
number of random variables is approximately normal. 3
Suppose, that X1 – p PMF of Z1
Z1 =
X1, X2 , ………Xn are independent and identically ⎯⎯⎯⎯⎯⎯
√ p (1 – p)
distributed random variable with expected values EXi =
μ < ∞ and variance Var (Xi) = σ 2 < ∞. Then as we saw
– x + x2 + x3 ………+ xn
above, the sample mean X = 1 has
n X1 + X2 – 2p PMF of Z2
– – σ2 Z2 =
mean X = μ and variance Var (X) = . ⎯⎯⎯⎯⎯⎯⎯
√ 2p (1 – p)
n
Thus, the normalised random variable
–
X – μ X1 + X2 + ……+ Xn – nμ X1 + X2 + X3 – 3p PMF of Z3
Zn = = …(i)
σ ⎯ nσ
√ Z3 =
⎯⎯⎯⎯⎯⎯⎯
√ 3p (1 – p)
⎯n
√
has mean E Zn = 0 and variance (Zn ) = 1.
The Central Limit Theorem states that the Cumula- 30 PMF of Z30
tive Distribution Function (CDF) of Zn converges to the ∑ Xi – 30p
standard normal CDF. i=1
Z30 =
Expression (1) converges in distribution to the ⎯⎯⎯⎯⎯⎯⎯
√ 30p (1 – p)
standard normal random variable as n goes to infinity,
that is Fig. 1 : Zn is the normalised sum of n independent
lim P (Zn ≤ x) = φ (x), for all x ∑ R Bernoulli (p) random variables. The shape
n →∞
of its PMF, PZn (z), resembles the normal
where φ (x) is the standard normal CDF. curve as n increases.
Economics (NET) | 245U
The importance of the central limit theorem stems Descriptive Statistics
from the fact that, in many real applications, a certain
random variable of interest is a sum of a large number of Measures of Central Tendency
independent random variables. In these situations, we A measures of central tendency is a single figure
are often able to use the CLT to justify using the normal (or) single score in a distribution.
distribution. Examples of such random variables are Measures of central tendency has three parts.
found in almost every discipline. Here are a few—
● Laboratory measurement errors are usually modeled
by normal random variables.
● In communication and signal processing, Gaussian
noise is the most frequently used model for noise.
● In finance, the percentage changes in the prices of
some assets are sometimes modeled by normal There are five alternative measures of central
random variables. tendency. They are :
● When we do random sampling from a population to 1. Arithmetic Mean (A.M.)
obtain statistical knowledge about the population, 2. Median
we often model the resulting quantity as a normal 3. Mode
random variable. 4. Geometric Mean (G.M.)
The CLT is also very useful in the sense that it can 5. Harmonic Mean (H.M.)
simplify our computations significantly. If you have a
problem in which you are interested in a sum of one Arithmetic Mean
thousand i.i.d. random variables, it might be extremely Arithmetic mean of given set of observations is their
difficult, if not impossible, to find the distribution of the sum divided by the number of observations. For
sum by direct calculation. Using the CLT we can example the arithmetic mean of 5, 8, 10, 15, 24 and 28 is
immediately write the distribution, if we know the mean 5 + 8 + 10 + 15 + 24 + 28 90
= = 15
and variance of the XiXi’s. 6 6
Another question that comes to mind is how large Calculation
n n should be so that we can use the normal
Arithmetic mean can be calculated in the following
approximation. The answer generally depends on the
manner :
distribution of the XiXi’s. Nevertheless, as a rule of
thumb it is often stated that if nn is larger than or equal A. Arithmetic Average in Individual Series
to 3030, then the normal approximation is very good. (i) Direct method
Let’s summarize how we use the CLT to solve — ΣX
X =
problems. N
where
How to Apply the Central Limit —
X = Arithmetic Average of Mean
Theorem (CLT) Σ = Sum of values and read as summation
1. Write the random variable of interest, Y, as the sum X = Values of variable X
of n independent and identically distributed random N = Number of items
variable Xi’s— (ii) Short cut method
Y = X1 + X2 + …… + Xn — Σdx
X = A+
2. Find EY and Var (Y) by noting that N
EY = nμ, Var (Y) = nσ2 where
where μ = EXi and σ2 = Var (X i) —
X = Arithmetic mean
3. According to the CLT, conclude that A = Assumed Mean
Y – EY Y – nμ Σdx = Total of deviations of the values of
= is approximately variables from an assumed mean
⎯⎯⎯⎯⎯⎯
√ Var (Y) ⎯n σ
√
N = Number of is observations
Standard normal—
B. Arithmetic Average in Discrete Series
Thus, to find P (yi ≤ y ≤ y2 ), we can write — Σfx
(i) Direct Method = X =
⎛ yi – nμ ≤ y – nμ ≤ y2 – nμ ⎞ N
P (y1 ≤ y ≤ y2 ) = P ⎜ ⎟
⎝√⎯n σ √ ⎯n σ √ ⎯n σ ⎠ where
Σfx = Total of products of the frequencies (f) and the
⎛ y – nμ ⎞ – φ (y1 – nμ) variable X
≈ φ⎜ 2 ⎟
⎝√ ⎯n σ ⎠ ⎯n σ
√ N = Total of frequencies, i.e., N = Σf
246U | Economics (NET)
(ii) Shortcut Method Mathematical Properties of Arithmetic
— Σfm Mean
X =A+
N Arithmetic mean possesses some very interesting
Σfdx = Total of products of the frequencies (f) and and important mathematical properties as given below :
the deviations of the values of variables from an Property-1
assumed mean (dx)
The algebraic sum of the deviations of the given
N = Total of frequencies
set of observations from their arithmetic mean is
C. Arithmetic Average in Continuous Series zero.
(i) Direct Method —
Mathematically, Σ (X – X ) = 0
— Σfm
X =A+ Or for a frequency distribution
N
—
where Σf (X – X ) = 0
M = Mid-point Property-2
Σfm = Total of products of frequencies (f) and the — —
mid point (m) If n1 and n 2 are the sizes and X 1 , X 2 are the
—
(ii) Short-cut Method respective means of two series then the mean X of the
— Σfdx combined series of size n1 + n2 is given by :
X =A+
N — —
– n X +n X
where X= 1 1 2 2
n 1 + n2
Σfdx = Total of products of frequencies (f) and the
deviations of the values of mid-points from The above result can be generalized to the case of
an assumed mean (dx) more than two series. If we have k series with respective
— — —
(iii) Step-Deviation Method sizes n1 , n 2…nk and mean X 1 , X 2 , ... X k respectively,
— Σfdx —
X =A+ i then the mean X of the combined series of size n1 + n2
N
+ … nk is given by :
where Σfdx = Total of products of frequencies and
— — — —
the deviation from assumed mean — n1 X 1 + n2 X 2 + n3 X 3 + ... + nk X k
by step-deviation X =
n1 + n2 + ... + nk
o = Magnitude of class-intervals Property-3
D. Charliers Accuracy Check The sum of the squares of deviations of the given set
Σ [f(dx + 1)] = Σfdx + Σf of observations is minimum when taken from the
E. Combined Mean arithmetic mean.
— — Mathematically, for a given frequency distribution,
— N1 X 1 + N2 X 2
X 12 = the sum
N1 + N 2
S = Σf(X – A)2
where
— Which represents the sum of the squares of
X 12 = Combined Mean
deviations of given observations from any arbitary value
N1 = Number of items of the first group ‘A’ is minimum when.
N2 = Number of items of the second group —
— A= X
X 1 = Arithmetic Average of the first group Property-4
—
X 2 = Arithmetic Average of the second group If all the observations of a series are added,
subtracted, multiplied or divided by a constant, the
F. Weighted Mean
mean is also added, subtracted, multiplied or divided
— ΣWX by the same constant.
Xw =
ΣW
Property-5
where Xw = Weighted mean
The weighted arithmetic mean of first n natural
ΣWX = Total of products of weights and the numbers whose weights are equal to the corresponding
variables X
ΣW = Total of weights
numbers is equal to (2n + 1
3 )
Economics (NET) | 247U
Property-6 2. Calculation of Median in Discrete Series
The arithmetic mean of first n natural numbers is
equal to the arithmetic mean of its first and last term.
— 1 + 2 + 3 .... + n
M = Size ( )
n+1
2
of the item
X = Where
n
n(n + 1) 1 n + 1 M = Median
= – =
2 n 2 N = Total of frequencies
Merits and Demerits of Arithmetic 3. Calculation of Median in Continuous Series
Mean
Merits
M = Size of (N2) the item
1. It is rigidly defined. i
M = L 1 + (m – c)
2. It is easy to understand and calculate. f
3. It is based on all the observations. Where
4. It is least affected by the fluctuations of L = Lower limit of median group
sampling. i = Difference of lower and upper limit of median
5. It does not require the arranging the data. group
Demerits f = Frequency of median group
1. The strongest draw back of arithmetic mean is
that it is very much affected by extreme observations.
Two or three very large values of the variable may
m = Median number = ()
N
2
the item
unduly affect the value of the arithmetic mean. c = Cumulative frequency of the group preceeding
the median group
2. Arithmetic mean cannot be used in the case of
open end classes such as less than 10, more than 70 etc. If data are arranged in descending order then we
3. It cannot be determined by inspection nor can it apply the following formula—
be located graphically.
4. Arithmetic mean cannot be used if we are dealing
M = L2 – ( )
i N
f 2
–c
with quantitative characteristics which can not be Where
measured quantitatively such as intelligence, honesty, L2 = Upper limit of the median group
bequty etc. In such cases median is the only average to
be used. Merits and Demerits of Median
5. Arithmetic mean cannot be obtained if a single
observation is missing or last or is illegible unless we Merits
drop it out and compute the arithmetic mean of the 1. It is rigidly defined.
remaining values.
2. Median is easy to understand and easy to
6. In extremely asymmetrical (skewed) distribution, calculate for a non-mathematical person.
usually arithmetic mean is not representative of the
distribution and hence is not a suitable measure of 3. Since median is a positional average, it is not
locations. affected at all by extreme observations and as such is
Median very useful in the case of Skewed distributions,
J-Shapad or inverted J-Shaped distribution such as the
Median is the central value of the variable when the distribution of wages, incomes and wealth. So in case of
values are arranged in ascending or descending order of
extreme observations, median is a better average to use
magnitude.
than the arithmetic mean since the latter gives a distored
According to connor—“The median is that value of picture of the distribution.
the variable which divides the groups into two equal
parts, one part comprising all the values greater and the 4. Median can be computed while dealing with a
other, all values less than median.” distribution with open end classes.
Calculation : Median may be, calculated in the 5. Median can sometimes be located by simple
following manner; inspection and can also be computed graphically.
1. Calculation of Median in Individual Series 6. Median is the only average to be used while
M = Size of( ) n+1
2
the item dealing with quantitative characteristics which cannot be
measured quantitatively but can still be arranged in
Where ascending or descending order of magnitude e.g., to find
M = Median the average intelligence, average beauty, average
N = Number of items honesty etc., among a group of people.
248U | Economics (NET)
Demerits of continuous frequency distribution, the corresponding
class contains θ3 and value of θ3 is given by the formula :
1. In case of even number of observations for an
ungrouped data, median cannot be determined exactly.
We merely estimate it as the arithmetic mean of the two
θ3 = l +
f (
h 3N
4
–C)
middle terms. where
2. Median, being a positional average, is not based l = lower limit of the class containing θ3
on each and every item of the distribution. It depends on h = magnitude of the class containing θ3
all the observations only to the extent whether they are f = frequency of the class containing θ3
smaller than or greater that it; the exact magnitude of the
c = c.f. of the class preceding the class containing θ3
observations being immaterial.
3. It does not lead itself to algebric treatment. Deciles
4. It is affected by fluctuations of items. Deciles are the values which divide the series into
5. It is less stable measure of central tendency than ten equal parts. Obviously there are nine deciles D 1 ,
the mean. D2, D 3 … D9 such that D1 ≤ D 2 ≤ ….. ≤ D9. Incidentally
6. In the case of continuous series, it cannot be D5 coincides with the median.
calculated exactly. The method of computing the deciles Di, (I = 1,
2,….9) is the same as discussed for θ 3 and θ3. To
Partition Values
compute the ith decile Di, (I = 1, 2, 3,…..9). See the c.f.
The values which divide the series into a number of iXN
equal parts are called the partition values. Thus, median just greater than 10 . The corresponding value of item
may be regarded as a particular partition value which is Di. In case of continuous frequency distribution the
divides the given data into two equal parts. corresponding class contains Di and its value is obtained
Quartiles by the formula
h i×N
The values which divide the given data into four
equal parts are known as quartiles obviously there will
Di = l + (f 10 )
–C
be three such point θ1, θ2 and θ3 such that θ1 ≤ θ2 ≤ θ3 , i = 1, 2, 3,…9
termed as the three quartiles. θ 1 , known as the lower or Where
first quartile is the value which has 25% of the items of l = lower limit of the class containing Di
the distribution below it and consequently 75% of the h = frequency of the class containing Di
items are greater than it θ2, known as the second f = magnitude of the class containing Di
quartile, coincides with the median and has an equal
c = c.f. of the class preceding the class containing Di.
number of observations above it and below it θ3, known
as the upper or third quartile, has 75% of the observa- Percentiles
tions above it. Percentiles are the values which divide the series
To compute θ1, the following steps are required : into 100 equal parts. Obviously, there are 99 percentiles
N P 1 , P2 , ….P99 Such that P1 ≤ P2 ≤….. ≤ P 99 . The ith
(i) Find where N = Σf percentile Pi, (I = 1, 2, ….99) is the value of item
4
(ii) See the cumulative frequency (c.f.) just greater corresponding to c.f. just greater than i × Ν . In case of
than N/4 100
continuous frequency distribution, the corresponding
(iii) The corresponding value of & observation gives class contains P and its value is obtained by the formula
the value of θ 1 . In case of continuous frequency i
h i×N
distribution, the corresponding class contains θ1, and the
value of θ1 is obtained by the interpolation formula :
Pi = l + (
f 100 )
–C
i = 1, 2, 3, ……99
θ1 = l + ( )
h N
f 4
–C where
l = lower limit of the class containing Pi
where h = magnitude of the class containing Pi
l = lower limit of the class containing θ 1 f = frequency of the class containing Pi
f = frequency of the class containing θ1 c = c.f. of the class preceding the class contain-
h = magnitude of the class containing θ1 ing Pi.
c = cumulative frequency (c.f.) of the class preceding In particular, we shall have
the class containing θ 1 P 25 = Q1
Similarly to compute θ3, see the c.f. just greater than P 50 = D5
3N P 75 = Q3
. The corresponding value of items gives θ3 In case D1 = P 10, D2 = P20, D3 = P30,….. D9 = P90
4
Economics (NET) | 249U
Mode usually lie on the two ends and median lies in between
Mode is the value which occurs frequently in a set than and they obey the following important empirical
of observations and around which the other items of the relationships given by Prof. Karl Peason.
set cluster densely. In other words, mode is the value of Mode = Mean – 3 (Mean – Median) …(1)
a series which is predominant in it. In the words of ⇒ Mean – Mode = 3 (Mean – Median)
Croxton and Cowden, “The mode of a distribution is 1
value at the point around which the items tend to be ⇒ Mean – Median = (Mean – Mode)
3
most heavily concentrated. It may be regarded as too
most typical of a series of values.” Thus we see that the difference between mean and
mode is three times the difference between mean and
Computation of Mode
median. In other words, median is closer to mean than
The value of mode is obtained by the following
Mode. The above relation between mean (M), median
formula :
(Md) and mode (Mo ) can be exhibited diagrammatically
f1 – f0 as follows :
Mode = L1 + ×i
2f1 – f0 – f2 Relationship between Arithmetic Mean, Median and
where Mode
L = lower limit of the modal class
f1 = frequency of the modal class
f0 = frequency of the class preceding the modal class
f2 = frequency of the class succeeding the modal
class
i = class interval of modal class
When mode is ill-defined the value of mode may be
calculated with the help of following formula : Remarks
Mode = 3 Median – 2 Mean
1. Equation (1) may be rewritten to give :
Merits and Demerits of Mode Mode = Mean = 3 Mean + 3 Median
Merits Mode = 3 Median – 2 Mean …(2)
1. Mode is easy to calculate and understand. In some This formula is specially useful to determine the
cases it can be located merely by inspection. It can also value of mode in case of bimodal or multi-modal
be estimated graphically from a his to gram. distributions.
2. Mode is not all affected by extreme observations 2. If we know any two of the three values M, Md
and as such is preferred to arithmetic mean while and M 0 the third can be estimated by using the formula
dealing with extreme observations. (2).
3. It can be conveniently obtained in the case of 3. For a positively Skewed distribution, mean will
open end classes which do not pose any problems here. be greater than median and median will be greater than
Demerits mode i.e.
M > Md > M 0 ⇒ M0 < M d < M
1. Mode is not rigidly defined.
However, in a negatively Skewed distribution the
2. Since mode is the value of X corresponding to the
order of the magnitudes of the three averages will be
maximum frequency, it is not based on all the
reversed i.e., for negatively Skewed distribution we have
observations of the series.
M 0 > M d > M ⇒ M < M d < M0
3. Mode is not suitable for further mathematical
treatment. Geometric Mean
4. As compared with mean, mode is affected to a The geometric mean (usually abbreviated as G.M.)
greater extent by the fluctuations of sampling. of a set of n observations is the nth root of their product.
Thus if X1, X2 , …..Xn are the given n observations then
Empirical Relation between Mean (M), Median
(Md ) and Mode (M0 ) their G.M. is given by
n
In case of a symmetrical distribution mean, median G.M. = √ ⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯
X1 · X2 · X3......Xn
and mode, coincide. Thus = (X 1 , X2, X3….. Xn )1/n …(3)
Mean = Median = Mode If n = 2, i.e., if we are dealing with two observations
However, for a moderately asymmetrical (non- only then G.M. can be computed by taking the square
symmetrical or Skewed) distribution, mean and mode root of their product. For example G.M. of 4 of 16 is
250U | Economics (NET)
G.M. of 4 and 16 is 4. Unlike arithmetic mean which has a bias for
higher values, geometric mean has bias for smaller
G.M. = √ ⎯⎯⎯⎯
4 × 16 = ⎯ √⎯64 = 8 observations.
But if the number of observations is greater than 2, than 5. As compared with mean, G.M. is affected to a
the computation of the nth root is very tedious, In such a lesser extent by extreme observations.
case the calculations are facilitated by making use of the 6. It is not affected much by fluctuations of
logarithms. Taking logarithm of both sides in (3), we get sampling.
1
Log (G.M.) = log (X1 ·X2 ..... X3) Demerits
n
1 1. Because of its abstract mathematical character,
= (logX1 + log X2 +.... log Xn ) geometric mean is not easy to understand and to
n
calculate for a nonmathematical person.
1
= Σ log X 2. If any one of the observations is zero, geometric
n mean becomes zero and if any one of the observations is
Thus, we see that the logarithm of the G.M. of a set negative, geometric mean becomes imaginary regardless
observations is the arithmetic mean of their logarithms. of the magnitude of other items.
Taking Antilog of both sides in (4) we finally 3. It cannot be calculated if some of values in a
obtain, series are not known.
G.M. = Antilog [ 1
n
Σlog X] Harmonic Mean
If X1 , X2 ,….. Xn is a given set of n observations,
Calculation of Geometric Mean in Case of then their harmonic mean abbreviated as H.M. or simply
Discrete Series it is given by :
G.M. = Antilog [1n Σf logX] H =
1
Where [
1 1
+
n X1 X2
1
+ ... + ]
1
Xn
Σflog X = Sum of the products of frequencies (f) 1 n
with logarithms of variable log X = =
n = Total of frequencies (Σf) [ ( )] ( )
1
n
Σ
1
X
Σ
X
1
Calculation of Geometric Mean in Case of In other words, Harmonic Mean is the reciprocal of
grouped or continuous frequency distributions the arithmetic mean of the reciprocals of the given
Σf logm observations.
G.M. = Antilog [ n ] In case of frequency distribution we have :
1 ⎡⎢ f1 f ⎤
+ 2 + ... + n ⎥⎥
where Σf log m = Sum of the products of frequencies 1 f
(f) with logarithms of mid-points (logm) H
= ⎢
N ⎣ X1 X2 Xn ⎦
n = Total of frequencies (Σf)
Weighted G.M. = Antilog [ Σw logx
]
⇒
1
H
=
1
N
Σ ()F
X
Σw N
Where Σw log x = Sum of the products of weights ⇒ H =
(w) with logarithms of variable log X Σ() X
f
Σw = Total of weights where N = total frequency (Σf)
Merits and Demerits of Geometric X = value of the variable or the mid-value
Mean of the class
(In case of grouped or continuous frequency distri-
Merits bution)
1. Geometric mean is rigidly defined. f = corresponding frequency of X
2. It is based on all the observations.
3. It is suitable for further mathematical treatment. Merits and Demerits of Harmonic
If G1 and G2 are the geometric means of two series Mean
of sizes n1 and n2 respectively, then the geometric means Merits
G of the combined series of size n1 + n2 is given by 1. Harmonic mean is rigidly defined.
n log + n log G2 2. It is based on all the observations.
Log G = 1 1 2
n 1 + n2 3. It is suitable for further mathematical treatment.
Economics (NET) | 251U
If H 1 and H2 are the harmonic mean of two series of i.e., if and only if the two numbers are equal. Again
sizes N1 and N2 respectively, then the harmonic mean H from (2) we get
of the combined series of size N1 + N2 is given by
G.M. – H.M. = √ ⎯⎯ab – a2ab
1 1 ⎡⎢ N1 N2⎤⎥ +b
N1 + N2 ⎢⎣ H1 H2⎥⎦
= +
H ⎛ 2√ ⎯⎯ab⎞⎟
√⎯ab ⎜ 1 –
=⎯
4. It is not affected very much by fluctuations of ⎝ a + b⎠
sampling. ⎛ ⎯⎯ab⎞⎟
5. It is the most suitable average for measuring the √⎯ab ⎜⎝ a + ba –+ 2b√
=⎯
time, speed, etc. ⎠
2
Demerits √⎯ab (√
⎯ ⎯ b)
⎯a – √
= ≥0
1. It is not easy to understand and calculate. a+b
2. Its value cannot be obtained if any one of the Since a > 0, b > 0 and square of a real quantity is
observations is zero. always non-negative
3. It is less popular. ∴ G.M. – H.M. ≥ 0
4. It cannot be calculated if some of the values in a ⇒ G.M. ≥ H.M. …(4)
series we are not know. The sign of equality holds if and only if
Relation between Arithmetic Mean, Geo- ⎯a – ⎯
√ √b = 0
metric Mean and Harmonic Mean ⇒ a = b
The arithmetic mean (A.M.), the geometric mean Thus, combining the results in (3) and (4) we get
(G.M.) and the harmonic mean (H.M.) of a series of n
observations are connected by the relation A.M. ≥ G.M. ≥ H.M.
A.M. ≥ G.M. ≥ H.M. …(1) The sign of equality holds if and only if the two
numbers are equal.
the sign of equality holding if and only if all the n
observations are equal. Remark—For two numbers we also have
We shall establish the result (1) for two G2 = A × H
numbers only, although the result holds in general for n where A, G and H represent arithmetic mean,
observations. geometric mean and harmonic mean respectively.
Let a and b be two real positive numbers i.e., Proof—Let a > 0, b > 0 be two positive numbers.
(a > 0, b > 0). Then from (2) above we get
Then a + b 2ab
A×H= · = ab = G2.
a+b 2 a+b
A.M. = and G.M. = √
⎯⎯ab
2
Dispersion
1 2ab
and H.M. = = …(2) Averages or the measures of central tendency give
[ ]
1 1 1
2 a b
+
a+b
us an idea of the concentration of the observations about
the central part of the distribution. In spite of their great
We have, utility in statistical analysis, they have their own
limitations. If we are given only the average of a series
a+b ⎯⎯ab
√
A.M. – G.M. = √⎯ab = a + b 2–
–⎯ of observations, we cannot form complete idea about the
2 distribution since there may exist a number of
1 2
=
2
( ⎯
√ a– √
⎯ b ) distributions whose averages are same but which may
differ widely from each other in a number of ways. The
Since the square of a real quantity is always non- following example will illustrate this view point.
negative, we have Consider the following ten observations on a certain
2 variable :
(√⎯ a – √⎯ b) ⇒ 0 5, 5, 5, 5, 5, 5, 5, 5, 5, 5.
∴ A.M. – G.M. ≥ 0 Clearly A.M. = 5, and all deviations from A.M. are
⇒ A.M. – G.M. ...(3) zero. Therefore, there is no dispersion at all.
the sign of equality holds if and only if Another example has following observations on the
variable :
⎯a – ⎯
√ √b = 0 4, 3, 6, 5, 7, 4, 8, 8, 2, 3.
⇒⎯√ a = ⎯√ b The A.M. is again equal to 5, but the nature of
⇒a=b distribution of values is quite different in this case.
252U | Economics (NET)
Therefore, knowledge of the central value alone is In other words, coefficient of range is the ratio of
not enough to appreciate the nature of distribution of the difference between two extreme observations
values. In one case the values may have wide disparity (biggest and smallest) of the distribution to their sum.
whereas in the other case they may be close to the
central value. The frequency curves shown in the figure Merits and Demerits of Range
may help to illustrate this point graphically. Merits
Both in case of I and II the distributions have the 1. It is easy to understand.
same A.M. but in case I there is larger dispersion of 2. It is easy to calculate.
values then in II.
3. It can be used in Openend frequency distribution.
From the above illustration it is obvious that the
measures of central tendency are in adequate to describe Demerits
the distribution completely. Thus, the measures of 1. Range is not based on the entire set of data.
central tendency must be supported and supplemented 2. Range is very much affected by fluctuations of
by some other measures. One such measure (v) Disper- sampling. Its value varies very widely from sample to
sion. sample.
3. It is not possible to fine out the range in openend
frequency distribution.
4. It does not present the very accurate picture of the
series.
5. It is affected by extreme values.
Quartile Deviation or Semi Inter
Quartile Range
Quartile deviation is obtained by dividing the
difference of third quartile and first quartile (Q3 – Q2 )
According to Connor “Dispersion is the measure of
by 2. Thus
the extent to which the individual items vary.”
Q – Q1
Measures of Dispersion Quartile Deviation (Q.D.) = 3
2
The various measures of dispersion are Where
1. Range Q3 = Third Quartile or Upper Quartile
2. Quartile deviation or Semi-Interquartile range Q1 = First Quartile or Lower Quartile
3. Mean deviation Q.D. as defined above is only an absolute measure
4. Standard deviation of dispersion. For comparative studies of variability of
5. Lorenz curve two distributions we need a relative measure which is
Range known as coefficient of Quaritile Deviation and is given
by
The range is defined as the difference between the Q – Q1
highest and lowest values in the series. This is the Coefficient of Q.D. = 3
Q3 – Q1
simplest method of measuring dispersion. Thus
Range = L – S Remark
Where The quartile deviation gives the average amount by
which the two quartiles differ from median. For a
L = Largest value
symmetrical distribution we have
S = Smallest value Q3 – Qd = M d – Q1
Absolute and Relative Measures of Range Q + Q1
⇒ Md = 3
Range a s defined above i s an absolute measure of 2
dispersion and depends upon the units of measurement. i.e., median lies half way on the scale from Q1 to Q3 .
Thus if want to compare the variability of two or more Thus, for a symmetrical distribution we have
distributions with the same units of measurement, we Q – Q1
may use the above formula. However, to compare the Q.D. + Q1 = 3 + Q1
2
variability of the distributions given in difference units
Q + Q1
of measurement we cannot use the above formula but we = 3 = Md [From (1)]
need a relative measure which is independent of the 2
units of measurement. This relative measure, called the Q – Q1
and Q3 = Q.D. = Q3 – 3
coefficient of range, is defined as follows : 2
L–S Q3 + Q1
Coefficient of Range = Q1 = = Md [From (1)]
L+S 2
Economics (NET) | 253U
In other words, for a symmetrical distribution we The given measures are obsolute measures only.
have The relative measure of variability based on percentiles
Q1 = M d = Q.D. is given by
P – Pi
and Q3 = M d + Q.D. …(2) Coefficient of i–j percentile = j
P j Pi
Since in a distribution 25% of the observations lie
below Q1 and 25% observations lies above Q3 , 50% of Mean Deviation
the observations lie between Q1 and Q 3 . Therefore, using Mean deviation is defined as the arithmetic average
(2) we conclude that for a symmetrical distribution. of the deviations of various items from a measure of
Md ± Q.D. covers exactly 50% of the observations. central tendency, may it be, mean, median or mode.
It may also be pointed out here that the word Generally mean deviations is calculated either from
symmetrical distribution used in above connection refers mean or from median. Mode is usually not considered as
to symmetry in the central 50% of the distribution and its value is indeterminate. Between mean and median,
may be symmetrical (Skewed) at the tail ends. the median is supposed to be better than the mean
because the sum of the deviations from the median is
Merits and Demerits of Quartile less than the sum of the deviations from the mean. It is
Deviation also known as first moment of dispersion.
Computation of Mean Deviation
Merits If X1 , X2 …..Xn are n given observations then the
Quartile deviation is quite easy to understand and mean deviation (M.D.) about an average A, say, is given
calculate. It has a number of obvious advantages over 1 1
by M.D. = Σ | X – A | = Σ | D |
range as a measure of dispersion. For example n n
(a) As against range which was based on two Where |D| = |X – A| read as mod (X – A) is the
observations only, Q.D. makes use of 50% of the data modulus value or absolute value of the deviation (after
and as such is obviously a better measure than range. ignoring the negative sign) d = X – A and Σ|d| is the sum
of these absolute deviations and A is any one of the
(b) Since Q.D. ignores 25% of the data from the
averages mean (M), median (Md) and mode (M0 ).
beginning of the distribution and another 25% of the
data from the top end, it is not affected at all by extreme In the case of frequency distribution or grouped or
continuous frequency distribution, mean deviation about
observations.
an average A is given by
(c) Q.D. can be computed from the frequency 1
distributions with open end classes. In fact Q.D. is the M.D. = Σf | X – A |
N
only measure of dispersion which can be obtained while
Where
dealing a distribution having open end classes.
X = value of the variable or mid-value of the class
Demerits interval
1. Q.D. is not based on all the observations since it N = Σf
ignores 25% of the data at the lower end and 25% of the A = Mean/Median/Mode
data at the upper end of the distribution, it cannot be Remarks
regarded as a reliable measure of variability.
1. Usually, we obtain the mean deviation (M.D.)
2. Q.D. is affected considerably by fluctuations of about any one of the three averages mean (M), median
sampling. (Md) or mode (M 0 ). Thus,
3. Q.D. is not suitable for further mathematical 1
treatment. M.D. (about mean) = Σf | X – M |
N
Thus quartile deviation is not a reliable measure of 1
variability, particularly for distribution in which the M.D. (about median) = Σf | M – D d |
N
variation is considerable. 1
M.D. (about mode) = Σf | X – M 0 |
Percentile Range N
This is a measure of dispersion based on the 2. The sum of the absolute deviations (after ignoring
difference between certain percentile. It P i is the ith the signs) of a given set of observations is minimum
when taken about median. Hence mean deviation is
percentile and Pj is the Jth percentile then the so called
minimum when it is calculated from median. In other
i–j percentile range is given by words, mean deviation calculated about median will be
i–j percentile Range = Pj – P i (i < j) les than mean deviation about mean or mode.
P – Pi 3. For a symmetrical distribution the range Mean ±
and i–j Semi Percentile Range = j (i<j) M.D. (about mean) or Md ± M.D. (about median), [Q M
2
254U | Economics (NET)
= Md for a symmetrical distribution] covers 57·5% of the Standard Deviation
observations of the distribution. If the distribution is Standard deviation, usually denoted by the letter σ
mode the range will cover approximatily 57·5% of the (sigma) of the Greek alphabet was first suggested by
observations. Thus a small value of mean deviation Karl Pearson as a measure of dispersion in 1893. It is
world imply that the distribution is uniform since in this defined as the positive squares of the deviations of the
case a small interval around the average will contain given observations from their arithmetic mean. Thus, if
more than 50% of the observations of the series. X1, X 2 ,…..Xn is a set of n observations then its standard
Relative Measures of Mean deviation is given by
The relative measure of dispersion, called the 1 —
σ= Σ(X – X )2
coefficient of mean deviation is given by n
Co–efficient of M.D. Where
Mean Deviation – ΣX
= X= arithmetic mean of the given values
Average about which it is calculated n
Thus Computation of Standard Deviation in
Co-efficient of M.D. about mean =
M.D. Case of Frequency Distribution
Mean In case of frequency distribution, the standard
M.D. deviation is given by
Co-efficient of M.D. about median =
⎯⎯⎯⎯⎯⎯
√
Median 1 —
The coefficient of mean deviation defined above are σ= Σf(X – X )2
N
pure numbers undependent of the units of measurement Where X is the value of the variable or the mid-
and are useful for comparing the variability of different value of the class (in case of grouped or continuous
distributions. frequency distribution); f is the corresponding frequency
of the value X; N = Σf, is the total frequency and
Merits and Demerits of Mean — 1
Deviation X = ΣfX
N
Merits is the arithmetic mean of the distribution.
1. Mean deviation is rigidly defined and is easy to Remarks
understand and calculate.
1. It may be pointed out that although mean
2. Mean deviation is based on all the observations deviation could be calculated about any one of the
and is thus definitely a better measure of dispersion than averages (M, Md or M0 ), standard deviation is always
the range and quartile deviation.
computed about arithmetric mean.
3. As compared with standard deviation it is less
2. The value of the s.d. depends on the numerical
affected by extreme observations.
— — —
4. Since mean deviation is based on the deviations value of the deviations (X1 – X ), (X2 – X )…, (Xn – X ).
about an average, it provides a better measure for Thus the value of σ will be greater if the values of X are
comparison about the formation of different distribu- scattered widely away from the mean. Thus, a small
tions. value of σ will imply that the distribution is homoge-
neous and a large value of σ will imply that it is
Demerits heterogeneous. In particular s.d. is zero if each of he
1. The strongest objection against mean deviation is deviations is zero i.e., σ = 0 if and only if,
that while computing its value we take the absolute — — —
value of the deviations about an average and ignore the ⇒ X1 – X = 0, X2 – X = 0, ....Xn – X = 0
sins of the deviations. –
⇒ X1 = X2 = X3 + ....Xn =X
2. It is not a satisfactory measure when taken about
mode or while dealing with a fairly Skewed distribution. which is the case if the variable assumes the constant
As already pointed out, theoretically mean deviation value i.e.,
gives the best result when it is calculated about median. σ=0
But median is not a satisfactory measure when the if X1 = X2 = X3 = ……Xn = K (constant)
distribution has great variations.
3. It is rarely used in Sociological studies. Merits and Demerits of Standard
4. It cannot be computed for distributions with open Deviation
end classes.
Merits
5. Mean deviation tends to increase with the size of
the sample though not proportionately and not so rapidly 1. It is rigidly defined.
as range. 2. Its value is very precise.
Economics (NET) | 255U
3. Its calculation is based on all the items of the (n + 1)
= [2(2n + 1) – 3(n + 1)]
series. 12
4. It is least affected by fluctuations in sampling. (n + 1)
= [4n + 2 – 3n + 3]
5. It tends itself to further algebric treatment. 12
(n + 1)(n – 1) (n2 – 1)
Demerits =
12
=
12
1. It is difficult to calculate.
n2 – 1
2. It gives more weight to extreme items. ⇒ s.d. =
12
Remarks Remark—For any discrete distribution standard
— deviation is not less than mean deviation from mean.
Since X – X ≤ R (Range) for all the values X1 ,
X2….Xn we get Coefficient of Variation
1 — Standard deviation is only an absolute measure of
σ2 = Σf(X – X )2 dispersion, depending upon the units of measurement.
N
— 2 — 2 The relative measure of dispersion based on standard
=
1
N
[( )
f1 X1 – X + f2 X2 – X( ) deviation is called the coefficient of standard deviation
— 2 and is given by
(
+ ... + fn Xn – X )] σ
Coefficient of Standard Deviation = –
1
≤ [f1 R 2 + f2R 2 ... + fn R2] X
N
This is a pure number independent of the units of
( — — —
Q X1 – X ≤ R‚ X2 – X ≤ R‚ ...‚ Xn – X ≤ R ) measurement and thus, is suitable for comparing the
variability, homogeneity or uniformity of two or more
1 distributions.
∴σ≥ · R2 (f1 + f2 + f3 + ... + fn
N We have already discussed the relative measures of
1 dispersion based on range, deviation and mean deviation.
⇒ σ2 ≤ · N. [∴ Σf = N]
N Since standard deviation is by for the best measure of
⇒ σ2 ≤ R2 dispersion, for comparing the homogeneity o f two o r
⇒ σ S.d. ≤ R2 . more distributions we generally compute the coefficient
of standard deviation asked otherwise.
Variance 100 times the coefficient of dispersion based on
Variance is the square of the a standard deviation standard deviation is called the coefficient of variation,
and is denoted by σ2 . For a frequency distribution abbreviated as C.V. Thus,
variance is given by σ
C.V. = 100 × = —
1 —
Variance = σ2 = Σf(X – X )2 X
N For comparing the variability of two distribution we
Remark compute the ‘coefficient of variation’ for each distribu-
tion. A distribution with smaller C.V. is said to be more
Variance or standard deviation is independent of the homogeneous or uniform or less variable than the other
change of origin but of the scale. and the series with greater C.V. is said to be more
Example 1. Find the mean and standard deviation of heterogeneous or more variable than the other.
the first n natural numbers.
Solution–If the variable X denotes the natural Relation between Various Measures
number, then the first n notural numbers are 1, 2, of Dispersion
3…., n
ΣX For a Normal Distribution we have the following
∴ Mean = relations between the different measures of dispersion :
n
1 + 2 + 3 + ... + n n(n + 1) 1 1. Mean ± Q.D. covers 50% of the observation of
= = · the distribution.
n 2 n
n+1 2. Mean ± M.D. covers 57·5% of the observation.
and = 3. Mean ± σ Includes 68·27% of the observation.
2
ΣX2 —2 4. Mean ± 2σ includes 95·45% of the observation.
Variance = –X
n 5. Mean ± σ includes 99·73% of the observation.
1 + 2 2 + 3 2 + ... + n2
2
=
n
–( )n+1 2
2
2
6. Q.D. = S.D. (approximately)
3
n(n + 1)(2n + 1) 1 (n + 1)2 4
= · – 7. M.D. = S.D. (approximately)
6 n 4 5
256U | Economics (NET)
5 equal distribution of income. If the plotted cumulative
8. Q.D. = S.D. (approximately) percentages lie on this line, there is no variability in the
6
Combining the results (6), (7) and (8) we get distribution of income of persons. The points lying on
approximately : the curve OAP indicate a less degree of variability as
compared to the points lying on the curve OBP.
3 Q.D. = 2 S.D. Variability is still greater, when the points lie on the
5 M.D. = 4 S.D. curve OCP. Thus a measure of variability of the
6 Q.D. = 5 M.D. distribution is provided by the distance of the curve of
the cumulated percentages of the given distribution from
⇒ 4 D.S. = 5 M.D. = 6 Q.D.
the line of equal distribution.
Thus we see that standard deviation ensures the
highest degree of reliability and Q.D. the lowest.
9. we have :
2 4
Q.D. : M.D. : S.D. :: σ : σ : σ
3 5
⇒ Q.D. : M.D. : S.D. :: 10 : 12 : 15
10. Range = 6 S.D. = 6σ
Lorenz Curve
This is the graphic method of measuring dispersion
between two series. It was designed by Dr. Lorenz for
measuring in equalities in the distribution of wealth. It is Lorenz Curve
a cumulative percentage curve.
A very distinctive feature of the Lorenz curve
Remarks
consists in dealing with the cumulative values of the 1. An obvious disadvantage of the Lorenz curve is
variable and the cumulative frequencies rather than its that it gives us only a relative idea of the dispersion as
absolute values and the given frequencies. The technique compared with the line of equal distribution. It does not
of drawing the curve is fairly simple and consists of the provide us any numerical value of the variability for the
following steps : given distribution. Accordingly it should be used
(a) The size of the item (variable value) and the together with some numerical measure of dispersion.
frequencies are both cumulated. Taking grand total for However, this should not undermine the utility of
each as 100, express these cumulated totals for the Lorenz curve in studying the variability of the distri-
variable and the frequencies as percentage of their butions particularly relating to income wealth, wages,
corresponding grand totals. profits, lands and capital etc.
(b) Now take coordinate axes, X-axis representing 2. From the Lorenz curve we can immediately find
the percentages of the cumulated frequencies (x) and out as to what percentage of persons (frequencies)
Y-axis representing the percentages of the cumulated correspond to a given percentage of the item (variable
values of the variable (y). Both x and y take the value value).
from 0 and 100 as shown in the diagram given below. Ginni’s Coefficient of Concentration
(c) Draw the diagonal line y = x, joining the origin) Ginni’s coefficient of concentration, also known as
(0, 0) with the point P (100, 100)as shown in the
concentration Ration is based on his coefficient of mean
diagram. The line OP will make an angle of 45° with the
X-axis and is called the line of equal distribution. difference and is defined as :
(d) Plot the percentages of the cumulative values of Δ
G = 1
the variable (y) against the percentages of the 2X
corresponding cumulated frequencies (x) for the given where
distribution and join these points with a smooth free G = Ginni’s coefficient of concentration
hand curve. Obviously, for any given distribution this
curve will never cross the line of equal distribution OP. Δ1 = Ginni’s Coefficient of mean difference
It will always lie below OP unless the distribution is —
X = Mean of the given distribution
uniform (equal) in which case it will coincide with OP.
Thus, when the distribution of items is not G is a pure number independent of units of
proportionately equal, the variability (dispersion) is measurement and lies between O and 1, G is equal to O
indicated and the curve is farther from the line of equal in equl distribution and its value goes up with increase in
distribution OP. The greater the variability the greater is the inequality.
the distance of the curve from OP. In fact, Ginni’s coefficient is the ratio of area of
Let us consider the following Lorenz curve for the concentration to the total area of lower triangle below
distribution of income. In this figure, OP is the line of the line of equal distribution.
Economics (NET) | 257U
Skewness and Kurtosis We study Skewness to have an idea about the shape
Two distributions may have the same mean and of the curve which we can draw with the help of the
standard deviation but may differ widely in their overall given frequency distributions. It helps us to determine
appearance. It is this difference which shows the the nature and extent of the concentration of the
presence of Skewness. The Skewness refers to ‘lack of observations towards the higher or lower values of the
symmetry’. It means when a distribution is asymmetri- variable. In a symmetrical frequency distribution which
cal (not symmetrical) it is known as a Skewed is unimodal, if the frequency curve or histogram is
distribution. Measures of Skewness help us to distin- folded about the ordinate at the mean, the two halves so
guish between various types of distribution. obtained will coincide with each other. In other words,
According to Simpson and Kafka “Skewness or in a symmetrical distribution equal distances on either
asymmetry is the attribute of a frequency distribution side of the central value will have same frequencies and
that extends further on one side of the class with the consequently both the tails, (left and right), of the curve
highest frequency than on the other.” would also be equal in shape and length.
List of Formula
Individual Observations Discrete and continuous series
Range But L, i.e., largest value, will be the upper limit of the highest
Range = L – S class and S will be the lower limit of the lowest class.
L–S (Same as on the (left)
Coeff. of ranges =
L+S
Quartile Deviation
Q – Q1
Q. D. = 3
2
Q – Q1
Coeff. of Q. D. = 3
Q 3 + Q1
Mean Deviation Σ|D|
M.D. =
Σ|D| N
M. D. =
N M.D.
M.D. Coeff. of M.D. =
Median
Coeff. of M.D. =
Median
Or M.D. (if deviations are Mean)
M.D.
Or Coeff. of M.D. = (taken from mean)
Mean
(if deviations are taken from mean)
Standard Deviation Actual Mean Method
Actual Mean Method
Σf (x – –x )
2
Σ(x – –x )2 σ=
σ= N
N
Assumed Mean Method Assumed Mean Method
σ= Σd 2 Σ(d)2
N
–
N
Step Deviation Method
σ=
Σfd2
N
– ( )
Σ(fd)
N
2
Step Deviation Method
σ=
Σ (d') 2
N
– ( )
Σd '
N
2
σ
C.V. = × 100
σ–
Σd 2
N
– ( )
Σd' '
N
2
X
Combined Standard Deviation σ
C.V. = × 100
X
N1σ21 + N2σ22 + N1d 21 + N2d 22
σ12 -
N1 + N2
( –
) –
Where d1 = X1 – X2 and d2 = X2 – X2( )
258U | Economics (NET)
A distribution is said to be Skewed if; comparative study of the two distributions measured in
(i) The frequency curve of the distribution is not a different units of measurement;
symmetric bell shaped curve but it is stretched more (ii) Even if the distributions are having the same
to one side than to the other. In other words, it has a units of measurement, the absolute measures are not
longer tail to one side (left or right) than to the other. A recommended because we may come across different
frequency distribution for which the curve has a longer distributions which have more less identical Skewness
tail towards the right is said to be positively Skewed and (absolute measures) but which vary widely in the
if the longer tail lied towards, the left, it is said to be measures of central tendency and dispersion.
negatively Skewed. Thus for comparing two or more distributions for
Skewness we compute the relative measures of
Skewness, also commonly known as coefficients of
Skewness which are pure numbers independent. The
following are the coefficients of Skewness which are
commonly used :
1. Karl Pearson’s Coefficient of Skew-
ness
Symmetrical Distribution This is given by the formula :
(ii) The value of Mean (M), Median (Md) and mode Mean – Mode
Sk =
(M0) fall at different points i.e., they do not coincide. s.d.
M – M0 M – (3Md – 2M)
= =
s.d s.d.
3(M – Md )
=
s.d.
Remarks
1. Theoretically Skewness given by the above
formula lies between the limits ± 3, but these limits are
Positively Skewed Distribution rarely attained in practice.
(iii) Quartiles Q1 and Q 3 are not equidistant from the 2. From above formula skewness is zero if M = M0
median i.e., – M d . In other words, for a symmetrical distribution
Q3 – M d ≠ Md – Q1 mean, mode and median coincide.
(iv) The sum of the positive deviations from the 3. Since s.d. is always positive, we have
median is not equal to the sum of the negative deviations S k > O, if M > M0
from the median. And Sk > O. if M > Md
Q 3Md = M 0 + 2M
∴ Sk > O, if 3Md > M 0 + 2M 0
⇒ Sk > O, if 3Md > 3M 0
⇒ Sk > O, if Md > M 0
From above equations we conclude that
S k > O, if M > Md > M 0
Negatively Skewed Distribution
Or S k > O, if M0 > M d > M
Measures of Skewness Thus for a positively skewed distribution, the value
Absolute Measure of Skewness of the mean is the greatest of the three measures and the
value of mode is the least of the three measures.
a. Skewness = Mean – Mode = M – M0
If the distribution is negatively Skewed, the above
b. Skewness = 3(Mean – Median) = 3(M Md) inequality is reversed i.e., the inequalities ‘greater than’
c. Skewness = (Q3 –Md ) – (M d – Q1) (i.e., >) and ‘less than’ (i.e., <) are inter changed thus :
= Q3 + Q1 – 2Md S k < O, if M < Md < M 0
These are the absolute measures of Skewness and Or S k < O, if M0 > M d >M
are not of much practical utility because of the following In other words, for a negatively skewed distri-
reasons : butions, of the three measures of central tendency mean,
(i) Since the absolute measures of Skewness involve median and mode, the mode has the maximum value and
the units of measurement, they cannot be used for the mean has the least value.
Economics (NET) | 259U
2. Bowley’s Coefficient of Skewness Moments
Prof. A.L. Bowley’s coefficient of Skewness is Moment is the measure of a force with respect to its
based on the quartiles and is given by : tendency to produce rotation. The notion of moments in
(Q 3 – Md)(M d – Q1) statistics is analogus to that in mechanics. The
Sk = strength of tendency depends on the amount of force and
(Q 3 – Md ) + (Md – Q1)
Q + Q1 – 2Md the distance from the origin of the point at which the
⇒ Sk = 3 force is exerted.
Q3 – Q1
Moments are calculated with the help of arithmetic
Where mean. Moment calculated from arithmetic mean are
Q3 = Upper Quartile called ‘central moments’ or ‘moments about the
Q1 = Lower Quartile arithmetic mean’.
Md = Median In the calculation of moments it deviations are taken
from mean the resulting moments are denoted by symbol
Remarks μ (pronounced as MU).
(a) Bowley’s coefficient of Skewness is also known
as Quartile coefficient of Skewness and is especially Moments about Mean
useful in situations where quartiles and median are used. —
The rth moment of X about the mean X , usually
(b) From Bowley’s equation we observe that
denoted by μ, is defined as
S k = O, if Q3 – Md = M d – Q1 — r
This implies that for a symmetrical distribution μr =
1
N
(
Σf X – X )
(Sk = 0), median is equidistant from the upper and lower
where
quartiles. Moreover, Skewness is positive if :
r = 0, 1, 2, 3….
Q3 – Md > M d – Q1 ÷ Q3 + Q1 > 2M d
putting r = 0, in above equation we get
and skewness is negative if — 0
Q3 – Md < M d < Q1 ÷ Q3 + Q1 < 1M d μ0 =
1
N
(
Σf X – X )
(c) If would be clearly understood that the values of 1 1
the coefficient of skewness obtained by Bowley’s = Σf = · N
N N
formula and pearson’s formula are not comparable,
although in each case, Sk = O implies the absence of = 1
skewness i.e., the distribution is symmetrical. It may putting r = 1 in above equation, we get
— 1
even happen that one of them gives positive Skewness
while the other gives negative Skewness.
μ1 =
1
N
(
Σf X – X )
(d) The only and perhaps quite serious limitation Because the algebraic sum of deviations of a given
of this coefficient is that it is based only on the central set of observations from their mean is zero. Thus the
50% of the data and ignores the remaining 50% of the first moment about mean is always zero.
data towards the extremes. Again taking r = 2 we get
3. Kelly’s Measure of Skewness 1 ( — 2
)
μ2 = Σf X – X = (S.d.)2
This is given by the formula N
S k = (P 90 – P 50) – (P50 – P10) Hence the second moment about mean gives the
variance of the distribution.
= P90 + P10 – 2P50
Remark—The moments about mean are invariant
But P 90 = D9 and P10 = D1 . Hence under change of origin but not of scale.
S k = (D9 – D5) – (D5 – D1) [∴ P50 = D5 ]
Sheppard’s Correction for Moments
= D9 + D1 – 2D5
This correction is valid only for symmetrical or
But this is an absolute measure of Skewness.
slightly asymmetrical continuous distributions and can
However, for practical purposes, we generally compute
not be applied in the case of extremely asymmetrical
the coefficient of Skewness, which is given by :
(Skewed) distributions like J-shaped or inverted J-shaped
(P90 – P50)(P50 – P10) or U-shaped distributions.
S k (Kelly) =
(P90 – P 50) + (P50 – P10)
P90 + P10 – 2P50 D9 + D1 + 2D5 Kurtosis
= = The ‘Kurtosis’ is the property of ‘peakedness’ of a
P 90 – P 10 D9 – D1
frequency distribution.
Q D5 = P50 = Median
If the frequency curve has long tails and high peak
P90 + P10 – 2Md D9 + D1 – 2Md we call it ‘lepto Kurtic’ distribution. On the other hand if
∴ S k (Kelly) = =
P 90 – P 10 D9 – D1 the frequency curve has shot and thick tails and is flat
260U | Economics (NET)
topped we call it ‘play kurtic’. A ‘mesokurtic Utility of the Study of Correlation
distribution’ describes the situation in between a lepto
1. With the help of correlation we can measure the
kurtic and platykurtic distribution’. Diagrammatically
degree of relationship existing between the variables.
these distributions will be as follows :
2. Correlation analysis contribute to the economic
behaviour, aids in locating the critically important
variable and on which other depend.
Positive and Negative Correlation
A. Positive Correlation—If both the variables move
in the same direction, correlation is said to be positive.
Some examples of series of positive correlations are :
a. Heights and weights.
b. The family income and expenditure on luxury
Curve of type B which is neither flat nor peaked is items.
known as Normal curve and shape of its hump is
c. Price and supply of a commodity and so on.
accepted as a standard one. Curve with humps of the
form of normal curve are said to have normal kurtosis B. Negative Correlation—If both the variables
and are termed as mesokurtic. The curves of the type A, move in opposite direction, the correlations is said to be
which are more peaked than the normal curve are known negative.
as lepto kurtic and are said to lack kurtosis or to have Some examples of negative correlation are—
negative kurtosis. On the other hand, curves of the type a. Price and demand of a commodity.
C, which are flatter than the normal curve are called b. Volume and pressure of a perfect goes.
platy kurtic and they are said to possess kurtosis in c. Sale of woolen garments and the day tempe-
excess or have positive kurtosis. rature, and so on.
Measurement of Kurtosis Linear and Non-Linear Correlation
Karl Pearson gave the following formula for the The correlation between two variables is said to be
measurement of kurtosis. linear if corresponding to a unit change in one
variable, there is a constant change in the other variable
μ μ
β2 = 42 = 4 over the entire range of the values. For example, let us
μ 2 σ4 consider the following data :
where X 1 2 3 4 5
β2 = Measure of Kurtosis Y 5 7 9 11 13
μ4 = Fourth moment of Dispersion Thus for a unit change in the value of X, there is a
μ2 = Second moment of Dispersion constant change in the corresponding values of Y (2
Units). Mathematically, above data can be expressed by
σ = Standard Deviation
the equations.
If β 2 = 3, the curve is mesokurtic.
Y = 2X + 3
If β 2 > 3, the curve is Lepto Kurtic.
In general two variables X and Y are said to be
If β 2 < 3, the curve is Platy Kurtic. linearly related, if these exists a relationship of the form
Correlation Y = a + bX …(1)
Between than. But we know that (1) is the equation
Meaning of Correlation of a straight line with slope ‘b’ and which an intercept
The study of relationship between two or more ‘a’ on the Y-axis. Hence, if the values of the two
variables is the most important in life. It is a common variables are plotted as points in XY-plane, we shall get
a straight line.
knowledge that change in are variable will affect the
other. For example, when the price of the commodity The relationship between two variables is said to be
increases, its demand decreases and on the other hand, Non-linear or curvilinear if corresponding to a unit
change in one variable, the other variable does not
when the price of a commodity decreases, its demand
change in one variable, the other variable does not
increases. The statistical device with the help of change at a constant rate but a fluctuating rate. In such
which relationships between two or more than two cases if the data are plotted on the XY-plane we do not
variables are studied is called correlation. get a straight line curve mathematically speaking, the
According to L.R. Connor, “If two or more correlation is said to be non-linear it the slope of the
quantities vary in sympathy so that movement in the one plotted curve is not constant such phenomena are
tend to be accompanied by corresponding movements in common in the data relating to economics and social
the others, then they are said to be correlated.” sciences.
Economics (NET) | 261U
Degree of Correlation (iii) If there is an upward trend rising from lower
left hand corner and going upward to the upper right
Degree Positive Negative
hand corner, the correlation is positive since this reveals
Perfect +1 –1 that the values of the two variables move in the same
High Between Between direction. If, on the other hands, the points depict a
+ ·75 and +1 – ·75 and —1 downward trend from the upper left hand corner to the
Moderate Between Between lower right hand corner, the correlation is negative since
+ ·50 and + ·75 – ·50 and – ·75 in this case the values of the two variables move in the
Low Between Between opposite directions.
0 and + ·50 0 and – ·50
Absence 0 0
Methods of Studying Correlation
The commonly used methods for studying the
correlation between two variables are :
1. Scatter Diagram Method
2. Karl Pearson’s coefficient of correlation
3. Ran King Method
4. Concurrent Deviations Method
(iv) In particulars if all the points lie on a straight
Scatter Diagram Method line starting from the left bottom and going up towards
The scatter diagram implies the plotting of values the right top, the correlation is perfect all positive, and if
of two variables on graph paper and then observe the, all the points lie on a straight line starting from left top
movements. The following points may be borne in mind and coming down to right bottom, the correlation is
in interpreting the scatter diagram regarding the perfect and negative.
correlation between the two variables :
(i) If the points are very dense i.e., very close to
each other, a fairly good amount of correlation may be
expected between the two variables. On the other hand,
if the points are widely scattered, a poor correlation may
be expected between them.
(ii) If the points on the scatter diagram reveal any
trend (either upward or downward), the variables are
said to be correlated and if no trend is revealed, the
variables are un correlated.
262U | Economics (NET)
Properties of Correlation Coefficient
Property-1
Pearsonian correlation coefficient can not exceed
1 numerically. In other words it lies between –1 and
+1. Symbolically,
–1 ≤ r ≤ 1
In other words, r = ± 1 implies perfect positive
correlation between the variables and r = –1 implies
perfect negative correlation between the variables.
Karl Pearson’s Coefficient of Correlation Property-2
A mathematical method for measuring the intensity Correlation coefficient is independent of the change
or the magnitude of linear relationship between two of origin and scale.
variables was suggested by Karl Pearson, a great British
Bio-metriciam and statistician and is by for the most Property-3
widely used method in practice. Two independent variables are uncorrelated but the
Karl Pearson’s coefficient of correlation is calculated converse in not true.
by applying the following formula : Rank Correlation Method
Ungrouped Data Sometimes we come across statistical series in
When deviations are taken from an actual mean which the variables under consideration are not capable
Σxy of quantitative measurement but can be arranged in
r = serial order. This happens when we are dealing with
N·σxσy
where qualitative characteristics such as honesty, beauty,
character, morality, etc., which cannot be measured
r = Karl Pearson’s Coefficient of Correlation quantitatively but can be arranged serially. I n such
–
x = (x – y) situations Karl Pearson’s coefficient of correlation
–
y = (y – y) cannot be used as such. Charles Edward Spearman, a
British Psychologist, developed a formula in 1904 which
σx = Standard Deviation of x series
consists in obtaining the correlation coefficient between
σy = Standard Deviation of y series the ranks of n individuals in the two attributes under
N = Number of pairs of item study.
An alternate formula of the above is : Suppose we want to find if two characteristics A,
Σxy say, intelligence and B, say, beauty are related or not
r =
⎯⎯⎯⎯⎯
√ Σx2·Σy2 Both the characteristics are in capable of quantitative
measurement, but we can arrange a group of n
where
individuals in order of merit (ranks) w.r.t. Proficiency in
Σx2 = Total of squares of deviations taken from an the two characteristics. Let the random variables X Y
actual mean of X series denote the ranks of the individuals in the characteristics
Σy = Total of squares of deviations taken from an
2
A and B respectively. If we assume that there is no tie,
actual mean of Y – Series i.e., if no two individuals get the same rank in a
When deviations are taken from an assumed mean characteristic then, obviously, X and Y assume numerical
NΣdx·dy – (Σdx)(Σdy) values ranging from 1 to n.
r =
[NΣdx 2 – (Σdx)2] [NΣdy 2 – (Σdy)2] Spearman’s rank correlation coefficient, is given
by the formula
Where
Σd2
dx = Deviations taken form an assumed mean of rk = 1 – where
X variable (X – A) n(n2 – 1)
dy = Deviations taken form an assumed mean of d = Differences in ranks
Y variable (Y – A) n = Number of pairs of items
Remark
Grouped Data
Spearman’s rank correlation coefficient lies between
N·Σdx·dy – (Σdx)(Σdy) –1 and +1, i.e.,
r=
[NΣdx 2 – (Σfdx) 2] [NΣfdy2 – (Σfdx) 2 ] –1 ≤ rk ≤ 1
Economics (NET) | 263U
Concurrent Deviation Method If r is the observed correlation coefficient in a
sample of n pairs of observarions then its standard erros,
This method is one of the ways of calculating the usually denote by
coefficient of correlation. It is the simplest method of
studying correlation. This method is based on the signs S.E. (r) is given by
of the deviations (i.e., direction of the change) of the 1 – r2
S.E. (r) =
values of the variable from its preceding value and does ⎯n
√
not take into account the exact magnitude of the values Probable error of the correlation coefficient is given
of the variables. Thus, we put a plus (+) sign, minus (–) by
sign or equality (=) sign for the deviation if the value of
the variable is greater than, less than or equal to the P.E. (r) = 0·6745 × S.E. (r)
preceding value respectively. The deviations in the 1 – r2
= 0·6745
values of two variables are said to be concurrent if they ⎯n
√
have the same sign, i.e., either both deviations are Reason for taking the factor 0·6745 is that in a
positive or both are negative or both are equal. The normal distribution 50% of the observations lie in the
formula used for computing correlation coefficient r by range M ± 0·6745 σ, where M is the mean and σ is the
this method is given by S.d.
r=± ±[2cn– n] Use of Probable Error
1. The probable error of correlation coefficient may
where c is the number of pairs of concurrent be used to determine the limits within which the
deviations and n is the number of pairs of deviations. In population correlation coefficient may be expected to
the above formula plus/minus –1 ≤ r ≤ 1, the quality lie.
inside the square not must be positive, otherwise r will Limits for population correlation coefficient are
be imaginary which is not possible.
r ± P.E. (r) …(1)
Thus if (2c – n) is positive, we take positive sign in This implies that if we take another random sample
and outside the square root in the above equation and if of the same size n from the same population from which
(2c – n) is negative, we take negative sign in and outside the first sample was taken, then the observed value of
the square root in the above equation. the correlation coefficient, say, r1 in the second sample
Note—It should be clearly noted that here n is not can be expected to lie within the limits given in (1).
the number of pairs of observations but it is the number 2. P.E. (r) may be used to test if an observed value
of pairs of deviations and as such it is one less than of sample correlation coefficient is significant of any
number of pairs of observations. correlation in the population. The following guidelines
may be used :
Assumptions Underlying Karl Pearson’s (a) If r < P.E. (r) i.e., if the observed value of r is
Correlation Coefficient less than its P.E, then correlation is not at all significant.
Pearsonian correlation coefficient r is based on the (b) If r < σP.E. (r), i.e., if observed value of r is
following assumptions : greater than σ times its P.E. Then r is definitely
significant.
(i) The variables X and Y under study are linearly
related. In other words, the scatter diagram of the data (c) In other situations, nothing can be concluded
with certainly.
will give a straight line curve.
(ii) Each of the variables is being affected by a large Remarks
number of independent contributory causes of such a P.E. can be used only under the following condi-
nature as to produce normal distribution. tions :
(i) The data must have been drawn from a normal
(iii) The forces so operating on each of the variable
population.
series are not independent of each other but are related
(ii) The conditions of random sampling should
in a causal fashion.
prevail in selecting sampled observations.
Probable Error Coefficient of Determination
After computing the value of the correlation Coefficient of correlation between two variable
coefficient the next step is to find the extent to which it series is a measure of linear relationship between them
is dependable. Probable error of correlation coefficient, and indicates the amount of variation of one variable
usually denoted by P.E. ® is an old measure of testing which is associated with or is accounted for by another
the reliability of an observed value of correlation variable. A more useful and readily comprehensible
coefficient in so far as it depends upon the conditions measure for this purpose is the coefficient of determina-
of random sampling. tion which gives the percentage variation in the
264U | Economics (NET)
dependent variable. In other words, the coefficient of called the coefficient of non-determination. It is usually
determination gives the ratio of the explained variance to denoted by K2 and is given by the formula :
the determination is given by the square of the Un-explained Variance
correlation coefficient, i.e., r2 . Thus, K2 =
Total Variance
Coefficient of determination Explained Variance
= 1–
Explained Variance Total Variance
= r2 =
Total Variance = 1–r 2
The coefficient of determination is much useful and 5. Coefficient of Alienation—The coefficient of
better measure for interpreting the value of r. alienation is given by the square root of the coefficient
For example if the value of r = 0·8, we cannot of non-determination, i.e., by K as given below
conclude that 80% of the variation in the relative series
K=±√
⎯⎯⎯⎯
1 – r2
(dependent variable) is due to the variation in the subject
series (independent variable). But the coefficient of Index Numbers
determination in this case is r2 = 0·64 which implies that
only 64% of the variation in the relative series has been Meaning
explained by the subject series and the remaining 36% An index number is as its name suggests, an
of the variation is due to other factors. indicator of the general trend of a set of figures. Index
By the same argument while comparing two numbers are devices for measuring the net amount of
correlation coefficient, one of which is 0·4 and the other change in a group of related variables over a certain
is 0·8 it is misleading to conclude that the correlation in period of time. Index numbers are used to measure
the second case is twice as high as correlation is the first changes in industrial output, fluctuations in the level of
case. The coefficient of determination clearly explains business of variations in the size of agricultural output
this view point, since in the case r = 0·4, the coefficient etc.
of determination is 0·16 and in the case r = 0·8, the The important definition of index numbers are given
coefficient of determination is 0·64, from which we below :
conclude that correlation in the second case is four times According to croxton and Cowden, “Index numbers
as high as correlation in the first case. are devices for measuring differences in the magnitude
Remarks of a group of related variables.”
According to Blair, “Index numbers are a
1. The above discussion implies that—
specialised type of averages.”
“The closeness of the relationship between two
variables as determined by correlation coefficient r is Uses of Index Numbers
not proportional” Following are the main used of Index Numbers.
2. The following table gives the values of the 1. Index numbers are used to measure the changes in
coefficient of determination (r2 ) for different values of the price level over a period of time.
r.
2. Index numbers are used to reduce complex forms
r r2 of measurement to simple numbers.
0·1 0·01 3. Index numbers are also used for the purpose of
0·2 0·04 forecasting.
0·3 0·09 4. Index numbers are also compelled to compare
0·4 0·16 physical changes over a period of time. Such changes
0·5 0·25 relate to industrial production, sales, volume of imports
0·6 0·36 or exports, etc.
0·7 0·49 5. Since the index numbers study the relative
0·8 0·64 changes in the level of a phenomenon at different
0·9 0·81 periods of time, they are specially useful for the study of
1·0 1·00 the general trend for a group phenomenon in a time
series data.
It may be seen from the above table that as the value
of r decreases, r2 decreases very rapidly except in two Types of Index Numbers
particular cases r = 0 and r = 1 when we get r = r2 . 1. Price Index Numbers
3. Coefficient of Determination is Always non- 2. Quality Index Numbers
negative and as such it does not tell us about the 3. Value Index Numbers
direction of the relationship (whether it is positive or
negative) between the two series. Methods of Constructing Index Numbers
4. Coefficient of Non-Determination—The ratio of The various methods for constructing index numbers
the unexplained variation to the to the total variation is are given ahead :
Economics (NET) | 265U
1. Fixed Base Method Paasche’s Price Index
Price Relatives If we take current year quantities as weights we
P obtain Paasche’s Price Index which is given by :
(R) = 1 × 100
P0 ΣP1q0
P 01 = × 100
where ΣP0q0
P 1 = Price of the current year This formula was given by German statistician
P 0 = Price of the base year Paasche in 1874.
2. Simple Aggregative Method Dorbhish-Bowley Price Index
ΣP1 This index is given by the arithmetic mean of
P 01 = × 100
ΣP0 Laspeyre’s and Paasche’s price index numbers and we
where have :
1 ⎡ ΣP q ΣP q ⎤
P 01 = Price index of the current year P 01 = ⎢⎢ 1 0 + 1 1⎥⎥ × 100
2 ⎣ ΣP0q0 ΣP0q1⎦
ΣP1 = Total of current year prices
ΣP0 = Total of base year prices This is also sometimes known as L – P formula.
Fisher’s Price Index
Remark Irving Fisher advocated the geometric mean of
Based on this method, the quantity index is give by Laspeyre’s and Paasche’s price index numbers and is
the formula given by :
Σq1 ⎡ ΣP q ΣP q ⎤
Q01 =
Σq0
× 100 P 0 – 1 ⎢⎢ 1 0 × 1 1⎥⎥ × 100
⎣ ΣP0q0 ΣP0q1⎦
where Σq0 and Σq1 are the quantities of all the selected Fisher’s index is termed as an ideal index since it
commodities consumed in the base year and the current satisfies time reversal and factor reversal tests for the
year respectively. consistency of index numbers.
3. Simple Average of Price Relatives Methods
⎛P1 ⎞ Marshall Edgeworth Price Index
Σ ⎜ P × 100⎟ Taking the arithmetic cross of the quantities in
⎝ 0 ⎠ the base year and the current year as weights i.e.,
P 01 =
N (q + q1 )
where N stands for number of items or commo- w= 1 , we obtain the Marshall – Edgeworth
2
dities. formula given by
4. Weighted Aggregate Method (q + q 1 )
ΣP1· 0
ΣWP1 2
P 01 = × 100 P 01 = × 100
ΣWP0 (q0 + q 1 )
ΣP0·
where w is the weight attached to a commodity. By 2
using different systems of weighting we get a number of ΣP1(q0 + q1 )
= × 100
formulas. Some of the important formulas are given ΣP0(q0 + q1 )
below :
⎡⎢ ΣP1q0 + ΣP1q1 ⎤⎥
Laspeyre’s Price Index or Base Year = ⎢⎣ ΣP0q0 + ΣP0q0 × 100⎥⎦
Method
Taking base year quantities as weights, i.e., Walsch Price Index
w = q0 we get Laspeyre’s price Index given by : Instead of taking the arithmetic mean of base year
ΣP1q0 and current year quantities as weights, if we take their
P 01 = × 100 geometric mean, i.e., w = √
⎯⎯⎯
q0 q1, then we obtain Walsch
ΣP0q0
Index given by the formula :
where
P 1 = Current Year Price ΣP1√
⎯⎯⎯
q0 q1
P 01 = × 100
q0 = Base Year Quantity ΣP0√
⎯⎯⎯
q0 q1
P 0 = Base Year Price Kelly’s Price Index or Fixed Weights
q1 = Current Year Quantity Index
This formula was devised by French Economist This formula, named after L.Kelly, requires the
Laspeyre in 1871. weights to be fixed for all periods and is also sometimes
266U | Economics (NET)
known as aggregative index with fixed weight and is La F ME Pa
then P01 < P01 < P01 < P01
given by the formula : La Pa
and if P01 < P01
ΣP1q
P 01 = × 100 Pa F ME La
ΣP0q than P01 < P01 < P01 = P01
where the weights are the quantities (q) which may Tests of Consistency of Index Numbers
refer to some period (not necessarily the base year or the
current year) and are kept constant for all periods.
Formula
1. Unit Test–This test requires that the index
Values Indices number formula should be independent of the units in
Value index numbers are obtained on expressing the which the prices or quantities of various commodities
total value (or expenditure) in any given year as a are quoted. All the formulae discussed above except
percentage of the same in the base year symbolically, we quoted. All the formulae discussed above except the
write index number based on simple Aggregate of Prices
Total value in current year (Quantities) satisfy this test.
V01 = × 100 2. Time Reversal Test–The time reversal tests
Total value in base year
proposed by Prof. Irving Fisher requires the index
ΣP q
⇒ V01 = 1 × 100 number formula to possess time consistency by working
ΣP0q both forward and back ward w.r.t time.
Remarks In other words, if the index numbers are computed
1. In general, Laspeyre’s price index is greater than for the same data relating to two periods by the same
Paasche’s price index. In other words, Laspeyre’s Price formula but with the bases reversed, then the two index
Index has an upward bias in general, with rise in price. numbers so obtained should be the reciprocals of each
But if the correlation coefficients between the price other. Mathematically, we should have (omitting the
relatives and quantity relatives is positive (a phenomenon factor 100),
which is rarely observed in economics), then Laspeyre’s P 01 × P10 = 1
price index is less than Paasche’s price index. or more generally
2. Fisher’s ideal index number lies between P ab × Pba = 1
Laspeyre’s and paasche’s index numbers where
Proof : Let us consider two real positive numbers a and P ab = Price index (without factor 100) for year ‘b’
b such that a > 0. with year ‘a’ as base
Let a > b P ba = Price index (without factor 100) for year ‘a’
⇒ a2 < ab (multiplying by a > 0) with year ‘b’ as base
⇒a<√ ⎯⎯ab ...(1) Time reversal test is satisfied by the following index
(Q a > 0, negative sign is rejected) number formulae :
Also a < b (i) Marshall – Edge worth formula
⇒ ab < b (Multiplying by b > 0)
2 (ii) Fisher’s ideal formula
(iii) Walsch formula
⇒⎯ √⎯ab < b (Q b > 0) …(2) (iv) Kelly’s fixed weight formula
Hence, from equation (1) and (2) (v) Simple aggregate index
a<√ ⎯⎯ab < b (vi) Simple Geometric mean of Price Relatives
This, the geometric mean of two real positive formula
numbers lies between than. Hence Fisher’s ideal index (vii) Weighted Geometric mean of Price Relatives
which is the geometric mean of Laspeyre’s and Paasche’s formula with fixed weights.
index numbers lies between them. More precisely,
La Pa
Remark
if P 01 < P01 Laspeyre’s and Paasche’s index numbers do not
La F Pa
there P01 < P01 < P01 satisfy this test.
Po La Let us verify this test for Kelly’s fixed weight
and if P01 < P01
Pa F La formula. We have (without factor 100)
then P01 < P01 < P01
k ΣWP1
La Pa P 10 =
and if P01 = P01 ΣWP0
Pa La F
then P01 = P01 =
P01 k ΣWP1
and P 10 =
3. Marshall – Edgeworth index also lies between ΣWP0
Laseyre’s and Paasche’s indices. Rather we have k k ΣWP1 ΣWP0
La Pa ∴ P o1 × P10 = × =1
if P01 < P01 ΣWP0 ΣWP1
Economics (NET) | 267U
Hence Kelly’s fixed weight formula satisfied time (i) Conversion of fixed Base to Chain Base
reversal test. Chain Index No
3. Factor Reversal Test. This is the second of the Current year fixed base index No.
two important tests of consistency proposed by Prof. = 100
Previous year fixed base index No.
Irving Fisher. This implies that if the price and quantity (ii) Conversion of Chain Base to Fixed Base
indices are obtained for the same data. Same base and
current periods and using the same formula, then their Fixed Base Index No.
product (without the factor 100) should give the true Current year’s chain base index No.
value ratio, since price multiplied by quantity gives total × Previous year’s fixed base index No.
=
value. Symbolically, we should have (without factor 100
100),
ΣP q Cost of Living Index Number
P 01 × Q01 = 1 1 The wholesale price index numbers measure the
ΣP0q0
changes in the general level of prices and they fail to
where reflect the effect of the increase or decrease of prices on
ΣP1q1 and ΣP 0 q0 denote the total value in the current the cost of living of different classes or groups of people
and base year respectively. in a society. Cost of living index numbers, also termed
Fisher’s formula satisfies the factor reversal test. In as ‘Consumber Price Index Numbers, or Retail Price
fact Fisher’s index is the only index satisfying this test Index Numbers’ are designed to measure the effects of
and none of the formulae discussed above satisfied this changes in the prices of a basket of goods and services
test. on the purchasing power of a particular section or class
of the society during any given (current) period w.r.t.
Remark same fixed (base) period. They reflect upon the average
Since Fisher’s index is the only index which increase in the cost of the commodities consumed by a
satisfied both the time reversal tests, it is sometimes, class of people so that they can maintain the same
termed as Fisher’s ideal Index. Standard of living in the current year as in the base year.
4. Circular Test–Circular test, first suggested by
Westergaard, is an extension of time reversal test for
Construction of Cost of Living Index
more than two periods and is based on the shiftability of Numbers
the base period. This requires the index to work in a The cost of living index numbers are constructed by
circular manner add this property enables us to find the the following methods :
index numbers from period to period without referring (i) Aggregate Expenditure Method or Weighted
back to the original base each time. For, three periods a, Aggregate Method
b, c, the test requires. In this method, the quantities consumed in the base
For, three periods a, b, c, the test requires : year are used as weights. Thus in the usual notations
P ab × Pbc × Pca = 1, a ≠ b ≠ c Σp q
Cost of Living Index = 1 0 × 100
or P01 × P12 × P20 = 1 Σp0 q0
For Instance Total expenditure in current year
= × 100
La La La Σp q Σp2 q1 Σp0 q2 Total expenditure in base year
P 01 × P12 × P20 = 1 0 × × (ii) Family Budget Method or Method of Weighted
Σp0 q0 Σp1 q1 Σp2 q2
Relatives
Hence Laspeyre’s index does not satisfy the circular
In this method the cost of living index is obtained on
test. Similarly, it can be verified that none of Pasche’s M
taking the weighted average of price relatives, the
– E’s, Walsh’s and Fisher’s indices satisfies this test. In
weights being the values of the quantities consumed in
fact, circular test is not satisfied by any of the weighted
the base year. Thus, if we write
aggregative formula with changing weights, i.e., if the
weights used in the construction of index numbers P01, P
I = Price Relative = 1 × 100
P 12 , and P20 change. This test is satisfied only by the P0
index number formulae based on : and w = P0q0
(i) Simple geometric mean of the price relatives ΣWI
then cost of Living Index =
(ii) Kelly’s fixed base method ΣW
Substituting the values of W and I we get
Remark ⎛p ⎞
The circular test can be generalized to the case of ΣP0q0⎜ 1 ×⎟
more than three periods to give : ⎝ q0 ⎠
= Cost of Living Index =
P 01 × P12 × P 23 ×……× Pn,o = 1 Σp0 q0
Σp1 q0
where the indices are, considered without the factor = × 100
400. Σp0 q0
268U | Economics (NET)
Remark the people in a particular city, the population will
comprise as the earning people in that city. On the other
Thus we see that the cost of living Index numbers hand if we want to study the expenditure habits of the
obtained by both the methods are same. families in that city, then the population will consist of
Use of Cost of Living Index Numbers all the house holds in that city. In sampling theory, the
population means the larger group from which the
1. Cost of living index numbers are used to samples are drawn.
determine the purchasing power of money and for
computing the real wages (income) from the nominal or A population containing a finite number of objects
money wages (income). We have or items in known as finite population, e.g., the students
Purchasing Power of Money in a college, the day’s production in an industrial
concern, the populations of a city or a town, etc. On the
1
= other hand, a population having an infinite number of
Cost of Living Index No.
objects or with the number of objects so large as to
Money Wages
Real Wages = × 100 appear practically infinite, is termed as an infinite
Cost of Living Index population, e.g., the population of temperatures at
Thus, cost of living index number enables us to find various points of the atmosphere; the population of stars
if the real wages are rising or falling, the money wages in the sky, etc.
remaining unchanged.
2. The government of many big industrial and Sampling
business units use the cost of living index numbers to A finite subset of the population, selected from it
regulate the dearness allowance (D.A,) or grant of bonus with the objective of investigating its properties is called
to the employees in order to compensate them for in a sample and the number of units in the sample is known
creased cost of living due to price rise. as the sample size. Sampling is a tool which enables us
Limitations of Index Numbers to draw conclusions about the characteristics of the
populations after studying only those objects or items
Although index numbers are very important tools that are included in the sample.
for studying the economic and business activity of a
country, they have their limitations and as such should The main objectives of the sampling theory are :
be used and interpreted with caution. The following are (i) To obtain the optimum results, i.e., the maximum
some of their limitations : information about the characteristics of the population
1. Since index numbers are based on the sample with the available sources at our disposal in terms of
data, they are only approximate indicators and may not time, money and man power by studying the sample
exactly represent the changes in the relative level of a values only.
phenomenon. (ii) To obtain the best possible estimates of the
2. There is likelihood of error being introduced at population parameters.
each stage of the construction of the index numbers,
namely, Sampling Distribution
If we draw a sample of size n from a given finite
(i) Selection of commodities. population of size N, then the total number of possible
(ii) Selection of the base period. samples is;
(iii) Collection of the data relating to prices and N!
quantities of the commodities. Ncn = = K, (say)
n!(N – n)!
(iv) Choice of the formula–the system of weighting
to be used. For each of these K samples we can compute some
–
(v) The average to be used for obtaining the index statistic t = t (x 1 , x2 ,..., xn), in particular the mean X, the
for the composite group of commodities. variance S2 , etc., as given below :
Sampling Methods and Sampling Sample Number Statistic
Distribution t –
X
s2
Sampling 1 t1 –
X1
2
s1
Universe or Population 2 t2 – 2
s2
X2
: t3 –3 2
s3
In any statistical investigation the interest usually X
lies in studying the various characteristics relating to : : : :
items or individuals belonging to a particular group. : : :
This group of individuals under study is known as the K tk – sk
2
Xk
population or universe. For example, if an enquiry is
intended to determine the average per capita income of
Economics (NET) | 269U
The set of the values of the statistic so obtains, one Sample
for each sample, constitutes what is called the sampling In the sample method we inspect only a selected
distribution of the statistic. For example, the values it 1 , representative and adequate fraction (finites subset) of
t2 , t3,…tk determine the sampling, distribution of the the population and after analyzing the results of the
statistic t. In other words, statistic t may be regarded as a sample data we draw conclusions about the characteris-
random variable which can take the values t1, t2 , t3 , ….tk tics of the population. Prof. R.A. Fisher sums up the
and we can compute the various statistical constants like advantages of sampling techniques over complete census
mean, variance, Skewness, Jurtosis, etc., for its in just four words : Speed, Economy, Adaptability and
distribution. For example, the mean and variance of the scientific Approach. We summaries below the merits of
sampling distribution of the statistic t are given by : the sample method over the census method :
– 1 1. Speed i.e., less time
t = (t1 + t2 + t3 + ... + tk)
k 2. Economy i.e., Reduced cost of the Enquiry
1 k 3. Administrative convenience
= ∑ ti 4. Greater Scope
k i=1
–
where t = mean
Limitations of Sampling
The merits of sample surveys over complete enume-
1 – – –
Var (t) =
k
[
(t1 – t )2 + (t2 – t )2 + ... + (tk – t )2 ] ration can be realized only if :
(i) the sample is drawn n a scientific manner,
1 k –
= ∑ (ti – t )2 (ii) the appropriate sampling design is used,
k i=1 (iii) the sample size is adequate.
Standard Error In spite of the above P.T.O
The standard deviation of the sampling distribution 1. If a sample survey is not properly planned, the
of a statistic is known as its standard Error (S.E.). Thus, results obtained will not be reliable and quite often
the standard Error of the statistic t is given by : might even be misleading.
k
2. An efficient sampling scheme requires the
1 –
S.E. (t) = √
⎯⎯⎯⎯⎯
Var (t) = ∑ (t1 – t )2 services of qualified, skilled and experienced personnel
k i =1 and more sophisticated equipment and statistical tech-
niques for the planning and execution of the survey
Census Versus Sample Enumeration and for the collection, processing and analysis of the
For any statistical enquiry in any field of human sample data. In the absence of these the results of the
activity, whether it is in business, economics or social survey may not be reliable.
sciences, the basic problem is to obtain adequate and 3. Sometimes the sample survey might require more
reliable data relating to the particular phenomenon under time, money an labour than a complete census.
study. There are two methods of collecting the data : 4. Sampling procedure cannot be used if we want to
1. The census method or complete Enumeration. obtain information about each and every unit of the
2. The sample Method or Partial Enumeration. population.
Census Method Principal Steps in Sample Survey
In the census method we resort to 100% inspection The following are the principal steps in the planning
of the population and enumerated each and every unit of and execution of the sample surveys :
the population. The census method has its obvious 1. Objectives and Scope of the Survey
limitations and drawbacks given ahead : 2. Defining the Population to be Sampled
(i) The complete enumeration of the population 3. Sampling Units
requires lot of time, money, manpower and administra-
tive personnel. 4. Data to be Collected
(ii) Since the entire population is to be enumerated, 5. The Questionnaire or Schedule
the census method is usually very time consuming. 6. Method of Collecting Information
7. Selection of Proper Sampling Design
Remark
8. Organisation of Field Work
Census method is recommended in the following 9. Summary and Analysis of the Data
situations :
(a) If the information is required about each and Measures of Statistical Errors (Absolute
every unit of the population, there is no way but to resort and Relative Errors)
to 100% enumeration. A measure of the statistical errors is provided by
(b) If the size of item is small. absolute and relative errors.
270U | Economics (NET)
Absolute Error. An absolute error (A.E.) is the Simple Random Sampling
difference between the true value of any particular
Simple random sampling is the techniques in which
observed item and its estimated or approximated value.
“sample is so drawn that each and every unit in the
Symbolically, we may write–
population has an equal and independent chance of
A.E. = |a – e| being included in the sample.”
where
If the unit selected in any draw is not replaced in the
A.E. = absolute error population before making the next draw, then it is
a = actual value known as simple random sampling without replacement
e = estimated value and if it is replaced back before making the next draw,
|a – e| = modulus value of (a – e) then the sampling plan is called simple random sampling
For example, if a value 5487350 is approximated to with replacement.
the nearest lakh, it can be taken as 55 lakhs. Thus, A very important and interesting feature of simple
A.E. = |a – e| random sampling without replacement is that, “the
= |5487350 – 5500000| probability of selection a specified unit of population at
any given draw is equal to the probability of its being
= |–12650| = 12650 selected at the first draw.” This implies that in this case
The Magnitude of the absolute error is quite from a population of size N, the probability that any
independent of the magnitude of the actual value. For sampling unit is included in the sample is 1/M and this
example in the above case AE remains same for all those probability remains constant throughout the drawing.
values which have the digit in the 10 thousand place
greater than 5. Consequently, absolute errors cannot be Stratified Random Sampling
compared meaningfully. For example, the above error of When the population is heterogeneous with respect
12,650 in a value of 5487350 may be quite insignificant to the variable or characteristic under study, then the
or immaterial as compared with an absolute error of 10 technique of stratified random sampling is used to obtain
in a value of 500. Moreover, these errors are in the units more efficient results. Stratification means division into
of measurement and as such AEs in different units layers or goups.
cannot be compared meaningfully. In order to facilitate
comparison of the errors, they are reduced to pure The criterion used for the stratification of the
numbers which are independent of the units of universe into various strata is known as stratifying
measurement. This is done by calculating the Relative factor. In general geographical sociological or economic
Error (R.E.) which is defined as the ratio of the absolute characteristics from the basis of stratification of the
error to the actual value. Symbolically, given population. Some of the commonly used stratifying
factors are age, sex, income, occupation, educational
AE | a – c|
RE = = level, geographic area, economic status, etc. In many
Actual value a fields of highly skewed distributions, stratification is
Thus in the above example, RE which relates the very effective and valuable tool.
magnitude of the error to the magnitude of the true
value, is given by Systematic Sampling
12650 Systematic sampling is slight variation of the simple
RE = = 0·0023
5487350 random sampling in which only the first sample unit is
The relative error may also be expressed as selected at random and the remaining units an
percentage. automatically selected in a definite sequence at equal
12650 spacing from one another. This technique of drawing
Percentage RE = × 100
5487350 samples is usually recommended if the complete and up-
In statistical analysis, relative error is a much more to-date list of the sampling units, i.e., the frame is
useful measure than the absolute error as it provides a available and the units are arranged in some systematic
useful coefficient (a pure number independent of units of order such as alphabetical, chronological geographical
measurement) for comparing the degree of the error of order, etc. This requires the sampling units in the
different sets of data.
population to be ordered in such a way that each item in
Types of Sampling the population is uniquely identified by its order, for
Some of the important types of sampling are given example the names of persons in a telephone directory,
below : the list of voters etc.
1. Simple Random Sampling Cluster Sampling
2. Stratified Random Sampling In this case the total population is divided, depending
3. Systematic Sampling on problem under study, into some recognizable
4. Multistage Sampling subdivisions which are termed as clusters and a simple
5. Quota Sampling random sample of these clusters is drawn.
Economics (NET) | 271U
For example, if we are interested in obtaining the a
=1–
income or opinion data in a city, the whole city may be N
divided into N different blocks or localities (which ⇒Q=1–P
determine the clusters) and a simple random sample of n
In sampling theory, the possession of an
blocks is drawn. The individuals in the selected blocks
determine the cluster sample. attribute by a sampling unit is termed as a success and
non-possession as a failure. Therefore, P and Q may be
Multistage Sampling interpreted as representing the proportion or probability
As the name suggests, multistage sampling refers to of success and failure respectively in the population.
a sampling technique which is carried out in various
stages. For example, if we are interested in obtaining a Sampling Distribution
sample of, say, n households from a particular state the A sampling distribution is a probability distrib-
first stage units may be districts, the second stage units ution of a statistic obtained through a large number of
will be households in the villages. Each stage thus samples drawn from a specific population. The sampling
results in a reduction of the sample size. distribution of a given population is the distribution of
frequencies of a range of different outcomes that could
Quota Sampling possibly occur for a statistic of a population.
Quota sampling may be looked as a special form of A lot of data drawn and used by academicians,
stratified sampling. In this method, that investigator it statisticians, researchers, marketers, analysts, etc. are
told in advance the number of the sample units he is to actually samples, not populations. A sample is a subset
examine or enumerate from the stratum assigned to him. of a population. Each sample has its own sample mean
In the language of stratified sampling, the quota of the and the distribution of the sample means is known as the
units to be examined by the investigator from the sample distribution.
stratum assigned to him is fixed for each investigators. The average weight computed for each sample set is
The sampling quotes may be fixed according to some the sampling distribution of the mean. Not just the mean
specified characteristic such as income group, sex, can be calculated from a sample. Other statistics, such as
occupation, political or religious affiliations, etc. The the standard deviation, variance, proportion and range
choice of the particular units or individuals for can also be calculated from sample data. The standard
investigation is left to the investigators themselves. deviation and variance measure the variability of the
Sampling Distribution of Proportion sampling distribution.
We talk of population proportion or sample The number of observations in a population, the
proportion, if the characteristic under study is an number of observations in a sample and the procedure
attribute. An attribute is a quality characteristic which used to draw the sample sets determine the variability of
cannot be measured quantitatively, e.g., beauty, honesty, a sampling distribution. The standard deviation of a
intelligence, colour, habit, etc. In a number of situations sampling distribution is called the standard error. While
it may not be possible to measure the classify the given the mean of a sampling distribution is equal to the mean
population into various classes w.r.t. the given attribute. of the population, the standard error depends on the
If we classify the population is termed as dichotomous standard deviation of the population, the size of the
classification and if the population is divided into more population and the size of the sample. Knowing how
than two classes, it is termed as mainfold classification. spread apart the mean of each of the sample sets are
Here we shall confine our attention to the cases where from each other and from the population mean will give
the population can be classified only into two mutually an indication of how close the sample mean is to the
exclusive and exhaustive classes, say, C or C’ according population mean. The standard error of the sampling
as the given unit possess or does not possess the attribute distribution decreases as the sample size increases.
respectively. A population or one sample set of numbers will
have a normal distribution. However, because a sampling
Let us consider a population consisting of N units distribution includes multiple sets of observations, it will
and let the number of units possessing the attribute not necessarily have a bell-curved shape.
under study be ‘a ’, say. Then in a dichotomous Suppose that we draw all possible samples of
classification, the number of units which do not possess size n from a given population. Suppose further that we
the given attribute is (N – a). compute a statistic (e.g., a mean, proportion, standard
Then deviation) for each sample. The probability distribu-
P = Proportion of units (in the population) tion of this statistic is called a sampling distribution.
possessing the given attribute = a/N And the standard deviation of this statistic is called
the standard error.
Q = Proportion of population units which do not
posses the given attribute Variability of a Sampling Distribution
N–a The variability of a sampling distribution is
=
N measured by its variance or its standard deviation. The
272U | Economics (NET)
variability of a sampling distribution depends on three Like the formula for the standard error of the mean,
factors : the formula for the standard error of the proportion uses
● N : The number of observations in the population. the finite population correction, sqrt[ (N – n ) / (N – 1) ].
When the population size is very large relative to the
● n : The number of observations in the sample.
sample size, the fpc is approximately equal to one; and
● The way that the random sample is chosen. the standard error formula can be approximated by :
If the population size is much larger than the sample σp = sqrt [PQ/n]
size, then the sampling distribution has roughly the same
standard error, whether we sample with or without Statistical Inference
replacement. On the other hand, if the sample represents Statistical inference is the comparison of particular
a significant fraction (say, 1/20) of the population size, statistics from on observational data set (i.e., the mean,
the standard error will be meaningfully smaller, when the standard deviation, the differences among the means
we sample without replacement. of subsets of the data), with an appropriate reference
distribution in order to judge the significance of those
Sampling Distribution of the Mean statistics. When various assumptions are met, and
Suppose we draw all possible samples of size n from specific hypotheses about the values of those statistics
a population of size N. Suppose further that we compute that should arise in practice have been specified, then
a mean score for each sample. In this way, we create a statistical inference can be a powerful approach for
sampling distribution of the mean.The mean of the drawing scientific conclusions that efficiently uses
sampling distribution (μX ) is equal to the mean of the existing data or those collected for the specific purpose
population (μ). And the standard error of the sampling of testing those hypotheses. Even in a context when a
distribution (σX) is determined by the standard deviation formal experimental design is not possible, or when the
of the population (σ), the population size (N), and the objective is to explore the data, significance evaluation
sample size (n). These relationships are shown in the can be useful.
equations below : Characterization of Samples
μX = μ Once a sample has been obtained, and descriptive
σX = [σ/sqrt(n)]* sqrt[(N – n)/(N – 1)] statistics calculated, attention may then turn to the
In the standard error formula, the factor sqrt [(N – n) significance (representativeness as opposed to unusual-
/ (N – 1) ] is called the finite population correction or ness) of the sample or of the statistics. This information
fpc. When the population size is very large relative to may be gained by comparing the specific value of a
the sample size, the fpc is approximately equal to one; statistic with an appropriate reference distribution, and
and the standard error formula can be approximated by : by the calculation of additional statistics that describe
the level of uncertainty a particular statistic may have. In
σ
σX = the case of the sample mean, the appropriate reference
sqrt (n) distribution is the normal distribution, which is implied
by the Central Limit Theorem.
Sampling Distribution of the Proportion
Standard error of the mean and confidence
In a population of size N, suppose that the interval for the mean : Uncertainty in the mean can be
probability of the occurrence of an event (dubbed a described by the standard error of the mean or by the
"success") is P; and the probability of the event's non- confidence interval for the mean. The standard error of
occurrence (dubbed a "failure") is Q. From this popula- the mean can be thought of as the standard deviation of a
tion, suppose that we draw all possible samples of size n. set mean values from repeated samples.
And finally, within each sample, suppose that we –
determine the proportion of successes p and failures q. The standard error of the mean is given by σ X =
In this way, we create a sampling distribution of the σ
, where σ is the standard deviation of the population
proportion. ⎯n
√
We find that the mean of the sampling distribution and n is the sample size. In practice, because the
of the proportion (μ p ) is equal to the probability of standard deviation of the population is not known, the
success in the population (P). And the standard error of standard deviation of sample, s, is used in place of σ.
the sampling distribution (σp ) is determined by the The standard error of the mean (which is sometimes
standard deviation of the population (σ), the population referred to as the standard deviation of the mean), has
size, and the sample size. These relationships are shown the nice property of increasing as the variability of the
in the equations below : data increases, and decreasing as the sample size
μp = P increases.
σp = [σ/sqrt(n)]* sqrt[(N – n)/(N – 1)] The confidence interval for the mean is the range
of values that is likely to enclose the “true” value of the
σp = sqrt[PQ/n)* sqrt [(N – n)/(N – 1)] mean some particular proportion of the time (e.g. as in
where σ = sqrt [PQ].[Square root of {PQ}] repeated sampling of the same processor or phenomena).
Economics (NET) | 273U
The confidence interval for the mean can be described the establihment of truth or its rejection. A hypothesis
by noting that may or may not be true, after the data has been collected.
(a) means are normally distributed (which is implied Thus it is not at all essential that hypothesis must always
by the central limit theorem) and consequently be true.
(b) the normal distribution can be used to describe Stages for Establishing Hypothesis : Whether a
the probability of observing different values of the hypothesis is true or not for that various stages are to be
mean. crossed. The first stage in the establishment of a
The (1 = α)% confidence interval for the mean is hypothesis is that problem must be conceived. It is
– – called observation. Once the problem has been observed
written as : X = ± Z σX then comes the need for collecting data sufficient
– – enough to establish whether problem conceived is based
Where X is the sample mean, and σ X is the standard on facts or not. Then comes the next stage when various
error of the sample mean, and Z is a value (obtained aspects of the problem are examined and their mutual
using the cumulative density function (cdf) of the normal comparability is taken into consideration. After these
distribution, such that (α/2)% of the area under the pdf stages have been crossed on the basis of data available
lies to the left of – Z (i.e., (α/2)% of the values of X an attempt is made to establish or refute the hypothesis.
observed in practice are less than-Z and (α/2)% of the As already said hypothesis may or may not be true. It
area lies to the right of + Z (i.e., (α/2)% values of the X may also be clearly understood that there is no particular
observed in practice are less than + Z). The width of method in establishing a hypothesis. It entirely depends
the confidence interval depends on the magnitude of on the sweet will of the social scientist. It depends on his
the standard error, and the desired precision. wisdom and knowledge as well as on depth of study.
Simple Inferences Based on the Standard Tests of Significance
Error of the Mean From the knowledge of the sampling distribution of
The standard error of the mean, along with the a staristic, it is possible to find the probability that a
knowledge that the sample mean is normally distributed sample statistic would differ from a given hypothetical
allows inferences about the mean to made For example, value of the parameter or from another sample value, by
questions of the following kind can be answered : more than a certain amount and hence to answer the
● What is the probability of occurrence of an question of significance. Accordingly, a procedure to
observation with a particular value? assess the significance of a statistic or difference
between two independent statistics is known as test of
● What is the probability of occurrence of a sample
significance. We say that—
mean with a particular value?
● What is the “confidence interval” for a sample mean (i) The difference between a statistic and the
with a particular value? corresponding population parameter, or
Types of Inference (ii) The difference between two independent
statistics, is not significant if it can be attribute to the
There are three forms of statistical inference , each
fluctuations of sampling, otherwise it is said to be
one representing a different way of using the informa-
tion obtained in the sample to draw conclusions about significant.
the population. These forms are : Null Hypothesis—The random selection of the
● Point Estimation : In point estimation, we estimate samples from the given population makes the tests of
an unknown parameter using a single number that significance valid for us. For applying any test of
is calculated from the sample data. significance we first set up a hypothesis — a definite
● Interval Estimation : In interval estimation, we statement about the population parameter (s). Such a
estimate an unknown parameter using an interval of statistical hypothesis, which is under test, is usually a
values that is likely to contain the true value of that hypothesis of no difference and hence is called Null
parameter (and state how confident we are that this Hypothesis. It is usually denoted by H0 . In the words of
interval indeed captures the true value of the Prof. R.A. Fisher “Null hypothesis is the hypothesis
parameter). which is tested for possible rejection under the
assumption that it is true.”
Hypothesis Testing
The following points may be borne in mind in
In social investigation hypothesis plays a very setting the null hypothesis :
important role. Briefly speaking hypothesis is a
supposition, which is not fully well established or in 1. If we want to test the significance of the
support of which there is no actual evidence. A difference between two sample statistics then we set up
hypothesis is an attempt at explanations : a provisional the null hypothesis H0 that the difference is not
supposition made in order to explain scientifically some significant. This means that the difference is just due to
facts or phenomenon. In fact hypothesis is a stage before fluctuations of sampling.
274U | Economics (NET)
For example, if we want to test if a particular drug is Step 1. Set up the Null Hypothesis H0 .
effective, we shall take a neutral attitude and set-up the Step 2. Set up the Alternative Hypothesis H1 . Any
hypothesis that it is not effective. For testing if out of the hypothesis which is complementary to the null
two foodstuffs, one is better than the other, we shall set- hypothesis is called an alternative hypothesis. This will
up the hypothesis that there is no difference between enable us to decide whether we have to us a single tailed
them. (right or left) test or two-tailed test.
2. If we want to test any statement about the Step 3. Choose the appropriate level of
population, we set up the null hypothesis that it is true. significance (α) depending on the reliability of the
For example, if we want to find if the population mean estimates and permissible risk. This is to be decided
has specified value H0 : μ = μ0 . before sample is drawn, i.e., α is fixed in advance.
Step 4. Compute the test statistic
Types of Errors in Testing of Hypothesis t – E(t)
As already stated, the inductive inference consists in Z=
S.E. (t)
arriving at a decision to accept or reject a null hypothesis
(H 0 ) after inspecting only a sample from it. As such an under the null hypothesis. Some of the commonly
used distributions in obtaining the test statistic or test
element of risk–the risk of taking wrong decisions is
criterion are normal, chi-square, t and F tests.
involved. In any test procedure, the four possible
mutually disjoint and exhaustive decisions are : Step 5. We compare the computed value of Z in step
(4) with the significant value Zα at given level of
1. Reject H0 when actually it is not true, i.e., when significance, ‘α’.
H0 is false. If |Z| < Zα , i.e., if the computed value of Z is less
2. Accept H0 when it is true. than Zα we say it is not significant. By this we mean that
3. Reject H0 when it is true. the different [t – E (t)] is just due to fluctuations of
sampling and the sample data do not provide us
4. Accept H0 when it is false.
sufficient evidence against the null hypothesis which
The decision in (1) and (2) are correct decisions may, therefore, be accepted.
while the decisions (3) and (4) are wrong decisions. If |Z| > Zα, i.e., if the computed value of test statistic
These decisions may be expressed in the following is greater than the critical or significant value, then we
dichotomous table : say that it is significant and the null hypothesis is
Decision from sample rejected at level of significance α or confidence
coefficient (1 – α).
Reject H0 Accept H0
True State H0 True Wrong (Type I Error) Correct
χ2) Test
Chi-Square (χ
The square of a standard normal variable is called a
H0 False Correct (Type II Error) Wrong
chi-square variate with 1 degree of freedom. Thus if X is
a random variable following normal distribution with
Thus, in testing of hypothesis we are likely to
(X – μ)
commit two types of errors. The error of rejecting H0 mean μ and standard deviation σ then is a
σ
when H0 is true is known as Type I Error and the error
standard normal variate.
of accepting H0 when H0 is false, is known as Type II
Error.
Level of Significance
∴ ( x σ– μ) 2
is a Chi-square (abbreviated by the
letter χ 2 of the Greek alphabet) variate with 1 d.f.
The maximum size of the type I error, which we are
prepared to risk is kown as the level of significance. If is Application of the χ2-Distribution
usually denoted by α and is given by : Chi-square distribution has a number of appli-
P [Rejecting H0 when H0 is true] = α cations, some of which are enumerated below :
Commonly used levels of significance is practice are 1. Chi-square test of goodness of fil.
5% and 1%. If we adopt 5% level of significance, it 2. Chi-square test for independence of attributes.
implies that in 5 samples out of 100 we are likely to 3. To test if the population has a specified value of
reject a correct H0. In other words this implies that we the variance σ2 .
are 95% confident that out decision to reject H0 is
correct. Level of significance is always fixed in advance
Conditions for the Validity of Chi-square
before collecting the sample information. Test
The Chi-square test can be used only if the
Procedure of Testing of Hypothesis following conditions are satisfied.
We now summaries below the various steps in 1. N, the total frequency, should be reasonably large,
testing of a statistical hypothesis in a systematic manner. say greater than 50.
Economics (NET) | 275U
2. The sample observations should be independent. in given by
This implies that no individual item should be included N(ad – bc)2
twice or more in the sample. χ2 =
(a + c ) (b + d)(a + b)(c + d)
3. No theoretical frequency should be small. Small where N = a + b + c + d, is the total frequency and
is a relative term. Preferably each theoretical frequency figure in brackets in the denominator are row and
should be larger than 10 but in any case not less than 5. column totals.
If any theoretical frequency is less than 5 , then we
cannot apply χ2 – test as such. Yates Correction for Continuity for 2 × 2
4. The given distribution should not be replaced by Table
relative frequencies or proportions but the data should be If any cell frequency in 2 × 2 table is less than 5,
given on original units. then for the application of χ 2 – test. It has to be pooled
with the preceding or succeeding frequency so that total
Degrees of Freedom is greater than 5. This results in the loss of 1 d.f. Since
As the name suggests the degree of freedom, for 2 × 2 table d.f. = (2 – 1) × (2 – 1) = 1; the degrees of
abbreviated as d.f., denotes the extent of independence freedom left after adjusting for pooling are v = 1 – 1 = 0,
(freedom) enjoyed by a given set of observed which is absurd [χ2 must have at least 1 d.f.]. In such a
frequencies. Degrees of freedom are usually denoted by situation i.e., when any cell frequency in 2 × 2 table is
the letter v of the Greek alphabet. Suppose we are given less than 5, we apply the correction due to F. Vates
a set of n observed frequencies which are subjected to (1934) and popularly known as the Yates correction for
k independent constraints, then ‘continuity’. This consist in adding 0·5 to the cell
d.f. = (Number of frequencies) – (Number of frequency which is less than 5 and adjusting the
independent constraints on them) remaining frequencies accordingly, since row and
⇒v=n–k column totals are fixed and then applying χ2 -test without
Thus if we are given n frequencies subject to the pooling.
linear constraint, then for the application of χ2 – test, The value of the χ2 for 2 × 2 table.
v = n = 1. a b
Degrees of freedom for r × s contingency table c d
For r × s contingency table, the total number of after applying yates correction is :
frequencies is n = r × s = rs. There n frequencies
N[|ad – bc| – N]2
are subjected to the following linear constraints : χ2 =
(a + c)(b + d)(a + b)(c + d)
(i) r row total (A1), (A2 ),….., (Ar) are fixed.
where |ab – cd| is the absolute or modulus value of
(ii) s column total (B1), (B2),….., (Bs) are fixed. the deviation ad – bc after ignoring negative sign, if
Thus there are r + s constraints on the frequencies any.
but these (r + s) constraints are not independent since we
have : Remark
r s 1. Yates correction for continuity can be applied
∑ (Ai) = ∑ (BJ) = N only in the case of 2 × 2 table.
i=1 J=1
Thus the number of independent constraints is 2. If N is sufficiently large, the value of χ 2 is not
effected much by Yates correction.
k=r+s–1
χ2-Test the Population Variance
Hence for r × s contingency table, d.f. are :
Suppose we want to test if the given normal
v=n–k population has a specified variance σ2 = σ2 , say.
= rs – (r + s – 1) We say up the null hypothesis H0 : σ2 = σ0 2 . If x 1 ,
= rs – r – s + 1 x2, x 3 ,…. xn is a random sample of size n from the given
= (r – 1) × (s – 1) population then under the null hypothesis H0 , the
Hence for 2 × 2 contingency table, d.f. = (2 – 1) × statistic.
(2 – 1) = 1; for 3 × 4 contingency table d.f. = (3 – 1) × n
(4 – 1) = 2 × 3 = 6 and so on. ∑ (x – –x)2
i
i=1
χ2 =
2 × 2 Contingency Table σ0
2
ns2
Under the null hypothesis of independence of
⇒ χ2 = 2 ...(1)
attributes the value of χ2 for the 2 × 2 contingency table. σ0
Total it follows χ2-distribution with (n – 1) d.f., where
a b a+b 1 n
S 2 = ∑ (xi – –x)2
c d c+d n i=1
Total a+c b+d N=a+b+c+d denotes the sample variance.
276U | Economics (NET)
By comparing the value of χ 2 obtained in (1) with Assumptions for Student’s t-Test
the tabulated value for (n – 1) d.f. at certain level of The following assumptions are made in the student’s
significance, we may accept or reject the null hypothesis t-test.
at that level of significance. A. The parent population from which the sample is
drawn is normal.
Remarks
B. The sample observations are independent, i.e.,
This test can be applied only if the population is the given sample is random.
normal. C. The population standard deviation σ is unknown.
Applications of t-Distribution Fisher’s Transformation
The t-distribution has a number of applications in Fisher’s Z-transformation has the following applica-
statistics. tions in statistics.
1. t-test for significance of single mean, population A. To test if the correlation coefficient in the
variance being unknown. population has a specified value.
2. t-test for the significance of the difference B. To test if two independent sample correlation
between two sample means, the population variances coefficients r1 and r2 differ significantly.
being equal but unknown.
3. t-test for significance of an observed sample F-Statistic
correlation coefficient. F-statistic is the ratio of two independent chi-square
variates divided by their respective degrees of freedom.
Suppose we are interested to test :
a. If the given normal population has a specified Applications of F-Distribution
value of the population mean, say, μ0 . F-distribution has a number of applications in
statistics, some of which are given below :
b. If the sample mean x– differes significantly from
specified value of population mean. 1. F-test for Equality of Population variances.
2. F-test for testing the significance of an observed
c. If a given random sample x1 , x2,… xn of size n has
sample multiple correlation.
been drawn from a normal population with specified
mean, μ0. 3. F-test for testing the significance of an observed
sample correlation ratio.
Basically, all the three problems are same. We set 4. F-test for testing the linearity of regression.
up the corresponding null hypothesis as follows :
5. F-test for testing the equality of several
a. H0 : μ = μ0 , i.e., the population mean is μ0 . population means, i.e., for testing H0 : μ1 = μ2 = …= μk ,
b. H0 : There is no significant difference between the (say), for k normal populations.
sample mean and the population mean. In other words,
the difference between and μ is due to fluctuations of Relation between t and F Distributions
sampling. If a statistic t follows student’s t-distribution with n
c. H0 : The given random sample has been draw d.f. then its square (t2 ) follows Snedecor’s F-distribution
from the normal population with mean μ0 . with (1, n) d.f. Symbolically,
t ~ tn ÷ t2 ~ F(1, n)
Under H0 the test-statistic is
With the help of this relation, all the applications of
x– – μ0 –x – μ0 t-distribution may be taken as applications of F-distribu-
t= = tion. For example, for testing the significance of sample
s s2 mean, we may consider the test statistic.
⎯n
√ n
⎡ –x – μ⎤
2
F = t2 = ⎢⎢ ⎥ ~ F(1, n)
1
where –x = Σx ⎥
n ⎢ s ⎥
⎢√ ⎥
and S2 =
1
Σ(x – x)–2 ⎣ ⎯n ⎦
n–1 and apply F-test.
and it follows student’s t-distribution with (n – 1) Relation between F and χ 2 Distribution
degrees of freedom.
In F-distribution with (n1 , n2 ) d.f. if we put
We compute the test-statistic (1) under H0 and
n1 F = χ 2
compare it with the tabulated value of t for (n – 1) d.f. at
certain level of significance. If calculated |t| is greater χ2
⇒F=
then tabulated ‘t’, we say it is significant and H0 is n1
rejected and if calculated |t| is less than tabulated t. H0 and let n2 → ∞, then we get chi-square distribution
may be accepted at the level of significance adopted. with n1 d.f.
Economics (NET) | 277U
Sampling Error dependent variable around the regression function, which
can be described by a probability distribution.
In statistics, sampling error or estimation error is
the error caused by observing a sample instead of the Regression analysis is widely used for prediction
whole population. The sampling error can be found by and forecasting, where its use has substantial overlap
subtracting the value of a parameter from the value of a with the field of machine learning. Regression analysis
statistic. In nursing research, a sampling error is the is also used to understand which among the independent
difference between a sample statistic used to estimate a variables are related to the dependent variable, and to
population parameter and the actual but unknown value explore the forms of these relationships. In restricted
of the parameter (Bunns & Grove, 2009). An estimate of circumstances, regression analysis can be used to infer
a quantity of interest, such as an average or percentage, causal relationships between the independent and
will generally be subject to sample-to-sample variation. dependent variables.
These variations in the possible sample values of a A large body of techniques for carrying out regres-
statistic can theoretically be expressed as sampling sion analysis has been developed. Familiar methods such
errors, although in practice the exact sampling error is as linear regression and ordinary least squares regression
typically unknown. Sampling error also refers more are parametric, in that the regression function is defined
broadly to this phenomenon of random sampling in terms of a finite number of unknown parameters that
variation. are estimated from the data. Nonparametric regression
refers to techniques that allow the regression function to
The likely size of the sampling error can generally
lie in a specified set of functions, which may be infinite-
be controlled by taking a large enough random sample
dimensional.
from the population, although the cost of doing this may
be prohibitive; see sample size and statistical power for The performance of regression analysis methods in
more detail. If the observations are collected from a practice depends on the form of the data-generating
random sample, provides probabilistic estimates of the process, and how it relates to the regression approach
likely size of the sampling error for a particular or being used. Since the true form of the datagenerating
estimator. These are often expressed in terms of its process is not known, regression analysis depends to
standard error. some extent on making assumptions about this process.
These assumptions are sometimes (but not always)
Sampling bias is a possible source of sampling
testable if a large amount of data is available. Regression
errors. It leads to sampling errors which either have a
models for prediction are often useful even when the
prevalence to be positive or negative. Such errors can be
assumptions are moderately violated, although they may
considered to be .
not perform optimally. However, in many applications,
Sampling error can be contrasted with non-sampling especially with small effects or questions of causality
error. Non-sampling error is a catch-all term for the based on observational data, regression methods give
deviations from the true value that are not a function of misleading results.
the sample chosen, including various systematic errors The earliest form of regression was the method
and any random errors that are not due to sampling. of least squares (French: méthode des moindres carrés),
Non-sampling errors are much harder to quantify than which was published by Legendre in 1805, and by Gauss
sampling error. in 1809. Legendre and Gauss both applied the method to
the problem of determining, from astronomical obser-
Regression Analysis vations, the orbits of bodies about the Sun. Gauss
In statistics, regression analysis includes any tech- published a further development of the theory of least
niques for modelling and analyzing several variables, squares in 1821, including a version of the Gauss–
when the focus is on the relationship between a Markov theorem.
dependent variable and one or more independent The term ‘regression’ was coined by Francis Galton
variables. More specifically, regression analysis helps us in the nineteenth century to describe a biological
understand how the typical value of the dependent phenomenon. The phenomenon was that the heights of
variable changes when any one of the independent descendants of tall ancestors tend to regress down
variables is varied, while the other independent variables towards a normal average (a phenomenon also known as
are held fixed. Most commonly, regression analysis regression toward the mean). For Galton, regression had
estimates the conditional expectation of the dependent only this biological meaning, but his work was later
variable given the independent variables—that is, the extended by Udny Yule and Karl Pearson to a more
average value of the dependent variable when the general statistical context. In the work of Yule and
independent variables are held fixed. Less commonly, Pearson, the joint distribution of the response and
the focus is on a quantile, or other location parameter of explanatory variables is assumed to be Gaussian. This
the conditional distribution of the dependent variable assumption was weakened by R.A. Fisher in his works
given the independent variables. In all cases, the esti- of 1922 and 1925. Fisher assumed that the conditional
mation target is a function of the independent variables distribution of the response variable is Gaussian, but the
called the regression function. In regression analysis, it joint distribution need not be. In this respect, Fisher's
is also of interest to characterize the variation of the assumption is closer to Gauss's formulation of 1821.
278U | Economics (NET)
Regression methods continue to be an area of active In the last case, the regression analysis provides
research. In recent decades, new methods have been the tools for :
developed for robust regression, regression involving 1. Finding a solution for unknown parameters that
correlated responses such as time series and growth will, for example, minimize the distance between
curves, regression in which the predictor or response the measured and predicted values of the dependent
variables are curves, images, graphs, or other complex variable Y (also known as method of least squares).
data objects, regression methods accommodating various 2. Under certain statistical assumptions, the regression
types of missing data, nonparametric regression, Baye- analysis uses the surplus of information to provide
sian methods for regression, regression in which the statistical information about the unknown parame-
predictor variables are measured with error, regression ters β and predicted values of the dependent variable
with more predictor variables than observations, and Y.
causal inference with regression.
Necessary Number of Independent
Regression Models Measurements
Regression models involve the following variables : Consider a regression model which has three
● The unknown parameters denoted as β; this may be unknown parameters, β 0 , β1, and β2. Suppose an
a scalar or a vector. experimenter performs 10 measurements all at exactly
the same value of independent variable vector X (which
● The independent variables, X.
contains the independent variables X1 , X2 , and X3 ). In
● The dependent variable, Y. this case, regression analysis fails to give a unique set of
In various fields of application, different termino- estimated values for the three unknown parameters;
logies are used in place of dependent and independent the experimenter did not provide enough information.
variables. The best one can do is to estimate the average value and
A regression model relates Y to a function of X and the standard deviation of the dependent variable Y.
β. Similarly, measuring at two different values of X would
give enough data for a regression with two unknowns,
Y ≈ f (X, β)
but not for three or more unknowns.
The approximation is usually formalized as E(Y | X)
If the experimenter had performed measurements at
= f(X, β). To carry out regression analysis, the form of
three different values of the independent variable vector
the function f must be specified. Sometimes the form of
X, then regression analysis would provide a unique set
this function is based on knowledge about the relation-
of estimates for the three unknown parameters in β.
ship between Y and X that does not rely on the data. If
no such knowledge is available, a flexible or convenient In the case of general linear regression, the above
form for f is chosen. statement is equivalent to the requirement that matrix
XTX is invertible.
Assume now that the vector of unknown parameters
β is of length k. In order to perform a regression analysis Linear Regression Model and their
the user must provide information about the dependent Properties
variable Y : Regression analysis, in the general sense, means the
● If N data points of the form (Y, X) are observed, estimation or prediction of the unknown value of the
where N < k, most classical approaches to regression variable from the known value of the other variable. It is
analysis cannot be performed: since the system of one of the very important statistical tools which is
equations defining the regression model is under- extensively used in almost all sciences–natural; social
determined, there is not enough data to recover β. and physical. It is specially used in business and
economics to study the relationship between two or
● If exactly N = k data points are observed, and the
more variables that are related casually and for
function f is linear, the equations Y = f(X, β) can be
estimation of demand and supply curves. Cost functions,
solved exactly rather than approximately. This
production and consumption functions, etc.
reduces to solving a set of N equations with N
unknowns (the elements of β), which has a unique Prediction or estimation is one of the major problems
solution as long as the X are linearly independent. If in almost all spheres of human activity. The estimation
f is nonlinear, a solution may not exist, or many or prediction of future production, consumption, prices,
solutions may exist. investments, sales, profits, income, etc, are of paramount
● The most common situation is where N > k data importance to a businessman or economist. Regression
points are observed. In this case, there is enough analysis is one of the very scientific techniques for
information in the data to estimate a unique value making such predictions. In the words of M.M.Blair
for β that best fits the data in some sense, and the “Regression analysis is a mathematical measure of the
regression model when applied to the data can be average relationship between two or more variables in
viewed as an overdetermined system in β. terms of the original units of data.”
Economics (NET) | 279U
In regression analysis there are two types of Hence in case of perfect correlation (r = ± 1) both
variables. The variable whose value is influenced or is to the line of regression coincide. Therefore, in general we
be predicted is called dependent variable and the always have two lines of regression except in the
variable which influences the values or is used for particular case of perfect correlation when both the lies
prediction, is called independent variable. In regression coincide and we get only one line.
analysis independent variable is also known as regresses
or predictor or explanatory while the dependent variable Angle between the Regression Lines
is also known as regressed or explained variable. The equations of the lines of regression of y on x
and x on y are respectively :
Lines of Regression
σy
Line of regression is the line which gives the best y – y– = r· (x – x– ) ...(1)
σx
estimate of one variable for any given value of the other
variable. In case of two variables x and y, we shall have σx
and x – x– = r· (y – y– )
two lines of regression, one of y on x and the other of x σy
on y. σy
⇒ y – –y = r· (x – x– ) ...(2)
1. Line of Regression of y on x σx
Line of regression of y on x is the line which gives The slopes of lines (1) and (2), are respectively :
the best estimate for the value of y for any specified rσy σy
value of x. Hence, the equation of line of regression of y M1 = and M2 =
σx rσx
on x is
σy If Q is the angle between the two lines of regression,
y = a +bx or y – y– = r · – where
(x – x) then
σx
–x = Arithmetic Mean of x – series rσy σy
–
m1 – m2 σx rσx
–y tan θ = =
= Arithmetic Mean of y – series 1 + m1 m2 σy σy
1+r· ·
σx = Standard Deviation of x – series σx r·σx
σy = Standard Deviation of y – series σy
r = Coefficient of Correlation between two
=
( )
σx
r–
1
r
variables x and y. σx2 + σy2
Line of Regression of x and y ( σx2)
σxσy 2
σx + σy ( r )
Line of regression of x and y is the line which gives r –1
= 2 · 2
the best estimate for the value of x for any specified
value of y. σxσy 2
⇒ θ = tan {
σx + σy ( r )}
–1 r –1
Mathematically 2 2
σx
x = A + By o x – x– = r· (y – y)– if r = ±1 then
σy
θ = tan–1 (0)
Remarks
⇒ θ = 0 or π
1. Both the lines of regression passes through the
i.e., the two lines are either coincident (θ = 0) or
point (x– – y)
– . In other words, the mean values ( –x, y–)
can be obtained as the point of intersection of the two they are paralled (θ = π). But since both the lines of
regression lines. regression interest at the point (–x, –y), they cannot be
2. There are always two lines of regression. In a parallel. Hence in case of perfect correlation, positive or
particular case of perfect correlation, positive or negative, the two lines of regression coincide.
negative i.e., r = ±1, the equation of line of regression of if r = 0, then
y on x becomes π
θ = (∞) = = 90°
– ⇒ y – y = ± ⎛⎜ x – x ⎞⎟
σy – – 2
y – y– = ± (x – x)
σx σy ⎝ σx ⎠
Similarly, the equation of the line of regression of x
on y becomes :
σx
x – –x = ± (y – –y )
σy
y – –y ⎛ x – –x ⎞
⇒ =±⎜ ⎟
σy ⎝ σx ⎠
Both the equations are same.
280U | Economics (NET)
Two Regression Lines Coincide (If r = –1) the dependent variable y for a unit change in the value
of the independent variable x. In other word, it
represents the rate of change of y w.r.t x. For notational
convenience, the slope b, i.e., coefficient of regression of
y on x is written as byx. Mathematically
rσy
byx =
σx
Similarly in the regression equation of x on y
x = A + By
The coefficient B represents the change in the value
of dependent variable x for a unit change in the value of
independent variable y and is called the coefficient of
Two lines coincide (If r = +1) regression of x on y. For convenience, it is written as
bxy.
r σx
bxy =
σy
Remarks
1. Correlation coefficient between two variables
x and y is a symmetrical function between x is y, i.e.,
rxy = ryx. However, the regression coefficient are not
symmetric functions of x and y, i.e., byx ≠ bxy.
2. Both the regression coefficients must have the
Two Lines Perpendicular (If r = 0) same sign.
3. The sign of correlation coefficient is same as that
of the regression coefficients. If regression coefficients
are positive, r is positive and if regression coefficient are
negative, r is negative.
Theorems on Regression Coefficients
Theorem-1
The correlation coefficient is the geometric mean of
the regression.
Coefficients i.e., r = √
⎯⎯⎯⎯⎯⎯
byx · bxy
Proof. We have
Two lines Apart (Low Degree of Correlation)
σy
bxy = r · …(i)
σy
σy
and byx = r · …(ii)
σx
Multiplying (i) and (ii) we get
r2 = byx.bxy
⇒r=±√ ⎯⎯⎯⎯⎯⎯
byx · bxy
which establishes the result.
Theorem-2
Two Line Closer (High Degree of Correlation) If one of the regression coefficients is greater than
i.e., if the variables are uncorrelated, the two lines of unity, the other must be less than unity :
regression become perpendicular to each other. Proof—Let byx > 1
1
Coefficients of Regression ⇒ …(i)
bxy < 1
Let us consider the line of regression of y on x, we have
y = a + bc 1
byx ·bxy = r2 ≤ 1 ⇒ bxy ≤ ≤ < 1 From (i)
The coefficient ‘b’ which is the slope of the line of byx
regression of y on x is called the coefficient of regression Hence if one of the regression coefficients is greater
of y on x. It represents the increment in the value of than one, the other must be less than one.
Economics (NET) | 281U
Theorem-3 2. Fixed X values or X Values—Independent of
The arithmetic mean of the regression coefficients is the error term values taken by the regression X may be
greater than the correlation coefficient. considered fixed in repeated samples (the case of fixed
regress or) or they may be sampled alongwith the
Proof. We known that for any two real distinct dependent variable Y (the case of stochastic regressor).
positive numbers a and b : In the later case, it is assumed that X variable (s) and the
a+b
A.M. > G.M. ⇒ >√⎯⎯ab …(i) error term are independent, that is,
2 cov (Xie, ui) = ∞
Taking a = byx and b = bxy in (i), we get 3. Zero Mean Value of Disturbance μi—Given
1 (byx + bxy)
(byx + bxy) > √
⎯⎯⎯⎯⎯⎯
byx · bxy ⇒ >r that value of Xie the mean, or expected, value of the
2 2 random disturbance term μi is zero.
Q r =⎯ √⎯⎯⎯⎯⎯⎯
byx – bxy E (ui/Xi) = 0 …(2)
or if X is nonstochastic,
Theorem-4 E (ui) = 0
Regression coefficients are independent of change 4. Homoscedasticity or Constant Variance of ui—
of origin but not of scale : The variance of the error, or disturbance, term is the
Correlation Analysis Vs. Regression same regardless of the value of X.
Var (ui) = E (ui – E (ui/Xi)] 2
Analysis
= E (u2 i/Xi), because the value of
1. Correlation coefficient rxy is a relative measure of
the random disturbance term ui is zero.
the linear relationship between x and y and is
independent of the units of measurement. = E (u2 i), if Xi is nonstochastic
On the other hand, the regression coefficients are Thus, Var (ui) = σ2 …(3)
absolute measures representing the change in the value 5. No Autocorrelation Between the Disturbance—
of the variable y(x), for a unit change in the value of the Given any two X values, Xi and X j (i ≠ j), the correlation
variable x(y). between any two ui and uj (i ≠ j) is zero.
2. Correlation analysis is confined only to the study It means the observations are sampled indepen-
of linear relationship between the variables and dently
therefore, has limited applications. Regression analysis Cov (uie uj/Xie Xj) = 0 …(4)
has much wider applications as it studies linear as well Cov (uie, uj) = 0 if X is nonstochastic
as non-linear relationship between the variables. where i and j are two different observations and where
3. Correlation need not imply cause and effect Cov means covariance.
relationship between the variable under study. 6. The Number of Observations n must be
However, regression analysis clearly indicates the Greater than the Number of Parameters to be
cause the effect relationship between the variables. Estimated—Alternatively, the number of observations
must be greater than the number of explanatory
The Linear Regression Model variables.
The linear regression model is the single most 7. The Nature of X Variables—X values in a given
useful tool in the econometrician’s kit. The multiple sample must not all be the same. Technically, var (X)
regression model is the study if the relationship between must be a positive number. Furthermore, there should
a dependent variable and one or more independent not be any outliers in the values of the X variable, i.e.,
variables. In general it can be written as— values that are very large in relation to the rest of the
y = f (x1, x2……xk) + ε observations.
= x1β1 + x2β2 + …+ xKβK + ε Ordinary Least Squares Regression
The random disturbance ε arises because we cannot The first distinction needed at this point is between
capture every influence on an economic variable in a population parameters and sample estimates. From the
model. The net effect of the omitted variables is previous discussion we have β and ε as population
i
captured by the disturbance. Notice that y is the
parameters, hence we use b and e i as their sample
summation of two parts, the deterministic part and the
random part, ε. The objective is to estimate the unknown estimates. For the population regression we have E[yi]
'
parameters (β1, β2, ……, βK) in this model. [xi] = xiβ, however β is unknown and we use its estimate
Assumptions of Linear Regression Model b. Therefore we have—
1. Linear Regression Model—The regression E[yi] [x i] = ^yi = xi' b …(5)
model is linear in the parameters, though it may or it For observation i, the (population) disturbance term
may not be linear in the variables. is given by :
yi = β1 + β2Xi + μi …(1) εi = yi – x iβ
'
…(6)
282U | Economics (NET)
Once we estimate b the estimate of the disturbance value of the sum of squared residuals. Recall that e = My
term εi is its sample counter-part, the residual— = M [Xβ + ε] = Mε. Then, the sum of squared residuals
is—
ei = yi – x 'ib …(7)
e′e = ε′Mε …(12)
It follows that
E [e′e|X] = E [ε′Mε|X]
yi = xi' β + ε i = xi' b + ei …(8) = E[tr(ε′Mε)|X]
Properties of OLS = E[tr(Mεε′)|X]
= tr(ME[εε′|X])
Unbiasedness
= tr(Mσ2I)
The least square estimator b is unbiased for every
= σ2 tr(M)
value of n.
= σ2 tr(In – X (X′X)– 1X′)
b = (X′X)– 1X′y …(9)
= (X′X)– 1X′ (Xβ + ε) = σ2 [tr(In ) – tr (X (X′X)– 1X′)]
= β + (X′X)– 1X′ε = σ2 [tr(In ) – tr (I K)]
E [b] [X] = β + E [(X′X)– 1 X′ε] = σ2 (n – K)
where ε′ M ε is a scalar (1 × 1 matrix), so it is equal to
= β
its trace, and the operation from the third to the fourth
The second term after taking expectations is zero line follows from the results on cyclic permutations.
because the errors are assumed to be orthogonal to the From equation 12 we obtain the unbiased estimator of
regression residuals. σ2 .
Variance and the Gauss-Markov s2 =
e′e
…(13)
Theorem n–K
Hence, the standard errors of the estimators b can be
It is relatively simple to derive the sampling variance obtained by first obtaining an estimate of σ 2 using
of the OLS estimators. However, the key assumption in equation 13 and then plugging s2 into equation 10.
the derivation is that the matrix X is constant. If X is not
constant, then the expectations should be taken Statistical Inference
conditional on the observed X. From the derivation of Given that b is a linear function of ε, if ε has a
the unbiasedness of OLS we have that b – β = (X′X)–1X′ε. multivariate normal distribution we have that—
Using this in the variance-covariance matrix of the OLS b | X ~ N [β, σ2 (X′X)– 1] …(14)
we have—
Var [b] [X] = E [(b – β) (b – β)′X] Hypothesis Testing
= E [((X′X)– 1X′ε) ((X′X)– 1X′ε)′ | X] Assuming normality conditional on X and with Skk
being the kth diagonal element of X′X– 1 we have that :
= E [((X′X)– 1 X′ε) (ε′X(X′X)– 1) | X]
b – βk
= (X′X)– 1 X′E [εε′ | X] X (X′X)– 1 zk = k …(15)
= (X′X)– 1 X′ (σ2 I) X (X′X)– 1 ⎯⎯⎯⎯
√ σ2 Skk
= σ2 (X′X)– 1 …(10) has a standard normal distribution. However, σ 2 is an
unknown population parameter. Hence, we use—
Gauss-Markov Theorem—In a linear regression b – βk
model (with spherical disturbances), the Best Linear tk = k …(16)
Unbiased Estimator (BLUE) of the coefficients is the ⎯⎯⎯
√ s2 S kk
ordinary least squares estimator. that has a t distribution with (n – K) degree of freedom.
In the Gauss-Markov Theorem, best refers to We use equation 16 for hypotheses testing about the
minimum variance. In addition, errors do not need to elements of β.
have a normal distribution and the X could be either
stochastic or nonstochasic.
Confidence Intervals
Based on equation 16 we can obtain the (1 – α)
Estimating the Variance confidence interval for the population parameter βk
In order to obtain a sample estimate of the variance- using—
covariance matrix presented in equation 10, we need an P (bk – tα/2,n – KSb k ≤ βk ≤ bk + tα/2,n – KSb k) = 1 – α
estimate of the population parameter σ2 . We can use— …(17)
1n 2 What this equation is saying is that the true
σ2 = ∑ ei , …(11)
n i=1 population parameter β k will lie between the lower
which makes sense because e i is the sample estimate of confidence intervals b k – tα /2, n – K S b k and the upper
2
εi, and σ2 is the expected value of εi . However, this one confidence intervals b k + tα/2,n– KS bk in (1 – α) % of the
is biased because β is not observed directly. To obtain an times. Moreover, tα/2,n – K is the critical value from the t
unbiased estimator of σ2 we can start with the expected distribution with (n – K) degrees of freedom.
Economics (NET) | 283U
Multiple Linear Regression Model (vi) y = β 0 + β1X + β2X2 + β2X3
We consider the problem of regression when study is a cubic polynomial model which can be written as
variable depends on more than one explanatory or y = β0 + β1X + β2X2 + β3X3
independent variables, called as multiple linear which is linear in parameters β 0 , β1, β2, β3 and
regression model. This model generalizes the simple linear in variables X1 = X, X2 = X2 , X3 = X3 . So it is
linear regression in two ways. It allows the mean a linear model.
function E (y) to depend on more than one explanatory
variables and to have shapes other than straight lines, Best Linear Unbiased Estimator (BLUE)
although it does not allow for arbitrary shapes. In many estimation problems, the Minimum-
Variance Unbiased Estimator (MVUE) or a sufficient
The Linear Model statistics cannot be found or indeed the Probability
Let y denotes the dependent (or study) variable that Density Function (PDF) or the distribution of the data is
is linearly related to k independent (or explanatory) itself unknown (only the second-order statistics are
variables X1, X2 ,……,Xk through the parameters β1, β2, known in the sense that they can be estimated from
…, βk and we write data). In such cases, one solution is to assume a
functional model of the estimator, as being linear in the
y = X1β1 + X2 β2 + … + Xkβk + ε data, and find the linear estimator which is unbiased and
This is called as the multiple linear regression has minimum variance. This estimator is referred to as
model. The parameters β 1 , β2, …, βk are the regression the best linear unbiased estimator (BLUE).
coefficients associated with X1 , X2 , …, Xk respectively Consider the general vector parameter case θ, the
and ε is the random error component reflecting the estimator is required to be a linear function of the data,
difference between the observed and fitted linear i.e.,
relationship. There can be various reasons for such ^θ = Ax
difference, e.g., joint effect of those variables not
included in the model, random factors which can not be The first requirement is that the estimator should be
accounted in the model etc. unbiased i.e.,
Note that the jth regression coefficient βj represents E (^θ) = AE (x) = 0
the expected change in y per unit change in j th which can be only satisfied if
independent variable Xj. Assuming E (ε) = 0, E (x) = Hθ ⇒ AH = I
∂E (y) The BLUE is derived by finding the A which
βj = minimizes the variance, C θ^ = AT CA subject to the
∂Xj
Linear Model constraint AH = I, where C is the covariance matrix of
the data x. Carrying out the minimization yields the
A model is said to be linear when it is linear in following form for the BLUE.
∂y ∂E (y)
parameters. In such a case (or equivalently ^θ = Ax = (HTC– 1H) – 1HTC– 1(x)
∂βj ∂Xj
should not depend on any β′s. For example where C ^θ = (HTC– 1H) – 1.
(i) y = β 0 + β1X is a linear model as it is linear is Salient Attributes of BLUE
parameter. ● For the general linear model, the BLUE is identical
(ii) y = β 0 Xβ1 can be written as in form to the MVUE.
log y = log β0 + β1 log X ● The BLUE only assumes only up to 2nd -order
* statistics and not the complete PDF of the data
y* = β0 + β1x* unlike the MVUE which was derived assuming
*
which is linear in parameter β 0 and β1 , but nonlinear Gaussian PDF.
is variables y* = log y, x * = log x. So it is a linear ● If the data is truly Gaussian then the BLUE is also
model. the MVUE.
(iii) y = β0 + β1X + β2X2 The BLUE for the general linear model can be
stated in terms of following theorem.
is linear in parameters β0, β 1 and β 2 but it is
Gauss-Markov Theorem—Consider a general data
nonlinear is variables X. So it is a linear model. model of the form—
β1 x = Hθ + w
(iv) y = β 0 +
X – β2 where H is known, and w is noise with covariance C
is nonlinear in parameters and variables both. So it (the PDF of w otherwise arbitrary).
is a nonlinear model. Then the BLUE of θ is—
(v) y = β 0 + β1Xβ2 ^θ = (H TC– 1H) – 1 HTC– 1x
is nonlinear in parameters and variables both. So it where C ^θ = (H C– 1H) – 1 is the minimum covariance
T
is a nonlinear model. matrix.
284U | Economics (NET)
The Identification Problem two reduced-form coefficients. Recall from high school
algebra that to estimate four unknowns we must have
The identification problem states whether numerical four (independent) equations, and, in general, to estimate
estimates of the parameters of a structural equation can k unknowns we must have k (independent) equations.
be obtained from the estimated reduced-form coeffi- Incidentally, if we run the reduced-form regression (2)
cients. If this can be done, than it can be said that the and (5), there are no explanatory variables, only the
particular equation is identified. If this cannot be done, constants, and these constants will simply give the mean
then the equation under consideration is unidentified, or values of P and Q (why ?).
underidentified.
There is an alternative and perhaps more illumina-
An identified equation may be either exactly (or ting way of looking at the identification problem.
fully or just) identified or overidentified. It is said to be Suppose we multiply equation (1) by λ (0 ≤ λ ≤ 1) and
exactly identified if unique numerical values of the equation (2) by 1 – λ to obtain the following equations
structural parameters can be obtained. It is said to be
overidentified if more than one numerical value can be λQt = λα0 + λα1P t + λu1t …(8)
obtained for some of the parameters of the structural (1 – λ) Qt = (1 – λ)β0 + (1 – λ)β1P t + (1 – λ)u2t
equations. …(9)
The identification problem arises because different Adding these two equations gives the following
sets of structural coefficients may be compatible with linear combination of the original demand-and-supply
the same set of data. To put the matter differently, a equations—
given reduced-form equation may be compatible with Q t = γ 0 + γ 1 P t + wt …(10)
different structural equations or different hypothesis
(models), and it may be difficult to tell which particular where γ0 = λα0 + (1 – λ) β 0
hypothesis (model) we are investigating. In the γ1 = λα1 + (1 – λ) β 1 …(11)
remainder of this section we consider several examples w t = λu1t + (1 – λ) u2t
to show the nature of the identification problem.
The “bogus”, or “mongrel”, equation (10) is
Underidentification observationally indistinuishable from either equation (1)
or (2) because they involve the regression of Q and P.
Consider the demand-and-supply model (1) and (2),
Therefore, if we have time series data on P and Q only,
together with the market-clearing, or equilibrium,
any of (1), (2) or (10) may be compatible with the same
condition that demand is equal to supply. By the equili-
data. In other words, the same data may be compatible
brium condition, we obtain
with the “hypothesis” equation (1), (2) or (10), and there
α0 + α1P t + u1t = β0 + β1P t + u2t …(1) is no way we can tell which one of these hypothesis we
Solving equation (1), the equilibrium price are testing.
P t = Π 0 + vt …(2) For an equation to be identified, that is, for its
β – α0 parameters to be estimated, it must be shown that the
where Π0 = 0 …(3) given set of data will not produce a structural equation
α1 – β1 that looks similar in appearance to the one in which we
u – u1t are interested. If we set out to estimate the demand
vt = 2t …(4)
α1 – β1 function, we must show that the given data are not
Substituting Pt, from equation (2) into equation (1) consistent with the supply function or some mongrel
equation.
or (2), we obtain the following equilibrium quantity—
Q t = Π 1 + wt …(5) Just, or Exact, Identification
where The reason we could not identify the preceding
α β – α0β1 demand function or the supply function was that the
Π1 = 1 0 …(6)
α1 – β1 same variables P and Q are present in both functions and
α u – β0u1t there is not additional information. But suppose the
w t = 1 2t …(7) following demand-and-supply model is considered.
α1 – β1
Demand function : Qt = α0 + α1P t + α2It + u1t
Incidentally, note that the error terms v t and w t are
linear combinations of the original error terms u1 and u2. α1 < 0, α2 > 0 …(12)
Equations (2) and (5) are reduced-form equations. Supply function : Qt = β0 + β1P t + u2t β1 > 0 …(13)
Now demand-and-supply model contains four structural where I = income of the consumer, an exogenous varia-
coefficients α0, α1, β0, and β 1 , but there is no unique ble, and all other variables are as defined previously.
way of estimating them. Why ? The answer lies in the Notice that the only difference between the
two reduced-form coefficients given in equations (3) and preceding model and our original demanded-supply
(6). These reduced-form coefficients contain all four model is that there is an additional variable in the
structural parameters, but there is no way in which the demand function, namely, income. From economic
four structural unknowns can be estimated from only theory of demand we know that income is usually an
Economics (NET) | 285U
important determinant of demand for most goods and γ2 = λα2
services. Therefore, its inclusion in the demand function and w t = λu1t + (1 – λ) u2t
will give some additional information about consumer
behaviour. For most commodities income is expected to Equation (20) is observationally indistinguishable
have a positive effect on consumption (α2 > 0). from the demand function (12) although it is distingui-
shable from the supply function (13), which does not
Using the market-clearing mechanism, quantity contain the variable I as an explanatory variable. Hence,
demanded = quantity supplied, we have the demand function remains unidentified.
α0 + α1P t + α2It + u1t = β0 + β1P t + u2t …(14) Notice an interesting fact—It is the presence of
Solving equation (14) provides the following an additional variable in the demand function that
equilibrium value of Pt— enables us to identify the supply function ! Why ? The
inclusion of the income variable in the demand equation
P t = Π 0 + Π1It + vt …(15) provides some additional information about the
where the reduced-form coefficients are variability of the function.
β – α0 But suppose we consider the following demand-
Π0 = 0
α1 – β1 and-supply model—
α2 Demand function :
Π1 = – …(16)
α1 – β1 Qt = α0 + α1P t + α2It + u1t
u – u1t α1 < 0, α2 > 0 …(12)
and vt = 2t
α1 – β1 Supply function :
Substituting the equilibrium value of Pt into the Qt = β0 + β1P t + β2P t – 1 + u2t
preceding demand or supply function, the following β1 > 0, β2 > 0 …(22)
equilibrium quantity is obtained where the demand function remains as before but the
Qt = Π 2 + Π3It + wt …(17) supply function includes an additional explanatory
α β – α0β1 variable, price lagged one period. The supply function
where Π2 = 1 0 postulates that the quantity of a commodity supplied
α1 – β1
depends on its current and previous period’s price, a
αβ
Π3 = – 2 1 …(18) model often used to explain the supply of many
α1 – β1 agricultural commodities. Note that P t – 1 is a predeter-
α u – β1u1t mined variable because its value is known at time t.
and w t = 1 2t
α1 – β1 By the market-clearing mechanism we have
Since equations (15) and (17) are both reduced-form α0 + α1P t + α2It + u1t
equations, the ordinary least squares (OLS) method can = β 0 + β1P t + β2P t– 1 + u2t …(23)
be applied to estimate their parameters. Now the
demand-and-supply model (12) and (13) contains five Solving this equation, we obtain the following
structural coefficients—α0, α1, α2, β0 and β 1 . But there equilibrium price :
are only four equations to estimate them, namely, the P t = Π 0 + Π1It + Π2P t– 1 + vt …(24)
four reduced-form coefficients Π0 , Π1 , Π2 and Π3 given β – α0
where Π0 = 0
in equation (16) and (18). Hence, unique solution of all α1 – β1
the structural coefficients is not possible. But it can be α2
readily shown that the parameters of the supply function Π1 = –
α1 – β1
can be identified (estimated) because
β2
β0 = Π 2 – β1Π 0 Π2 = …(25)
α1 – β1
Π
β1 = 3 …(19) u – u1t
Π1 vt = 2t
α1 – β1
But there is no unique way of estimating the
parameters of the demand function—therefore, it remains Substituting the equilibrium price into the demand
underidentified. or supply equation, we obtain the corresponding
equilibrium quantity—
To verify that the demand function (12) cannot be
identified (estimated), let us multiply it by λ (0 ≤ λ ≤ 1) Qt = Π 3 + Π4It + Π5P t– 1 + wt …(26)
and (13) by 1 – λ and add them up to obtain the where the reduced-form coefficients are
following “mongrel” equation— α β – α0β1
Q t = γ 0 + γ 1 P t + γ 2 It + w t Π3 = 1 0
…(20) α1 – β1
where γ0 = λα0 + (1 – λ) β 0 αβ
Π4 = – 2 1 …(27)
γ1 = λα1 + (1 – λ) β 1 …(21) α1 – β1
286U | Economics (NET)
α1β2 that is, there are two estimates of the price coefficient in
Π5 =
α1 – β1 the supply function, and there is no guarantee that these
two values or solutions will be identical. Moreover,
α u – β1u1t
and w t = 1 2t since β1 appears in the denominators of all the reduced-
α1 – β1 form coefficients, the ambiguity in the estimation of β1
The demand-and-supply model given in equation will be transmitted to other estimates too.
(12) and (22) contains six structural coefficients—α0,
α1, α2, β0, β1 and β2—and there are six reduced-form Simultaneous-Equation Models
coefficients—Π0, Π1, Π2, Π3, Π4 and Π5—to estimate In single-equation models there was a single
them. Thus, we have six equations in six unknowns, and dependent variable Y and one or more explanatory
normally we should be able to obtain unique estimates. variable, the X’s. In such models the emphasis was on
Therefore, the parameters of both the demand-and- estimating and/or predicting the average value of Y
supply equations can be identified, and the system as a conditional upon the fixed values of the X variables. The
whole can be identified. cause-and-effect relationship, if any, in such models
therefore ran from the X’s to the Y.
Overidentification But in many situations, such a one-way or unidi-
For certain goods and services, income as well as rectional cause-and-effect relationship is not meaningful.
wealth of the consumer is an important determinant of This occurs if Y is determined by the X’s, and some of
demand. Therefore, let us modify the demand function the X’s are, in turn, determined by Y. There is a two-
(12) as follows, keeping the supply function as before— way, or simultaneous, relationship between Y and (some
Supply function : of) the X’s, which makes the distinction between
dependent and explanatory variables of dubious value. It
Q1 = β0 + β1P t + β2P t– 1 + u2t
is better to lump together a set of variables that can be
β1 > 0, β2 > 0 …(28) determined simultaneously by the remaining set of
Supply function : variables—precisely what is done in simultaneous-
Qt = β0 + β1P t + β2P t – 1 + u2t …(22) equation models. In such models there is more than one
where in addition to the variable already defined, R equation—one for each of the mutually, or jointly,
represens wealth; for most goods and services, wealth, dependent or endogenous variables. And unlike the
like income, is expected to have a positive effect on single-equation models, in the simultaneous-equation
consumption. models one may not estimate the parameters of a single
Equating, demand to supply, we obtain the equation without taking into account information
following equilibrium price and quantity— provided by other equations in the system.
P t = Π 0 + Π1It + Π2R t + Π3P t– 1 + vt …(29) What happens if the parameters of each equation are
estimated by applying, say, the method of ordinary least
Qt = Π 4 + Π5It + Π6R t + Π7P t + wt …(30) squares (OLS), disregarding other equations in the
β – α0 α2 system ? One of the crucial assumptions of the method
Π0 = 0 Π1 = –
α1 – β1 α1 – β1 of OLS is that the explanatory X variables are either
α3 β2 nonstochastic or, if stochastic (random), distributed
Π2 = – Π3 = independent of the stochastic disturbance term. If neither
α1 – β1 α1 – β1 of these conditions is met, then, the least-squares
α1β0 – α0β1 αβ estimators are not only biased but also inconsistent; that
Π4 = Π5 = – 2 1 …(31)
α1 – β1 α1 – β1 is, as the sample size increases identifinitely, the
αβ α1β2 estimators do not converge to their true (population)
Π6 = – 3 1 Π7 = values. Thus, in the following hypothetical system of
α1 – β1 α1 – β1
equations,
α u – β1u1t u – u1t Y1i = β10 + β12Y2i + γ11X1i + u1i …(1)
w t = 1 2t vt = 2t
α1 – β1 α1 – β1 Y2i = β20 + B21Y1i + γ21X1i + u2i …(2)
The preceding demand-and-supply model contains where Y1 and Y2 are mutually dependent, or endo-
seven structural coefficients, but there are eight equations genous, variables and X1 is an exogenous variable and
to estimate them—the eight reduced-form coefficients where u1 and u2 are the stochastic disturbance terms, the
given in equation(31); that is, the number of equations is variables Y1 and Y 2 are both stochastic. Therefore,
greater than the number of unknowns. As a result, unless it can be shown that the stochastic explanatory
unique estimation of all the parameters of our model is variable Y2 in equation is distributed independently of u1
not possible, which can be shown easily. From the and the stochastic explanatory variable Y1 in equation
preceding reduced-form coefficients, we can obtain
(2) distributed independently of u2 , application of the
Π
β1 = 6 …(32) classical OLS to these equations individually will lead to
Π2 inconsistent estimates.
Π Some of the examples of simultaneous-equation
or β1 = 5 …(33)
Π1 models are following.
Economics (NET) | 287U
Demand-and-Supply Model Keynesian Model of Income Determina-
As is well known, the price P of a commodity and tion
the quantity Q sold are determined by the intersection of Consider the simple Keynesian model of income
the demand-and-supply curves for that commodity. If determination—
the demand-and-supply curves are linear and adding the Consumption function—
stochastic disturbance terms u 1 and u2 , the empirical
C t = β0 + β1Yt + ut 0 < β1 < 1 …(5)
demand-and-supply functions may be written as—
Demand function— Income identity—
d
Qt = α0 + α1P t + u1t α1 < 0 …(3) Yt = C t + It (= S t) …(6)
Supply function— where C = consumption expenditure
5
Qt = β0 + β1P t + u2t β1 > 0 …(4) Y = income
Equilibrium function— I = investment (assumed exogenous)
d 5
Qt = Qt S = savings
where Qd = quantity demanded t = time
Q5 = quantity supplied u = stochastic disturbance term
t = time β0 and β1 = parameters
and the α’s and β’s are the parameters. A priori, α1 The parameter β 1 is known as the marginal pro-
is expected to be negative (downward-sloping-demand pensity to consumer (MPC) (the amount of extra
curve), and β1 is expected to be positive (upward-sloping consumption expenditure resulting from an extra dollar
supply curve). of income). From economic theory, β1 is expected to lie
P and Q are jointly dependent variables. If, for between 0 and 1. Equation (5) is the (stochastic)
example, u1t in equation (3) changes because of changes consumption function; and equation (6) is the national
in other variables affecting Qtd (such as income, wealth, income identity, signifying that total income is equal to
and tastes), the demand curve will shift upward if u1t is total consumption expenditure plus total investment
positive and downward if u1t is negative. expenditure, it being understood that total investment
A shift in the demand curve changes both P and Q. expenditure is equal to total savings.
Similarly, a change is u 2t (because of strikes, weather, From the postulated consumption function it is clear
import or export restrictions, etc.) will shift the supply that C and Y are interpendent and that Y t in equation (5)
curve, again affecting both P and Q. Because of this is not expected to be independent of the disturbance
simultaneous dependence between Q and P, u1t and Pt in term because when u t shifts (because of a variety of
equation (3) and u2t and Pt in equation 3 cannot be factors subsumed in the error term), then the
independent. Therefore, a regression of Q on P as in consumption function also shifts, which, in turn, affects
equations (3) would violate an important assumption of Yt. Therefore, once again the classical least-squares
the classical linear regression model, namely, the method is inapplicable to equations (5). If applied, the
assumption of no correlation between the explanatory estimators thus obtained will be inconsistent, as we shall
variables(s) and the disturbance term. show later.
P P C, I
Y=C+I
S S
Consumption, investment
P1
C+I
Price
Price
P0 P0
C = β0 + β1Y
D1
D0 D0
O Q0 Q O Q0 Q1 Q
Quantity Quantity 45°
O National Income Y
P
S Keynesian model of income determination.
P0
Wage-Price Model
Price
P1 Consider the following Phillips-type model of
money-wage and price determination—
Wt = α0 + α1UNt + α2P t + u1t …(7)
D1 D0
O Q1 Q0 Q P t = β0 + β1Wt + β2R t + β3Mt + u2t …(8)
Quantity where W = rate of change of money wages
Interdependent of price and quantity. UN = unemployment rate, %
288U | Economics (NET)
P = rate of change of prices OLS estimation of this equation. OLS can be applied in
R = rate of change of cost of capital equation (3) because both Y1 and Y2 are uncorrelated
M = rate of change of price of imported raw material with u3.
t = time Thus, in the recursive system OLS can be applied to
u1 , u2 = stochastic disturbances each equation separately. Actually, we do not have a
simultaneous-equation problem in this situation. From
Since the price variable P enters into the wage the structure of such systems, it is clear that there is no
equation and the wage variable W enters into the price interdependence among the endogenous variables. Thus,
equation, the two variables are jointly dependent. Y1 affects Y2 , but Y 2 does not affect Y1. Similarly, Y 1
Therefore, these stochastic explanatory variables are and Y2 influence Y3 without, in turn, being influenced
expected to be correlated with the relevant stochastic
by Y 3 . In other words, each equation exhibits a unilateral
disturbances, once again rendering the classical OLS
method inapplicable to estimate the parameters of the causal dependence, hence the name causal models.
two equations individually. Schematically as is evident in following figure.
u1 Y1
Recursive Models and Oridinary Least
Squares
As we have observed that because of the u2 Y2 (X1, X2)
interdependence between the stochastic disturbance term
and the endogenous explanatory variable(s), the OLS
u3 Y3
method is inappropriate for the estimation of an equation
in a system of simultaneous equations. If applied Recursine Model
erroneously, the estimators are not only biased (in small As an example of a recursive system, wage and
samples) but also inconsistent; that is, the bias does not price determination is given as under
disappear no matter how large the sample size. There is,
Price equation—
however, one situation where OLS can be applied
appropriately even in the context of simultaneous . . . . .
P t = β10 + β11 Wt– 1 + β12R t + β13Mt + β14Lt + u1t
equations. This is the case of the recursive, triangular, or
causal models. To see the nature of these models, …(5)
consider the following three-equation system— Wage equation—
Y1t = β10 + γ11X1t + γ12X2t + u1 …(1) . .
Wt = β20 + β21UNt + β32 P t + u2t
Y2t = β20 + β21Y1t + γ21X1t + γ22X2t + u2t …(2) .
Y3t = β30 + β31Y1t + β32Y2t + γ31X1t + γ32X2t + u3t where P = rate of change of price per unit of output
.
…(3) W = rate of change of wages per employee
where, as usual, the Y’s and the X’s are, .
respectively, the endogenous and exogenous variables. R = rate of change of price of capital
The disturbances are such that .
cov (u1t, u2t) = cov (u1t, u3t) = cov (u2t, u3t) = 0 …(4) M = rate of change of import prices
that is, the same-period disturbances in different .
L = rate of change of Labour productivity
equations are uncorrelated (technically, this is the
UN = unemployment rate, %
assumption of zero contemporaneous correlation).
The price equation postulates, that the rate of
Now consider the equation (1). Since it contains change of price in the current period is a function of the
only the exogenous variables on the right-hand side and rates of changes in the prices of capital and of raw
since by assumption they are uncorrelated with the material, the rate of change in labour productivity, and
disturbance term u1t, this equation satisfies the critical the rate of change in wages in the previous period. The
assumption of the classical OLS, namely, uncorrela- wage equation shows that the rate of change in wages in
tedness between the explanatory variables and the the current period is determined by the current period
stochastic disturbances. Hence, OLS can be applied rate of change in price and the unemployment rate. It is
straightforwardly to this equation. Next consider the clear that the causal chain runs from Wt – 1 → P t → Wt,
equation (2), which contains the endogenous variable Y1 and hence OLS may be applied to estimate the para-
as an explanatory variable along with the nonstochastic meters of the two equations individually.
X’s. Now OLS can also be applied to this equation, Although recursive models have proved to be
provided Y 1t and u 2t are uncorrelated. Is this so ? The useful, most simultaneous-equation models do not
answer is yes because u1 , which affects Y1 , is by exhibit such a unilateral cause-and-effect relationship.
assumption uncorrelated with u 2 . Therefore, for all Therefore, OLS, in general, is inappropriate to estimate
practical purposes, Y1 is a predeter-mined variable a single equation in the context of a simultaneous-
insofar as Y2 is concerned. Hence, one can proceed with equation model.
Economics (NET) | 289U
Non-recursive Models Note that X^ and X
3
^ at will not be correlated with
4
In recursive models, the causal flows all go in one the error terms in the model, e.g., since X1 and X 2
direction, e.g., if X1 affects X2 , then X2 does not directly ^ and X
^
are not correlated with u and v, and since X 3 4
or indirectly also affect X1. Further, it was assumed that
^
the disturbance in an equation was uncorrelated with any are computed from X1 and X2,X3 will not be corre-
of the independent variables in the equation. For ^ will not be correlated with u.
lated with v and X 4
example, if Y is regressed on X1 and X2 , the error term
for Y is assumed to be uncorrelated with both X 1 and ● In the second stage of 2SLS, any endogenous
variable X j serving as an explanatory variable in
X2. If this assumption is violated and Ordinary Least
one of the structural equations is replaced by the
Square (OLS) is used to estimate the model, the
corresponding predicted variable computed in the
estimates of the coefficients will be biased.
first step. In the present case, we estimate the
The assumption that the residual term for Y is regressions—
uncorrelated with the Xs might be violated if, say, ^ +u
variables were omitted from the model that affected Y X3 = β31X1 + β34X 4
that was also correlated with the Xs that were in the ^
X4 = β42X2 + β43X3 + v
model. Another situation in which assumptions will be
Given these substitutions, each explanatory variable
violated is when there is reciprocal causation. Consider
in the modified structural equations can be assumed
the following—
uncorrelated with the error terms in the model. Hence,
X1 X3 u you can use OLS to estimate the parameters of the
revised structural equations.
X2 X4 v The standard errors of 2SLS estimators are partially
a function of the degree to which the variables created
In this model, X1 and X2 are exogenous variables in the first stage are similar to the endogenous variables
(their values are determined outside the model) while they replace. Ceterus Paribus, the higher the correlation
X3 and X4 are endogenous (their values are determined between the predicted variables and the original
within the model). There are reciprocal effects between endogenous variables, the more efficient the parameters
X3 and X 4 . The residuals, u and v, are also correlated. produced by 2SLS. The reason we use all (as opposed
to some) of the exogenous variables as independent
Note that, in this model, v is correlated with X3, variables in the first stage regressions is because we
because v affects X4 which in turn affects X3 , i.e., v is an want to construct variables as similar as possible to the
indirect cause of X 3 . Hence, if OLS is used to estimate endogenous variables while still making certain that the
the regression of X4 on X2 and X3 , the assumption that new variables are uncorrelated with the error terms in
the residual v is uncorrelated with X2 and X3 is violated. the equations.
Similarly, when X3 is regressed on X1 and X4 , OLS Note that the coefficient estimates are identical to
assumptions are violated because u is an indirect cause what we got before, but the standard errors are different.
of X4 and hence is correlated with it. This is because, when we do each step separately, the
2 nd step estimation does not take into account the fact
Estimation of Non-Recursive Models : 2 that some of the variables are regression estimates rather
Stage Least Squares than observed values. The default option of 3 stage
There are various ways of estimating this non- least squares produces the same coefficient estimates in
recursive model (e.g. instrumental variables, indirect this case but slightly different standard errors. 3SLS
least squares, linear structural relations (LISREL) combines two-stage least squares (2SLS) with
models). For now, the focus is on a technique called 2 seemingly unrelated regressions (SUR), i.e., it takes into
stage least squares (2SLS). 2SLS is best done with a account the fact that there are multiple equations and
single programme that handles all the steps. If each step that the residuals for those equations may be correlated
is done separately, the co-efficients will be correct but with each other. 3SLS is probably slightly better but, at
least in the examples used here, it doesn’t seem to matter
the standard errors will be wrong.
much.
Conceptually, the procedure is as follows—
The Problem of Underidentification—Unfortuna-
● Regress each endogenous variable on all exogenous tely, estimating non-recursive models is not just as
variables (in this case, regress X3 on X1 and X2 , simple as using a different Stata command. In order to
and regress X4 on X1 and X2 ). Use the OLS estimate the model it must be identified. Some models,
parameter estimates to computr predicted values for whether true or not, are impossible to estimate. For
X3 and X 4 — example, consider this model—
^ * * X1 X3 u
X3 = b31 X1 + b32 X2
^ * *
X2 X4 v
X4 = b41 X1 + b42 X2
290U | Economics (NET)
How then do we avoid the problem of under- Discrete Choice Model
identification? Suppose Xi and Xj each affect each Discrete choice models are used to explain or
other (in this case X3 and X4). For the Xj equation to be predict a choice from a set of two or more discrete (i.e.,
identified, there must be at least one predetermined distinct and separable; mutually exclusive) alternatives.
variable that directly affects Xi but not Xj. This variable For example, a discrete choice model may be used to
is the "instrument" for Xi (or instruments if there is analyze why people choose to drive, take the subway, or
more than one such variable). Similarly, for the Xi walk to work, or to analyze the factors causing people to
equation to be identified, there must be at least one pick one job over another, or investor chooses the
variable that directly affects Xj but not Xi. In the present particular share over others.
example, X2 affects X4 but not X3, hence the X3 Discrete choice models operate within a framework
equation is identified. However, every variable that of rational choice; that is, it is assumed that when
affects X3 also affects X4, hence the X4 equation is not confronted with a discrete set of options, people choose
identified. Conversely, in the earlier example, the option of maximal benefit or utility. It means the
person concern behave rationally. Utility of a choice is a
X1 X3 u
function of the characteristics of the possible choices
and the characteristics of the person making the choice.
X2 X4 v Discrete choice models characterize that function for a
population, thereby allowing for statistical inference
X2 affected X4 but not X3, and X1 affected X3 but about the functional parameters. For example, by fitting
not X4. Hence, as drawn, underidentification is not a a discrete choice model to a dataset of transportation
problem with this model. mode choices (e . g . drive/walk/subway) of 100
From the above, there would seem to be a individuals over 2 weeks, investigators might find that
straightforward solution to the identification problem. If the mode choice is related both to characteristics of the
the X j equation is underidentified, simply add pre- choice (e.g. the choice to walk may be preferred by few
determined variables to the Xi equation but not to the individuals in general) and to interactions between the
Xj equation. That is, you simply need to add variables in choices and characteristics of individuals (e.g. those who
the “right” place. For example, in our underidentified live close to work or are particularly physically active in
model, it would seem that all we have to do is add a general may choose to walk more often).
variable X1B that affects X3 but not X4— Discrete choice models can be distinguished from
X1B
standard regression models by the explicit incorporation
of a defined set of choices, some of which were not
selected. Two types of choice data exists : (a) stated
X1 X3 u preference and (b) revealed preferences. Stated
preference data is obtained from hypothetical scenarios
X2 X4 v or a set of choices presented by the investigator to the
subjects (e.g. subjects are asked “do you prefer to walk
However, this is much harder than it sounds. or take the subway to work?”), while revealed
● The added variables must have a significant direct preferences analyze subjects’ recorded past choices (e.g.
effect on X3. Adding a variable whose expected subjects record how they get to work each day for 2
value is zero is the same as not adding the variable weeks and investigators analyze the results). The
in the first place. Adding weak or extraneous preferred form of choice set depends on the research
variables may make the model appear to be iden- question. For example, research aimed at increasing the
tified, but in reality they won’t solve your problem health workforce in rural areas would use stated
if their effects are very weak or nonexistent. preferences instead of revealed preferences, as revealed
Put another way, the added variables must make preferences cannot be obtained for jobs that do not exist.
sense theoretically. If we add a variable to the X3 In some cases, researchers may use a combination of
equation, it should be the case that we think this both types, potentially to compare stated preferences to
variable affects X3. If we don't think it has an revealed preferences.
effect, then its expected value is zero, which means Discrete choice models are fitted with a two-stage
it does us no good to add it. procedure—
● Perhaps even more difficult, we must believe that first, the analyst generates a choice-set, that is, the
any added variables have indirect effects on X4, but set of all choices subjects might have chosen.
do not have direct effects on X4. That is, we have to Choice Sets—Depending on the research question,
believe that X3 is the mechanism through which the choice set may range from trivial to a considerable
added variable affects X4, and that once X3 is implementation challenge. For example, choice set
controlled for, the added variable has no direct generation would be simple for an analysis of factors
effect on X4. It can be quite difficult to think of such contributing to a voter’s choice in a Parliamentary
variables. election; the set of names on an EVM are well-defined.
Economics (NET) | 291U
By contrast, an analysis investigating revealed residential Uij > Uik. Thus, we can fit a conditional logit model
preferences among the residents of Delhi might logically looking at the probability of actual choice selected in
need to consider every apartment available for rent in pairwise comparisons as a function of choice and
Delhi (or, more broadly, every home in the Delhi individual characteristics.
metropolitan area) as a potential choice. Note—the conditional logit model is valid only
In general, generating a choice set is a matter of when the independence from irrelevant alternatives (IIA)
enumerating all possibilities for choices a subject may holds. IIA, a common assumption in econometrics,
have made in lieu of the one the subject actually did states that overall choice preference is unaffected by the
make (if investigating revealed preferences) or might set of choices offered. For example, if a subject indicates
want to make (if investigating stated preferences). If the that he prefers The Beatles to The Rolling Stones, when
set of possible choices is too large (e.g. there are 100 asked which of The Beatles, The Rolling Stones and The
Who he prefers, he must not select The Rolling
choices not selected for every one choice that is),
Stones. However, behavioral psychology (and marketing
however, data become sparse and statistical modeling is research) suggests the IIA assumption is often violated
more time-intensive or even impossible. In such in practice.
situations, several techniques are frequently used to
select choice subsets. Implementing and Interpreting Discrete
1. Random sampling involves picking a simple Choice Models
random sample from the set of possible alternatives. ● Note that units for U are not generally interpretable
2. Labeling involves picking alternatives for a choice in discrete choice models. β and γ are usually
set in order to maximize certain properties of interest. presented in relation to each other or as Z-scores.
For example, when considering residential pre- ● The tradeoff between attributes included in the
ference in Delhi, an analyst might implement (1) by model can also be valuable (e.g. how much extra
picking 5 options at random from a real estate web site distance is the average pedestrian willing to accept
to represent alternatives. To implement (2) the analyst in exchange for, say, an overpass over a busy
might find the choice that minimizes commute time, the intersection). It is often easiest to interpret these
choice with lowest rent, the choice with highest square choices in terms of a continuous variable. For
footage, etc. example, in job choice literature, salary is
commonly used : a researcher might describe how
Next, the analyst fits a model with (latent) utility on
much loss in income one is willing to trade for an
the left hand side of the equation and characteristics of
improvement in working environment. Similarly, in
subjects, characteristics of choices, and an error term on
the walkability literature, route length is used to
the right hand side.
measure the utility of route attributes.
Model Fitting—The goal of a discrete choice
● Validating assumptions—It is possible to test for
model is to characterize and make inference from the
IIA by partitioning out a subset of the choice set and
random utility function describing utility as a function of seeing if the model estimates of using the full
features of potential choices and subjects. However, in choice set are the same as those using a subset. This
the discrete choice context, utility cannot be observed test is analogous to tests of instrumental variable
directly, so to understand the model, we first consider assumptions in that the test can detect assumption
how to estimate the latent utility variable. In the general violations but does not guarantee the assumption
form, utility (U) for an individual i making a choice j is holds (i.e., failure to detect a violation does not
a function of one or more observed features or the imply lack of violations.)
individual (Xi), and one or more observed feature of the
choice (Zj), and an error term representing unobserved Time Series Analysis
attributes of choices and individuals (eij). Thus: In every field of science, social sciences, humanities
etc. the past trends give a certain direction which helps
Uij = F (X i, Zj, eij)
to draw conclusions for future, forecast the future
In the simplest model, F is assumed to be a linear outcomes and plan the policies and programmes
function (note: this is sometimes called a linear random accordingly. Time series is a sequence of well defined
utility model), so that for a given individual i selecting data sets measured at consistent time intervals over a
choice j— period of time. Time series analysis is the use of
Uij = βZ j + γZj Xij + e ij statistical tools and methods to analyse the time series
data and extract some meaningful information and key
In order to estimate β and γ (i.e., the utility associated
characteristics of such data sets.
with the choice features and interaction of choice
features and individual features respectively), we assume Time series analysis helps us to understand the
the individual considered all choices and selected j, and underlying forces behind a particular trend in time series
therefore for all k choices in the choice set where j != k, data . Time series analysis can be useful to see how a
292U | Economics (NET)
given asset, security or economic variable changes over Measurement of Secular Trend—
time. It can also be used to examine how the changes 1. Graphic or Free-hand Curve Fitting Method—
associated with the chosen data point compare to shifts It is the easiest, simplest and the most flexible method of
in other variables over the same time period. Time series estimating secular trend. Original data is plotted on a
analysis is useful in economics, sociology, political graph by representing years on x-axis and values of
sciences, Anthropology, Business, State administration variable on y-axis. While fitting a trend line by the free
and Planning, Sciences, Astronomy, Life Sciences etc. hand method.
● It helps in understanding past behaviour and ● The curve should be smooth.
estimation of future trends. ● Approximately equal number of points above and
● It helps in planning and forecasting. below the curve.
● It is used to do a comparative analysis of cross- ● Total deviation of the data above the trend line
sectional data. should be the same as the vertical deviation below
● Growth, development, progress can be evaluated the line.
with time series data ● The sum of the squares of the vertical deviations
● Seasonal, cyclical, secular trend of data provide from the trend line should be as small as possible.
valuable information which can be used for policy
formulation. Trend by Free-Hand Method
Food Production in Million Tonners 290
Time Series Models
1. Mathematical Models—It is assumed in classical 280
analysis that some type of relationship exists among four
components of time series. Following models are used to 270
decompose a series.
1. Additive Model—Time series can be expressed 260
as—
y = T+S+C+I 250
[where T = Trend value, S = Seasonal variation, C =
Cyclical variations, I = Irregular fluctuations] 240
2010 2012 2014 2016 2018 2020
The above four components are independent of each Year
other, but their values are additive. For the segregation
2. Semi-Average Method—This method is as
of each of these components one must have trend data
simple as the free hand method. The entire original data
T = Y – (S + C + I) is divided into two equal parts, and the arithmatic mean
Y = T – (S + C + I) of the two sets of values of 4 is calculated for both the
S = Y – (T + C + I) past. There averages are called semi-averages. If the
number of observations is odd, then the middle most
C = Y – (T + S + I)
I = Y – (T + S + C) item i.e.,
n+1
2 ( )
th, is left out. The two averages are
2. Multiplicative Model— joined by a straight line. Which shows the trend.
Assumption—Output of an economy is the product Example—
of various forces acting on one another. Years Value in Crore Semi Average
Application—All the values of T, S, C and I are
given in percentage form or in relative terms
1985
1986
18·6
22·6
⎫⎪
Y = T×S×C×I 1987 38·1 ⎬ 161·6 32·32
40·9 ⎪
Y = log T + log S + log C + log I
Components of Time Series—
1988
1989 41·4
⎭
40·1 ⎫
Long-term components
Secular Trends (T) 1990
⎪
Cyclical (C)
Regular
1991
1992
46·6
60·7 ⎬
⎪ 258·0 51·60
57·2 ⎪
Short-term components Seasonal (S)
Irregular (I)
(Erratic/Random fluctuations)
1993
1994 53·4 ⎭
⎪
Economics (NET) | 293U
Trend line ● This method cannot be used for forecasting future
trend which is the main objective of the time series
60 analysis.
55
50 Least Squares Method
45 The least squares method is a form of mathematical
40 regression analysis that finds the line of best fit for a set
35 of data, providing a visual demonstration of the
30 relationship between the data points. Each point of data
25 is representative of the relationship between a known
20 independent variable and an unknown dependent
15 variable.
10 The least squares method provides the overall
5 rationale for the placement of the line of best fit among
the data points being studied. The most common
0 application of the least squares method, which is
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
referred to as linear or ordinary, aims to create a straight
Trend by Semi-Average Method line that minimizes the sum of the squares of the errors
generated by the results of the associated equations, such
3. Moving Average Method—This method uses as the squared residuals resulting from differences in the
the concept of ironing out the fluctuations of the data by observed value and the value anticipated based on the
taking the means. It measures the trend by eliminating model.
the changes or the variations by means of a moving This method of regression analysis begins with a set
average. The simplest of the mean used for the measure- of data points to be plotted on an X- and Y-axis graph.
ment of a trend is the arithmetic means (averages). The An analyst using the least squares method will seek a
moving average of a period (extent) m is a series of line of best fit that explains the potential relationship
successive averages of m terms at a time. The data set between an independent variable and a dependent
used for calculating the average starts with first, second, variable.
third and etc. at a time and m data taken at a time.
In regression analysis, dependent variables are
In other words, the first average is the mean of the designated on the vertical Y-axis and independent
first m terms. The second average is the mean of variables are designated on the horizontal X-axis. These
the m terms starting from the second data up to (m + designations will form the equation for the line of best
1)th term. Similarly, the third average is the mean of fit, which is determined from the least squares method.
the m terms from the third to (m + 2) th term and so on. The trend line is called the ‘line of best fit’.The sum
Three Year Moving Average—(a + b + c)/3, (b + c of deviations of the actual values of Y and the trend
+ d)/3, (c + d + e)/3 value (Yc) is 0 and the sum of squares of deviation of the
Four Year Moving Average—(a + b + c + d)/4, actual values and the trend value is the least.
(b + c + d + e)/4, (c + d + e + f)/4 (Y – Yc) = 0 and (Y – Yc)2 = least , so this method
is called least square method . This method can be used
If the extent or the period, m is odd i.e., m is of the
to explain the linear and non-linear trend i.e., a straight
form (2k + 1), the moving average is placed against the line trend or parabolic trend.
mid-value of the time interval it covers, i.e., t = k + 1.
The straight line trend or the first degree parabola is
On the other hand, if m is even i.e., m = 2k, it is placed
represented by the mathematical equation—
between the two middle values of the time interval it
covers, i.e., t = k and t = k + 1. Yc = a + bx
When the period of the moving average is even, where Yc = required trend value, and X = unit of time
then we need to synchronize the moving average with a and b are constants or unknown
the original time period. It is done by centering the The equation for second degree parabola is
moving averages i.e., by taking the average of the two Yc = a + bx + cx2
successive moving averages.
The equation for third degree parabola is
Drawbacks of Moving Average Yc = a + bx + cx2 + dx3
● The main problem is to determine the extent of the The straight line method or the first degree parabola
moving average which completely eliminates the gives a straight line and the other equations (Second/third
oscillatory fluctuations. degree parabola) give curved line or non-linear trends.
● This method assumes that the trend is linear but it is For the first degree parabola the values of unknown
not always the case. constants, a and b can be calculated by
● It does not provide the trend values for all the terms. ∑Y = Na + b ∑x
294U | Economics (NET)
∑XY = a ∑ x + b ∑ x2 If be take time origin in middle than ∑X = 0 in that
where N = Number of years or months for which case sum of any odd power of X, such as ∑x 3 = 0,
data is given therefore, three equations are reduced to
When X = 09 (when middle year is taken as the ∑Y = Na + b ∑x …(4)
origin), the equation becomes ∑XY = b ∑x 2 …(5)
∑Y = Na ∑X2Y = a ∑x2 + c ∑x …(6)
By solving equation (4) and (6) the values of a and
because b ∑x = 0, Thus, a = ∑Y/N (Mean value of
c and b can be determined as under
Y values)
(∑Y – c ∑X2)
∑XY = b ∑x2 a =
N
∑XY
Thus, b = (Rate of change) ∑XY
∑x 2 b =
∑x 2
Parabolic Curve (∑X 2 Y – a ∑x2)
and c =
∑X4
Parabolas of second and third degree are non-linear;
thus, they form smooth curves. The shape of these curves Logarithmic Trend—The straight-line arithmetic
trend is used where the time series is found to be
depends upon the values of constant terms a, b, c, etc.
increasing and decreasing by equal absolute amounts in
The following form of equation represent the parabola— each time period. The logarithmic straight line is used as
Yc = a + bx + cx2 + dx3 an expression of the secular movement when the series
The equation of this type does not represent a curve is increasing or decreasing by a constant percentage
of strictly parbolic type but in common usage, the term rather than a constant absolute value. The equation of
such series is given by
parabolic curve is used to indicate curves obtained by
equations of above type. Log y = log a + X log b or y = abx
Normal equations are
The trend equation in this case is
∑(log y) = N log a + ∑(X) log b
Yc = a + bx + cx2
∑(X log y) = log a ∑(X) + ∑ (X2 ) log b
[where a = trend value at the time of origin; If middle year is taken as origin than normal
b = slope at the origin, c = shows whether the curve is up equation becomes
or down and how much] ∑ log y = N log a
Values of constant terms a, b, c can be determined ∑log y
by the following equations ∴ log a =
N
∑Y = Na + b ∑x + c ∑x 2 …(1) ∑ (X · log y) = ∑ (X2 ) log b
∑XY = a ∑ x + b ∑x + c ∑ x …(2)
2 3 ∑ (X · log y)
∴ log b =
∑X2Y = a ∑x2 + b ∑x3 + c ∑ x4 …(3) ∑ (X2 )
Economics (NET) | 295U
Objective Questions
1. Pie-diagrams are— — —
n1 X 1 n2 X 2
(A) One dimensional diagram (B) +
n1 n2
(B) Two dimensional diagrams
— —
(C) Three dimensional diagrams n1 X 1 + n2 X 2
(D) Multi-dimensional diagrams (C)
n1 + n2
2. Government budget (specially revenue from various (D) None of the above
sources) can be best represented by— 11. The algebraic sum of deviations from mean is—
(A) Circle diagram (B) Rectangular diagram (A) Maximum (B) Minimum
(C) Pie diagram (D) Histogram (C) Zero (D) None of these
3. The technique of presenting data by pictograms was 12. The sum of squares of deviations from mean is—
developed by— (A) Least (B) Zero
(A) Spearman (B) Karl Pearson (C) Maximum (D) None of these
(C) Bourbeg (D) Otto Neurth 13. An additional observation of 15 is included in a
series of 11 observations and its mean remains
4. Pictograms are used for—
unaffected. The mean of the series is—
(A) Making comparisons of expenses on various
(A) 11 (B) 15
items of production
(C) 165 (D) 4
(B) Drawing attention of masses, such as exhibi-
tions, fairs etc. 14. The median of a series is 10. Two additional
(C) Showing weather variations observations, of 5 and 20, are added to the series.
(D) None of the above The median of the new series will—
(A) 9 (B) 20
5. Statistics as a singular noun means—
(C) 7 (D) 10
(A) Statistical data (B) Statistical methods
15. In a batch of 13 students 4 have failed. The marks of
(C) Inductive statistics (D) Descriptive statistics
the successful candidates were 41, 57, 38, 61, 36,
6. Statistics as a plural noun indicates— 35, 71, 50 and 40. Find the median marks—
(A) Statistical data (B) Statistical methods (A) 40 (B) 50
(C) Inductive statistics (D) Descriptive statistics (C) 41 (D) 38
7. Distrust of statistics is due to— 16. From the information given below choose the
(A) Misuse of statistics correct answer—
(B) Insufficient statistical methods Factor A Factor B
Mean daily wage R 120 R 80
(C) Scope of statistics is limited No. of workers 80 120
(D) Statistics is considered useless by many people (A) Factory A pays larger amount as daily wages
8. Statistics facilitates— (B) Factory B pays larger amount as daily wages
(A) Comparison of data (C) Both factories pays equal amount as daily
(B) Collection of data wages
(C) Organization of data (D) It cannot be determined
(D) Disposal of data 17. The arithmetic of 9 observations is 100 and that of 6
is 80, the combined mean of all the 3 observations
9. Which of the following statement is/are not true ? will be—
(i) Statistics is concerned with quantitative (A) 100 (B) 80
data only. (C) 90 (D) 92
(ii) Statistics helps in forecasting. 18. The arithmetic mean of the first N natural numbers
(iii) As a singular noun statistics means data. is—
(iv) Any single numerical figure is statistics. N+2
(A) N/2 (B)
(A) (i) and (ii) only (B) (ii) and (iii) only 2
(C) (iii) and (iv) only (D) (i) and (iv) only N(N + 1)
(C) (D) None of these
— — 2
10. If n 1 and n 2 are the sizes and X 1 , X 2 are the
19. For a symmetrical distribution, Q1 and Q3 are 20
—
respective means of two groups then the of the X and 40 respectively. The value of 50th percentile
combined group of size n1 + n2 is given by— will be—
— — (A) 40 (B) 20
(A) (n1 + X 1 ) (n2 × X 2 )/n1 + n2 (C) 30 (D) None of these
296U | Economics (NET)
20. For a symmetrical distribution P25 and P75 are 40 31. Which of the following is not a mathematical
and 60 respectively. The value of median will be— average ?
(A) 50 (B) 40 (A) A.M. (B) G.M.
(C) 60 (D) 100 (C) Weighted A.M. (D) Median
21. In a series of 25 observations, Z (x – 7) = – 8 . Then,
32. What is the major assumption that one makes when
mean is equal to—
computing a mean from a grouped data ?
(A) 7 (B) 8 (A) All value are discrete
(C) 6·68 (D) 7·68
(B) No value occurs more than once
22. Total wages paid to the workers in two factories A (C) Every value in a class is equal to its mid - point
and B are the same but the modal wage in factory A
is larger than the modalwage in factory B. In which (D) Each class contains exactly the same number of
factory workers are well off ? values
(A) A (B) B 33. Which index number is used in a situation when one
(C) Equal in both (D) No answer is willing to compare changes in the monetary value
of consumption, sale, exports, etc., if a commodity
23. Which of the following would be an appropriate on two or more points of time ?
average for determining the average size of
readymade garments ? (A) Price relatives (B) Quantity relatives
(A) Arithmetic mean (B) Median (C) Value relatives (D) Volume relatives
(C) Mode (D) Geometric mean 34. If the mean, median and mode of a data set are
24. Most appropriate average to determine the size of equal then, which of the following is true with
oranges on a tree is— regard to the distribution of the data ?
(A) Mode (B) Median (A) It is symmetrical
(C) A.M. (D) G.M. (B) It is asymmetrical
(C) It is negatively skewed
25. Most appropriate average for qualitative measure-
ment is— (D) It is positively skewed
(A) A.M. (B) G.M. 35. The 50th percentile is—
(C) H.M. (D) Median (A) Mean (B) Median
26. The most unstable measure of central tendency is— (C) Mean deviation (D) Standard deviation
(A) A.M. (B) G.M. 36. Measures of central tendency are called averages
(C) Median (D) Mode of—
27. The sum of deviations of observation is zero when (A) First order (B) Second order
measured from— (C) Third order (D) None of these
(A) A.M. (B) G.M. 37. If the arithmetic mean of the ages of a group of boys
(C) Median (D) Mode is 20 years, then the arithmetic mean of their ages
after 2 years will be—
28. The average, most affected by the extreme observa- (A) Remains constant (B) 18 years
tions, is— (C) 22 years (D) None of these
(A) A.M. (B) G.M.
38. Which of the following statements is not true ?
(C) Median (D) Mode
(A) The median of distribution can be determined
29. The most stable average is— graphically
(A) A.M. (B) G.M. (B) The value of mean is least affected by sampling
(C) Median (D) Mode fluctuations
30. Which of the following is not true ? (C) Arithmetic mean is always the best measure of
(A) The value of median of a data set gets central tendency
affected by extreme values that are not repre- (D) The median can be obtained for open ended
sentative of the data set distributions
(B) Median is the point below which 50% of the 39. Which of the following statements is/are correct ?
data items fall (i) Average sale of a firm for different years can
(C) Median can be calculated from a grouped data be better represented by mode.
with open ended classes (ii) Arithmetic mean is highly affected by extreme
(D) Median of a set of ungrouped data can be found values.
out only after arranging them is ascending of (iii) Sum of absolute deviations from median is
descending order minimum.
Economics (NET) | 297U
(iv) All positional averages are mathematical (iii) 75% observations in a distribution are greater
acreages. than Q3 .
(A) (i) and (ii) only (B) (ii) and (iii) only (iv) 80% of observations of a series lie between
(C) (iii) and (iv) only (D) (i) and (iv) only first and ninth deciles.
40. Which of the following statements is incorrect ? (A) (i), (ii) and (iii) only
(A) Algebraic sum of deviations from arithmetic (B) (i), (ii) and (iv) only
mean is equal to zero (C) (i), (iii) and (iv) only
(B) For a symmetrical distribution, mean = median
(D) (ii), (iii) and (iv) only
= mode
(C) For dealing with qualitative data, median is 46. Mean is not used in—
most suitable (A) Calculating per capita income of a country
(D) None of the above (B) Correlation and regression analysis
41. Which of the following statements is/are true ? (C) Quality control
(i) The mean of a series remains unaffected if an (D) Case of open ended class intervals
observation equal to mean is included in the 47. If different articles are purchased at different rates
series. by spending equal amount on each article, the
(ii) 50th percentile is median. average rate of purchase is given by—
(iii) Q1 equals the 25th percentile. (A) Arithmetic mean (B) Geometric mean
(iv) A.M. can be calculated for a distribution with (C) Harmonic mean (D) Median
open ends.
(A) (i) and (ii) only (B) (i), (ii) and (iii) only 48. In averaging index numbers, which of the following
(C) (ii) and (iii) only (D) (ii), (iii) and (iv) only averages is used ?
(A) A.M (B) G.M.
42. Which of the following is not true ? (C) H.M. (D) Median
(A) Quartiles divide the series in four parts
(B) Percentiles are hundred in number 49. In compound interest calculations average rate of
(C) Mean is highly affected by extreme values interest against varying rate of interest is calculated
by—
(D) Median is not affected by extreme observation
(A) A.M. (B) G.M.
43. Which of the following statements is/are correct ? (C) H.M. (D) Median
(i) Measures of central tendency are called
averages of first order. 50. If the data is qualitative, which of the following
(ii) Histogram is used to find mode graphically. averages can be calculated ?
(iii) If the mean, median and mode of a data (A) A.M. (B) G.M.
set are equal, then the distribution of the data is (C) H.M. (D) Median
symmetrical.
(iv) Median is the point below which 50% of the 51. Which of the following statements is correct ?
data items fall. (A) Median can be calculated from a grouped data
(A) (i), (ii) and (iii) only with open-ended classes
(B) (ii), (iii) and (iv) only (B) The value of median of a data set gets affected
(C) (i), (ii) and (iv) only by extreme values
(D) All the four (C) Arithmetic mean is always the best measure of
44. Which of the following is not correct ? central tendency
(A) The arithmetic mean of the first N natural (D) The arithmetic mean can be computed even if
n+1 an observation of the series is missing
numbers is
2 52. The mean marks of 100 students were found to be
(B) If for a symmetrical distribution, Q 1 and Q3 are 40. Later on it was observed that score of 53 was
20 and 40 respectively, then the value of 50th misread as 83. What is the corrected mean corres-
percentile will be 30 ponding to the corrected score ?
(C) First quartile divides the series into two equal (A) 37·7 (B) 39·7
parts (C) 38·7 (D) None of these
(D) G.M. is used to obtain average exponential 53. The median marks of 50 students were 60. But, later
rates of growth on it was found that the marks of a student who
45. Which of the following statements is/are correct ? secured 75 were wrongly taken as 65. What is the
(i) Mode is the value with maximum frequency in correct median ?
the data. (A) 60 (B) 61
(ii) Mean is based on all the observations. (C) 60·2 (D) 58·8
298U | Economics (NET)
54. One of the measures of dispersion which is more 66. The standard deviation of 30 items in a data set is
useful in case of open-ended distributions is— 5/3. If every item in the data sets multiplied by 3,
(A) Range (B) Standard deviation then the variance of the group will be—
(C) Mean deviation (D) Quartile deviation (A) 5 (B) 15
55. Standard deviation is always computed from— (C) 25 (D) 41
(A) Mean (B) Mode 67. If every observation in a data set is increased by a
(C) Median (D) Geometric mean constant quantity then the coefficient of variation of
the resulting set of values will be—
56. Mean deviation is— (A) Less than the coefficient of variations of the
(A) Less than S. D. original data set.
(B) More than S.D. (B) Greater than the coefficient of variations of
(C) Not related to S.D. the original data set.
(D) Equal to standard deviation (C) Equal to the coefficient of variations of the
57. Coefficient of variation is given by— original data set.
–x (D) Equal to the coefficient of variations of the
σ
(A) – (B) original data set plus the square root of the
x σ constant quantity.
–x σ 68. To which of the following distributions is Bienayme
(C) · 100 (D) – · 100
σ x and Chebyshev’s theorem applicable ?
58. Quartile deviation is based on the— (A) Normal distribution
(A) Highest 50 per cent of the items (B) Rectangular distribution
(B) Lowest 25 per cent of the items (C) Symmetric distribution
(C) Highest 25 per cent of the items (D) Any type of distribution
(D) Middle 50 per cent of the items 69. The following data pertain to a sample containing 5
59. If 25% of the items are less than 20 and 25% are observations : Σx = 15; Σx2 = 55. The variance of
more than 40, the quartile deviation is— the sample is—
(A) 20 (B) 30 (A) 1·5 (B) 2·0
(C) 40 (D) 10 (C) 2·5 (D) 3·0
60. The sum of squares of deviations for 10 observations 70. According to Bienayme - Chebyshev theorem, at
taken from mean 50 is 25. The coefficient of least what percentage of the observation in a
variation is— distribution of data will lie within + 2 standard
(A) 50% (B) 10% deviations of the mean ?
(C) 40% (D) None of these (A) 30% (B) 45%
61. mean + 3 σ covers— (C) 60% (D) 75%
(A) 90% items (B) 99% items 71. The mean and standard deviation of a data set are 10
(C) 95% items (D) None of these and 3 respectively. If every observation in the data
set is increased by 2, then the coefficient of
62. The percentage of observation lying between D1 and variation of the resulting data set will be—
D5 is— (A) 20% (B) 25%
(A) 10% (B) 50% (C) 30% (D) 35%
(C) 4·0% (D) 60% 72. Which of the following is a relative measure of
63. Quartile deviation is— dispersion ?
2 4 (A) Variance (B) Standard deviation
(A) σ (B) σ
3 5 (C) Range (D) Coefficient of variation
3 5
(C) σ (D) σ 73. If every item in a data set is decreased by the same
2 4 quantity then the standard deviation of the resulting
— data set—
64. X = 50 and σ = 25, then the coefficient of variation
(A) Remains the same
is—
(B) Increased by the same quantity b y which
(A) 200% (B) 25%
every data item is increased
(C) 50% (D) 75%
(C) Decreases by t h e same quantity b y which
65. If Q. D. is 16, the most likely value of S. D. will very data item is increased
be— (D) Increases by the square root of the same
(A) 24 (B) 42 quantity by which every data item is
(C) 16 (D) None of these increased
Economics (NET) | 299U
74. The following details are available with regard to a 81. The sum of the observations in a data set containing
sample of eight observations : 10 observations is 120 and the standard deviation of
8 8
the data set is 3. If 3 is added to every observation
∑ x i = 15, ∑ xi2 = 2412 in the data set then, what will be the coefficient of
i=1 i=1
The standard deviation is— variation of the resulting data set ?
(A) 6·12 (B) 10·25 (A) 7·5% (B) 20%
(C) 17·36 (D) 42·77 (C) 25% (D) 50%
75. Which of the following measures does not use every 82. The following details are available with regard to a
observation in the data set ? sample of ten observations :
(A) Variance A.M. of the first four observations = 16
(B) Coefficient of variation A.M. of the next six observations = 16
10
(C) Mean ∑ xi2 = 1726
(D) Mode i=1
What is the standard deviation of the sample ?
76. The coefficient of variation cannot be meaningfully
(A) 1·9 (B) 2·9
used to compare the variability of two or more set of
data, when— (C) 3·9 (D) 4·9
83. The values which divide the series in 100 equal
(A) The S. D. is zero for one or more set of data
parts is known as—
(B) The S. D. is one for one or more set of data (A) Mode (B) Mean deviation
(C) The mean is one for one or more set of data (C) Percentiles (D) None of these
(D) The mean is zero for one or more set of data
84. The difference between the value of the smallest
77. If every item is a data set is multiplied by the same item and the value of the largest item included in the
quantity, k, then the standard deviation of the distribution is called—
resulting data set is— (A) Mean (B) Median
(A) Equal to the variance of the original data (C) Mode (D) Range
(B) Equal to the average of the original data set 85. The formula for standard deviation taken from
(C) Equal to the standard deviations of the original assumed mean is—
data set multiplied by k
Σfd2 (Σfd)2
(D) Equal to the range (A) σ = –
N N
78. If a constant quantity is subtracted from every
observation in a data set then the range of the Σd2
(B) σ =
resulting set of values will be equal to— N
(A) Range of the original data set plus the constant
Σfd2 (Σfd)2
quantity (C) σ = – ×c
N N
(B) Range of the original data set minus the
constant quantity (D) None of the above
(C) Range of the original data set 86. The formula for standard deviation by step devia-
(D) Range of the original data set divided the tion method is—
constant quantity Σd2
(A) σ =
79. If every observation in a data set is increased by a N
constant quantity then the coefficient of variation of
the resulting set of values will be— Σfd2 (Σfd)2
(B) σ = – ×c
(A) Less than the coefficient of variation of the N N
original data set Σd2 (Σd) 2
(B) Greater than the coefficient of variation of the (C) σ = –
N N
original data set
(D) None of the above
(C) Equal to the coefficient of variation of the
original data set 87. Lorenz curve is a graphic method of studying—
(D) Any of the above (A) Correlation (B) Index numbers
(C) Averages (D) Dispersion
80. The variance of a data set is 9. If every item in the
data set is multiplied by 2 then, what is the variance 88. Which analysis helps us to determine the degree of
of the resulting data set ? relationship between variables ?
(A) 12 (B) 36 (A) Dispersion (B) Index numbers
(C) 72 (D) 324 (C) Correlation (D) Averages
300U | Economics (NET)
89. What is Croxton and Cowden’s definition of index 94. What is Marshall-Edgeworth method of index
numbers ? number ?
(A) It is a numerical value characterizing the ΣP q + ΣP1q1
change in complex economic phenomena over (A) P 01 = 1 0 × 100
ΣP0q0 + ΣP0q1
a period of time or space
(B) It is a statistical designed to show changes in Σp q
(B) P 01 = 1 × 100
variables of a group of related variable with Σp0 q
respect to time, geographical location or other ΣP
characteristic (C) P 01 = 1 × 100
Σq0
(C) Index number are devices for measuring
differences in the magnitude of group of P
(D) P 01 = 1 × 100
related variables q1
(D) None of the above 95. Which law states that the larger the group, the higher
90. What is Laspeyres method for calculating index is the degree of stability ?
number ? (A) The law of statistical regularity
Σp q
(A) P 01 = 1 1 × 100 (B) The law of inertia of large numbers
Σp0 q0
(C) Both (A) and (B)
Σp q
(B) P 01 = 1 × 100 (D) None of the above
Σp0 q
Σp1 q0 96. “The degree to which numerical data tend to spread
(C) P 01 = × 100 about an average value is called the variation or
Σp0 q0
dispersion of the data”. Who made this definition ?
Σp1 q0 + ΣP1q1
(D) P 01 = × 100 (A) A.L. Bowley
Σp0 q0 + ΣP0q1
(B) Spiegel
91. What is Paasche’s method of index number ?
(C) B. C. Brooks and W. F. L. Dick
Σp q
(A) P 01 = 1 × 100 (D) L. R. Connor
Σp0 q
Σp q 97. Correlation—
(B) P 01 = 1 1 × 100
Σp0 q1 (A) Is a single value which represents a set of
ΣP1q1 + ΣP1q0 values in a distribution
ΣP0q1 + ΣP0q0 (B) Is a statistical technique which measures and
(C) P 01 = × 100 analyses the degree of extent to which two or
2
ΣP q + ΣP1q1 more variables fluctuate with reference to one
(D) P 01 = 1 0 × 100 another
ΣP0q0 + ΣP0q1
(C) Is the degree of the scatter of variation of the
92. Which is Bowley’s method of index number ? variables about a central value
ΣP1 q0 ΣP1 q1 (D) None of the above
(A) P 01 = × × 100
ΣP0 q1 ΣP0 q1 98. What is Karl Pearson’s correlation coefficient
ΣP q + ΣP1q1 between X and Y from the following data ?
(B) P 01 = 1 0 × 100
ΣP0q0 + ΣP0q1 N = 11, Σx = 117, Σx2 = 1313
ΣP1q1 + ΣP1q0 Σy = 260, Σy2 = 6580, Σxy = 2827
ΣP0q1 + ΣP0q0 (A) r = 0·3566 (B) r = 0·4237
(C) P 01 = × 100
2 (C) r = 0·5275 (D) r = 0·3827
Σp q
(D) P 01 = 1 × 100 99. The co-efficient of correlation is independent of—
Σp0 q (A) Change of scale only
93. Which is Fisher’s ideal method of index number ? (B) Change of origin only
ΣP q + ΣP1q1 (C) Both change of scale and origin
(A) P 01 = 1 0 × 100
ΣP0q0 + ΣP0q1 (D) None of the above
ΣP1 q0 ΣP1 q1 100. The co-efficient of correlation—
(B) P 01 = × × 100
ΣP0 q1 ΣP0 q1 (A) Cannot be positive
Σp q (B) Cannot be negative
(C) P 01 = 1 × 100
Σp0 q (C) Is always positive
(D) None of the above (D) Can be either positive or negative
Economics (NET) | 301U
101. Karl Pearson’s Co-efficient of correlation lies 111. Quantity index reflects ……… changes from one
between— period to another.
(A) − 2 to + 2 (B) Zero to + 1 (A) Consumers (B) Cost of living
(C) − 1 to + 1 (D) None of these (C) Quantity (D) Barometers
102. Probable error of r is— 112. ……… Test is satisfied both by Fisher’s and
n – r2 n + r2 Kelly’s formula.
(A) 0·6475 (B) 0·6754
⎯N
√ ⎯N
√ (A) Circular (B) Factor reversal
n – r2 n + r2 (C) Time reversal (D) None of these
(C) 0·6547 (D) 0·6754
N N 113. To study change in the price level for a group of
103. The extent of linear relationship between two people ………… index is prepared.
variants X and Y is determined by— (A) Whole sale price (B) Consumer price
(A) Co-efficient of correlation (C) Cost of living (D) None of these
(B) Probable error
(C) Standard error 114. What is the relationship between mean, median
and mode ?
(D) Co-efficient of determination
(A) Mean – Mode = 2 (Mean – Median)
104. Which is often described as ‘barometers of econo- (B) Mean – Mode = 3 (Mean – Median)
mic change’ ?
(C) Mean + Mode = 3 (Mean – Median)
(A) Average (B) Correlation
(D) Mean – Mode = 2 (Mean – Median)
(C) Dispersion (D) Index Numbers
115. Which of the following is correct ?
105. Index numbers are today one of the most widely
used statistical device. They are used to take the (A) A M ≤ G M ≤ H M
pulse of the ecomomy and they have come to be (B) A M > G M > H M
used as indicators of inflationary of deflationary (C) A M ≥ G M ≥ H M
tendencies. Whose words are these ? (D) H M ≥ G M ≥ A M
(A) A.M. Tuttle
116. The exponential law is most useful in economics in
(B) Horace Secrist
case of—
(C) G. Simpson and F. Kafka (A) Consumption pattern
(D) Croxton and Cowden (B) Population growth
106. Paasche index is based on— (C) Income earned from interest
(A) Base year quantities (D) None of the above
(B) Current year quantities 117. In economics when rates of growth are being
(C) Average of current and base year assessed over a period of time, having negative and
(D) None of the above positive growth the average rate of growth over a
period of time can be determined by—
107. Fisher’s ideal index is—
(A) Mean (B) Median
(A) The median of Laspeyre’s and Paasche’s index
(C) Mode (D) Root mean square
(B) Arithmetic mean of Laspeyre’s and Pasche’s
(C) Geometric mean of Laspeyre’s and Paasche’s 118. Root mean square of all deviations is—
(D) None of the above (A) Mean deviation (B) Standard deviation
(C) Geometric mean (D) Quartile deviation
108. The circular test is satisfied when—
119. Which of the following cannot be considered as a
(A) P 12 × P23 × P31 = 0
merit of primary data ?
(B) P 12 × P23 × P31 = 1 (A) It is generally free from bias
(C) P 21 × P32 × P31 = 1 (B) It is less time consuming as compared to
(D) None of the above secondary data
109. The circular test is satisfied by— (C) It is original in nature
(D) It exactly matches the reeds of the project
(A) Simple aggregative index
(B) Paasche’s index 120. Which of the following is one of the merits of
(C) Laspeyre’s index secondary data ?
(A) It is original in nature
(D) Kelly’s index
(B) It is more reliable, authentic and accurate
110. Fisher’s ideal index number is ……… mean of (C) It is much less expensive as compared to
Laspeyre’s and Paasche’s Index numbers. primary data
(A) Factor reversal (B) G.M. (D) It can be used with greater confidence as
(C) Normal (D) H.M. compared to primary data
302U | Economics (NET)
121. Which of the following statements is not correct ? 129. Sample study is useful—
(A) Primary data are original (A) To know the characteristics of the population
(B) The u s e of time and money in collecting where the population is not completely known
secondary data is insignificant (B) Because it is easy to handle samples
(C) Primary data do not contain any bias (C) Because the results are more reliable
(D) No editing is required in using secondary data (D) Because it is cheap
122. Which of the following is not a source of secondary 130. Primary data is preferred on secondary data
data ? where—
(A) Government publications (A) Accuracy is important
(B) Report of joint stock companies (B) Time available is short
(C) Semi-official publications (C) Sufficient finance is not available
(D) Mailed questionairs (D) Much accuracy is not required
123. The collection of all possible observations of a 131. Secondary data is preferred on primary data
specified characteristic of interest is called— where—
(A) Random sampling (A) Sufficient time is available
(B) Purposive sampling (B) Sharp precision is required
(C) Convenience sampling (C) Sufficient finance is available
(D) Population (D) Much accuracy is not required
124. The collection of data on beauty, sex marital status 132. In random sampling—
is called— (A) Each element has equal chance of being
(A) Quantitative data (B) Sampling data selected
(C) Attributes (D) None of these (B) Sample is always full of bias
125. A sample selected in such a way that every item in (C) Cost involved is very less
the population has an equal chance of being (D) Cost involved is high
included is called— 133. Stratified sample is preferred where—
(A) Random sampling (A) The population is perfectly homogeneous
(B) Purposive sampling
(B) The population is not homogeneous
(C) Quota sampling
(C) Random sampling is not possible
(D) Convenience sampling
(D) Small samples are required
126. A method of sampling in which the population is
divided into different homogeneous groups in 134. Any device such as a graph or table that displays
terms of some characteristics is called— the values that a variable can assume along with the
frequency of occurrence of these values either
(A) Judgment sampling
individually or as they are grouped into a set of
(B) Cluster sampling mutually exclusive and exhaustive intervals is
(C) Systematic sampling called—
(D) Stratified sampling (A) Frequency distribution
127. A method of sampling, which, divides the (B) Frequency array
population into groups and each group is a (C) Both (A) and (B)
representative of the population, i.e., the groups (D) None of these
are similar to each other, is called— 135. When the data are classified on the basis of time
(A) Judgment sampling then it is known as—
(B) Cluster sampling (A) Quantitative classification
(C) Systematic sampling (B) Temporal classification
(D) Stratified sampling (C) Spatial classification
128. A method of sampling in which, each element has (D) Dichotomous classification
an equal chance of being selected but each 136. If the data are classified on the basis of same
sample does not have an equal chance of being characteristics such as height, age, etc., the
selected, is called— classification is known as—
(A) Judgment sampling (A) Quantitative classification
(B) Cluster sampling (B) Temporal classification
(C) Systematic sampling (C) Spatial classification
(D) Stratified sampling (D) Dichotomous classification
Economics (NET) | 303U
137. When the data are classified on the basis of place, 144. Special purpose tables can be called—
e.g., cities, districts etc., it is called— (i) Reference tables
(A) Quantitative classification (ii) Repository tables
(B) Temporal classification (iii) Analytical tables
(C) Spatial classification (iv) Summary
(D) Dichotomous classification (A) (i) and (ii) only (B) (ii) and (iii) only
138. In the case of inclusive type classification, class (C) (iii) and (iv) only (D) (i) and (iv) only
boundaries are obtained by— 145. Stochastic variables are—
(A) Decreasing the upper class limit and increasing (A) Imply causation
lower class limit by one half of the difference (B) Deterministic values
between the upper limit of one class and the
(C) Non-random variables
lower limit of the next class
(D) Have probability distribution
(B) Increasing the upper class limit and decrea-
sing lower class limit by one half of the 146. Regression analysis—
difference between them (A) Does not necessarily imply causation
(C) Increasing both the upper class limit and (B) Imply correlation effects
lower class limit by one half of the difference (C) Necessarily imply causation
(D) Decreasing both the upper class limit and (D) Always analysis the cause-effect relation
lower class limit by one half of the difference
147. Correlation analysis measures—
139. Commutative frequency of any class is—
(A) Regression between the two variables
(A) The sum of frequencies of all the preceding
classes (B) Predictability of the two variables
(B) The sum of frequencies of all the preceding (C) Degree of linear association between two
classes plus the frequency of that class variables
(C) Frequency per unit width of the class (D) Degree of causation between two variables
(D) None of the above 148. Data collected for a variable over a period of time
140. The formula for standard error is given by— is called—
⎯n
√ 1 – r2 (A) Time series data
(A) (B) (B) Cross-sectional data
1– r2 ⎯n
√
(C) Pooled data
⎯n
√ 1 + r2 (D) Panel data
(C) (D)
1+ r2 ⎯n
√ 149. Census of population data is an example of—
141. An index number which is used for measuring (A) Qualitative data
changes in the volumes of commodity is called— (B) Cross-sectional data
(A) Price relatives (B) Quantity relatives
(C) Periodic data
(C) Value relatives (D) All of these
(D) Pooled data
142. Which of the following is not an objective of
classification of data ? 150. In equation yi = E(y/x i) + ui, the deterministic
component is—
(A) To condense the mass of data in such a
manner that similarities and dissimilarities are (A) yi (B) E (y/x i)
readily apprehended (C) ui (D) E (y/x i) + ui
(B) To facilitate comparison 151. Equation yi = β1 + β2 Xi + ui represents—
(C) To eliminate unnecessary details contained in
(A) Sample regression function
the raw data
(B) Population regression function
(D) To depict trend and pattern of data
(C) Non-linear regression function
143. General purpose tables are also called as— (D) Estimate of regression function
(i) Reference tables
(ii) Repository tables 152. In equation yi = ^β1 + β^2Xi + u^i, ^ui represents—
(iii) Analytical tables (A) Fixed component
(iv) Summary tables (B) Residual component
(A) (i) and (ii) only (B) (ii) and (iii) only (C) Estimates
(C) (iii) and (iv) only (D) (i) and (iv) only (D) Estimators
304U | Economics (NET)
153. Which of the following is/are linear-in-parameter 161. In a confidence interval estimation, α = 5% this
functions ? means that this interval includes the true β with
I. Y = β1 + β2X + β3X2 probability of—
II. Y = eβ1 + β2 x (A) 5% (B) 45%
III. Y = β1 + β2X + β3X2 + β4X3 (C) 50% (D) 95%
(A) Only I (B) Only I and II 162. For H 0 : β2 = O; H1 : β2 ≠ 0; this is—
(C) Only II and III (D) I, II and III all (A) One-sided hypothesis test
(B) Two-sided hypothesis test
154. Which of the following is/are an assumption (s) of
(C) t-test
the classical linear regression model ?
(D) Open ended hypothesis test
I. Linear in parameters
II. Fixed X values are independent of the error 163. When we do not reject a H0 for β 2 , this means that
term the value of β2 under H0 falls within the confidence
III. Zero mean value of disturbance ui interval defined by—
IV. Homoscedasticity (A) (1 – α) % (B) (α ± 1) %
V. An autocorrelation between the disturbances (C) 100 (1 – α) % (D) (100 – α) %
(A) I, II and III only 164. The confidence internal is constructed as……
(B) II, III and IV only under one tail test.
(C) I, II, III, IV and V all (A) α % (B) (1 – α) %
(D) III, IV and V only (C) (100 – α) % (D) 100 (1 – α) %
155. The least square estimators are— 165. For t-test and F-test, particularly in small samples,
(A) Period estimators the error terms should be……
(B) Point estimators (A) Normal distribution
(C) Population estimators (B) t-distribution
(D) Popular estimators (C) F-distribution
156. In classical linear regression model, Xi and ui (D) Chi-square distribution
are— 166. The Jarque-Bera test is a……
(A) Positively correlated (A) Residual normality test
(B) Negatively correlated (B) Model misspecification test
(C) Highly correlated (C) Test of unbiasedness of estimators
(D) Not correlated (D) Test of goodness of fit for the model
2
^ = Y for each i in a regression model then 167. The regression model Yi = β1 + β2 Xi + μi is—
157. When Y e i (A) Intrinsically linear model
the value of r2 would be— (B) Intrinsically non-linear model
(A) r2 = Y (B) 0 ≤ r2 ≤ 1 (C) Taylor series
2
(C) r = 1 (D) r2 = 0 (D) Non-linear in variable
^ = – 12 + 0.5 X.
158. The fitted regression is given by Y 168. The regression model Yi = β1e+β3x1 + u1 is—
e
What is the value of the residual at the point X = 50 (A) Logistic (Probability) distribution function
and Y = 70— (B) Cobb-Douglas production function
(A) 57 (B) – 57 (C) Constant elasticity of substitution production
(C) 0 (D) 33 function
(D) Exponential regression model
159. What is the number of degrees of freedom for a
simple be variate linear regression with 100 obser- 169. The linearisation of a nonlinear equation is based
vations ? on the technique of……
(A) Direct sereach method
(A) 2 (B) 97
(B) Taylor series expansion
(C) 98 (D) 100
(C) Method of steepest descent
160. Which of the following is the characteristics of (D) Hit-or-miss method
OLS estimators under the normality assumption ?
170. In simultaneous-equation model there must be
I. They are unbiased more than one—
II. They efficient estimators (A) Endogenous variable
III. They have consistency (B) Exogenous variable
(A) Only II (B) Only I and II (C) Parameter to be estimated
(C) Only II and III (D) I, II and III only (D) Equation to be estimated
Economics (NET) | 305U
171. An equation can be identified in simultaneous Answers
equation model if—
1. (B) 2. (C) 3. (D) 4. (B) 5. (B)
(A) The structural equation parameter can be
obtained from the reduced form estimates 6. (A) 7. (A) 8. (A) 9. (C) 10. (C)
(B) Reduced form coefficient can be obtained 11. (C) 12. (D) 13. (B) 14. (D) 15. (D)
from their structural equation estimates 16. (C) 17. (D) 18. (B) 19. (C) 20. (A)
(C) The underlying theory is strong 21. (C) 22. (A) 23. (C) 24. (A) 25. (D)
(D) All the variables appear only once in the 26. (D) 27. (A) 28. (A) 29. (A) 30. (A)
model 31. (D) 32. (C) 33. (C) 34. (D) 35. (B)
172. For an simultaneous equation model with k 36. (A) 37. (C) 38. (C) 39. (B) 40. (D)
unknown and k reduced form equations, the model 41. (B) 42. (B) 43. (D) 44. (C) 45. (B)
is said to be— 46. (D) 47. (C) 48. (B) 49. (B) 50. (D)
(A) Exactly identified 51. (A) 52. (B) 53. (A) 54. (D) 55. (A)
(B) Over identified
56. (A) 57. (D) 58. (D) 59. (D) 60. (D)
(C) Under identified
61. (B) 62. (C) 63. (A) 64. (C) 65. (A)
(D) Unidentified
66. (C) 67. (A) 68. (D) 69. (B) 70. (D)
173. Indirect least squares model and two stage least
71. (B) 72. (D) 73. (A) 74. (A) 75. (D)
squares model are examples of—
(A) Full information method 76. (A) 77. (C) 78. (C) 79. (A) 80. (B)
(B) Simultaneous equation model 81. (B) 82. (A) 83. (C) 84. (A) 85. (A)
(C) Single equation model 86. (B) 87. (D) 88. (C) 89. (C) 90. (C)
(D) Systems method 91. (B) 92. (C) 93. (B) 94. (A) 95. (B)
174. Under 2 stage least square estimation technique the 96. (B) 97. (B) 98. (A) 99. (C) 100. (D)
significance of an individual coefficient is tested 101. (C) 102. (A) 103. (D) 104. (D) 105. (C)
using— 106. (B) 107. (C) 108. (B) 109. (D) 110. (B)
(A) Students t test 111. (C) 112. (B) 113. (C) 114. (B) 115. (C)
(B) F-test 116. (B) 117. (D) 118. (B) 119. (B) 120. (C)
(C) Chi-square test 121. (D) 122. (D) 123. (D) 124. (C) 125. (A)
(D) Modified t-test 126. (D) 127. (B) 128. (C) 129. (A) 130. (A)
175. A collection of random variables ordered in time is 131. (D) 132. (A) 133. (B) 134. (C) 135. (B)
known as— 136. (A) 137. (C) 138. (B) 139. (B) 140. (B)
(A) Stationary series 141. (B) 142. (A) 143. (A) 144. (C) 145. (D)
(B) Stochastic process 146. (A) 147. (C) 148. (A) 149. (A) 150. (B)
(C) Spurious variable 151. (B) 152. (B) 153. (D) 154. (C) 155. (B)
(D) Non-stationary series 156. (D) 157. (C) 158. (A) 159. (C) 160. (D)
176. The autocorrelation function at log k can take 161. (D) 162. (B) 163. (C) 164. (C) 165. (A)
values between— 166. (A) 167. (B) 168. (D) 169. (B) 170. (A)
(A) – 1 and + 1 (B) 0 and 1 171. (A) 172. (A) 173. (C) 174. (A) 175. (B)
(C) – 1 and 0 (D) 0 and 2 176. (A)
●●
UNIT-4
Mathematical Economics
Set (9) Set of subsets of a set A is called power set of a
denoted by P (A).
(1) Set—A well defined collection of objects is
called a set. The objects in a set are called its members If n (A) = n, then n (P (A)) = 2n and number of
or elements. proper subsets of A is 2n – 1.
Example 1. Set of integers : Z′ = {… – 3, – 2, – 1, Example. Write down the power set of
0, 1, 2, 3……) A = {1, 2, 3}.
Example 2. Set of vowels S = {a, e, i, o, u} Solution :
(2) Notation—The sets are denoted by capital P (A) = {φ, {1}, {2}, {3}, {1, 2}
letters and their elements by small letters. There are two (2, 3}, {1, 3}, A}
methods of describing a set— (10) Union Sets—Let A and B be two sets, the
(i) Roster method and (ii) Set builder form. union is A ∪ B.
(i) Roster Method—We just make a list of all A ∪ B = {x/x ∈ A or x ∈ B}
elements of the set and put them under { }. Example. A = {1, 2, 3}, B = {2, 3, 4},
(ii) Set builder Form—This method consists in then A ∪ B = {1, 2, 3, 4}.
listing the properties common to all the elements of the Note—x ∈ A ∪ B ⇒ x ∈ A or x ∈ B and x ∉ A ∪ B
set. ⇒ x ∉ A and x ∉ B.
(3) Empty Set—A set containing no elements is (11) Intersection of Sets—Let A and B be two sets,
called empty set. This set is also known as void set, null the intersection of A and B is A ∩ B—
set. It is denoted by φ.
A ∩ B = {x | x ∈ A and x ∈ B}
(4) Finite and Infinite Sets—A set is finite if it has
only a finite number of elements. It is infinite if it has Thus we have
infinite number of elements. x ∈ A ∩ B ⇒ x ∈ A and x ∈ B and
Example 1. S = {x | 2 < x < 6, x is a natural x ∉ A ∩ B ⇒ x ∉ A or x ∉ B
number). (12) Difference of Sets—For any two sets A and B,
Clearly S is finite as it has only 3 elements viz. 3, 4, 5. we define
Example 2. S {x | x > 1, x is any number}. A – B = {x/x ∈ A and x ∉ B}
This set is infinite set as it has infinitely many
Example. A = {3, 4, 5, 6}, B = {5, 6, 7, 8}
elements.
(5) Subset—A set A is subset of B, denoted by Then A – B = {3, 4}
A ⊂ B if x ∈ A ⇒ x ∈ B., It number of elements of A is B – A = {7, 8}
less than that of B then A is proper subset of B, denoted Note that A – B ≠ B – A if A ≠ B.
by A ⊂ B. Two sets A and B are comparable if either Thus A – B = B – A ⇔ A = B.
A ⊂ B or B ⊂ A.
(6) Equal Sets—Two sets A and B are equal if (13) Symmetric Difference of Sets—A Δ B =
A ⊂ B, B ⊂ A. symmetirc difference of A and B = (A – B) ∪ (B – A).
Remark—(i) The elements of a set may be listed in (14) Universal Set—In a given problem on sets
any order. Thus {1, 2, 3} = {1, 3, 2} = {2, 3, 1} etc. there happens to be a set which is a superset of all sets.
That set is called universal set, denoted by U.
(ii) Repetition is not allowed in a set. For examples
S = {1, 1, 2, 2, 3} = {1, 2, 3} (15) Complement of a Set—Let A be a set and U is
(7) Cardinal Number of a Set—The number of universal set, then
elements in a set A is called cardinal number n (A). AC = {x/x ∉ A, x ∈ U}
(8) Equivalent Sets—Sets A and B are equivalent if (16) Notice φ C = U, UC = φ , A ∪ AC = U,
n (A) = n (B). A ∩ AC = φ
Economics (NET) | 307U
(17) Properties of Union and Intersection— (20) n (A ∪ B) = n (A) + n (B) – n (A ∩ B) while
(i) A ∪ A = A counting the members of A ∪ B, we count the members
(ii) A ∪ φ = A of A ∩ B twice so we have to subtract n (A ∩ B) from
sum of n (A) and n (B).
(iii) A ∩ A = A
(iv) A ∩ φ = φ A B
(v) Associative Law—
(A ∪ B) ∪ C = A ∪ (B ∪ C)
and (A ∩ B) ∩ C = A ∩ (B ∩ C)
(vi) Commutative Law—
(A ∪ B) = B ∪ A If A ∩ B = Q, then n (A ∪ B) = n (A) + n (B)
A∩B = B∩A Note—
(vii) Distributive Laws— (i) n (A – B) + n (A ∩ B) = n (A)
A ∪ (B ∩ C) = (A ∪ B) ∩ (A ∪ C) (ii) n (B – A) + n (A ∩ B) = n (B)
(iii) n (A – B) + n (B – A)
and A ∩ (B ∪ C) = (A ∩ B) ∪ (A ∩ C)
= n (A ∪ B) – n (A ∩ B)
(viii) De Morgan’s Law—
(21) Cartesian Product of Two Sets—Let X and Y
(A ∪ B)C = AC ∩ BC be two non empty sets then cartesian product X × Y is
(A ∩ B)C = AC ∪ BC given by
(18) Some Important Results— X × Y = {(x, y)/x ∈ X, y ∈ Y}; note that (y, x) ∉
(i) A ⊆ B ⇔ BC ⊆ A C X × Y.
(ii) A–B = φ⇒A⊆B Hence X×Y ≠ Y×X
(iii) A – B = A ∩ BC n (X × Y) = n (X) · n (Y)
(iv) A – (B ∪ C) = (A – B) ∩ (A – C) Example. If A = {1, 2, 3}, B = (2, 3, 4)], then find
A × B, B × A.
(v) A – (B ∩ C) = (A – B) ∪ (A – C)
Solution :
(vi) A – (B ∩ C) = (A – B) ∪ (A – C)
A × B = {(1, 2), (1, 3) (1, 4) (2, 2) (2, 3) (2, 4),
(vii) A ∩ (B – C) = (A ∩ B) – (A ∩ C)
(3, 2), (3, 3), (3, 4)}
(viii) A ∪ B = φ ⇔ A = φ and B = φ
B × A = {(2, 1) (2, 2) (2, 3) (3, 1), (3, 2), (3, 3),
(19) Venn Diagrams— (4, 1) (4, 2), (4, 3)}
Notice—Universal sets are denoted by rectangle (22) Function—Let A and B be two non empty
and sets by circles. sets. A function f : A → B is a rule that corresponds each
(i) To show A ⊂ B a ∈ A to unique b ∈ B. A is called domain and B is
U called co-domain. We denote b = f (a)., b is called image
of ‘a’. Range of ‘f ’ is the set of images of members of
‘A’.
A B Thus range of f = f (A) = {f (a)/a ∈ A) ⊆ B.
Notice that f (A) is always a subset of B.
If f (A) = B, then f is onto otherwise ‘f ’ is into. If
(ii) A ∩ B is shown as distinct elements in A have distinct images in B then f is
one-one. Thus if
U
A B f (x1) = f (x2)
⇒ x1 = x2
then f is 1 – 1. Or equivalently
x1 ≠ x2
⇒ f (x1) ≠ f (x2)
(iii) A ∪ B is shown as shaded part If f is not one-one then it is many one.
U To show f is onto let b ∈ B (i.e., co-domain), now
A B search some a ∈ A such that f (a) = b.
Example 1. Let A = {2, – 1, 4} and B = {4, 16, 1}.
Let f : A → B be defined as f (a) = a2 . Show f is one-one.
Solution :
f (2) = 4, f (– 1) = (– 1)2 = 1, f (4) = (4)2 = 16.
Important Results from Venn Diagram Thus two distinct members of ‘A’ have distinct
Let A and B be two intersecting sets, then images in B, hence f is one-one.
308U | Economics (NET)
Example 2. Let f : R → R be defined as f (x) = sin x, 4. Removable discontinuity—
then show f is many one and f is into. R is a set of real If the L. limx → a f (x) = R. limx → a f (x) ≠ f (a), then
numbers.
f (x) is said to have a removable discontinuity or discon-
Solution— tinuity of third kind.
Let f (x1) = f (x2)
Properties of Continuous Functions—
⇒ sin x 1 = sin x 2
(1) If f (x) and g (x) are continuous at x = a, then f (x)
⇒ x1 = nπ + (– 1)n x2 + g (x), f (x) – g (x), f (x).g (x), f (x)/g (x), if g
⇒ x1 ≠ x2 (a) ≠ 0 are also continuous functions at x = a.
(Notice that implication of f (x1) = f (x2 ) should be (2) If f (x) is continuous at a and if g (x) is conti-
only ‘one’ that is x1 = x2) nuous at f (a), then composite function gof is
∴ f is many one. also continuous at a.
Let 10 ∈ R (co-domain) then there is no real x ∈ R (3) If f (x) is continuous on the closed interval [a, b],
(domain) such that sin x is equal to 10; so f is into. then the interval can always be divided u p
into a finite number of sub-intervals such that
(Note that f (R) = [– 1, 1] ⊂ R.).
given ∈ > 0
Continuity ⏐f (x1) – f (x2)⏐ < ∈
Continuity of a Function at a Point—A function Where x1 and x2 are any two points in the same
y = f (x) is said to be continuous at x = a, if sub-interval.
L. limx → a f (x) = R.limx → a f (x) = f (a). (4) If f (x) is continuous in the closed interval
[a, b], then (i) f (x) is bounded in [a, b ]
A function which is not continuous at a point is said (ii) f (x) attains its superimum and infimum at
to be discontinuous function. least once in [a, b ]
Continuity of a Function in a n Interval—A (5) If f (x ) is continuous at x = a , where
function f (x) is said to be continuous in an open interval f (a) ≠ 0, then a positive number δ can be found
(a, b), if f (x) is continuous at every point in (a, b). such that f (x) has the same sign as f (a) for
A function f (x) is said to be continuous in a closed every value of x in (a – δ, a + δ)
interval [a, b], if (6) If f (x) is continuous in [a, b ] and f (a) and f (b)
(1) f (x) is continuous at x = a from right i.e., have opposite signs, then there is at least one
R lim x → a f (x) = f (a) value of x for which f (x) vanishes
(2) f (x) is continuous at every point of open interval (7) If f (x) is continuous in [a, b ], then f (x) must
(a, b) take at least once all values between f (a) and
(3) f (x) is continuous at x = b from left i.e., f (b)
L. limx → b f (x) = f (b) Derivability at a point—The function y = f (x)
is said to be derivable at x = a ∈ D (f), if limh → 0
Continuous Function—A function f (x) is said to
be a continuous function if it is continuous at every point f (a + h) – f (a)
of its domain. exist, where h is a small number either
h
Note—(1) A polynomial function is always a positive or negative.
continuous function. Derivative of f (x) at x = a is denoted by f′ (a) or D f
(2) A rational function is always a continuous
function except at the zeroes of the denominator. (a) or () dy
dx x = a.
Kinds of Discontinuity—Let f (x) be a function Left-hand derivative of f (x) at x = a is denoted by L.
and a ∈ R. f′ (a)
1. Discontinuity of first kind— f (a – h) – f (a)
If the L. limx → a f (x) ≠ R. limx → a f (x) then f (x) is L. f′ (a) = limh→0 , if exist
–h
said to have discontinuity of first kind or jump disconti- L.f ′ (a) is also denoted by f′ (a – 0), when (h > 0)
nuity. Right-hand derivative of f (x) at x = a is denoted by
2. Discontinuity of second kind— R.f′ (a)
If the L. limx → a f (x) and R. limx → a f (x) both do f (a + h) – f (a)
∴ R. f′ (a) = limh → 0 , if exist.
not exist, then f (x ) is said to have discontinuity of h
second kind. R.f ′ (a) is also denoted by f′ (a + 0), when (h > 0)
3. Mixed discontinuity— ∴ f ′ (a) exist, if both L. f′ (a) and R .f′ (a) exist and
If either L. lim x → a f (x) or R. limx → a f (x) does not are equal i. e.,
exist, then f (x) is said to have mixed discontinuity. L.f′ (a) = R.f′ (a) = f′ (a)
Economics (NET) | 309U
Derivability of a Function in an Interval—A (iii) Oscillatory—The infinite series
function f (x) is said to be derivable in an open interval u 1 + u 2 + u3 + ....... is said to be an oscillatory series, if
(a, b), if f (x) is derivable at every point in (a, b). limn→∞ Sn = limn→∞ (u1 + u2 +… + un ) is not defined or
A function f (x) is said to be derivable in a closed
oscillates between two limits.
interval [a, b ], if
4. Properties of Convergent and Divergent
(1) f (x) is derivable at x = a from right
Series—(i) The nature of an infinite series remains
(2) f (x) is derivable at every point in (a, b) unaltered by adding or removing a finite number of
(3) f (x) is derivable at x = b from left. terms.
Derivable Function—A function f (x) is said to be (ii) The nature of an infinite series remains
derivable, if f (x ) is derivable at each point in D (f) unaltered by multiplying or dividing the terms by some
[domain of f (x)]. fixed non-zero constant.
Sequence and Series (iii) If Σun and Σvn are two series such that 0 ≤ un
≤ vn for all n and Σv n is convergent, then Σun is also
1. Sequence—A set of numbers u1, u 2 , …,un … convergent.
formed according to some definite rule is called a (iv) If Σun and Σvn are two series such that un ≥ vn
sequence. A sequence is generally denoted by {un } i.e.,
≥ 0 for all n and Σvn is divergent, then Σun is also
{un } is a sequence, if it has one-one correspondence
divergent.
with set of natural numbers.
(v) If the infinite series Σun and Σv n both are
A sequence is called a finite sequence if it has a convergent, then Σ(u + v ), Σ(u – v ) and Σ(λ u + μ v )
finite number of terms. If the sequence has infinite are also convergent. n n n n n n
number of terms, then the sequence is called an infinite
sequence. (vi) If the series Σun of positive terms is convergent,
then limn→∞ un = 0.
1 3 5 7 9
Example 1. The set of numbers , , , , is a (vii) The series Σ un is divergent, if
2 2 2 2 2
2n –1 limn→∞ un ≠ 0
finite sequence, the n th term is given by un = ,
2
5. Leibnitz’s Test (Alternating series test)—The
where n = 1, 2, 3, 4……
infinite series u1 – u2 + u3 – u4 + …… is convergent, if
1 1 1
Example 2. The set of numbers 1, , , …...... is (i) u1 > u2 > u3 >u4 > …
3 9 27
1 and (ii) un → 0 as n → ∞
an infinite sequence with nth term un = n , where n = 0,
3 6. Geometric Series Test—The geometric series
1, 2, … a + ar + ar2 + … is—
2. Series—The sum of the corresponding terms of (i) Convergent when | r | < 1
the sequence u1, u2, u3… i.e., u1 + u2 + u3 +... is called a (ii) Divergent when r ≥ 1
series. (iii) Oscillatory when r ≤ – 1
A series is called a finite or infinite according as the 7. Hyperharmonic or p-Series Test—The infinite
corresponding sequence is finite or infinite. 1 1 1 1
series Σ p = p + p + p + … is
A series u1 + u2 + u3 +… is called a positive term n 1 2 3
series, if un > 0 ∀ n. (i) Convergent, if p > 1
A series u1 – u2 + u 3 – .... is called an alternating (ii) Divergent, if p ≤ 1
series, if un > 0 ∀ n. 8. Comparison Test—If Σun and Σvn are two series
The infinite series u1 + u2 + u3 + …… + un + …… of positive terms such that lim un
is finite (≠ 0), then
is denoted by Σ un and the sum of the first n terms series n→∞ vn
is denoted by Sn. Σ un and Σ vn behave alike.
∴ S n = u1 + u2 + u3 + … + u n Note—The test series Σ vn of the comparison test is
3. Nature of the Series : called the auxiliary series and
(i) Convergent—The infinite series highest power term in numerator of un
vn =
u1 + u2 + u3 +…....... is said to be convergent, if highest power term in denominator of un
lim S = lim (u + u2 + … + un) is finite. 9. D’Alembert’s Ratio Test—If Σun is a series of
n→∞ n n→∞ 1
un
(ii) Divergent—The infinite series positive terms and, if lim = L, then the series
n→∞ un+1
u1 + u2 + u3 + .…...... is said to be divergent, if is—
limn→∞ Sn =limn→∞ (u1 + u2 + … + un) = + ∞ or – ∞. (i) Convergent, if L > 1
310U | Economics (NET)
(ii) Divergent, if L < 1 Note—Cauchy’s test is useful when un can be
(iii) The test fails, if L = 1 expressed as nth power of something whose lim as n→∞
10. Raabe’s Test—If Σ u n is a series of positive is expressible.
⎛ u ⎞ 16. Cauchy’s Condensation Test—If Σ un i s a
terms and, if limn→∞ n ⎜ n – 1⎟ = L. Then the series series of positive terms and, if un + 1 < un, then the series
⎝ n+1 ⎠
u
Σ un and Σ an ua n (a > 1 any integer) behave alike.
is—
(i) Convergent, if L > 1 17. Cauchy’s Integral Test—If Σ u n is a series of
positive terms and f(x) be a continuous positive
(ii) Divergent, if L < 1
decreasing function of x(> 0) such that f(n) = un for all n,
∫
(iii) The test fails when L = 1 then Σ un and ∞f(x) dx behave alike.
Note—When Raabe’s test fails, then apply 1
D’Morgan and Bertrand’s test. 18. Kummer’s Test—Let a divergent series of
11. Gauss’s Test—If Σ u n is a series of positive positive terms Σ (dn)–1 be given, and let the terms of a
u series of positive terms Σ un be such that
terms and if the ratio n is expressed in the form
un + 1 ⎛ u ⎞
limn→∞ ⎜ dn n – dn + 1⎟ = L, then the series is—
un λ μ α ⎝ n+1u ⎠
= 1 + + 2 + 3 + …,
un + 1 n n n (i) Convergent, if L > 1
then the series is (ii) Divergent, if L < 1
(i) Convergent, if λ > 1 (iii) The test fails, if L = 1
(ii) Divergent, if λ ≤ 1 Note—D’Alembert’s and Raabe’s test are particular
cases of Kumar’s test and can be verified by taking
12. Logarithmic Test—If Σun is a series of positive
dn = 1 and dn = n respectively.
⎛ u ⎞
terms and if limn→∞ ⎜ n log n ⎟ = L, then the series is 19. Absolutely Convergent Series— A series Σ un
⎝ un + 1⎠ is said to be absolutely convergent, if the series Σ | un | is
(i) Convergent, if L > 1 convergent.
(ii) Divergent, if L < 1 20. Conditionally (or semi) Convergent Series—
(iii) The test fails, if L = 1. A convergent series Σ un is said to be conditionally
Note—If logarithmic test fails, then it is useful to convergent series, if Σ | un | is divergent.
apply higher logarithmic test. Note—If a series is convergent, then it is always
13. De Morgan and Bertrand’s Test— If Σ un is a convergent.
series of positive terms and if Exponential and Logarithmic Series
⎡⎢ ⎧ ⎛ un ⎞ ⎫ ⎤⎥
limn→ ∞ ⎢⎣ ⎨n⎜⎝ un + 1 – 1⎟⎠ – 1⎬ log n ⎥⎦ = L, then the
⎩ ⎭
lim
1. e = n→∞ (1 + 1n) n
series is 1 1 1 1
2. 1 + + + + .... + + .... is called e series.
(i) Convergent, if L > 1 1! 2! 3! n!
(ii) Divergent, if L < 1 3. e is finite and lies between 2 and 3. Its value
(iii) The test fails, if L = 1 approximately is 2·7183.
14. Higher Logarithmic Test—If Σ un is a series 4. e is an irrational number.
of positive terms and if 5. The infinite series
⎧⎛ un ⎞ ⎫ x x2 x3
1 + + + + ......
limn→∞ ⎨⎜ n log
un + 1 ⎟⎠
– 1 log n⎬ = L, then the series is 1! 2! 3!
⎩⎝ ⎭
is known as exponential series and is denoted by
(i) Convergent, if L > 1 ex.
(ii) Divergent, if L < 1 x x2 x3 x2
(iii) The test fails, if L = 1 6. ex = 1 + + + + .... + + ......
1! 2! 3! r!
15. Cauchy’s Root Test—If Σun is a series of x x2 x3 xr
positive terms and, if limn→∞ (un)1/n = L, then the series 7. e–x = 1 – + – +.....+(–1)r +...
1! 2! 3! r!
is— 2 4
(i) Convergent, if L < 1
8. ( x x
ex + e–x = 2 1+ + +.....
2! 4! )
x x3 x5
(ii) Divergent, if L > 1
(iii) The test fails, if L = 1
9. ex–e–x = 2 ( + + +.....
1! 3! 5! )
Economics (NET) | 311U
1 1 1 1 Rule 2. Differentiation of a constant.
10. e = 1 + + + +.....+ +...
1! 2! 3! n! Suppose the functional relationship is of the form :
1 1 1 1 y = C(C being constant)
11. e –1 = 1 – + – +.....+(–1)n +...
1! 2! 3! n! We can write this as y = Cx° (since x° = 1)
12. ( 1 1
e + e –1 = 2 1 + + +.....
2! 4! ) Applying Rule 1,
dy
= C(0)(x)0–1 = 0
13. e –e–1 = 2 ( 1 1 1
+ + +.....
1! 3! 5! ) dy
If y = c; then = 0
dx
14. ay = ey log a dx
y2 y3 Rule 3. Differentiation of sum and differences
= 1 + y (logea) + (log ea)2+ (log ea)3+ ....
2! 3! Let y = 7x3 + 5x5 – 3x6 + 8
x2 x3 x4 dy
15. loge (1+x) = x – + – + ..... We obtain by differentiating each term separately
2 3 4 dx
x2 x3 x4 by applying rules 1 and 2.
16. loge (1–x) = –x – – – – .....
2 3 4 dy d d d d
= (7x 3 )6 (5x 5 ) – (3x 6 ) + (8) = 21x 2 +
x3 x5
17. log
1+x
1–x (
= 2 x + + +.....
3 5 ) dx dx
25x4 – 18x5
dx dx dx
x2 x4 x6 If y = u + v + w;
18. log (1+x) (1–x) = –2 ( + + +.....
2 4 6 ) then =
dy du dv dw
+ +
1 1 1 dx dx dx dx
19. loge 2 = 1 – + – +..... Rule 4. Differentiation of a product
2 3 4
Some Important Formulae for Logarithms dy du dv
If y = UV; then = V · + U ·
dx dx dx
20. If ax = y, then x = loga y More generally, If y is expressed as a product of
21. loga a = logb b = 1 four functions of x, i.e., if y = SUVW, then;
22. loga 1 = 0, logb 1 = 0 dy dw dv du ds
= SUV + SUW · + SWV · UVW+
dx dx dx dx dx
1
23. logb a . loga b = 1 or logb a = Rule 5. Differentiation of a quotient.
loga b
U
24. logb a = logc a . logbc If y =
V
logca
=
logcb
then
dy
=
( ) ()
V·
du
dx
– U·
dv
dx
25. loga mn = loga m + logan dx V2
m Rule 6. Differentiation of a function of a function
26. loga n = loga m – loga n (chain rule).
Let us suppose that consumption is not related to
27. loga mn = n loga m
total utility directly but indirectly via income (1).
28. a log a n = n And our problem is what will be the change in total
utility if consumption changes by one unit. Here we
29. loga an = n
have to apply the rule for differentiation of a function of
a function.
Differential Calculus and Its 1 x
Applications Assume that y = and 1 =
2 5
Rules of Differentiation x
Take the expression 1 = ; here differentiating I
Rule 1. Functions in power terms (ax n ). 5
Let us suppose that the functional relationship w.r.t. x (which represents changes in I due to a small
between x and y is of the form : y = axn, where a is some change in x), we get
contant term dI 1
=
dy dx 5
In this case = anxa – 1 1 dy 1
dx Also when y = , then = =
Thus our first rule of differentiation about power 2 dI 2
terms is as under : Thus now we have two derivatives,
dy dy 1 dy 1
If y = axn = anxa – 1 = and =
dx dI 5 dI 2
312U | Economics (NET)
But we need the change in y with small change in dy
More specifically, as measures that rate at which y is
dy dx
x , i.e., we need . The result can be obtained by
dx d2 y
changing w.r.t. small changes in x ; similarly
following rule : dx2
dy dy dI 1 1 1 dy
= = · = measures the rate at which is changing w.r.t. small
dx dI dx 2 5 10 dx
This particular way of getting the desired derivative dy
changes in x. In other words, measure the rate of
in case of a function of a function is known as Chain dx
Rule. d2 y
change in y = 8x4 as x changes, while 2 measures the
dx
SL Form of Function Derivative (dydx) rate of change of the rate of change (that is 32x3) as x
No. Function
change.
1. Power terms y = axn anx–1 Some-Notations
2. Constant y=C 0 The successive differential coefficients or deriva-
3. Sum and y=U±V dU dV tives of the original functions are also conveniently
±
differences dx dx denoted in a particular short form as follows :
4. Product y = UV d(U) d(V) If the given function is denoted by symbol : y f(x);
V· +
dx dx then
5. Quotient U d(U) d(V) First differential coefficient or first derivative is
y= V· – U·
V dx dx denoted by f(x).
V2
Second differential coefficient or second derivative
Some Standard Results is denoted by f(x).
SL Form of Function Derivative Third differential coefficient or first derivative is
No. Function denoted by f(x).
1. Trigonometric y = sin x cos x Sign of Derivative and Nature of Function
y = cos x –sin x dy
1 1. If > 0, i.e., when first derivative of the given
y = tan x sec2 x = dx
cos2 x
1 function is positive, the curve rises fro left to
y = cot x –cosec2 x = right.
sin 2 x
y = sec x sec x, tan x dy
2. If < 0, i.e., when first derivative of the given
y = cosec x –cosec x, cot x dx
2. Exponential y = ex ex function is negative, the curve falls form left to
y = e–x –e–x right.
y = eexx aexx
dy
y = ax ax log a a 3. If = 0, i.e., when first derivative of the given
dx
3. Logarithmic y = log x 1
x
function is zero, the curve remains stationary
for a moment and then changes its course.
Derivatives of Higher Order Therefore, this point is minimum, maximum or
Let us consider a functional relationship between point of inflexion.
two variables x and y, y = 8x4 ; if we want to measure the Second Derivative and Nature of Curve
dy
rate of change in y due to a small change in x, we find The first derivative refers to the absolute value of
dx function and the second derivative refers to the slope of
of this expression which is given by : the curve. Thus with the help of second derivative we
dy are able to decide about the rising and falling nature of
= 32x3
dx the curve.
This expression 32x3 can once again be differen- We consider the following four possible cases :
tiated as Case 1. f• (x) > 0 and f•• (x) > 0
d This would mean that the value of function is
(32x3) = 96x2,
dx increasing at an increasing rate or that the slope of the
dy curve at this point is positive and increasing as the value
which is in fact the derivative of . In the terminology of x increases. In this case the curve is concave upwards.
dx
of calculus we call this expression (96x2) as the second Case 2. f• (x) > 0 and f•• (x) < 0
differential coefficient of y = 8x 4 . To represent this This would mean that the value of function is
symbolically, we write increasing at a decreasing rate or that the slope of the
d2 y curve is positive but decreasing as the value of x
= 96x2, increases. In this case the curve is concave downwards.
dx2
Economics (NET) | 313U
Case 3. f•(x) < 0 and f••(x) < 0 which is numerically equal to
p
if the sign is x
This means that the value of function is decreasing x
at a decreasing rate or that the slope of the curve must be ignored.
negative and decreasing as x increases. (Note that this Example : The total cost function is
means that the negative slope of the curve tends to π=⎯ √⎯⎯⎯⎯⎯⎯
ax + b + c.
become steeper and steeper as the value of x increases).
In this case the curve is concave downwards. Find an expression for marginal cost and show that
it decreases as output increases.
Case 4. f•(x) < 0 and f ••(x) > 0
This means that the value of function is decreasing Ans. π = ⎯⎯⎯⎯⎯⎯⎯
√ ax + b + c
at an increasing rate or that the slope of the curve is d(π)
∴ MC =
negative but increasing as the value of x increases. dx
Remember that this means that the negative slope tends d
to become less steep as x increases. In this case the ⇒ MC = (√
⎯⎯⎯⎯⎯⎯⎯
ax + b + c)
dx
curve is concave upwards.
d(⎯
√⎯⎯⎯
ax + b) d(c)
Conditions for Maximum-Minimum Values ⇒ MC = +
dx dx
A. Conditions for minimum value a
1. First order condition ⇒ MC =
(Necessary condition) } f(x) = 0 2√⎯⎯⎯⎯
ax + b
3
2. Second order condition d(MC) 1
= – (ax + b)2 < 0
(Sufficient condition) } f(x) = 0 dx 4
B. Condition for maximum value Since the first derivative of the MC curve is
1. First order condition negative it means that as x increases MC falls.
(Necessary condition) } f(x) = 0
Example : If the demand law is x =
20
, find ed
2. Second order condition p+1
(Sufficient condition) } f(x) = 0 with respect to price at the point, where p = 3
Ans. We are given
Note that first order condition is the same for both
maximum and minimum values. 20 dp –20
x = ∴ =
C. In certain cases p + 1 dx (p + 1)2
When f •• (x) = 0, the above conditions fail to give dx –20 –5
At p = 3, = =
the maximum or minimum values of the given function. dp (4) 2 4
p dx 3 –5 –3
If f ••(x) = 0, it means there may be a point of ∴ ed = · = × =
inflexion. x dp 5 4 4
Application of Derivatives in Economic Theory 3
| ed | =
4
Example : Show that marginal revenue can always
a
(
be expressed as p + x )
dp
dx
. Deduce that the gradient of Example : Show that the demand curve p =
x+b
–c
p is downward sloping and convex from below. Do the
the demand curve is numerically equal to at the output same properties hold the marginal revenue curve.
x
where MR is zero. Ans. Condition for demand curve to be downward
Ans. The demand function is p = f(x). sloping is f(x) < 0
TR = px = x.f(x) and condition for demand curve to be convex from
below is f′ (x) > 0
d(RT) d
MR = = {xf(x)} a
dx dx Q p = –c
x+b
d d
= x [f(x)] + f(x) (x) dp a
dx dx ∴ = – <0
dx (x + b)3
dp
MR = x +p hence demand curve is downward sloping.
dx d2 p 2a
when MR = 0 putting in (i) we have = >0
dx2 (x + b)3
dp p hence demand curve is convex from below
= –
dx x d(TR) ax
dp Q MR = = – cx
But is the slope of the demand curve, hence dx x+b
dx d(MR) (x + b) (a) – ax
when MR = 0 the slope of the demand curve is = –c
dx (x + b)2
dp p d(MR)
= – Since > 0, It is upward sloping.
dx x dx
314U | Economics (NET)
d2 (MR) –2cx – 2bc When the firm fixes the price :
and = <0
dx2 (x + b)4 Given :
hence it is concave from below assuming a > 0, b > 0. Total Cost = C
Thus the same properties do not hold true. 1
Example : A firm has the following total cost and = Q3 – 7Q2 + 111Q + 50
3
demand functions.
Demand Q = 100 – p
1
C = Q3 – 7Q2 + 111Q + 50Q Total revenue = p × Q
2
= p(100 – p)
and Q = 100 – p
= 100p – p2
Find profit maximizing level of output; also find
profit at this level of output. Similarly, TC which is given in terms of Q must
now be changed in terms of p.
Ans. We are given
1
Q = 100 – p ∴ TC = (100 – p)3 – 7(100 – p) 2 + 111
3
or p = 100 – Q (100 – p) + 50
Assuming that the profit maximizing level of output π = TR – TC = (100p – p2 )
is Q.
∴ TR = Q × p – [ 1
3 ]
(100 – p)2 – 7(100 – p) 2 + 111(100 – p) + 50
= Q(100 – Q)
First order condition for maximizing total profit :
= 100Q – Q2
dπ
Profit π = TR – TC = (100 – 2p) + (100 – p) 2 – 14 (100 – p) + 111 = 0
dp
= (100Q Q2) – ( 1 3
2
Q – 7Q2 + 111Q + 50) ⇒ 8811 – 188p + p2 = 0
(p – 89)(p – 99) = 0
1
= Q3 + 6Q2 – 11Q – 50 ∴ either p be fixed at 89 or at 99 units to maximize
3 the net revenue.
First order condition for maximizing total profit If p = 89, and since Q = 100 – p, Q = 11 which is
dπ the same level of output as we got by first method.
= – Q2 + 12Q – 11 = 0
dQ If p = 99, Q = 1 which is not possible as has been
⇒ (Q – 1) (11 – Q) = 0 explained in first method.
⇒ Profit will be maximum when either Q = 1 or Example : A monopolist firm has the following
total cost and demand functions :
Q = 11. To decide between the two quantities apply
second order condition : C = aQ2 + bQ + c
d2 π p = β – αQ.
= –2Q + 12
dQ2 what is the profit maximizing output level when the firm
is assumed to fix the output? Verify that this is the same
which should be < 0
result as when firm fixed the price.
(a) Substitute Q = 1, the inequality does not hold Ans. 1. When firm fixes the output level.
good.
TR = Qp
(b) Substitute Q = 11, the inequality holds good.
= Q(β – αQ)
Therefore, output level of 11 units is the only d(TR)
profit maximizing level. The total profit at this level of ∴ MR =
dQ
output will be = β – 2aQ
1
π = (11)3 + 6(11)2 – 11(11) – 50 = 111·33. TC = C = aQ 2 + bQ + c
3
d(TC)
In above example, if the firm is assumed to act as ∴ MC = = 2aQ + b
dQ
monopolist with the object of maximizing net revenue, it
fixes the output Q and leaves the price to be determined condition for profit maximizing output level is
by the demand conditions; alternatively, the firm can MR = MC
also fix its price and let demand condition determine the i.e., β – 2αQ = 2aQ + b
approximate output. Let us examine here how the result β – b = 2aQ + 2αQ
of the above example is affected if the firm is assumed β–b
∴ Q =
to fix the price. 2(a + α)
Economics (NET) | 315U
Hence, profit maximizing level of output is Example : The production function of a commodity
β–b is given by
{ 2(a + α)} .
Q = 40F + 3F2 –
F3
2. When firm fixes the price. Now TR and TC 3
should be put in terms of price p. where Q is the total output and F is the units of
Since p = β – αQ inputs.
β–p (i) Find the number of units of input required to give
Q =
α maximum output.
β–p βp – p2
TR = Qp = ( ) α
=
α
(ii) Find the maximum value of marginal product.
(iii) Verify that when the average product is
βp – p 2
maximum, it is equal to marginal product.
MR =
α
dQ
d(TR) Ans. (i) MP of F =
= dF
dp
3F2
β–p 2 β–p = 40 + 6F –
TC = a ( ) ( )
α
+b
α
+c
= 40 + 6F – F2
3
d(TC) For maximum or minimum : 40 + 6F – F2 = 0
MC =
dp or, (F + 4) (F – 10) = 0
=[ –2aβ + 2ap b
α2
–]α
i.e.,
2
d Q
F = – 4 or 10
For profit maximization MR = MC = 6 – 2F
dF 2
∴
1
α
(β – 2p) =( –2aβ + 2ap b
α2
–)α
when F = –4
d2 Q
= 14 < 0
2aβ + αβ + ab dF 2
This gives, p =
2(α + a) and when F = 10
Since the demand function is p = β – αQ 2
d Q
= –14 < 0
2aβ + αβ + αb dF 2
∴ = β – αQ
2(α + a) i.e., output is maximum when 10 units of input are
2aβ + αβ + ab used.
or, αQ = β –
2(α + a) dQ
(ii) MPF =
β–b dF
i.e., Q =
2(α – a) = 40 + 6F – F2
which is the same level as when firm fixes the dQ
output. For MPF to be maximum : should be = 0
dF
Example : For the Cobb-Douglas function or, 6 – 2F = 0
Q = ak2L1 – a F = 3
where k is capital, L is labour and a is constant, 2
d Q
verify that : = 2<0
dF 2
dQ dQ
K +L = Q MPF is maximum when F = 3.
dK dL
Ans. Gives : F2
(iii) AP = 40 + 3F –
Q = ak2L1 – ∞ 3
dQ For APF to be maximum :
∴ = a2ka – 1L1 – ∞
dK d(AP) 2F 2F
dQ = 3– =3–
and, = a(1 – a)kaL–a dF 3 3
dL should be = 0
dQ dQ 9
∴ K +L = K(a2 La–1L1–a ) or, F =
dK dL 2
+ L[a(1 – a)K2L–a] d2 (AP) 2
2 a 1 – a a 1–a and, = <0
=a K L + a(1 – a)k L dF 2 3
= a2 Ka – 1L1 – a[a + (1 – a)] 9
∴ AP is max, when F =
= Q; hence proved 2
316U | Economics (NET)
AP (when F = 92) Hence
dx2
dp1
>0
= 40 + 3( ) –
9 81 For demand function : x1 = p1 0··5 p2 –0·2
= 46·75
2 12 dx2
= 0·5p 1–0·5 p2 –0·2 which is also a positive Hence
MP(When AP is max i.e. F = )
9 dp1
2 dx2
81 187 > 0.
= 40 + 27 – = = 46·75 dp1
4 4 Therefore, the commodities X1 and X2 are compe-
Technique of Partial Differentiation titive.
The process of taking partial derivative is called Partial elasticities of demand for demand function :
partial differentiation and it differs from previously x1 = p1 –1·7 p2 0·8 are given by
discussed differentiation and it differs from previously p dx p
discussed differentiation primarily in that we hold and 1. 1 · 1 = –1·71 0·8 {(–1·7)p1–2·7 p2 0·8} = (–1·7)
treat all the independent variables constant except the x1 dp1 p1 p2
one which is assumed to vary. p dx p
2. 2 · 1 = –1·72 0·8 {(–1·8)p1–1·7 p2 0·8} = (+0·8)
The practical technique of partial differentiation is x1 dp2 p1 p2
illustrated by the following example : Elasticities for demand function
Example : Given function is U = 5x – 6y + 8 and
x2 = p1 0·5 p2 –0·2 are given by :
we are required to find partial derivatives. There can be
only two partial derivatives. p dx p
3. 2 · 2 = –0·5 2 –0·2 {(–0·2)p1–0·5 p2 1·2} = (–0·2)
(1) U with respect to x when y is held constant i.e., x2 dp2 p1 p2
dU p dx p
or fx. 4. 1 · 2 = 0·5 1 0·2 {(0·5)p1–0·5 p2 0·2} = (–1·7)
dx x2 dp1 p1 p2
and (2) U with respect to y when x is held constant
dU Example : If the utility function is :
i.e., or fx.
dx
U = (ax1 + bx2 + c√⎯⎯⎯x1x2)
In case of (1), since y is held constant it is treated as
a constant term during differentiation; while in case of where x1 and x2 are two goods consumed by a
(2), since x is held constant it is treated as a constant person and U is the utility derived therefrom; obtain
term during differentiation; thus we have ratio of marginal utilities.
dU dU 1 1
(1) f = 5 – 0 + 0 = 5 (–6y and + 8 are treated as Ans. = a + c(x1 x2)–2 ·x2
dx x dx1 2
constant terms)
2a⎯
√⎯⎯
x1x2 + cx2
dU =
dU 2√
⎯⎯⎯
x1x2
(2) = f x = 0 – 6 + 0 = – 6 (5x and + 8 are d x
dx dU 1 1
treated as constant terms) and = b + c(x1 x2)–2 ·x1
dx2 2
Similarly if z = ax + by + c then
dz dz 2b⎯
√⎯⎯
x1x2 + cx1
= a and = 6 =
dx dy 2√
⎯⎯⎯
x1x2
Example : Following are the demand functions for So that the ratio of marginal utilities of two goods x1
two commodities X1 and X2 : and x2 is
x1 = p1–1·7p2 0·8
dU
x2 = p1 0·5p2 –0·2
dx1 2a⎯ √⎯⎯x1x2 + cx2
Determine whether the commodities are comple- = =
dU 2b⎯ √⎯⎯x1x2 + cx1
mentary or competitive; also find four partial elasticities
dx2
of demand.
Ans. In order to find the nature of commodity we Example : Find the point where the utility function :
must find the cross partial derivatives : U = 48 – (x – 5)2 – 3(y – 4)2
dx1 dx will have maximum or minimum value, if it is
and 1
dp1 dp1 subject to x + 3y = 9.
For demand function : x 1 = p1 –1·7 p2 0·8 Ans. Combining the two functions through
dx1 Lagrange's multiplier λ,
= 0·8p1 –1·7 p2 –0·2, which is positive quantity.
dp1 Z = 48 – (x – 5)2 – 3(y – 4)2 + λ(x + 3y – 9)
Economics (NET) | 317U
First order condition gives the following results : Example : Given the function: U = x2 + y2 + w2
dz subject to a linear constraint y + x + w = 1; find at what
fs = = –2(x – 5) + λ = 0 point U has a maximum or minimum value. Find also
dx
dz the value of U.
fy = = –6(x – 4) + 3λ = 0 Ans. Combining the function and constraint through
dy
dz Largrange's multiplier l, we form;
fl = = x + 3y – 9 = 0 z = x2 + y 2 + w2 + l(x + y + w – 1) = 0
dλ
Solving these three equations, we get First order condition :
x = 3, y = 2 and λ = –4 dz dz
fx = = 2x + l = 0; fy = = 2y + λ = 0
In other words, the given function: U = 48 – (x – 5)2 dx dy
– 3(y – 4)2 will have either maximum or minimum value dz
(since we have considered only first order condition) at fw = = 2w + λ = 0
dw
point (3, 2) and the value of the given function will be : dz
48 – (3 – 5) 2 – 3(2 – 4)2 = 32. fλ = =x+y+w–1=0
dλ
Second Order Conditions For Maximiza- Solving these equations, we obtain
tion : Hessian Determinant 1
(Maximisation Under Constraints) x = y=w=
3
Suppose q = ax2 + 2hxy + b y2 which is subject to 2
and λ = – .
constraint: αx + βy = 0 3
α
∴ ()
y =
β
x In other words, function U can have either
substituting y in q, we get
minimum value of maximum value at point ( 1 1 1
)
‚ ‚ .
3 3 3
α α 2 We apply second order condition to decide about this.
( ) ( )
q = ax2 + 2hx – x + b – ·x
β β Second order condition :
i.e., q = (αβ2 – 2hαβ + bα2 ) 2
x 2
⎪ 0 1 1 1 ⎪
β — ⎪ 1 2 0 0 ⎪
The value of q will be positive if and only if Bordered Hessian | H | =
⎪ 1 0 2 0 ⎪
⎪⎪ 0 α β ⎪⎪
⎪ α a h ⎪ < 0,
⎪ 1 0 0 2 ⎪
⎪ ⎪ The principal minors are
⎪⎪ β h b ⎪⎪
⎪⎪ 0 1 1 ⎪⎪
| H2 | = ⎪ ⎪
and value of q will be negative if and only if —
⎪⎪ 0 α β ⎪⎪ ⎪1 2 0 ⎪=–4<0
⎪⎪ 1 0 2 ⎪⎪
⎪ α a h ⎪ < 0,
⎪ ⎪
⎪⎪ β h b ⎪⎪ ⎪ 0 1 1 1 ⎪
— ⎪ 1 2 0 0 ⎪
it can be noticed that this determinant is different
⎪⎪ a h ⎪⎪
| H3 | =
⎪ 1 0 2 0 ⎪ = –12 < 0
from the determinant ⎪
⎪ h b ⎪⎪
when the quadratic ⎪ 1 0 0 2 ⎪
function was of the form q = ax2 + 2hxy + by2 and when That is, all the principal minors are < 0, therefore,
it was considered without any side condition. d 2
z will have positive value.
Comparing the two determinants of two different Since d2 z possesses positive value, the given
cases, we find that determinant of constrained function function will have minimum value at point 1‚ 1‚ 1 .
contains one extra row and one extra column. Further ( 3 3 3)
more, the extra row and column is merely composed of ∴ U = x2 + y2 + w2
the two coefficients of α and β from the constraint plus a
zero element in the principal diagonal.
Since this extra row and column is on the border of
=() () ()
1 2
3
+
1 2
3
+
1 2 1
3
=
3
⎪ a h ⎪⎪
the determinant ⎪
The Theory of Consumer Behaviour
⎪⎪ h b ⎪⎪, we call the Hessian of the Example : Suppose that a consumer has R 90 to
constraint function. be divided between two commodities x and y and
⎪⎪ 0 α β ⎪⎪ suppose the unit price of y is fixed at R 0·20. What will
⎪ ⎪
= ⎪ α a h ⎪ as Hessian
be his demand equation for x if his utility function is :
U = log Qx + 2 log Qy (where Qx and Qy are the amounts
⎪⎪ β h b ⎪⎪ of x and y consumed by him).
318U | Economics (NET)
Ans. Condition for utility maximisation is Equation (iii) gives :
MUx P L0·3L–0·3 = 4
= x
MUy Py
Q U = log Qx + 2log Qy
i.e., L· ( )3 0·3
14
= 0
dU 1 [by substituting from (iv)]
∴ MUx = –
dQx Qx
and MUx =
dU 2
–
∴ L=4 ( )
14
3
0·3
= 4(4·6)0·3
dQy Qy
Substituting all the values in the above condition,
and K = ( )
6 14 0·3
7 3
we get = 0·86(4·6) 0·3
1
Qx
2 P Q P
In other words, the firm should use {( ) }
4
14 0·3
3
= x or, y = x
2Qy 0·20 2Qx 0·20 and {( ) }
6 14 0·3
7 3
unit of labour and capital respecti-
∴ 2P xQx = 0·2Qy … 1 vely for on output rate of 20. This will incur the firm
Substitute the value of Qy from the given budget minimum cost (and bring maximum profit).
constraint : Example : A firm’s production function is q = 12
P x·Qx + Py·Qy = 90 1
– (L + K). The prices of labour, capital and output
∴ 0·2Qy = 90 – QxPx LK
are R 1, 4 and 9 respectively. Find the maximum profit
∴ Eq. (1) becomes : combination of capital, labour and output.
2pxQx = 90 – QxPx
Ans. The cost equation : C = L + 4K. Assuming
30 level of output = q that maximises the firm’s profit,
Qx = is the required demand function.
Px ∴ π = 9q – L – 4K
The Theory of the Firm For constrained profit maximisation we construct a
Example : A firm’s production function is Q = new function
5L0·7K0·3. The price of labour is R 1 per unit and the
price of capital is R 2 per unit. Find the minimum cost
combination of capital and labour for an output rate of
[
Z = 9q – L – 4K + λ q – 12 +
1
LK
(L + K)]
20. First order condition :
Ans. The cost equation : dZ
= 9+λ=0
C = L + 2K. dq
Production function : dZ
= –1 – λL –2 = 0
Q = 5L K 0·7 0·3 dL
For cost minimization under the dZ
= –4 – λK–2 = 0
Constraint : dK
Solving these equations, we obtain
Q = 5L0·7K0·3 = 20
2
Z = L + 2K + λ[20 – 5L0·7K0·3] L = 3, K =, q = 11 and π = 90
3
First order condition gives :
Example : Given the function : U = Axb yc; A, b and
dZ c are constants.
= 1 – 3·5 λL –0·3K0·3
dL A. Find the conditions under which this is a linear
= 1 – 3·5 λ(K/L)0·3 = 0 …(i) homogenous function;
dZ B. Apply Euler’s theorem if these conditions hold
= 2 – 1·5 λL 0·7K–0·7
dK true.
= 2 – 1·5 λ(K/L)–0·7 = 0 …(ii) Ans. A. Let each variable be increased by constant
dZ 0·7 –0·3
1 times, the new function becomes :
= 20 – 5L K = 0 …(iii)
dλ = A(xt)b (yt)c
Equations (i) and (ii) give : = A.tb + c.xb.yx
= tb + c·A.xb ·yc
()
3·5
K 0·3
L
= ()
1·5 K –0·7
2 L = tb + c (U)
L 14 In other words, the given function is homogeneous
i.e., =
K 3 function of (b + c) degree. The given function will be
Economics (NET) | 319U
linearly homogenous when b + c = 1. B. Euler’s theorem Since x = 11 – 2p1 – 2p2
states : 3
If f(x, y) is the homogeneous of the kth degree then ∴ x =
2
Kf(x, y) = xfx(x, y) + y.fy(x, y) 7
In our case given function is U = Axby c which is and y = 16 – 2p1 – 3p2 =
2
homogenous of degree (b + c)
πmax = (p1x + p2 y) – (3x + y)
Hence, (b + c).U
( ) ( )
= x b·
U
x
+ y c·
U
y
=
8[
21 21
+
2 ] [ ] = 418
–
9 7
+
2 2
= x(A.b.x y ) + y(A.Cx b .yc – 1)
b – 1 x = 5·13
7
( ) ( )
= x b·
U
x
+ y c·
U
y
That is, the monopolist should fix the prices at
4
and
3 for two commodities x and y to maximize his gross
= U(b + c), which proves the theorem.
profit, which would be equal to 5·13 units.
The theory of market Equilibrium
Example : The demand functions of two com-
Example : The demand functions of two compe- modities x and y are :
titive commodities are :
p1 = 8 – 2x and p2 = 14 – y2 and joint cost function is
x = 11 – 2p1 – 2p2
y = 16 – 2p1 – 3p2 C = 10 + 4x + 2y
and the average cost of production of the commodities Determine the quantities that miximise the profit of
are constants, 3 and 1 respectively. Determine prices and monopolist and also find the maximum profit.
quantities that maximize the profit. Ans. Profit π = TR – TC
Ans. Suppose the monopolist in question produced = (p1x + p2 y) – (10 + 4x + 2y)
x and y units of two commodities which are sold at p1 = (8 – 2x)x + (14 – y2)y – (10 + 4x + 2y)
and p2 prices.
= –y 3 + 12y + 4x = 2x2 – 10
Total revenue : TR = p1 x + p2 y
First order condition
Total cost : TC = 3x + y
dπ
Total profit : π = TR – TC = 4 – 4x = 0
dx
= (p1x + p2 y) – (3x + y) dπ
substituting x and y is terms of p1 and p2 from = – 3y2 + 12 = 0
dy
demand functions : So we get x = 1 and y = ± 2.
π = p1 (11 – 2p1 – 2p2 ) + p2 (16 – 12p1 – 3p2 ) As y cannot be negative, we consider solution :
– {3(11 – 2p1 – 2p2 ) + (16 – 2p1 – 3p2 )} x = 1, y = 2.
π = 19p1 + 25p2 – 4p1 p2 – 2p1 2 – 3p2 2 – 49 To ensure the π is maximum at (1, 2), we apply
second order condition :
First order condition :
d2 π
dπ = –4<0
= 19 – 4p2 – 4p1 = 0 dx2
dp1
d2 π
dπ = – 6y = –6 × 2 = –12 < 0
= 25 – 4p2 – 4p1 – 6p2 = 0 dy2
dp2
At x = 1
Solving Equations (1) and (2), we get
and y = 2
7
p1 = and p2 = 3 p1 = 6
4
and p2 = 10
To ensure that π is maximum at ( ) 7
4
‚ 3 , we apply
and πmax = (p1x + p2 y) – (10 + 4x + 2y)
second order condition : = 12 – 18 = 8
d2 π
= –4<0 The producer would fix the output levels of
dp1 commodities x and y at 1 and 2 respectively to maximise
d2 π his gross profit; which would be 8 with given prices 6
= –6<0
dp2 2 and 10 of the commodities in the market.
Hence this condition is satisfied for maximum value. Example : A monopolist firm produces two types
of chocolate, X1 and X2 at constant average costs of
Therefore, π is maximum at ( ) 7
4
‚3 R 2·50 and R 3·00 per kilo respectively. If P1 and P2 are
320U | Economics (NET)
prices charged (per kilo) and the market demands are If there had been 2 monoplists each producing the
given by, chocolate independently, then
X = 5(P– P) πx1 will have to be maximized assuming that the
X = 32 + 5P1 – 10P 2 other monopolists will not change his price, i.e., P2 will
obtain the levels at which prices will be fixed for the be taken as constant.
two types of chocolates for maximum joint monopoly πx1 = 5P 1 P 2 – 5P 1 2 – 12·50P2 + 12·50P1
revenue.
dπx1
Find also the prices of two types of chocolates fixed = 5P 2 – 10P 1 + 12·50 = 0 …(iii)
dP 1
by two independent monopolists and show that they are
less than the joint monopoly prices. Again, πx1 = 32P2 – 5P1 P 2 – 10P2 2 – 96 – 15P1
Ans. Suppose the monopolist produces x 1 quantity + 30P2
of X chocolate and x2 quantity of X2 chocolate. Assuming that P1 remains constant for maximizing
∴ Total cost of x1 = C x1 πx2, we get
= ACx1 × x x dπx2
= 62 + 5P1 – 20P 2 = 0 …(iv)
= 2·50x1 dP 2
Total Revenue of x1 = Rx1 Solving equations (iii) and (iv), we get
= P 1 × x1 P 1 = 3·2 and P2 = 3·9 (approx.)
= P 1 × 5(P2 – P 1 ) Thus it can be observed that price in the present
∴ Profit from x 1 = R x1 – C x1 case are less than the joint monopoly prices.
πx1 = 5P 1 (P2 – P 1 ) – 2·50x1 Discriminating Monopoly
πx1 = 5P 1 (P2 – P 1 ) Example : Under discriminating monopoly that
– 2·50{5(P 2 – P 1 )} demand curve of a monopolist is made up of two parts :
πx1 = 5P 1 – 5P 1 – 12·50P2
2 P 1 = 140 – 7q1
+ 12·50 P1 q
and P 2 = 90 – 2
Again total cost of x2 is Cx1 = AC x1 × x2 = 3x2 2
Total Revenue of x2(Rx2 ) = P 2 × x2 Total cost curve is given :
C = 20 + 2q + 3q2 (q = q1 + q2 )
Rx2 = P 2 (32 + 5P 1 – 10P 2 )
Assuming that the first maximizes profit, determine
∴ Profit form
the prices it will set in the two markets.
x2(πx2 ) = R x2 – C x2
Ans. Let TR1 and TR2 represent the total revenues
πx2 = P 2 (32 + 5P 1 – 10P 2 ) – 3(32 in the markets I an II and respectively.
+ 5P1 – 10P 2 ) TR1 = P 1 q1
πx1 = 32P 2 + 5P1P 2 – 10P 2 2
⇒ TR1 = 140q1 – 7q1 2
– 96 – 15P1 + 30P2 d(TR1 )
Gross (Joint) Profit ∴ MR 1 =
dq1
π = πx1 + πx2 ⇒ MR 1 = 140 – 14q1
i.e., π = 10P 1 P 2 – 2·50P1 + 49·50P2 TR2 = P 2 q2
– 5P1 2 – 30P 2 2 – 96 q2
To maximize gross profit : (Assuming that the fixes ⇒ TR2 = 90q2 – 2
2
prices to maximize profit) d(TR2 )
dπ d2 π ∴ MR 2 =
= 0 and <0 dq2
dP 1 dP 1 2 ⇒ M2 = 90 – q2
dπ d2 π d(c)
and = 0 and <0 and MC = = 2 + 6q
dP 2 dP 1 2 dq
dπ Condition for profit maximization for discriminating
= 10P 1 – 2·50 – 10P1 = 0 …(i) monopoly is MR1 = MR2 = MC; but since MC involves
dP 1
q in its function (MC = 2 + 6q), we shall not be able to
dπ
= 10P 1 + 49·50 – 20P2 = 0 …(ii) calculate the value of q 1 and q 2 using this condition
dP 2 directly. We follow that method by which we first obtain
Solving equations (i) and (ii), we get the value of q and then of q1 , q2 , p1 and p2.
P 1 = 4·45 and P2 = 4·70 MR 1 = 140 – 14q1
Economics (NET) | 321U
And MR 2 = 90 – q2 Duopoly
MR 1 Example : Suppose there are only two firms in an
∴ q1 = 10 –
14 industry producing a homogeneous product. Market
and q2 = 90 – MR 2 demand function is P = 140 – 0·6 Q and the cost
functions of the duopolists are C1 = 7Q1 and C2 = 06.Q2 2 .
q = q1 + q2 We are required to find the equilibrium output of each
MR 1 duopolist ignoring their interdependence.
= 100 – – MR 2
14 Ans. (a) Profit of duopolist can be obtained as
15 under :
q = 100 – MR
14 π1 = PQ1 – C 1
[Q MR1 = MR2 = MR] ⇒ π1 = {140 – 0·6(Q1 + Q2 )} Q1 – 7Q1
For profit maximization MR = MC, and π2 = PQ2 – C 2
15 ⇒ π2 = {140 – 0·6(Q1 + Q2 )Q 2 – 0·6Q2 2
i.e., q = 100 – (MR)
14 Since Q = Q1 + Q2
15
or, q = 100 – (MR) ∴ π1 = 133Q1 – 0·6Q1 2 – 0·6Q1 Q3
14
and π2 = 140Q2 – 1·2Q2 – 0·6Q1 Q2
15
or, q = 100 – (2 + 6q) 1st order condition
14
(Q MC = 2 + 6q) dπ1
= 144 – 1·2Q – 0·6Q2 = 0
dQ1
685
or, q = dπ1
52 and = 140 – 2·4Q2 = 0·6Q1 = 0
dQ1
i.e., for profit maximization the total output to be
685 Thus we have two equations :
sold in the two markets should be = units
52 1·2Q1 + 0·6Q2 = 133 …(1)
MC = 2 + 6q 0·6Q1 + 2·4Q2 = 140 …(2)
⇒ MC = 2 + 6 ( ) 685
52
The equilibrium output is given by their point of
intersection; thus solving them for Q1 and Q2, we obtain :
2107 Q1 = 93·3
⇒ MC =
26 and Q2 = 35·0
For profit maximization MR1 = MC
π1 = 5227
2107
i.e., = 140 – 14q1 and π2 = 1471
26
The second order conditions are satisfied for this
1533
or, q1 = solution :
364
d2 π1
Also, P 1 = 140 – 7q1 = –1·2 < 0
dQ12
∴ P 1 = 140 – 7( )1533
364 and
d2 π2
dQ22
= –2·4 < 0
5747
⇒ P1 = (b) Consider mutual collusion.
52
Agian, MR 2 = MC If duopolists recognize their mutual interdepen-
dence and agree to act untidily in order to maximize
2107 their total profit jointly. It becomes a case of monopoly.
i.e., = 90 – q2
26
Let us solve the above example with this assumption.
233
or, q2 = , Since gross profits of both together are to be
26 maximized, therefore, the objective function becomes :
q π = π1 + π2
and P 2 = 90 – 2
2
⇒ π = (133Q 1 – 0·6Q1 2 – 0·6Q1 Q2)
233
⇒ p2 = 90 – + (140Q 2 – 1·2Q2 2 – 0·6Q1 Q2)
52
4447 Now we have to maximize π with respect to Q1
⇒ P2 = and Q2
52
322U | Economics (NET)
1st order conditions Note. In the find answer we have added up all the
dπ constants into a single constant C.
= 133 – 1·2Q1 – 1·2Q2 = 0 …(3) Rule 5. Integral of a multiple
dQ1
dπ If a function is multiplied by a constant number, this
= 140 – 2·4 Q2 – 1·2 Q1 = 0 …(4) number will remain a multiple of the integral of the
dQ2
function.
Solving (3) and (4) we obtain Q1 = 105 and Q2 = 5·8
Output: Q1 = 105 and Q2 = 5·8 ∫
Example : 4x 3dx = 4 x 3dx ∫
Price: P = 140 – 0·6 (Q 1 + Q2 ) = 73·5 4x 4
=+ C = x4 + C
Profit: π 1 = 133 Q1 – 0·6 Q12 – 0·6 Q1Q2 = 6741 4
π2 = 140 Q2 – 1·2 Q22 – 0·6 Q1 Q2 = 169·4 Important steps in evaluating a definite integral :
b
∫
On comparison with the situation when duopolist
ignored their interdependence, we observe that in the f (x) dx
a
present situation the profits of the Ist duopolist have
1. Find the indefinite integral
increased (from 5227 to 6741 = 1514) while that of 2nd
duopolist have been reduced [from 1471 to 169·4 =
–1301·6].
∫ f (x)dx = F(x) + c
But still the collusion appears to be profitable to 2. Substitute for x in this integral the upper limit b,
both, since the reduction in the profit of 2nd duopolist i.e., = F(b) + c.
(= –1301·6) is less than the corresponding increase in the 3. Substitute for x the lower limit a, i.e., = F(a) + c.
profit of Ist duopolist (= 1514). 4. Substract (2) from (3), i.e., F(a) + C from F(b) + c.
Thus the profit of both together has increased to
6910·4 from 6698 in the previous situation. Naturally,
Applications
therefore, mutual distribution of profit will put each of Example : Given the marginal cost function f (x),
them on higher indifference curve. find the total cost function when fixed cost is 50 units
and f (x) = 2 + x + x 2; x being output produced.
Integration
If x is the differential coefficient of F(x); we say that
Ans. Total cost = ∫ f ′ (x)dx
∫ f (x)dx = F(x) + C is an indefinite integral; because C is ∫ x2 x3
= (2 + x + x 2)dx = 2x +
2
+ +c
3
unknown here. But if integral of f(x) exists for all values
of x from a to b, we define. But since fixed cost = 50, i.e., total cost when
output x = 0 is 50.
∫
b
f (x) dx = F(b) – F(a)
a ∴ f (o) = o + o + c = 50
as a definite integral of f(x) between limits a and b, a is ∴ c = 50
the lower limit and b is the upper limit. x2 x3
Basic Rules of Integration Hence the total cost function is f (x) 2x + + + 50
2 3
Rule 1. Power Rule Example : If the marginal cost function is f (q) = 2
∫
x n dx =
1
n+1
xn + 1 + c √ q + 5 , find total cost function
+ 3⎯
⎯q
√
Rule 2. Exponential Rule F(q) when F(1) = 21
∫e x dx = e x + c Ans. Total cost – F(q) = f ′ (q)dq ∫
Rule 3. Logarithmic Rule
1
∫· dx = log x + c
= ∫ ⎛⎜⎝2 + 3√⎯ q + √⎯5q⎞⎟⎠dq
x
3 1
Rule 4. Integral of sum q2 q2
Integral of sum of a number of functions is equal to Total cost : TC = 2q + 3 + 5· + C
3 3
the sum of their separate integrals. 2 2
∫
Example : (x 3 – x + 1)dx = 2q + 2q3/2 + 10q1/2 + C
when q = 1 : F(q) is given to be 21.
= ∫ x dx – ∫ x dx + ∫ 1dx
3
∴ 21 = 2(1) + 2(1)3/2 + 10(1)1/2 + C
4 2 ⇒ 21 = 14 + C
= (x4 + C ) – (x2 + C ) + (x + C )
1 2 3 ⇒ C = 7(which is fixed cost)
x4 x2 ∴ Total cost function
= – x+C
4 2 F(q) = 2q + 2q3/2 + 10q1/2 + 7
Economics (NET) | 323U
Example : If the marginal revenue function is— (ii) Total revenue
Pm = { ab
(x + b)2
–C } (R) = ∫ (16 – x )dx
2
x3
show that P = { a
x+b }
– C is the demand law. = 16x –
3
+C
Ans. Let R be the total revenue, P is the price and x When x = 0, revenue must also be zero.
is the total output. ∴ C = 0
x3
∴ R = P.x and MR =
dR
dx (
∴ R = 16x –
3 )which is the required total
we are given that : revenue.
MR = P m =
dR
dx
= {
ab
(x + b)2
–C} (iii) Average revenue =
TR
output
∴ Total Revenue (R) =
dR
∫
dx
dx
R
16x –
x3
3
= =
⇒ R = ∫{ ab
(x + b)2
– C dx } x
x2
x
⇒ R = ab .
(x – b) – 1
– Cx + A
(
= 16 –
3) is the required average revenue.
–1 Example : The marginal cost and revenue of a firm
(A = constant) are given as :
But R = P.x MC = 4 + 0·08x, MR = 12
– ab
∴ P.x = – cx + A Compute the total profit, given that total cost is zero
x+b at zero level of output
We know that if output x = 0 revenue must also be Ans. For profit maximization
zero. Therefore, by substituting R = 0 and x = 0 in (1)
MC = MR
we get
– ab i.e., 4 + 0·08x = 12
O = +A or, 0·08x = 8
b
⇒ A = a x = 100
Now Eqn. (1) will be Since MR = 12 = constant, hence there is perfect
– ab competition.
R = – cx + a = Px
x+b ∴ P = MR = 12
⇒ P.x = { a–
ab
x+b }
– Cx and Total Revenue = 12x
⇒ P.x =
ax
– Cx
Total cost = ∫ (4 + 0·08x)dx
x+b 0·08x 2
a = 4x + +A
⇒ P = –C 2
x+b = 4x + 0·04x 2 + A
Example : If MR = 16 – x 2 , find the maximum total
∴ Total cost = 0 when x = 0
revenue. Also find the total and average revenue and
demand. ∴ A = 0 and TC = 4x + 0·04x 2
Ans. Given MR = 16 – x 2 Hence total profit = TR – TC
We known that TR is maximum when MR = 0 = 12x + (4x + 0·04x 2)
∴ 16 – x2 = 0 = 8x – 0·04x 2
⇒ x = ± 4. = 400 (when output x = 100)
Hence total revenue (TR) is maximum when output Example : If the demand function is P = 85 – 2x –
is 4 units. Our problem now is to find the maximum total x2, and the demand x is 3; what will be the consumer’s
revenue which happens when output is 4 units. surplus ?
∫
4
∴ TR = (MR)·dx Ans. Given demand function is
0
P = 35 – 2x – x 2
∫
4
= (16 – x 2)dx
0 For x = 2, P = 20
3 4
= [16x – x3 ] = 1283 0
Therefore, CS = Area of the curve below the demand
from 0 to 3 minus Area of rectangle (20 × 3) = 60.
∫
3
128
is the maximum total revenue. ∴ C.S = (35 – 2x – x 2 )dx – 60
3 0
324U | Economics (NET)
y pure competition, and (ii) the demand and price are
determined under monopoly (so as to maximize the
profit) and the supply function is identified with the
marginal cost function.
P = 35 − 2x − x2
Ans. Under pure competition : Market equilibrium
Price
30
conditions are found by equating demand and supply.
20
i.e., (6 – x)2 = 14 + x = P
10
x
i.e., P = 16 and x = 2
O
∫
1 2 3 4 5 Demand 2
∴ C.S. = (36 – 12x + x 2)dx – (16 × 2)
0
Example : If the demand law is P = 35 – 4x – x 2 ,
3 2
find consumer surplus : (a) If x = 5 and (b) If P = 64.
Ans. (a) If x = 5, P will be = 40
= [36x – 6x +x3 ] – 32 = 563 units
2
0
∫
5 (ii) To find demand and price under monopoly we
∴ C.S. = (85 – 4x – x2 )dx – (40 × 5)
0 have
3 5
TR = P d × x
⇒ C.S. = [85x – 2x –x3 ] – 200 2
0
⇒ TR = (36 – 12x + x 2 )x
C.S. = [333 ] – 200
1 ⇒ TR = 36x – 12x 2 + x 3
⇒
3
d (TR)
1 ∴ MR = = 36 – 24x + 3x 2
⇒ C.S. = 133 units. dx
3 Supply price : Ps = 14 – x
(b) If P = 64, then But since supply price is to be identified with MC
64 = 85 – 4x – x 2 ∴ 14 + x = MC
i.e., either x = 3 or x = – 7 (which has not meaning) To maximize profit, MC = MR
∫
3
∴ C.S. = (85 – 4x – x2 )dx – (64 × 3) ∴ 36 – 24x + 3x2 = 14 + x
0
3 3
or (x – 1) (3x – 22) = 0
= [85x – 2x –x3 ] – 192
2
0 i.e., either x = 1 or x =
22
3
= 228 – 192 = 36 units. Therefore, at x = 1, Pd = 25
Example : The price of the quantity demand under
∫
1
pure competition is determined by the demand and ∴ C.S. = (36 – 12 + x2 )dx – (25 × 1)
0
supply laws :
16
8 1 = units
Pd = – 2 and Ps = (x + 3) respectively; 3
x+1 2 22
Determine the corresponding consumer’s surplus. Similarly find C.S. at x = ·
3
Ans. The equilibrium point is found by equating Example : The marginal cost function for a firm is
and then solving the given functions. 100 – 10x + 0·1x 2, where x is the output. Obtain the total
In equilibrium cost function of the firm under the assumption that its
fixed cost is R 500.
Demand = Supply
Ans. ∴ MC = 100 – 10x + 0·1x2
∴ ( ) 8
x+1
–2 =
x+3
2 ∴ TC = ∫ (100 – 10x + 0·1x )dx 2
2
or x + 8x – 9 = 0 x3
= 100x – 5x 2 + +C
∴ x = 1 or x = – 9 30
At x = 1, P will be 2. · . · Fixed cost = 500
x3
∫
1
∴ C.S. = 0
8
x+1 (
– 2 dx – (2 × 1) ) ∴ TC = 100x – 5x 2 +
30
+ 500
1 x3
⇒ C.S. = [8 log (x + 1) – 2x]0 – 2 ⇒ TC = – 5x2 + 100x + 500
30
⇒ C.S. = 8 log 2 – 2 – 2 Example : The demand function for a commodity is
∴ C.S. = 8(0·693) – 4 = 1·54. P = 20 – 3D. The supply function on this market is P =
Example : The demand and supply laws are Pd = 2D. Find consumer’s surplus.
(6 – x)2 and Ps = 14 + x respectively. Find the consumer’s Ans. Given P = 2 – 3D, and
surplus if (i) the demand and price and determined under P = 2D is the supply function
Economics (NET) | 325U
∴ Equilibrium price P = 8 and D = 4
or, ∫ dD = ∫(
ρ )
a – bρ
dρ
∫
4 D
∴ C.S. = (20 – 3D)dD – (8 × 4)
0 or, log D = a log ρ – bρ + C
3D 4
[
= 20D –
2 0 ]
– 32 = 24
⇒
D = e a log ρ – bρ + C
D = e log(ρ)a – bρ + C
Example : The marginal cost function for some ⇒ D = P a .e – bρ + C = e C – bρ
product is (1 + 2x + 6x 2 ) where x is the output. Find the This is the required demand curve.
total cost function if the fixed cost is R 100 when the
output is zero. Example : Demand and supply functions for tea are
given by :
Ans. MC = 1 + 2x + 6x 2
∴ TC = ∫ (1 + x + 6x )dx 2 xd = { 120 – 2ρ + 5 } dρ
dt
kg. per week, and
x2
= x+
2
+ 2x 3 + c xs = { 3ρ – 30 + 50 } dρ
dt
kg. per week;
Since fixed cost is given to be 100 where ρ is the price at time t.
x2 If the initial price is 36 paise kg., find the condition
∴ TC = 2x 3 + + x + 100
2 for equilibrium (dynamic).
Example : An individual’s preference scale for the Ans. At equilibrium D = S
goods x and y is defined by the marginal rate of substi- dρ dρ
x–a ∴ 120 – 2P + 5· = 3ρ – 30 + 50·
tution of y for x = . Show that dt dt
y–b dρ
U = (x – a)2 + (y – b)2 45· + 5ρ – 150 = 0
dt
is the form of the utility function. dρ dρ ρ 10
Ans. MRS between y and x is given by 9· + ρ = 30 or + =
dt dt 9 3
dy x–a dy
= This is the differential equation of the form + ay
dx y–b dx
∴ dy + ( ) x–a
y–b
dx = 0
= b of which the solution is,
(y – b)dy + (x – a)dx = 0 (
b
)
y = + y(o) – e – ax
a a
y
Integrating, we have 1 10
Here a = and b =
9 3
y3 x2
( 2 ) (
– by = –
2 )
– ax + c
be
Solution of this differential equation will therefore
y2 – 2by = – (x 2 – 2ax) + 2c 10
or, (y – b)2 + – (x – a)2 + 2c – a2 – b2 P(t) = · 9 + [ρ(o) – 30]e – t/9
3
∴ (y – b)2 + (x – a)2 = U (some constant) P(t) = 30 + [ρ(o) – 30]e – t/9
⇒ U = (y – b)2 + (x – a)2 Initial price, i.e., at t = 0, ρ(o) = 36 (given)
is the form of utility function. ∴ ρ(t) = 30 + (36 – 30) e – t/9
Example : It is known that the elasticity of a = 30 + e – t/9
demand curve, x = φ(P) is of the form (a – bP), where a is the time = path of price for tea
and b are given constants. Find the demand curve. What will be the price after 10 weeks ?
Ans. We known that elasticity of demand It will be : ρ(10) = 30 + be – 10/9
% change in demand The Cobweb Model
=
% change in price
The basic Cobwed model assumes that today’s
D demand for any commodity is a function of the present
d
D dD ρ price (Pt) while today’s supply depends upon yesterday’s
= = ·
dp dp D decisions about the output. Hence, output is naturally
p influenced by yesterday’s price (ρ t – 1).
But in this example, To put this in symbolic form :
dD ρ dD ρ Demand function : XDt = a + αρt
· = ·
dp D dp D Supply function : Xst = b + βρt – 1
dD
D
=( a – bp
ρ ) dρ thus both demand and supply functions are assumed
to be linear.
326U | Economics (NET)
For equilibrium and since supply curve’s positively sloped.
XDt = XSt ∴β>0
or a + αρ1 = βρ1 β (+) sing
∴ = = (–) sign.
— α (–) sign
Let ρ be the equilibrium price
Hence the time-path must always be oscillatory.
–
∴ ρt = ρ for all t’s …(1) Three possibilities arise :
– – β
a + αρ = b βρ …(2) 1. If β > | α |, then , then there will be explositve
|α|
– b–a oscillations.
⇒ ρ =
α–β
y
Subtracting (2) from (1), we get S
– –
α(ρ1 – ρ) = β(ρt – 1 – ρ)
∴ αρt = β(ρt – 1) β > |α|
Price
β
⇒ ρt = (ρt – 1)
α
which represents the first order difference equation. D
The complementary function of this equation will be x
O
β t Demand/supply
ρt = ρ0 () α Fig. B
– β ′ β
or
–
(ρt – ρ) = (ρ0 – ρ) ()
α
2. If β = | α |, then
|α|
, the there will be regular
oscillations.
– β ′
–
ρt = ρ + (ρ0 – ρ)() α β
3. If β < | α |, then < 1, the there will be damped
|α|
ρ0 is the initial price. oscillations (Fig. A)
Now we have Thus the dynamic equilibrium can only be obtained
– b–a in the third case when β < | α | or when the demand
(i) ρ = , which is the equilibrium price of the
α–β curve is steeper than the supply curve.
model. This being a constant term, it gives a stationary Time-path of output X : This can be obtained by
equilibrium price. substituting the value of pt in the demand equation or the
–
(ii) The term (ρ 0 –ρ) < 0 depicts the scale effect. If supply equation.
– y
(ρ0 – ρ) < 0. the time-path, as said above, will blow up.
D
–
If (ρ0 – ρ) < 0, the time-path will start from below the
equilibrium price.
Price
–
The magnitude of (ρ 0 – ρ) < 0 determines how far
above or below ρ t the time-path starts. S
β t x
(iii) The crucial factor is() α
when β and α are
O
Demand/supply
Fig. C
the slopes of the supply and demand curves. Since the
demand curve is generally negatively sloped; Thus the disequilibrium price ρ oscillates over
–
y S successive periods around the equilibrium price ρ and
–
converges to ρ if and only if | β | < | α |, or if and only if D
is steeper than S around the point of intersection.
Example : Give the following demand and supply
Price
β < |α|
functions, find equilibrium price and determine whether
the equilibrium is stable.
D (a) x dt = 18 – 3P t
x
O Demand/supply
x st = – 3 + 4Pt – 1
Fig. A (b) x dt = 19 – 6P t
∴a<0 x st = 6P t – 1 – 5
Economics (NET) | 327U
Ans. (a) Slope of demand curve = | α | = 3 (b) Let V(F) be a vector space. Then
Slope of supply curve = | β | = 4 (i) If a, b ∈F and α is a non-zero vector of V,
Since β > α we have aα = bα ⇒ a = b
∴ There will be explosive oscillations and equili- (ii) If α, β ∈V and a is a non-zero element of
brium will be unstable. F, we have
–
Equilibrium price : ρ = 3 aα = aβ ⇒ α = β
(b) Slope of demand curve = | α | = 6 5. Vector Subspaces—Let V be a vector space
over the field F and let W ⊆ V. Then W is called a
Slope of supply curve = | β | = 6
subspace of V if W itself is a vector space over F with
Since β = α respect to the operations of vector addition and scalar
∴ There will be regular oscillations and the multiplication in V.
equilibrium will be unstable. 6. Some Theorems on Vector Sub-Spaces—
Linear Algebra (1) The necessary and sufficient condition for a non-
empty subset W of a vector space V(F) to be a subspace
1. Internal Composition—Let A be any set. If a * of V is that W is closed under vector addition and scalar
b∈A ∀ a, b∈A and a * b is unique, then operation * is multiplication in V.
said to be an internal composition. (2) The necessary and sufficient condition for a
2. External Composition—Let V and F be any non-empty subset W of a vector space V(F) to be a
two sets. If aoα ∈ V ∀a∈F and ∀ α∈V and aoα is subspace of V is
unique, then o is said to be an external composition in V a, b ∈ F and α, β ∈ W ⇒ aα + bβ ∈W.
over F.
(3) The intersection of any two subspaces W1 and
3. Vector Space—Let (F, +, •) be a field, the W2 of a vector space V(F) is also a subspace of V(F).
elements of F are Scalars. Let V be a non-empty set
whose elements are vectors. Then V is a vector space (4) The union of two subspaces is a sub-space, if
over the field F, if and only if one is contained in the other.
(i) (V, +) is an abelian group i.e., (5) The intersection of any family of sub-spaces of
(a) α + β ∈ V, ∀α, β ∈ V a vector space is a subspace.
(b) α + β = β + α, ∀ α, β ∈ V 7. Linear Combination of Vectors—Let V(F) be a
vector space. If α1, α2,...αn∈V, then any vector α = a1α1
(c) α + (β + γ) = (α + β) + γ, ∀ α, β, γ ∈V
+ a2 α2 +....+ an αn where a 1,a2 ,..., a n∈F is called a linear
(d) There exists an element 0 ∈V, such that combination of the vectors α1 , α2,...., αn.
α + 0 = α, ∀ α ∈ V
(e) To every vector α∈V there exists a vector 8. Linear Span—Let V(F) be a vector space and S
–α∈V such that α + (–α) = 0 be any non-empty subset of V. Then the linear span of S
is the set of all linear combination of finite sets of
(ii) V is closed with respect to scalar multi- elements of S and is denoted by L(S). Thus
plication, i.e., There is an external composition
in V over F called scalar multiplication, i.e., a α L(S) = {a1 α1 + a2 α2 +....+an αn : α1, α2,...
∈V, ∀ a ∈F and ∀ α ∈V. αn∈S and a1 , a2 ,.....an ∈F}
(iii) Scalar multiplication and addition o f Vectors 9. Theorem on Linear Span—The linear span
satisfy the following postulates— L(S) of any subset of a vector space V(F) is a subspace
(a) a (α+β) = aα + aβ, ∀ a∈F and ∀ α, β∈V of V generated by S, i.e., L(S) = {S}.
(b) (a+b)α = aα + bα, ∀ a, b∈F and ∀ α∈V 10. Linear Sum—Let W1 and W2 be two subspaces
(c) (ab)α = a(bα), ∀ a, b∈F and ∀ α∈V of the vector space V(F). Then the linear sum of the
(d) 1α = α, ∀ α∈V and 1 is the unity element subspaces W1 and W2 is W1 + W 2 which is the set of
of the field F. α1 + α2 such that α1∈W 1 and α2 ∈W 2
4. General Properties of Vector Spaces— ∴ W1 +W 2 = {α1 + α2 : α1∈W 1 , α2∈W 2 }
(a) Let V(F) be a vector space and 0 is the null 11. If W1 and W2 are subspaces of the vector space
vector of V, then V(F), then
(i) a ·0 = 0, ∀ α ∈F (i) W1 + W2 is a subspace of V(F)
(ii) 0α = 0, ∀ α ∈V (ii) L(W 1 ∪W2) = W1 + W2
(iii) a (–α) = –(a α), ∀ a ∈F, ∀ α ∈V 12. Linear Dependence—A finite set {α1 , α2.....,
(iv) (–a)α = –(aα), ∀ a ∈F, ∀ α ∈V αn} of vectors of a vector space V(F) is said to be linear
(v) a (α–β) = aα – aβ, ∀ a ∈F and ∀α, β ∈V dependent, if there exist scalars a1 , a2 ,...…., an∈F not all
(vi) aα = 0 ⇒ a = 0 or α = 0 of them zero such that a1α1 + a2 α2 +.....+ an αn = 0
328U | Economics (NET)
13. Linear Independence—A finite set {α1, α2,..., (iv) Each subspace W of a finite dimensional vector
αn} of vectors of V(F) is said to be linear independent, if space V(F) of dimension n is a finite dimensional space
every relation of the form with dim m ≤ n.
a1 α1 + a2 α2 +...+an αn = 0, ai ∈F Also V = W, iff dim V = dim W
⇒ ai = 0 for each 1 ≤ i ≤ n. (v) If W 1 and W 2 are two subspaces of a finite
dimensional vector space V(F), then
14. Any infinite set of vectors of V is said to be
linearly independent if its every finite subset is linearly dim (W1 + W2 ) = dim W1 + dim W2
independent, otherwise it is linearly dependent. – dim (W1 ∩ W2 ).
15. Some theorems on Linearly Dependence and (vi) Each set of (n+1) or more vectors of a finite
Independence— dimensional vector space V(F) of dimension n is
(i) If α1, α2,......., αn are non-zero vectors ∈V, then linearly dependent.
either they are linearly independent or some αk, 2 ≤ k ≤ (vii) If V(F) is a finite dimensional vector space of
n is a linear combination of the preceeding ones α 1 , dimension n, then any set of n linearly independent
α2,...., αk–1. vectors in V forms a basis of V.
(ii) The set of non-zero vectors α 1 , α2, ..., α n of (viii) If a set S of n vectors of a finite dimensional
vector space V(F) of dimension n generates V(F), then S
V(F) is linearly dependent if some α k , 2 ≤ k ≤ n, is a
is a basis of V.
linear combination of preceeding ones.
(ix) If W is a subspace of a finite dimensional
(iii) If in a vector space V(F), a vector β is a linear vector space V(F), every linearly independent subset of
combination of the set of vectors α1, α 2 , α 3 ,...., αn, then W is finite and is part of a finite basis for W.
the set of vectors β, α1, α2,..., αn is linearly dependent.
20. Direct Sum of Subspaces—Let V(F) be a
(iv) The set of non-zero vectors α1, α 2 ,.....α n ∈V vector space and W1 , W 2 ,..., W m be subspaces of V.
(F) is a linear dependent if one of these vectors is a Then V is said to be direct sum of W1 , W2 ,....,Wm, if
linear combination of the remaining (n–1) vectors. every element α∈V can be written in one and only one
(v) Every superset of a linearly dependent set of way as
vectors is linearly dependent. α = α1 + α2 +....+ α m ,
(vi) Every subset of linearly independent set of where α1∈W 1 , α2∈W 2 ,...., αm∈Wm .
vectors is linearly independent.
The direct sum is denoted by ⊕.
(vii) A set of vectors which contains the zero
vector is necessarily linearly dependent. 21. Disjoint Subspaces—Two subspaces W1 and
(viii) A system consisting of a single non-zero W2 of a vector space V(F) are said to be disjoint if their
vector is always linearly independent. intersection is the zero subspace, i.e., W1 ∩ W2 = {0}.
16. Basis of Vector Space—A subset S of a vector 22. Dimension of a Direct Sum—If a finite
space V(F) is said to be a basis of V(F), if dimensional vector space V(F) is a direct sum of two
(i) S consists of linearly independent vectors subspaces W1 and W2 , then
(ii) S generates V(F), i.e., L(S) = V dim V = dim W1 + dim W2 .
17. Finite Dimensional Vector Space—The vector 23. The necessary and sufficient conditions for a
space V(F) is said to be finite dimensional or finitely vector space V(F) to be a direct sum of its two
generated, if there exists a finite subset S of V such that subspaces W1 and W2 are that
V = L(S). (i) V = W1 + W2 (ii) W1 ∩ W2 = {0}
Note—A vector space which is not finitely 24. Let V be a finite dimensional vector space and
generated may be referred as an infinite dimensional let W1 , W2 be subspaces of V such that V = W1 + W2
space. and dim V = dim W1 + dim W2 . Then V = W1 ⊕ W2 .
18. Dimension of a Finitely Generated Vector
25. Homomorphism of Vector Spaces —Let U(F)
Space—Dimension of the vector space V(F) is the
and V(F) be two vector spaces. Then a mapping f : U →
number of elements in any basis of a finite dimensional
V is called a homomorphism of U into V, if f(aα + bβ) =
vector space V(F) and it is denoted by dim V.
af(α) + b f(β) ∀ a, b ∈F and α, β ∈U
19. Properties of Finite Dimensional Vector
Space— Note—If f is a homomorphism of U onto V, then V
is called a homomorphic image of U.
(i) There exists a basis for each finite dimensional
vector space. 26. Isomorphism of Vector Space—Let U(F) and
V(F) be two vector spaces. Then a mapping f : U→V is
(ii) If V(F) is a finite dimensional vector space, then
called an isomorphism of U into V, if
any two bases of V have the same number of elements.
(i) f is one-one
(iii) Every linearly independent subset of a finitely
generated vector space V(F) is either a basis of V or can (ii) f is onto
be extended to form a basis of V. (iii) f (aα + bβ) = a f(α) + b f(β) ∀ a, b∈F, α, β∈U.
Economics (NET) | 329U
Note—The vector space V(F) is also called (ii) Column Matrix—If in a matrix, there is only
isomorphic image of the vector space U(F). one column, then it is called a column matrix.
27. Theorems on Homomorphism and Isomor-
In other words [aij]m × n is a column matrix, if n = 1
phism—
(i) If f is a homomorphism of U(F) into V(F), then f (iii) Horizontal Matrix—If in a matrix, the number
will become isomorphism of U into V, if f is one-one. of rows is less than the number of columns, then it is
Also in addition if f is onto V, then f will become an called a horizontal matrix.
isomorphism of U onto V.
In other words, the matrix [aij]m × n is a horizontal
(ii) If f is homomorphism of U(F) into V(F), then
matrix, if m < n
(a) f (0) = 0', where 0 and 0' are the zero vectors of
U and V respectively (iv) Vertical Matrix—If in a matrix, the number of
(b) f (–α) = – f (α), ∀ a∈U. rows is greater than the number of columns, then it is
(iii) Two finite dimensional vector spaces over the called a vertical matrix.
same field are isomorphic, if they are of the same In other words, the matrix [aij] m × n is a vertical
dimension.
matrix, if m > n
28. Co-ordinates—Let V(F) be a finite dimensional
vector space. Let B = {α1, α 2 ,.., αn} be an ordered basis (v) Null (or zero) Matrix—A matrix is said to be a
for V. null matrix, if its all elements are zero.
Let α ∈V, then there exists a unique n-tuple (x1, In other words, the matrix [aij] m × n is a null
x2,...,xn) of scalars such that matrix, if aij = 0 for all i and j.
α = x1 α1 + x2 α2 +....+xn αn (vi) Square Matrix—A matrix is said to be a
Then the n-tuple (x1, x2,..., xn) is called the n-tuple square matrix if the number of rows is equal to the
of co-ordinates of α relative to the ordered basis B. number of columns.
29. Linear Transformation—Let U(F) and V(F) In other words, the matrix [a ij] m × n is a square
be two vector spaces over the same field F. matrix if m = n.
Then, a function T from U into V such that
Note—The elements a 11 , a 22 …a nn are called the
T (aα + bβ) = aT(α) + bT(β), ∀ α, β∈U and a, b∈F
diagonal elements and the line having elements a11,
is called linear transformation from U into V.
a22… is called principle diagonal.
30. Linear Operator—Let V be a vector space,
then a linear transformation from V into V itself is (vii) Diagonal Matrix—A square matrix in which
called the linear operator V into V. all elements except in diagonal are zero is called a
diagonal matrix.
Matrices and Determinants In other words, the matrix [aij]m × n is a diagonal
1. Definition of a Matrix—A system of any m n matrix, if
numbers arranged in a rectangular array of m rows and n
(i) m = n (ii) aij = 0, if i ≠ j
columns is called a matrix of order m × n.
⎡⎢ a11 a12 … a1n
a21 a22 … a2n
⎤⎥ (viii) Scalar Matrix—A square matrix in which all
elements except in diagonal are zero and all principal
Let A = ⎢ … … … … ⎥ diagonal elements are equal, is called a scalar matrix.
⎢⎣… … … … ⎥⎦ In other words, the matrix [aij] m × is a scalar
am 1 am 2 am n n
matrix, if
Then A is an m × n matrix. (i) m = n
(ii) aij = 0, if i ≠ j
Symbolically, matrix A is written as (iii) aij = k (constant), if i = j
A = [aij]m × n
where, 1 ≤ i ≤ m, 1 ≤ j ≤ n (ix) Unit Matrix—A square matrix in which all
aij is the element of ith row and j th column elements except in diagonal are zero and all principal
diagonal elements are unity.
2. Types of Matrices—
In other words, the matrix [aij] m × n is a unit
(i) Row Matrix —If in a matrix, there is only one
matrix, if
row, then it is called a row matrix.
(i) m = n
In other words, the matrix [aij] m × n is a row (ii) aij = 0, if i ≠ j
matrix, if m = 1 (iii) aij = 1, if i = j
330U | Economics (NET)
(x) Upper Triangular Matrix—A square matrix is 7. Product of Matrices—Let A and B are two
said to be a upper triangular matrix if each element matrices of order m × n and n × p. The product AB is
below the principal diagonal is zero. defined only if the no. of columns of A is equal to the
no. of rows of B. The order of the product AB will be
In other words, the matrix [aij]m × n is an upper
m × p.
triangular matrix, if
(i) m = n (ii) aij = 0, if i > j In other words, if A = [aij]m × n , B = [bjk]n × p., then
n
(xi) Lower Triangular Matrix—A square matrix is AB = cik = ∑ aij bjk
j=1
said to be a lower triangular matrix if each element
above the principal diagonal is zero. 8. Properties of Multiplications—
M1. If A, B, C be m × n , n × p, p × q matrices
In other words, the matrix [aij] m × n is a lower
respectively, then
triangular matrix, if
(i) m = n , (ii) aij = 0, if i < j (A.B) . C = A.(B.C) [Associativity]
M2. If A, B, C be m × n , n × p, n × p matrices
(xii) Sub Matrix—A matrix is called a sub matrix respectively, then
if it is obtained by leaving some rows or some columns
or both from the given matrix. A. (B + C) = A . B + A . C
(xiii) Comparable Matrices—Two matrices are ∴ The matrix multiplication is distributive
said to be comparable, if they are of same order. over addition.
(xiv) Equal Matrices—Two matrices are said to be M3. Multiplication of matrices is not commutative
equal if the matrices are of same order and their in general.
corresponding elements are equal. i.e., AB ≠ BA. It may be happened that the
product AB or BA or both are not defined.
In other words, the matrices A = [aij]m × n and B =
M4. If A is a m × n matrix, then
[bij]m × n are equal, if aij = bij.
AI n = A and I m A = A.
3. Addition of Matrices—If A = [aij] and B = [bij] Thus, In is the right identity of A and Im is the left
be two matrices of same order, then their sum is defined identity of A.
as the matrix A + B = [aij + bij]. 9. Trace of Matrix—Let A be a square matrix,
i.e., the sum of two matrices of same order is found then the sum of elements lying along the principal
by adding the corresponding elements. diagonal is said to be the trace of A and we write it as
trace A.
In other words, if A = [aij ] m × n , B = [bij ] m × n , then
A + B = [aij ]m × n + [bij ]m × n = [aij +bij ]m × n. In other words, if A = [aij]m × m, then trace of A is
written as
4. Properties of Addition—Let A = [aij], B = [b ij], m
C = [cij] be three matrices of same order m × n, then tr. A = ∑ aij = a11 + a22 + … + amm
i =1
A1. A + B is also an m × n matrix (Closure)
A2 . A + B = B + A (Commutativity) For example—
A3. A + (B + C) = (A + B) + C ⎡⎢ 3 5 9 ⎤⎥
If A = ⎢ 2 4 6 ⎥, then
(Associativity) ⎢⎣ 7 0 –2 ⎥⎦
A4 . A + O = A = O + A (‘O’ is additive identity)
Where ‘O’ is the m × n null matrix. tr. A = 3 + 4 + (– 2) = 5.
A5. A + (–A) = O = (– A) + A 10. Properties of Trace—Let A and B be any
(– A is the additive inverse of A) square matrices and λ any scalar, then
5. Scalar Multiplication of Matrices —If A is an (i) tr. (λA) = λ . tr (A)
m × n matrix and λ is a scalar, then λ A is defined as m × n (ii) tr. (A + B) = tr. (A) + tr. (B)
matrix whose each element is λ times the corresponding
(iii) tr. (AB) = tr. (BA)
elements of the matrix A.
6. Properties of Scalar Multiplication—Let A and 11. Transpose of a matrix—The transpose of a
B be two matrices of same order and λ 1 , λ 2 are any given matrix A is obtained by interchanging the rows
scalars, then and columns of the matrix A. Transpose of A is denoted
by A' or At.
(i) (λ1 + λ2) A = λ1 A + λ2 A
(ii) λ (A + B) = λ A + λ B (Distributive Law) Thus, if A = [aij]m × n
(iii) λ1 (λ2 A) = (λ1 λ2) A Then A' = [bij]n × m
(iv) (– λ) A = – (λ A) = λ (– A) where, bij = aji.
Economics (NET) | 331U
Example— corresponding complex conjugate. The transpose conju-
⎡⎢ 1 3 5 ⎤⎥ gate of A is denoted by A*.
If A = ⎢⎣ 2 7 0 ⎥⎦ –
Thus, A* = (A)'
⎡ 2 1 + i 0 ⎤⎥
⎡⎢ 1 2 ⎤⎥ Example—If A = ⎢⎢
⎣ 3 2 i ⎥⎦
, then
Then A' = ⎢⎢ 3 7 ⎥⎥
⎢⎣ 5 0 ⎥⎦ ⎡⎢ 2 3 ⎤⎥
⎢ 1–i 2 ⎥⎥
Note (1)—Trace A' = Trace A A* = ⎢
Note (2)—Trace AA' ≥ 0
⎢⎣ 0 – i ⎥⎦
12. Properties of Transpose— — —
Note—It is also possible that ( A )' = (A')
T 1 . If A be any matrix, then (A')′ = A.
16. Properties of Transpose Conjugate—
T 2 . For any matrices A and B of same order Tr. 1 If A be any matrix, then (A*)* = A.
(A + B)' = A' + B' Tr. 2 If A and B be two matrices of same order,
T 3 . If A be any m × n and B be any (n × p) matrix, then (A + B)* = A* + B*
then (AB)' = B'A'. Tr. 3 If A be any m × n and B be any n × p matrix,
T 4 . If A be any matrix and k be any scalar, then then (AB)* = B*A*.
(kA)' = kA' Tr. 4 If A be any matrix and k be any scalar, then
T 5 . If A be any square matrix, then –
(kA)* = k A*
(A n )' = (A')n.
Tr. 5 If A be any square matrix, then
13. Conjugate o f a Matrix—The conjugate of a
given matrix A is obtained by replacing the elements of (A n )* = (A*)n .
A by their corresponding complex conjugates. The 17. Symmetric Matrix—A square matrix A is
–
conjugate of A is denoted by A. said to be symmetric if it is equal to its transpose. i.e.,
A' = A ⇒ aij = aji.
– –
Thus, if A = [aij]m × n, then A = [aij]m × n. Note—Every symmetric matrix is necessarily
square.
⎡ 1 1 + i ⎤⎥ ⎡⎢ 1 – 5 7 ⎤⎥
Example—If A = ⎢⎢ ⎥, Example— A = ⎢ – 5 3 2 ⎥, then
⎣ 3 1–i ⎦ ⎢⎣ 7 2 0 ⎥⎦
⎡ ⎤⎥
A = ⎢⎢
– 1 1–i
then ⎥⎦ ⎡⎢ 1 – 5 7 ⎤⎥
⎣ 3 1 +i A' = ⎢ –5 3 2 ⎥ = A
⎢⎣ 7 2 0 ⎥⎦
Note—If all the elements of A are purely real, then
–
A = A. Hence, matrix A is symmetric.
14. Properties of Conjugate— Note—In a symmetric matrix the elements above
—– ) = A. the principal diagonal and below the principal diagonal
C . If A be any matrix, then ( A
1
are same.
C2. If A and B be matrices of same order, then
18. Important Facts—
⎯⎯⎯ – –
( A + B ) = A + B. (i) If A is a symmetric matrix, then kA is also
C3. If A be any m × n and B be any n × p matrix, symmetric for any scalar k.
⎯ – – (ii) If A and B are symmetric matrices of same
then (AB) = A . B.
order, then λ1A + λ2B is also symmetric for
C4. If A be any matrix and k be any scalar, then any scalar λ1, λ2.
⎯
( ) ––
k A = k A. (iii) If A be any matrix, then AA' and A'A both
C5. If A be any square matrix, then will be symmetric.
(iv) If A and B are both symmetric, then AB is
(A–- ) = (A)
n – n
. symmetric, iff AB = BA.
15. Tranjugate or Transposed Conjugate of a (v) If A and B are symmetric matrices of same
Matrix—The transpose conjugate of a given matrix is order, then AB + BA must be symmetric.
obtained by interchanging the rows and columns of the (vi) If A is any square matrix, then A + A' is
matrix obtained by replacing the elements of A by their always symmetric .
332U | Economics (NET)
(vii) If A is any symmetric matrix, then all –
(v) If A is a hermitian matrix, then A is also
positive integral powers of A are symmetric. hermitian.
i.e., (An )' = An .
(vi) If A and B are hermitian matrices of same
19. Skew-Symmetric Matrix—A square matrix A order, then AB + BA is also hermitian.
is said to be a skew-symmetric, iff A' = – A ⇒ aij = – aji. (vii) If A is a square matrix, then A + A* is a
Note—All the diagonal elements of a skew- hermitian matrix.
symmetric matrix are zero i.e., aii = 0. (viii) Any square matrix can be uniquely expressed
Example—The matrices as A + iB, where, A and B are hermitian matrices.
(ix) If A is any hermitian matrix, then all positive
⎡⎢ 0 –7 ⎤⎥ ⎡⎢ 0 1 + i 3 ⎤⎥ integral powers of A are hermitian.
⎢⎣ 7 0 ⎥⎦ and ⎢⎢ – 1 – i 0 – 2 ⎥⎥ 23. Skew-Hermitian Matrix—A square matrix A
⎣ –3 2 0 ⎦
is said to be skew-hermitian, If
are skew-symmetric matrices. –
A* = – A ⇒ aij = – aji.
20. Important Facts—(i) If A is a skew-symmetric Note—The elements on the principal diagonal must
matrix, then kA is also skew-symmetric matrix for any be purely imaginary number or zero.
scalar k.
Example—
(ii) If A and B are skew-symmetric matrices of
⎡⎢ 2i ⎡⎢ 4i 2 + i 3 ⎤⎥
same order, then λ1 A + λ2B is also skew-symmetric for 5 + 4i ⎤⎥ ⎢ – 2 + i 0 4i ⎥ are
any scalar λ1, λ2. ⎢⎣ – 5 + 4i 0 ⎥⎦ and ⎢ ⎥
⎢⎣ – 3 4i – 3i ⎥⎦
(iii) If A and B are symmetric matrices of same
order, then AB – BA must be skew-symmetric. skew-hermitian matrices.
(iv) If A is any square matrix, then A – A' is always 24. Important Facts—(i) If A is a skew-hermitian
skew-symmetric. matrix, then kA is also skew-hermitian for any real
number k.
(v) Any square matrix is uniquely represented as the
sum of a symmetric matrix and a skew-symmetric (ii) If A and B are skew-hermitian matrices of same
1 orders, then λ 1 A + λ 2 B is also skew-hermitian for any
matrix. Symmetric part is (A + A') and skew-symmetric
2 real number as λ1 , λ2 etc.
1 (iii) If A and B are hermitian matrices of same
part is (A – A'). order, then AB – BA is skew-hermitian.
2
(iv) If A is any square matrix, then A – A* is a
(vi) If A is any skew-symmetric matrix, then all skew-hermitian matrix.
positive odd integral powers of A are skew-symmetric
(v) Every square matrix can be uniquely represented
matrix.
as the sum of a hermitian and a skew-hermitian matrices.
21. Hermitian Matrix—A square matrix A is said (vi) If A is a skew-hermitian (hermitian) matrix,
to be a hermitian matrix if the transpose of the conjugate then iA is a hermitian (skew-hermitian).
–
matrix is equal to the matrix itself i.e., A* = A ⇒ aij = aji –
(vii) If A is a skew-hermitian matrix, then A is also
Where A = [aij]n × n; skew-hermitian.
Note—In hermitian matrix, the elements on the 25. Idempotent Matrix—A square matrix A, such
– that A2 = A is called idempotent matrix.
principal diagonal must be all real numbers. i.e., aii = aii.
Example— 26. Properties of Idempotent Matrix—
⎡⎢ 2 3 + 2i ⎤⎥ ⎡⎢ 3 2 + i 5i ⎤⎥ I1 . If A and B are idempotent matrices, then AB is
⎢⎣ 3 – 2i 7 ⎥⎦ and ⎢⎢ 2 – i 0 2 ⎥⎥
an idempotent, iff AB = BA.
⎢⎣ – 5i 2 7 ⎥⎦ I2 . If A and B are idempotent matrices, then A + B
is an idempotent, iff AB = BA = O.
are hermitian matrices. I3. If A is an idempotent matrix and A + B = I,
22. Important facts—(i) If A is hermitian matrix, then B is also idempotent and AB = BA = O.
then kA is also hermitian for any real number k. I4 . Diagonal (1, 1, 1,…1) is an idempotent matrix.
(ii) If A and B are hermitian matrices of same order, I5 . If AB = A and BA = B, then A2 = A, B 2 = B.
then λ1A + λ2 B is also hermitian for any real number as I6 . If λ 1 , λ2, λ3 are direction cosines, then
λ1, λ2 etc.
(iii) If A be any square matrix, then AA* and A*A ⎡⎢ λ12 λ1 λ2 λ1 λ3 ⎤⎥
⎢ λ1 λ2 λ22 λ2 λ3 ⎥
are also hermitian. ⎢⎣ ⎥
λ3 λ1 λ3 λ2 λ32 ⎦
(iv) If A and B are hermitian, then AB is also
hermitian, iff AB = BA. is an idempotent matrix.
Economics (NET) | 333U
27. Nilpotent Matrix—If A is a square matrix such 34. Properties of Determinants (i)—If rows be
that, A m = O, where m is a positive integer, then A is changed into columns and columns into rows, the value
called a nilpotent matrix. of the determinant remains unchanged.
If m is the least positive integer for which Am = O, ⎪⎪ 5 7 ⎪⎪ ⎪⎪ 5 9 ⎪⎪
then A is said to be nilpotent matrix of index m. Example— Let Δ = ⎪⎪ 9 2 ⎪⎪ = ⎪⎪ 7 2 ⎪⎪
28. Involutory Matrix—A square matrix A such
that, A2 = I is called involutory matrix. = 10 – 63 = – 53
Note 1. A is an involutory, iff (A + I) (A – I) = O. (ii) If any two rows or columns of a determinant are
Note 2. Identity matrix is trivial example of interchanged, the sign of the determinant is changed but
involutory matrix. the numerical value remaining unchanged.
29. Orthogonal Matrix—A square matrix A is said Example—
to be orthogonal matrix, iff AA' = I = A'A.
⎪⎪ 1 1 1 ⎪⎪ ⎪⎪ x y z ⎪⎪
Δ=⎪ x y z ⎪=–⎪
⎪ ⎪ ⎪
30. Properties of Orthogonal Matrices—
O1 . If A is an orthogonal matrix, then A' is also ⎪ 1 1 1 ⎪
⎪⎪ x2 y2 z2 ⎪⎪ ⎪⎪ x2 y2 z2 ⎪⎪
orthogonal.
O2 . For any two orthogonal matrices A and B, AB (iii) If any two rows or two columns of a
is an orthogonal matrix. determinant are identical, then the value of the deter-
O3 . For any two orthogonal matrices A and B, BA minant vanishes.
is an orthogonal matrix. ⎪⎪ 1 3 7 ⎪⎪
O4 . If A is an orthogonal matrix, then A – 1 is also Example— Δ = ⎪ ⎪2 3 7⎪
⎪
orthogonal. ⎪⎪ 5 3 7 ⎪⎪
31. Unitary Matrix—A square matrix A is said to
= 1(21 – 21) – 3(14 – 35) + 7(6 – 15)
be unitary matrix, iff AA* = I = A*A.
= 0 + 63 – 63 = 0
32. Properties of Unitary Matrices—
U1. If A is a unitary matrix, then A' is also unitary. (iv) If each element in any row or in any column be
U2. For any two unitary matrices A and B AB and multiplied by a scalar (k), then the value of the new
determinant is equal to k times the value of the original
BA are also unitary matrices.
determinant.
U3. If A is a unitary matrix, then A –1 is also
unitary. ⎪⎪ 3 7 2 ⎪⎪
Example— Δ = ⎪ ⎪5 8 6⎪
⎪
33. Definition of Determinant—
⎪⎪ 0 4 9 ⎪⎪
Let A = [aij] n × n be a matrix, then ⏐A⏐ is called a
determinant of order n. It is denoted by Δ. = 3(72 – 24) – 7(45 – 0) + 2(20 – 0)
⎪⎪ a11
a21
a12
a22
…
…
a1n
a2n
⎪⎪ = 144 – 315 + 40 = – 131
Let 2nd column be multiplied by 2, then
∴ Δ = ⎪ … … … … ⎪ ⎪⎪ 3 14 2 ⎪⎪
⎪⎪ … … … … ⎪⎪ Δ1 = ⎪ ⎪
an 1 an 2 … ann ⎪ 5 16 6 ⎪
⎪⎪ 0 8 9 ⎪⎪
is a determinant of order n. The numbers a11, a12 …ann
= 3(144 – 48) – 14(45 – 0) + 2(40 – 0)
are the elements of the determinant.
= 288 – 630 + 80 = – 262 = 2Δ
Note—
(v) If each element in any row or column consists of
(i) In determinants number of rows must be r terms, then the determinant can be expressed as the
equal to number of columns.
sum of r determinants.
(ii) The determinant has a value,
⎪ a1 a2 a3 + α1 ⎪
(iii) Determinants are used for judging the inver- ⎪ ⎪
tiability of square matrices Example— ⎪ ⎪
⎪ b1 b2 b3 + β1 ⎪
(iv) Determinants are also used to solve the ⎪ c1 c2 c3 + γ1 ⎪
⎪ ⎪
system of linear equations.
⎪3 5 ⎪⎪ ⎪⎪ 1 7 – 5⎪⎪ ⎪ a1 a2 a3 ⎪ ⎪ a1 a2 α1 ⎪
Example— ⏐7⏐,⎪
⎪ ⎪⎪a n d⎪⎪ 3 – 4 8⎪⎪ are
⎪ ⎪ ⎪ ⎪
⎪7 9 ⎪ 0 9 2⎪ =⎪ ⎪ ⎪ ⎪
⎪ b1 b2 b3 ⎪ + ⎪ b1 b2 β1 ⎪
⎪c c c ⎪ ⎪c c γ ⎪
the determinants of order 1, 2, 3 respectively. ⎪ 1 2 3 ⎪ ⎪ 1 2 1 ⎪
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(vi) If a constant multiple of the elements of a row = – (0 + 16)
or column of a determinant is added to any other row or = – 16
column of determinant, the value of the determinant
remains unchanged. A13 = Cofactor of 8 = (– 1) 1 + 3 M13
⎪ – 2 5 ⎪⎪
= (– 1) 1 + 3 ⎪
35. Product of two determinants of same order—
Let Δ1 and Δ 2 are two determinants of order 3. ⎪ ⎪ 1 4 ⎪⎪
⎪ a1 a2 a3 ⎪ ⎪ x1 x2 x3 ⎪
⎪ ⎪ ⎪ ⎪ = (– 8 – 5) = – 13
Δ1 = ⎪ ⎪ ⎪
⎪ b1 b2 b3 ⎪, Δ2 = ⎪ y1 y2 y3
⎪
⎪ A22 = Cofactor of 5 = (– 1)2 + 2 M22
⎪c c c ⎪ ⎪z z z ⎪
⎪ 1 2 3 ⎪ ⎪ 1 2 3 ⎪ ⎪3 8 ⎪⎪
= (– 1)2 + 2 ⎪
⎪ ⎪⎪ = (6 – 8)
⎪ a1 a2 a3 ⎪ ⎪ x1 x2 x3 ⎪ ⎪1 2
⎪ ⎪ ⎪ ⎪
∴ Δ1 .Δ2 =⎪ ⎪ ⎪ ⎪ = –2
⎪ 1 2 3 ⎪×⎪ y1 y2 y3
b b b ⎪
⎪c c c ⎪ ⎪z z z ⎪ 38. Important Results—(i) The sum of products of
⎪ 1 2 3 ⎪ ⎪ 1 2 3 ⎪ elements of a row (or column) with their cofactors is
⎪⎪a1 x1 + a2 x2 + a3 x3 a1y1 + a2 y2 + a3 y3 equal to the value of the determinant.
=⎪⎪⎪b1 x1 + b2 x2 + b3 x3b1 y1 + b2 y2 + b3 y3
⎪⎪ 2 – 3 5 ⎪⎪
c1x1 + c2x2 + c3x3 c1y1 + c2y2 + c3y3 Example— If Δ = ⎪ ⎪3 7 0⎪
⎪
a1 z1 + a2 z2 + a3 z3⎪ ⎪⎪ 4 1 8 ⎪⎪
⎪
b1 z1 + b2 z2 + b3 z3⎪
⎪ a21 A21 + a22 A22 + a23 A23
c1z1 + c2z2 + c3z3 ⎪
⎪ – 3 5 ⎪⎪ ⎪ 2 5 ⎪⎪
The rule by which the above product is obtained = 3 (– 1) 2 + 1⎪
⎪ ⎪ + 7(– 1) 2 + 2 ⎪
⎪⎪ 4 8 ⎪⎪
from Δ1 and Δ 2 is called the row-by-row rule. ⎪ 1 8⎪
⎪ 2 – 3 ⎪⎪
+ 0.(– 1) 2 + 3 ⎪
36. Minors— The minor of an element aij of a
determinant of order n × n is the determinant of order
⎪⎪ 4 1 ⎪⎪
(n – 1) × (n – 1) obtained by leaving ith row and jth = – 3(– 24 – 5) + 7(16 – 20) + 0(2 + 12)
column. It is denoted by Mij. = 87 – 28 + 0 = 59 = Δ
⎪ a11 a12 a13 ⎪
⎪ ⎪ (ii) The sum of products of elements of a row (or
Example— If Δ= ⎪ ⎪
⎪ a21 a22 a23 ⎪ column) with the cofactors of any other row (or column)
⎪a a a ⎪ is zero.
⎪ 31 32 33 ⎪ ⎪⎪ 2 – 3 5 ⎪⎪
M21 = The minor of a21 Example— If Δ = ⎪ 3 7 0 ⎪
⎪⎪ 4 1 8 ⎪⎪
⎪ a12 a13 ⎪⎪
= ⎪
⎪⎪ a a ⎪⎪ a12 A13 + a22 A23 + a32 A33
32 33
= a12 .a33 – a13.a32. ⎪3 7 ⎪⎪
= (– 3) (– 1) 1 + 3 ⎪
⎪ ⎪⎪ + 7(– 1) 2 + 3
M23 = The minor of a23 ⎪4 1
⎪⎪ a11 a12 ⎪⎪
= ⎪ ⎪ ⎪⎪ 2 – 3 ⎪⎪ ⎪⎪ 2 – 3 ⎪⎪
⎪⎪ a a ⎪⎪ ⎪⎪ 4 1 ⎪⎪ + 1 (– 1) 3 + 3 ⎪⎪ 3 7 ⎪⎪
31 32
= a11 .a32 – a12.a31. = – 3(3 – 28) – 7(2 + 12) + 1(14 + 9)
37. Cofactors—The cofactor of an element aij of a
= 75 – 98 + 23 = 0
determinant is equal to (– 1) i + j times of its minor. The
cofactor of aij is denoted by Aij. 39. Adjoint of a Square Matrix—The adjoint of a
square matrix A is defined as the transpose of the matrix
∴ Aij = (– 1)i + j . Mij
obtained by replacing the elements of matrix A by their
⎪⎪ 3 7 8 ⎪⎪ corresponding cofactors in ⏐A⏐. The adjoint of a matrix
Example— If Δ = ⎪⎪ –2 5 0
⎪, then
⎪
A is denoted by Adj A.
⎪⎪ 1 4 2 ⎪⎪
⎡⎢ aa
11 a12
a22
…
…
a1n
a2n
⎤⎥
⎢… ⎥, then
A32 = Cofactor of 4 = (– 1) 3+2 M32 21
i.e., If A = … … …
⎪ 3 8
= (– 1) 3 + 2 ⎪
⎪⎪ – 2 0
⎪⎪
⎪⎪
⎢⎣ a… … … … ⎥⎦
n1 an 2 … ann
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⎡⎢ AA11 A21
A22
… An1
… An2
⎤⎥ 43. Important Facts—(i) Inverse of a square
matrix if it exists is unique. Let B and C be two inverses
⎢… ⎥
12
of a non-singular matrix A, then AB = BA = I and AC =
Adj A = … … … CA = I, hence, AB = AC ⇒ B = C (By cancellation),
⎢⎣ A… … … … ⎥⎦ hence uniqueness is established.
1n
A2n … Ann
(ii) Only non-singular matrix has an inverse. A non-
40. Important Facts—(i) If A is a square matrix, singular matrix A has its non zero determinant hence
and I is the unit matrix of the same order as A, then Adj A
A.(Adj A) = ⏐A⏐.I = (Adj A).A is meaningful hence A–1 exists. Conversely if A–1
⏐A⏐
(ii) If ⏐A⏐ ≠ 0, then Adj A
n–1 exists i.e., if is meaningful, then ⏐A⏐ ≠ 0 hence,
⏐Adj . A⏐ = ⏐A⏐ ⏐A⏐
Where, n × n is the order of matrix A. A is non-singular.
(iii) If ⏐A⏐ ≠ 0, then (iii) If A and B are square matrices of same order,
then AB is invertable iff A and B are both non-singular.
A ( 1
⏐A⏐ )
Adj . A = I = (1
⏐A⏐
Adj . A .A ) (iv) If A and B are non-singular matrices of same
order, then (AB)–1 = B–1 A–1.
(iv) If A be n × n matrix, then
(v) If A is a non-singular matrix, then
Adj .(Adj .A) = ⏐A⏐n – 2.A
2 (A n )–1 = (A –1)n
and⏐Adj .(Adj .A)⏐ = ⏐A⏐(n – 1)
(vi) If A is a non-singular matrix, then
(v) If A is a square matrix of order n , then
Adj. (k A) = (Adj .A).kn – 1 (A –1)–1 = A
Where, k is any scalar. (vii) If A is a non-singular matrix, then
(vi) If A is any square matrix, then (A') –1 = (A –1)'
Adj A' = (Adj A)' (viii) If A is a non-singular matrix, then
and Adj A* = (Adj A)* (A * )–1 = (A –1)*
(vii) Adjoint of a symmetric (Hermitian) matrix is (ix) Inverse of a non-singular symmetric (Hermitian)
symmetric (Hermitian). matrix is symmetric (Hermitian).
44. Elementary operations—An elementary opera-
41. Singular Matrix—A square matrix A is said to
tion is said to be row (or column) operation if it is
be singular, if its determinant is zero
applied to rows (or columns).
i.e., ⏐A⏐ = 0.
There are three types of elementary operations—
It is said to be regular or non-singular, if Type (1) The interchanging of ith and jth rows (or
⏐A⏐ ≠ 0. columns) of the matrix, this operation is denoted by
⎡ 5 3 ⎤⎥ R i ↔ Rj (or Ci ↔ Cj) or by Rij (Cij).
Example—The matrix ⎢⎢ ⎥⎦ is singular because
⎣ 10 6 Type (2) If ith row (or column) of the matrix is
⎪⎪ 5 3 ⎪⎪ multiplied by scalar k (k ≠ 0), then this row (or column)
⎪⎪ 10 6 ⎪⎪ = 30 – 30 = 0. operation is denoted by Ri → k Rj (or Ci → k Cj).
Type (3) If k times of the elements of the
Note—Every skew-symmetric matrix of odd order i th row (or column) are added to the corresponding
is singular. elements of jth row (or column), then this row (column)
42. Inverse of a square matrix—Let A be a square operation is denoted by R j → Rj + kRi (or Cj → Cj +
matrix of order n. Then the matrix B of order n is called kCi).
an inverse of A if it exists such that. 45. Elementary Matrices—A matrix obtained from
AB = In = BA a unit matrix by a single elementary operation is called
The inverse of A is denoted by A–1. It is clear that if an elementary matrix.
B is the inverse of A, then A is an inverse of B. The elementary matrices obtained by applying
We know that elementary operations R i ↔ Rj or Ci ↔ C j on unit matrix
A.(Adj A) = ⏐A⏐.I are same and are denoted by Eij.
= (Adj A).A The elementary matrices obtained by applying
elementary operations Ri → kRi and Ci → k C i on the
or, A (Adj .A
⏐A⏐ ) = I= (Adj .A
⏐A⏐
.A ) unit matrix are same and denoted by Ei (k).
The elementary matrices obtained by applying
Adj . A elementary operations Rj → Rj + kRi and Ci → Ci + k Cj
Hence, A–1 =
⏐A⏐ on unit matrix are same and denoted by E ji (k).
336U | Economics (NET)
46. Important Facts—(1) The matrix obtained by (viii) If A' is the transpose of A, then ρ (AA') = ρ
applying a row operation on a given matrix be same as (A).
the matrix obtained by pre-multiplication of the given (ix) If A * is the transpose conjugate of A, then ρ
matrix by the corresponding elementary matrix. (AA* ) = ρ (A).
(2) The matrix obtained by applying a column 49. Normal Form of a Matrix—Every non-zero
operation on a given matrix be same as the matrix
matrix A, of order m × n can be reduced by using finite
obtained by post-multiplication of the given matrix by
the corresponding elementary matrix. number of elementary operations into equivalent matrix
of one of the following form
(3) The effect of a row operation on a product of
⎡ Ir 0 ⎤⎥ ⎡ Ir⎤
(i) ⎢⎢ (ii) ⎢⎢ ⎥⎥
two matrices is equivalent to the effect of the same row
operation applied only to the pre-factor. ⎣0 0⎦ ⎥ ⎣0 ⎦
(4) The effect of a column operation on a product of (iii) [I r 0] (iv) [ Ir ]
two matrices is equivalent to the effect of the same
column operation applied only to the post-factor. Where, Ir is the unit matrix of order r × r and 0 is
47. Rank of a Matrix— null matrix of any order.
Definition—A number r is defined as the rank of a These four forms are called the normal form of the
m × n matrix A if, original matrix.
(i) A has at least one minor of order r which is not Then, ρ (A) = r
equal to zero. 50. Nullity of a Matrix—If A is a square matrix of
(ii) There is no minor of order (r + 1) which is not order n and ρ (A) is the rank of the matrix A, then nullity
equal to zero. of the matrix A is given by n – ρ(A). The nullity of A is
The rank of the matrix A is denoted by ρ (A). denoted by N (A).
Note (1) : The rank of a null matrix is defined as zero 51. Linear Equation—Consider the following
i.e., ρ (0) = 0. system of n linear equations in n unknown x 1 , x2, …xn.
Note (2) : If In is a unit matrix of order n, then its
rank I = n. i.e., ρ (In ) = n.
⎫⎪
a11 x1 + a12 x2 + … + a1n xn = b1
Note (3) : From the definition of the rank of a matrix,
we concluded that ⎪
a21 x1 + a22 x2 + … + a2n xn = b2
………………………………………⎬ …(i)
⎪
(a) If a matrix A does not possesses any
minor of order (r + 1), then ρ (A) ≤ r.
(b) If at least one minor of order r of the
matrix is not equal to zero, then ρ (A)
………………………………………
a x +a x +…+a x =b
n1 1 n2 2
⎪⎭ nn n n
≥ r.
The above system of equations can be written as
Note (4) : If every (r + 1)th order minor of A is zero,
then any higher order minor will also be AX = B
zero.
Note (5) : If A is n × n non-singular matrix, then ρ
⎡⎢
a11 a12 … a1n
a21 a22 … a2n
⎤⎥ ⎡⎢
x1
x2
⎤⎥
b1
b2
⎡⎢ ⎤⎥
(A) = n. ⎢
or, … … … … ⎥⎢
… = … ⎥ ⎢ ⎥
48. Important Results—(i) Elementary operations ⎢⎣
… … … … … ⎥⎦ ⎢⎣ …⎥⎦ ⎢⎣ ⎥⎦
do not change the rank of a matrix. an 1 an 2 … an n xn bn
(ii) If A' is a transpose of A, then If B = 0 i.e., b1 = b2 = b3 … bn = 0, then the system
ρ (A') = ρ (A). of equations is called homogeneous.
(iii) If A* is the transpose conjugate of A, then ρ
(A * ) = ρ (A). If B ≠ 0, then the system of equations is non-
homogeneous.
(iv) The rank of a skew-symmetric matrix cannot be
one. 52. Cramer’s Rule—For the system of linear
(v) The rank of a matrix A does not change by equations (i) if ⏐A⏐ ≠ 0, then
premultiplication or post-multiplication with any non- ⏐A1⏐ ⏐A2⏐ ⏐A3⏐
singular matrix. x1 = , x2 = , x3 = ,
⏐A⏐ ⏐A⏐ ⏐A⏐
(vi) If A and B are matrices of same order, then
ρ (A + B) ≤ ρ (A) + ρ (B). ⏐An⏐
.…………………..xn =
(vii) If A and B are two matrices such that the ⏐A⏐
product AB is defined, then rank (AB) cannot exceed the Where, ⏐A1⏐, ⏐A2⏐, ⏐A3⏐…⏐An⏐ are the determi-
rank of the either matrix. nants obtained by replacing the elements of 1st, 2nd,
i.e., ρ (AB) ≤ min {ρ (A), ρ (B)} 3rd… n th column of ⏐A⏐ by the elements of B.
Economics (NET) | 337U
53. Solution of the equations using inverse of For such a system the rank of the matrix A and
coefficient matrix— augmented matrix [A : B] are equal. Hence a system of
homogeneous linear equations is always consistent.
Let us consider the system of equations
If x = 0 (zero) i.e., x1 = x2 … = xn = 0, then the
AX = B solution is a trival solution. Thus condition for a trival
Then X = A–1 B solution of the system of linear equations is ρ (A) = n.
if ⏐A⏐ ≠ 0 If ρ (A) < n, then the solution will be non-trival.
Which is the required solution. Note—A homogeneous system of linear equation in
n unknowns whose determinant of coefficient does not
54. Non-Homogeneous System of Linear Equa-
equal to zero, has only the trival solution.
tions—Consider the following system of m linear
equations in n unknowns x 1 , x2 … xn. 57. Characteristic Equation of a Matrix—Let A
be a square matrix of order n and In be a unit matrix of
a11 x1 + a12 x2 + … + a1n xn = b1
order n. Then | A – λ In | = 0 is called the characteristic
a21 x1 + a22 x2 + … + a2n xn = b2
equation of A. The values of λ are called eigen values of
…………………………………… …(i) A.
…………………………………… Properties—
am1 x1 + am2 x2 + … + amn xn = bm (i) If A is a square matrix of order 2 and f(x) =
The system of equation can be written as x2 – 4x + 3
AX = B …(ii) Then f(A) = A2 – 4A + 3
⎡⎢ aa aa …
11 12
… a
a 1n ⎤⎥ (ii) The sum of the eigen values of A is equal to its
trace.
⎢… … … … ⎥,
21 22 2n
(iii) The product of the eigen values of A is equal to
Where, A =
⎢⎣ a… a… … … ⎥⎦ its determinant.
(iv) The eigen values of an orthogonal matrix are of
m1 … a
m2 mn
unit modulus.
⎡⎢ xx ⎤⎥ ⎡⎢ bb ⎤⎥
1 1 (v) The eigen values of a unitary matrix are of unit
modulus.
⎢ … ⎥B=⎢ … ⎥
2 2
X = (vi) A and At have same eigen values.
⎢⎣ … ⎥⎦ ⎢⎣ … ⎥⎦ (vii) The eigen values of a Skew-hermitian matrix are
n x b n either purely imaginary or zero.
The system of equation (i) is said to be consistent if (viii) If λ is an eigen value of A, then λ is the eigen
it has at least one solution. value of Aθ.
The system of equation (i) is said to be inconsistent
if it has no solution. (ix) The eigen values of a triangular matrix are its
diagonal elements.
⎡⎢ aa
11 a12
a22
… a1n
… a2n
:
:
b1
b2
⎤⎥ (x) If λ is the eigen value of A and | A | ≠ 0, then
(1/λ) is the eigen value of A–1.
⎢… ⎥
21
The matrix … … … : … (xi) If λ is the eigen value of A and | A | ≠ 0, then
⎢⎣ a… … … … : … ⎥⎦ |A|
m1 am 2 … amn : bn is the eigen value of adj A.
λ
is called augmented matrix and denoted by [A : B] (xii) If λ 1 , λ 2 ...... λ n are eigen values of A, then the
55. Important Facts—The system of equation (i) is eigen values of A2 are λ 1 2 , λ22 .....λn2 .
consistent if ρ [A : B] = ρ (A), otherwise inconsistent. 58. Cayley–Hamilton Theorem—Every square
Now if system is consistent we have the following matrix satisfies its own characteristic equation.
conclusions—
(1) If ρ (A) = n (the number of unknowns), then Static Optimisation Problems and
there is only one solution. their Applications
(2) If ρ (A) < n, then n – r unknowns may have, Optimisation is the process of minimising the cost
arbitrary values and the values of the remaining or maximising the benefits of any action or the decision.
unknowns is determined uniquely. There will be infinite It can be understood in the following manner—
solutions for the system. (1) A person has money which he wants to invest.
56. Homogeneous System of linear equations—If He would try and optimise his return by maximising the
b1 = b2 = b3 … = bm = 0, the set of equations is said to be interest he gets on that money.
homogeneous. Thus (2) A person has money which he wants to invest.
AX = 0 The optimum condition is that he gets maximum
338U | Economics (NET)
possible interest and minimum possible risk. Thus, he ● If f has a local maximum at x, then the hessian of
can optimise his return by a balance in maximisation of f at x H (x) is negative semi-definite.
interest return and minimisation of risk. ● If f has a local minimum at x, then the hessian of f at
The term ‘Static Optimisation’, in more specific x H (x) is positive semi-definite.
form refers to the process of minimising or maximising
the costs/benefits of some action for one instant in time The necessary second-order conditions are not
only. extremely useful in practice though—the only thing they
do is to restrict a bit more the set of possible candidates
An optimisation in Rn consists in maximising or for a global maximum, excluding the points at which the
minimising an objective function. hessian is not negative semi-finite.
f : Rn → R over a constant set
Typically, however, the first order conditions have
D ⊆ Rn already reduced the candidates to only a few, so that the
max/min f (x)·s·t x ∈ D. second order necessary conditions are not very useful.
x ∈ Rn
because minimising f is equavalent to maximising – f, all Equality-constrained Prolems : The
results on minimisation are easy to derive from results Theorem of Lagrange
on maximisation.
So far we have learnt the condition of the maxima to
Instantly, our goal is to determine not only the be interior points of D. This is obviously guaranteed if
maximum of f, but also the set of its maximisers arg D is open, but more generally the methods can be used
max. (f (x), x ∈ D). to find the maxima in the interior of D for any constraint
By asuming that f is at least once differentiable, the set D. However, this leaves out the maxima that lie on
following three types of maximisation problems are the frontier.
considered, subject to the constraint set D.
In the case of equality constraints D = {x, g1 (x) = 0,
1. Optimisation on an open set if D is an open set. …gk (x) = 0}.
2. Equality constraints if O can be written as
Let us start with the issue of existence of maxima.
D = {x/g (x) = 0, …gk (x) = 0} As long as the function g = (g1, …, gk)′ is continuous, D
3. Inequality constraints : If D can be written as is closed since D is the inverse image of the closed set
D = {x/g1 (x) ≥ 0, …gk (x) ≥ 0} {0} by a continous function. If D is also bounded, then
(1) Optimisation on as open set—This is some- D is compact. If in addition f is continuous, the problem
times referred to as unconstrained optimisation, which has a solution by Weierstrass theorem.
seems to restrict the case to the absence of constraints Consider a canonical maximization problem, the
D = Rn . Instead, the terminology reflects that the utility maximization problem of a consumer. It is
constraints “do not matter” when D is an open set : assumed that a consumer has preference over n goods
when maxima are interior points of D, the methods to that can be represented by a utility function U : Rn → R.
find possible maxima are the same as if the problem had The consumer decides how much to consume of each
no constraints— n
Necessary first-order conditions—Let D be an good subject to his budget constraint ∑ pixi = w, where
t=1
open set of Rn , and f : D → R a differentiable function. pi is the price of the good i and w is the consumer’s
If f has a local maximum of x, then f ′ (x) = 0, i.e., income. Assuming the consumer behaves to get most
all the partial derivatives are nil, fi′ (x) = 0 for all i. satisfaction out of his consumption, his consumption is
x is a critical point or stationary point of f when f ′ solution to the program—
(x) = 0 it means “if x is a local maximum, then it is a n
critical point”. maxn U (x1, …, xn) s.t. ∑ pixi = w
x∈R t=1
In general the first order conditions select more than
just the local maxima being a critical point is a necessary The novelty relative to the previous section is in the
condition but not sufficient condition for being a local constraint ∑ipixi = w . But do we really need a new
maximum-let alone a global maximum. In this regard method ? Can’t we just use the constraint to replace one
consider the following points. variable in the objective and end up with an
The set of critical points also contains local (inclu- unconstrained program ? For instance, we could replace
1 ⎛ ⎞
n–1
ding global) minima. But there are also critical points
xn through x n = ⎜ w – ∑ pixi⎟ and use the method of
that are neither local maximum nor local minimum. pn ⎝ t=1 ⎠
They are called saddle points.
the previous section to find the maxima of the
Necessary Second-order Condition—For C2 unconstrained problem in n – 1 variables x1, …, xn– 1.
functions, second-order condition gives additional
⎡⎢ 1⎛ n–1
⎞⎤
∑ pixi⎟⎥⎥
necessary condition that differ between local maxima
and local minima. Let D be an open set of Rn , and max U ⎢⎣ 1
x ‚…‚x ‚ ⎜
pn ⎝
w –
⎠⎦
n–1 n– 1
x1 ‚…‚xn – 1 ∈ R i=1
f : D → R a C2 function :
Economics (NET) | 339U
The first-order conditions give—
p '
[ ]
f1 (x*) + – f2 (x*) g'2 (x*)– 1 g'1 (x* ) = 0
' '
∀i = 1,…,n – 1, Ui' (x) – i Un (x) = 0 Defining λ* =–
'
f2 (x*)
'
g2 (x*)– 1, we get
pn
' '
We absolutely can—in this example. But this is f1 (x*) + λ*g1 (x*) = 0
because the constraint lets us express xn as an explicit ' '
(x*) +
f2 λ*g2
(x*) = 0
function of x 1 ,…,xn – 1. This is not always the case— Which is precisely the result.
sometimes we cannot turn the equation g (x) = 0 into an
The constraint qualification guarantees that there
explicit function of k variables as a function of the n – k
exists a way to replace k variables by n – k in the
others. The theorem of Lagrange deals with constraints
objective. If it is not satisfied at a local maximum, then a
that only give implicit relationships between the
local maximum may well fail to satisfy the first-order
optimization variables. As the proof of the theorem of
condition stated in the Lagrange theorem. To select all
Lagrange will make clear however, the idea of the
possible maxima, we must therefore also look for the
theorem is precisely to replace k variables into the
points where the constraint qualification fails, as they
objective using the constraints. Its only sophistication is
are possible maxima even if they do not satisfy the first-
to the use the implicit function theorem to do the
order conditions.
replacement.
As an example, let us solve the consumer problem
The theorem of Lagrange using the theorem of Lagrange. The constraint is g
The Theorem of Lagrange (necessary first-order (x1 ,…,xn) = w – ∑ipixi. Since g′ (x) = p′, which has rank
conditions)— 1 assuming p ≠ 0, the constraint qualification is satisfied
Let f : Rn → R be C1 , and g = (g1 ,…, gk)′ : Rn → Rk everywhere. We form the Lagrangian—
be C 1 functions, and consider the program— ⎛ n
⎞
L(x, λ) = U (x) + λ ⎜ w – ∑ pixi⎟
maxn f (x) s.t. gi (x) = 0 for all i = 1,…,k ⎝ t=1 ⎠
x∈R
And look for solutions (x, λ) to the system—
If x is a local maximum of f on D and x satisfies the '
constraint qualification rank (g′(x)) = k, then there exist ∀i = 1,…,ni Ui (x) = λpi
k Lagrange multipliers λ = (λ1,…, λk)′ ∈ R k such that n
the first-order condition holds— ∑ pixi = w
t=1
k
′ We can eliminate λ using one first-order condition,
f ′ (x) + λ′g′ (x) = f ′ (x) + ∑ λig i (x) = 0 '
t=1 Ui(x)
A point and associated Lagrange multiplier (x, λ) for instance for xn : λ = . We end up with—
pi
that satisfy the first order condition can be seen as a
' p '
critical point of the Lagrangian defined as— ∀i = 1,…,n – 1, Ui (x) = i Un (x)
k pn
′
L (x, λ) = f (x) + λ′g (x) = f (x) + ∑ λig i (x) n
i=1 ∑ pixi = w
(The derivative of L with respect to λ is simply the t=1
constraint g (x) = 0). which is the same system as the one we obtain replacing
Let us check the assumptions of the implicit function the constraint in the objective.
* *
theorem. First, g is C1. Second, g (x1 , x2 ) = 0, since x* ∈ Even in case such as the consumer problem where
' * * we can do without the method of Lagrange, the method
D. Third, we need g2 (x1 , x2 ) to be invertible. But this is of Lagrange is to be preferred for interpretation
precisely what the constraint qualification guarantees, purposes. First, it treats all variables symmetrically,
provided a recording of the variables in x*. So by the which is usually easier to handle. Second and most
implicit function theorem, we know there exists a C1 importantly, we will see below that the Lagrange
* * *
function h : B (x1 , r) → R k such that x2 = h (x 1 ), g [x1, h multipliers have an economic interpretation that makes
* * '
(x1 )] = 0 for all x1 ∈ B (x1 , r), and h′ (x1 ) = – g2 (x*)– 1 the first-order conditions of the method of Lagrange
economically insightful.
g' (x*).
1
Inequality-constrained Problems : The
The assumption that x* is a local maximum of f can
* Theorem of Kuhn-Tucker
now be phrased as saying that x 1 is a local maximum of
the C1 function F (x1 ) = f [x 1 , h (x1)] on the open ball B Let us now consider inequality-constrained
* programs. D = {x, g1 (x) ≥ 0,…,gk (x) ≥ 0}. As long as
(x1 , r) without constraint. From the previous section, we the function g = (g ,…,g )′ is continuous, D is closed
* 1 k
know that x 1 must satisfy the first-order condition— since D is the inverse image of the closed set (R+)k by a
' ' *
f1 (x*) + f2 (x*) h′ (x1 ) = 0 continuous function. If D is also bounded, then D is
compact. If in addition f is continuous, the problem has a
' '
[ '
]
f1 (x*) + f2 (x*) – g'2 (x*)– 1 g1 (x*) = 0 solution by Weierstrass theorem.
340U | Economics (NET)
With inequality constraint, the question appears of goods (inputs) for further use in producing final goods
whether a constraint binds or not at a point x ∈ D. We (outputs). There are flows of goods in “whirpools and
say that the constaint gi (x) ≥ 0 is effective or active or cross currents” between different industries. The supply
binding at x * if it holds with equality at x*, gi (x*) = 0. side consists of large inter-industry flows of intermediate
Note that an equality constraint g (x) = 0 can always be products and the demand side of the final goods. In
seen as two inequality constraints g (x) ≥ 0 and – g (x) essence, the input-output analysis implies that in
≥ 0, the theorem of Kuhn and Tucker (and Karush) is equilibrium, the money value of aggregate output of the
going to generalize the theorem of Lagrange. The result whole economy must equal the sum of the money values
is very similar, but the following points must be taken of interindustry inputs and the sum of the money values
into conside ration. of inter-industry outputs.
1. The signs of the Lagrange multipliers now matter. Main Features
2. Complementary slackness conditions are added to The input-output analysis is the finest variant of
the necessary conditions. general equilibrium. As such, it has three main elements.
3. The constraint qualification applies to the Firstly, the input-output analysis concentrates on an
effective consraints only. economy which is in equilibrium. It is not applicable to
partial equilibrium analysis. Secondly, it does not
The Theorem of Kuhn and Tucker (necessary
concern itself with the demand analysis. It deals
first-order conditions)—
exclusively with technical problems of production.
Let f : Rn → R, and g = (g1,…,gk)′ : Rn → Rk be C1 Lastly, it is based on empirical investigation.
functions, and consider the program—
maxn f (x) s.t. gi (x) ≥ 0 for all i = 1,…,k Assumptions
x∈R This analysis is based on the following assump-
Let x be a local maximum of f on D. tions :
Let gi,…,gie be the e effective constraints at x; 1. The whole economy is divided into two sectors–
“inter-industry sectors” and “final-demand sectors,”
assume the constraint qualification rank (g' (x),…,g i ) =
'
i1 e both being capable of sun-sectoral division.
e holds. 2. The total output of any inter-industry sectors is
Then there exist k Lagrange multipliers λ ∈ R k such generally capable of being used as inputs by other
that the Kuhn-Tucker conditions hold— inter-industry sectors, by itself and by final demand
1. The first-order conditions— sectors.
k 3. No two products are produced jointly. Each industry
′ ′
Lx (x, λ) = f′' (x) + λ′g′ (x) = f ′ (x) + ∑ λigi(x) = 0 produces only one homogenous product.
i=1 4. Prices, consumer demands and factor supplies are
2. The constraints are satisfied, all lagrange given.
multipliers are weakly positive, and the complementary 5. There are constant returns to scale.
slack-ness conditions are satisfied, meaning that for each 6. There are no external economies and diseconomies
i, either the constraint is effective at x, or λ i = 0 (or of production.
both). 7. The combinations of inputs are employed in rigidly
∀i, gi (x) ≥ 0, λ i ≥ 0 and gi (x) λ i = 0 fixed proportions. The inputs remain in constant
proportion to the level of output. It implies that
Input-Output Analysis there is no substitution between different materials
Input-output is a novel technique invented by and no technological progress. There are fixed input
Profession Wassily W. Leontief in 1951. It is used to coefficients of production.
analyse inter-industry relationship in order to understand Importance
the interdependencies and complexities of the economy
and thus the conditions for maintaining equilibrium The concept of input-output is of tremendous
between supply and demand. It is also known as “inter- practical value and importance.
industry analysis”. 1. A producer can know from the input-output table,
The input-output analysis tells us that there are the varieties and quantities of goods which he and
industrial inter-relationships and inter-dependencies in the other firms buy and sell to each other. In this
the economic system as a whole. The inputs of one way he can make the necessary adjustments and
industry are the outputs of another industry and vice thus improve his position vis-à-vis other producers.
versa, so that ultimately their mutual relationships lead 2. It is also possible to find out form the input-output
to equilibrium between supply and demand in the table the inter-relations among firms and industries
economy as a whole. Coal is an input for steep industry about possible trends towards combinations.
and steel is an input for coal industry, though both are 3. The repercussions of a prolonged strike, of a war
the outputs of their respective industries. A major part of and of a business cycle can be easily perceived from
economic activity consists in producing intermediate the input-output table.
Economics (NET) | 341U
4. The input-output model has come to be used for 2. Rows of the table give us the equality between
national income accounting “because it provides a the demand and supply of each product :
more detailed breakdown of the macro aggregates X1 = X11 + X12 + X13 + X14 + F1
and money flows.
X2 = X21 + X22 + X23 + X24 + F2
Input-Output Table X3 = X31 + X32 + X33 + X34 + F3
The input-output table relates to the economy as a
whole in a particular year. It shows the values of the X4 = X41 + X42 + X43 + X44 + F4
flows of goods and services between different productive L1 = L1 + L2 + L3 + L4
sectors especially inter-industry flows. In general terms, if there are x producing sectors :
Let us assume that an economy consists of 4
producing sectors only; and that the production of each X1 = X11 + X12 + X13 … X1n + F1
sector is being used as an input in all the sectors and is X2 = X21 + X22 + X23 … X2n + F2
used for final consumption.
…………………………………
Suppose (i) x 1 , x2 , x3 and xare total outputs of the 4
…………………………………
sectors;
(ii) F1 , F2 , F3 and F4 are the amounts of final …………………………………
demand consumption capital formation and exports for Xn = Xn1 + Xn2 + Xn3 … Xnn + Fn
output of these sectors.
(iii) X11 , X12 , X13 and X14 are the amounts of and L = L1 = L1 + L2 + L3 … Ln
n n
product of sector Ist, 2nd, 3rd and 4th sectors respec-
tively. or Xi = Σ XiJ + Fi and L = Σ Li
J=1 i=1
We can now translate the distribution of total where Xi = Total output of ith sector
product of 4 producing sectors in the following way :
XiJ = Output of ith sector used as input in
Input-Output Transaction Table Jth sector
Produc- Total Require- and F i = Final demand for ith secor.
ing ouput of Input requirements ment of
sector the sector of producing sectors for final The above identity states that all the output of a
No. uses particular sector could be utilized either as an input in
one of the producing sectors of the economy and/or as a
X1 X2 X3 X4
final demand. Basically, therefore, input-output analysis
1 2 3 4 5 6 7 is nothing more than finding the solution of these
1 X1 X11 X12 X13 X14 F1 simultaneous equations.
2 X2 X21 X22 X23 X24 F2 The Technological Coefficient Matrix
3 X3 X31 X32 X33 X34 F3 From the assumption of fixed input requirements we
4 X4 X41 X42 X43 X44 F4 see that in order to produce one unit of Jth commodity,
the input used of ith commodity must be a fixed amount,
Primary Total L1 L2 L3 L4 –
which we denote by aiJ XJ or X iJ = aiJ XJ.
Input Primary
As such we can not put the input-out transaction
(Labour) Input table in terms of technical coefficients as follows :
=L
Purch- Total Input requirement of Re-
We derive two imortant equations from the above asing output producing of Producing quire-
table : sector of the sectors ment
1. Columns 3, 4, 5 and 6 of the above table give us sector Pur- asing
total inputs (from all sectors) utilized by each sector for chases X2 X3 X4 sector
its production. In other words col. 3 gives the production ↓ X1
function of sector 1 and col. 6 represents the production
function of sector 4. Sales →
X1 = f 1 (X11, X21, X31, X41, L1) 1 X1 a 11X1 a 12X2 a 13X3 a 14X4 F1
X2 = f 2 (X12, X22, X32, X42, L2) 2 X2 a 21X2 a 22X2 a 23X3 a 24X4 F2
X3 = f 3 (X13, X23, X33, X43, L3) 3 X3 a 31X1 a 32X2 a 33X3 a 34X4 F3
X4 = f 4 (X14, X24, X34, X44, L4) 4 X4 a 41X1 a 42X2 a 43X3 a 44X4 F4
In general terms, if there are ‘n’ number of pro- Primary L 1 1 X1 1 2 X2 1 3 X3 1 4 X4 –
ducing sectors then the production function of sector n Input
will be represented by It should be noted that all these coefficients are non-
Xn = fn (X1n, X2n, X3n,…X4n) negative (≥ 0).
342U | Economics (NET)
The above table gives us the total output of each i.e., either zero or greater than zero. The cost of the
sector in terms of technical coefficients; and if these are primary inputs (which is also termed as value added)
‘n’ producing sectors : needed in producing a unit of Jth commodity should be
X1a11X1 + a12X2 + a13X3, …… a1nXn + F1 ⎡⎢ n ⎤⎥
⎢⎣ 1i Σ= 1 aiJ⎥⎦
X1a11X1 + a12X2 + a13X3, …… a2nXn + F2
……………………………………………… Note here that a iJ are in value terms.
……………………………………………… A Numerical Example
Xn = an1X1 + an2X2 + an3X3, …… annXn + Fn Suppose there are only three industries in an
economy and we have to estimate the output of each
L = 1 1 X1 + 1 2 X2 + 1 3 X3 + 1 4 X4
industry with the given input coefficient matrix and final
n
demand as follows (the coefficient matrix is in value
or Xi = Σ aiJXJ + FJ(i = 1, 2, …n)
J=1 terms) :
and L = Σ1i Xi ⎡⎢ 0·3 0·4 0·2 ⎤⎥
A = ⎢ 0·2 0 0·5 ⎥
The equations may be nut in matrix notations. ⎢⎣ 0·1 0·4 0·1 ⎥⎦
⎛ X1 ⎞ ⎛
a11 a12 a13…a1n ⎞⎛
X1 ⎞
F1 ⎛ ⎞
⎜ X2 ⎟ ⎜
a21 a22 a23…a2n ⎟⎜
X2 ⎟
F2 ⎜ ⎟ ⎡⎢ 100⎤⎥
and F = ⎢ 40 ⎥ million rupees·
⎜ ⎟ ⎜
… = ………………… ⎟⎜
… + … ⎟ ⎜ ⎟ ⎢⎣ 50 ⎥⎦
⎜⎝…
Xn
⎟⎠ ⎜⎝
…………………
an1 an2 an3…anm
…⎟⎠ ⎜⎝
Xn
⎟⎠
…
Fn
⎜⎝ ⎟⎠ Here we note that 3-column sums of A are (0·3 +
0·2 + 0·1) = 0·6, (0·4 + 0 + 0·3) = 0·7 and (0·2 + 0·5 +
or X = AX + F 0·1) = 0·8; which are less than 1 in each case. In other
and L = Σ1i Xi words, (1 – 0·6) = 0·4, (1 – 0·7) – 0·3 and (1 – 0·8) = 0·2
is the maximum amount of primary input which can be
Closed and Open Input-Output Model used for producing “a rupee worth” of the three commo-
In the above example besides n industries, our dities (P·Q and R) respectively.
model contains exogenous sector of final demand which ⎡⎢ 0·3 0·4 0·2 ⎤⎥
supplies primary input factors (labour services-which are Since A = ⎢ 0·2 ⎥
not produced by n industries) and consumes the output ⎢⎣ 0·1 0·30 0·5
0·1 ⎥⎦
of the n-producing industries (not a input). Such an
⎡⎢ + 0·7 – 0·4 – 0·2 ⎤⎥
and [1 – A] = ⎢ – 0·2 + 1 – 0·5 ⎥
input-output model is known as open model. In includes,
exogenous sectors in terms of “final demand bill” along ⎢⎣ – 0·1 – 0·3 + 0·9 ⎥⎦
with the endogenous sectors in terms of n-producting
substituting these values in X = [1 – A] – 1 F, we get
sectors. Input-output model which has endogenous final
demand vector is known as closed input-output model. ⎡⎢ X1⎤⎥ ⎡⎢ 0·7 – 0·4 – 0·2 ⎤⎥–1 ⎡⎢ 100⎤⎥
X = ⎢⎢ X2⎥ = ⎢ – 0·2 1 – 0·5 ⎥ ⎢ 40⎥
Coefficient Matrix in Value Terms ⎣ X3⎥⎦ ⎢⎣ – 0·1 – 0·3 0·9 ⎥⎦ ⎢⎣ 50⎥⎦
Agains if we assume prices of all the outputs to be ⎡⎢ 0·7 – 0·4 – 0·2 ⎤⎥–1
given, the iJ th elements of [aiJ] matrix will represent the But ⎢ – 0·2 0·5 ⎥
amount of ith commodity in money terms for “a rupee ⎢⎣ – 0·1 – 0·31 – 0·9 ⎥⎦
worth” of Jth commodity. For example, it aiJ = 0.35, it ⎡
1 ⎢⎢ 0·75 0·42 0·40 ⎥
⎤
means that 35 paise worth of ith commodity is required = 0·23 0·61 0·39 ⎥
0·401 ⎢⎣ 0·16 2·25 0·62 ⎥
as an input for producing a rupee worth of Jth commo- ⎦
dity. ⎡⎢ X1⎤⎥
Also, in view of the presence of exogenous sector ∴ X = ⎢⎢ X2⎥
(which supplies primary inputs) the sum of the elements ⎣ X3⎥⎦
of each input coefficient column [aij] must be less than I. ⎡ ⎤–1 ⎡ ⎤
1 ⎢⎢ 0·75 – 0·42 – 0·40 ⎥ ⎢⎢ 100⎥
Each column-sum represents the partial input cost = – 0·23 0·61 – 0·39 ⎥ 40⎥
0·401 ⎢⎣ – 0·16 – 0·25 0·62 ⎥ ⎢⎣ 50⎥
(excluding the cost of primary input) incurred in ⎦ ⎦
producing a rupee worth of some commodity; If this 1
sum is greater than or equal to one rupee, the production ∴X1 = [0·75(100) + 0·42(40) + 0·40(50)]
0·401
will not be economically justifiable. Symbolically this = R 279 million (approx.)
fact may be stated as : 1
n X2 = {0·23(100) + 0·61(40) + 0·39(50)}
0·401
Σ aiJ < 1 (J = 1, 2, … , n)
i=1 = R 167 million (approx.)
Economics (NET) | 343U
1 300
X3 = {0·16(100) + 0·25(40) + 0·62(50)} The input coefficient, for agriculture are = 0·3
0·401 1000
= R 142 million (approx.) 400
and = 0·4 the input coefficients of industry are
The Hawkins-Simon Conditions 1000
600 1200
Many a time input-output matrix solution may given = 0·3 and = 0·6
2000 2000
outputs expressed by negative numbers. If out solution The technology matrix then is
gives negative outputs, it means that more than one
tonne (or any unit) of that product is used up in the
production of every one tonne of that product; which is
[
0·3 0·3
A = 0·4 0·6 ]
definitely unrealistic situation. Such a system is not a
viable system. Hawkins-Simon conditions guard [ ]
The final Demand vector is F = 800
200
against such eventualities.
Our basic equation is X = [1 – A] – 1 F, in order that [ ]
0·7 – 0·3
Now [1 – A] = – 0·4 0·4
this does not give negative numbers as a solution, the
matrix [I – A], which is fact is : [1 – A] – 1 =
1
[ ] 0·4 0·3
0·28 – 0·12 0·4 0·7
⎛ 1 – a11 –a12 –a13 –a1n ⎞
⎜ – a21 (1 – a22) –a23 … –a2n ⎟
⎜
…
⎟
=
1
[ ]0·4 0·3
0·16 0·4 0·7
⎜ – a31 –a32 (1 – a33) … –a3n ⎟
⎜⎝ … (1 – anm) ⎟⎠
We know that
– an1 – an2 –an3 X = [1 – A]– 1 F
Shoud be such that :
1. The determinant of the matrix must always be
=
1
[ ][ ]
0·4 0·3
0·16 0·4 0·7
200
800
positive, and
2. The diagonal elements : (1 – a11), (1 – a22),
=
1
[ ]
80 + 240
0·16 80 + 560
(1 – a33), … (1 – anm) should all be positive or in other
words elements : a11,a22,a33…anm should all be less than
=
1
[ ]320
0·16 640
X = [4000]
one. One unit of output of any sector should use not 2000
more than I unit of its own output. ∴
These are Kawkins-Simon conditions. Hence the output in the agricultural sector is 2000
Example, units and that in the industry is 4000 units.
Example. In an economy of three industries R, S, T,
[ ]0·8 0·2
Suppose [A] = 0·9 0·7 the data given below (in million) are available.
Users
[1 – A] = [– 0·9 0·3 ]
0·2 – 0·2 Final Output
∴ Producers demand
R S T
and the values of determinant of [1 – A] will be 0·06 R 80 100 100 40 320
– 0·18 = – 0·12 which is less than zero. S 60 200 60 60 400
As such Hawkins-Simon conditions are not satisfied. T 80 100 100 20 300
No solution will be possible in this case. Determine the output if the final demand changes to
Example : Given the following transaction matrix, 60 for R, for S and 60 for T.
find the gross output so meet the final demand of 200 Ans. From the data the input coefficients of R are
units of Agriculture and 800 units of Industry : 80 , 80 , 80 1 1 1
or , ,
320 320 320 4 4 4
Producing Purchasing sector Final
the input coefficients of S are
sectors Agriculture Industry demand
100 , 200 , 100 1 , 1 , 1
Agriculture 300 600 100 or
400 400 400 4 2 4
Industry 400 1200 400 the input coefficients of T are
Ans. The Input-output table can be re-written as 100 , 60 , 100 1 , 1 , 1
or
300 300 300 3 5 3
Agri. Ind. Final demand
Gross
Output ⎪⎪
1 1 1
4 4 3
⎪⎪
Agri. 300 600 100 1000
⎪
1 1 1 ⎪
Ind. 400 1200 400 2000 ∴ Technology matrix is A =
⎪
4 2 5 ⎪
From this table the input coefficients can be easily ⎪⎪
1 1 1 ⎪⎪
determined. 4 4 3
344U | Economics (NET)
⎡⎢ X1⎤⎥ ⎡⎢ 60⎤⎥ Ans. From the question we get the transaction
and X = ⎢⎢ X2⎥, F = ⎢ 40⎥ Matrix to be
⎣ X3⎥⎦ ⎢⎣ 60⎥⎦
∴ X = AX + F or (I – AX) = F
[X 12] = 5 4
4 3
[ ]
∴ X = (1 – A)– 1 F, if |I – A| ≠ 0 The technology Matrix can be derived from above
3 ⎡⎢1 1
– – ⎤⎥ given the gross output of each sector.
⎡4 3⎤
[X iJ] ⎢⎢ 20 12⎥⎥
4 4 3
⎢
1 1 1 ⎥ =⎢5 4⎥
Now [1 – A] = –
⎢
4 2
–
5 ⎥ A = [aiJ] =
XJ ⎢ ⎥
⎢⎣
1 1 2
– – ⎥⎦ ⎣ 20 12⎦
23
4 4 3
[
0·2 0·25
= 0·25 0·33 ]
∴ [1 – A] =
240 Now [1 – A]
⎡⎢
17 1 13
60 4 60
⎤⎥ [0·8 – 0·25
= – 0·25 0·66 ]
240 13 5 14⎢ ⎥
⎢ ⎥ 0·528 – 0·0625 [0·25 0·8 ]
∴ (1 – A) – 1 = ∴ [1 – A]– 1 =
1 0·66 0·25
23 60 12 60
3 1 5 ⎢⎣ ⎥⎦
0·4655 [0·25 0·8 ]
16 4 16 1 0·66 0·25
=
⎡⎢17 1 13 ⎤⎥ ··· X = [1 – A]– 1 F
⎡⎢ X1⎤⎥ 60 4 60
240 ⎢13 ⎥ ⎡⎢⎢60⎤⎥
[0·66
0·25 0·8 ] [ 3]
⎢ X2 ⎥ = 5 14
40⎥ 1 0·25 23
23 ⎢60 ⎥ ⎢⎣60⎥⎦
∴ ⎢⎣ ⎥⎦ =
12 60 0·4655
X3
⎢⎣ 3 1 5 ⎥⎦
0·4655 [ 5·7 + 2·4 ]
1 15·18 + 0·75
16 4 16 X =
⎡⎢17 + 10 + 13 ⎤
⎥ 0·4655 [ 8·10 ]
1 15·93
50 X =
= ⎢
240 13 +
3
+ 14
⎥
⎢⎣ + 10 + ⎥⎦
23 45 75 X = [ 17·4 ]
34·22
4 4
The new transaction matrix is
⎡ 40 ⎤
240 ⎢⎢ 131⎥⎥ [ ]
6·844 4·35
[X iJ] = [Q iJ] [XJ] = 8·555 5·742
23 ⎢⎢ 3 ⎥⎥
=
⎣ 40 ⎦ Example. The following is a transaction matrix for
240 a two sector economy.
∴ X1 = × 40 = 417·39
23 A B Final demand
240 131 A ⎡⎢ 30 40⎤⎥
X2 = × = 455·65
23 3 ⎢ ⎥
B ⎣ 20 10⎥⎦
⎢
240
X3 = × 40 = 417·39
23 Obtain the technology matrix for the economy.
Example. You are given are following transactions Calculate the total output for a final demand of 80 units
matrix for a two section economy : of A and 40 units of B.
Ans. The transaction matrix can be re-write as
Producing Purchasing Final Gross
sectors sector Demand output
A B demand Final output Gross
1 2
A 30 40 60 130
1 4 3 13 20
B 20 10 40 70
2 5 4 3 12
Primary Inputs 11 5 From this table the input coefficients can be deter-
mined
1. Wrtie the technoloty matrix.
2. Re-write the new transactions matrix when the The input-coefficient for sector A are
final demand for the output of sector 1 increases to 23 30 3 20 2
= and =
units. 130 13 130 13
Economics (NET) | 345U
while the input-coefficient for sector B are applies to those problems which require the solution of
maximization or minimization problems subject to a
40 4 10 1
= and = system of linear inequalities states in terms of certain
70 7 70 7 variables. If x and y, the two variables, are the function
∴ The technology matrix is of z, the value of z is maximized when any movement
⎡ 3 4⎤ from that point results in a decreased value of z. The
⎢ 13 7⎥
A = ⎢⎢ 2 ⎥ value of z is minimized when even a small movement
⎢ 1⎥⎥ results in an increased value of z. When cost and price
⎣ 13 7⎦ per unit change with the size of output, the problem is
not linear and if they do not change with output, the
Now problem is linear. Linear programming may thus be
⎡ 10 4 ⎤ defined as a method to decide the optimum combination
⎢ 13 – 7 ⎥
[1 – A] = ⎢⎢ 2 ⎥ of factors to produce a given output or the optimum
⎢– 6 ⎥⎥ combination of products to be produced by given plant
⎣ 13 7 ⎦ and equipment.
Assumptions
= [– 0·77
0·15 0·86 ]
– 0·57
The linear programming analysis of the firm is
based upon the following assumptions :
∴[1 – A]– 1
1. The decision-making body is faced with certain
=
1
[
0·86 0·57
0·6622 – 0·0855 0·15 0·77 ] constraints or resource restrictions. They may be
credit, raw material and space constraints on its
=
1
[
0·86 0·57
0·5767 0·15 0·77 ] activities. Type of constraints infact depend upon
the nature of problem. Mostly they are fixed factors
We know that in the production process.
∴ X = [1 – A]– 1 F 2. It assumes a limited number of alternative prduc-
tion processes.
The new final demand vector is
3. It assumes linear relations among the different
F = [8040] variable which implies constant proportionality
between inputs and output within a process.
4. Input-output prices and co-efficients are given and
∴ X =
1
[0·86
0·57670·15 0·77 ] [40]
0·57 80
constant. They are known with certainty.
5. The assumption of additivity also under lies linear
0·5767 [ 12 + 30·8 ]
1 68·8 + 22·8 programming techniques which means that the total
X =
resources used by all firms must equal the sum of
resources used by each individual firm.
0·5767 [42·8 ]
1 91·6
X = 6. Linear programming techniques further assume
continuity and divisibility in products and factors.
X = [ 74·22]
158·8 7. Institutional factors are also assumes to be constant.
Lastly, for programming a certain period is assumed.
The new total output will be 158·8 units for sector A For convenience and more accurate results, the period
and 74.22 units for sector B. is generally short, though longer periods are not ruled
Linear Programming out.
Linear Programming is a mathematical device Mathematical Note : Graphic Solutions
developed by the mathematician George Dantzing is
We attempt below a complete description and
1947 for planning the diversified activities of the U.S.
working of some problems of linear programming
Air Force connected with the problem of supplies to the
mathematically and graphically.
forces. Linear or mathematical programming also known
as activity analysis, has been further developed in its Maximisation of Revenue
application to the economic theory of the firm, manage-
rial economics, interregional trade, general equilibrium Take a firm that produces two products x and y at
analysis, welfare economics and to development pla- given prices of R 12 and R 15 respectively for each unit.
nning. To produce product x, the form requires 12 units of input
A, 6 units of input B and 14 units of input C. Product y
Meaning requires 4 units of input A, 12 units of B, and 12 units of
It is mathematical technique for the analysis of input C. Total available inputs in each case are 48 units
optimum decisions subject to certain constraints in the of A, 72 units of B and 84 units of C. The input-output
form of linear in equalities. Mathematically speaking, it data for this problem is presented in following Table.
346U | Economics (NET)
Table : Input-Output Data Similarly, assuming that the product y is produced
Amount of inputs Total inputs by utilizing the entire amount of 48 units of input A, we
Required to Produce Available in have
Input One Units of Output Each Case 0 + 4y = 48
Units
or y = 12 (when x = 0)
x-Units y-Units
The equation 12x + 4y = 48 is represented in figure
A 12 4 48
A by the line AB where OA = 12y and OB = 4x. Any
B 6 12 72 point on AB such as T satisfies the equation 12x + 4y
C 14 12 84 = 48, while the area below and to the left of the line AB
Net Revenue Per R 12 R 15 satisfies the inequality 12x + 4y ≤ 48.
Unit of Product
By solving the equation 6x + 12y = 72 in a similar
Every linear programming problem has three parts way, we obtain x = 12, and y = 6. This is plotted in
to start with. They are as follows in terms of out problem figure A as the line CD which satisfies this equation
stated above. where OC = 6y and OD = 12x.
The objective function states that if the two products And by solving the equation 14x + 12y = 84, we
x and y bring the revenue of 12 and 15 per units,
R R
obtain x = 6, and y = 7. Line EF in figure A satisfies this
how much of these products be produced so that the firm equation when OE = 7y and OF = 6x.
earns the maximum revenue. It can be written as
y
Max : f = 12x + 15y
A
The constraints—The above table can not be
transformed in the form of equations signifying the
12x + 4y = 48
constraints or restraints within which the firm operates.
These are known as structural constraints. E (0, 6)
C S (1.5, 5.25)
First, we take input A. The maximum available (2.73, 3.81)
quality of input A is 48 units. But the amounts of two T 6x + 12y = 72
14x +
products (x and y) cannot be greater than 48 units. 12y = 84 (4, 0)
Mathematically, since 12x + 4y ≤ 48. With the same O B F D
x
Units of X
reasoning we can have the constraints in terms of
inequalities for inputs B and C. Thus the three structural Figure shows that all the points in the shaded area
constraints in our problem can be written as : bounded by the three lines intersecting each other would
12x + 4y ≤ 48 …(1) satisfy the three inequalities. At point S, line EF
6x + 12y ≤ 72 …(2) intersects line CD, and at T, line CD intersects AB.
14x + 12y ≤ 84 …(3) Thus the shaded area OBTSC which lies below and
The Non-Negativity Constraints—Then there are to the left of the three line intersecting at points S and T
the non-negativity constraints in the linear programming satisfies the inequalities of the three equations. This
problem which assume that there can be no negative shaded area is called the feasible region of production
values of variables in the solution of the problem. This and every point without the region or on the boundary of
means that the output of x and y products can be zero or the region represents the feasible solution to our problem.
positive, but is cannot be negative. Thus the non-
Out of the various points BTSC which represents
negative constraints of our problem are x ≥ 0 and y ≥ 0.
the feasible solution, we have to find out the optimal
The Graphic Solution point that would maximize the revenue of the firm.
For the graphic solution, we restate our problem : We known the coordinates of points B and C from
Maximise f = 12x + 15y Equations (1) and (2), where by OB = 4x, and OC = 6y.
Subject to (i) 12x + 4y ≤ 48 In order to determine the coordinates of point T, we treat
6x + 12y ≤ 72 Equations (1) and (3) as simultaneous equations and
14x + 12y ≤ 84 solve them as
(ii) x ≤ 0 and y ≤ 0 12x + 4y = 48 …(1)
To represent each inequality graphically we ignore 14x + 12y = 84 …(3)
the inequality sign (≤) in our equations and replace it By multiplying Equation (1) by 3 and subtracting
by the equality sign. We write Equation (1) as 12x + 4y Equation (3) from it, we have
= 48.
36y + 12y = 144
By assuming that the product x is produced only by
utilizing the entire amount of 48 units of input A, we 14x + 12y = 84
obtain – – –
12x + 0 = 48 (at the maximum) 22x = 60
or x = 4 (when y = 0) x = 2·73
Economics (NET) | 347U
By substituting this value of x in Equation (1). we and 2x + 4y ≤ 16
obtain or x + 2y ≤ 8
12 × 2·73 + 4y = 48 (ii) x ≥ 0, and y ≥ 0
32·76 + 4y = 48 By solving the equation x + y = 6 we have x = 6 and
4y = 48 – 32·76 y = 6. This is shown as line AB in figure B, where OA
or 4y = 15·24 = 6y and OB = 6x.
y = 3·81 Similarly by solving the equation x + 2y = 8, we
Thus the coordinates of point T are x = 2·73 and y have x = 8 and y = 4. This is shown as line CD in figure,
– 3·81. Similarly, we can solve the coordinates of where OC = 4y and OD = 8x.
point S with Equations (3) and (2) which arrive at x = The shaded area OBPC satisfies all the conditions
1·5 and y = 5·25. of these two equations and is the feasibility region.
At B, we have x = 4 and y = 0 and subtituting these Every point in this region satisfies the mathematical
in the objective function f = 12x + 15y, we have inequalities.
12 × 4 + 15 × 0 = 48 …(4) y
A (0, 6)
At T, we have x = 2·73 and y = 3·81 and similarly
obtain C (0, 4)
12 × 2·73 + 15 × 3·81 = 89·91 …(5)
Units of y
P(4, 2)
At S, we have x = 1·5 and y = 5·25 and we obtain
12 × 1·5 + 15 × 5·25 = 96·75 …(6)
At C, we have x = 0 and y = 6 and we get (0, 6) (8, 0)
x
12 × 0 + 15 × 6 = 90 …(7) Units of x
B D
From the above Equations (4), (5), (6) and (7) we In order to fine out which of the corner point O, B,
find the equation (6) gives the maximum revenue of P or C represents the feasible solution when the profit
96·75. This shows that given the prices of the two is maximized. We treat the two equations as simulta-
products x and y and given the amounts of inputs, the neous equations and solve them as under :
total revenue of the firm is maximized at point S. S is x+y = 6 …(i)
thus the optimal point subject to the given constraints. x + 2y = 8 …(ii)
Profit Maximisation By multiplying equation (i) by 2 and subtracting
equation (ii) from it, we get
Let us take another linear programming problem 2x + 2y = 12
relating to the maximization of profits. Suppose there is
x + 2y = 8
a small manufacturer who produces two products x and y – – –
on two different machines, A and B. Product x requires 3
x = 4
hours on machines, A and 2 hours on machine B,
Substituting the value of x = 4 in equation (1), we
whereas product y requires 3 hours on machine A and 4
have
hours on machine B. Machine A can be operated for 18
4+y = 6
hours a day while machine B can be operated for 16
y = 2
hours a day. The producer earns a profit of R 30 on each
unit of each product should be product y. How many Thus the coordinates of point P are x = 4 and y = 2.
units of each product should be manufacture per day so As already calculated above the coordinates of point B
as to have the maximum profit ? are x = 6 and y = 0 and the coordinates of point C are
x = 0 and y = 4.
For a better understanding the problem is presented
in the following Table : In order to get the maximum profit we calculates the
profit at the corners of the feasibility region, i.e., O, B, P
Table : Data For Profit Maximisation Problem and C with the help of the values of these coordinates.
Machine Product Total Profit at point O is zero.
x y Working Time Profit at point B = 30 × 6 + 40 × 0 = 180
A 3 hours 3 hours 18 hours Profit at point P = 30 × 4 + 40 × 2 = 200
B 2 hours 4 hours 16 hours Profit at point C = 30 × 0 + 40 × 4 = 160
Profit from each R 30 R40 Thus the manufacturer will earn R 200 as the
maximum profit (at point P) by producing 4 units of x
For the graphic solution, this linear programming and 2 units of y per day. The optimal solution is,
problem can be restated as : therefore, x = 4, y = 2 and Profit = R 200 (maximum).
Maximise P = 30x + 40y
Subject to Minimisation of Cost
(i) 3x + 3y ≤ 18 Example : A small-scale manufacturer has produc-
or x+y ≤ 6 tion facilities for producing two different products. Each
348U | Economics (NET)
of the products requires three different operations : Solve graphically for the optimal production level if
grinding assemble and testing. Product 1 requires 15, both the products sell at R 40 per unit and the average
20 and 10 minutes to grind, assemble and test respecti- costs of the two products x and y are R 14 and R 20
vely, whereas product 2 requires 7·5, 40 and 45 minutes respectively.
for grinding, assemble and testing. The production run Ans. Mathematically, the problem appears as :
calls for at least 7·5 hours of grinding time, at least 20 Maximize Z = (40 – 14)x + (40 – 20)y
hours of assemble time and at least 15 hours of testing
time. If product I costs R 60 and product 2 costs R 90 to Subject to x ≤ 4000
manufacture, determine the number of units of each x ≤ 5000, y ≤ 5000
product the firm should produce in order to minimize the x ≤ 7000, y ≤ 4000
cost of operations. x ≤ 8000, y ≤ 3000
Ans. Mathematically, this problem may be formula- and x, y ≥ 0
ted as follow : Graphically the problem appears as :
Minimize Total Cost, C = 60x + 90y y
Subject to 15x + 7.5y ≥ 450
x = 4000
x = 5000
x = 7000
x = 8000
20x + 40y ≥ 1200
y = 5000
10x + 45y ≥ 900 5000
y = 4000
4000
x, y ≥ 0 3000
R O y = 3000
The variables x, y indicates, respectively number of
units of product I and number of units of product 2.
Graphical solution requires setting the first three P
x
O 4000 5000 7000 8000
inequalities as equalities and solving for extreme values
of x and y in each case and then plotting the linear The solution to LPP lies on any corner of the feasi-
constraints. The feasible region is the shaded area above ble region OPQR. We evaluate the objective functions at
ABCE in the figure. each corner.
y
A Corner Co-ordinates Value of objective function
60
15x + 7.5y = 450 (Z = 26x + 20y)
O (0, 0) Z=0
30
P (4000, 0) Z = 104000
20 B 20x + 40y = 1200 Q (4000, 3000) Z = 164000
C 10 + 45y = 900
R (0, 3000) Z = 60000
D Therefore, the optimal solution occurs at point
x
O
Q(4000, 3000).
The coordinates of the four vertices of unbounded
convex region are given by A (0, 60), B (20, 20), C (36, Mathematical Economics
12) and D (90, 0). Input-Output Model
We evaluate the objective function C = 60x + 90y at Production function develops a physical relationship
each solution points; between inputs and outputs. It is the relationship between
C(A) = 5400 C(B) = 3000 the quantity of output and the quantities of different
C(C) = 3240 C(D) = 5400 inputs used in the process. Algebraically a production
function can be noted as :
Hence, the optimum solution is at the point B (20,
20) i.e., the production of 20 units each of products 1 O = f(I1 I2 I3 I4 … Zn )
and 2, minimizes the cost. where O = quantity of output
Example : A company manufactures two products I1 I2 I3 = quantity of different inputs
x and y using four major departments Q, R, S and T. The Thus, the production function specifies a flow of
capacity limits of those departments are given in the output resulting from the flow of inputs during a
table below : specified period of time. A production function thus
Department Capacity for the production of involves a wide range of activities from the plant
x y location to distribution of output by the marketing
Q 4000 Nil division of an organisation.
R 5000 5000 The production function expresses the relationship
S 7000 4000 between the quantity of output and the quantities of the
T 8000 3000 various inputs used for the production. More precisely,
Economics (NET) | 349U
the production function states that maximum quantity of 3. Specificity reveals that the inputs are specific to
output that can be produced from any chosen quantities the production of a particular product. Machines and
of various inputs or, in other words, it states the equipments, specialised workers and raw materials are a
maximum quantities of various inputs that are required few examples of the specificity of factors of production.
to yield a given quantity of output. If a small firm The specificity may not be complete as factors may be
produces wooden tables in a day, its production function used for production of other commodities, too. This
will consist of the maximum number of tables that can reveals that in the production process none of the factors
be produced from given quantities of various inputs such can be ignored and in some cases ignorance to even
as wood, varnish, labour, time, machine time, floor slightest extent is not possible if the factors are perfectly
space, etc. that are required to produce a given number specific.
of tables. The efficiency of production process depends
upon three factors : Managerial Uses of Production Function
(a) The quantities of different inputs used in the Though production may seen to be highly abstract
process and unrealistic, in fact it is both logical and useful. If the
(b) The quantities of output price of a factor of production declines whereas that of
(c) The productivity of each point another goes up, the former is likely to substitute the
Production function is directly responsible for the latter. The usefulness of the production function can be
productivity. explained with the help of an example. Dairy
Two things must be noted in respect of production economists, for instance are interested in minimising the
function : cost of feeding cows in milk production. Taking a cow
1. Production function of firm is determined by the as a single firm, and grain and roughage as inputs, the
state of technology. When the technology advances, the question arises what proportion of grain and roughage
production function changes with the result that the new would be economical in feeding the cow. In the past,
production can yield greater flow of output from the there has been some tendency to prescribe a fixed ratio,
given inputs, or smaller quantities of inputs can be used but economic analysis suggests that the optimal ratio
for producing a given quantity of output. depends on the input prices. For instance, if we draw
isoquants relating various quantities of grain and
2. Production function like the demand function,
roughage to various levels of milk output and then
must be considered with reference to a particular period
superimpose iso-cost lines on the iso-quant diagram, the
of time. Production function expresses a flow of inputs
optimum, the point of largest output for a given outlay
resulting in a flow of output in a specific period of time.
or of minimum outlay for given output would depend on
In economic theory we are interested in two types of the prices of the factors of production, and it would
inputoutput relationship or production function : change as these prices change. The dairy farmer can use
1. We study the input-output relation by varying all such analysis for increasing the return from his
inputs. This forms the subject matter of the law of expenditure on feeds.
returns to scale.
2. We study the production function when the Certain economists have devoted special attention to
quantities of same inputs are kept constant and the the application of their findings. For instance, Earl
quantity of one inputs (or quantities of few inputs) is Heady and his associates have developed a mechanical
varied. This kind of input/output relation forms the device known as Pork Costulator which facilitates the
subject matter of the law of variable proportions. farmer to determine the most profitable ratio for feeding
lags under different price conditions.
Nature of Production Function Production function, thus, are not just theoretical
The nature of production function is as follows : and useless devices. On the other hand, theory can be
1. The factors of production are also complementary used as aids in decision making because they can give
to one another, that is, the two or more inputs are to be guidance in two conditions : (i) how to obtain the
used together as nothing will be produced if the quantity maximum output from a given set of inputs and (ii) how
of other of the inputs used in the production process is to obtain a given output from the minimum aggregation
zero. of inputs. Of course, in more complex problems, with
The principle of returns to scale is another mani- longer numbers of inputs and outputs, the mathematics
festation of complementarity of inputs as it reveals that of optimisation becomes complicated. But recently, the
the quantities of all inputs are to be increased development of linear programming has made it possible
simultaneously in order to attain a higher scale of total to handle these complex problems. The use of complex
output. production functions in managerial decision making is
2. The factors of production or inputs are substitutes going to be further facilitated with the development of
of one another which make it possible to vary the total electronic computers.
output by changing the quantity of one or few inputs, Types of Production Functions
while the quantities of all other inputs are held constant.
It is the substitutability of the factors of production that Production functions may take the following forms :
gives rise to law of variable proportions. (a) Fixed proportion production function
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(b) Variable proportion production function In this case, the ratio in which the factors of
(c) Linear homogeneous production function production are used is not fixed but it is variable. That
is, a given quantity of the product can be produced by
(d) Cobb. Douglas production function several alternative combinations of factors. In the
(a) Fixed Proportion Production Function : In Y
fixed proportion production function, the factors of
production are used in definite fixed proportions. For
Factor Y
instance, a fixed number of workers may be required to
produce a unit/ units of the product and this proportion Ip" (100 units)
Ip" (80 units)
cannot be varied by substituting one factor for other Ip' (60 units)
factors. In the case of variable proportions production Ip (40 units)
O X
function, the technical coefficient of production is Factor X
variable. In other words, the quantity of a factor of Marginal rate of technical substitution
production required to produce a given unit of product isoquant map, various equal product curves are drawn to
can be varied by substituting some other factor/-factors show how different combinations of factors of technical
in its place. This means that in this case a given quantity substitution production can be used to produce a given
of a product can be turned out by several alternative level of output,
combinations of factors of production as shown in a iso- (c) Linear Homogeneous Production Function :
quant map. Suppose we require 40 workers to produce The linear homogeneous production function implies
200 units of a product, the technical coefficient of that if all the factors of production are increased in some
production in this case is 1/5. In case the technical proportion, the output also increases in the same
coefficient of production is fixed then in a case this one proportion. That is, the doubling of all inputs will double
fifth of labour must be employed for the production of a the output and tripling them will result in the tripling of
unit of the commodity in question and there is no scope the output, and so on. This represents a case of constant
for varying its production through substitution of some results to scale. This type of production function is
factor. This is the case of fixed proportion production called by the economists as a well-behaved production
function in which the factors of production, e.g., labour function because it can be handled and used in empirical
and capital must be used in fixed proportion in the studies. It can be used by computers in calculations.
production of a certain level of output. The fixed That is why it is widely used in linear programming and
proportion production function can be illustrated with input-output analysis. It is also extensively used in
the help of the Fig. model analysis of production, distribution and economic
8 growth.
7
6
C
300
This is a function which is homogeneous of the first
5 degree. That is, it shows that the increase in output in
B
4 200 some proportion follows a given change in the factors of
3
A production. This has been put mathematically as
2 100
1 MP = f(Mx, MY)
O 1 2 3 4 5 6 7 8 9 10 Here, M is any number and P stands for the total
Labour
production of the production or it can be expressed as
Fixed Proportional Production Function
PMK = f(Mx, MY)
In the given Fig. OR represents the fixed labour Here M is any number and K means constant. This
capital ratio. This ratio must be maintained whatever be function is homogeneous of Kth degree. If K is equal to
the level of output. Since this ratio is fixed, the iso- one, then this homogenous function is homogenous of
quants relating to such a production function are shown the first degree and if K is equal to two it is
at right angles. Suppose the ratio is 2/3, 2 units of capital homogeneous of the second degree, and so on. If K is
and 3 units of labour. When 100 units of product are to greater than one, the production function gives increasing
be produced, then for units producing zero units, 4 units returns to scale and if it is less than one it gives
of capital and 6 units of labour will be required, and so decreasing returns to scale. In the case of homogeneous
on. It may be noticed that along each iso-quant, the production function, the expansion is always a straight
marginal product of a factor is zero. For instance, at ‘p’ line through the origin (see Fig.). This means that in the
an iso-quant of 200 if the amount of capital used is case of homogeneous production function of the first
fixed, the use of extra labour makes no addition to the degree, given constant relative factor prices, the
total production i.e., the marginal product of labour is proportions between the factors used will always be the
zero. However, doubling both factors will result in same whatever be the level of output. This makes the
doubling the output, and so on. task of the entrepreneur easy. Having hit on an optimum
(b) Variable Proportion Production Function : factor proportion, he need not change the decision so
Variable proportion production function can be long as the relative prices of the factors remain
illustrated by the iso-quant map given in the Fig. unchanged.
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Y given by banks and/or non-banking financial institu-
K tions. Banks also determine the monthly instalments of
Scale line recurring deposite scheme by using difference equation.
Factor Y P
or expension Compound interest is relevant to loans or deposits
E Q" path
Q man over longer periods. The interest is added to the
H Q" Ip" (120 units)
Q' Ip" (100 units) initial sum at regular intervals, called conversion
Q Ip' (80 units) periods, and the new amount, rather than the initial one,
Ip (60 units)
O X is used for calculating the interest for the next
L F T D
Factor X conversion period. The fraction of a year occupied by
Scale Lines the conversion period is denoted by α so that the
1
(d) Cobb-Douglas Production Function : Many conversion period of 1 month is given by α = .
production functions have been examined by economists 12
to measure relationship between changes in physical Instead of saying that the conversion period is 1 month
inputs and physical output. A famous statistical pro- we say that the interest is compounded monthly.
duction function is the one associated with the names of For an annual interest rate of p% and conversion
Professor C.W. Cobb and P.H. Douglas. The Cobb- period equal to α, the interest earned for the period is
Douglas production function is based on the empirical equal to αp% of the amount on deposit at the start of the
study of the American manufacturing industry made by period, that is
Senator Paul H. Douglas and C.W. Cobb. It is a linear,
homogeneous production function of the first degree ⎧⎪amount on ⎫ ⎧amount on ⎫ ⎧amount on ⎫
deposit ⎪ ⎪ deposit ⎪ αp ⎪ deposit ⎪
which takes into account only two inputs-labour and
⎨ after k + 1 ⎬ = ⎨ after k ⎬ + 100 ⎨ after k ⎬
capital for the entire output of the manufacturing
⎪conversion⎪ ⎪conversion⎪ ⎪conversion⎪
industry. The Cobb-Douglas Production function is
P = KLaC –a
⎩ periods ⎭ ⎩ periods ⎭ ⎩ periods ⎭
where ‘P’is output, ‘L’is the amount of labour, ‘C is To express this as a difference equation, for each k
capital employed and ‘K’ and ‘a’ are positive constants, let S (k) denote the amount on deposit after k conversion
where a < 1 – a. The production function solved by periods. Thus
αp αp
Cobb-Douglas had 3/4 contribution of labour to the
increase in manufacturing industry and 1/4 of capital. S (k + 10 = S (k) +
100 (
S (k) = S (k) 1 +
100)
Thus, the Cobb-Douglas production function is which is a simple first-order (that is, expressing the
P = KL3/4 C1/4 relation only between the consecutive values of the
Which shows constant return to scale because the unknown sequence) difference equation. Here, Sk
total of the values of L and C is equal to one
3 1
+
4 4
. ( ) follows the geometric progression so that
αp k
To prove it, let us increase the quantities of labour and
capital by ‘g’ items then output :
(
S (k) = 1 +
100) S0 …(1)
gives the so-called compound interest formula. If we
P = K(gL)a (gC)1 – a t
= K(ga La ) (g1 – nC1 – a) want to measure time in years, then k = where t is time
α
= Kg(L a ) (C1 – a) in years. Then equation (1) becomes
αp t/α
= gKLaC 1 – a
= gP
(
S (t) = 1 +
100) S0 …(2)
Thus, the output ‘P’ has become ‘gP’ when the It is worthwhile to introduce here the concept of
inputs are increased by ‘g’ times. It shows that doubling effective interest rate. First we not that in equation (2)
the inputs, doubles the output. It implies that the Cobb- with S0 = 1
Douglas production formation is linear and homo- αp 1/α
geneous.
In the Cobb-Douglas function, the sum of the expo-
(
S(1) = 1 + )
100
nents shows that degree of return to scale in production. p p
= 1+ +…>1+
a + b > 1increasing returns to scale 100 100
a + b = 1constant returns to scale so if the interest is compound several times per year the
increase in savings is bigger than if it was compounded
a + b < 1decreasing returns to scale
annually. This is the basis of defining the effective
Difference Equations in Economics interest rate reff (relative to the conversion period),
The concept of difference equations is an useful tool namely
αp 1/α
in banking and financial sectors. It helps to determine
the equated monthly instalment of a loan and advance (
1 + reff = 1 + )
100
…(3)
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that is, reff is the interest rate which, compounded period starting from some base year. The rate of growth
annually, would given the same return as the interest p ⎛ yt – yt – 1⎞
compounded with conversion period α. of y at any period may be represented as ⎜ ⎟.
⎝ yt – 1 ⎠
A slight modification of the above argument can be Note that this is the expression that gives the rate of
used to find the equation governing a loan repayment. growth of y at a particular point in time. In contrast, it
The scheme described here is usually used for the dy(t)/dt
has been seen the expression when y was treated
repayment of house or car loans. Repayments are made y
at regular intervals and usually in equal amounts to as a continuous variable. Treating y as discrete, we find
reduce the loan and to pay the interest on the amount the numerator as the increment of income in current
still owing. period (period t) over the level attained in the
immediately preceding period (period t – 1). The ratio of
It is supposed that the compound interest at p% is
this to the income yt – 1 of the preceding period gives the
charged on the outstanding debt with the conversion
period equal to the same fraction α of the year as the current rate of growth. Since we have said that rates of
period between the repayments. Between payments, the growth of income, g, is constant (i.e., independent of t)
debt increases because of the interest charged on the over ten year’s interval, it can be written as—
debt still outstanding after the last repayment. Hence, yt – yt – 1
= g, t, = 1, 2, 3, 4,…,10
yt – 1
{k +debt
1 payments} = { k payments}
after debt after
or yt = (1 + g)yt – 1, t = 1, 2,…,10 …(1)
Equation (1) relates the values of the variable y at
+ { on this debt} – {payment}
interest two distinct periods t and (t – 1). It is an example of a
difference equation.
To write this as a difference equation, let D0 be the There is a one-period lag in the values of the
initial debt to be repaid, for each k let the outstanding relevant variable (yt and yt–1). Therefore, it is an example
debt after the kth repayment be Dk, and let the payment of a first order difference equation. The order of a
made after each conversion period be R. Thus difference equation is determined by the maximum
number of periods lagged. Some examples of difference
αp αp
Dk + 1 = Dk + (
D – R = Dk 1 +
100 k 100 )–R equations are given below with the orders noted.
yt – 3 – 3yt – 4 = 0 order 1
…(4)
yt = a (yt – 1 – yt – 2) + 10 order 2
We note that if the instalment was paid at the
log yt + 9 – y t + 7 (yt + 6)3 + 6yt = 0 order 9
beginning of the conversion period, the equation would
t
18 yt + 4 – yt = 2 – 5 5 + 1 order 4
take a slightly different form
αp αp yt + 3 + ayt + 1 = byt – 1 + c order 4
Dk +1 = Dk – R +
100 k (
(D – R) = (Dk – R) 1 +
100 ) Consider a difference equation of the following
…(5) form :
The reason for the change is that the interest is y = a1 yt – 1 + a2 yt – 2 + … + anyt – n + b
calculated from the debt Dk reduced by the payment R where a1 , a2 , …, an and b are constants.
done at the beginning of the conversion period. These This is called an n th order linear constant coeffi-
equations are more difficult to solve. cient difference equation (assuming an ≠ 0, otherwise
The modelling process in these two examples was the order will be less than n). It is linear because the
very simple and involved only translation of given rules dependent variable y is not raised to any power and there
into mathematical symbols. This was due to the fact that are no product terms, constant coefficients because a1,
there was no need to discover these rules as they are …, an are constants and do not change with t. This
explicitly stated in bank’s regulations. In the next equation will be homogeneous if b = 0. If b = 0, then it
sections we shall attempt to model behaviour of more is non-homogenous.
complicated systems and then modelling will involve
making some hypotheses about the rules governing them.
Solving First Order Difference Equations
In solving a difference equation, we find a time path
Difference Equations in Economics y (t) from a given initial condition. As pointed out
To understand the concept of difference equation in above, a first order difference equation takes the form
economics, let us consider the pattern of growth in yt = f (t, yt – 1) for all t
national income. Such an equation can be solved by successive
The national income y of a particular country has calculation, also called recursive method, taking the
been growing at a constant rate g over (say) a ten year initial value of y (say y0) as given. Thus,
Economics (NET) | 353U
y1 = F (1, y0 ) We call y* the equilibrium value of y and rewrite
y2 = F (2, y1 ) = f [2, f (1, y 0 )] the solution as
yt = at (y0 – y*) + y*.
and so on.
Note that given any value y0 , there exists a unique Economic Applications of First Order
solution path y1 , y2, …… Equations
However, resorting to calculation of the (a) Harrod-Domar One Sector Model—An eco-
solution through such a method doesn't tell us much nomy produces one good Q with capital K through a
about the properties of the solution. We should have a production function Q t = b K t, where b = constant
general formula, which exists if the form of f is simple. productivity of capital. Accumulation of capital between
Let us start with a first-order linear difference equation t and t+1 is given by
with constant coefficient. It takes the form
yt = ayt – 1 + bt where bt for t = 1, …are constants. It = Kt + 1 – Kt, where It = investment in t.
When the recursive method is used following Saving St = sQt
pattern emerges. Equilibrium level of income is determined at the
t
equality of savings and investment. So,
yt = ay0 + ∑ at – k bk …(2)
k=1 S t = It
and such an equation has a unique solution path.To or sQt = Kt + 1 – Kt
check that we get the unique solution from the above
formulation, verify that it satisfies the original equation. Since Qt = bKt + 1, we have sbKt = Kt – 1 – Kt
Since we have or Kt + 1 = (1 + sb) Kt, a homogeneous first order
⎛ t–1
⎞ linear difference equation. Therefore, solution to this
ayt – 1 + bt = a ⎜ at – 1 y0 + ∑ at – k bk⎟ + bt equation is given by
⎝ k=1 ⎠
t–1 Kt = (1 + sb)t K0
= at y0 + ∑ at – k bk + bt Since b is productivity of capital in the model, we
k=1
1
t write = capital output ratio = v (say).
= at y0 ∑ at – k bk b
s t
= yt,
k=1
Now ( )
Kt = 1 +
v
K0
so that the solution obtained is correct. Taking the s t
equation (2), we can examine the special case of bk = b and ( )
Qt = 1 +
v
Q0
for all k = 1…….. We have
s
t– 1 Remember that = warranted rate of growth and
yt = aty0 + b ∑ at – 1 v
j=0 constituted by two basic parameters s and v. We can find
Making use of the result of geometric series out the output growth rate given s and v.
t–1
summation, the term ∑ at – 1 may be expanded as 1 + a Differential Equations and their
j=0
Applications in Economics
+ a2 + … + at – 1 to give
A differential equation expresses the rate of change
1 + a + a2 + … + an – 1 = (1 – an )/(1 – a)
of the current state as a function of the current state.
if a ≠ 1. Thus we have Many economic models with a temporal dimension
yt = aty0 + b · (1 – at)/(1 – a) involve relationships between the rate of change of a
if a ≠ 1 variable and its value at a given point of time.
For any given value y0, the unique solution of the Example—A model of price dynamics might
difference equation assume that the rate of change of a price is proportional
yt = ayt – 1 + b, to the difference between the demand and supply at that
price, and a macroeconomic model of economic growth
where a ≠ 1, is might assume that the rate of change of the capital stock
yt = at [y0 – b)/(1 – a)] + b/(1 – a) is a constant function of the value of output. When time
is modeled as a discrete variable (taking the values 1, 2,
Equilibrium or Stationary Value 3,……), relationships like these may be modeled as
For a given value y0 , the value of yt changes with t. difference equations. When time is modeled as a
But there may be some value of y0 for which y t doesn't continuous variable, they may be modeled as differential
change. Such a solution exists if equations.
y* = b/(1 – a) Ordinary Differential Equations—An ordinary
and yt is constant, equal to b/(1 – a). differential equation is a relationship between a variable
354U | Economics (NET)
t, the value of a function x of a single variable at t, and differential equation if every solution is equal to the
the derivatives of x of all orders upto some number x at function for some value of the parameters.
r. It can be expressed as. The function f of the variable t and a vector C of
b {t, x (t), x′ (t), x′′ (t), ……xn (t)} = 0 numbers is the general solution of an ordinary
Where b is a function of n + 2 variable and x′ (t), x′′ differential equation if for every solution x of the
(t), … xnt are the first second, third ……nth derivatives. equation there is a value of C such that x(t) = f(t, C) for
all t.
The unknown term in an ordinary differential
Example—
equation is the function x.
The general solution of the differential equation
One must note that in many applications, t repre-
sents time, and it is often convinient to think of it as time x'(t) – 1 = 0 is the function f defined by f(t, C) = t + C for
when interpreting equations. all t, where C is a scalar.
A common though somewhat informal way to
In expositions of the theory of differential equations,
express the conclusion of this example is that “the
derivatives are sometimes are denoted by dots of the
general solution of the equation x'(t) – 1 = 0 is x(t) =
variable rather than primes besides the variable.
t + C.” That is, the symbol C in a solution is taken to be
The word “ordinary” indicates that the unknown a constant that may take any value. The same is true for
function x her only one argument. An equation involving the symbols C1, C and so on.
the partial derivatives of a function of more than one
variable is known as “partial differential equation.” Example—
Some of the examples of ordinary differential Consider the differential equation x"(t) – 1 = 0. From
equations are the following the previous example we know every solution x
x′ (t) – 1 = 0 has the property that x'(t) = t + C 1 for all t. Thus the
x′′ (t) – 1 = 0 general solution of the equation is x(t) = t2 /2 + C1 t + C2.
x′′(t) – 2tx (t) = 0 1. Geometrical Meaning of a Differential
x′′ (t) [(x′ (t)] 1/2 – t/xt = 0 Equation of the First Order—Consider a differential
equation
Solutions
The function x of a single variable is a solution of (
f x‚ y‚ )
dy
dx
= 0
the ordinary differential equation and the general solution of this equation is
G(t, x(t), x'(t), x"(t), ..., x (n)(t)) = 0 φ(x, y, c) = 0 …(1)
if the equation is satisfied for all values of t. Where, c is the arbitrary constant. The equation (1)
A solution of the equation represents a family of curve. c being the parameter of
x'(t) - 1 = 0, the family. Thus, every differential equation of first
for example, is the function x given by x(t) = t for all t, order represents a family of curves.
because the derivative x'(t) is equal to 1 for all values
of t. You will immediately notice that the equation has ILLUSTRATION
many other solutions : for any number C, the derivative Example 1. The general solution of the differential
of the function x defined by x(t) = t + C for all t is also 1 dy
equation x + y = 0 represents which family of curves ?
for all values of t, and is hence a solution. dx
This multiplicity of solutions is normal : most Solution : The given equation can be written as
differential equations with at least one solution have x dx + y dy = 0
many solutions. It reflects the fact that a differential
equation specifies a relationship among the derivatives Integrating, we get
of the unknown function x of various orders but not the x2 y2
+ = c
level of this function for any given value of t. Adding to 2 2
a differential equation the requirement that the or, x2 + y2 = 2c
function x or its derivatives of various orders take Which represents a family of circles with centre at
specific values for specific values of t may narrow down origin.
the set of solutions to a single function.
2. Singular Solution—A solution of a differential
For example, suppose that we add the requirement
equation which is not derived from general solution by
x(0) = 1 to the differential equation x'(t) – 1 = 0. For a
giving the constant a particular value is called a singular
solution x(t) = t + C to satisfy this additional requirement,
solution. The singular solution does not involve any
we need C = 1, so the only solution of the differential
arbitrary constant.
equation that satisfies the requirement is x(t) = t + 1.
3. Determination of Singular Solution—Let f (x,
“General Solution” y, p) = 0 be a given differential equation and its general
A function that includes parameters, like C in the solution is φ(x, y, c) = 0. The singular solution of the
previous example, is the “general solution” of a given equation is the envelope of φ (x, y, c) = 0. The
Economics (NET) | 355U
envelope of the family of curves φ(x, y, c) = 0 is Solution : The given equation is
contained in the locus obtained by eliminating c (D 2 + 3D – 54) y = 0
∂
between. φ(x, y, c) = 0 and φ(x, y, c) = 0. Auxiliary equation is
∂c
m2 + 3m – 54 = 0
4. Trajectory—A curve which cuts every member
⇒ (m + 9)(m – 6) = 0
of a given family of curves according to a given law is
called a Trajectory of the given family. ⇒ m = 6, – 9
5. Orthogonal Trajectories—A trajectory of a Hence, the general solution of the given differential
family is called an orthogonal trajectory of the family, if equation is y = c1 e6x + c2e– 9x.
it cuts every member of the family at right angle. Case II. When auxiliary equation has real
The orthogonal trajectories of a family of a curve and some equal roots—If the auxiliary equation has
represented by the cartesian differential equation f (x, y, two roots equal, say m 1 = m 2 and others are distinct say
m3, m 4, …, m n . I n this case the general solution o f the
(
p) = 0 are given by f x‚ y‚ – ) 1
p
= 0. equation (1) is
The orthogonal trajectories of a family of a curves y = (c 1 + c2x)em1x + c3em3x + … + cn emnx
(
represented by the polar differential equation f r‚ θ‚
dr
dθ) where c1, c2…cn are arbitrary constants.
Example. Solve the differential equation.
(
= 0 are given by f r‚ θ‚ – r2 )
dθ
dr
= 0. (D 4 – D3 – 9D2 – 11D – 4)y = 0
Solution : The auxiliary equation of the given
1. Linear Differential Equations with Constant equation is
Coefficients—A differential equation in which the m4 – m3 – 9m2 – 11m – 4 = 0
dependent variable and its derivatives appear only in the or, (m + 1)3 (m – 4) = 0
first degree and are not multiplied together is called a
linear differential equation. ⇒ m = – 1, – 1, – 1, 4
Thus, the general form of such a differential Hence, the required general solution is
equation is y = (c 1 + c2x + c 3 x2)e– x + c4e4x
dn y dn – 1 y dn – 2y Case III—When the auxiliary equation has some
n + P1 n – 1 + P2 n – 2 + …+ Pny = X imaginary roots—If there is one pair of imaginary roots
dx dx dx
where, P1 , P 2 , .…, Pn are constants and X is any function say m1 = α +i β, m2 = α –i β and other distinct roots are
d m3, m4, …, mn. Then the general solution of equation (1)
of x. The operator is denoted by D. is
dx
y = c 1 e(α + iβ)x + c2e(α – iβ)x + c3em3x +
∴ Dny + P 1 Dn – 1y + …… + Pn y = X
… + cnemnx = 0
or, f (D) y = X
Using Euler’s Theorem.
where, f (D) = Dn + P1Dn – 1 + …+ Pn y = c 1 eαx (cos βx + i sin βx) + c2eαx
2. Solution of the Differential Equation—If the (cos βx – i sin βx) + c 3 em3x + …… + cn emnx
given equation is y = (c 1 + c2)eαx cos βx + (c 1 – c2) ieαx sin βx
dn y dn – 1y dn – 2y + c 3 em3x +…… + cnemnx
+ P1 n – 1 + P 2 n – 2 + … + P n y = 0 …(1)
dxn dx dx Now, let c1 + c2 = A and (c1 – c2)i = B.
or, (Dn + P1 Dn–1 + P2Dn–2 +…+ Pn )y = 0 …(2) where A and B are arbitrary constants, then the general
Let y = emx ⇒ Dry = mremx, 1 ≤ r ≤ n solution is
∴ Then from equation (2) y = (A cos βx + B sin βx)eαx + c3em1x + … + cn emnx
(m n + P1mn – 1 + P2mn – 2 + …+ Pn)emx = 0 Example. Solve the differential equation
y = e mx is a solution of (1), if (D 4 + 8D2 + 16)y = 0
mn + P1mn – 1 + P2mn – 2 + …… + Pn = 0 Solution : Here, the auxiliary equation is
This equation is called the auxiliary equation. m4 + 8m2 + 16 = 0
Case I. When Auxiliary Equation has Distinct or, (m 2 + 4)2 = 0
and Real Roots—Let m1, m2, … mn are distinct roots of ⇒ m = 0 ± 2i, 0 ± 2i
the auxiliary equation, then the general solution of (1) is Hence, the general solution is
y = c 1 em1x + c2em2x + ……+ cnemnx y = [(c1 + c2x) cos 2x + (c3 + c4x)sin 2x] e0.x
where c1, c2,…, cn are arbitrary constants. or, y = (c1 + c2x) cos 2x + (c3 + c4x) sin 2x
Example. Solve the differential equation 3. Particular Integral (P.I.)—When the equation is
d2 y dy (D n + P1Dn – 1 + …… + Pn )y = X
+ 3 – 54y = 0 or, f (D)y = X
dx2 dx
356U | Economics (NET)
The general solution of f(D) y = X is equal to the 6. Homogeneous Linear Equations—
sum of the general solution of f (D) y = 0 called Any homogeneous equation of the form
complementary function (C.F.) and any particular dn y dn–1y dn–2y
integral of the equation f (D) y = X. xn n + P1 xn–1 n–2 + P2 xn–2 n–2 + .......
dx dx dx
∴ General solution = C.F. + P.I. x dy
+ Pn–1 + Pn y = Q, is called homogeneous linear
A Particular integral of the differential equation dx
1 differential equation of nth order where P1, P2 ,…, Pn are
f (D)y = X is given by X. constants and Q is a function of x.
f (D)
7. Solution of Homogeneous linear equations—
4. Methods of finding Particular Integral— To solve homogeneous linear equations, substitute
Case I. P.I. when X = eα x — x = e z, or z = log x
1 dy dy d
P.I. = eαx x = = Dy, where D ≡
f (D) dx dz dz
d2y
x2 2 = D (D–1)y
∴ P.I. =
1
[e {cos 2x
– 8i
2ix dx
d3y
x3 3 = D (D–1) (D–2)y etc.
π
+ i (sec tan ( + x ) – sin 2x)} – e – 2ix dx
4 After substitution, the equation will be linear
differential equation with constant coefficients.
{cos 2x – i (sec tan(π4 + x) – sin 2x)}] Example. Solve
d2y dy
x2 2 – 4x + 6y = x
= – [(e – e ) cos 2x + i ( e + e )
1 2ix – 2ix 2 ix – 2 ix dx dx
8i Solution : Putting x = ez or z = log x
π and D ≡ d/dz, the given equation reduces to
. { sec tan ( + x) – sin 2x}]
4 [D (D–1) – 4D + 6]y = ez
or, (D2 – 5D + 6) y = ez
= – [2i sin 2x. cos 2x + i . 2 cos 2x
1
C.F = c1 e2z + c2 e3z
8i
1
P.I. = 2 ez
{sec tan (π4 + x) – sin 2x }] D – 5D + 6
1 1
= ez = ez
π 1–5+6 2
= – cos 2x. sec tan ( + x)
1
4 4 ∴ General solution is
1
Hence, general solution of the given equation is y = c1 e2z + c2 e3z + ez
2
π
1
4 ( )
y = c1 cos 2x + c2 sin 2x – cos 2x .sec tan + x
4 or y = c1 x2 + c2 x3 + x
1
2
Economics (NET) | 357U
Objective Questions
1. If the two regression lines are perpendicular to each (c) – 0·89 3. High positive relation
other, then— (d) 0·98 4. Low negative relation
(A) r = 0 (B) r = –1 5. No relation
(C) r = +1 (C) r > 1 Codes :
2. If the regression lines are identical, then— (a) (b) (c) (d)
(A) r = 0 (B) r = –1 (A) 3 1 5 2
(C) r = + 1 (D) Either (B) or (C) (B) 2 4 1 3
(C) 2 1 5 3
3. The error of estimate is measured by—
(D) 3 4 1 2
(A) the arithmetic mean of the squared differences
(B) the square of the squared differences 9. Which of the following formulae is correct for
(C) the square root of the squared difference computing correlation coefficient ?
(D) the square root of the A. M. of the squared Convariance (x‚ y)
differences (A) r =
⎯⎯⎯⎯⎯
√ σx . σy
4. Standard error of estimate of regression of y values Cov. x‚ y
from yc is given by— (B) r =
Var. of X‚ Var. of Y
(A) σy √
⎯⎯⎯⎯
r2 – 1 (B) σy √
⎯⎯⎯⎯
1 – r2
(C) r = Cov. x‚ y
1 1
(C) ⎯⎯⎯⎯
√ r2 – 1 (D) ⎯⎯⎯⎯
√ 1 – r2 Ãx . Ãy
σy σy
Cov. x‚ y
5. If all the scatter of points live on a straight upward (D) r =
line from left to right the correlation is said to be— ⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯
√ Vat. of x . Var. of y
(A) perfect positive (B) perfect negative 10. Which of the following is/are not correct ?
(C) highly positive (D) highly negative (A) The coefficient of correlation r lies between
– 1 and + 1
6. Fisher’s ideal index number satisfies—
(B) r is a pure number having no units
(A) Time reversal test only
(C) Interchanges of all x and y values will change
(B) Factor reversal test only
the sign of correlation coefficient
(C) Both time and factor reversal tests
(D) The value of ‘r’ does not change if all the
(D) Circular test only values of either variable are counted to a
Directions—The following items consist of two different scale
statements, one labelled as ‘Assertion A’ and the other 11. For comparing yearly changes in price level, the
labelled as ‘Reason R’. You are to examine these two suitable index to be used is—
statements carefully and decide if the Assertion A and (A) F B I
the Reason R are individually true and if so, whether the (B) F B I with average price as base
reason is a correct explanation of the assertion. Select
(C) C B I
your answers to these items using the codes given below
and mark your answer sheet accordingly. (D) None of the above
Codes : 12. The weights used in Laspeyre’s price index are
(A) Both A and R are true and R is the correct denoted as—
explanation of A (A) q0 (B) q1
(B) Both A and R are true but R is NOT a correct (C) p0 (D) p1
explanation of A 13. The weights used is Laspeyre's quantity index are
(C) A is true but R is false denoted as—
(D) A is false but R is true (A) q0 (B) q1
7. Assertion (A) : Fisher Index Number is the (C) p0 (D) p1
geometric mean of Laspeyres and Paasche indices.
14. The weights used in Paasche's price index are
Reason (R) : It satisfies both time reversal and
denoted as—
factor reversal tests.
(A) q0 (B) q1
8. Match List I (r value) with List II (Interpretation)
(C) p0 (D) p1
and select the correct answer using the code given
below the Lists— 15. The weights used in Paasche's quantity index are
List I (r value) List II (Interpretation) denoted as—
(a) 0·26 1. High negative relation (A) q0 (B) q1
(b) – 0·35 2. Low positive relation (C) p0 (D) p1
358U | Economics (NET)
16. Weighted aggregate index formula using base year (C) Index numbers are not expressed in percentages
quantities as base is called— (D) Index numbers measure changes which are not
(A) Lasperyre’s price index directly measurable
(B) Passche’s price index 26. Which of the following is NOT correct ?
(C) Bowley’s price index
(A) Index numbers are economic barometers
(D) Fischer’s price index
(B) Index numbers cannot be used in forecasting
17. Weighted aggregate index formula using the (C) Index numbers are used in computing the real
average of base year and current year's quanti- income or wages
ties as base is called—
(D) The ideal average used in the construction of
(A) Lasperyre’s price index index numbers is the arithmetic mean
(B) Fischer’s price index
(C) Marshall Edgewoth's index 27. Which of the following is NOT correct ?
(D) Bowley’s index (A) Base Year used in index numbers should be a
normal year
18. The geometric mean of Laspeyre's and Paasche's
(B) Weighted index numbers are better and more
indices is—
representative than simple index numbers.
(A) Fisher’s ideal index
(C) Geometric mean is the most suitable average in
(B) Bowley’s index the construction of index numbers
(C) Marshall and Edgewoth’s index
(D) Paasche’s formula is a weighted aggregate
(D) None of the above
index with base year quantity weights
19. Weighted average of relatives, if base year value is
28. Which of the following is NOT correct ?
taken as weight, gives—
(A) Price relatives are formed to study price
(A) Fisher’s ideal index
changes over time
(B) Laspeyre’s index
(B) Quantity relations are used to measure chnages
(C) Paasche’s index in quantum of volume of productions or
(D) Bowley’s index conception of a commodity
20. The formula for simple average of price relative (C) Laspeyre’s formula is a weighted aggregate
is— index with base year quantity weights
1 p ΣP1 (D) Fisher’s index formula is the airthmetic mean
(A) Σ 1 × 100 (B) · 100
n p0 ΣP0 of Laspeyer’s and paasche’s formula
1 q 29. Simple price index is defined as—
(C) Σ 1 (D) None of these
n q0 p1 p
(A) (B) 0 · 100
21. Consumer price index number measures— p0 p1
(A) changes in the retail prices (C) Both (A) and (B) (D) Either (A) or (B)
(B) changes in wholesale prices 30. If the changes in the average level of various items
(C) Both (A) and (B) is being studied together, this index number would
(D) None of these be called a—
(A) Simple index number
22. If the price index increases by 20 per cent, the cost
(B) Composite index number
of Economics book, which at present is R 350, will
increase by— (C) Value index number
(A) R 20 (B) R 60 (D) None of the above
(C) R 70 (D) None of these 31. Value index number is defined as—
23. Index of industrial production is a— ΣP1q1 ΣP0q1
(A) · 100 (B) · 100
(A) price index (B) cost of living index ΣP1q0 ΣP1q0
(C) quantity index (D) development index ΣP1q0 ΣP0q0
(C) · 100 (D) · 100
ΣP0q1 ΣP1q1
24. Index numbers indicate—
(A) absolute changes (B) relative changes 32. Simple arithmatic mean of price relatives is given
(C) Both (A) and (B) (D) None of these by—
1 ⎡⎢ P 1 ⎤ n ⎡⎢ P 1 ⎤
25. Which of the following is NOT correct ? (A) ⎢ Σ · 100⎥⎥ (B) ⎢ Σ · 100⎥⎥
(A) Index numbers are specialized averages n ⎣ P0 ⎦ 100 ⎣ P 0 ⎦
(B) Index number is a statistical measure represen- ⎡ P1 ⎤
ting changes in a variable or group of related (C) n ⎢⎢ Σ · 100⎥⎥ (D) None of these
variables ⎣ P0 ⎦
Economics (NET) | 359U
33. Simple geometric mean of price relatives is given 38. Match list I with list II and select the correct
by— answer—
1 P List-I List-II
(A) log01 = log 100 + · Σ 1
n P0 (a) ΣP1q0 1. Fisher
· 100
1 P ΣP0q0
(B) log01 = 100 + · Σ log 1
n P0 2. Paasche
(b) ΣP1 q0 ΣP1 q1
1 P ·
(C) log01 = log 100 + · Σ log 1 100 ΣP0 q0 ΣP0 q1
n P0
⎡ ⎤ (c) ΣP1q0 ΣP1q1 3. Kelly
(D) log01 = · ⎢⎢ Σ log 1⎥⎥ × 100
1 P · · 100
n ⎣ P 0⎦ ΣP0q1 ΣP0q1
(d) ΣP1q 4. Marshal and
34. Laspeyre’s price index number is given by— · 100
ΣP0q Edgeworth
ΣP1q0 Codes :
(A) · 100
ΣP0q0 (a) (b) (c) (d)
ΣP1q1 (A) 1 2 3 4
(B) · 100
ΣP0q1 (B) 2 3 4 1
(C) 2 1 4 3
1 ⎛ ΣP1q0 ΣP1q1 ⎞
2 ⎜⎝ ΣP0q0 ΣP0q1 ⎟⎠
(C) + 100 (D) 4 3 2 1
39. Which of the following averages is considered,
ΣP1 q0 ΣP1 q1 theoretically, the best average for the construction
(D) 100 ·
ΣP0 q0 ΣP0 q1 of index numbers ?
(A) A.M. (B) G.M.
35. Fisher’s ideal index number is given by—
(C) H.M. (D) Median
ΣP1q0
(A) · 100 40. Which of the following is NOT correct with regard
ΣP0q0 to Fisher’s index number ?
ΣP1q1 (A) It is geometric mean between Laspeyre’s and
(B) · 100
ΣP0q1 Paasche’s index number
1 ⎛ ΣP1q0 ΣP1q1 ⎞ (B) It takes into account both current year as well
2 ⎜⎝ ΣP0q0 ΣP0q1 ⎟⎠
(C) + 100 as base year quantities
(C) It satisfies time reversal and factor reversal tests
ΣP1 q0 ΣP1 q1 (D) None of the above
(D) 100 ·
ΣP0 q0 ΣP0 q1 41. Which of the following is NOT correctly matched ?
36. Paasche’s price index number is given by— ΣP1q0
(A) · 100 : Laspeyer
ΣP1q0 ΣP0q0
(A) · 100
ΣP0q0 ΣP1 q0 ΣP1 q1
ΣP1q1 (B) 100 · : Fisher
(B) · 100 ΣP0 q0 ΣP0 q1
ΣP0q1
ΣP1q0 + ΣP1q1
1 ⎛ ΣP1q0 ΣP1q1 ⎞ (C)
ΣP0q0 + ΣP0q0
· 100 : Marshall
2 ⎜⎝ ΣP0q0 ΣP0q1 ⎟⎠
(C) + 100
1 ⎛ ΣP1q0 ΣP1q1 ⎞
2 ⎜⎝ ΣP0q0 ΣP0q1 ⎟⎠
(D) + 100 : Bowley
ΣP1 q0 ΣP1 q1
(D) 100 ·
ΣP0 q0 ΣP0 q1
42. Which of the following index numbers suffer from
37. Which of the following represents Bowley’s price upward bias ?
index number ?
(A) Laspayere’s index number
ΣP1q0
(A) · 100 (B) Paasche’s index number
ΣP0q0 (C) Fisher’s index number
ΣP1q1 (D) None of the above
(B) · 100
ΣP0q1
43. Which of the following index number suffer from
1 ⎛ ΣP q ΣP q ⎞ downward bias ?
(C) ⎜ 1 0 + 1 1 ⎟100
2 ⎝ ΣP0q0 ΣP0q1 ⎠ (A) Laspeyre’s index number
(B) Pasche’s index number
ΣP1 q0 ΣP1 q1 (C) Fisher’s index number
(D) 100 ·
ΣP0 q0 ΣP0 q1 (D) None of the above
360U | Economics (NET)
44. Time reversal test requires that— 53. If the regression equation is a perfect estimator of
ΣP1q1 the dependent variable then which of the following
(A) P 01 × P10 = 1 (B) P 01 × Qn = is not true ?
ΣP0q0
(A) The standard error of estimate is zero
(C) P 01 × P12 × P20 = 1 (D) None of these
(B) The coefficient of correlation is zero
45. Factor reversal test implies that— (C) The coefficient of determination is 1·00
ΣP1q1 (D) All the data points fall on the regression line
(A) P 01 × P10 = 1 (B) P 01 × Q01 =
ΣP1q0 54. The extent to which the observed values of the
(C) P 01 × P12 × P20 = 1 (D) None of these depended variable differ from the predicted values
according to the regression line is measured by—
46. Circular test implies that—
(A) the slope of the regression line
(A) P 01 × P10 = 1
(B) the intercept of the regression line
ΣP q (C) the standard error of estimate
(B) P 01 × Q01 = 1 1
ΣP0q0 (D) the coefficient of determination
(C) P 01 × P12 × P20 = 1
55. If the co-variance between two variables is positive
(D) None of the above then, the coefficient of correlation between them
47. Which of the following index numbers does not will be in the range of—
satisfy the unit test ? (A) 0 to – 1·00 (B) 0 to – 0·50
(A) Simple aggregative index number (C) 0 to – 0·25 (D) 0 to 1·00
(B) Laspeyre’s index number 56. The variances of variables, x and y, are 49 and 16
(C) Bowley’s index number respectively, and the covariance between them is
(D) Fisher’s index number 14. What is the coefficient of correlation between
48. The figure of a particular year expressed as a per- x and y ?
centage of the preceeding year’s figure is called— (A) 0·75 (B) 0.·50
(A) price relative (B) quantity relative (C) 0·25 (D) 0·10
(C) link relative (D) chain relative 57. For a simple linear regression equation Σ(y – ^y)2
49. Over period of time, an existing series of index = 256 and the standard error of estimate is 4. What
numbers tends to becomes obsolete and it fails to is the number of observations ?
include new commodities gaining importance at a (A) 4 (B) 12
later date or to exclude the commodidies losing (C) 16 (D) 18
signifiance in course of time. These problems can 58. The regression relationship between the variables x
be overcome by— and y is given by ^y = 4 + 5 × and, it explain 64% of
(A) Fisher’s ideal index the changes in the variable y. What is the coefficient
(B) Fixed based index of correlation between x and y ?
(C) Chain index numbers (A) – 0·80 (B) 0·80
(D) Both Fisher’s ideal index and fixed base index (C) 0·08 (D) – 0·08
50. The arithmetic mean of marks scored by girls in the 59. Which of the following is correct with regard to the
class is 70 while that of the boys is 60. If the method of least squares used in simple regression
arithmetic mean of marks scored by students is 63, analysis ?
then are percentage of girls in the class— (A) It minimizes the sum of the squared differences
(A) is less than that of the boys between the values of the independent variable
and their mean
(B) is equal to that of the boys
(B) It minimizes the sum of the squared values of
(C) is more than that of the boys the independent variable
(D) cannot be computed because of insufficient data (C) It minimizes the sum of the squared differences
51. For which measure of central tendency the sum of between the actual values of the dependent
deviations (taking sings into account) of the items variable and the estimated values of the depen-
from the measure of central tendency is zero ? dent variables as per the regression equation
(A) The coefficient of determination is positive (D) It minimizes the sum of the squared values of
always. the dependent variables
(B) The coefficient of determination is negative if 60. If a regression line is represented by Y = 1·5 – 2·0x
the coefficient of correlation is negative and the coefficient of determination is 0·49, then the
(C) The coefficient of determination is negative coefficient of correlation is—
if the coefficient of correlation is positive (A) – 0·70 (B) – 0·60
(D) None of the above (C) – 0·02 (D) 0·50
Economics (NET) | 361U
61. If the variance of x and y are 2·56 and 6·25 re- 67. Which of the following is correct when the slope of
spectively, and the covariance between them is 3·20 a regression line is negative ?
then the coefficient of correlation between x and y (A) The correlation coefficient between the depen-
is— dent and independent variables is 1
(A) 0·25 (B) 0·50
(C) 0·68 (D) 0·80 (B) The correlation coefficient between the depen-
dent and independent variables, lies between 0
62. The standard error of estimate is developed from the to 1
variations of the— (C) There is a negative correlation between the
(A) observed values of the dependent variable dependent and independent variables
around a fixed quantity
(D) The regression line is parallel to the horizontal
(B) observed values of the dependent variable axis
around the mean of the observed values of the
independent variable 68. Which of the following is correct with regard to a
given coefficient of correlation and its corres-
(C) observed values of the dependent variable
ponding coefficient of determination ?
around the fitted regression line
(A) The coefficient of determination is always
(D) observed values of the independent variable
greater than or equal to zero, and less than or
around their mean
equal to 1
63. The Y intercept in the simple linear regression (B) The coefficient of determination is always
equation (x is the independent variable and y is the less than zero
dependent variable) represents the
(C) The coefficient of determination is always
(A) true value of y when x = 0 equal to 1
(B) change in average value of y per unit change (D) The coefficient of determination always has the
in x same sign as the coefficient of correlation
(C) expected value of y when x = 0
69. Which of the following is the graphical plot of the
(D) standard deviation of the values of x values of the dependent and independent variables,
64. The slope of the simple linear regression equation (x in the context of regression analysis ?
is the independent variable and y is the dependent (A) Scatter diagram (B) Histogram
variable) represents the— (C) Frequency polygon (D) pchart
(A) mean value of y when x = 0
(B) change in mean value of y per unit change in x 70. r will be positive when—
(C) true value of y for a fixed value of x (A) X increases, Y decreases
(D) variance of the values of x (B) X decreases, Y increase
65. Which of the following is true with regard to simple (C) Both X and Y decreasing
regression and correlation analysis ? (D) None of the above
(A) Correlation analysis provides a measure, which
indicates how well an equation for estimating 71. If two variables have the linear relationship and
one variable from another explains the changes X + Y = 100, the correlation will be—
in the estimated variable (A) – 1 (B) + 1
(B) If the coefficient correlation between two (C) 0·80 (D) 0·20
variables is close to 1, then there is no correla- 72. If X – Y = 50, the correlation between X and will
tion between the two variables be—
(C) If the slope of a regression equation is positive, (A) –1 (B) + 1
then the coefficient of correlation between the (C) 0·50 (D) – 0·25
variables involved is negative
(D) If the slope of a regression equation is negative, 73. The coefficient of correlation—
the dependent variable decreases as the inde- (A) has no limit (B) is less than 1
pendent variable decreases (C) is more than –1 (D) None of these
66. Which of the following is indicated if the standard 74. If the sum of the product of deviations of x and y
error of estimate for a regression equation is zero ? series from their means is zero, the correlation
(A) The standard deviation of the observed values coefficient will be—
of the dependent variable is zero (A) 0 (B) 1
(B) The standard deviation of the independent (C) – 1 (D) None of these
variable is zero
75. Karl Pearson's coefficient of correlation measures—
(C) The observed value of the dependent variable
will always be equal to its estimated value, (A) linear correlation
for a given value of the independent variable (B) non-linear correlation
(D) There is no correlation between the variables (C) Both (A) and (B)
involved (D) None of these
362U | Economics (NET)
76. Maximum positive value of coefficient of cor- 85. Which of the following is/are correct ?
relation is— (i) Correlation coefficient is a relative measure.
(A) 0·50 (ii) – 1 < r < 1
(B) 1·00 (iii) If r = + or –1, the correlation will be perfect.
(C) 2·00 (iv) Correlation coefficient measures only the
(D) there is no maximum limit degree of linear relationship.
(A) (i) and (ii) only (B) (i), (ii), and (iii) only
77. The minimum value of coefficient of correlation
is— (C) (ii) and (iii) only (D) All the four
(A) 1·00 86. Which of the following is/are correct ?
(B) 0 (i) Negative correlation means that both the
(C) –1·00 variables have decreasing values.
(D) there is no maximum limit. (ii) Positive correlation means that both the
variables have increasing values.
78. Correlation between price and demand is— (iii) If the direction of change in the two variables
(A) positive (B) negative in the same, the two variables will be positi-
(C) Both (A) and (B) (D) Either (A) or (B) vely correlated.
79. Correlation between price and supply is— (iv) If the change in the two variables is in opposite
(A) positive (B) negative direction, the correlation will be negative.
(C) Both (A) and (B) (D) Either (A) or (B) (A) (i) and (ii) only (B) (ii) and (iii) only
(C) (iii) and (v) only (D) (i) and (iv) only
80. If the coefficient of correlation between x and y is
0·75 then the relationship can be termed as— 87. Which of the following is an example of positive
and perfect correlation ?
(A) positive and perfect
(A) X + Y = 20 (B) X – Y = 20
(B) positive but not perfect
(C) 2x + 3y = 25 (D) None of these
(C) negative and perfect
88. Which of the following is an example of negatives
(D) negative but not perfect and perfect correlation ?
81. If the coefficient of correlation between two (A) X + Y = 20 (B) X – Y = 20
variables x and y is – 1·00, then the relationship can (C) 3x + 2y = 20 (D) None of these
be termed as—
89. If x = y + 2, then—
(A) positive and perfect
(B) positive but not perfect (A) r = + 1 (B) r = – 1
(C) negative and perfect (C) r = 0.5 (D) r = – 2
(D) negative but not perfect 90. Which of the following is/are correct ?
82. Which one of the following statements is true ? (i) If x = 2y, x and y will be perfectly correlated.
(A) Correlation coefficient establishes cause and (ii) If x = 30 – y, there will be a perfect negative
effect relationship between the two variables correlation between x and y
(B) Coefficient of correlation is a relative measure (iii) If x = y + 2, r = + 1
of association between two variables (iv) R = 0 means absence of correlation.
(C) Correlation coefficient is an absolute measure (A) (i) and (ii) only
of relationship between the two variables (B) (ii) and (iii) only
(D) Correlation coefficient is expressed in the units (C) (i), (ii) and (iii) only
of original data (D) All the four
83. Which of the following is correct ?
91. Which of the following statements is true ?
(A) r > 1 (B) 0 <| r | < 1
(A) Coefficient of correlation between height and
(C) – 1 < r < 0 (D) None of these weight is 1.4
84. Which of the following statements is/are not (B) If SD2 = 0, the rank correlation = 1 and if ΣD2
correct ? = 1, the rank correlation = 0
(i) Correlation coefficient is always positive (C) Correlation coefficient is independent of
(ii) Scatter diagram helps in determining the degree change in origin and scale
of correlation (D) The correlation coefficient increases with the
(iii) If r = + 1 or – 1, the correlation will be perfect. number of paired observations
(iv) Correlation coefficient is a relative measure. 92. Which of the following is correct ?
(A) (i) and (ii) only (B) (ii) and (iii) only (A) Rank correlation can be computed only for
(C) (iii) and (iv) only (D) (i) and (iv) only quantitative data
Economics (NET) | 363U
(B) The coefficient of correlation has the same 99. If two regression coefficients are 0.8 and 0.6, what
unit as the Pearson’s r would be the value of the coefficient of correlation ?
(C) The coefficient of correlation can be calculated (A) 0·14 (B) 1·4
only if both the variables are in the same unit (C) 0·69 (D) 0·31
(D) The correlation between the age of applicants
for life insurance and premium of insurance is 100. Given the regression equation of y on x and x on y
positive are respectively y = 2x and 6x – y = y. What is the
value of correlation coefficient ?
93. Which of the following is/are not correct ?
(i) A relation such as (A) 1·414 (B) 0·333
650 500 (C) 0·578 (D) 0·422
(i) r2 = 1 – and r2 = 1 – is not possible.
500 400 101. Which of the following is correct statement ?
(ii) Spearman’s rank correlation is distribution free (A) φ = { } (B) φ = {0}
or non-parametric.
(C) φ = { φ } (D) { φ }
(iii) If one of the regression coefficients are greater
than unity, the other must also be greater than 102. If A is the set of all integral multiples of 3 and B is
unity. the set of all integral multiples of 5, then A ∩ B is
(iv) Arithmetic mean of regression coefficients is the set of all integral multiples of—
always zero. (A) 3 (B) 3 + 5
(A) (i) and (ii) only (B) (ii) and (iii) only (C) g.c.d. (3, 5) (D) 1.c.m. (3, 5)
(C) (iii) and (iv) only (D) (i) and (iv) only 103. If X = {4n – 3n – 1/n ∈ N}, Y = {9 (n – 1)/n ∈ N},
94. Which of the following is correct ? then—
(A) Correlation coefficient is independent of the (A) X ⊂ Y (B) X ⊆ Y
change of origin (C) X = Y (D) X ⊇ Y
(B) Correlation coefficient is independent of the
change of scale 104. Let A = {0, 1, 3, 4}, B = {5, 6, 1, 3, 9} and
(C) Both (A) and (B) C = {1, 2, 3, 4, 9, 13}, then (A ∩ B) ∪ C is—
(D) None of these (A) C (B) {0, 1, 2, 3, 4, 9, 13}
95. Which of the following is correct ? (C) {0, 1, 3} (D) (1, 3}
(A) Correlation coefficient is independent of the 105. Let A = {1, 2, 3,…9), B = (2, 4, 6, 7, 8} and C =
change of origin {3, 4, 5, 8, 9, 10}, then (A – B) ∪ C is—
(B) Correlation coefficient is independent of the (A) {1, 3, 4, 5, 8, 9, 10}
change of scale (B) {1, 2, 3, 4, 5, 6, 7, 8, 9}
(C) Both (A) and (B) (C) {2, 4, 6, 7, 8}
(D) None of these (D) {1, 3, 4, 5, 8, 9}
96. Which of the following is true ?
106. X = {1, 2, 3}, Y = {3, 4, 5, 6}, (X – Y) ∪ (Y – X)
(A) Scatter diagram helps in determining the is—
degree of correlation
(A) {1, 2, 4} (B) {1, 2, 4, 5}
(B) Correlation coefficient measures only the
degree of linear relationship (C) {1, 2, 4, 5, 6} (D) None of these
(C) Coefficient of correlation between height and 107. De’Morgan’s law is—
weight is negative (A) (A ∪ B)C = AC ∪ BC
(D) Correlation coefficient is independent of the (B) (A ∩ B)C = AC ∩ BC
change of origin but depends on the change of (C) (A ∪ B)C = (A ∩ B)C
scale
(D) (A ∪ B)C = AC ∩ BC
1
97. If by x = –2 and bxy = – then rxy is— 108. If n (A) = m and n (B) = p and A ∩ B = φ then
4
1 n (A ∪ B) is—
(A) 1 (B) (A) m – p (B) m + p
⎯2
√ (C) m + p – 4 (D) None of these
1
(C) –1 (D) 109. If A = {– 1, 0, 1}, B = {– 1, 0} and C = {0, 1},
⎯2
√ then—
98. If regression equations are 8x – 10 = 64 and 40 x - 1. (A × B) ∩ (A × C) = {(– 1, 0), (0, 0), (1, 0)}
18y = 320, then what are the mean values of x and 2. (A × B) ∪ (A × C) = {(– 1, – 1), (– 1, 0),
y? (– 1, 1), (0, – 1), (0, 0), (0, 1), (1, – 1), (1, 0),
(A) x = 8, y = 0 (B) x = 10, y = 2 (1, 1)}
(C) x = 2, y = 10 (D) y = 6, x = 0 3. (A ∩ C) × B = {(0, – 1), (0, 0), (1, – 1)}
364U | Economics (NET)
of these statements— ↔ ↔ ↔
118. If R ∈ PQ, S ∉ PQ and S does not lie on PQ
(A) 2 and 3 are correct (B) 1 and 2 are correct
extended, then—
(C) 3 alone is correct (D) 1 and 3 are correct
↔ ↔ ↔ ↔
110. The shaded region in the diagram is— (A) PQ ∩ RS = φ (B) PQ ∩ RS = [R]
↔ ↔ ↔ ↔
(C) PQ ∩ RS = [S] (D) PQ ∩ RS = [P]
A B
119. Consider the following expression with regard to a
relation R in number—
x R y ↔ 3x + 4y = 5
1
(1) ORI (2) 1 R
(A) (A – B) ∪ (B – A) (B) (A – B) ∩ (B – A) 2
(C) A ∪ (B – A) (D) (A – B) ∪ B 2 3 3 1
(3) R (4) R
3 4 2 4
111. The shaded region in the diagram given below
Correct code is—
represents—
(A) 2 and 3 are correct (B) 1 and 2 are correct
A B (C) 3 and 4 are correct (D) 1 and 4 are correct
120. Let A = {a, b, c, d}, which one of the following
subsets of AXA is not a function on A ?
(A) {(a, d), (d, a), (a, b), (d, c)}
C
(B) {(d, a), (a, b), (b, c), (c, d)}
(A) A ∩ (B ∪ C) (B) A ∪ (B ∩ C) (C) {(a, d), (b, a), (c, b), (d, c)}
(C) A ∪ (B – C) (D) B – (A ∪ C) (D) {(d, a), (a, d), (b, a), (c, c)}
112. If 57% of Indian like milk and 75% like tea, how 121. Which of the following functions is/are onto
many like both ? functions ?
(A) 32%
(C) 70%
(B) 35%
(D) 60%
I. φ : R → R defined as φ (x) = { – x‚ x < 0
x‚ x ≥ 0
113. In a group of 75 persons, 20 take tea but not coffee II. φ : R → (1, – 1) defined as
and 30 take tea. How many take coffee but not tea ?
(A) 45 (B) 35
φ (x) = { 1‚ if x is rational
– 1‚ if x is irrational
(C) 40 (D) None of these III. f (x) = x2, x ∈ R
IV. f : R → R, defined by f (x) = 3x ∀x ∈ R
114. If X is the set of integers and f is defined on X by f Correct code is—
(n) = n2 , then the image of the set {– 2, – 1, 0, 1, 2}
is— (A) I and III only (B) II and IV only
(C) I and IV only (D) II and III only
(A) {– 2, – 1, 0, 1, 2} (B) {– 2, 1, 0}
(C) {0, 1, 2} (D) {0, 1, 4} 1
122. Let f (x) = x2 sin for x ≠ 0, f (0) = 0, then—
x
115. The function f : R → R, given by f (x) = sin x is— (A) f (x) is continuous and derivable at x = 0
(A) one-one and into (B) f (x) is continuous but not differentiable at x = 0
(B) one-one and onto (C) f (x) is neither continuous nor differentiable at
(C) many one and into x=0
(D) many one and onto (D) None of the above
116. The range of the function f (x) = a cos (bx + c) + d 123. The function
a > 0 is— f (x) = |x – 1| + |x – 2|
(A) [– a, a] (B) [– a – d, a – d] is not derivable at—
(C) [– d – a, d + a] (D) [d – a, d + a] (A) x = 0 (B) x = 1
(C) x = 3 (D) x = 1, x = 2
117. If f (x) = x 2 and g (x) = x3, x being real, then—
124. The series
(A) f is one-one but g is not one-one 12 12 .3 2 12 .3 2 .5 2
(B) f is not one-one and g is 1 – 1 + + + ……is—
22 22 .4 2 22 .4 2 .6 2
(C) Neither f nor g is 1 – 1 (A) Convergent (B) Divergent
(D) Both f and g are one-one (C) Oscillatory (D) Not convergent
Economics (NET) | 365U
125. The series 130. Solution of the equation
3 5 7
1+ + + + …… is— ⎡⎢ x y ⎤⎥ 2 ⎡⎢ 0 0 ⎤⎥
2 3 4 ⎢⎣ z t ⎥⎦ = ⎢⎣ 0 0 ⎥⎦ is given by—
(A) Convergent (B) Divergent
(C) Not convergent (D) None of these ⎡⎢ ± ⎯√⎯αβ – β ⎤⎥
(A) ⎢ ⎥
126. Consider the List-I and List-II and choose the ⎢⎣ α ± ⎯
√⎯αβ ⎥⎦
correct code given below—
List-I List-II ⎡⎢ ± ⎯√⎯αβ α ⎤⎥
(a) ∑
1 (B) ⎢⎢ ⎥
(n + 1)2
1. Absolutely convergent
⎣ –β ± ⎯ √⎯αβ ⎥⎦
(– 1)n
(b) ∑ 6/5 2. Convergent ⎡⎢ ± ⎯√⎯αβ ⎤⎥
n β
(C) ⎢ ⎥
(c) 1 – 2 + 2 2 – 23 + … 3. Conditionally ⎢⎣ – α ± ⎯√⎯αβ ⎥⎦
convergent
(– 1) n
(D) Both (B) and (C)
(d) ∑ 4. Oscillatory
n
(a) (b) (c) (d) Where α and β are arbitrary scalars.
(A) 2 3 4 1 ⎡ ⎤
⎢ 0 – tan α ⎥
(B) 2 4 3 1
131. If A = ⎢⎢ 2 ⎥ and I = ⎡⎢ 1 0 ⎤⎥
⎥ ⎢⎣ 0 1 ⎥⎦, then
⎢ tan α 0
2
(C) 2 1 4 3 ⎥
(D) 4 1 2 3 ⎣ 2 ⎦
⎡ cos2 θ cos θ sin θ ⎤⎥ I2 + A = (I2 – A) M, where M is given by—
127. A = ⎢⎢
⎣ cos θ sin θ sin2 θ ⎥⎦ ⎡⎢ cos α sin α ⎤⎥ ⎡⎢ cos α – sin α ⎤⎥
(A) ⎢⎣ –sin α cos α ⎥⎦ (B) ⎢⎣ sin α cos α ⎥⎦
⎡ cos2 φ cos φ sin φ ⎤⎥
and B = ⎢⎢
⎣ cos φ sin φ sin2 φ ⎥⎦ ⎡⎢ sin α – cos α ⎤⎥
is a null matrix, then θ and φ is differed by—
(C) ⎢⎣ cos α sin α ⎥⎦ (D) None of these
π
(A) An even multiplication of 132. If a diagonal matrix is commutative with every
2
π matrix of same order, then it must be—
(B) An odd multiplication of
2 (A) Null matrix (B) Identity matrix
(C) An even multiplication of π (C) Scalar matrix (D) Triangular matrix
(D) An odd multiplication of π
133. If A and B are square matrices of the same order
128. Two matrices A and B are said to be comparable, such that AB = A and BA = B, then A and B are
if— both.
(A) No. of columns in A is equal to no. of rows in (A) Singular (B) Non-singular
B
(B) No. of rows in A is equal to no. of columns in (C) Idempotent (D) Involutary
B 134. Match the List I and List II given below :
(C) No. of rows and columns in A is equal to no. of
rows and columns in B List (I) (Matrix)
(D) No. of rows and columns in A does not equal to ⎡ 2 1–i ⎤⎥ ⎡⎢ 0 –4 1 ⎤⎥
no. of rows and columns in B (a) A = ⎢⎢ ⎥ (b) A = ⎢ 4 0 –5⎥
⎣ 1+i 6 ⎦ ⎢⎣ –1 5 0 ⎥⎦
129. If A = [–10 01] and (aI + bA) = A, a, b ∈ IR, then a
2
⎡⎢ 4 –1 –4⎤⎥ cos θ sin θ
and b are given by—
1 1
(c) A = ⎢ 3 0 –4⎥ (d) A =
⎢⎣ 3 –1 –3⎥⎦ [–sin θ cos θ]
(A) ± (B) ±
⎯3
√ ⎯5
√ ⎡⎢ 1 2 3 ⎤⎥ ⎡⎢ 2 –2 –4⎤⎥
1 (e) A = ⎢ 1 2 3 ⎥ (f) A = ⎢ –1 3 4 ⎥
(C) ± (D) None of these ⎢⎣ –1 –2 –3⎥⎦ ⎢⎣ 1 –2 –3⎥⎦
⎯2
√
366U | Economics (NET)
⎡1 1 ⎤ 140. The orthogonal trajectories of the rectangular
⎢ 2 (1 + i) – 2 (1 – i)⎥ hyperbola xy = c2 are given by—
⎢
(g) A = ⎢ 1 ⎥
⎥ (A) y (x – y) = k (B) x2 + y2 = k2
⎢ (1 + i) (1 – i) ⎥
1
⎣2 2 ⎦ 2 2
(C) x – y = k 2 (D) x (x + y) = k
List (II) (Type of Matrix) 141. The equation 8ap3 = 27y has a singular solution
(i) Idempotent (ii) Orthogonal given by—
(iii) Involutary (iv) Nilpotent of order 2 (A) y = 0 (B) y = c
(v) Skew-symmetric (vi) Hermitian (C) y2 = (x – c)2/a (D) y = (x – c)2 /a
(vii) Unitary
The correct match is : 142. The differential equation of the orthogonal trajecto-
(a) (b) (c) (d) (e) (f) (g) ries of the system of parabolas y = ax2 is—
(A) (v) (vi) (iii) (ii) (iv) (i) (vii) (A) y′ = x2 + y (B) y′ = x – y2
(B) (vi) (v) (iii) (ii) (vii) (i) (iv) –x x
(C) y′ = (D) y′ =
(C) (vi) (v) (iii) (i) (vii) (ii) (iv) 2y 2y
(D) (vi) (v) (iii) (ii) (iv) (i) (vii)
Answers
1
135. If f (x) = , then at x = 0 the function is— 1. (A) 2. (D) 3. (D) 4. (B) 5. (A)
1 + 2 1/x
6. (C) 7. (B) 8. (B) 9. (D) 10. (C)
(A) Continuous
(B) Discontinuous, because 11. (C) 12. (A) 13. (C) 14. (B) 15. (D)
R. limx → 0 f (x) does not exist 16. (A) 17. (D) 18. (A) 19. (B) 20. (A)
(C) Discontinuous, because 21. (A) 22. (C) 23. (C) 24. (B) 25. (C)
L. limx → 0 f (x) ≠ R. limx → 0 f (x) 26. (B) 27. (D) 28. (D) 29. (A) 30. (B)
(D) Discontinuous, because 31. (A) 32. (A) 33. (C) 34. (A) 35. (D)
limx → 0 f (0) ≠ f (0) 36. (B) 37. (C) 38. (C) 39. (B) 40. (D)
136. The general solution of a differential equation of 41. (A) 42. (A) 43. (B) 44. (A) 45. (B)
first order represents— 46. (C) 47. (A) 48. (C) 49. (C) 50. (D)
(A) A family of surfaces 51. (C) 52. (A) 53. (B) 54. (C) 55. (D)
(B) A pair of curves in xy- plane 56. (B) 57. (D) 58. (B) 59. (A) 60. (A)
(C) A family of curves in xy- plane 61. (D) 62. (C) 63. (C) 64. (B) 65. (A)
(D) None of the above 66. (C) 67. (C) 68. (A) 69. (A) 70. (C)
71. (A) 72. (B) 73. (D) 74. (A) 75. (A)
137. A particular solution of a differential equation
represent— 76. (B) 77. (C) 78. (B) 79. (A) 80. (B)
(A) A line (B) A circle 81. (C) 82. (B) 83. (B) 84. (A) 85. (D)
(C) An ellipse (D) A curve 86. (C) 87. (B) 88. (A) 89. (A) 90. (D)
138. The envelope of the family of curves represented 91. (C) 92. (D) 93. (C) 94. (C) 95. (D)
by a differential equation of first order is called 96. (B) 97. (D) 98. (A) 99. (C) 100. (C)
its— 101. (A) 102. (D) 103. (A) 104. (A) 105. (A)
(A) General solution (B) Particular solution 106. (C) 107. (D) 108. (B) 109. (B) 110. (A)
(C) Singular solution (D) Clairaut’s solution 111. (D) 112. (A) 113. (A) 114. (D) 115. (C)
139. The singular solution of the differential equation 116. (D) 117. (B) 118. (B) 119. (A) 120. (A)
y = px + p – p3 is given by— 121. (D) 122. (A) 123. (D) 124. (B) 125. (A)
1 x + 1 3/2 x + 1 3/2
(A) y =
2( ) 3
(B) y = 2 ( )
3
126. (C)
131. (B)
127. (B)
132. (C)
128. (C)
133. (C)
129. (C)
134. (D)
130. (D)
135. (C)
3/2 3/2 136. (C) 137. (D) 138. (C) 139. (B) 140. (C)
(C) y = (
3 )
(D) y = 2 (
3 )
1 x–1 x–1
2 141. (A) 142. (C)
●●
UNIT-5
International Economics
Various Concepts in International Balance of Payments—The Balance of Payments
(the sum total of all economic transactions between one
Trade country and its trading partners around the world),
International Trade—International trade is the which includes capital movements (money flowing to a
exchange of goods and services between countries. This country paying high interest rates of return), loan
type of trade gives rise to a world economy, in which repayment, expenditures by tourists, freight and
prices, or supply and demand, affect and are affected by insurance charges, and other payments.
global events. Foreign Exchange—Foreign exchange is the
Free Trade Vs. Protectionism—As with other exchange of one currency for another or the conversion
theories, there are opposing views. International trade of one currency into another currency. Foreign exchange
has two contrasting views regarding the level of control also refers to the global market where currencies are
placed on trade : Free trade and protectionism. Free trade traded virtually around the clock.
is the simpler of the two theories : a laissez-faire Foreign Exchange Market—A market where
approach, with no restrictions on trade. The main idea is currencies of the countries can be exchanged i.e., soled
that supply and demand factors, operating on a global or purchased is known as the Foreign Exchange Market.
scale, will ensure that production happens efficiently. The global foreign exchange market is the largest and
Therefore, nothing needs to be done to protect or the most liquid financial market in the world, with
promote trade and growth, because market forces will do average daily volumes in the trillions of dollars. Foreign
so automatically. exchange transactions can be done for spot or forward
In contrast, protectionism holds that regulation of delivery. There is no centralized market for forex
international trade is important to ensure that markets transactions, which are executed over the counter and
function properly. Advocates of this theory believe that around the clock.
market inefficiencies may hamper the benefits of The largest foreign exchange markets are located in
international trade, and they aim to guide the market major financial centers like London, New York, Singa-
accordingly. Protectionism exists in many different pore, Tokyo, Frankfurt, Hong Kong and Sydney. The
forms, but the most common are tariffs, subsidies, term foreign exchange is usually abbreviated as "forex"
and quotas. These strategies attempt to correct any and occasionally as "FX."
inefficiency in the international market. Terms of Trade—Terms of trade (TOT) repre-
Imports—Imports are the products shipped into our sent the ratio between a country's export prices and
country from other places. The origins of the word its import prices. How many units of exports are
import are literally “to bring into port.” required to purchase a single unit of imports? The
Exports—To export something is to move it from ratio is calculated by dividing the price of the exports
its current location to a different territory. The verb by the price of the imports and multiplying the result
export comes from the Latin word exportare which by 100.
means ‘to carry out’ or ‘send away.’ To export Ad valorem (According to value)—A tax imposed
something is to move it across borders. on imports by the customs authority of a country based
Balance of Trade—The difference in value over a on the value of the goods.
period of time between a country’s imports and exports Consignment—Delivery of merchandise from an
of goods and services, usually expressed in the unit of exporter (the consignor) to an agent (the consignee)
currency of a particular country or economic union (e.g., under agreement that the agents sell the merchandise for
dollars for the United States, pounds sterling for the the account of the exporter. The consignor retains title to
United Kingdom, or euros for the European Union). If the goods until the consignee has sold them. The
the exports of a country exceed its imports, the country consignee sells the goods for commission and remits the
is said to have a favourable balance of trade, or a trade net proceeds to the consignor.
surplus. Conversely, if the imports exceed exports, an (CV) Countervailing Duty—A duty imposed to
unfavourable balance of trade, or a trade deficit, exists. counter unfairly subsidized products.
368U | Economics (NET)
(DDA) Doha Development Agenda—The DDA subsequent transportation costs, including the costs of
mandates negotiations on a range of issues, including the loading the merchandise on a vessel. If the contract
implementation of the present agreements. The negotia- stipulates “FOB vessel,” the seller bears all transporta-
tions take place in the Trade Negotiations Committee tion costs to the vessel named by the buyer, as well as
and its subsidiaries. Other work takes place in other the costs of loading the goods on that vessel. The same
WTO councils and committees. principle applies to the abbreviations FOR (free on rail)
Dumping—Sale of an imported commodity at a and FOT (free on truck).
lower price in one market than in another—i.e., selling Free-Trade Zone—A port designated by the
at less than “normal value” on the same level of trade, government of a country for duty-free entry of any non-
and in the ordinary course of trade. Dumping is prohibited goods. Merchandise may be stored, displayed,
considered an actionable trade practice when it disrupts used for manufacturing, etc., within the zone and re-
markets and injures producers of competitive products in exported without duties being paid. Duties are imposed
the importing country. Article VI of the General on the merchandise (or items manufactured from the
Agreement on Tariffs and Trade (World Trade merchandise) only when the goods pass from the zone
Organization) permits the imposition of special into an area of the country subject to the customs
antidumping duties on goods equal to the difference authority.
between their export price and their normal value. (GATT) General Agreement on Tariffs and
Exchange Rate—The price of one currency in Trade—A multilateral treaty signed in 1947 to help
terms of another, that is, the number of units of one reduce trade barriers between signatory countries and to
currency that may be exchanged for one unit of another promote trade through tariff concessions. The workings
currency of the GATT agreement are the responsibility of the
Export Processing Zone (EPZ)—Site in a foreign Council for Trade in Goods, which is made up of
country established to encourage and facilitate representatives from all WTO member countries. GATT
international trade. EPZs include free trade zones, membership now includes more than 110 countries.
special economic zones, bonded warehouses, free ports, (GCC) Gulf Cooperation Council—The Gulf
and customs zones. EPZs have evolved from initial Cooperation Council, created in response to the outbreak
assembly and simple processing activities to include of the Iran-Iraq war, established the Gulf Standards
high-tech and science parks, finance zones, logistics Organization in November 1982. The GCC seeks to
centers, and even tourist resorts. strengthen cooperation (in areas such as agriculture,
Export Quotas—Specific restrictions or ceilings industry, investment, security, and trade) among its six
imposed by an exporting country on the value or volume members: Bahrain, Kuwait, Quatar, Oman, Saudi
of certain exports designed, for example, to protect Arabia, and the United Arab Emirates.
domestic producers and consumers from temporary
Intellectual Property (IP)—Collective term used
shortages of the goods affected or to bolster their prices
to refer to new ideas, inventions, designs, writings,
in world markets.
films, and so on that are protected by a copyright, patent,
Export Subsidies—Government payments or other or trademark.
financially quantifiable benefits provided to domestic
producers or exporters contingent on the export of their Letter of Credit—Instrument issued by a bank on
goods and services. behalf of an importer that guarantees an exporter
payment for goods or services, provided that the terms
Export Licenses—An export license grants permi- of the credit are met. A letter of credit issued by a
ssion to conduct a certain type of export transaction. It is foreign bank is sometimes confirmed by a U.S. bank.
issued by the appropriate licensing agency after a careful This confirmation means that the U.S. bank (the
review of the facts surrounding the given export confirming bank) adds its promise to pay to that of the
transaction. Most export transactions do not require foreign bank (the issuing bank). A letter of credit may be
specific approval in the form of licenses from the U.S. either irrevocable, in which case it cannot be changed
Government. Exporters should learn which federal unless both parties agree, or revocable, in which case
department or agency has jurisdiction over the item they either party may unilaterally make changes. A revocable
are planning to export in order to find out if a license is letter of credit is inadvisable as it carries many risks for
required. the exporter.
Free on Board (FOB)—An international commer-
cial term (Incoterm) that means free on board and is Trading House—Company specializing in the
used in international sales contracts. In an FOB contract, exporting and importing of goods produced or provided
a buyer and a seller agree on a designated FOB point. by other companies.
The seller assumes the cost of having goods packaged Analytical Tools of International
and ready for shipment from the FOB point, whether it
is the seller’s own place of business or some inter- Trade
mediate point. The buyer assumes the costs and risks The first set of analytical tools contains easy-to-follow
from the FOB point, including inland transportation steps which illustrates the processes and objectives of
costs and risks in the exporting country, as well as all calculating the following trade and tariff indicators :
Economics (NET) | 369U
1. Import Intensity Indexes Indices used in Analysis
2. Export Intensity Indexes ● Export specialization index—
3. Revealed Comparative Advantage (RCA)
⎛
Xijk ⎞
⎜ ⎟
4. Revealed Trade Barriers (RTB)
Xijt
⎜ ⎟
5. Intra Industry Trade Indexes and ESIijk =
Mjk
6. Tariff Data Profiles
These tools are efficient in that they progressively ⎝
Mjt ⎠
display and examine the steps in calculating the different where Xijk is the exports of country i to country j of
indicators. They serve as a practical capacity building product k, Xijt is the total exports of country i to country
tool where users can replicate the steps in their own j, Mjk is the imports of country j of product k, and Mjt is
calculations. the total imports of country j. If larger than one, then
The second, more advanced, set of indicators differs country is considered to be specialized in the relevant
from the first set in that these tools are fully formulated product
to produce formatted answers for each indicator.
● Trade complementarity index—
The second set of tools include :
⎛M ⎞
1. Growth & Share measures, including t h e standard TCIij = ∑RCA jk.RCDjk. ⎜ wk⎟
revealed comparative advantage measure ⎝ Mw ⎠
2. Market diversification measures according to the ⎛X jk ⎞
Hirfindahl and Weighted Spread index
⎜X i ⎟
3. Product diversification measures according to the Where RCA ik =
⎜M ⎟
⎝M ⎠
wk
Hirfindahl and Weighted Spread index
w
4. Intra-industry trade measures
5. Trade Intensity measures ⎛M ik ⎞
6. Decomposition of change in global export share ⎜M i ⎟
according to the International Trade Centre (ITC) and RCD ik =
⎜M ⎟
⎝M ⎠
wk
approach. w
The aim is modest in terms of capacity building by
Trade complementarity index RCAik is the revealed
bringing selected trade performance measures to the
attention of trade analysts in a learning by doing self- comparative advantage of country or region i in product
help style so that own applications can be considered. k, RCD jk is the revealed comparative disadvantage of
country or region j in product k, and Mw k/M w is the
Other Important Tools of International share of product k imports in total world imports. Note
Trade Analysis that X and M signify exports and imports, respectively.
● Trade flows analysis Analyzing trade complementarity is important to get a
● Example—assessment of trade patterns and/or trade measure of how a country’s (or region’s) export supply
performance fits into the import demand of its trading partners. The
● Conceptual tools TCI has a threshold of one, with an index greater (lower)
● Revealed comparative advantage, intra-industry than one indicating a greater (lower) level of comple-
trade, export diversification, etc. mentarity between trade commodity profiles.
● Empirical tools—Entropy indices, revealed compa- Descriptive Analysis
rative adv
● Trade policy analysis, Example : Trade policy
Trade Performance and Competitiveness assessment.
Assessment ● Conceptual tools : Effective protection, non tariff
● Trade in services barriers, bound and applied tariffs, tariff escalation,
● Merchandise trade etc.
● Trade performance ● Empirical tools : Averages, dispersion indices,
● Growth and pattern in the direction of trade coverage ratios,
● Composition of trade ● Trade Policy Assessment
● Export concentration and principal products
1. Trade policy reviews
● Competitiveness, specialization and complemen-
tarity ● Trade and investment regime
● International competitiveness of exports ● Trade policies by measure and by sector
● Export specialization 2. Tariff profiles
● Trade complementarity and intensity ● NAMA tariff simulations
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Econometric Estimation of Gravity trade in degree. Factor mobility is greater between
Equations regions than between countries and thus equalization of
factor prices. Both national and international market
● Can be used to study the impact of trade policy differ on grounds of tastes and habits. Both are run
variables on trade flows between different political unit each with a sovereign
● Example : Effect of regional trade agreement government responsible for the well being of unit.
● Ex post: not well suited for making predictions This accounts for differences in national economic
● No welfare effects policies.
● Reasonable data requirements Inter-regional trade refers to trade between regions
● Reasonable entry costs within a country. It is what Ohlin calls interlocal trade.
● Cost of econometric software package ? Thus interregional trade is domestic or internal trade.
● Importance of integrating theory with estimation International trade, on the other hand, is trade between
two nations or countries. A controversy has been going
Econometric Estimation of Economic on among economists, whether there is any difference
Consequences of Trade between interregional trade and international trade.
● Example—Assessment of the distributional effects There are several reasons to believe the classical
of trade policy view that international trade is fundamentally different
● Ex post from interregional trade. These reasons are :
● Variable level of econometric sophistication (i) Factor immobility,
● Variable data requirements (ii) Differences in natural resources,
(iii) Geographical and climate difference,
Partial Equilibrium Simulations (iv) Different markets,
● Focuses on a specific market or product and ignores (v) Different currencies,
interactions with other markets
(vi) Problem of balance of payment,
● Best suited for the analysis of sectoral policies, or
(vii) Transportation costs,
when interactions with other markets are expected
to be limited (viii) Different political group,
● Allows to include more market relevant details than (ix) Different national policies.
General Equilibrium models. Classical Theory of International
● Example : Assessing the welfare effect of a reduction
of the tariff on wheat. Trade
● A number of partial equilibrium models have been The Classical Theory of International Trade was
developed to simulate international trade policy formulated by Aam Smith (1723-1790) in terms of his
changes; Those include SMART, ATPSM, SWOP- “Absolute Advantage Model”. David Ricardo (1722-
SIM. 1823) expanded it further into what is called Compara-
tive Advantage model. The models of Smith and
● Data requirements are manageable; Elasticities are
Ricardo together constitute what is sometimes referred
crucial.
to as “Supply version of Classical Theory of Trade”.
● General Equilibrium explicitly accounts for all the They treated supply or production costs the determining
links between sectors of an economy – households, factor of trade and gains from trade. The modern version
firms, governments and the rest of the world. of Classical Theory of Trade however treats supply and
● Imposes constraints s.t. income equals expenditure demand with equal weight, John Stuard Mill being the
● Trade off between detail and breadth of coverage. first to indicate that demand considerations must be
● Assesses effects of policy changes on aggregate and incorporated into the Comparative Advantage model.
sectoral variables, including— Adam Smith’s Theory of Absolute Cost
● Income, production, employment, relative factor and Difference
product prices, etc.
Adam Smith extolled the virtues of free trade. These
● Single or multiple country models are the result of the advantages of division of labour and
● Highly intensive in data and parameters specialisation both at the national and international
● SAM, behavioural parameters, elasticities levels.
● GTAP provides data and a simple model Assumptions—Adam Smith based his ‘Absolute
● Entry cost is significant Cost Advantage’ theory of international trade on the
● High risk of misinterpretation. following assumptions :
(i) Labour is the only factor of production.
Theories of International Trade (ii) There is full employment in the economy.
Inter-regional and international trade are both (iii) Labour is perfectly immobile between the
concerned with problems of overcrowding space. countries.
International trade differs from domestic or inter regional (iv) Law of constant returns is in operation.
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Explanation of the Theory—According to Smith, (5) There is perfect competition. The inter-national
the division of labour at the international level requires market is perfect so that the exchange ratio for
the existence of absolute differences in costs. Every the two commodities is the same.
country should specialise in the production of that (6) No transportation costs are involved in carying
commodity which it can produce more cheaply than trade between the two countries.
others and exchange it for the commodities which cost
(7) No barriers to trade. There is free trade between
less in other countries.
the two countries, i.e., there is no restrictions in
The following example illustrates the case of the movement of commodities.
absolute difference in costs as the basis of international
(8) Trade takes place between two countries of
trade.
equal economic strength and in two commo-
Absolute Difference in Costs dities of equal economic value.
Country Commodity - X Commodity - Y Cost Difference—Given these assumptions, the
A 10 5 theory of comparative costs is explained by taking three
B 5 10 types of differences in cost; absolute, equal and
comparative.
The table reveals that country A can produce 10X or
(1) Absolute Differences in Costs—This may be
5Y with one unit of labour and country B can produce
when one country produces a commodity at an absolute
5X or 10Y with one unit of labour.
lower cost of production than the other. Suppose country
In this case, country A has an absolute advantage in can produce 10x or 5y and country B can produce 5x or
the production of X and country B has an absolute 10y.
advantage in the production of Y.
In this case, country A has an absolute advantage
And, therefore, Adam Smith maintained that country in the production of X (for 10x is greater than 5x), and
A should specialise in the production of commodity X country B has an absolute advantage in production of Y
and country B in the production of commodity Y. Both (for 10y is greater than 5y).
the countries would gain by this specialisation.
Trade between the two countries will benefit both.
Ricardo’s Theory of Comparative Cost (2) Equal Differences in Costs—Equal differences
Advantage in cost arise when two commodities are produced in
both countries at the same cost difference. Suppose
The principle of comparative cost is based on the country A can produce 10x or 5y and country B can
difference in production costs of similar commodities in produce 8x or 4y.
different countries. Production costs differ i n countries In this case with one unit of labour in country A can
because of geographical division of labour and produce either 10x or 5y and the cost ratio between x and
specialisation in production. Due to differences in y is 2 : 1. In country B one unit of labour can produce
climate, natural resources, geographical situation and either 8x or 4y, and the cost ratio between the two
efficiency of labour. A country can produce one com- commodities in 2 : 1. Thus, the cost of producing x in
modity at lower cost than the other. In this way, each terms of y is the same in both countries. This can be
country specialises in the production of that commodity expressed as
in which its comparative cost of production is the least. 10x of A 5y of A
Therefore, when a country enters into trade with some = =1
8x of B 4y of B
other country, it will export those commodities in which
its comparative cost of production is the least and will When cost differences are equal, no country stands
import those commodities in which its comparative to gain from trade. Hence international trade is not
production costs are high. This is the basis of intern- possible.
ational trade, according to Ricardo. (3) Comparative Differences in Costs—Compara-
tive differences in cost occur when one country has an
Assumptions of the Theory—The Ricardian
absolute advantage in the production of both commo-
doctrine of comparative advantage is based on the
dities, but a comparative advantage in the production
following assumptions :
of one commodity than in the other. Suppose country A
(1) They use a 2 × 2 × 1 model i.e., 2 countries, 2 can produce 10x or 10y and country B can produce 6x or
commodities and 1 factor of production that is 8y.
labour. In this case country A has an absolute advantage on
(2) The cost of production equals total labour cost, the production of both x and y , but a comparative
i.e., the number of labour units employed to advantage in the production of x. Country B is at an
produce each. absolute disadvantage in the production of both
(3) All the units of labour are homogeneous. commodities but it has comparatively less disadvantage
in the production of y.
(4) Production functions are characterised by
constant costs, i.e., there is constant returns Thus, country A has a comparative advantage in the
to scale. production of commodity x, and has least comparative
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disadvantage in the production of y. Thus trade is an economy. Thus, the assumption of full employment
beneficial for both countries. The comparative advantage makes the theory unrealistic.
position of both countries is illustrated in the following (6) Neglects the Role of Technology—This is
figure. unrealistic because technological changes help in
increasing the supply of goods not only for the domestic
market.
(7) Ignores Transportation Costs—This is highly
unrealistic because transport costs play an important role
in determining the pattern of world trade.
(8) Static Assumption of Fixed Proportions—
This is essentially a static analysis and hence unrealistic.
As a matter of fact, labour is used in varying
propositions in the production of commodities.
(9) No Similar Taste—Tastes differ with different
income brackets in a country. Moreover, they also
change with the growth in an economy.
In the figure, PQ is the production possibility curve (10) Self-Interest Hinders its Operation—The
of country A, and RS that of country B. Country A doctrine of comparative cost does not operate if a
enjoys an absolute advantage in the production of both country having a comparative disadvantage does not
x and y over country B. It produces OQ units of x or OP wish to import a commodity from the other country due
units of y as against OS units of x or OR units y to strategic, military or development considerations.
produced by country B. But the slope RT reveals that A (11) Impossibility of Complete Specialisation—
has a comparative advantage in the production of Complete specialisation will be impossible on the basis
commodity x only because if it gives up the resources of comparative advantage in producing commodities
required to produce OR of commodity, it can produce entering into international trade.
OT > OS of commodity x. On the other hand, if it gives
up resources required to produce OS units of x, it would To conclude, though the classical theory of inter-
be able to produce commodity x by an amount less than national trade has been developed on unrealistic
OR. Thus country A has a comparative advantage in assumptions and has been vigorously attacked by many
the production of commodity x and country B has a less economists, we cannot completely discard the theory of
comparative disadvantage in the production of comparative costs because even if we drop many of its
commodity y. assumptions the theory stays to explain the phenomenon
of trade.
Criticism of the Comparative Cost Theory—Till
recently, the classical theory of international trade was Mills’s Theory of Reciprocal Demand
accepted as an authoritative explanation of international Ricardo formulated his theory of international trade
trade. In recent times the theory has come in for severe in terms of comparative cost advantage. But Ricardo did
criticism, especially by the economists like Bertlin not pay attention to the ratio or rate at which one
Ohlin, Frank Graham, etc. The theory has been criticised commodity would exchange for the other commodity.
principally on the following points : The term ‘reciprocal demand’ was introduced by Mill to
(1) Unrealistic Assumption of Labour Cost— explain the determination of the equilibrium terms of
In calculating production costs, it takes only labour costs trade. It is used to indicate a country’s demand for one
and neglects non-labour costs involved in the production commodity in terms of the quantities of the other
of commodities. commodities it is prepared to give up in exchange.
(2) Unrealistic Assumption of Constant Cost— Assumptions of Reciprocal Demand Theory—
In the real world, the fact is that there are either Mill’s theory of reciprocal demand is based on the
increasing costs or diminishing costs. Thus the following assumptions :
assumption of constant cost is unrealistic. (i) It is 2 X 2 X 1 model.
(3) Factor Not Fully Mobile Internally—Even (ii) There is constant returns to scale.
within a country factors not move freely, from one (iii) Absence of transportation costs.
industry to another or from one region to another. The (iv) There is perfect competition.
greater the degree of specialisation in an industry, the (v) There is full employment.
less is the factor mobility. (vi) There is free trade.
(4) Two-Country, Two-Commodity Model is Explanation of the Mill’s Theory—Mill’s Theory
Unrealistic—In actuality, international trade is among of reciprocal demand can be explained as follows :
many countries trading in many commodities. (i) The possible range of barter terms of trade is
(5) Unrealistic Assumption of Full Employ- given by the respective domestic terms of trade
ment—Keynes falsified the assumption of full employ- as set by comparative efficiency in each
ment and proved the existence of under-employment in country.
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(ii) Within this range, the actual terms of trade will 2. There is perfect competition in both the factor
depend upon reciprocal demand, i.e., the and commodity markets.
strength and elasticity of each country demand 3. There is fixed supply of factors.
for the other country’s product. 4. There is full employment.
5. There is free trade between the countries.
6. The price of each commodity equals its
marginal money costs.
7. The price of each factor equals its marginal
value productivity in each employment.
It is the shape of the production possibility curve
under different cost conditions that determines the bases
and the gains from international trade under the theory
of opportunity cost.
Trade Under Constant Opportunity Costs—
(iii) Only those barter terms of trade will be stable Under constant opportunity costs, the production possi-
at which the exports offered by each country bility curve is a straight line.
just suffice to pay for the imports it desires. In the figure, PA is the production possibility curve
Mill’s theory of reciprocal demand is explained of country A, and PB of country B. As the relative prices
diagrammatically in terms of Marshall’s offer curves. differ in the two countries, trade is possible between the
In the figure country A’s production of X is taken two.
on the horizontal axis and country B producing only Y is
taken on vertical axis. The curve OA is country A’s offer Country A has a comparative advantage in the
curve. It shows how many units of X country A will give production of X, and B has a comparative advantages
up for given quantity of Y. Similarly OB is the offer (least disadvantage) in the production of Y. Under the
curve of country B which shows how many units of Y circumstances, country A will specialise in t h e pro-
country B is prepared to give up in exchange for a given duction of commodity X and export it to B, and country
quantity of cloth. The point E where the two offer curves B will specialise in Y and export it to A.
OA and OB intersect is the equilibrium point at which
OX of commodity X is traded by country A for OY of
commodity Y of country B. The rate at which X is
exchanged for Y is equivalent to the slope of the line
OT.
Haberler’s Opportunity Cost Theory of
International Trade
Classical theory of comparative cost advantage is
based on the labour theory of value, where all factors of
production can be converted into labour equivalent and
prices of goods and services are determined by the
amount of labour needed to produce these goods and
services. However, labour theory of value is an
unrealistic theory. Modern economists have discarded
the labour theory of value. Haberler has presented an PR is the new international price line. Before trade,
explanation of the comparative cost theory in terms of
B was consuming and producing both the commodities
opportunity cost.
The opportunity cost theory says that if a country at point E. After trade it specialises exclusively in the
can produce either commodity X or Y, the opportunity production of Y at point P and its consumption level
cost of commodity X is the amount of the other shifts up from point E to C on the international price line
commodity Y that must be given up in order to get one PR. It will now export TC of Y to country A in
additional unit of commodity X. Thus the exchange ratio exchange for PT of X. In this situations, both countries
between the two commodities is expressed in terms of will gain from trade.
their opportunity costs. Trade Under Increasing Opportunity Costs—The
Assumptions—Haberler’s opportunity cost theory production possibility curve under increasing opportunity
of international trade is based on the following assump-
costs is concave to the origin. In the figure (panel [I]),
tions :
AA1 is the production possibility of country A which is
1. It is 2 X 2 X 2 model, i.e., two countries, two
commodities and two factors of production concave to the origin. The slope of this curve shows that
(labour and capital). A will specialise in the production of X.
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gains from trade are less than that under complete
specialisation. Further, the law of comaprative costs is
valid only under increasing opportunity costs. In a two
good world if one country is more efficient in producing
both goods than another country, it profits by
concentrating on the product in which it has a greater
comparative advantage.
Trad under Decreasing Opportunity Cost—
When two countries experience decreasing opportunity
costs, their production possibility curves are convex
to the origin. Under decreasing opportunity costs, each
country completely specialises in the production of only
one commodity after trade because there are increasing
returns based on international economies of production.
Panel [II] of the figure shows BB1 is the production
possibility curve of country B. The slope of this curve
reveals that it will specialise in the production of
commodity Y.
In the absence of foreign trade, country A produces
and consumes some quantities of both X and Y at point
K where the line aa is tangent to AA 1 curve. The line aa
indicates the domestic relative commodity prices of X
and Y. Similarly country B produces and consumes
some quantities of the two commodities at point K1
where its price line bb is tangent to the production
possibility curve BB1.
In the figure, AA1 is the production possibility
curve of country A1 and BB1 is that of country B. The
pre-trade consumption and production point of country
A is K and that of country B is K 1 . The slope of the
domestic price line aa of country A shows that its
comparative advantage is greater in the production of
commodity X. Similarly, the slope of country B’s
domestic price ratio bb shows its greater comparative
advantage in the production of commodity Y.
If trade starts between the two countries, the
international price line (ratio) will be BA1 . The country
A will completely specialise in the production of X at
point A1, and country B will completely specialise in the
International trade is possible only if the production of Y at B. Now each will move along the
international price ratio of the two commodities differs international price line BA1 , country A from point A1
from that prevailing in the domestic market of each upward and country B from point B downward, and
country. The international price ratio is given by the PL reach point C in consumption. A will export D1A1 of X
line in country A and P1 L1 in country B.
to country B and import D 1 C of Y from it on the trade
The new equilibrium point as determined by the triangle CD1 A1.
price line PL A is E. It will thus produce OR of X and OQ
of Y. The consumption point for country A will be at C Modern Theory of International
on the price line PL. It will then export TR of X and Trade : Heckscher–Ohlin Thesis
import QS of Y.
The Heckscher–Ohlin theory explains the basis of
The new equilibrium point for country B is point E 1 . international trade in three stages :
The consumption point of country B will at C1 on the
(a) the basis of trade lies in the difference in the
price line P1 L1 . It will import D 1 C 1 of X and export final price of a commodity.
D1E1 of Y on the trade triangle E1 D1 C1 . (b) the difference in the final price of a commodity
Under increasing opportunity costs specialisation is is due to differences in the comparative cost of
always incomplete due to decreasing returns. Hence the producing that commodity.
Economics (NET) | 375U
(c) finally it examines the root cause which produ- endowed with labour, it is also necessary to know the
ces this difference in the comparative cost. capital endowment of each country. Thus only if the
The difference in the comparative cost advantage labour/capital ratio in the country X is greater than
occurs because of two reasons : labour/capital ratio of country Y, we can say that
(a) the difference in the relative scarcity of factors country X is relatively well endowed with labour.
of production in the two countries.
(b) the different factors combinations is required in
Thus() L
K X
may be 10 units/5 units = 2
the production function for producing different
commodities. () L
K Y
may be 8 units/2 units = 4.
This reason being so important that it made Ohlin where L stands for Labour, K for Capital X and Y
call his theory the factor proportions or the factor for two countries.
intensity theory.
In this example though country Y possesses a
It is the difference in factor intensities in the smaller absolute amount of labour than Country X, it is
production function of goods along with actual nevertheless relatively well-endowed with Labour
difference in relative factor endowments that explains (because L/K in country Y is greater than L/K in country
the international difference in comparative cost of X).
production. A country can produce a commodity more
cheaply by matching its abundant factor with the factor Ohlin explains richness in factor endowment in
intensity of the commodity because when a nation has terms of factor prices.
relatively more of a particular factor, the cost of that According to his definition country A is abun-
factor will be comparatively lower. ⎛P ⎞ ⎛P ⎞
dant in capital if ⎜ C⎟ < ⎜ C⎟ , where PC and PL refers
Assumptions of Theory ⎝ P L⎠ A ⎝ P L⎠ B
(1) Perfect Competition exists in both the product to prices of capital and labour, and the subscripts A and
and factor markets in each country. B denote the two countries. In other words if capital is
(2) There is perfect mobility of factors of produc- relatively cheap in country (A), the country is abundant
tion within a country, but factor mobility between the in capital and if labour is cheap in country B, the
countries is non-existent. country is abundant in labour. Thus country A will
export the capital intensive good and country B will
(3) Factors are identical and homogeneous export the labour intensive good. This is illustrated in
qualitatively in both the countries. the figure.
(4) Factor supplies in each country are fixed and
fully employed and there is constant returns to scale.
(5) Trade is free and cost less—There are no
barriers to trade and no cost of transport.
(6) The physical amounts of each productive
factors possessed by the countries are different and can
be measured.
(7) Techniques of producing identical goods are the
same in both the countries but the production functions
are different for different commodities.
In the Figure OX is the labour intensive goods and
(8) Goods can be classified according to the factor OY is the capital intensive goods. And the obvious
intensity. conclusion is that country A will produce the relatively
(9) The production functions of the two commodi- cheap commodity Y and export it to B. While country B
ties have different factor intensities. will produce the relatively cheap commodity X and
(10) Factor intensities are non-reversible. export it to A. This establishes the Ohlin theorem that
Ohlin argues that once we know from assumption the capital abundant country will export the capital
(6) above what the relative factor endowments are for intensive commodity and the labour abundant country
each country we can infer from this what the relative will export the labour intensive commodity.
factors price structure will be in each country. A country Criticism
endowed with more labour and less capital will have a
factor price structure such that capital will be more Ohlin’s Theory has been criticised on the following
expensive relative to labour. grounds :
In considering the Heckscher-Ohlin model one must (1) The assumption of two-by-two-by-two model is
constantly think in terms of relative quantities. We not realistic,
cannot say simply because one country say X has a (2) Like the classical theory, the Ohlin model is
greater physical amount of one factor say Labour than static in nature,
other country Y, that country X, is relatively well (3) Factors are not homogeneous,
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(4) Production techniques can not be homo- Leontief Paradox
geneous, The most interesting empirical test of the Heckscher-
(5) Leontief paradox has falsified the theory. Ohlin theorem that has been made so far is the study
(6) Prof. Haberler criticises Ohlin for his failure to undertaken by Wassily Leontief in the early 1950s.
develop a comprehensive, general equilibrium Leontief tests his hypothesis with the help of an input-
concept. He regards Ohlin’s theory as, by and output table for the United States for 1947. He attempted
large, a capital equilibrium analysis. to verify the empirical validity of the Heckscher-Ohlin
Despite these criticisms the Ohlin theory of theorem that a capital abundant country would export
international trade is definitely an improvement over the relatively capital intensive goods and in turn import
classical theory as it attempts to explain the basis of more labour intensive goods. In context of U.S.A.
international trade in the general equilibrium setting. economy, the Heckscher-Ohlin model tells that this
country specialised in export of those good which use
Its Superiority Over the Classical Theory more capital than labour and import relatively labour
Ohlin’s theory is an improvement over the classical intensive goods. But by Leontief’s practical test, it was
theory of international trade in many respects. found that U.S.A. exported more of labour intensive
1. Ohlin’s theory is superior to the classical theory goods and imported more of capital intensive goods, a
in that it regards international trade as a special case of situation that was in direct contrast to its relative factor
interregional or inter-local trade as distinct from the endowment position. As such Leontief’s result came as a
classical theory which considers international trade great surprise to many economists of the world. Some
totally different from domestic trade. economists criticised Leontief’s findings on the ground
that 1947 was not the right year for testing the theory as
2. The Ohlin model takes two factors-labour and
during this year the economy was beset with the post
capital-as against the one factor (labour) classical model,
and is thus superior to the latter. war disorganisation of production. In defence to
criticisms Leontief stated that America’s participation in
3. Again, the Ohlin theory is superior to the international division of labour was based on its
Ricardian theory in that it regards differences in factor specialisation in labour intensive rather than capital
supplies as basic for determining the pattern of intensive lines of production. In other words the country
international trade while the latter theory takes no notice resorts to foreign trade in order to economise its capital
of it. and dispose of its surplus labour, rather than the reverse.
4. The Ohlin model is more realistic because it is It was also argued that the U.S. export industries
based on the relative prices of factors which in turn employed more skilled labour and are thus human
influence the relative prices of goods, while the capital intensive rather than physical capital intensive.
Ricardian theory considers the relative prices of goods Abundance of human capital in the U.S. economy
only. explains its exports of labour intensive goods.
Theories of Internal Trade International Trade Under Imperfect
G Theory of Absolute Cost Advantage Company
(1776) : Adam Smith
Most of the classical theories of international trade
G Theory of Comparative Cost are based on perfect competition under which every
Advantage (1817) : David Ricardo
buyer and seller is the price taker, no barrier on the entry
G Theory of Reciprocal Demand and exit of the firm, commodities are homogeneous, no
(1848) : J. S. Mill
G
advertisement, and technically AR=MR=MC=AC
Theory of Opportunity Cost (1936) :
Haberler
,means every is earning normal profit in the long run.
G Modern Theories of International Policy of ‘lasisez faire’ is a common rule. But, in practice
Trade no such market exists in real world. In modern days
(i) Resource Trade Theory (1919- Eli Heckscher and international trade is being performed under imperfect
1933) : Bestil Ohlin competition. Imperfect competition means the absence
Model of one or more conditions of perfect competition.
(ii) Specific Factors and Income Paul Samuelson- Monopoly, Monopolistic competition, oligopoly, and
(1948) : Ronal Jones duopoly are the types of markets of imperfect
Distribution Theory (Factor Equali- Model competition.
sation Theorem)
(iii) The Standard Model of Trade : Paul Krugman- In reality , monopolies do not exists. The profits of
Maurice Obsfeld monopoly attract competitors. Therefore , oligopoly
Model and/or monopolistic competition arises.
(iv) The Competetive Advantage Michael Poster’s Oligopoly is a type of market where several firms
(1990) : Model sell their products at different prices ,but in many
(v) Gravity Model of Trade (1962) : Tinbergen aspects every firm is dependent on other firms.
(vi) Product Life Cycle Theory Raymond Vernon Monopolistic competition is a market structure
(1960) : defined by four main characteristics :
Economics (NET) | 377U
● large numbers of buyers and sellers; ● Few producers specialized in different models, that
● perfect information; compete with each other (they are substitutes,
● low entry and exit barriers; thought not perfectly) but they have some scope on
setting prices given a certain monopoly capacity due
● similar but differentiated goods. to the differences introduced by each maker.
This last one is the key to distinguish monopolistic ● Each company is a monopoly (just one produces
competition from perfect competition since in the latter each variety), although the demand of the good
all products are homogenous. This product differen- depends on the number of available similar products
tiation leads consumers to perceive products in this and on the prices of other firms in the industry.
market as unique, providing firms with a monopolistic-
like property that enables them having price-making MONOPOLISTIC COMPETITION : The Basic
power. There is a distinction to be made between Model
horizontally and vertically differentiated products in Demand faced by the firm under monopolistic
order to be able to understand different strategies that competition
monopolistic firms might adopt. The former is given Q = S [1/n – b (p – P′)]
when consumers base their purchasing decision on Where Q = Firm’s sales; S = Total sales in the
subjective preferences when comparing products, e.g. industry; n = number of firms; p= price in the firm;
colours or flavours. The latter occurs when the product P’ = average price charged by competitors
can be evaluated with another one in terms of
● Each firm sells more the higher the total demand in
measurable and qualitative factors, e.g. technological
the industry, and the higher the prices of the
differences or technical properties in engines.
competitors.
The extent to which each firm can take advantage of ● If p = P’ all the firms will sell S / n (= share for each
their monopoly condition depends on the flexibility of one).
their demand curve. If it is too rigid (steeper), in order
for the monopolist to achieve a higher price, it has only ● The larger the difference of p over P’ the smaller the
to reduce some of its production. However, the more firm’s market share.
flexible (flatter) the demand curve is, the less market ● The total sales S don’t depend on the price (pieces
power the firm has to increase prices. Naturally, every of a given “cake”)
monopolist in an imperfect market tries to expand the Market Equilibrium :
size of the market in which its product dominates. For Assumption :
this they have to compete with other monopolists ● All firms are symmetric in costs and demand, even
leading them to a series of costs other than production thought their products are differentiated.
(manufacturing and transportation costs), which are
● The long run equilibrium depends on: “the average
defined as selling expenses. These expenses are incurred
price” of the varieties (P’) and the “number of
with the aim of modifying the demand curve so
firms” (n).
quantities demanded for the product increase for each
level of prices. If a firm fails to have its product ● We will obtain them in 3 steps
differentiated, the market would be shared with other 1. Number of firms and average cost—Since the
firms, turning into a duopoly, oligopoly or even, if other firms are symmetric, in equilibrium, everyone
conditions are met, a perfectly competitive market. produce with the same price (P=P’). Then Q=S/n.
Roy Harrod was the first economist to develop the On the other hand, we know that the AC depends
theory of imperfect competition and, other authors, such inversely on Q :
as Edward Chamberlin and Joan Robinson renewed its AC = TC / Q = FC / Q + c = FC / S / n + c = (n FC)
interest and made major contributions. Nevertheless, it is /S+c
important to point out that Cournot, in his “Researches Interpretation—The more firms in the industry,
into the Mathematical Principles of the Theory of (and/or) the smaller the share that each one
Wealth”, 1838, was the first to model this kind of produces → the higher the average cost (that is, the
markets. more difficult to take advantage of the increasing
Monopolistic competition: returns).
● Few firms with different products (varieties): 2. Number of firms and the price—The price that a
firm charges also depends on the number of firms in
● Product differences ensure a monopoly in its the industry. When n increases, there is more
variety even thought there are some slight price competition, and prices will be reduced. On the
differences with other substitutive goods. other hand, each company accepts the price of the
● Different and independent prices. other firms (average price in the industry, P’) as
● Each company accepts other firms’ prices as given. Then the Demand can be written as—
given. Q = S [1/n - b (p – P’)] = Q = S / n + S b P’ - S b p
Examples: Automobile market, Tooth Paste market, Where Q = Firm's sales; S = Total sales in the
White Goods market, Toiletries market, etc. industry; n = number of firms p = company price;
378U | Economics (NET)
P’ = average price charged by competitors b = The PP Curve (Price of the industry) does not vary
parameter that measures the sensitivity of Q to the c+1
price because p =
bn
↑ n → ↑ competition → ↓ price
CLOSED COUNTRY
Q = S [1/n – b (p – p′)] C (S1) = n FC/S1 + c
P
Q = S/n + SbP′ – Sbp
Where S/n + Sbp′ = A; and Sb = B
AC LARGE MARKET
Thus Q = A - Bp (Demand in a monopoly and it is
the firm's sales will equal the equilibrium share if 1 WITH TRADE
p1 C (S2) = n FC/S2 + c
P = P´, plus an additional gain/loss from the share
according to the difference in prices (p) from the 2
p2
rest of the industry (P´)
P = c + 1/bn
Substituting Q in MR we get—
MR = p - Q / B = p - Q / Sb
Since the firm maximizes the profits when MR = n1 n2 N : firms/variety
MC
MR = p - Q / Sb = c Equilibrium in the Automobile Market
It can be rearranged as: p = c+ Q / Sb If all the firms
charge the same price, each one will sell an amount Price
Q = S/n. per PP
Substituting this we have auto
CC
p = c + (S/n / Sb) = c + 1 / (nb) 10
The larger the # of firms, the lower the price: price
↓ →n↑
Firm’s mark-up over marginal cost : p – c = 1 / (nb). n
It can be expressed in the following diagram: 6
AC (H) : Q = 900·000
CC = average cost
p Domestic Market
in the company
E = n FC/S + c
p2 = AC2 Price
PP = price of the
industry = c + 1/nb per PP
auto
n CC
N2 = n firms in equilibrium 8, 7
(with profit = 0)
3. The equilibrium number of firms— n
8
● PP Curve—▲ # of firms in the industry, ▲ compe-
tition and ▼ price. (F) : Q = 1·600·000
● CC Curve—▲ # of firms in the industry, ▲ average Foreign Market
cost in each company. Integrated World with Trade = Domestic
● E—long run equilibrium in the industry (n2 firms Market + Foreign Market
producing on AC2)
PP Equilibrium in the Global Market S = S1 + S2
Monopolistic Competition and Trade AC P n = 10 (car varieties), with lower AC (= p)
● In monopolistic competition without trade, the small
countries are restricted by their size: they have to
AC
choose between + varieties or higher production
costs. 8
● Trade increases market size, and the increase of the
market produces the rise of Q and decreases of AC :
10 n
AC = n × FC / S + c if n = constant and AC↓→↑S.
If two markets are compared S1 < S2 , the S1 costs Conclusion—In monopolistic competition, trade
will be > S2 costs . Its CC curve (Average cost in allows taking advantage of internal economies of scale
the firm)changes. without giving up the variety.
Economics (NET) | 379U
Balance of Payments : Composition, changes in claims on or of a country owed by or owed to
the rest of the world. Owes a claim to that resident who
Equilibrium, and Disequilibrium and in turn has an equivalent assets. Changes in bank
Adjustment Mechanism balances held by foreigners in the domestic banks
Balance of Payments Accounts and are included in the capital account. Capital account may
be divided into official and private account on the basis
Adjustments of private capital flows and official flows. Private capital
The balance of payments of a country is a flows normally takes place in order to make profit or
systematic record of all its economic transaction with the avoid loss whereas official flows may be induced
outside world in a given year. It is a statistical record of responses to changes which taking place else where in
the character and dimensions of the country’s economic the balance of payments. There is also an additional
relationships with the rest of the world. According to third major sub account known as Monetary Gold
Sodersten “The balance of payments is merely a way of account which includes all movements of gold between
listing receipts and payments in international transaction countries out of and into official monetary reserves.
for a country. It shows the country’s trading position,
changes in its net position as foreign lender or borrower Balance of Payments Model
and changes in its net position as foreign lender or I. Current Account
borrower and changes in its official reserve holding”. A. Merchandise Inputs (Visible items)
The balance of payments account of a country is 1. Merchandise imports
constructed on the principle of double entry book 2. Merchandise exports
keeping. Each transaction is entered on the credit and B. Service Transactions (Invisible items)
debit side of the balance sheet. But balance of payments 1. Rendered by foreign vessels
accounting differ from business accounting in one 2. Rendered by domestic vessels
respect. In business accounting debits (–) are shown on
C. Travel Expenditure
the left side and credits (+) on the right of the balance
sheet. But in balance of payments accounting the 1. In foreign countries by domestic residents
practice is to show credits on the left side and debits on 2. By foreigners in home country
the right side of the balance sheet. When a payment is D. Interest and Dividends
received from a foreign country it is credit transaction 1. Paid to foreigners
and when payment to a foreign country is made it is a 2. Received from abroad.
debit transaction. E. Banking and Insurance Services
Current account : The current account can be 1. Rendered by foreign institutions
divided into two components— 2. Rendered to foreign countries by
(i) Trade in goods; domestic institutions
(ii) Other, non-goods transactions, or invisibles.
The invisible, portion of the current account is F. Government Expenditure
sometimes referred to as the “services” account. The 1. By home government abroad
invisible account includes two different types of receipts. 2. By foreign government in home country.
(a) Factor income (primarily returns to capital— II. Capital Account
e.g., dividends, interest income—returns to labour, such A. Long term
as wages of Indian citizens working abroad). 1. Purchase of securities from foreigners
(b) Non-factor income (receipts and payments for 2. Sale of securities to foreigners
value-added services. B. Short term
IMF includes the following items as invisible 1. Increase in bank balances
transaction 2. Decrease of foreign hold bank balances in
(1) International transportation of goods, including home country.
warehousing, while in transit and other transit 3. Decrease of bank balances.
expenses.
(2) Travel for business, education, health, or plea- III. Unilateral Transfers
sure. A. Private
1. Personal and institutional remittances
(3) Insurance premium and payment of claims.
2. Remittances received from abroad.
(4) Investment income including, interest, rent,
dividends and profit. B. Governmental Indemnities
(5) Donations, migrant remittances and legacies. 1. Grants, indemnities made to other countries.
(6) Repayment of commercial credits. 2. Grants indemnities received from other
countries.
(7) Contractual amortisation and depreciation of
direct investment. IV. Gold Account
Capital Account covers debts and claims payable 1. Import of gold
in money or those constituting money. It contains all 2. Export of gold.
380U | Economics (NET)
Balance of Payments and Balance of Trade
There is a marked distinction between the concept Balance of Trade (BoT) and Balance of Payments (BoP).
Balance of trade refers to the merchandise account of exports and imports only. Balance of payments is a
broader term and it includes balance of trade. It is more comprehensive than the balance of trade. It includes all
international economic transaction and items such as merchandise trade, services, banking, insurance, capital flow,
gold buying and selling etc.
In accounting sense balance of payments must always be in balance. Any deficit or surplus in balance o f
payments refers only to the difference between the receipts and payments in the current account. If Rf – P f = 0 there
is no disequilibrium. There is no deficit or surplus in the balance of payments.
Components of Balance of Payments
Credit Debit
1. Exports of goods. 1. Imports of Goods
2. Exports of Services. 2. Imports of Services
3. Unilateral transfer receipts (gifts, indemnities from 3. Unilateral transfer payments (gifts, indemnities to
foreigners) foreigners)
4. Capital Receipts (borrowings from, capital repayments by 4. Capital payments (lending to, capital payments to, or
or sale of assets to foreigners) purchase of assets from foreigners).
If Rf – P f > 0 there is surplus in the balance of sustain an open economy without severe unemployment
payments. If Rf – Pf < 0 there is deficit in the balance of on a continuing basis. There are two kinds of
payments. equilibrium :
(a) Static Equilibrium is one in which the exports
Where Rf = Receipts from foreigners and Pf is the
equal imports including exports and imports of services
payments to the foreigners. as well as goods and the other items on the balance of
The disequilibrium in balance of payments may payments such as short term capital, long term capital
occur due to the cyclical forces or structural factor or and monetary gold are in the balance zero.
secular changes. ( b ) Dynamic Equilibrium—The condition of
Meaning of Deficit and Surplus in equilibrium for short periods of time is that exports and
imports differ by the amount of short term capital
Balance of Payments movements of gold and there are no large destabilising
Autonomous transactions are those which are short term capital movements.
undertaken for their own-sake for the profits they give.
Autonomous transactions have to be distinguished from 2. Balance of Payments Disequilibrium
induced transaction which are movement of reserves. There are three main types of disequilibrium.
International reserves serve the purpose of filling up (a) Cyclical Disequilibrium—This is caused by
gaps in balance of payments. countries having different cyclical patterns of incomes
A deficit appears in a country’s balance of or the same income pattern with different income
payments, when autonomous transactions requiring elasticities or identical income patterns and income
payments, exceed autonomous transaction involving elasticities with different price elasticities.
receipts. A surplus is said to arise when receipts from (b) Secular Disequilibrium—This is a long term
exports of goods and services exceed payments for phenomenon. It is caused by persistent deep rooted
similar items. dynamic changes which slowly take place in the eco-
Any imbalance in the current account must be offset nomy over a long period of time. Secular disequilibrium
by appropriate action under the capital account. A deficit is caused by dynamic forces such as population growth,
in current account must be covered by a surplus in the territorial expansion and technological development.
capital account by borrowing from foreign countries, Technological changes are another major cause of
sale of gold and drawing down foreign exchange from disequilibrium in the balance of payments. Each
the official reserves. A surplus in the current account technological change implies a new comparative
must be eliminated by a deficit in the capital account by advantage which the other country adjusts but the
lending to foreigners, purchasing gold and adding to the adjustment process itself produces a balance of payment
official reserves. deficit.
Equilibrium and Disequilibrium in (c) Structural Disequilibrium—Occurs on account
Balance of Payments of structural changes in some sectors of the economy at
home or abroad which may alter demand or supply
1. Balance of Payments Equilibrium relations of exports on imports or both. Structural
Equilibrium is that state of the balance of payments disequilibrium at the factor level results from factor pri-
over the relevant time period which makes it possible to ces which fail to reflect accurately factor endowments.
Economics (NET) | 381U
Measures to Correct the Disequilibrium Theories Concerning Disequilibrium in
in Balance of Payments Balance of Payments
The main problem is to check adverse balance of (1) Classical Theory—This theory explains
payments. There are many measures to correct disequilibrium in the balance of payments of a country
disequilibrium in the balance of payments. in terms of relative costs and price structure. A country
The important ones are : is likely to have an adverse balance of payments if her
cost and price structure is higher as compared with that
(1) Exchange Depreciation : Price Effects— of her trading partners. This theory assumes that there
Under flexible exchange rates the disequilibrium in the exists a significant element of substitutability between
balance of payments is automatically solved by the the home made goods and foreign goods.
forces to demand and supply of foreign exchange. An
exchange rate is the price of a currency which is (2) Income Theory—According to this theory a
determined, like any other commodity by demand and country would face a disequilibrium in the balance of
supply. Depreciation of currency means that its relative payments if her income is rising faster than that of her
value decreases. Depreciation has the effect of trading partners. This theory assumes that imports are a
encouraging exports and discouraging imports. function of income. Therefore if the income of a country
is rising faster than that of her trading partners her
(2) Devaluation—Devaluation raises the domestic imports are bound to increase faster which will give rise
price of imports and reduces the foreign price of exports to a disequilibrium in her balance of payments.
of a country devaluating its currency in relation to the (3) Demonstration Effect Theory—This theory
currency of another country. There is difference between was propounded by Nurkse. It was suggested that the
depreciation and devaluation of the exchange rate. high standards of living of the advanced countries had
Depreciation is the decision of the market forces
the effect of inducing the developing countries to raise
whereas devaluation is the decision made by the
their standard of living too. The fancy and aspirations of
monetary authority. When the external value of currency
these countries to imitate the living standards of the
is reduced through devaluation, export becomes cheaper
advanced countries resulted in their undertaking heavy
and imports dearer. As a result, exports increase and
investment programmes and in huge imports of luxury
import decline and the balance of payments deficit is
items. The standard of living of the advanced countries
eliminated.
served as a ‘demonstration model’ for less developed
(3) Import Restrictions—To correct disequilibrium countries.
in the balance of payments, governments also adopt
direct controls which aim at limiting the volume of Theories of Balance of Payments : The
imports. The government restricts the import of Adjustment Mechanism
undesirable or unimportant items by levying heavy The adjustment mechanism can be explained with
import duties, fixation of quotas, etc. At the same time, the help of different theories of balance of payments.
it may allow imports of essential goods duty free or at Devaluation—The Elasticity Approach : The elas-
lower import duties or fix liberal import quota for them. ticity approach is associated with Marshall and Lerner. It
For instance, the government may allow free entry of studies the conditions under which devaluation restores
capital goods but impose heavy import duties on equilibrium in the balance of payments.
luxuries. In these ways imports are reduced in order to In its simplest form, the rule states that the price
correct an adverse balance of payments. elasticities of demand for imports and exports must
sum to greater than unity for an improvement in the
(4) Exchange Control—Exchange control has a balance of payments position. Thus, the condition for
dual purpose. It restricts imports and also controls and improving balance of payments position by devaluation
regulates the foreign exchange. With reduction in of domestic currency is given by
imports and control of foreign exchange, visible and
invisible imports are reduced. Consequently adverse ex + em > 1
balance of payments is corrected. Where e x is demand elasticity of exports and em is
(5) Adjustment through Capital Movement— the demand elasticity of imports.
A country can use capital imports to correct a deficit in Above condition is known as Marshall-Lerner
its balance of payments. Condition.
(6) Stimulation of Exports—The deficit in the Devaluation—The Absorption Approach :
balance of payments can also be corrected by Absorption approach runs through the income effect of
encouraging exports. Exports can be encouraged by devaluation as against the price effect of the elasticity
producing quality products, by making exports surplus approach. The theory states that if a country has a deficit
through increased production and productivity and by in the balance of payments, it means that people are
better marketing. An increase in exports causes the absorbing more than they produce. The analysis can be
national income to rise by many times through the explained in the following form :
operation of the foreign trade multiplier. Y = C + Id + X − M
382U | Economics (NET)
Where, Y is national income, C is consumption If the price elasticity of demand for the exports
expenditure, Id total domestic investment, X represents of the country is less than unity, a given percentage fall
exports and M imports. in the rate of exchange, say of 20 per cent, will cause
The sum of C+Id is the total absorption designated less than 20 per cent (say only 10 per cent) increase in
as A, and the balance of payments (X-M) is designated the total quantity of exports of the country. This is the
as B. Thus, positive quantity effect of devaluation. But while the
total quantity of exports increases by 10 per cent the
Y = A+B
total foreign exchange earnings or total value of exports
Or B = Y−A of the country will be less than the pre-devaluation total
This means, balance of payments is the difference value of exports because while the total quantity of
between national income and total absorption exports has increased by 10 per cent, the foreign
(consumption plus investment). currency price per unit of export goods has fallen by 20
Devaluation increases the national income. The per cent. The negative price factor more than offsets the
additional income so generated will further increase positive quantity factor reflected in the increase of the
income via the multiplier effect. This will lead to an total quantity of exports, making the net effect on the
increase in domestic consumption. Thus the net effect of total foreign exchange earnings of the country through
the increase in national income on the balance of exports negative. It has been illustrated in figure A
payments is the difference between the total increase where the two countries taken are India and America
in income and the induced increase in absorption, i.e., with India devaluing her currency rupee in order to
ΔB = ΔY − ΔA correct her external balance of payments deficit. In this
figure, the demand and supply of India’s exports have
This difference between Y and A is called the real been shown on the x-axis and price expressed in the US
hoarding. Thus the effect on the balance of payments of dollars has been shown on the Y-axis. DxDx is inelastic
the increase in income due to devaluation is equal to demand curve for India’s exports while ASx is perfectly
the real hoarding in the economy. elastic supply curve of Indian exports.
So an improvement in the balance of payments can
be brought about by reduction in absorption. Domestic
absorption can fall automatically as a result of
devaluation due to a real cash balance effect, money
illusion and income redistribution.
International trade deals with business transactions
that take place between citizens of different nations and
with considerations of commercial diplomacy that
spring from such business transactions. Consequently,
international trade may be defined as the exchange of
goods and services among the citizens of independent or
sovereign states or countries. It consists of the exchange
by each country of its low-priced goods and services for
those goods and services which can be secured at lower
prices from abroad than the prices at home.
Before devaluation of the Indian rupee, the dollar
Methods of Removing Balance of Pay- price of export was OA, the total quantity exported was
OQ1 and the total foreign exchange (dollars) earned by
ments Deficit
the country through the exports was OQ 1 × OA (=
The conditions under which devaluation would rectangle AOQ1 E).
cause an improvement in the balance of payments Consequent on devaluation of the rupee, the dollar
position of the currency devaluing country have been (foreign currency) price of Indian exports falls by AB
discussed by Lerner, Robinson, Meade and others. The from OA to OB showing that the dollar price in
extent to which deficit of the external balance of percentage terms has fallen by the full extent of
payments of the currency devaluing country can be devaluation. Consequently, the supply curve of India’s
corrected through devaluation depends upon the price exports Asx shifts downward to the position of BS′ x
elasticities of demand and the price elasticities of supply
while the total quantity of exports increases by Q1 Q2
of her exports and imports. Considering first the price
elasticity of demand for the exports of the country, if the (=ΔQ) from OQ1 to OQ2 The new total foreign exchange
price elasticity of demand for the exports of the revenue (total dollar earnings) is OQ2 × OB (= rectangle
currency-devaluing country is less than unity in absolute BOQ2 G). The net change in the total foreign exchange
value, devaluation will not reduce deficit of the balance earnings of the country due to devaluation will be
of payments of the country; rather the balance of positive (increase) or negative (decrease) according as
payments deficit of the country would increase as a ABFE is smaller or greater than rectangle Q1 Q2 GF. In
consequence of devaluation. this case, the demand for India’s exports being inelastic,
Economics (NET) | 383U
rectangle ABFE > rectangle Q1 Q2 GF. Consequently new supply curve is now BS′m. Consequently, the total
devaluation increases rather than decrease the deficit amount of imports decreases by Q1Q2 from OQ1 to OQ2.
of India’s balance of payments. It, therefore, follows However, after devaluation India pays higher price OB
that although currency devaluation will always lead to for her imports. The total rupee-cost of imports is now
an increase in the total quantity of exports of the OQ2GB. The improvement in the balance of payments
currency-devaluing country (unless the price elasticity of resulting from decrease in total imports consequent on
demand for her exports is zero), it does not, however, devaluation of the rupee would depend on the relative
necessarily follow from this that it will always also lead sizes of rectangle Q2Q1EF and ABGF. If the elasticity of
to an increase in the total foreign exchange earnings of demand for imports is greater than unity, then rectangle
the country from exports. Q2Q1EF will be larger than rectangle ABGF. Conse-
Figure B shows the position of total export earnings quently, the balance of payments position of the country,
in terms of rupees (domestic currency). It is obvious that in so far as imports are concerned, will improve due to
the total rupee-earnings will always increase as result of devaluation.
devaluation even when the foreign demand for country’s
exports is inelastic. In this case, instead of the country’s
perfectly elastic supply curve shifting downward the
demand curve shifts upward from Dx D x to D′xD′x
showing higher demand for exports at each different
rupee-price since the same rupee-price now means lower
dollar-price for the Americans inducing them to buy
Q1Q2 amount more. However, although the total rupee
earnings from exports increase by EQ1 Q2F amount but it
does not necessarily follow from this that the total dollar-
earnings also increase.
Figure D shows the effect of devaluation on the
total imports and total foreign exchange bill which must
fall unless the demand for imports is perfectly inelastic.
However, although the total dollar payments obligation
is reduced from OQ1 EA to OQ2 FA but it does not
necessarily follow from this that the total rupee-
payments burden of the country will also fall. It will fall
only if the demand for imports is elastic, i.e., if the
elasticity of demand for imports is greater than unity.
There will be no change in the total-rupee payments
burden if the elasticity of demand for imports is unity
and the burden will increase in the event of the elasticity
Coming to imports, devaluation will help in reducing of demand for imports being less than unity.
the deficit of external balance of payments only if the It can be proved by means of a formula that under
price elasticity of domestic demand for imports is greater conditions of perfectly elastic supply of imports and
than unity (e m > 1) because in that situation a given exports, if a country devalues her currency in order to
percentage increase in the price of imports measured in remove her external balance of payments deficit, the
terms of the domestic currency would cause more than sum of the price elasticities of demand for the currency
proportionate fall in the quantity of imports as shown in devaluing
figure C when the demand for and supply of imports
have been shown on the X-axis and the price of imports
expressed in domestic currency has been shown on the
Y-axis. Dm Dm is the demand curve for imports while
ASm is the perfectly elastic supply curve for imports.
Before devaluation, the rupee-price of imports was OA
and the total imports were OQ 1 giving the total rupee
value of imports represented by rectangle OQ1EA (= OA
× OQ1 ). As a consequence of devaluation, although the
price of imports in foreign currency (dollars) remains
unchanged, since the supply curve for imports is
expressed in terms of the domestic currency, it shifts
upward by the full amount of the difference between the
pre-devaluation and post-devaluation rupee-price. The
384U | Economics (NET)
country’s exports and imports should be greater than expansion will start from expansion in exports which
unity in absolute value, i.e., e x + em > 1. This is the well- will raise real national income through the multiplier
known Marshall-Lerner Condition. If ex + em = 1, no process. The increase in exports will, however, depend
improvement in the balance of payments deficit of the on the extent to which export’s prices in the currency-
country will result from devaluation. If e x + e m < 1, devaluing country rise and the extent to which rest of the
devaluation will increase rather than decrease the world is willing to absorb the exports from the currency-
balance of payments deficit of the country. devaluing country.
The net effect of the increase in real national income
Absorption Approach on the balance of trade does not, however, comprise the
An alternative approach to the effects of devaluation total increase in real income or production; it comprises
formulated in macro terms, as against the elasticity the difference between the increase in real income and
approach formulated in micro terms, is the absorption the induced increase in total absorption. This difference
approach. This approach as first developed by Sidney between increase in real production and real absorption
Alexander in his famous paper published in 1952. may be called real hoarding (saving). The effect of
According to the absorption approach, the balance of devaluation on the balance of trade is, therefore, equal to
trade can be treated as the difference between national the amount of real hoarding which takes place in the
income (Y) and total expenditure (E) or absorption so economy and which is determined by the propensity to
that hoard (1 – C). As long as C, the propensity to absorb, is
B = Y–E ...(1) positive and less than unity, the propensity to hoard will
where B = balance of trade also be positive and less than unity. Consequently, some
hoarding will take place and to this extent devaluation
E = total expenditure Designating total will exert a positive effect on currency-devaluing
expenditure (E) or total demand as country’s balance of trade. If the propensity to absorb
total absorption (A), the above equa- is greater than unity, devaluation have a negative effect
tion can be rewritten as on the balance of trade since the induced increase in
B = Y–A …(2) absorption will be greater than the original increas in
Since total absorption is composed of the demand national income.
created for all purposes, it includes the demand for
consumption and investment purposes. Thus, for a three- Theories of Foreign Exchange Rate
sector economy 1. The Mint Par Parity Theory—This theory is
A = C+I+G ...(3) associated with the working of the international gold
Devaluation will affect the balance of trade either standard. Under this system, the currency in use was
by affecting the real national income, Y, or by affecting made of gold or was convertible into gold at a fixed rate.
the total absorption, A. Thus, the change in the balance The value of the currency unit was defined in terms of
of trade may be expressed as certain weight of gold, that is, so many grains of gold to
dB = dY – dA ...(4) the rupee, the dollar, the pound, etc. The central bank of
the country was always ready to buy and sell gold at the
Total absorption can be separated in two parts. First, specified price. The rate at which the standard money of
any change in real income (Y) will cause a change in the country was convertible into gold was called the
absorption (consumption demand) which will be mint price of gold. If the official British price of gold
equivalent to the change in real income (dY) multiplied was 6 per ounce and of the US price of gold 35 per
by the propensity to absorb (C). Secondly, devaluation ounce, they were the mint prices of gold in the
will directly affect absorption which will depend, among respective countries. The exchange rate between the
other things, on the level of real income at which 36
devaluation takes place. Let us call this direct effect on dollar and the pound would be fixed at = $6. This rate
6
absorption as D. Consequently
was called the mint parity or mint par of exchange
dA = CdY + dD ...(5) because it was based on the mint price of gold. Thus
By substituting equation (5) for the term dA in under the gold standard, the normal or basic rate of
equation (4) we obtain exchange was equal to the ratio of their mint par values
dB = (1 – C) dY – dD ...(6) (R = $/£).
Equation (6) states that the effects of a devaluation 2. The Purchasing Power Parity Theory—The
on the balance of trade depend on first, the effect of purchasing power parity theory was developed by
devaluation on real income (Y), second, the propensity Gustav Cassel in 1920 to determine the exchange rate
to absorb (C), and third, the effect on direct absorption between countries on the basis of inconvertible paper
(D). currencies. The theory states that equilibrium exchange
If there are enough unemployed resources in the rate between two inconvertible paper currencies is
currency-devaluing country (as is generally true of most determined by the equality of their purchasing power. In
developing countries) production can increase in the other words, the rate of exchange between two countries
short period following the devaluation. The process of is determined by their relatives price levels.
Economics (NET) | 385U
Cassel’s purchasing power parity theory became Importance of Foreign Trade
very popular among economists during 1914-1924 and (1) When a country specialises in the production
was widely accepted as a realistic explanation of the of a few goods due to division of labour and international
determination of foreign exchange rate under inconver- trade, it exports those commodities which it produces
tible paper currencies. But it has been severely criticised cheaper in exchange for what others can produce at a
for its weak theoretical base. lower cost.
Trade and Aid (2) Small size of domestic market in UDCs fail to
In recent decades an interesting debate has been absorb sufficient volume of output. This leads to low
raised over the relative virtue of trade and aid. Though inducement to invest.
both are means of acquiring external resources in the (3) Foreign trade also helps to transform the sub-
form of foreign exchange, but there are significant sistence sector into the monetised sector by providing
difference between the two. As we know that foreign aid markets for farm produce and raises the income and
is frequently made available in the form of tied aid. Tied standard of living.
aid has a number of disadvantages for the recipient
country because it limits its freedom in a number of Importance of Foreign Aid
ways. There choice of projects and the conditions of (1) UDCs suffer from technological back-wardness,
purchase of goods under the aid programme are reflected in high average cost of production and low
determined by the donor country. The type of technology productivity of labour and capital due to unskilled labour
made available under this aid programme may at and obsolete capital equipment and has high capital-
times, be unsuitable to the factor endowments of the output ratio.
recipient country. (2) Foreign aid helps in building economic overhead
Aid exposes the recipient country to a number of capital like rails, roads and power projects which provide
risks. In the non-economic field, the greatest risk is that the necessary infrastructure for development.
of the political interference of the donor country in the (3) Foreign capital helps in industrialising the
domestic affairs of the recipient country. In the economic economy.
field the greatest risk is the burden of debt repayment. (4) With the help of foreign aid untapped natural
At times, the burden can soar to seen high limits that the resources can be exploited, it opens up inaccessible areas
entire export-earnings of the country can be absorbed helps in augmenting natural resources.
merely to pay off the debts. If this happens the economic (5) Importation of capital creates more employment
growth of the country is likely to suffer a set back as the opportunities.
capacity to export goods, essential for economic (6) Foreign aid overcomes the balance of payments
development, will dry up. The way out of this crisis is a difficulties experienced by UDCs.
substantial expansion of recipient country. This brings
us to trade. Thus even if a country starts its planning Prebisch-Singer Thesis on Trade and
process by giving more importance to aid it must Development
eventually turn its attention to trade. In fact, the very aim According to Prebisch and Singer, the terms of
of the aid-receiving country should be to ensure that its trade between the peripheral (developing countries) and
utilization results in the creation of export capacity the cyclical centres (developed countries) have shifted
either directly or indirectly. Thus aid should ultimately in favour of the latter because monopolistic elements in
lead to more trade. their product and factor markets have allowed them to
In conclusion, we may state that from the points of keep the benefit of their technological progress in the
view of the developing countries, both aid and trade form of rising factor incomes.
have important roles to play. Aid, provides resources to Prebisch opines that in the organic growth of the
the developing countries to implement programmes of world economy, over the last seventy years, the primary
economic development which otherwise wouldn’t have producing developing countries have failed to share in
been undertaken. It also fills up the foreign exchange the gains of this world economic growth generated by
gap and technological gap. However, aid must eventually the developed countries and the reason for this has been
their declining capacity to import. The peripheral
lead to more export earnings for the developing countries
countries have not only failed to share in the productivity
else they would not be able to repay their debts. Thus aid gains because of population pressures, technological
must be accompanied by more trade. For this purpose backwardness and for the principal reason that their
the developed countries will have to change their selfish economic activity is dominated by the cycles of
narrow outlook and pull down their trade barriers to industrial activity in the developed countries.
enable the developing countries to export earnings. The According to Singer, the opening of the deve-
slogan “Aid or a Trade” is a misnomer. The approach of loping countries to foreign trade has tended to inhibit
both, the developed and the developing countries should their development since the purpose and effect of these
be “Aid and Trade”. investments and trade have been to open up new sources
386U | Economics (NET)
of food for people and for the machines of developed required imports for the target growth rate of the
countries. The specialization of developing countries in economy.
exports of food and raw materials to industrialized
countries has been unfortunate for the developing Foreign Exchange Rate : Meaning and
countries for the following reasons : Determination
(i) The investing countries have reaped the larger Each country has a different unit of currency.
share of the commulative multiplier effects of Examples—India—rupee; USA—dollar; Japan—
foreign investment as a result of heavy profit yen; UK—pound, etc. In international economic
remittances abroad. relations, goods, services and capital flow between
(ii) It has diverted the underdeveloped countries nations.
into types of activity offering less scope for Examples—India sells software to rest-of-the-
technical progress, internal and external world; India buys sophisticated technology from advan-
economies taken by themselves. ced nations.
(iii) It has led to the deterioration in the terms of These flows have to be paid for, either in the
trade of developing countries. currency of the seller-country or in some universally
The remedy Singer suggests is that the developing accepted foreign exchange, like the American dollar, or
countries should absorb the flow of international the Japanese yen.
investment into their economic system by reinvesting Since trade is settled to foreign exchange, there is a
its profits, by generating complementary domestic need to determine the rate of exchange of one currency
investments. On the other hand, Prebisch favour in terms of other currencies.
protectionist measures for them.
Meaning of Foreign Exchange
Two Gap Model of Foreign Aid Foreign exchange refers to the sum total of the
Chenery and other economists have put forth the stocks of the following available with a country.
two-gap model to economic development. ● stock of foreign currencies, and
According to two gap model, saving gap and ● stock of securities and bonds issued by foreign
foreign exchange gap are two separate and independent corporates and bonds.
constraints on the attainment of a target rate of growth in
developing countries. Chenery suggests foreign aid as a Thus, foreign exchange represents purchasing
way of filling these two gaps in order to achieve the power over foreigners goods and services.
target growth rate of the economy. The term ‘rate of exchange’ can be defined in two
The two gaps are explained in terms of the national alternative ways:
income accounting identities: ● It means the number of units of domestic
E−Y=I−S=M−X=F currency required to buy a unit of foreign currency.
Where E is national expenditure, y is national output Example—$ 1 = R 50.
and income, I is investment, S is saving, m represents ● It means the number of units of foreign currency
imports, x exports and f is net capital inflow. that can be purchased in exchange for a unit of domestic
I−S is the domestic savings gap and M-X is the currency.
foreign exchange gap. Example—R 1 = 2 Cents.
If the savings gap is larger than the foreign Rate of exchange represents the external purchasing
exchange gap, the economy is said to be in a savings of a currency.
constraint. On the other hand, if the foreign exchange Example—When we say that $ 1 = R 50 what we are
gap is larger than the savings gap, the economy is in a trying to say is that an American dollar can purchase
foreign exchange constraint. goods and services worth R 50 in the Indian markets.
Foreign aid can help in removing the savings Depreciation and Appreciation of a
constraint by the inflow of capital. Over the long-run,
the amount of foreign aid required will equal the Currency
difference between the increase in investment and the A currency is said to have suffered depreciation
increase in savings generated by raising income. When when its external purchasing power goes down.
the savings gap disappears the target growth rate of the Similarly, a currency is said to be appreciated when
economy will be sustained. its external purchasing power goes up.
If the foreign exchange gap is dominant, foreign aid Example—Suppose $ 1 = R 50.
can help in overcoming it. The country can start new
Suppose, after some period one dollar becomes
investment projects by importing capital and inter-
equal to R 55.
mediate goods. Over the long-run, the required foreign
aid will equal the difference between the increase in Now, this change can be interpreted in two ways :
imports and exports. The foreign exchange gap will ● Earlier 50 rupees were required to purchase 1
disappear when exports rise to a level which covers the dollar. Now, we cannot be exchanged for 1 dollar. Now,
Economics (NET) | 387U
we require 55 rupees to purchase 1 dollar. Rupee has ● Withdrawal of deposits by foreigners—If such
lost its purchasing power in terms of American dollar. deposits are to be remitted back home by foreigners,
We will say that the rupee has depreciated in value. foreign exchange would be required.
● Earlier 1 dollar could be exchanged for 50 rupees. ● Repayment of loans—If a foreign loan is to be
Now one can get 55 rupees in exchange for a dollar. repaid back, the liability could be settled only in foreign
Purchasing power of dollar in terms of rupees has exchange.
increased. We can say dollar has appreciated in value. ● To speculate on foreign currencies.
Thus, depreciation of one currency implies Similarly, any other transaction that involves either
appreciation of the corresponding currency. payment or remittance of foreign exchange would give
Floating Exchange Rate System rise to demand for foreign exchange.
A floating exchange rate system is a flexible Sources of Supply of Foreign Exchange
exchange rate system. The rate of exchange of a A country earns foreign exchange from varied
currency may change from one point to another. sources. These result in supply of foreign exchange.
There are two types of this system : Some of these are as follows :
● Free floats, and ● Exports of goods—Receipts against the sale of
these goods are received in the form of foreign
● Managed floats.
exchange.
● In a free float system, the rate of exchange is
● Sale of services—Foreigners make use of various
determined by the market forces of demand and supply. services owned by domestic residents. These are paid
● In a managed float system, the rate of exchange in back in foreign exchange.
terms of other currencies is decided by the central bank ● Remittances by residents working abroad—
of the country. The central bank may change this rate at These come in the form of foreign exchange.
any time at its discretion.
● Loans and borrowings—These are received in
● In a free float system the rate of exchange of a
foreign exchange.
currency vis-a-vis other currencies is determined by
market forces of demand and supply. ● Inflow of foreign capital—Whenever such
inflows take place, foreign exchange comes to a country.
Every country has a market for foreign exchange.
Those who need foreign exchange demand the same Market Rate of Exchange
from this market. Thus, the buyers of foreign exchange
constitute the demand side of the market. Every country has a market for foreign exchange.
Supply of foreign exchange comes from those who Buyers constitute the demand side of the market,
are in receipt of foreign exchange. They need to sell the whereas sellers constitute the sellers side.
foreign exchange in the foreign exchange market. Thus, Demand for foreign exchange bears an inverse
the sellers of the foreign exchange constitute the supply relation to the price of foreign exchange. If the price of
of the market. It is the interaction between the buyers foreign exchange (i.e., the rupee price of dollars) goes
and the seller that determines the equilibrium price of up, less dollars would be demanded and vice versa.
foreign exchange.
Demand curve for foreign exchange has a negative
Sources of Demand for Foreign Exchange slope as shown in Fig. 1.
Demand for foreign exchange arises from those who
need to make some payments in foreign exchange.
The principal sources of demand for foreign
exchange can be identified as follows :
● Imports of goods—Suppliers of foreign goods
need be paid in foreign exchange.
● Use of foreign services—Foreign nationals
working in the domestic economy need to remit back
their incomes to their countries. They need foreign
exchange. Foreign corporations working in a host
country would want to remit back their profits to their
own country. They will need foreign exchange. Fig. 1
Borrowers of foreign money would have to pay Supply of dollars bears a direct relation to the price
interest to lenders. Borrowers need foreign exchange to of dollars. If the rupee price of dollars goes up, more
settle this liability. dollars would be supplied in the market.
Transfer payments in form of gifts, donations, etc., Supply curve of dollars has a positive slope, as
are made to other countries. Foreign exchange is required shown in Fig. 2. As the rupee price of dollars goes up,
for this purpose. more dollars are supplied, and vice versa.
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foreign exchange market and remit the same to the
London School of Economics.
● Credit function—Like domestic trade, foreign
trade also thrives on credit. Foreign exchange market
arranges for credit in foreign trade transactions.
● Hedging function—Besides the normal business
risks, foreign trade involves foreign exchange risks.
Foreign exchange markets provide a shelter against such
foreign exchange risks and thus help the foreign trade to
flourish.
Fig. 2 Spot and Forward Markets
The price of dollars, at which the quantity demanded (a) Spot Markets—Spot market in foreign exchange
and quantity supplied are equal, is the equilibrium price refers to the current transactions in foreign exchange.
of dollars. This would be the market rate of exchange. The sale and purchase of foreign currency is affected at
Determination of equilibrium rate of exchange is the prevailing rate of exchange at that very point of time.
illustrated in Fig. 3. The delivery of foreign exchange is also affected
instantaneously.
Example—You have received a gift of $ 100 from
your uncle at New York by way of a cheque. You go to
your bank; you deposit the cheque; the bank credits your
account with rupees calculated at the prevailing rate of
exchange. Suppose, the rate of exchange at that point of
time is $ 1 = R 45. Your account is credited with R 4,500.
(b) Forward Markets—In a forward deal in foreign
exchange :
● Contracts to purchase and sell foreign exchange are
entered on ‘spot’.
Fig. 3
Excess supply of foreign exchange will push down ● The price at which the foreign exchange will be
the price of foreign exchange. Conversely, excess sold/purchased is decided in advance on spot.
demand for foreign exchange will push up the price of ● Payment will be made on the specified date in
foreign exchange. future.
Foreign Exchange Market ● Delivery is to done on a specified date in future.
A market is any effective arrangement where-by ● The forward seller may charge a ‘premium’ or offer
buyers and sellers come into contact with each other and a ‘discount’ on the spot rate :
do the transaction. — If the foreign currency is expected to appreciate
Similarly, a foreign exchange market is an arrange- in future, the forward seller will charge a
ment whereby buyers and sellers of foreign currencies premium on the spot rate.
come into contact with each other. — If the foreign currency is expected to depreciate
Buyers are those who need a foreign currency for in future, the forward seller will offer a
any of the transactions which involve payment in a discount on the spot rate.
foreign currency.
Sellers are those who are in possession of a foreign Nominal Exchange Rate, Nominal Ef-
currency that has been earned in any of the transactions fective Exchange Rate, Real Exchange
that involve payment in a foreign currency. Rate, Real Effective Exchange Rate
Thus, buyers and sellers of foreign currencies Nominal exchange rate (NER)—The units of
constitute the market for foreign exchange. domestic currency required to purchase a unit of foreign
A foreign exchange market performs the following currency is what is called nominal exchange rate.
three functions: (i) transfer function, (ii) credit function, Thus, $ 1 = R 45. It may move to $ 1 = R 50 and so on.
and (iii) hedging function. Nominal effective exchange rate (NEER)— The
● Transfer function—It arises when some concept is useful for an aggregate analysis.
transaction between residents of two countries takes A nation has to deal with a number of countries, and
place. For example, you have to apply to London School hence a number of currencies. For example, India.
of Economics for admission. You require £ 100 to pay as During a period, Indian rupee may be gaining value
application fee. You can purchase £ 100 from the against the American dollar, but it may he losing value
Economics (NET) | 389U
against Euro. Therefore, we would, be interested in (a) Commercial Banks
knowing what is happening in aggregate to our rupee. (b) Cooperative Banks
Is it gaining or losing ? (c) Exchange Banks
For this purpose, we prepare a basket of all the (d) Saving Banks
currencies in which we are interested, and find out the (e) Central Banks
average of the changes in these currencies in a given
period. This gives us the nominal effective exchange Gains from Trade
rater (NEER).
Trade-domestic as well as international occurs
For computing the NEER, we convert the NER into between two or more than two parties in such a way that
index numbers and compute the average. both the trade partners are benefited from the exchange
Real exchange rate—It is NER adjusted for of goods and services, either under barter system of
inflation differential. trade or under exchange mechanism through any
Real effective exchange rate (REER)—Nominal medium of exchange. Basically trade emerged out of the
effective exchange rate adjusted for the inflation specialization and division of labour occurred at macro
differential is called real effective exchange rate. level . Classical economists believed that there was a
fundamental difference between home trade and foreign
Adjustable Peg System, Wider Bands trade. They pointed out that labour and capital move
System and Crawling Peg System freely within a country but not between different
Adjustable peg system—The fixed exchange rate countries. Thus, international immobility of factors was
system as adopted by the International Monetary System the basic criterion accepted by the classical economists
may be called the adjustable peg system. for the emergence of international trade. Moreover,
The member countries were required to fix the different national policies, different political units,
parity of their currencies with gold. different monetary systems, and artificial barriers like
A change in the parity was possible only after a tariffs and exchange controls involved in international
prior approval from the IMF. It is a form of a fixed trade distinguish it from domestic trade. However, Bertil
exchange. Ohlin, the Swedish economists, challenged the
Wider bands system—This system provides that a traditionally accepted notion on international trade by
member country can change the exchange value of its advocating that there is no need for a separate theory of
currency within a range of 10 per cent. That is, a international trade. In this view "international trade is
member is free to devalue its currency by 10 per cent, but a special case of inter-regional trade". In short, from
and similarly, it can be revalued by 10 per cent. the "space" consideration, there arose the concept of
Crawling peg system—In this system, a country mobility or immobility of the factors of production as
specifies a parity value for its currency. It permits a located not in certain places but in certain "districts".
small variation (+ per cent) around that parity. According to Kindleberger, important features of
The parity rate is adjusted regularly by small international trade are the following . ● Immobility of
amounts as warranted by (i) the position of international Factors ● Heterogeneous Markets ● Different National
reserves held by the country, (ii) changes in money Groups ● Different Political Units ● Different National
supply or prices, or (iii) recent variations in the Policies and Government Intervention ● Different
exchange rate around the parity. Currencies ● Specific Problems.
There are ceiling and floor limits so that these can Different markets (Countries) of the world
provide some discipline on the part of the monetary specialized- on the basis of certain natural or
authorities. geographical advantages or through research and
development in the field of product development –
Advances of the Flexible Exchange Rates themselves in certain goods and services. It gave them
Flexible exchange rate system has some advantages. advantage in the field of international trade. Many
Among these, the more important are as follows : countries of the world have treated ‘trade as an engine of
● Flexible exchange rates dispense with the need to growth’ , as the economies of these countries grew by
hold international reserves by the central banks. leaps and bounds because of high growth rate of exports.
● They help eliminate barriers on trade and capital These economies of the word tagged themselves as
movements. ‘export oriented economies’. Erstwhile colonial powers
● They enhance the efficiency in the economy by of the Europe expanded their empires throw the
achieving optimum allocation of resources. expansion of trade. In modern time, China has emerged
second largest economy of the world because of high
A bank can be defined as a company which accepts
growth rate of foreign trade.
deposits from the public for the purpose of lending or
investment. The sum of money thus accepted being In nutshell the grains from the international trade
repayable to the depositor on demand or otherwise, are following—
according to the nature of deposits. The banks are Static Gains from International Trade—Static
usually classified into five groups. gains are the gains from the reallocation of factors of
390U | Economics (NET)
production in sectors where the country has a 5. Stage of Development—An industrialist advanced
comparative advantage. Static gains can be reaped and capital rich country generally enjoys a larger
immediately in the short-run through more efficient share of the gain of trade than an economically
allocation. backward and labour-abundant country.
1. Maximisation of Production i.e., efficiency gains 6. Size of the Economy—Inverse relationship between
from exploiting comparative advantage size of the economy and gains from trade. A smaller
2. Increase in Welfare country gains more from specialisation.
3. Increase in National Income 7. Nature of Export Goods—A country exporting
4. Reduced Costs from Economies of Scale primary goods have adverse terms of trade and
5. Increased Product Variety gains less from trade whereas a country exporting
6. Product diversification manufacturing goods gains more from trade.
7. Market diversification 8. Transport Costs—High transport costs limits the
8. Vent for Surplus gains from trade. An decrease in transportation costs
increases the gains from trade.
DYNAMIC GAINS from International Trade—
Dynamic gains are those gains which accumulates over a 9. Competition and Monopoly—Goods having pro-
period of time. Dynamic gains accrue only over time in duction in many countries faces more competition
less obvious and direct ways. 1. 1. and hence the gains from trade will be less to the
1. Efficient Utilisation of Resources countries exporting these goods.
2. Discovery and exploration of new resources Terms of Trade
3. Development of new and innovative manufacturing
processes The terms of trade is one of the measurements of the
gains from international trade to a particular country.
4. Expansion of the Market The term (barter) ‘terms of trade’ was first coined by
5. Increase in Saving and Investment the American ecconomist Frank William Taussig in his
6. Educational Effect (Learning by importing and 1927 book—“International Trade”. However, an earlier
learning by exporting) version of the concept can be traced back to the
7. Checking of Monopolies English economist Robert Torrens and his book. “The
8. Increase in Competition Budget : On Commercial and Colonial Policy” (1844).
The concept, in more refined form, was given by John
Sources of Gains From International Stuart Mill in his essay—“Laws of interchange between
Trade nations, and the distribution of gains of commerce
among the countries of the commercial world” (1844).
1. Expansion of the Size of the Market
2. Division of Labour Different Concepts of Terms of Trade
3. Gains from Specialisation
Several concept of terms of trade, such as the net
4. Gains from Increased Product Variety barter, gross barter, income, single factoral, and double
5. Gains from Increased Competition factoral terms of trade have been given by different
6. Gains from Increased Economies of Scale writers. These several concepts have been put by Meier
7. Productivity Gains under the following three broad groups.
1. Those terms of trade that relate to the real ratio of
Determinants of Gains From Interna- international exchange between the commodities. In this
tional Trade 1 group we have the
1. Terms of Trade—Terms of trade refers to the rate A. Net barter terms of trade
at which the goods of one country are exchanged for B. Gross barter terms of trade
the goods of another country. Country with better
C. Income terms of trade
term of trade gains more.
2. Reciprocal Demand—If the demand of a country 2. Those terms of trade that relate to their inter-
change between the productive resources. In this group
for the production of another country is inelastic,
we have the
terms of trade will be unfavourable.
A. Single factoral terms of trade
3. Difference in Cost Ratios—More the difference in
the cost ratios of t wo countries, more is the gain B. Double factoral terms of trade
from international trade. 3. Those terms of trade that interpret the gains from
4. Improvement in Productivity—With improvement trade in terms of the utility analysis. In this group we
in productivity, costs and prices fall in both the have the
countries leading to enlargement of productivity A. Real cost terms of trade
gains. B. Utility terms of trade
Economics (NET) | 391U
Net Barter or Commodity Terms of greater this ratio the more favourable being the gross
Trade barter terms of trade. Taussing introduced this concept
to correct the commodity or net barter terms of trade for
While discussing the terms of trade, Frank William unilateral transactions, or unrequited exports or imports
Taussing introduced the concept of the net barter or such as tributes, gifts, immigrant’s remittance etc. The
commodity terms of trade. His net barter terms of trade, gross barter terms of trade can be expressed as
popularly called ‘the commodity terms of trade,’ is the
QM
ratio between import prices and export-prices and can be Tc =
written as QX
P where
TC = x
Pm TG = gross barter terms of trade
where QM = total quantity of imports
Tc = net barter terms of trade Qx = total quantity of exports
P x = price of export commodity For comparing changes in the gross barter terms of
P m = price of import commodity trade between two time periods we use the index
When this concept of net barter terms of trade is numbers of the quantities of exports and imports in the
applied to more than one export and import commodity two time periods instead of the quantities alone. The
we use the export price and the import price indices ratio is expressed as
instead of using the prices of particular export and QM1 Qx0
import goods. Consequently, a change in the net barter Tc = ·
QX1 QM0
terms of trade would be written as
P x1/Px0 where the terms Q x and QM stand for the index of
Tc = quantity of exports and imports of the country and the
P M1/PM0 subscripts 0 to 1 stand for the base year and the given
P x1 P M0 year respectively.
= ·
P M1 P x0 Income Terms of Trade
where
Dorrance and Staehle refined the concept of the
Tc = net barter terms of trade commodity terms of trade and developed a new concept
P x1 = price index of exports for any given known as the ‘income terms of trade.’ The income terms
year of trade is the ratio of the value of exports divided by the
P M1 = price index of imports for any given price index of imports and can be written as
year PQ
T1 = x M
P x0 = price index of exports for base year PM
P M0 = price index of imports for base year where
T1 = income terms of trade
As the price index of imports and exports for the
P M0 P x = price of exports
base year will always be equal to 100, the term in P M = price of imports
P x0
the formula will be equal to 100/100 = 1. Consequently, QM = quantity of exports
the net barter terms of trade will, therefore, move in It is obvious from the formula that given the import
accordance with the movement of any given year’s price prices, if the export prices rise and the volume of
indices of imports and exports. Let us suppose that the country’s exports fall equally, the net barter terms of
price index of imports and exports in India in the base trade will improve while the income terms of trade will
year 1960 is 100 and in 1988 the price indices of imports show no change.
and exports are 120 and 160 respectively. Consequently,
the net barter terms of trade will be Unilateral or Single Factoral Terms of
Tc =
160 100
·
Trade
120 100 With changing factor productivity, the concept
= 1·33 of the net barter terms of trade is distinctly misleading
This means that in 1988 the net barter terms of trade as a measure of the gains for a country from trade
show an improvement of 33 per cent over the base year. without keeping in view the improvement in factor
productivity which results from trading. The concepts
Gross Barter Terms of Trade which used the commodity technical coefficient index
Introduced by Taussing, the gross barter terms of were developed by Jacob Viner. The concepts
trade is the ratio of the total physical quantity of imports developed by him are known as the ‘single factoral’
to the total physical quantity of exports of a country, terms of trade.
392U | Economics (NET)
The single factoral terms of trade is the ratio of the index of the amount of disutility per unit of the produc-
export price index and the import price index adjusted tive resources employed in producing the exports. The
for changes in the productivity of a country’s factors of real cost terms of trade can be symbolically expressed as
production engaged in the production of export TR = TS.Rx
commodities. If the commodity terms of trade index is
multiplied by the reciprocal of the export commodity P
= x · Z X · Rx
technical coefficients index, the resultant index is known PM
as the ‘single factoral terms of trade’ which can be where TR denotes the real cost terms of trade and Rx
expressed as stands for the index of the amount of disutility suffered
P per unit of productive resources employed in producing
Ts = x · Z x
PM exports. The terms Rx,PM and Zx have the same meaning
where as they have in the formula of the single factoral terms
Ts = single factoral terms of trade of trade.
Px Utility Terms of Trade
= net barter terms of trade
PM
The utility terms of trade are obtained by
Zx = index of factor productivity in exports multiplying the real cost terms of trade with the index of
Bilateral or Double Factoral Terms of the relative desirability or utility of imports as compared
Trade to the goods that could have been produced for home
consumption with those factors of production which are
The concept of the double factoral terms of trade now used in the production of export goods (UM). The
takes account of the productivity of factors of production utility terms of trade may be written as
entering into the production of country’s exports as well
as of the productivity of foreign factors of production TU = TR · UM
producing country’s imports. The concept of double P
factoral terms of trade can be expressed as = x · Z x · Rx · Ux
PM
TD = double factoral terms of trade Factors Affecting the Terms of Trade
ZM = index of factor productivity in imports The major factors which affect the terms of the
Zx = index of factor productivity in exports trade of a country are :
P x = price index of exports 1. Economic growth
P M = price index of imports 2. Shifts in the demand for exports and/or import
Real Cost Terms of Trade 3. Tariff
4. Devaluation
The real cost terms of trade are obtained by
multiplying the single factoral terms of trade with the 5. Availability of Substitutes
Various Forms of Terms of Trade
Terms of Trade Formulae Economist Year Remarks
1. Net Barter Terms of Trade N = Px/P m Taussig 1927 Px and Pm are price index numbers of exports
and imports.
2. Gross Barter Terms of Trade G = Q m/Qx Taussig 1927 Q m and Qx are the volume index numbers of
imports and exports respectively.
3. Income Terms of Trade Px · Qx G.S. 1950
I= Dorrance and
Pm
H. Stachle 1951
4. Single Factoral Terms of Trade S = N·Zx Jacob Viner 1937 Zx = Export productivity index
N = Px/P m
5. Double Factoral Terms of Z Jacob Viner 1937 Zm = Import productivity index
Trade D = N· x
Zm
6. Real Cost Terms of Trade R = N·Fx·Rx Jacob Viner 1925 Fx = Index o f productivity efficiency in the
industries of export
Rx = Index of the amount of disutility
incurred per unit.
7. Utility Terms of Trade U = N·Fx ·Rx·Um Jacob Viner 1925 Um = Index of relative utility of imports
Economics (NET) | 393U
Devaluation and Terms of Trade In his well-known work ‘Towards a New Trade
Devaluation lowers the value of the home currency Policy for Development Raul Prebisch maintains that
expressed in terms of the currency of foreign country. there is a long-run tendency for the prices of the primary
After the foreign exchange value of the home currency products to deteriorate relative to the prices of
has been lowered as a result of devaluation, it is natural manufactured goods. Prebisch’s argument is based on
to think that the terms of trade of the currency devaluing the fact that the underdeveloped countries are net
country will deteriorate because the prices of country’s producers of primary products such as coffee, copper,
exports fall in terms of the foreign currency while prices tea, rich, sugar, fats, etc. These products are roughly the
of her imports rise in terms of the local currency. But same goods today that these were 50 years ago. On the
this is not a bare fact. As a matter of fact, the effects of other hand, the quality of manufactured goods produced
devaluation depend upon the elasticities of demand for by the developed countries such as the automobiles,
and supply of imports and exports of the country. The radios, petroleum refinery, equipments, trucks, etc., has
tendency of devaluation is to improve the terms of trade improved tremendously. Consequently, in the world
if the product of the demand elasticities for the country’s markets these goods fetch higher prices relative to those
imports and exports is greater than the product of the fetched by the primary products.
supply elasticities of her imports and exports. Singer gives a different explanation for the
In general, if the elasticities of supply of exports and deteriorating terms of the trade of the primary products
imports are large in proportion to the elasticities of producing countries. According to him, the fruits of
demand for exports and imports, devaluation of a technical progress can either be retained by the
country’s currency will worsen its terms of trade and producers in terms of the high incomes or passed on to
revaluation will improve its terms of trade. Expressed the consumers in the form of low prices. The fruits of
differently, if the product of the supply elasticities is technical progress in the underdeveloped countries have
greater than the product of the demand elasticities, been passed on to the consumers in the developed
devaluation will cause deterioration in the country’s countries in the form of lower prices of primary products
terms of trade and vice-versa. If the elasticities of supply whereas these have been retained by the producers in
of exports and imports are equal to the elasticities of the developed countries in the form of higher incomes of
demand for exports and imports so that the product of producers. Singer does not give any explanation in
the supply elasticities equals the product of the demand support of his argument. A.M. McLeod, however,
elasticities, the country’s terms of the trade will remain states that it has happened due to the presence of greater
unchanged consequent upon devaluation. This relation- degree of monopolistic control prevalent in the
ship between the terms of trade and devaluation can be production of finished goods in the developed countries.
stated thus : The less developed countries more or less produce the
same (identical) goods and search the markets for these
A. Terms of trade will improve due to currency goods abroad. As these countries are less organised they
devaluation if Dx·DM > Sx·SM compete among themselves for the export markets for
B. Terms of trade will deteriorate due to their products and in the process give away a
currency devaluation if Dx·DM < Sx·SM substantial part of their gains in productivity to the
C. Terms of trade will remain unchanged due to developed countries in the form of fall in the prices of
currency devaluation if Dx·DM = Sx·SM their exports.
Underdeveloped Countries and Terms of Foreign Trade Multiplier
The foreign trade multiplier also known as export
Trade multiplier operates like the investment multiplier of
For world’s most underdeveloped countries which Keynes. It may be defined as the amount by which
are caught in the vicious trap of low income, low national income of a nation will be raised by a unit
employment and low technical know-how, foreign trade increase in domestic investment on exports. As exports
is life and blood of the economy. Consequently, ‘Trade increase there is an increase in the income of all persons
or Perish’ is an appropriate slogan in the context of the associated with the exports industries. These in turn
need of their rapid economic development. It is, how- create demand for goods. But this is dependent upon
their marginal propensity to save (MPS) and marginal
ever, argued by the spokesmen of the underdeveloped
propensity to import (MPM). The smaller these two
countries that international trade which had served as an propensities are, the larger will be the value of multiplier
engine of economic growth for the open lands in the and vice versa.
nineteenth century is no more an engine of economic In very simple terms we can say that foreign trade
growth for them today. According to the less developed multiplier is a concept that states that net exports
countries, today they face unfavourable conditions (exports minus imports) may magnify the impact on
which are very different from the favourable ones faced nation’s income.
by the open lands in the nineteenth century. Raul The foreign trade multiplier based on the following
Prebisch insists that the terms of trade of the less factors—
developed countries have been secularly deteriorating. 1. Full employment in the domestic economy.
394U | Economics (NET)
2. Direct link between domestic and foreign country in Tariff
exporting and importing goods and the country is
small with no foreign country. Meaning of Tariff
3. Fixed Exchange-Rate System, the multiplier is Tariff refers to duties or tax levied by the
based in instantaneous process without time lag and government on commodities which are imported into a
the domestic investment (id) remains invariable. country from abroad. Tariff is thus synonymus with
import duties or custom duties.
4. No accelerator and the analysis is applicable to only
two countries. Tariffs are used for two different purposes: for
revenue and for protection. Revenue tariffs are imposed
5. No tariff barriers and exchange controls. on luxury consumer goods. The lower the import duties,
6. Public expenditure is constant. the larger is the revenue from them. Protective tariff are
meant to maintain and encourage those branches of
Derivation of Trade Multiplier in an home industry protected by the duties.
Open Economy
Y = C+I+X–M Types of Tariff
where Y = Income, C = Consumption, I = Total The following types of tariff duties are levied: (i) ad
Investment, X = Exports and M = Imports valorem tariff, (ii) specific tariff, (iii) compound tariff,
and (iv) sliding scale tariff.
or Y–C = I+X–M
(i) Ad Valorem Tariff—The most common type of
or S = I+X–M import duty is the ad valorem tariff. Ad valorem import
Because Y = C+S duty is imposed as a percentage of the value of the
Hence, S = Y–C imported commodity. The import duty is a fixed
percentage of the C.I.F. (cost, insurance and freight)
or S+M = I+X value of commodity.
In an open economy savings plus total imports must (ii) Specific Duty—Specific import duty is imposed
be equal to total investment plus exports at equilibrium. by the government on the basis of number of units
Total Investment (I) = Domestic Investment (Id ) + imported. In other words, specific duty is levied per
Foreign Investment (If). physical unit of the imported commodity.
or I = Id + I f (iii) Compound Tariff—Compound import duty is
a combination of the ad valorem and the specific duties.
or S = Id + If because S = I In this case, a specific duty is imposed on each unit of
and If = X – M the commodity plus a percentage of ad valorem also.
∴ S = Id + (X – M) (iv) Sliding Scale Tariff—Sliding tariff is imposed
on ad valorem basis or on specific basis. Sliding import
or S + M = Id + X
duties vary with the prices of commodities imported.
Foreign trade multiplier coefficient (kt) is given as
under Effects of Tariff
ΔY The effects of a tariff may be analysed from the
kt =
ΔX standpoint of the economy as a whole which is known as
the general equilibrium analysis, or they may be
and ΔX = ΔS + Δ M
discussed from the point of view of a particular good or
if both sides an divided by ΔY. market which is known as the partial equilibrium
ΔX ΔS + Δ M analysis.
then =
ΔY ΔY Effects of Tariff under Partial Equilibrium—It is
ΔY ΔY the price effect that is first affected by a tariff and
or =
ΔX ΔS+ΔM therefore, it may be said that all the above eight effects
of a tariff are the result of price effect of a tariff.
ΔY
Hence kt = Price Effect—If a tariff is imposed on an imported
ΔX
commodity, the price of the commodity will rise, if the
ΔY
= demand for the commodity is inelastic in the importing
ΔS+ΔM country. On the other hand, if demand for imported
1 commodity is highly elastic, the price of the commodity
kt =
ΔS ΔM will not rise and the import duty will be paid by the
+
ΔY ΔY exporting country. If the position is in between, the price
ΔS of the commodity in the importing country will not rise
˙.˙ MPS = by the full amount of the tax but only partly.
1 ΔY
∴ kt =
MPS + MPM and MPM = Δ M Charles Kindleberger has made an attempt to analyse
ΔY effects of tariffs–(i) protective effect, (ii) consumption
Economics (NET) | 395U
effect, (iii) revenue effect, (iv) redistribution effect, (v) (viii) Balance of Payments Effect—A tariff
terms of trade effect, (vi) competitive effect, (vii) income reduces the country’s international expenditure and
effect (vii) balance of payments effect. brings stability in the balance of payments.
(i) Protective (production) Effect—The protective Optimum Tariff
effect shows how the domestic industry can be protected
from foreign competition by imposing an import duty. The tariff that maximises a country’s welfare is
The decrease in amount (quantity) of imported good due called the optimum tariff.
to price effect of tariff is called production or protective The imposition of a tariff improves the terms of
effect. When the domestic producers face the higher trade of the imposing country, reduces the volume of
price, they are able to cover the rising marginal costs of trade, and improves the tariff imposing country’s
additional output, and expand production. This welfare. The improvement in the terms of trade is the
replacement of foreign production with domestic positive effect of a tariff and the reduction in the volume
production is called the import substitution effect of of trade is the negative effect of a tariff. It is only when
a tariff. the positive effect of a tariff is larger than its negative
effect that there is improvement in the welfare of a
(ii) Consumption Effect—The consumption effect
country.
of the tariff is to reduce the consumption of the
commodity on which the tariff is imposed, as also to Prof. Kindleberger has devised a formula to
reduce consumers’ net satisfaction. measure the rate of optimum tariff which is where Tf =
1
(iii) Revenue Effect—The revenue effect is the T is the optimum tariff rate and e is the point
change in government receipts as a result of the tariff. e–1 f
Revenue effect is equal to the amount of the import duty elasticity of the offer curve of the country.
multiplied by the quantity of imports. When e is more than unity, the value of optimum
tariff falls. When e is less than unity, the value of
(iv) Redistributive Effect—The redistribution optimum tariff is negative thereby indicating that the
effect result from producers receiving a high price for optimum tariff does not exist on the inelastic portion of
their commodity after the imposition of tariff. The the foreign offer curve.
redistribution effect is an addition to producers is surplus
derived by subtraction from consumer surplus. A part of Effective Rate of Protection
loss of consumers’ surplus which is neither transferable The nominal tariff rate does not take into
to the producers nor to the government is called, consideration the height of the duty on the imported
deadweight loss of the tariff or the cost of the tariff. intermediate products and raw materials which are used
in the domestic import competing industries. The theory
(v) Terms of Trade Effect—The terms of trade of effective rate of protection takes into account duties
effect of a tariff is that it improves the terms of trade of levied on such raw materials and intermediate products.
the country imposing it. If the supply of a commodity is Under the usual assumptions of international immobility
perfectly inelastic in the exporting country and the of labour and capital, the effective rate of duty will
demand for it fairly elastic in the importing country, the indicate the degree of protection of value added in the
entire burden of the tariff will be borne by the exporting manufacturing process. The effective rate of protection
country. It means that after imposing the tariff, terms of is defined as the percentage in the value added of an
trade would move in favour of the country imposing industry per unit of output as a result of the tariff relative
the tariff. to the free trade situation but with the same exchange
(vi) Competitive Effect—The competitive effect of rate.
a tariff is to protect the domestic industry from foreign The effective rate of protection is measured by et =
competition by imposing a tariff on the commodity tn – ati
imported. According to Prof. Kindleberger, “the where e t is the effective rate, tn the nominal tariff
1–a
competitive effect of a tariff is really an anticompetitive rate on the final product, a is the ratio of the value of the
effect; competition is stimulated by tariff removal.” imported input to the value of the final product in the
(vii) Income Effect—The income effect refers to absence of tariff, and the tariff rate on imported inputs
the effect of a tariff on the national income of a country and (1-a) is the proportion of the final production
imposing the tariff. A tariff reduces the demand for accounted for by value added.
imported goods by reducing imports, and increases the Import Quotas
demand for home-produced goods on the assumption
that there is no retaliation by the other country. This As a protectionist device, import quotas are
stimulates import substitution industries in the country. alternative to tariffs.
Expansion of these industries will mean more Import quota means permitting import of a fixed
employment to people and increasing opportunities of quantity of commodity in volume or value during a
earning income. Under conditions of less than full specified period of time, generally one year. For this
employment, import duty will raise money and real purpose, the government may issue an import license
income and employment. that it may sell either to importers at a competitive price
396U | Economics (NET)
or just give it to importers on the basis of first come first (iii) Imposition of a tariff benefits the government
served. in the form of additional revenue while an
import quota brings profits to importers to
Objectives of Import Quota holding licenses. However, the government
The main objectives of import quota are as follows : may profit from the quota if it auctions import
1. To provide protection and help domestic licenses to imports.
industries. (iv) An import quota eliminates foreign compe-
tition and encourages domestic monopoly
2. To improve balance of payments position of the
more than a tariff. An import quota is worse
country.
than a tariff when it creates monopoly.
3. To use rationally of scarce foreign exchange (v) Import quota is generally fixed by an executive
reserves. decree of the government, it is, therefore, often
Types of Import Quota arbitrary and is liable to be altered by another
order under pressure. On the other hand, tariff
Import quotas are of five types : duty is imposed after passing due legislation.
1. Tariff Quota—Under this system, a pre- Legislative changes cannot be brought about
determined quantity of a commodity is permitted to be often and certainly not in an arbitrary way
imported either duty free or on payment of import duty as can be done in the case of import quota.
that is relatively low. Imports in excess of that quantity
are charged a relatively high rate of duty. The Optimum Tariff
2. Unilateral Quota—Under this system, import Usually, the imposition of a tariff improves the
quota of a particular commodity is fixed by law or terms of trade of the imposing country, reduces the
decree by the importing country without any negotiation volume of trade, and may improve the country’s welfare.
or agreement with the other country(ies). The The improvement in the terms of trade is the positive
autonomously fixed quota may be either global or effect of a tariff and the reduction in the volume of trade
allocated. Under the global quota, the full amount of the is the negative effect of a tariff. It is only when the
quota may be imported from any one country. While positive effect of a tariff is larger than its negative effect
under the allocated quota system, the total quantity of that there is improvement in the welfare of a country.
the quota is distributed among different countries. The tariff that maximises a country’s welfare, is called
the optimum tariff.
3. Bilateral Quota—Under this system, a country
can negotiate with each country separately and fix The optimum tariff is explained with the help of
import quotas. Import quota are fixed by some figure where OA is the offer curve of country A and OB
agreement with one or more other countries. Haberler is the offer curve of country B. Ca is the community
calls them agreed quota. indifference curve of country A. Under free trade the
terms of trade between the two countries are given by
4. Mixing Quota—Under this system, the quota the ray OT from the origin. Consequently, they are in
fixing country insists that domestic producer of a equilibrium at point T where their offer curves intersect
certain specified commodity compulsorily use imported each other. Suppose country A imposes a tariff on
raw material in a certain fixed proportion along with B’s goods. This is shown by change in country A’s offer
domestically produced raw material while producing curve to OA′. The new terms of trade are given by the
the commodity. This quota system benefits the quota ray OT′ and T′ is the new equilibrium point determined
fixing country in two ways : by country B’s original offer curve and country A’s new
(i) It protects domestic producers of raw materials offer curve OA′. This tariff which has changed country
from foreign competition. A’s offer curve OA to OA′ is the optimum tariff of this
(ii) It saves the foreign exchange of the country. country.
Comparison between Tariff and Quota
An import quota, like a tariff, causes a reduction in
imports, a rise in prices and an increase in domestic
production of a commodity on which it is imposed. But
there are important differences between an import quota
and a tariff which are discussed as under :
(i) An import quota brings speedier and also
definite quantitative results in respect of the
imported commodity compared to the effects
of tariff.
(ii) An import quota is more discriminatory than a
tariff in restricting the supply of commodities The point T′ where country A’s community
from different countries. indifference curve C′a is tangent to country B’s offer
Economics (NET) | 397U
curve, is the point where the tariff is the optimum. The The idea of the effective rate of protection (E.R.P.)
welfare of the people in country A is greater at point T′ is that when inputs are taken into account the nominal
than at point T. This is because at T they are at the Ca tariff of a good may differ from the rate of protection
indifference curve which is above the Ca indifference given to the value added in the production of the good.
curve. Thus this is the optimum tariff. According to the proponents of the theory, it is the
The tariff imposing country can gain from the protection to the value added that is of importance, not
optimum tariff only if the offer curve of the other the nominal tariff on the final good.
trading country is less than perfectly elastic. If the Assume that the final tariff on a good is 10 per cent
offer curve of the other country is infinitely elastic, and that inputs (raw material, intermediate goods, etc.)
levying a tariff will not increase the welfare of the used in the production of the good amount to 50 per cent
tariff-imposing country. This is illustrated in figure of the value of production and that these inputs are
where the offer curve of country B is shown as the imported without duty. The effective rate of protection
straight line curve OB and OA is the offer curve of accorded to value added is then 20 per cent, not 10 per
country A. Under free trade, the terms of trade are given cent as the manifest duty implies.
by OT and the equilibrium is established at point T The Formula for the Effective Rate of
where the two offer curves intersect each other. When
country A imposes a tariff, its offer curve shifts to OA′. Protection
The new equilibrium is set at T. In this case, the terms of v2 – v
r =
trade remain unchanged, while the volume of trade is v
reduced from point T to T′. Here the positive effect of where r = rate of effective protection
tariff is zero while the negative effect is stronger. v′ = value added per unit of output with
Therefore, the optimum tariff is zero. protection
v = value added per unit of output without
protection
Thus we can illustrate the concept with the
following example :
Free Trade With Protection
Input 0·50 0·50
Value added 0·50 0·60
Unit price of final output 1·00 1·10
Thus the effective rate of protection
1
r = = 0·20 = 20 per cent
e–1
Prof. Kindleberger has devised a formula to Trade Creation and Trade Diversion
measure the rate of optimum tariff which is The pioneering study of the theory of customs
1 unions was made by Jacob Viner. In the beginning,
T = customs unions had been viewed favourably. The
e–1
reasoning was as follows : free trade maximizes welfare;
where T = optimum tariff rate customs unions are a move toward free trade; therefore,
e = point elasticity of the offer curve of they will increase welfare even though they might not
the other country. maximize it.
By applying this formula to the above case of a Viner showed this conclusion to be incorrect. He
straight line offer curve having infinite elasticity, the introduced, instead, the key concepts of trade creation
and trade diversion. They might best be illustrated by
optimum tariff is 1/(∞ – 1) = 0. Thus the higher the
table. The table measures the production cost of a
elasticity of the offer curve of other country, the lower commodity in three countries.
the level of the optimum tariff of a country and vice-
versa. Spot and Forward Foreign Exchange
Rates
Effective Rates of Protection There are the spot rate of exchange and the forward
Expirical estimates have shown that a large share rate of exchange ruling in the foreign exchange markets.
and perhaps most of international trade consists of trade The spot rate of exchange is the rate or price expressed
in intermediate goods which are used as inputs in the in terms of the home currency which is payable for spot
production of other goods. Most of trade theory, delivery of a specified type of foreign exchange. The
however, has been concerned only with trade in final forward rate of exchange is the rate or price at which a
goods. Economists have viewed the neglect of transaction will be consummated at some specified time
intermediate goods in trade theory differently. in future.
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Arbitrage Uruguay Round and Dunkel
An arbitrageur is a dealer or trader who by taking Proposals
advantage of “inconsistencies” in the buying and selling The 8th round of GATT popularly known as
prices quotes in different parts of the foreign exchange Uruguay round was started in September 1986. The
market makes profit. Unlike the risky activities of a negotiations were expected to be concluded in 4 years
speculator, the activities of an arbitrageur are free from but on account of differences among participating
exchange risk because he never takes an uncovered countries on certain critical areas, agreement could not
position in the foreign currency. The arbitrageur may be reached. To break this deadlock Mr. Arthur Dunkel,
trade either in spot or in forward foreign exchange or he Director General of GATT, compiled a very detailed
may even simultaneously trade in both the spot and document, popularly known as Dunkel Proposals. This
forward foreign exchange. proposal culminated into the Final Act on December 15,
General Agreement on Tariffs and 1993.
India signed this proposal on April 15, 1994. In all
Trade (GATT) 124 countries signed on this agreement.
During great depression of 1930s the international Uruguay Round contained the mandate to have
trade was badly affected and various countries imposed negotiations in 15 areas. Part I of the declaration
import restrictions for safe-guarding their economies. contained the following 14 are as :
This resulted in a sharp decline in the world trade. In
1. Tariffs
1945, USA put forward many proposals for extending
international trade and employment. On October 30, 2. Non-tariff measures
1947, 23 countries at Geneva, signed an agreement 3. Tropical Products
related to tariffs imposed on trade. This agreement is 4. National Resource Based Products
known as General Agreement on Tariffs and Trade 5. Textiles and Clothing
(GATT). It came into force on January 1, 1948. Initially 6. Agriculture
GATT was established in the form of a temporary
arrangement but later on it took the shape of a 7. GATT-articles
permanent agreement. GATT’s headquarter was in 8. Safeguards
Geneva. 9. Multilateral Trade Agreements and Arrangements.
On December 12, 1995, GATT was abolished and 10. Subsidies
replaced by World Trade Organisation (WTO) 11. Dispute settlements
which came into existence on January 1, 1995. 12. Trade Related aspects of Intellectual Property Rights
(TRIPs)
GATT Rounds 13. Trade Related Investment Measures (TRIMs)
Round Year Venue Issues and 14. Functioning of GATT System
Outcomes Part II of the declaration included trade in services
I 1947 Geneva Signature on first and re-classified the above 15 areas into 7 as below :
(Switzerland) GATT agreement 1. Market Access, 2. Agriculture, 3. Textiles,
II 1949 Anesi (France) ⎫ Tariff reductions 4. TRIMs, 5. TRIPs, 6. Trade in Services, 7. Institutional
III 1950-51 Torquay ⎬ on specific Matters.
⎭ products
(England)
IV 1956 Geneva
World Trade Organisation (WTO)
V (Dillion 1960-61 Geneva Induction of Euro- The Uruguay round of GATT (1986–93) gave birth
Round) pean community to World Trade Organisation. The members of the
for the first time GATT signed on an agreement of Uruguay round in
and 20% tariff April 1994 in Morocco for establishing a new organisa-
reduction
tion named WTO. It was officially constituted on
VI (Kenedy 1964–67 Geneva 33% reduction in January 1, 1995 which took the place of GATT as an
Round) restrictions on
effective formal organisation. GATT was an informal
manufactured
goods organisation which regulated world trade since 1948.
Like GATT, WTO’s headquarter is also at Geneva.
VII (Tokyo 1973–79 Geneva Non-tariff
Round) restrictions, etc. Contrary to the temporary nature of GATT, WTO is
VIII (Uru- 1986–93 Punta Del Este Agriculture, a permanent organisation which has been established on
guay (Beginning in Service, TRIPS, the basis of an international treaty approved by
Round) Uruguay and TRIMS related participating countries. It achieved the international
closing at issues status like IMF and IBRD but it is not an agency of the
Geneva) UNO.
Economics (NET) | 399U
WTO has a General Council for its administration, 2. To ensure full employment and broad increase in
which includes one permanent representative of each effective demand.
member nation. Generally, it has one meeting per month 3. To enlarge production and trade of goods.
which is held at Geneva. The above three objectives were also included in
GATT, but WTO also included some other objectives
WTO Ministerial Conferences
which are :
The highest decision making body of the WTO is the
4. To enlarge production and trade of services.
Ministerial Conference, which has to meet at least every
two years. The Ministerial Conference can take decisions 5. To ensure optimum utilisation of world resources.
on all matters under any of the multilateral trade agree- 6. To accept the concept of sustainable development.
ments. Since the establishment of WTO in January 1995, 7. To protect environment.
so far eight Ministerial Conferences have been held :
I. Singapore (December 9–13, 1996) Functions of WTO
II. Geneva (May 18–20, 1998) 1. To provide facilities for implemention, administra-
III. Seattle (USA) (November 30–December 3, 1999) tion and operation of multilateral and bilateral
agreements of the world trade.
IV. Doha (Qatar) (November 9–14, 2001)
2. To provide a platform to member countries to
V. Cancun (Mexico) (September 10–14, 2003)
decide future strategies related to trade and tariff.
VI. Hong Kong (December 13–18, 2005)
3. To administer the rules and processes related to
VII. Geneva (July 2008) dispute settlement.
VIII. Geneva, Switzerland (Dec. 15–17, 2011)
4. To implement rules and provisions related to trade
IX. Bali, Indonesia (Dec. 3–7, 2013). policy review mechanism.
X. Nairobi (Kenya) (Dec. 15–19, 2015)
5. To assist IMF and IBRD for establishing coherence
XI. Buenos Aires (Argentina) (Dec. 10–13, 2017) in universal economic policy determination.
The highest authority of policy making is WTO’s 6. To ensure the optimum use of world resources.
Ministerial Conference which is held after every 2 years. Eighth WTO Ministerial Conference
The present the WTO has 164 members and 23 The Eighth Ministerial Conference was held in
observer governments. (Status as on July 31, 2018) Geneva, Switzerland, from December 15 to 17, 2011. In
Afghanistan was the last country to join WTO as parallel to the Plenary Session, where Ministers made
164th member. This includes China & Nepal whose prepared statements, three Working Sessions took place
accession was approved by the WTO Ministerial with the following themes : “Importance of the Multi-
Conferences held in Doha & Cancun in November lateral Trading System and the WTO”, “Trade and
2001 and Sept. 2003 respectively. There are presently Development” and “Doha Development Agenda.” The
Conference approved the accessions of Russia, Samoa
30 countries in the process of accession to the WTO.
and Montenegro. In the final session, Ministers adopted
There are number of important committees for a number of decisions.
administration of WTO, out of which, 2 committees play
the pivotal role in WTO. They are : Ninth WTO Ministerial Conference
1. Dispute Settlement Body—DSB. The Ninth Ministerial Conference of the WTO held
2. Trade Policy Review Body—TPRB. in Bali, Indonesia, from December 3 to 7, 2013
DSB considers the complaints of member countries strengthened the credibility of the WTO as an
against violation of rules by any member country. This institution. The outcome ensured that the development
body appoints a group of experts to investigate into such dimension remains the central focus in the Doha Round.
complaints. This body meets twice a month for such It reaffirmed India’s leadership role amongst the
cases. developing countries and demonstrated its constructive
approach in negotiations. India played a key role in
TPRB reviews the trade policy of member arriving at a breakthrough and shaping the agreement.
countries. The trade policy of all big trade powers of the India ensured on outcome which secures its supreme
World are reviewed after every 2 years. All the members national interests. It was made amply clear that while
of WTO are the members of TPRB. being fully prepared to engage, India will never
Other important bodies of WTO are : compromise on fundamental issues pertaining to food
1. Council for Trade in Goods. security, livelihood security, and the welfare of its poor.
2. Council for Trade in Services. Tenth WTO Ministerial Conference
3. Council f o r Trade related aspects of Intellectual
The WTO’s 10th Ministerial conference was held in
Property Rights.
Nairobi Kenya from 15th to 19th December, 2015. It
Objectives of WTO culminated in the adoption of the “Nairobi Package”, a
1. To improve standard of living of people in the series of six Ministerial Decisions on agriculture, cotton
member countries. and issues related to least-developed countries (LDCs).
400U | Economics (NET)
UNCTAD-I Cairo March 31–June 16, 1964 * SAARC Summit cancelled because Indian Prime Minister
Narendra Modi refused to visit Islamabad (Pakistan) to
UNCTAD-II New Delhi February-March 1968 participate in the Summit in view of killing of 18 soldiers in uri
UNCTAD-III Santiago (Chile) April-May 1972 by Uttras of Jaish. e-mohammad later on Bangladesh, Bhutan and
Afghanistan also refuse to participate in the summit.
UNCTAD-IV Nairobi (Africa) May 1976
UNCTAD-V Manila May 7–June 2, 1979 Dhaka Conference on December 7-8, 1985. Its head-
(Philippines) quarter has been established at Kathmandu. A conference
UNCTAD-VI Belgrade June 6–July 3, 1983 of heads of the countries is held every
(Yugoslavia) year but conferences were generally
UNCTAD-VII Geneva 1987 delayed for the one reason or the other.
(Switzerland) The mutual misunderstanding among
UNCTAD-VIII Cartegina DE Indias 1992 member nations have created a big
(Columbia) question mark in achieving its SAARC
UNCTAD-IX Midrand (Africa) April 27–May 11, 1996 objectives.
UNCTAD-X Bangkok (Thailand) February 12–19, 2000 SAARC Important Years
UNCTAD-XI Sao-Paulo (Brazil) June 13–18, 2004
1990 Year for Girls
UNCTAD-XII Accra (Ghana) April 20–25, 2008 1991 Year for House
UNCTAD-XIII Doha (Qatar) April 21–26, 2012 1992 Year for Environment
UNCTAD-XIV Nairobi (Kenya) July 17–22, 2016 1993 Year for Handicapped
1995 Year for Poverty Removal
Eleventh WTO Ministerial Conference 1996 Year for Literacy
WTO’s XI Ministerial Conference took place from 1991–2000 Decade for Girls
December 10–15, 2017 in Buenos Aires (Argentina). 2005 Year of South Asia Tourism
The Conference ended with a dull note as no concrete 2008 Year of Good Governance
decision could be taken. However, a number of decisions, 2016-17 Year of Cultural Heritage
including on fisheries subsidies and e-commerce duties
have been taken. South Asian Free Trade Area
Regional Trade Blocks (SAFTA)
The most significant aspect of the 12th SAARC
South Asian Association for Regional Summit (Jan. 4–6, 2004) at Islamabad, the Capital City
Co-operation (SAARC) of Pakistan, was the signing of a historic Agreement on
India, Maldives, Pakistan, Bangladesh, Sri Lanka, Free Trade. The leaders of India, Pakistan, Bangladesh,
Bhutan, Nepal and Afghanistan constituted an organisa- Bhutan, Maldives, Nepal and Sri Lanka have agreed
tion known as SAARC, on the recommendations of upon to create a ‘South Asian Free Trade Area’
(SAFTA).
SAARC Summit : When & Where ? SAFTA has come into force since January 1,
Summit Year Place 2006 replacing South Asian Preferential Trade
I Dec. 7-8, 1985 Dhaka (Bangladesh) Agreement (SAPTA) which was operative among
II Nov. 16-17, 1986 Bangalore (India) SAARC countries, since December 7, 1995. SAPTA
was the success of 8th SAARC conference held in New
III Nov. 2–4, 1987 Kathmandu (Nepal)
Delhi in 1995 where this new concessional trade system
IV Dec. 1988 Islamabad (Pakistan)
of SAPTA was approved. SAPTA was the factor which
V Nov. 1989 Male (Maldives) really opened all positive possibilities to establish
VI Dec. 1991 Colombo (Sri Lanka) SAFTA.
VII April 10-11, 1993 Dhaka (Bangladesh) SAFTA presupposes abolition of all kinds of trade
VIII May 2–4, 1995 New Delhi (India) and tariff restrictions. Ultimately it will pave the way for
IX May 12–14, 1997 Male (Maldives) the creation of common market with common currency.
X July 29–31, 1998 Colombo (Sri Lanka) Seven SAARC member countries agreed upon to
XI Jan. 5-6, 2002 Kathmandu (Nepal) reduce tariffs between 0–5% by 2016. The SAFTA
XII Jan. 4–6, 2004 Islamabad (Pakistan) agreement allows any states to pull out of the treaty at
XIII Nov. 12-13, 2005 Dhaka (Bangladesh) any time.
XIV Jan. 2007 New Delhi (India) ● Formation of sensitive lists.
XV August 2-3, 2008 Colombo (Sri Lanka) ● Outlining the products whose tariffs will not be
XVI April 28-29, 2010 Thimpu (Bhutan) reduced.
XVII November 10-11, 2011 Adu City (Maldives) ● Rules of origin.
XVIII November 2014 Kathmandu (Nepal) ● Revenue loss compensation mechanism for LDCs.
XIX November 2016 was Proposed in Pakistan (Bangladesh, Bhutan, Maldives and Nepal) by
but cancelled* comparatively developed nations (India, Pakistan
XX 2018 (Proposed) Sri Lanka and Sri Lanka).
Economics (NET) | 401U
● An arbitration council or dispute settlement body. ● A SAFTA Ministerial council with membership of
● India and Pakistan will reduce their tariffs 0–5% commerce/ trade ministers.
level within 7 years, while Sri Lanka gets 8 years ● A committee of Experts for the administration and
and LDCs like Nepal, Bangladesh, Bhutan and implementation of the treaty.
Maldives in 10 years. ● Removal of barriers to the intra-SAARC investment,
● Each of the countries will create two sensitive lists, harmonisation of customs facilities transit facilities
one of more developed countries and other for less for intra-SAARC trade and simplification of proce-
developed countries. dure for visas.
Association of South-East Asian Nations (ASEAN)
ASEAN is a union of South-East Asian Nations. Indonesia, Philippines, Malaysia, Singapore and Thailand
constituted this association on August 8, 1967. Brunei also joined this ASEAN in 1984. In July 1995, Vietnam was
also given its membership. Laos and Myanmar got its membership in 1997. On April 30, 1999, Cambodia also
became the member of ASEAN. At present, 10 countries are the member of ASEAN–Indonesia, Philippines,
Malaysia, Thailand, Singapore, Brunei, Vietnam, Laos, Cambodia and Myanmar. The object of ASEAN is to
promote economic co-operation in South-East Asia and also to ensure economic stability in the region. Its
headquarter is in Jakarta but a Secretary of ASEAN lives in the capital of each member country. The post of General
Secretary of ASEAN is rotated among each member country alphabetically, after every two years.
On July 23, 1996, ASEAN gave advisory status to India. Besides India, China and Russia also got this status.
USA got this status earlier. India cannot join the ASEAN as a member due to its geographical location. India is a
part of South-Asia while ASEAN is an organisation of South-East Asian Nations.
ASEAN Summits
● First ASEAN Summit, Bali, February 23-24, 1976
● Second ASEAN Summit, Kuala Lumpur, August 4-5, 1977
● Third ASEAN Summit, Manila, December 14-15, 1987
● Fourth ASEAN Summit, Singapore, January 27-29, 1992
● Fifth ASEAN Summit, Bangkok, December 14-15, 1995
● Sixth ASEAN Summit, Hanoi, December 15-16, 1998
● Seventh ASEAN Summit, Bandar Seri Begawan, December 5-6, 2001
● Eighth ASEAN Summit, Phnom Penh, November 4-5, 2002
● Ninth ASEAN Summit, Bali, October 7-8, 2003
● Tenth ASEAN Summit, Vientiane, November 29-30, 2004
● Eleventh ASEAN Summit, Kuala Lumpur, December 12–14, 2005
● Twelfth ASEAN Summit, Cebu, Philippines, January 9–15, 2007
● Thirteenth ASEAN Summit, Singapore, November 18–22, 2007
● Fourteenth ASEAN Summit, Cha-am, Thailand, February 26–March 1, 2009
● Fifteenth ASEAN Summit, Cha-am Hua Hin, Thailand, October 23–25, 2009
● Sixteenth ASEAN Summit, Hanoi, Vietnam, April 8-9, 2010
● Seventeenth ASEAN Summit, Hanoi, Vietnam, October 28–31, 2010
● Eighteenth ASEAN Summit, Jakarta, Indonesia, May 7-8, 2011
● Nineteenth ASEAN Summit, Bali, Indonesia, November 17–19, 2011
● Twentieth ASEAN Summit, Phnom Penh, Cambodia, April 3-4, 2012
● Twenty First ASEAN Phnom Penh, Cambodia November 18, 2012
● Twenty Second Summit Bandar Seri Begawan, Brunei Darussalam April 24-25, 2013
● Twenty Third Summit Bandar Seri Begawan, Brunei Darussalam–Oct. 9-10, 2013
● Twenty Fourth Summit Nay Pyi Taw, Myanmar, May 10-11, 2014
● Twenty Fifth Summit Nay Pyi Taw, Myanmar November 12-13, 2014
● Twenty Sixth Summit Kuala Lumpur/Lang Kawi April 26-27, 2015
● Twenty Seventh Summit Kuala Lumpur Nov. 18–22, 2015
● Twenty Eighth and Twenty Ninth Summit : September 16-8, 2016 Laos (Vietnam)
● 30th ASEAN Summit, Manila, Philippines, 26-29 April, 2017
● 31st ASEAN Summit, Manila, Philippines, 13-14 November, 2017
● 32nd ASEAN Summit, Singapore, 27-28 April, 2018.
402U | Economics (NET)
in global energy market and achieve economic
Organisation of the Petroleum prosperity.
Exporting Countries (OPEC) The Heads of States and Government of OPEC
The Organization of the Petroleum Exporting member countries also promised to support the fight
Countries (OPEC) was founded in Baghdad, Iraq, with against climatic changes and global warming. The
the signing of an agreement in September 1960 by five summit also reiterated its support to the sustainable
countries namely Islamic Republic of Iran, Iraq, Kuwait, development of the world countries and the continued
Saudi Arabia and Venezuela. They were to become the assistance for the developing nations in order to achieve
Founder Members of the Organization. the United Nations Millennium Development goals.
These countries were later joined by Qatar (1961),
Indonesia (1962), Socialist People’s Libyan Arab
G-7
Jamahiriya (1962), the United Arab Emirates (1967), The G-8, reformatted as G-7 from 2014 due to the
Algeria (1969), Nigeria (1971), Ecuador (1973), Gabon ‘suspension of Russia’s participation’, was an inter-
(1975) and Angola (2007). governmental political forum from 1997 until 2014.
Ecuador suspended its membership in December Initially it was G-7 but became G-8 after joining Russia
1992, but rejoined OPEC in October 2007. Indonesia in 1997. Russia left the organisation in 2014, so it again
suspended its membership in January 2009, reactivated renamed as G-7. The first G-7 summit was held at
it again in January 2016, but again suspended its Rambonilet near Paris in November 1975. Initially only
membership on November 30, 2016. Gabon terminated 5 industrialised countries—USA, UK, West Germany,
its membership in January 1995. France and Japan were its members. Later on, Canada
and Italy also joined it in 1976.
Currently, OPEC is a cartel of 12 countries which
produce 41% of the world’s total oil. The objective of Last Seven Summits of G-7
OPEC was to control production and price of petroleum 1. May 26-27, 2011 Deauville (France)
so as to safeguard the interests of oil exporting countries. 2. May 18-19, 2012 Camp David (USA)
OPEC also attempts not only to stabilize oil prices but 3. June 17-18, 2013 Lough Erne (UK)
also to seek the maximum oil prices from the oil 4. June 4-5, 2014 Brussels (Belgium)
importing countries. Any country exporting crude oil 5. June 7-8, 2015 Germany
may join OPEC. 6. May 26-27, 2016 Japan
The G-5 Summit 7. May 26-27, 2017 Italy
Earlier the leaders of developing countries, also called
the Group of Five emerging countries consisting of China, Future Summits of G-7
India, Brazil, Mexico and South Africa met on July 8, 2009 2018 Canada
at L’Aquila in the sidelines of the three day G-8 summit. 2019 France
At the end of the day’s meetings, which the Chairman 2020 United States
President Felipe Calderon of Mexico described as quite
2021 United Kingdom
interesting and very productive, the G-5 came out with a
declaration that it was important to comply with the Currently the G-7 Countries include Britain, Canada,
agreements reached at the earlier G-8 and G-5 meetings. France, Germany, Italy, Japan and United States. The
The G-5 came out with a political declaration and member Countries of G-7 account for 49% of global
another on trade. These were presented at a joint press
exports, 51% of industrial output and 49% of assets in
appearance where the leaders made opening statements.
the International Monetary Fund.
The G-5 declared its commitment to engage with all
World Trade Organisation members to complete the Doha G-15
round of negotiations.
G-15 is an organisation of 17 non-alligned deve-
Its headquarter is in Vienna (Austria). loping countries. It was established in September 1989
OPEC nations p r o d u c e about 75% of the total in Non-alligned Summit (NAM) at Belgrade. The
production of the world. member countries are : Mexico, Jamaica, Venezuela
The 3rd Summit of Head of States and Government Brazil, Chile, Argentina, Senegal, Algeria, Nigeria,
of OPEC member countries concluded on November Zimbabwe, Egypt, Iran, India, Malaysia, Indonesia,
18, 2007 in Riyadh, Saudi Arabia issuing a call to the Kenya and Sri Lanka.
international community to protect the stability of The Secretariat of G-15 is in Geneva. But its
global energy markets, reaffirming the need to use headquarter is rotated to the country belonging to the
energy for sustainable development and emphasizing Chairman of the group.
the importance of protecting environment. All the countries except Brazil and Mexico in G-15
The third summit in the OPEC’s history underlined organisation are non-aligned countries. Actually speak-
the interrelationship between security of supply and ing, it is not a correspondingly opposite institution to
security of demand and reiterated their commitment G-7. It is mainly an attempt to make G-77 (group of 77
to ensure adequate supply of oil to maintain stability developing countries) more strong at international forum.
Economics (NET) | 403U
and developing economies to discuss key issues relating
G-15 : Some Highlights to the global economy and financial stability. By
● Established in 1989 in NAM Summit at Belgrade.
contributing to the strengthening of the international
● Members : Mexico, Jamaica, Columbia, Venezuela,
financial architecture and providing opportunities for
Brazil, Chile, Argentina, Senegal, Algeria, Nigeria,
Zimbabwe, Egypt, Malaysia, India, Indonesia, Kenya and dialogue on national policies, international co-operation,
Sri Lanka. and international financial institutions, the G-20 helps to
● Summits : support growth, financial stability and development
I (1990)—Kuala Lumpur (Malaysia) across the globe.
II (1991)—Caracas (Venezuela) UN-Habitat, also known as United Nations Human
III (1992)—Dakar (Senegal) Settlements Program is a UN agency for sustainable urban
IV (1994)—New Delhi (India) development and human settlements. It was established in
V (1995)—Buenos Aires (Argentina) 1978 and has its headquarters in the UN Office at Nairobi,
Kenya. It is mandated by the United Nations General
VI (1996)—Harare (Zimbabwe)
Assembly to promote socially and environmentally
VII (1997)—Kuala Lumpur sustainable towns and cities with the goal of providing
(Malaysia) adequate shelter for all. It is also a member of UNDP. UN-
VIII (1998)—Cairo (Egypt) Habitat works in more than 70 countries in five continents
IX (1999)—Jamaica focusing on seven areas: Urban Legislation, Land and
Governance; Urban Planning and Design; Urban Economy;
X (2000)—Cairo (Egypt)
Urban Basic Services; Housing and Slum Upgrading; Risk
XI (2001)—Jakarta (Indonesia ) Reduction and Rehabilitation; and Urban Research and
XII (2004)—Caracus (Venezuela) Capacity Development.
XIII (2006)—Hawana (Quba)
XIV (2010)—Tehran (Iran) G-20 : Basic Facts
XV (2012)—Sri Lanka ● The G-20 comprises 20 countries namely-Argentina,
Australia, Brazil, Canada, China, European Union,
G-15 has initiated a number of projects. India had France, Germany, India, Indonesia, Italy, Japan,
suggested in its third summit to establish a professional Mexico, Russia, Saudi Arabia, South Africa, South
training institute in Africa. This recommendation was Korea, Turkey, the United Kingdom, the United States
accepted and this institution was established in Senegal of America.
with the view to induce African people for developing ● It represents 90 per cent of the global gross national
agriculture based industries, traditional handicrafts, product, 80 per cent of the world’s trade and two-third
agriculture, water management etc. It was also decided of the world’s population.
that the land, building and employees for this institute ● Six Summits at the level of G-20 leaders or Head of
State have been held since breakout of the global
will be arranged by the host country of Africa. India economic crisis in 2008.
agreed to supply equipments and expert services for two
years for this institution. After this period, the opera- S. No. Summit’s Venue Month/ Year
tional cost of the institution will be borne by both India
1. Washington DC, USA November 15, 2008
and Senegal.
On the recommendations of 4th Summit of G-15, a 2. London, UK April 2, 2009
Committee on Investment, Trade and Technology 3. Pittsburgh, USA September 24-25, 2009
(CITT) started its functioning for promoting investment, 4. Toronto, Canada June 26-27, 2010
trade and technology in member countries. The prime 5. Seoul, South Korea November 11-12 , 2010
objective of this committee is to strengthen mutual co- 6. Cannes, France November 3-4, 2011
operation among the member countries. The Committee 7. Los Cabos, Mexco June 19-20, 2012
will have a meeting atleast twice a year for deciding the 8. Saint Petersberg, Russia September 5-6, 2013
agreement base among member countries.
9. Brisbane, Australia November 15-16, 2014
India, Malaysia, Senegal and Zimbabwe are such
10. Serik Antalaya, Turkey Dec. 1, 2015
nations who sent their State Heads in all Summits of G-
15. In its 6th Summit G-15 raised their opposition to the 11. Hangzhou, China September 4-5, 2016
attempts of linking labour standards with international 12. Hamburg (Germany) July 7-8, 2017
trade on unilateral basis. This summit also considered the 13. Argentina (Proposed) Nov./Dec. 2018
view of making this group as G-2 by including 6 other
countries–South Africa, Philippines, Thailand, Vietnam, G-77
Kenya and China. This group was constituted under the banner of
G-20 UNO in 1964. G-77 includes 134 developing nations
belonging to Third World—Asia, Africa and Latin
The Group of Twenty (G20) was established in America. It is an international economic community of
1999 to bring together Finance Ministers and Central developing countries aiming at protecting economic
Bank Governors of systemically important industrialized interest of the member countries.
404U | Economics (NET)
Organisation for Economic Co- Brexit
operation and Development (OECD) Brexit is a word that has become used as a shorthand
way of saying the UK leaving the EU-merging the
To rehabilitate the weak economies of Europe after words Britain and exit to get Brexit. A referendum - a vote
Second World War, U. S. Foreign Minister Mr. Marshall, in which everyone (or nearly everyone) of voting age took
proposed a Plan in 1948 on the basis of which a Summit part - was held on June 23, 2016, to decide whether the UK
of European countries was called in Paris. Organisation should leave or remain in the European Union. Leave won
by 52% to 48%. The referendum turnout was 71·8%, with
of European Economic Cooperation (OEEC) was esta- more than 30 million people voting. England voted strongly
blished in this Summit. On September 30, 1961 it was for Brexit, by 53·4% to 46·6%, as did Wales, with Leave
renamed as OECD (Organisation f o r Economic Co- getting 52·5% of the vote and Remain 47·5%. Scotland and
operation and Development). Northern Ireland both backed staying in the EU. Scotland
The 34 member countries of OECD are Australia, backed Remain by 62% to 38%, while 55·8% in Northern
Ireland voted Remain and 44·2% Leave.
Austria, Belgium, Canada, Czech Republic, Chile,
Estonia, Denmark, Finland, France, Germany, Greece, At present, it is the largest commercial community
Hungary, Iceland, Ireland, Israel, Italy, Japan, South of the world.
Korea, Luxemburg, Mexico, Netherland, New Zealand, Its Headquarter is at Brussels (Belgium).
Norway, Portugal, Slovak Republic, Stovenia, Spain,
Sweden, Switzerland, Poland, Turkey, UK and USA. Its European Free Trade Association
headquarter is in Paris (France). The aim of the OECD is (EFTA)
to co-ordinate the welfare policies of the member EFTA was established at Stockholm on May 3,
countries and also to induce member countries for 1960 by 7 countries. These countries were Britain,
promoting welfare activities in their respective Austria, Denmark, Norway, Sweden, Switzerland and
economies. Portugal. It was constituted on EEC pattern. These 7
European Economic Community countries were known as ‘Outer Seven’ which were
(EEC) different from 6 member countries of EEC at that time.
The then 6 member countries of EEC were known as
Or ‘Inner Six’. EFTA was established with a view to
European Common Market (ECM) curtail custom duties and other tariffs among member
countries. Till December 31, 1996 all the tariffs among
Six European countries known as ‘Inner Six’ member countries were fully removed. The second
(France, Belgium, Netherlands, Luxemberg, W. objective of EFTA was to establish a market in West
Germany and Italy) constituted EEC on the basis of Europe, which was fulfilled in 1972 by an agreement
Rome Treaty (1957). The success of OECD played an with EEC. The third objective of EFTA is to promote
important role in inducing these countries to establish World Trade. At present, there are only 4 members of
EEC. The aim of EEC was to ensure complete free trade EFTA–Iceland, Liech-tenstein, Norway and Switzer-
among member countries. On January 1, 1973, Britain, land. Former members who left EFTA and joined EU /
Denmark and Ireland got its membership Greece, Spain EEC are : Austria, Denmark, Finland, Portugal, Sweden
and Portugal also became its members. Thus, the total and United Kingdom.
membership of EEC went upto 15 on January 1, 1995 Its Headquarter is at Geneva.
after the induction of Austria, Finland and Sweden to
this Organisation. The ten nations in Eastern Europe, North American Free Trade
officially joined world’s largest regional economic Agreement (NAFTA)
community–European Union on May 1, 2004. They are On August 12, 1992, a trilateral agreement between
Poland, Hungary, the Czech Republic, Slovakia, USA, Canada and Mexico took place which declared
Slovenia, Lithuania, Latvia, Estonia, Cyprus and Malta. North American region as Free Trade Area. This
Out of these Lithuania, Latvia and Estonia are new agreement came into force w.e.f. January 1, 1994. This
States created by disintegration of USSR; Poland, agreement is known as NAFTA (North American Free
Hungary. The Czech Republic, Slovakia and Slovenia Trade Agreement). USA played the dominant role in its
are once-communist states; while the Cyprus and Malta establishment. NAFTA was constituted mainly to meet
are Mediterranean Island. These ten new countries the challenges of EEC and Japanese economic policies.
account for 15% of the European Union population an Before NAFTA, free trade was already taking place
19% of EU area and will add 5% to the EU’s GDP, between USA and Canada but this free trade facility was
reflecting both the small size of most of the acceding now extended to Mexico. ‘Rule of the Origin’ was
countries as well as low income per capita. Bulgaria and developed, which implied that the economic resources of
Romania also joined European Union. The European the countries in the political region should be utilised for
Union, now world’s biggest trading entity, has a popu- economic development of people belonging to that
lation of 455 million. Its share would be 18–25% of country only. With NAFTA, it was planned to utilize
global GDP. After joining Croatia on July 1, 2013, the economic resources of North American region for deve-
membership of European Union became 28. loping the area in a better way.
Economics (NET) | 405U
The North America Free Trade Agreement Trade Policy Issues
(NAFTA) was signed in 1994. It is a free trade area Establishment of World Trade Organisation gave
among the United States of America, Canada and multilateralism a new lease of life. The widely held
Mexico. This is the largest and most important trading economic view that more free trade is good for all
bloc of the world. This trade bloc has special countries is under pressure. Trade policies are becoming
significance for India. more and more important as on one hand the world
Asia Pacific Economic Co-operation becomes more inter-connected and on the other hand,
governments around the world in both developing and
(APEC) developed countries are under pressure from their
APEC was founded in November 1989 to devise citizens to deliver better economic outcomes. Even in
programmes of co-operation between member nations, developed countries creation of more jobs and increase
through the establishment of meetings of economic in the average salary levels is a matter of great focus.
leaders trade and foreign ministers. It was institu- Trade agreements and tariffs are often cited as villains,
tionalised in June 1992 after a meeting in Bangkok, at coming in the way of economic prosperity of the
which it was agreed to set up a secretariat in Singapore. citizens. Trade policies are now in the center stage of the
APEC is a new commercial group appearing on World political discourse and protectionism is raising its head
forum after EEC and NAFTA. APEC was constituted on round the world.
the initiative of Australian Prime Minister Mr. Bob
Hawk, who called APEC as ‘Voice for the Asia Pacific Non-tariff Measures and Regional Inte-
in World Affairs’. Member countries are making all gration
efforts to develop APEC as free trade zone like EEC and NTMs are policy measures, other than ordinary
NAFTA. customs tariffs, that can potentially have an economic
The present membership of APEC is 21. Chile effect on international trade in goods, changing
joined the APEC in 1994 in Bogor Summit as its 18th quantities traded, or prices or both. The most common
member. Russia, Vietnam & Peru also joined APEC in NTMs are sanitary and phyto-sanitary restrictions,
1998. Members of APEC are Australia, America, certification procedures, quantity control measures,
Canada, Mexico, Japan, China, Hong Kong, Taiwan, other technical regulations, government procurement,
investment restrictions and intellectual property rights.
South Korea, Indonesia, Bruenei, Philippines,
Singapore, Malaysia, Thailand, Papua New Guinea, Some measures are legitimate, such as those relating
New Zealand, Chile, Russia, Vietnam and Peru. to food safety and the introduction of invasive species,
but other measures may be used to limit trade to protect
domestic producers or trade restrictiveness uninten-
Apec Summits
tionally exceeds what is needed for the measure’s non-
1993—Seatal (USA) trade objectives.
1994—Bogor (Indonesia)
It is relatively simple to list the numerous non-tariff
1995—Osaca (Japan)
measures, but assessing their impact is more difficult.
1996—Subic Port (Philippines) Two methods involve trying to measure the effect on
1997—Vancouver (Canada) quantity using a gravity model or by looking at the gap
1998—Kuala Lumpur (Malaysia) between world and domestic prices.
1999—Auckland (New Zealand)
2000—Bandar Seri Begawan (Brunei) Farm Support and Trade Rules :
2001—Shanghai (China) Towards a New Paradigm Under the
2003—Bangkok (Thailand) 2030 Agenda
2004—Santiago (Chile) After more than two decades from the conclusion of
2006—Hanoi (Vietnam) the Uruguay Round, producer support remains a
2007—Sydney (Australia) structural, systemic issue in agriculture. Most impor-
2008—Lima (Peru) tantly, the playing field is far from level, due to factual
2009—Singapore and formal discriminations across countries. The Doha
2010—Yakohama Japan Round, if concluded, would redress these imbalances but
2011—Honolulu (United States) only partially.
2012—Vladivostok (Russia) The “historic” Nairobi Package on agriculture,
2013—Bali (Indonesia) agreed at the 10th Ministerial Conference of the World
2014—Beijing Trade Organization (WTO) in December 2015,
eliminates agricultural export subsidies. But important
2015—Philippines
distortions and imbalances in the area of domestic
2016—Peru
support would stay. In particular, the proposed Doha
2017—Da Nang, Vietnam disciplines would not obstruct the main gate-ways
2018—Papua, New Guinea through which producer support is channeled today.
406U | Economics (NET)
How then to move forward in this setting? Where to set protection is an issue related to the level of policy space
limits to farm support policies, beyond the terms of the to use and the level of market protection to set.
Doha Draft, and how to arbitrate tradeoffs between
“policy space” and “trade fairness”? Maritime Connectivity and Trade Policy
Efforts to define the way ahead should take into Issues in International Trade and
account two important developments, compared to the Commodities
1980 scenario. First, the forms by which farm support is Access to foreign markets is a critical determinant
provided in the advanced market-based economies have of export performance. In technical literature foreign
altered significantly since the mid-1980s: from market market access is seen as representing the foreign market
price support to income support “decoupled” from potential of a country and relates inter alia inversely to
current production and prices. This type of support, bilateral transport costs.
largely notified under the WTO Green Box, is exempted The existence of a direct maritime connection has
from reduction commitments. Second, producer support also been recognized to play an important role in
is no longer a North issue: in nominal terms and as a determining trade costs. However, little theoretical and
percentage of farm receipts, farm support has increased empirical attention has been devoted to its impact on
appreciably in key emerging economies. In a few of bilateral exports. The lack of comprehensive evidence
them, producer support is now provided at a level on the relationship between maritime connections and
comparable with the OECD average. bilateral exports is due to the lack of data to a large
Given the changed scenario, and given that extent.
agricultural production accounts for around 24 per cent
of all human-caused greenhouse gas emissions, the way Market Access and FDI
ahead requires a pragmatic and groundbreaking Over the past 20 years, foreign direct investment
pathway. Trade rules in general and domestic support (FDI) and trade have expanded significantly. Outward
disciplines in particular are to be reorganized around FDI stocks rose almost twice as fast as global exports
sustainable development outcomes. The boundaries of worldwide. To explain the last two decades of
the Green Box have to be redefined accordingly. This re- globalization characterized by falling trade and
orientation is needed if trade policy is to fit into the new investment costs accompanied by booming exports and
programmatic framework shaped by the 2030 Agenda FDI flows, recent literature has been considering more
for Sustainable Development, the Addis Ababa Action complex types of multinationals which are neither
Agenda, and the Paris Climate Change Conference. purely horizontal nor purely vertical.
Policy Space in Agricultural Markets Another important area which has to be addressed in
the current scenario is that of unilateral trade
As an outcome of the Uruguay Round Agreement liberalization. There exists a fair amount of literature
on Agriculture, all agricultural products now have a with respect to multilateral, regional and bilateral trade
bound tariff rate on their imports. This system of bound liberalization but not on unilateral trade liberalization.
tariffs combines the rigidity of an upper limit that is Theory, facts and empirical literature state that trade and
independent of future economic conditions but openness are very powerful instruments. The unilateral
discretion as governments have a whole array of choices trade policy has to be relooked. It can be seen how
in terms of applied tariffs as long as they are set below tariffs have evolved overtime, signaling towards
the bound rate. One recurring argument is that bound unilateral trade liberalization. For instance, in the USA,
rates may limit countries’ policy flexibility, or policy French wine and Japanese automobiles are available at
space, in response to particular economic circumstances. cheaper rates as compared to the origin countries. This
Policy space in agricultural products is generally very well encapsulates the essence of unilateral
available, and only limited for developed countries. liberalization. Hence, every nation should aim at
Many developing countries have ample room to raise unilateral liberalization which increases competitiveness,
tariffs in most agricultural imports without infringing aims at acquiring economic strength, forges an economic
binding commitments. For LDCs there is virtually no environment which is distortion free and fosters a
imports for which policy space is not available. regulatory and policy environment that is conducive to
Four specific factors are related to the use of policy businesses.
space, which are the elasticity of import demand, the
fact that the goods are being used as intermediates, food Multilateralism at Risk : Concerns of
security and protection of local producers. LDC and Developing Countries are not
Policy space tends to be used relatively less for Addressed
products with lower elasticity of demand and for It is crucial to assess how international agreements
intermediate products. In regard of products relevant for related to trade and investment have evolved overtime
food security, the results suggest that policy space is and to analyze if they ensure a balanced and equitable
larger. In regard to products that face domestic environment. It is also important to understand if these
competitors, the results indicate lower tariff water and agreements possess features of global trading
more use of policy space, suggesting that producer arrangements across time. The major reason behind the
Economics (NET) | 407U
establishment of GATT/WTO was the emergence of ● Trade in Services
newly independent countries which had less favorable ● Intellectual Property Rights, Geographical Indica-
endowments. In order to ensure their enhancement and tions and Biodiversity
progress, it was proposed to undertake measures to have ● Trade and Environment
balanced and equitable trade and investment globally.
The opposite has been witnessed in the WTO ● Trade Facilitation
agreements. The most common instance is that of the ● Special and differential Treatment
Agreement on Agriculture. The agreement incorporated ● E-Commerce-a threat to retail trade
provisions which enabled developed countries to provide ● Country Groupings
huge subsidies to their farmers. Despite this it is being
seen that the developing countries are being pursued to International Monetary Fund (IMF)
change their paradigm on the issue of agriculture The International Monetary Fund (IMF) was
subsidies and also being intimated of modifying their established along with the International B a n k for
trade distorting and non-competitive actions in the area Reconstruction and Development (also known as World
of international trade. These measures indicate the upper Bank) at the Conference of 44 nations held at Bretton
hand of developed countries at the WTO. Another Woods, New Hampshire, USA in July 1944. It was
instance is that of the green box subsidies. It is perceived created to promote international monetary cooperation,
that if the green box subsidies are eliminated, then the to facilitate the expansion and balanced growth of
entire production pattern would shift from developed to international trade; to promote exchange stability; to
developing countries. Hence the formal agreements assist in the establishment of a multilateral system of
which were forged were not at all in practice balanced or payments to make its general resources temporarily
equitable. With the establishment of WTO in 1995 after available to its members experiencing balance of
the Uruguay round and subsequently the Doha round, payments difficulties under adequate safeguards; and to
the developing countries which lacked human resources, shorten the duration and lessen the degree of
technical capacity and legalist advice were handicapped disequilibria in the international balances of payments of
in the implementation aspect of the agreement. With the members.
passage of time, the developing countries understood the The Articles of Agreement of IMF came into force
skewed behavior of the WTO agreements and focused on December 27, 1945. IMF is the principal Inter-
on the incorporation of the Special and Differential national Monetary Institution established to promote a
Treatment. This would have helped in reducing cooperative and stable global monetary framework. At
disparities but the Doha development round was present 189 nations are members of the IMF. Nauru
disrupted as the developed world disengaged itself from becomes 189th member of IMF. Since the IMF was
it. In recent times it has been seen that the reciprocity established, its purposes have remained unchanged but
measures which were abandoned post Doha round are in its operations which involve surveillance, financial
focus in order to favor coercive bilateralism. The assistance and technical assistance have developed to
rhetoric has shifted from concerns of developing meet the changing needs of its member countries in an
countries like. evolving world economy. India is a founder member of
Countries in the developed world put forth their the IMF.
grievances in terms of the socialistic policies of their
own nations. These policies are majorly related to access Objectives of IMF
to education, skilling of people, public health and According to ‘Articles of Agreement’ of the IMF,
environment. The developed nations have emphasized its main objectives are as follows :
that the lags in these socialistic policies are attributed 1. To promote international monetary cooperation.
mainly to developing nations like India and China rather 2. To ensure balanced international trade.
than to their own internal practices. The entire concept
of equity and balance is being discarded and they fail to 3. To ensure exchange rate stability.
recognize the fact that a country cannot have sustainable 4. To eliminate or to minimize exchange restrictions
environment for trade and investment where one side is by promoting the system of multilateral payments.
impoverished. There is a dire need of prosperity for 5. To grant economic assistance to member countries
everyone to thrive. for eliminating the adverse imbalance in balance of
payments.
Some Other Issues 6. To minimize imbalances in quantum and duration of
Some other issues related to Trade Policies are international trade.
following—
● Trade War between US and China and its expansion IMF
over India, Iran & Turkey etc. Estd. — December 27, 1945
● Rise of Bilateralism H. Q. — Washington D.C. (USA)
● Protectionism is on the rise Membership — 189
● Non-Agricultural Market Access (NAMA) Managing Director — Christine Lagard
408U | Economics (NET)
Constitution, Membership and Capital of The IMF’s financial year is from May 1 to April 30.
IMF IMF lends to various member countries in the form of
various facilities (Extended Fund Facility, Standby
IMF is controlled and managed by a Board of Facility, Contingent Credit Lines, Compensatory Facility
Governors. Each member country nominates a Governor. etc.) designed to serve specific purpose, but essentially
All the nominated Governors make the Board of aimed at balance of payments stabilisation or meeting
Governors. Each country also nominates an alternate the emergent foreign exchange needs. The poor countries
Governor who casts his vote in the absence of the are also helped by funding from Poverty Reduction
Governor. Each Governor is allotted a number of votes and Growth Facility.
which is determined by the quota allotted to the
respective country in the capital of IMF. Each Governor The quota allotted by the IMF to each member
has got the right of 250 votes on the basis of the mem- country has to be deposited partly in the member's own
bership and one additional vote for each SDR 1,00,000 currency and the remainder in the form of foreign
of quota. The addition of these two types of votes exchange.
becomes the actual voting right of the member country. When a country joins the IMF, it is assigned an
India’s quota in IMF has been increased from 2·44% to initial quota in the same range as the quotas of existing
2·7%. Voting share of India has been increased from
members of broadly comparable economic size and
2·34% to 2·6%. For the first time, four emerging market
countries—BRIC (Brazil, Russia, India and China) will characteristics. The IMF uses a quota formula to help
be among the 10 largest members of IMF. It clearly indi- assess a member’s relative position.
cates that the voting right depends on the quantum of The currrent quota formula is a weighted average
quota of a particular country with IMF. That is the of GDP (weight of 50 per cent), openness (30 per cent),
reason why the rich and industrialised countries got the economic variability (15 per cent), and international
higher voting right due to their higher quotas, with the reserves (5 per cent). For this purpose, GDP is measured
IMF. through a blend of GDP—based on market exchange
The main source of IMF resources is the quotas rates (weight of 60 per cent)—and on PPP exchange
allotted to member countries. Till 1971, all the amounts rates (40 per cent). The formula also includes a
of quotas and the assistance provided were denominated
‘compression factor’ that reduces the dispersion in
in US dollar, but since December 1971 all the quotas
and transactions of IMF are expressed in SDR (Special calculated quota shares across members.
Drawing Right) which is also known as Paper Gold. In India’s Place in IMF General Quota
1971, one SDR was assumed equivalent to 1 dollar but
due to subsequent decline in dollar value SDR 1 became After the recent review of IMF’s General Quota,
equivalent to $ 1·3527 on January 12, 2017. India’s quota has gone up to 13114·4 million SDR. (At
present 1 SDR = $ 1·3527). This quota hike has raised
IMF Executive Board decided on November 30, India’s vote share from 2·34% to 2·6%
2015 that Chinese currency Renminbi will be freely
usable currency and will be included in the SDR basket The table below shows quota and voting shares for
as a fifth currency along with the US Dollar, the Euro, the top 10 IMF members as per the status on February 2,
the Japanese Yen and the British Pound. It has become 2017.
effective since October 1, 2016. So, at present the value Quota
Rank Country Quota %
of SDR is being determined by the basket of 5 (Millions of mSDR)
currencies. Consequently the revised SDR basket will be 1 USA 82994 ·2 17· 46
based on the following weights.
2 Japan 30820 ·5 6 ·48
SDR Basket 3 China 30482 ·9 6 ·41
Currency Revised Weight w.e.f. Division of Value 4 Germany 26634 ·4 5 ·60
Oct. 1, 2016 of SDR 5 UK 20155 ·1 4 ·24
US Dollar 41·73% 0·58252 5 France 20155 ·1 4 ·24
Euro 30·93% 0·38671 6 Italy 15070 ·0 3 ·17
Chinese Yuan 10·92% 1·0174 7 India 13114 ·4 2 ·76
Yen 8·33% 11·900 8 Russia 12903 ·7 2 ·71
British Pound 8·09% 0·85946 9 Canada 11023 ·9 2 ·32
The weights in SDR basket are based on the value of 10 Saudi Arabia 9992·6 2 ·10
issues’s exports, the amount of reserves denominated in
the respective currencies that were held by other India and IMF
monetary authorities, foreign exchange turnover and IMF has played an important role in Indian
international bank liabilities and international debt economy. IMF has provided economic assistance from
securities denominated in the respective currencies. time to time to India and has also provided appropriate
Economics (NET) | 409U
consultancy in determination of various policies in the Objectives of World Bank
country. India is the founder Member of IMF. The
According to the Clause I of the Agreement made at
Finance Minister is ex-officio Governor in IMF Board of
the time of establishment of World Bank, it was
Governors. Till 1970, India was among the first five
assigned the following objectives :
nations having the highest quota with IMF and due to
this status India was allotted a permanent place in 1. To provide long-run capital to member countries for
Executive Board of Directors. economic reconstruction and development. World
Bank provides capital mainly for following
World Bank purposes.
(A) International Bank for Recons- (i) To rehabilitate war ruined economies (this
objective is fully achieved).
truction and Development (IBRD) (ii) T o finance productive efforts according to
IBRD and its associate institutions as a group are peace-time requirements.
known as the World Bank. The Second World War (iii) To develop resources and production facilities
damaged economies of the most of the countries in underdeveloped countries.
particularly of those who were directly involved in the
2. To induce long-run capital investment for assuring
war. The global war had completely dislocated the
BOP equilibrium and balanced development of
multilateral trade and had caused massive destruction of
international trade. (This objective was adopted to
life and property. In 1945, it was realised to concentrate
increase the productivity of member countries and to
on reconstructing these war affected economies.
improve economic conditions and standard of living
Besides, it was also given a thought to develop
among them).
underdeveloped economies in a planned way. IBRD was
established in December 1945 with the IMF on the basis 3. To promote capital investment in member countries
of the recommendation of the Bretton Wood Conference. by following ways :
That is the reason why IMF and IBRD are called (i) To provide guarantee on private loans or capital
‘Bretton Wood Twins’. IBRD started functioning in investment.
June 1946. World Bank and IMF are complementary (ii) If private capital is not available even after
institutions. providing guarantee, then IBRD provides loans
The International Bank for Reconstruction and for productive activities on considerate condi-
Development (IBRD) aims to reduce poverty in middle tions.
income and creditworthy poorer countries by promoting 4. To provide guarantee for loans granted to small and
sustainable development through loans, guarantees, risk large units and other projects of member countries.
management products, and analytical and advisory 5. To ensure the implementation of development
services. Established in 1945 as the original institution projects so as to bring about a smooth transference
of the World Bank Group, IBRD is structured like a co- from a war-time to peace economy.
operative that is owned and operated for the benefit of World Bank Group
its 189 member countries.
IBRD raises most of its funds on the world’s Estd.
financial markets and has become one of the most (i) IBRD (189) : 1945 (December)
established borrowers since issuing its first bond in (ii) IFC (184) : 1956 (July)
1947. The income that IBRD has generated over the (iii) IDA (173) : 1960 (Sept., 24)
years has allowed it to fund development activities and (iv) MIGA (181) : 1988 (April, 12)
to ensure its financial strength, which enables it to (v) ICSID (159) : 1966 (Oct., 14)
borrow at low cost and offer clients good borrowing World Bank
terms. H.Qs : Washington D.C.
India is a member of four constituents of the World Membership : 189
Bank Group i.e., IBRD, IDA, IFC and MIGA (i.e., President : Jim Yong Kim (12th) (Since
Multilateral Investment Guarantee Agency) but not of its July 1, 2012)
fifth institute ICSID (i.e., International Centre for the Membership of the World Bank and the
Settlement of Investment Disputes). Voting Right
India is the largest recipient of loans from the world
Generally every member country of the IMF
bank, amounting to $ 102·1 billion between 1945 and automatically becomes the member of World Bank.
2015 (as on July 25, 2015), according to Bank’s lending Similarly, any country which quits IMF is automatically
report of 2016. While IBRD, a part of World Bank expelled from the World Bank’s membership. But under
Group, has lent $ 52·7 billion, IDA, a multilateral a certain provision a country leaving the membership of
concessional lender of the World Bank, has loaned $ IMF can continue its membership with World Bank if
49·4 billion to India over the last 70 years. 75% members of their Bank give their vote in its favour.
410U | Economics (NET)
Any member country can be debarred from the IDA (established on September 24, 1960) and IFC
membership of World Bank on following grounds : (established in July 1956) are the two main associate
1. Any member country can quit the Bank simply by institutions of IBRD. These institutions work under the
written notice to the Bank, but such country has to supervision of World Bank. MIGA is also an associate
repay the granted loans on terms and conditions institution in the World Bank group.
decided at the time of sanctioning the loan. Bank’s Lending Operations
2. Any country working against the guidelines of Bank
can be debarred from membership by the Board of IBRD gives loan to members in any one or more of
Governors. the following ways :
1. By granting or participating in direct loans but of its
Terms & Conditions of World Bank Lending own funds.
IBRD Loans Repayment 20 years including a grace 2. By granting loans out of the funds raised in the
period period of 5 years market of a member or otherwise borrowed by the
Interest LIBOR + variable spread bank and
Commitment Charges undis- 0·75 per cent 3. By guaranteeing in whole or part loans made by
bursed amount private investors through the investment channels.
Front End fee 1 per cent Before a loan is made or guaranteed the bank
Total Cost LIBOR + 40 basis points ensures that the—
(approx.)
1. Project for which the loan is asked has been
IDA Credits carefully examined by a competent committee as
Repayment period 35 years including a grace regards the merits of the proposal.
period of 10 years
2. Borrower has reasonable prospects for repayment of
Interest Nil
loans.
Service Charges 0·75 per cent
3. The loan is meant for productive purposes and
Commitment Charges on un-
disbursed amount 0·5 per cent 4. The loan is meant for reconstruction and develop-
ment.
Like IMF, World Bank has also two types of
members : Founder members and General members. The Functions of the World Bank
World Bank has 30 founder members who attained Presently, the World Bank is playing the main role
membership by December 31, 1945. India is also among of providing loans for development works to member
these founder members. The countries joining the World countries, especially to underdeveloped countries. The
Bank after December 31, 1945, come under the category World Bank provides long-term loans for various
of general members. As per status of end-September development projects of 5 to 20 years duration. The
2016, the total membership of the World Bank is 189. loaning system of the Bank can be explained with the
The voting right of member countries is determined on help of the following points :
the basis of member country’s share in the total capital of 1. Bank can grant loans to a member country upto
the Bank. Each member has 250 votes plus one 20% of its share in the paid up capital.
additional vote for each 1,00,000 shares of the capital 2. Bank also provides loan to private investors
stock held. belonging to member countries on its own
guarantee, but for this loan private investors have to
Capital Resources of World Bank seek prior permission from those countries where
The initial authorised capital of the World Bank was this amount will be collected. For such loans the
$ 10,000 million, which was divided in 1 lakh shares of consent of that country is also required whose
$ 1 lakh each. The authorised capital of the Bank has currency is given in loans. For granting such
been increased from time to time with the approval of guarantee, the Bank charges 1% to 2% as service
member countries. At present authorised capital of the charge.
World Bank is $ 280 billion. Member countries repay 3. The quantum of loans, interest rate and terms and
the share amount to the World Bank in the following conditions are determined by the Bank itself.
ways : 4. Generally, Bank grants loan for a particular project
1. 2% of allotted share are repaid in gold, US dollar or duly submitted to the Bank by the member country.
SDR. 5. The debtor nation has to repay either in reserve
2. Every member country is free to repay 18% of its currencies or in the currency in which the loan was
capital share in its own currency. sanctioned.
3. The remaining 80% share is deposited by the Besides, granting loans for reconstruction and
member country only on demand by the World development, World Bank also provides various tech-
Bank. nical services to the member countries. For this purpose,
The headquarter of World Bank is at Washington the Bank has established. ‘The Economic Development
D.C. Institute’ and a Staff College in Washington.
Economics (NET) | 411U
(B) International Finance focus on insuring investments in the areas where it can
make the greatest difference.
Corporation (IFC)
● Countries eligible for assistance from the Interna-
World Bank established IFC in July 1956. This
tional Development Association (the world’s poorest
corporation provides loan to private industries of
countries).
developing nations without any government guarantee
and also promotes the additional capital investment in ● Conflict-affected environments.
these countries. Thus, the main work of IFC is to ensure ● Complex deals in infrastructure and extractive
the financial support to private sector in developing industries, especially those involving project finance
countries. In the end of January 2017, its membership and environmental and social considerations.
was 184. On January 31, 2017 it was having total ● South-South investments (from one developing
authorised capital of $ 2·58 billion. country to another).
Objectives MIGA offers comparative advantages in all of these
areas—from its unique package of products and ability
1. To provide loans to private sector. to restore the business community’s confidence, to its
2. To co-ordinate capital and management. ongoing collaboration with the public and private
3. To induce capitalist countries to invest in developing insurance market to increase the amount of insurance
countries. available to investors. As a multilateral development
agency, MIGA only supports investments that are
(C) International Development developmentally sound and meet high social and envi-
Association (IDA) ronmental standards. MIGA applies a comprehensive set
of social and environmental performance standards to all
IDA is an associate institution of World Bank
projects and offers extensive expertise in working with
known as soft loan window of World Bank. IDA was
investors to ensure compliance to these standards.
established on September 24, 1960. It kept its
membership open to all members of World Bank. At MIGA’s membership is 181 which consists 156
present 173 countries are its member. IDA provides loan developing and 25 industrialised countries. Bhutan was
to its member countries and no interest is charged on the last member to join MIGA.
these long-term loans. These soft loans are provided to
the poor countries of the World. During 1995-96 (July-
(E) International Centre for
June) India ranked first among the nations getting Settlement of Investment Disputes
assistance from I DA. Vietnam and China stood second ICSID is an autonomous international institution
and third respectively in this list. The resources of IDA established under the Convention on the Settlement of
include subscribed capital by member countries, general Investment Disputes between States and Nationals of
replenishments by developed countries, net income Other States (the ICSID or the Washington Convention)
transferred by IBRD etc. with over one hundred and forty member States.
IDAs is administered by the same group which The Convention sets forth ICSID’s mandate, organi-
manages the working of World Bank. zation and core functions. The primary purpose of
ICSID is to provide facilities for conciliation and
arbitration of international investment disputes.
(D) Multilateral Investment
The ICSID Convention is a multilateral treaty
Guarantee Agency formulated by the Executive Directors of the Inter-
MIGA is a member of the World Bank Group. It national Bank for Reconstruction and Development (the
came into existence on April 1988. Its mission is to World Bank). It was opened for signature on March 18,
promote Foreign Direct Investment (FDI) into deve- 1965 and entered into force on October 14, 1966.
loping countries to help support economic growth, There a r e currently 159 signatory States to the
reduce poverty and improve people’s lives. MIGA’s ICSID Convention. Of these, 148 States have also depo-
operational strategy plays to its foremost strength in the sited their instruments of ratification, acceptance or
market place— attracting investors and private insurers approval of the Convention. However, India is not a
into difficult operating environments. MIGA’s strategies member of this organisation.
412U | Economics (NET)
Objective Questions
1. Factor endowment theory of trade is associated 10. A rise in domestic spending will most probably—
with— (A) Improve balance of trade
(A) Harrod Domar (B) Marx (B) Worsen balance of trade
(C) Mills (D) Heckscher-Ohlin (C) Not affect balance of trade
2. Outward Looking development policies are not (D) None of the above
associated with— 11. Since March 1973, the world, more or less, had a—
(A) Open system of communications (A) Free floating exchange rate system
(B) Free movement of capital (B) Managed floating exchange rate system
(C) Multinational enterprise (C) Fixed exchange rate system
(D) Learning by doing (D) Adjustable peg system
3. Export Promotion is an— 12. Any move towards free trade makes different
(A) Inward looking strategy nations price ratio—
(B) Outward looking strategy (A) Converge (B) Diverge
(C) Fiscal strategy (C) Stable (D) Fluctuate
(D) Political strategy 13. In Hechscher-Ohlin model factor abundance is
4. Net national gains from trade is a measurable defined in terms of—
function of— (A) Physical quantities of factors
(A) Volume of trade (B) Factor prices
(B) Relative prices in two countries (C) Both (A) and (B)
(C) Factor costs of commodities traded (D) None of the above
(D) Volume of trade created and change in prices 14. If nations terms of trade is 2 its partners terms of
caused by trade trade will be—
5. Any move towards free trade makes different (A) 4 (B) 2
nations price ratios to— (C) 1 (D) 1/2
(A) Converge (B) Diverge
15. A depreciation of a nation’s currency equally causes
(C) Stable (D) Fluctuate internal or domestic prices to—
6. The non-economic arguments for tariff protection (A) Remain unchanged
include— (B) Rise
(A) National pride (C) Fall
(B) Income redistribution (D) Any of the above
(C) National Defence 16. A country’s offer curve will be straight line when its
(D) All of the above price elasticity of supply for export is—
(A) Infinitely large (B) Unity
7. WTO prescribes export subsidies as—
(C) Zero (D) Negative
(A) Competition
17. The nature of accommodating capital flows is—
(B) Unfair competition
(A) Ex-ante
(C) Monopolistic competition (B) Ex-post
(D) Exploitation (C) Sometimes Ex-ante and other time Ex-post
8. The theory of reciprocal demand in the field of (D) Neither Ex-ante nor Ex-post
international trade is propounded by—
18. Under the gold bullion standard there was—
(A) Haberler (B) Marshall (A) No gold coinage
(C) Ricardo (D) Mill (B) Full gold coinage
9. Which of the following are not the kinds of balances (C) Inconvertible paper money
associated with BOP ? (D) Legislation against foreign exchange specula-
(A) Merchandise on trade balance tion
(B) Current account balance 19. Speculation in foreign exchange market refers to—
(C) Revenue account balance (A) Accepting risk to make profit
(D) Overall an Official settlements balance (B) Careful hedging
Economics (NET) | 413U
(C) Interest arbitrage 28. The international monetary system introduced by
(D) All of the above Bretton Woods rested on—
20. The convertibility of dollar was formally abandoned (A) The maintenance of stable exchange rates
in— (B) A multilateral credit mechanism institutiona-
(A) 1971 (B) 1966 lised in the IMF
(C) 1973 (D) 1962 (C) Both (A) and (B)
21. The appropriate expenditure switching policy to (D) The principle of gold standard
correct a deficit in balance of payment is— 29. Anti dumping measures are not allowed if the
(A) Revaluation (B) Devaluation margin of dumping is—
(C) Monetary policy (D) Fiscal policy (A) 1% of export price of the product
(B) 2% of export price of the product
22. Each member of IMF is assigned a quota expressed
in— (C) 4% of import price of the product
(A) Member country’s currency (D) 10% of the export price of the product
(B) Dollar 30. If we assume MPS = 0, automatic income
(C) Special Drawing rights adjustment mechanism by itself will bring about—
(D) None of the above (A) No adjustment
(B) Incomplete adjustment
23. Opportunity cost in international trade means—
(C) Complete adjustment
(A) The cost incurred in availing or contain
opportunities (D) Purchase adjustment
(B) Loss of money due to not availing the opportu- 31. Which is the major function of the IMF ?
nity (A) Regulatory function
(C) The cost on opportunistic item (B) Consultative function
(D) How much of one commodity must be given up (C) Financial function
to get move of the other (D) All of the above
24. Which of the following is most appropriate cause 32. Which of the following is the criteria for approving
for export surplus ? on IDA credit ?
(A) Export promotion drive (A) Poverty test (B) Performance test
(B) Stringent import policy (C) Project test (D) All of these
(C) Development of national and international
33. Devaluation works best when—
markets
(A) Developing country’s demand for imports is
(D) All of the above inelastic
25. The foreign trade multiplier given by— (B) Foreign demand for the developing country’s
(A) K = ds + dM export is elastic
dy (C) It is accompanied by a decline in short term
(B) K = interest rates
ds + dm
ds dm (D) Devaluation brings about price rises in export
(C) K = + industries
dy · dm dy
dx 34. The exchange rate is kept the same in all parts of
(D) K = market by—
dm
26. An inflationary effect arising from an increase in the (A) Exchange arbitrage (B) Hedging
balance of payments surplus can be offset by— (C) Interest arbitrage (D) Speculation
(A) Raising interest rate to check expansion 35. Which of the following is a debit entry in a county’s
(B) Cutting down demand for foreign exchange balance of payments accounts ?
(C) Reducing exchange rates (A) Imports of goods and services
(D) Lowering domestic price levels (B) Inflow of capital from abroad
27. Quotas of all IMF members are reviewed at (C) Exports of gods and services
intervals of— (D) Transfer receipt from a friendly country
(A) Five years 36. The Uruguay Round agreement deals with which
(B) Not more than five years one of the following types of subsidies ?
(C) Three years (A) Prohibited subsidies
(D) Two years (B) Actionable subsidies
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(C) Non actionable subsidies (C) The reciprocal of consumer surplus
(D) All of the above (D) The surplus value of labour kept with the
production
37. The fundamental cause for the collapse of the
Bretton Woods system was— 45. GATT prescribes export subsidies as—
(A) Set up borrowing facilities for nations in (A) Competition
temporary balance of payment difficulties (B) Unfair competition
(B) Set up code of rules for nations to follow in (C) Monopolistic competition
their conduct of international trade and finance (D) Exploitation
(C) Evolved over the years in several important 46. Import quota is a/an—
ways (A) Tariff
(D) Served the world farily well (B) Non tariff trade barrier
38. The necessary and sufficient condition for trade (C) Concession
between the two countries is— (B) International obligation
(A) Differences of equal cost 47. Trade policy measures for correction of balance
(B) Difference of absolute cost of payments disequilibrium include—
(C) Difference of comparative cost (A) Export promotion
(D) None of the above (B) Import control
(C) Both (A) and (B)
39. The Heckscher-Ohlin theory—
(D) Import substitution
(A) Consider the theory of comparative cost useless
48. When a commodity is subject to be both specific
(B) Replaces the theory of comparative advanta-
and advalorem duties, the tariff is generally referred
ges
as—
(C) Represents an explanation and a basis for
(A) Compound duty (B) Bilateral duty
comparative advantage of trade
(C) Transit duty (D) Double column tariff
(D) None of the above
40. The ultimate determinants of commodity factors in 49. How many countries have been undertaken to lend
various countries are— to IMF if there is need to cope with an important
of the international monetary system ?
(A) Factor endowments and monetary system
(B) Factor endowment and political organisation (A) 11 (B) 50
(C) Factor endowments and production function (C) 15 (D) 20
(D) Political organisation and production functions 50. In calculating our balance of payments position we
41. In the study of international economics we use the must—
tools of— (A) Omit invisible items
(A) Macro-economic theory only (B) Omit exports and imports of gold
(B) Micro-economic theory only (C) Include expenditures by foreign tourists as
(C) Neither macro nor micro theory imports
(D) Both (A) and (B) (D) Include long term loans abroad as debits
42. To which of the following would the Mercantilists 51. Technological progress—
have objected ?
(A) Increase the productivity of the nations factors
(A) Free trade of production
(B) Restricting imports (B) Reduces the amount of factors of production
(C) Stimulating exports required to produce any output level
(D) Accumulation (C) Is equivalent to an increase in the nations
43. Balance of payments must always balance supply of factors and unchanged technology
because— (D) All of the above
(A) Trade deficit is cancelled by invisible credits 52. The international monetary system that existed from
(B) Imports always equal exports 1947 to 1971 is generally known as—
(C) Of an accounting convention (A) Par value system
(D) What a country gets, it must either pay or save (B) Pegged exchange rate system
44. Product surplus is— (C) Both (A) and (B)
(A) Producer’s revenue minus cost (D) Fewer rupees in the spot market than in the
(B) Net profit after payment of taxes home market
Economics (NET) | 415U
53. Which method is the quickest method of trans- 60. When a country’s offer curve is a straight line lying
ferring funds from one centre to another ? on the line of terms of trade, the elasticity of the
(A) Bank Draft curve is—
(B) Mail transfer (A) Zero (B) Unity
(C) Telegraphic transfer (C) Less than unity (D) Infinity
(D) None of the above 61. The basic balance includes all but—
54. The production possibility curves implied by (A) The goods and services balance
Ricardo’s kind of examples embody a special (B) The unilateral transfer balance
assumption about— (C) The long-term capital balance
(A) Real cost (B) Total cost (D) The short-term private non-liquid capital
(C) Nominal cost (D) Opportunity cost balance
55. In terms of comparative advantage, the reason for 62. In the absorption approach, the balance of trade can
importing coffee to the United States rather than be viewed as the difference between—
growing it on a commercial basis in the United (A) Imports and exports
States is that—
(B) National income and imports
(A) Coffee cannot be produced except in tropical
areas (C) National income and exports
(B) It requires a great deal of training for farmers to (D) National income and total expenditure
be able to produce coffee that is marketable 63. According to the Marshall-Lerner condition,
(C) The resources of the United States would be devaluation shall improve the trade balance of a
better employed in producing other commodi- country provided the sum of elasticities of demand
ties because US has comparative disadvantage for a country’s exports and of its demand for
in the production of coffee imports is—
(D) Coffee is produced in other parts of the world. (A) Between one and two
56. The commodity terms of trade is given by— (B) Two
(symbols have usual meaning) (C) Greater than one
Px P (D) Less than one
(A) Tc = (B) Tc = m
qx qx 64. Which one of the following is not an item of
qx Px country’s invisible earnings from international
(C) Tc = (D) Tc =
qm Pm trade ?
57. The US official settlements balance includes all (A) Shipping charges (B) Gold Jewellery exports
but— (C) Insurance fee (D) None of these
(A) The basic balance 65. The internal equilibrium of relative commodity
(B) The net liquidity balance price in a nation in the absence of trade is
(C) The short-term private liquid capital balance determined by the nation’s—
(D) The changes in US liabilities to foreign holders (A) Production possibilities curve
and official reserve (B) Indifference map
58. A deficit in a country’s balance of payments refers (C) Production possibilities curve or indifference
to the difference between— map
(A) Autonomous receipts and autonomous payment (D) Production possibilities and indifference map
(B) Accommodating receipts and autonomous pay- 66. Under flexible exchange rate system, the exchange
ments rate is determined by—
(C) Accommodating receipts and accommodating (A) The forces of demand and supply in the foreign
payments exchange market
(D) Autonomous receipts and accommodating pay- (B) The monetary authority of the nation
ments (C) The price of gold
59. The net liquidity balance includes the basic balance (D) The quantum of foreign exchange reserves of
and— the nation
(A) The short-term private non-liquid capital 67. Under a freely flexible exchange rate system (and
balance stable foreign exchange market), a deficit in a
(B) The allocation of special drawing rights nation’s balance of payments is automatically
(C) Errors and omissions corrected by—
(D) All of the above (A) A depreciation of its currency
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(B) An appreciation of its currency (C) An increase in its interest rate and a short term
(C) Domestic inflation capital outflow
(D) A rise in the national income (D) An increase in its interest rate and a short term
capital inflow
68. The supply curve of foreign exchange of a nation is
derived from— 76. Interest arbitrage refers to transfer of liquid assets
from one monetary centre (and currency) to another
(A) The foreign demand curve for the nation’s
in order to—
exports
(B) The nation’s supply curve of imports (A) Take advantage of the difference in interest
rates
(C) The nation’s demand curve for imports
(B) Speculate
(D) The foreign supply curve of the nation’s
imports (C) Both (A) and (B)
69. Which one of the following is not a debit entry in (D) None of the above
the balance of payments account ? 77. A nation’s demand curve for foreign exchange is
(A) Import of goods derived from the—
(B) Import of services (A) Foreign demand curve for the nation’s exports
(C) Gifts from foreigners (B) Nation’s supply curve for exports
(D) Purchase of assets from foreigners (C) Nation’s demand curve for imports
70. The forward market in foreign exchange is a market (D) Foreign demand curve of the nation’s imports
of— 78. The spot and forward markets for foreign exchange
(A) Short-run are intimately linked together through—
(B) Long-run (A) Interest arbitrage (B) Hedging
(C) Both short and long run (C) Speculation (D) All of these
(D) Spot 79. The items of the current account of balance of
71. Automatic adjustment of balance of payments payments are—
disequilibrium can be brought about by variation (A) Flow variables
in— (B) Stock variables
(A) Internal prices (B) External prices (C) Changes in stock magnitudes
(C) Income (D) All of these (D) Both stock and flow variables
72. The items on the capital account of balance of 80. A depreciation of a nation’s currency usually cause
payments are— internal of domestic prices to—
(A) Flow variables (A) Fall
(B) Stock variables
(B) Rise
(C) Changes in stock magnitudes
(D) Both stock and flow variables (C) Remain unchanged
(D) All of the above
73. Adjustment under the gold standard was described
by— 81. A debit entry in the balance of payments account of
(A) The price-specie-flow mechanism a country refers to—
(B) Flexible exchange rates (A) Inflow of foreign currency
(C) Variation in national incomes (B) Outflow of foreign currency
(D) Exchange controls (C) Both (A) and (B)
74. Speculation in foreign exchange market refers to— (D) None of the above
(A) Accepting risk to make profit 82. The foreign exchange market provides—
(B) Careful hedging (A) Short term credit to finance foreign trade
(C) Interest arbitrage (B) Hedging facilities
(D) All of the above (C) Transfer of funds from one nation to another
75. Under the gold standard, the loss of gold and (D) All of the above
reduction in the money supply in the deficit nation
was also expected to lead to— 83. Viewing from the double entry book keeping
(A) Reduction in its interest rate and a short term system the balance of payments will be in equili-
capital inflow brium—
(B) A reduction in its interest rate and a short term (A) Always (B) Never
capital outflow (C) Sometimes (D) Generally
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84. According to the price-specie-flow mechanism, 90. The immediate cause for the collapse of the Bretton
which sequence of events was supposed to bring Woods System was—
about adjustment in a deficit nation ? (A) The expectation that the U.S. would soon be
(A) Reduction in its money supply, falling internal forced to devalue the dollar
prices, falling exports and rising imports
(B) The massive fight of liquid capital from the
(B) Reduction in its money supply, rising internal U.S.
prices, falling exports and rising imports
(C) The attempt by three small European central
(C) Reduction in its money supply, falling internal banks to convert part of their dollar holdings
prices, rising exports and falling imports into gold at the federal reserve
(D) Increase in its money supply, rising internal
(D) All of the above
prices, falling exports and rising imports
91. If there is no retaliation from its trading partner,
85. When the exchange rate changes from £ 1 = R 20 to
imposition of tariff by a country will—
£ 1 = R 18, the—
(i) Rupee has depreciated (A) Produce an expansionary effect on national
income
(ii) Pound has depreciated
(iii) Rupee has appreciated (B) Bring about a decrease in unemployment
(v) Pound has appreciated (C) Have a favourable effect on its balance of trade
(A) (i) and (iii) (B) (i) and (iv) (D) All of the above
(C) (ii) and (iii) (D) (ii) and (iv) 92. A tariff can help in bringing down unemployment
86. The exchange rate is kept same in all parts of the in a country (provided the other country does not
market through— retaliate) through—
(A) Hedging (A) An expansionary effect of national income
(B) Speculation (B) Reducing imports and increasing demand for
(C) Exchange arbitrage home produced goods
(C) Exporting part of its unemployment to its
(D) Flexible exchange rate system
trading partner
87. Under the gold standard— (D) All of the above
(A) Each nation defines the price of gold in terms 93. The fundamental cause for the collapse of the
of its currency and then stands ready to buy and Bretton Woods System was—
sell any amount of gold at that price (A) The liquidity problem
(B) There is a fixed relationship between any two (B) The adjustment problem
currencies called the mint parity (C) The confidence problem
(C) The exchange rate is determined by demand (D) All of the above
and supply between the gold points, and it is
prevented from moving outside the gold points 94. The ‘beggar thy neighbour’ policy refers to the use
by gold shipments of tariff for—
(A) Improving country’s balance of trade
(D) All of the above
(B) Eradicating unemployment
88. If a foreign exchange speculator expects the spot (C) Earning foreign exchange
rate of the pound three months from today to be (D) Importing sophisticated technology
lower than today’s forward rate on the pound for
delivery in three months, he will— 95. Which one of the following does not represent an
evolution of the Bretton Woods System as it
(A) Buy pound forward today and sell them in the
operated until 1971 ?
spot market three months from today
(A) The general Arrangements to Borrow
(B) Buy pounds in the spot market three months
from today (B) Standby arrangements
(C) Flexible exchange rates
(C) Sell pounds in the spot market three months
from today (D) Special drawing rights
(D) Sell pounds forward today and buy them in the 96. By changing from free trade to a situation of
spot market three months from today optimum tariff, a single country will—
(A) Never improve its welfare
89. The ‘optimum tariff’ is the tariff which—
(B) Always improve its welfare
(A) Maximizes country’s foreign trade (C) Improve its welfare if the trading partner
(B) Minimize imports country’s offer curve is non linear
(C) Maximizes country’s welfare (D) Improve its welfare if the trading partner
(D) Maximizes its earnings from tariff country’s offer curve is a straight line
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97. Direct controls refer to— (B) Reinforce each other and result in complete
(A) Interferences with the operation of the market adjustment
forces (C) Work at cross purposes from each other and
(B) Price and wage controls result in incomplete adjustment
(C) Trade and exchange controls (D) Work at cross purposes from each other and
(D) All of the above result in perverse adjustment
98. A country’s offer curve will be a straight line if it 105. Which one of the following is not correct ?
can shift, without any difficultly the cost of factors (A) A country can always run by levying a tariff
of production from— even if the other country retaliates
(A) Export to import-competing sector of produc- (B) The higher a country’s share of foreign trade,
tion the larger is the scope for its optimum tariff
(B) Import-competing to export sector of produc- (C) Developed countries are likely to gain more
tion from exploiting a monopoly position by
(C) Both (A) and (B) applying high tariffs
(D) None of the above (D) The less developed countries are not likely to
gain much from high tariffs and their optimum
99. Which one of the following statements is incorrect tariffs are likely to be quite low
with regard to the effect of a devaluation of a
country in recession ? 106. If there is no retaliation from its trading partner,
(A) The nation’s exports are stimulated while its imposition of tariff by a country will—
imports are discouraged (A) Produce an expansionary effect on national
(B) The nation’s real national income rises income
(C) The nation’s real national income rises due to (B) Bring about a decrease in unemployment
increase in the nation’s imports (C) Have a favourable effect on its balance of trade
(D) The original improvement in the nation’s trade (D) All of the above
balance is smaller than the final improvement 107. A tariff can help in bringing down unemployment in
100. If two countries jointly cooperate and act as a single a country (provided the other country does not
unit then— retaliate) through—
(A) Free trade will be the optimal policy (A) An expansionary effect on national income
(B) Each should levy a mutually agree upon tariff (B) Reducing imports and increasing demand for
on imports from the other home produced goods
(C) One should levy optimum tariff while the other (C) Exporting part of its unemployment to its
should not levy any tariff trading partner
(D) Both should play the tariff game (D) All of the above
101. A country’s offer curve will be straight line when its 108. The fundamental cause for the collapse of the
price elasticity of supply for exports is— Bretton Woods System is—
(A) Infinitely large (B) Unity (A) The liquidity problem
(C) Zero (D) Negative (B) The adjustment problem
(C) The confidence problem
102. The appropriate expenditure-switching policy to (D) All of the above
correct a deficit in the balance of payments is—
(A) Revaluation (B) Devaluation 109. Which of the following is not an agency of the
World Bank ?
(C) Monetary policy (D) Fiscal policy
(A) UNCTAD (B) IDA
103. As a result of imposition of tariff a nation’s offer (C) MIGA (D) ICSID
curve will—
(A) Remain at the original position 110. Which one of the following does not represent
an evolution of the Bretton Woods System as-it
(B) Shift towards the axis measuring its export operated until 1971 ?
goods
(A) The General Arrangements to Borrow
(C) Shift towards the axis measuring its import
goods (B) Standby arrangements
(D) Become a straight line (C) Flexible exchange rates
(D) Special drawing rights
104. In the real world, the automatic income, price and
interest adjustment mechanisms, if allowed to 111. Which of the following telecom companies got the
operate, are likely to— All India License in 3G-spectrum auction ?
(A) Reinforce each other but still result in (A) BSNL
incomplete adjustment (B) MTNL
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(C) Bharti Airtel (C) Midrand (South Africa)
(D) None of the telecom company (D) Bengkok (Thailand)
112. CONCORD of 8 states of Northern region is a 122. First Export Promotion Zone(EPZ) in private sector
scheme of— was established at—
(A) FICCI (A) Kandla (B) Vishakhapatanam
(B) ASSOCHAM (C) Noida (D) Surat
(C) CII
123. Which of the following is/are an motives of pro-
(D) A joint scheme of all the above
tectionism ?
113. The first BRIC Sunimit 2009 was held in— I. Protect Sunrise Industries
(A) India (B) Russia II. Protect Sunset Industries
(C) Brazil (D) China III. Protect Strategic Industries
114. Dunkel Draft was— IV. Deter Unfair Competition
(A) Associated with Uruguay round V. Limit Overspecialisation
(B) Related to atomic treaty among nations (A) I, II, III, IV and V (B) I, II, III and IV
(C) Related to Super 301 (C) I, II and III (D) I and II
(D) Related to promoting drugs trade
124. The two new nations of ASEAN included in the
115. lndia is not a member of— group of nations having FTA with India w.e.f. June
(A) G-l5 (B) UNO 1, 2010 are—
(C) ASEAN (D) Commonwealth (A) Vietnam and Myanmar
116. Which of the following is not a member of SAARC? (B) Singapore and Vietnam
(A) Nepal (B) Pakistan (C) Myanmar and Thailand
(C) Bangladesh (D) Myanmar (D) Malaysia and Vietnam
117. India has the maximum foreign trade with— 125. Which measure comes under quantitive credit
(A) USA (B) China controls adopted by Central Bank of the Country ?
(C) UAE (D) UK (A) Bank Rate
(B) Open Market Operations
118. In which nation, the two days summit of G-20
(C) Cash Reserve Ratio
nations was held in November 2018 ?
(D) All of the above
(A) India (B) Argentina
(C) China (D) Canada 126. Which of the following tools is not used in the
analysis of international trade ?
119. Which of the following is considered a major threat (A) Import Intensity Index
to the multilateralism in trade and development— (B) Revealed Trade Barriers
I. Trade war between US and China. (C) Goods and Services Tax
II. Rising protectionism (D) Tariff Data Profile
III. Inconclusive Doha Round Negotiations
127. 33rd ASEAN Summit was concluded on November
IV. Greater cooperation among development 11-15, 2018 in—
countries
(A) Singapore
V. Rising Bilateralism (B) Kuala Lumpur
(A) Only I, II and III (C) Bandar Seri Begawan (Brunei)
(B) Only II, III and IV (D) Manila
(C) Only III, IV and V
128. IMF is the result of—
(D) I, II, III, IV and V
(A) Hawana Conference
120. Which agency/organisation is not related to U.N.O.? (B) Rome Conference
(A) Universal Postal Union (UPU) (C) Brettonwood Conference
(B) International Finance Corporation (IFC) (D) Geneva Conference
(C) World Meterological Organisation (WMO) 129. Which of the following is an export specialisation
(D) International Confederation of Free Trade index ?
Union (ICFTU) (Xijk/Xijk)
(A) ESJ ijk =
121. UNCTAD XIII was held on July 17-22, 2016 at— (Mjk/Mjt)
(A) Nairobi (Kenya) (M /M )
(B) ESJ ijk = jk jt
(B) Jeneva (Switzerland) (X ijk/Xijt)
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(Xijk/M jk) (b) Hedging 2. A contract to buy and sell foreign
(C) ESJ ijk = exchange against another curren-
(X ijt/M jt)
∑Xijk · ∑Xijt cy at some fixed rate in the future
(D) ESJ ijk = (c) Arbitrage 3. The movement of exchange rate
Mjk · Mjt
between two limits set by the
130. What is OPEC ? cost of moving gold from one
(A) The latest space shuttle of USA country to another.
(B) The latest space drive of Russia (d) Specie 4. A mechanism which makes
(C) Organisation of oil producing companies of points two markets that are physically
India separate, into a single market in
(D) Organisation of oil exporting countries the economic sense.
131. Which of the following agency is a cartel ? Codes :
(A) OPEC (B) SAARC (a) (b) (c) (d)
(C) ASEAN (D) NAFTA (A) 4 3 2 1
(B) 2 1 4 3
132. Which of the following is odd one out ?
(C) 4 1 2 3
(A) ASEAN (B) NAFTA
(D) 2 3 4 1
(C) GCC (D) IAD
133. Which of the following statement is correct about 137. Which one of the following is non-debt flow of
the President of the World Bank ? capital between countries ?
I. President of the World Bank is always (A) Commercial borrowings
appointed with the consent of United State of (B) Portfolio investment
America (C) Short-term borrowings from IMF
II. David R. Malpass has taken over the charge of (D) Sale and purchase of bonds in the capital
13th World Bank President on April 9, 2019. markets
III. David R. Malpass served as under secretary of
138. Which one of the following treaties was covered by
the Treasury for International Affairs for the
the Uruguay Round Negotiations ?
US.
(A) General agreement on trade in services
IV. Jim Yong Kim was the XII President of the
World Bank. (B) Trade-related intellectual property rights
(A) I, II, III and IV (B) Only I, III and IV (C) Trade-related investment measures
(C) Only II, III and IV (D) Only II (D) All of the above
134. Which one of the following is a possible com- 139. Which one of the following pairs is not correctly
promise between the fixed and the flexible exchange matched ?
rate systems ? (A) Exchange depreciation Market mechanism
(A) Adjustable peg system (B) Devaluation Policy action of the government
(B) Crawling peg system (C) Deflation Cheap money policy
(C) Managed floating system (D) Exchange Foreign exchange control rationing
(D) All of the above 140. Gains in trade results from—
135. Consider the following statements: Under the Gold (A) exporting as much as possible and receiving
Standard System, represented— gold
1. common unit value. (B) reallocation of existing goods between the two
countries
2. international means of payment.
(C) the fact that exchange brings both specialisa-
3. a store of value. tion and reallocation of greater output and the
Which of these statements are correct ? increased welfare in each country
(A) 1 and 2 (B) 1 and 3 (D) one country receiving both imports and gold
(C) 2 and 3 (D) 1, 2 and 3 141. According to the elasticity approach, for a devalua-
136. Match List I with List II and select the correct tion to have a positive effect on a country’s trade
answer using the codes given below the lists— balance, the sum of the elasticities of demand for a
List I List II country’s exports and of its demand for imports has
to be equal to—
(a) Forward 1. A device of covering
exchange exchange risk against the price (A) unity (B) less than unity
rise of foreign currency. (C) zero (D) greater than unity
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142. Which of the following statements is not correct in 146. Suppose, a country has adopted a freely floating
respect of the balance of payments of a country ? exchange rate system. Then, ceteris paribus, if the
(A) The current account of balance of pay- price level in the country rises, it leads to a—
ments consists of export and import of goods (A) rise in the demand for the country’s currency
and the capital account consists of export and and the currency depreciates
import of services, borrowings and lendings (B) rise in the demand for the country’s currency
(B) The surplus on current account in the balance and the currency appreciates
of payments must be equal to the deficit on (C) fall in the demand for the country’s currency
capital account and vice versa and the currency appreciates
(C) If in the actual balance of payments, the credit (D) fall in the demand for the country’s currency
and debit do not balance, the balance is usually and the currency depreciates
achieved by adding one item ‘errors and
omissions’ 147. Which one of the following pairs is correctly
(D) The balance of payments of a country must matched ?
always balance in the accounting sense (A) MFA : Agricultural Free Trade
143. The flexible exchange rate has a number of (B) UNCTAD : Free Trade Area
advantages. Which one of the following is not to be (C) IMF : Balance of Payments Difficul-
considered as such an advantage ? ties
(A) The exchange rate moves in a free market (D) MFN : Direct Foreign Investment
to equate demand and supply so that the market
does not face the problem of scarcity or surplus 148. The terms of trade refer to—
of foreign currency (A) the excess of import expenditures over export
(B) It permits a continued existence of free trade earnings
and convertible currencies (B) trade agreements
(C) It permits a country to follow independent (C) the ratio between export prices and import
monetary and fiscal policies prices
(D) There is no need for keeping official foreign (D) the terms and conditions on which a country is
exchange reserves offered loan in the event of balance of
144. The diagram shows the demand and supply, DD and payments difficulties
SS, curves respectively, for fertilizers in India— 149. In Heckscher-Ohlin theory of international trade,
OP = price of fertilisers in India, before trade. the most important source of difference in relative
OW = price of fertilizers in world market. commodity prices between nations is a differnce
in—
D S
(A) factor endowments
Price of Fertilizers
(B) technology
(C) tastes
P
(D) demand conditions
W
150. The scope of international trade and division of
labour is limited by—
D
O (A) availability of technology
Quantity of Fertilizers
(B) size of the international market
Consider the following statements— (C) availability of capital
Under free trade— (D) surplus production for exports
1. prices of fertilizers will be lowered compared to 151. Match List I with List II and select the correct
world prices. answer using the codes given below the lists—
2. consumption of fertilizers will increase. List I List II
3. imports of fertilizers will be zero. (Assumption) (Implication)
Which of these statements are correct ? (a) No transport 1. Commodity prices costs in
(A) 1 and 2 (B) 1 and 3 trade same in the two
(C) 2 and 3 (D) 1, 2 and 3 countries
145. Which one of the following pairs is not correctly (b) Perfect compe- 2. Optimal allocation of
matched ? tition in factor factors
(A) Gross barter terms of trade —Taussing markets
(B) Purchasing power parity theory —J.S. Mill (c) Factor intensi- 3. Techniques of production
(C) Offer curves —A. Marshall ties differ bet- different for the two goods
(D) Factor-endowment model — Heckscher Ohlin ween goods
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(d) Production 4. Techniques of production 156. Match List I with List II and select the correct
functions same same in the two countries answer using the codes given below the lists—
in both List I List II
countries (a) Buying and selling of 1. Pegging
5. Techniques of production home currency in the operation
different in the two coun- foreign exchange market
tries by government or its
Codes : authorised agency
(a) (b) (c) (d) (b) Charging different prices 2. Dumping
(A) 2 1 5 4 in different markets for operation
(B) 3 4 2 5 an internationally traded
commodity
(C) 3 2 4 1
(c) The price of imports 3. Free on board
(D) 1 2 3 4
paid by local purchasers, (f.o.b.)
152. The tariff which maximises a country’s economic which is more than their
welfare is called— normal value
(A) protective tariff (d) Local producers of an 4. Cost, insurance
(B) discriminatory tariff export good receiving only and freight
(C) non-discriminatory tariff the price of the good as it (c.i.f)
(D) optimum tariff leaves the country
153. Match List I with List II and select the correct Codes :
answer using the codes given below the lists— (a) (b) (c) (d)
List I List II (A) 2 1 3 4
(B) 1 2 4 3
(a) Classical theory of compa- 1. David Ricardo (C) 3 1 2 4
rative cost advantage (D) 1 4 3 2
(b) Vent for surplus theory 2. G. Haberlere 157. Which one of the following pairs is correctly
(c) Theory of opportunity cost 3. J.S. Mill matched ?
(d) Theory of reciprocal 4. Adam Smith (A) Change in imports asso- Average propen-
demand ciated with a given change sity to import
Codes : in income
(a) (b) (c) (d) (B) Value of imports as a Marginal prop-
percentage of total national ensity to import
(A) 1 4 2 3
income income
(B) 1 2 3 4 (C) Change in nation’s income Foreign trade
(C) 4 1 2 3 caused by a change in its multiplier
(D) 3 1 2 4 exports
154. A country is said to be relatively well-endowed (D) When some products con- Balanced
with capital if the— tribute much more to growth growth
than others
(A) aggregate value of capital in the country is
greater than that of labour and land 158. The following graph shows different effects of
(B) the wage-rental ratio in that country is higher in tariffs in partial equilibrium. Which one of the
relation to that in its trading partners following indicates the revenue effect of a tariff
(C) the interest rate on capital is lower in that equal to PP• per unit ?
country relatively to the interest rate in its D S
trading partners
Price
(D) the per capita amount of investment in the
country had shown a rising trend
155. Which one of the following transactions represents
P a
a credit entry in the current account of a country’s b c
P S d D
balance of payments ?
O Q1 Q2 Q4 Q2 Quantity
(A) Merchandise imports
(B) Transportation services rendered by foreign (A) Area represented by ‘a’
companies (B) Area represented by ‘b’
(C) Expenditure of foreign tourists in a country (C) Area represented by ‘c’
(D) Fees paid to foreign contractors and engineers (D) Area represented by ‘d’
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159. Consider the following statements— 164. India is a net exporter of hand-made carpets and
Under the gold-standard inflow of gold from the an importer of high-tech products like computer
deficit to the surplus nation results in— memory chips and printers. This pattern of Indian
1. a fall in the interest rate in the surplus nation. trade is explained by the—
2. a fall in the interest rate in the deficit nation. (A) Ricardian theory
3. an outflow of capital from surplus to deficit (B) Hecksher-Ohlin theory
nation. (C) Labour theory of value
4. an outflow of capital from deficit to surplus (D) Purchasing power parity theory
nation. 165. Given the usual shapes of LM and IS curves and
Of the above statements— BOP curve, if there is a shift in the LM curve to
(A) 1 and 4 are correct (B) 1 and 3 are correct the right, the economy will face—
(C) 2 and 3 are correct (D) 2 and 4 are correct (A) surplus in the balance of payment and a fall
in the rate of interest
160. Direct control refers to—
(B) Deficit in the balance of payment and an
(A) interference with the operation of the market
increase in the rate of interest
forces
(C) Surplus in the balance of payment and an
(B) price and wage control
increase in the rate of interest
(C) trade and exchange control
(D) Deficit in the balance of payment and a fall
(D) All of the above in the rate of interest
161. Which of the following items were responsible for
most of the increase in international liquidity since 166. If the sum of the elasticities of the exports and
World War II ? imports is less than one, any devaluation will
further aggravate the deficit in the BOP. Who has
1. Gold given this view ?
2. Dollars (A) Marshall and Lerner
3. Other convertible currencies (B) Harrod and Domar
4. SDRs (C) Solow and Swan
Select the correct answer using the codes given (D) Hickscher and Ohlin
below—
(A) 1, 2 and 4 (B) 1 and 3 167. Where the foreign offer curves has an elasticity of
one, the optimum tariff will be—
(C) 2 and 3 (D) 2 and 4
(A) infinity (B) unity
162. ‘Most Favoured National Clause’ under GATT (C) less than unity (D) zero
requires—
(A) preferential treatment to particular identified 168. The Ricardian theory of comparative advantage
countries relates to—
(B) preferential treatment only to developing (A) short-run outcome
countries (B) long-run outcome
(C) preferential treatment to countries with a (C) intermediate outcome
balance of payments deficit (D) All of the above
(D) preferential treatment to all member countries 169. Which one of the following assumptions is the
of GATT most important assumption in the Heckscher-
163. The Government of India announces a new NRI Ohlin theorem of international trade ?
deposit scheme. This offers a very high interest rate, (A) Two factor model
compared to the interest rates abroad, on foreign (B) Two commodities
currency deposits by NRIs in Indian Commercial (C) No tariff
Banks. Many NRIs in the US do invest under this (D) Constant tastes
scheme. Under a flexible exchange rate system, this
170. The country is likely to be better off after export-
would tend to—
led growth provided that—
(A) depreciate the value of Indian rupee against (A) gains from export-led-growth exceed the
US dollar losses from worsening terms of trade
(B) appreciate the value of Indian rupee against (B) gains from growth off-set the losses from
US dollar worsening terms of trade
(C) deplete the foreign exchange reserve of India (C) the long-run terms of trade are favourable
(D) leave the value of rupee against US dollar (D) the elasticity of demand for imports is less
unchanged than unity
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171. Which of the following is termed as trade comple- Codes :
mentarity index ? (a) (b) (c) (d)
(X ik/Xi) (A) 2 3 1 4
(A) TCIij =
(Mwk/M w ) (B) 2 3 4 1
(Mik/Mi) (C) 3 2 4 1
(B) TCIij = (D) 3 2 1 4
(Mwk/M w )
(C) TCIij = ∑RCAjk · RCDjk · (Mwk/M w ) 177. Which of the following is not a gain from the
foreign trade ?
RCA jk · RCDjk
(D) TCIij = (A) Efficiency gains from exploiting comparative
Mwk/M w advantage
172. Assume that the nominal rate of tariff on imports (B) Reduced costs from economies of scale
of final commodity is 30%. The nominal rate of (C) Increase in national income
tariff on the imported inputs is 10% and the ratio (D) New wave of colonialism
of imported inputs to the value of the final
commodity is 50%. Then the effective rate of 178. Match List I with List II and select the correct
tariff will be— answer using the codes given below the lists—
List I List II
(A) 50% (B) 40%
(a) Supply side of 1. David Ricardo
(C) 30% (D) 10% International Trade
173. The balance of payments of a country is in (b) Demand side of 2. Bastable and Alfred
equilibrium when the— International Trade Marshall
(A) demand for the domestic currency is equal to (c) Opportunity cost of 3. G. Haberler
its supply International Trade
(B) demand for the domestic currency is the (d) Real cost theory of 4. Alfred Marshall and
highest International Trade Edgeworth
(C) demand for the domestic currency is the Codes :
lowest (a) (b) (c) (d)
(D) demand as well as supply of the domestic (A) 1 4 2 3
currency are the highest (B) 1 4 3 2
174. Dusenberry was of the opinion that less developed (C) 4 1 2 3
countries will have serious and adverse effect on (D) 4 1 3 2
their balance of payments due to—
179. The main objective of the World Trade Organi-
(A) backwash effect zation is to secure among others—
(B) spread effect (A) a general agreement among Common Market
(C) demonstration effect countries on technical training and mutual
(D) multiplier effect prices of traded goods
(B) the maintenance of intellectual property
175. Special Drawing Rights (SDRs) is the currency of rights and patent rights of member countries
IMF. This is in the form of— (C) an improvement in the USA’s terms of trade
(A) paper currency in the next decade
(B) gold (D) a reduction in tariffs through negotiation,
elimination of import quotas and globaliza-
(C) silver and gold both
tion of international trade
(D) book-keeping entry only
180. One of the advantages of free trade is improve-
176. Match List I with List II and select the correct ment in the distribution of income. Free trade thus
answer using the codes given below the lists— results in some income redistribution by—
List I List II (A) raising the income of the poor
(B) lowering the income of the rich
(a) Hamilton-List 1. Trade creation and
(C) raising the income of the poor and lowering
effects Trade diversion
the income of the rich
(b) Marshall-Lerner 2. Infant-industry (D) lowering the price of the scarce factor and
argument raising the price of the abundant factor
(c) F.Y. Edgeworth 3. Elasticity approach 181. If the demand of the domestic consumers is
(d) Jacob Viner 4. Impoverishing growth infinitely elastic and the supply of the foreign
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producer is perfectly inelastic, then the whole of Codes :
the tariff will— (a) (b) (c) (d)
(A) be paid by the domestic consumers
(A) 2 1 3 4
(B) be paid by the foreign producer
(B) 3 2 4 1
(C) be equally shared by the domestic consumers
and the foreign producer (C) 2 3 1 4
(D) yield neither revenue nor protection to either (D) 1 3 4 2
of them 187. Match List I with List II and select the correct
182. The optimum tariff is at a point where the elas- answer using the codes given below the lists—
ticity of the offer curve is— List I List II
(A) infinity (a) Unrequited 1. Gifts, reparations recei-
(B) unity receipts ved from foreigners
(C) greater than unity but less than infinity (b) Accommodating 2. Lending, borrowing and
(D) less than unity finance gold transfer
183. Denoting the price of capital and labour by PK and (c) Transfer items 3. Commercial imports and
exports
⎛ P K⎞ (d) Autonomous 4. Currency transfer by
P L respectively and countries by A and B, if ⎜P ⎟
⎝ L⎠ items monetary authority
⎛ P K⎞ Codes :
>⎜ ⎟ — (a) (b) (c) (d)
⎝PL ⎠ B
(A) 1 4 2 3
(A) Country B is relatively labour abundant (B) 4 1 2 3
(B) Country A is relatively labour abundant (C) 1 4 3 2
(C) Country A is relatively capital abundant (D) 4 1 3 2
(D) relative factor abundance is indeterminate 188. For a closed economy having no foreign trade
184. Which of the following pairs of GATT rounds and which one of the following is correct ?
the associated years are correctly matched ? (A) GDP = GNP (B) GDP > GNP
1. First Round 1948 (C) GDP < GNP (D) None of these
2. Kennedy Round 1964-67 189. The Singer-Prebisch theory maintains that—
3. Tokyo Round 1973-79 (A) less developed countries suffer a welfare loss
Select the correct answer using the codes given from secular decline in terms of trade due to
below— primary product exports
(A) 1, 2 and 3 (B) 1 and 2 (B) Less developed countries always gain in trade
when they trade with developed countries
(C) 2 and 3 (D) 1 and 3
(C) Less developed countries lose in terms of
185. Which of the following is not an assumption of welfare but gain in terms of foreign exchange
foreign trade multiplier ? (D) Dependence upon trade for development is
(A) Protectionism is limited to sunset industries not harmful to less developed countries
(B) Full employment in domestic economy 190. The given diagram represents a country producing
(C) Fixed-exchange system only two goods ‘A’ and ‘B’. PP represents the
(D) Public expenditure is constant production possibility curve. Consider the follow-
ing statements in this regard—
186. Match List I with List II and select the correct
answer using the codes given below the lists— P"
List I List II P'
P
(a) Free trade area 1. No restrictions on trade
Good A
and factor movement
(b) Customs union 2. Trade is free and no
customs duties
(c) Common 3. No customs duties; duties O P P' P"
market on Good B
(d) Economic 4. Advanced stage of inte- An outward shift of the production possibility
union gration curve (to P'P', P"P") will take place due to—
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1. technological progress. Select the correct answer using the codes given
2. increase in available resources. below—
3. increase in consumption. (A) 1, 2 and 3 (B) 1 and 2
Of these statements— (C) 2 and 3 (D) 1 and 3
(A) 1, 2 and 3 are correct 195. Which of the following is not true about recently
(B) 1 and 2 are correct declared ‘foreign trade policy’ of India ?
(C) 2 and 3 are correct (A) Whole export sector will be free from service
(D) 1 and 3 are correct tax
(B) To get a world trade share of R 1·5% by 2009
191. The terms of trade for a country will improve
(C) Ensuring 20% growth per year in exports in
as a result of currency devaluation (where Sx =
next 5 years
export elasticity of supply, Sm = import elasticity
(D) Export limit reduced to R 750 crores from
of supply, Dx = export elasticity of demand, Dm = existing R 1000 crores from getting “towns of
import elasticity of demand) if— export excellence” standards
(A) S xS m > DxDm (B) DxDm > SxSm 196. By changing from free trade to a situation of
S ·S optimum tariff, a single country will—
(C) DxDm > SxSm (D) x m < 1
Dx·Dm (A) Never improve its welfare
192. Which is the correct chronological order of (B) Always improve its welfare
following institutions ? (C) Improve its welfare if the trading partner
I. World Trade Organisation country’s offer curve is non-linear
(D) Improve its welfare if the trading partner
II. International Bank for Reconstruction and
country’s offer curve is a straight line
Development
III. United Nations Conference on Trade and 197. Direct controls refer to—
Development (A) Interferences with the operation of the market
IV. Multilateral Investment Guarantee Agency forces
(B) Price and wage controls
(A) II-III-IV-I (B) II-III-I-IV
(C) Trade and exchange controls
(C) III-II-IV-I (D) IV-III-II-I
(D) All of the above
193. Convertibility of the rupee implies—
(A) being able to convert rupee notes into gold 198. A country’s offer curve will be a straight line if it
can shift, without any difficulty or cost, factors of
(B) allowing the value of the rupee to be fixed
production from—
by market forces
(C) freely permitting the conversion of rupee (A) Export to import-competing sector of produc-
to other major currencies and vice-versa tion
(D) developing an international market for (B) Import-competing to export sector of pro-
currencies in India duction
194. In the given diagram, curves aa and bb repre- (C) Both (A) and (B)
sent the isoquants for good A and good B. P0 P 0 (D) None of the above
represents relative factor prices in country I. P1 P 1
199. Which one of the following statements is incorrect
and P 2 P 2 represent relative factor prices in country with regard to the effect of a devaluation on a
II. Which of the following inferences can be country in recession ?
drawn from the data presented in the diagram ?
(A) The nation’s exports are stimulated while its
P0
b
imports are discouraged
P1 (B) The nation’s real national income rises
b (C) The nation’s real national income rises in the
Capital
P2
a nation’s imports
(D) The original improvement in the nation's trade
b balance is smaller than the final improvement
P1
O P0 P2 Labour 200. If two countries jointly co-operate and act as a
single unit—
1. Good A is the capital intensive good. (A) Free trade will be the optimal policy
2. Good B is a labour intensive good. (B) Each should levy a mutually agreed upon tariff
3. Capital is cheap in country I. on imports from the other
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(C) One should levy optimum tariff while the other (c) SAARC 3. Sanction of soft loans.
should not levy any tariff (d) IDA 4. Promotes trade among South
(D) Both should play the tariff game Asian Countries.
201. A country’s offer curve will be straight line when Codes :
its price elasticity of supply for exports is— (a) (b) (c) (d)
(A) Infinitely large (B) Unity (A) 1 2 3 4
(C) Zero (D) Negative (B) 2 3 4 1
(C) 2 1 4 3
202. Which one of the following items has the largest
share in Indian export in terms of US-dollars ? (D) 3 2 4 1
(A) Electronic goods 209. A sudden shift from import tariffs to free trade
(B) Leather manufactures may induce short term unemployment in—
(C) Readymade garments (A) Import competing industries
(D) Gems and jewellery (B) Industries that are only exporters
(C) Industries that sell domestically as well as
203. A favourable balance of trade means—
export
(A) an excess of export of goods over imports of
(D) Industries that neither import nor export
goods
(B) an excess of goods and other credits and 210. The immediate cause for the collapse of the
imports of goods and other debits Brettonwoods system was—
(C) an excess of total imports of goods and ser- (A) The expectation that the U.S.A. would soon
vices over total exports of goods and services be forced to devalue the dollar
(D) an excess of total credits over total debits (B) The massive flight of liquid capital from the
U.S.A.
204. The appropriate expenditure-switching policy to (C) The attempt by three small European Central
correct a deficit in the balance of payments is— Banks to convert part of their dollar holding
(A) Revaluation (B) Devaluation into gold at the Federal Reserve Bank
(C) Monetary policy (D) Fiscal policy (D) All of the above
205. Which one of the following south east Asian 211. A feasible effect of international trade is that—
countries has largest share in Indian imports— (A) A monopoly in the home market becomes an
(A) Singapore (B) Malaysia oligopoly in the world market
(C) Thailand (D) Indonesia (B) An oligopoly in the home market becomes a
206. Under a managed floating exchange rate system, monopoly in the world market
the nation’s monetary authorities intervene in (C) A purely competitive firm in the home
foreign exchange markets to— market becomes an oligopolist
(A) Smooth out short-run and long-run fluc- (D) A purely competitive firm in the home
tuations in exchange rates market becomes a monopolist
(B) Keep exchange rates fixed among a group of
nations 212. In the given diagram curves I and II represents
respectively production-possibility curves of
(C) Smooth out short-run fluctuations in exchange
rates countries A and B. The diagram refers to a two
country, two-commodity model. When free trade
(D) Keep exchange rates flexible
opens up, each country specialises on the lines of
207. Euro currency market is a part of a larger global Ricardian model of trade. At some point of time,
market known as Eurodollar market— the terms of trade are settled at domestic exchange
(A) Above statement is correct ratio of country ‘A’. In this case, gain from
(B) Above statement is not correct international trade will accrue—
(C) Above statement is partially correct
100 A
(D) Above statement is partially incorrect
208. Match the following—
Cloth
List I List II
(a) WTO 1. Provide finance to correct I II
disequilibrium in balance of
payments. B C
(b) IMF 2. Generally forbids the use of O 100 200
quantitative restrictions in trade. Wheat
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(A) Wholly to country ‘A’ demand for edible oil = OB
(B) Wholly to country ‘B’ domestic supply of edible oil = OA
(C) to both the countries in equal proportions import of edible oil = AB
(D) to both the countries but ‘B’ will gain more Assume that a tariff is levied on import of edible oil.
than ‘A’ Price rises to OT.
The following inferences may be drawn from the
213. In a free economy inequality of income are mainly diagram regarding the effect of tariff. The import
due to—
tariff—
(A) Private property and inheritance
1. reduces consumption
(B) Difference in the marginal productivity of
2. increases production
labour
3. decreases the volume of trade
(C) Free competition
Select the correct answer using the codes given
(D) Private property only
below—
214. Which of the following is not an economic Codes :
organisation ? (A) 1, 2 and 3 (B) 1 and 2
(A) UNESCO (C) 2 and 3 (D) 1 and 3
(B) International Monetary Fund
219. If protection is given to a small import competing
(C) SAFTA
industry, consumer surplus and domestic profits
(D) NAFTA will, respectively—
215. The European Union has achieved all of the (A) rise, rise (B) fall, fall
following, except— (C) rise, fall (D) fall, rise
(A) Adopted a common fiscal policy for member
220. Which one of the following conditions is not
nations
assumed by the factor price equalisation theorem ?
(B) Established a common system of agricultural
(A) The countries are characterised by different
price supports
factor endowments
(C) Disbanded all tariffs between its member
(B) The countries are characterised by different
countries
production functions
(D) Levied common tariffs on products imported
(C) The industries are characterised by different
from non-members
factor intensities
216. Under the system of fluctuating exchange rates (D) Each country will export the commodity which
regime, the adjustment in the balance of payments uses its abundent factor relatively intensively
is brought about by the changes in—
(A) Prices (B) Exchange rate 221. India is large exporter of tea and a small exporter of
bicycles. In this context, which one of the following
(C) Income (D) Prices and income is true ?
217. The members of the NAFTA are— (A) An export subsidy to tea would improve India’s
(A) USA, Canada, Mexico terms of trade in the world tea market
(B) USA, Canada, India (B) An export subsidy to tea would worsen India’s
(C) USA, Canada, Japan terms of trade in the world tea market
(D) USA, UK, India (C) An export subsidy to bicycles would improve
India’s terms of trade in the world bicycle
218. Consider the following diagram in the context of market
India importing edible oil—
(D) An export subsidy to bicycles would worsen
Y D S India’s terms of trade in the world bicycle
market
222. There are two countries, Sugarland and Salt-land.
P E Each country produces sugar and salt. The former
Price
exports sugar and the latter, salt. Starting from a
T
free trade equilibrium, a tariff on salt by sugarland
W would affect the offer curves and the relative price
S D of sugar from sugarland’s perspective in which one
O X of the following ways ?
AF GB
Before trade, demand curve DD and supply curve (A) Shift the offer curve of saltland, increase the
SS intersect at E to give domestic price OP, which price of sugar
is higher than world price OW. At world price (B) Shift the offer curve of saltland, decrease the
OW— price of sugar
Economics (NET) | 429U
(C) Shift the offer curve of sugarland, increase (C) service imports and service exports respecti-
the price of sugar vely
(D) Shift the offer curve of sugarland, decrease (D) merchandise imports and service imports
the price of sugar respectively
223. Consider a Ricardian economy that is endowed with 230. In a flexible exchange-rate system, an increase in
45 units of labour. It can produce two goods: Gajar- the domestic interest rate would tend to—
Halwa and Kulfi. One unit of labour can produce 4 (A) improve the current account and worsen the
kilos of Gajar-Halwa or 6 kilos of Kulfi. The capital account
international price of Gajar-Halwa in terms of Kulfi (B) improve both the current and capital accounts
is 2. In free trade, this country will produce—
(C) worsen both the accounts
(A) 15 kilos of Kulfis
(D) worsen the current account and improve the
(B) 130 kilos of Kulfis capital account
(C) 180 kilos of Gajar-Halwa
231. In the diagram showing the demand and supply
(D) 270 kilos of Gajar-Halwa curves for dollars, the Central Authority wants to
224. The country can improve its balance of payments maintain the exchange rate (rupees per dollar) at
by devaluation when the sum of elasticities of E2 —
demand for exports and imports is—
/$ S$
(A) greater than unity (B) equal to unity
(C) less than unity (D) zero
225. The Purchasing Power Parity (PPP) theory of the
exchange-rate implies that the currency of a country
A would depreciate against that of country B if— E1
(A) the inflation rate in A exceeds that in B E2 DS
(B) the normal interest-rate in A exceeds that in B
O
(C) the growth rate of GDP in B exceeds that in A
(D) foreign direct investment moves from B to A Then the Central Authority will need to—
(A) buy dollars and sell rupees
226. In a freely floating exchange rate system—
(B) sell dollars and buy rupees
(A) the current account and capital account add to
zero (C) reduce tariff on imports
(B) each account can individually be equal to zero (D) impose a tax on exports
(C) exchange rate is determined by market forces Directions—The following items consist of two
(D) All the above statements are correct statements, one labelled as ‘Assertion A’ and the other
labelled as ‘Reason R’. You are to examine these two
227. In the current international monetary system the statements carefully and decide if the Assertion A and
Indian rupee is pegged to— the Reason R are individually true and if so, whether the
(A) U.S. dollar (B) U.K. pound reason is a correct explanation of the assertion. Select
(C) Euro (D) A basket of currencies your answers to these items using the codes given below
and mark your answer sheet accordingly—
228. Which one of the following is not permissible under
India’s current account convertibility ? Codes :
(A) Residents holding foreign exchange accounts (A) Both A and R are true and R is the correct
(B) Foreigners holding accounts in Indian banks explanation of A
(C) Exporters holding foreign currency accounts (B) Both A and R are true but R is not a correct
(D) Free movement of short term capital explanation of A
(C) A is true but R is false
229. During the last visit to India, BARAK OBAMA
travelled by the government owned airline. He also (D) A is false but R is true
watched cricket at Bangalore and for the growth of 232. Assertion (A) : Compared to no trade, there are
the game, donated one million dollars to the production and consumption gains to a country from
Karnataka Fund for Cricket (KFC). The amount he free trade.
paid for the air ticket and his donation to KFC Reason (R) : The magnitude of gain from trade is
would be classified as— independent of the magnitude of price change from
(A) service exports and unilateral transfers to India no trade.
respectively
(B) unilateral transfers to India in both the cases 233. Assertion (A) : Suppose, Pakistan forms a FTA
respectively (Free Trade Area) with its neighbouring countries
430U | Economics (NET)
including India, and before the formation of this (C) fully convertible for both capital and current
FTA, Pakistan used to import a certain kind of account transactions
jewellery from South Africa but now imports this (D) not convertible for either type of transactions
from India. This is called trade diversion. 244. Mr. Rahul Jain travelled to England for medical
Reason (R) : Now there is a lot of FDI (Foreign operation. He had to bear the cost of his air travel by
Direct Investment) by India in Pakistan, which was Air India as well as the cost of hospitalisation. In
non-existent before. This is called trade creation. this context, which one of the following is true in
234. Assertion (A) : A country’s balance of Payments is terms of entry in India’s balance of payments
transactions ?
always equal to zero.
(A) The cost of hospitalisation is included in
Reason (R) : If a country has a deficit in the service imports but the cost of air travel is not
balance of payments account, this must be financed (B) The cost of air travel is included in service
by change in reserve, long term capital movements imports but the cost of hospitalisation is not
or long term borrowing. (C) Both expenditures are included in the category
235. Assertion (A) : The open-economy Keynesian of service imports
multiplier is less than the closed economy Keynesian (D) Both expenditures are included in service
multiplier. exports
Reason (R) : The marginal propensity to import is
always greater than the marginal propensity to 245. Suppose that the world economy consists of two
consume. countries, ‘Home’ and ‘Foreign’. A tariff imposed
by the Home on its imports from the Foreign
236. Assertion (A) : Intellectual property rights were
shifts—
brought into the Uruguay Round Trade Negotiations.
(A) Home’s offer curve to the right
Reason (R) : International trade restrictions can be
used to discourage the violation of intellectual (B) Foreign’s offer curve to the right
property rights. (C) Home’s offer curve to the left
237. Assertion (A) : Devaluation leads to expenditure (D) Foreign’s offer curve to the left
switching. 246. In the context of a small, competitive currency, an
Reason (R) : Devaluation makes imports relatively increase in import tariff causes—
costhier than domestic goods. (A) a consumption dead weight loss in terms of
238. Assertion (A) : Special Drawing Rights (SDRs) welfare since consumers now pay a higher
have the characteristics of an international currency. price for the product
Reason (R) : SDRs were introduced to increase (B) a production dead weight gain in terms of
international liquidity. welfare since domestic producers gain from
239. Assertion (A) : The gains from trade are determined tariff protection
by the terms of trade. (C) an overall welfare gain
Reason (R) : The gains from trade depend on the (D) a trade gain since the amount imported
differences in comparative cost ratios. decreases
240. Assertion (A) : Factor price equalisation theorem 247. In the two-good Ricardian trade model, complete
deals with the effect of trade on factor prices. specialisation in production occurs in free trade
Reason (R) : Trade in goods has no effect on factor equilibrium because—
prices. (A) the production possibility frontier satisfies
241. Assertion (A) : Heckscher-Ohlin theory in validates increasing opportunity cost
the classical theory of comparative costs. (B) there are diminishing returns to the factor of
Reason (R) : Heckscher-Ohlin theory goes behind production
the comparative cost theory. (C) there are increasing returns to the factor of
production
242. Assertion (A) : A change in the income terms of
(D) the production possibility frontier satisfies
trade is an indicator of welfare.
constant opportunity cost
Reason (R) : Income terms of trade measure the
quantity of imports bought by exports. 248. Consider the following statements—
243. Presently, India’s exchange rate policy towards The Brettonwoods conference led to the estab-
current account and capital account transactions is lishment of—
that the rupee is— 1. IMF 2. IBRD
(A) fully convertible for current account transac- 3. United Nations
tions, but not for capital account transactions Which of the above statements are correct ?
(B) fully convertible for capital account transac- (A) 1 and 2 (B) 2 and 3
tions, but not for current account transactions (C) 1 and 3 (D) 1, 2 and 3
Economics (NET) | 431U
249. A deficit in a country’s balance of payments refers one another but maintain their original tariff
to the difference between— levels against the rest of the world
(A) autonomous receipts and autonomous pay- (B) Customs Union among a group of countries
ments means than they eliminate import tariffs against
(B) accommodating receipts and autonomous pay- one another, coordinate their macro-policies
ment and impose a common tariff wall against the
rest of the world
(C) accommodating receipts and accommodating
payments (C) In a common market the member countries
eliminate import tariffs against one another,
(D) autonomous receipts and accommodating pay- allow free mobility of factors between them
ments and maintain a common tariff wall against the
250. What is the correct sequence of the following ? rest of the world
1. Uruguay Round Talks (D) In an Economic Union, the member countries
2. WTO’s Seattle Meet eliminate import tariffs against one another,
allow free mobility of factors between them,
3. Establishment of GATT coordinate their macro-policies and maintain a
Select the correct answer using the codes given common tariff wall against the rest of the world
below— 254. For a large trading country, the optional tariff
Codes : argument is based on the proposition that a tariff on
(A) 1, 2, 3 (B) 3, 1, 2 imports—
(C) 3, 2, 1 (D) 2, 3, 1 (A) lowers the country’s terms of trade
251. In respect of the production possibility curve under (B) improves the country’s terms of trade
increasing opportunity costs given above, consider (C) leaves the country’s terms of trade unchanged
the following statements— (D) fails to protect the import competing industries
1. The production possibility curve is not 255. Which of the following does not form a part of the
identical with price curve as in the case of foreign exchange reserves of India ?
constant costs. (A) Gold
2. There would be complete specialisation of a (B) SDRs
country in a single commodity in a two- (C) Foreign currency assets
commodities and two-countries model.
(D) Foreign currency and securities held by the
P banks and corporate bodies
A
256. Match List I (Institution) with List II (Main objec-
W C tive) and select the correct answer using the codes
given below the lists—
Wheat
List I List II
P
(a) IMF 1. To promote viable and
durable multilateral trading
O C B system.
Cloth
(b) UNCTAD 2. To promote harmony between
Which of the statements is/are correct ? developed and developing
(A) 1 only (B) 2 only countries on trade related
(C) Both 1 and 2 (D) Neither 1 nor 2 developmental issues.
252. The Heckscher-Ohlin theory of trade pattern assu- (c) World Bank 3. To promote socio-economic
mes— development of the member
(A) perfect competition in the product markets but countries.
not in the factor markets (d) WTO 4. To reduce the degree of
(B) perfect competition in the factor markets but balance of payments disequi-
not in the product markets librium of the member coun-
(C) perfect competition in both product and factor tries.
markets Codes :
(D) unemployment in the labour market (a) (b) (c) (d)
253. Which one of the following statements is not (A) 4 3 2 1
correct? (B) 1 2 3 4
(A) Free Trade Area among a group of countries (C) 4 2 3 1
means that they eliminate import tariffs against (D) 1 3 2 4
432U | Economics (NET)
Answers 131. (A) 132. (D) 133. (A) 134. (D) 135. (D)
1. (D) 2. (D) 3. (B) 4. (D) 5. (A) 136. (B) 137. (B) 138. (D) 139. (C) 140. (C)
6. (D) 7. (B) 8. (D) 9. (C) 10. (B) 141. (C) 142. (A) 143. (C) 144. (A) 145. (B)
11. (B) 12. (A) 13. (C) 14. (D) 15. (A) 146. (D) 147. (C) 148. (C) 149. (A) 150. (B)
16. (A) 17. (D) 18. (A) 19. (D) 20. (A) 151. (D) 152. (A) 153. (A) 154. (D) 155. (C)
21. (B) 22. (C) 23. (D) 24. (B) 25. (B) 156. (B) 157. (B) 158. (C) 159. (D) 160. (D)
26. (A) 27. (B) 28. (C) 29. (B) 30. (A) 161. (A) 162. (D) 163. (B) 164. (B) 165. (A)
31. (B) 32. (D) 33. (B) 34. (B) 35. (A) 166. (A) 167. (A) 168. (B) 169. (A) 170. (A)
36. (D) 37. (B) 38. (C) 39. (C) 40. (C) 171. (C) 172. (A) 173. (A) 174. (C) 175. (D)
41. (D) 42. (A) 43. (C) 44. (A) 45. (B) 176. (B) 177. (D) 178. (B) 179. (D) 180. (D)
46. (B) 47. (C) 48. (D) 49. (A) 50. (B) 181. (B) 182. (C) 183. (B) 184. (C) 185. (A)
51. (D) 52. (A) 53. (C) 54. (D) 55. (C) 186. (C) 187. (C) 188. (A) 189. (A) 190. (B)
56. (D) 57. (D) 58. (A) 59. (D) 60. (D) 191. (B) 192. (A) 193. (C) 194. (A) 195. (D)
61. (D) 62. (D) 63. (D) 64. (B) 65. (D) 196. (C) 197. (D) 198. (D) 199. (C) 200. (D)
66. (A) 67. (A) 68. (A) 69. (C) 70. (C) 201. (D) 202. (D) 203. (A) 204. (C) 205. (A)
71. (A) 72. (A) 73. (A) 74. (A) 75. (D) 206. (C) 207. (B) 208. (C) 209. (A) 210. (D)
76. (A) 77. (A) 78. (D) 79. (A) 80. (C) 211. (A) 212. (B) 213. (A) 214. (A) 215. (A)
81. (B) 82. (D) 83. (A) 84. (C) 85. (C) 216. (D) 217. (A) 218. (A) 219. (D) 220. (B)
86. (C) 87. (D) 88. (D) 89. (C) 90. (D) 221. (C) 222. (C) 223. (C) 224. (A) 225. (A)
91. (D) 92. (D) 93. (D) 94. (C) 95. (C)
226. (C) 227. (D) 228. (D) 229. (A) 230. (D)
96. (C) 97. (D) 98. (C) 99. (C) 100. (C)
101. (A) 102. (B) 103. (C) 104. (B) 105. (A) 231. (A) 232. (B) 233. (C) 234. (D) 235. (A)
106. (C) 107. (D) 108. (C) 109. (A) 110. (D) 236. (B) 237. (A) 238. (A) 239. (A) 240. (B)
111. (D) 112. (C) 113. (B) 114. (A) 115. (C) 241. (A) 242. (A) 243. (A) 244. (A) 245. (C)
116. (D) 117. (B) 118. (B) 119. (D) 120. (D) 246. (D) 247. (D) 248. (A) 249. (A) 250. (B)
121. (A) 122. (D) 123. (A) 124. (A) 125. (D) 251. (A) 252. (C) 253. (B) 254. (B) 255. (D)
126. (C) 127. (B) 128. (A) 129. (A) 130. (D) 256. (C)
●●
UNIT-6
Public Economics
Market Failure and Remedial In order to fully understand market failure, it is
important to recognize the reasons why a market can
Measures fail. Due to the structure of markets, it is impossible for
Market failures is a situation when the voluntary them to be perfect. As a result, most markets are not
exchange process does achieve the allocative efficiency successful and require forms of intervention.
criterion that the value of goods produced equals the Reasons for market failure include—
value of goods not produced. The four types of market
failures are public goods, market control, externalities, ● Positive a n d Negative Externalities— A n exter-
and imperfect information. nality is an effect on a third party that is caused by
the consumption or production of a good or service.
1. Public Goods—These goods causes inefficiency
A positive externality is a positive spillover that
because non-payers cannot be excluded from consump-
results from the consumption or production of a
tion of these goods, which then prevents voluntary
good or service. For example, although public
market exchanges.
education may only directly affect students and
2. Market Control—These type of control occurs schools, an educated population may provide
because limited competition among buyers or sellers positive effects on society as a whole. A negative
prevents the equality between demand price and supply externality is a negative spillover effect on third
price. parties. For example, secondhand smoke may
3. Externalities—Externalities prevent efficiency negatively impact the health of people, even if they
because external costs or benefits mean demand prices do not directly engage in smoking.
or supply prices do not fully reflect the value of goods ● Environmental Concerns—Effects on the environ-
produced or the value of goods not produced. ment as important considerations as well as
4. Imperfect Information—In real world majority sustainable development.
of buyers or sellers do not possess perfect and complete ● Lack of Public Goods—Public goods are goods
information about the quality and quantity of goods, where the total cost of production does not increase
price structure of goods. Like externalities, imperfect with the rise in number of consumers. As an
information also means that demand prices or supply example of a public good, a Nation Highways has a
prices do not fully reflect the value of goods produced or fixed cost of production that is the same, whether
the value of goods not produced. one vehicle or one million vehicle pass on it , its
While markets do a relatively good (that is, efficient) cost does not increase. Public goods can be under-
job of allocating resources under most circumstances, produced; there is little incentive, from a private
when they fail, the ONLY alternative is some sort of standpoint, to provide a national highways because
govern-ment intervention. Intervention might take the one can wait for someone else (normally the
form of direct government provision or production, often government) to provide it, and then use it without
done with public goods. Intervention might be laws or incurring a cost. This problem – someone benefiting
regulation, a common remedy for market control and from resources or goods and services without
imperfect information. Government taxes are another paying for the cost of the benefit – is known as the
method of intervention that is often recommended for free rider problem.
externalities. ● Underproduction of Merit Goods—A merit good
Market failure occurs due to inefficiency in the is a private good that society believes is under
allocation of goods and services. A price mechanism consumed, often with positive externalities. For
fails to account for all of the costs and benefits involved example, education, healthcare, and sports centers
when providing or consuming a specific good. When are considered merit goods.
this happens, the market will not produce the supply of ● Overprovision of Demerit Goods—A demerit good
the good that is socially optimal – it will be over or is a private good that society believes is over
under produced. consumed, often with negative externalities. For
434U | Economics (NET)
example, cigarettes, alcohol, and prostitution are some have external benefits and costs. Many markets
considered demerit goods. have relatively good information available to buyers and
● Abuse of Monopoly Power—Imperfect markets sellers, some markets have limited information available.
restrict output in an attempt to maximize profit. Public Goods
When a market fails, the government usually
intervenes depending on the reason for the failure. Public goods are goods that can be consumed
simultaneously by a large number of people without the
Market Efficiency consumption by one imposing an opportunity cost on
others, what is termed non-rival consumption. They are
Market Efficiency
further characterized by the inability to exclude non-
100 payers from consumption. Non-rival consumption means
90 that public goods are efficiently allocated if provided at
S
80 a zero price, something markets are seldom inclined to
70 do. Moreover, the inability to exclude non-payers gives
60 rise to the free-rider problem, which further inhibits the
Price
50 voluntary exchange of public goods through markets.
40 If markets do attempt the voluntary exchange of
30 public goods, which results in a non-zero market price,
20 then efficiency is not achieved. A non-zero market price
10 means there is no equality between the value of goods
D
0
produced and the value, or opportunity cost, of goods
200 400 600 800 not produced, which is zero due to non-rival
Quantity consumption.
Common examples of public goods include national
Fig. 1. defense, public health and environmental quality,
Before discussing the specific to the failings of national highways, schools, parks etc. In each case
markets, first consider perfection in the form of market consumption by one does not impose an opportunity cost
efficiency. Efficiency in the allocation of resources is on others and non-payers cannot be excluded from
achieved when value received is equal to value foregone. consumption. And in each case, markets fail to
With this equality, value cannot be increased by efficiently allocate the production, consumption, or
changing the allocation of resources. provision.
Figure 1. Illustrates a typical market. Equilibrium is Closely related to public goods are near-public
achieved at a market price of R 50 and quantity of 400. goods and common-property goods that share one but
In a perfect world, with a perfect market, the demand not both of the key characteristics of non-rival
price fully reflects the value of the good produced and consumption or the inability to exclude non-payers.
the supply price fully reflects the value of goods not ● Near-public goods, like public goods, are non-rival
produced. Because demand price is equal to supply price in consumption, but non-payers can be excluded.
at the equilibrium price of R 50, efficiency is also Non-rival consumption means efficiency is
achieved at equilibrium. achieved if near-public goods are provided at a zero
Following conditions must be achieved to achieve price, which markets don't do.
efficiency in the market—
● Common-property goods, like public goods, are
● First—The market must be competitive. Competi- characterized by the inability to exclude non-payers,
tion among buyers and sellers is what creates but are rival in consumption. Non-rival
equality between demand price and supply price. consumption means efficiency is achieved if
● Second—The market must not have any benefits or markets are used for exchange, but such is not
costs external to the market. The demand price must possible with the inability to exclude non-payers.
reflect all value generated from a good and the
supply prices must reflect all opportunity cost of Market Control
foregone production. Market control arises when buyers or sellers are
● Third—The market buyers and sellers must have able to exert influence over the price of a good and/or
complete (ideally, perfect) information about prices the quantity exchanged. The ability to control the
and alternatives. market, especially the market price, prevents a market
While many markets closely approximate these from equating demand price and supply price.
three conditions, few conform perfectly. Many markets Market control on the supply side allows sellers to
are highly competitive; some have limited competition set a demand price, the value of the good produced,
among either buyers or sellers. Many markets fully above the value of goods not produced. An extreme
reflect the value of goods produced in the demand price example of market control on the supply side exists with
and the value of goods not produced in the supply price, monopoly, a market with a single seller. A less extreme,
Economics (NET) | 435U
but more common example is oligopoly, a market with a Remedial Measures to Control Market
small number of large sellers. Failures
Market control on the demand side allows buyers to Should markets fail for one or more of these
set a supply price, the value of goods not produced, reasons, governments are often called into action. The
below the value of the good produced. An extreme very existence of governments is largely attributable to
example of market control on the demand side exists the market failure of public goods. The scope of modern
with monopsony, a market with a single buyer. A less governments has expanded over the years to address
extreme, but more common example, is oligopsony, a other market failures.
market with a small number of large buyers.
Governments have three key tools for addressing
Common examples of markets with supply-side or the market failures of public goods, market control,
demand-side control include city-wide electrical externalities, and imperfect information.
distribution (monopoly), automobile manufacturing
● Direct Provision—A common method used by
(oligopoly), employment in a company town
(monopsony), and employment in professional sports governments to address the market failure of public
(oligopsony). goods is direct provision. That is, governments
oversee the production of public goods and/or their
Externalities distribution to the public. This alternative is most
An externality exists if a benefit is not included in obvious with national defense. The national
the demand price or a cost is not included in the supply government hires military personnel, purchases
price. This means that the demand price does not reflect armaments and equipment, maintains military bases,
the complete value of the good produced or the supply and generally oversees the operations of military
price does not reflect the complete value of goods not actions. Governments are also inclined to directly
produced. As such, market equilibrium does not achieve provide goods failing from market control, so called
an efficient allocation. public utilities that include water distribution,
electricity generation, and trash collection.
A noted externality example is pollution. The
● Regulation—A second noted method is the regula-
emission of residuals in the production or consumption
tion of production, consumption, and exchange
of goods imposes opportunity costs on others not
decisions undertaken by the private sector—busi-
involved in the market exchange. In this case the supply nesses and consumers. That is, governments set the
price in the market does not include all opportunity costs rules of the game, a task they generally undertaken
of production, the omitted costs are those imposed on for society, but in this case the policies are directed
others harmed by the pollution. specifically to the correction of market failures.
On the benefit side, education provides an example Government regulations are commonly used to
of an externality. The benefits of education extend address the market failures of market control,
beyond those receiving the education and thus beyond externalities, and imperfect information. For
the market exchange. In this case the demand price in example, the price of a firm with significant market
the market does not include the full value of the good control might be regulated by government.
Government might restrict the amount of pollution
production, the omitted value is that received by others
emissions from a particular productive activity.
benefitting from the education. Regulations requiring sellers to provide information
Imperfection Information to buyers is a means of addressing the market
failure of imperfect information.
The lack of information among buyers or sellers
● Taxes—A third alternative is to make use of
often means that the demand price does not reflect all
coercive government taxes. That is, governments
benefits of a good or the supply price does not reflect all
impose to create disincentives and thus discourage
opportunity costs of production. That is, buyers might be undesirable activities. Taxes are well-suited for
willing to pay more or less for a good because they don't controlling externalities or encouraging the
know the true benefits generated. Or sellers might be provision of information. For example, an industry
willing to accept more or less for a good than the true that creates a pollution externality can be
opportunity cost of production. encouraged to efficiency if government imposes a
In many cases, sellers have better information about tax equal to the external cost. Alternatively,
a good those buyers. Sellers own and control the good, government subsidies, effectively negative taxes,
they have direct contact with the good. If there are can be used to encourage activities and address the
defects or problems with the good, they are likely to market failure external benefits.
know. Buyers, in contrast, have much less familarity
with a good, perhaps only knowing the information Government Inefficiencies
provided by the sellers. In this case, buyers are likely to While market failures can be corrected, in principle,
have a different demand price than the value of the good only through some sort of government action,
produced, a value based on more complete information. government intervention neither guarantees a solution
436U | Economics (NET)
nor an efficient allocation of resources. The reason is more valuable to a non-investment professional, such as
that governments are also imperfect. Governments have a farmer, who may be interested in confidently trading
their own set of inefficiencies. stocks, to prepare for retirement.
Some of the key government inefficiencies are One alternative to ever-expanding asymmetric
following : information is for workers to study all fields, rather than
● Voter Apathy—The whole point about efficiency specialize in fields where they can provide the most
and addressing the scarcity problem is to get the value. However, this is an impractical solution, with
most satisfaction from available resources. When high opportunity costs and potentially lower aggregate
people don't vote, leaders don't know what really outputs, which would lower standards of living.
satisfies the public. Another alternative to asymmetric information is to
● Special Interest Groups—In a related matter, make information abundantly and inexpensively
when some people don't vote, those who do vote available through the internet and other data sources.
have a greater influence over an election. Leaders Disadvantages of Asymmetric Informa-
seek to provide satisfaction for those special interest
groups with the greatest influence. And such groups
tion
do not necessarily promote what is best for the In some circumstances, asymmetric information
entire economy. may have near fraudulent consequences, such as adverse
selection, which describes a phenomenon where an
● Re-election Minded Politicians—Leaders who
insurance company encounters the probability of
only need to please a majority of those who vote can
extreme loss due to a risk that was not divulged at the
largely ignore the interests of others. Once again,
time of a policy's sale. For example, if the insured hides
any resulting economic policies are not necessarily
the fact that he's a heavy smoker and frequently engages
in the best interest of the entire economy.
in dangerous recreational activities, this asymmetrical
● Complex Bureaucracies—Those who work in the flow of information constitutes adverse selection and
large, complex bureaucracies that tend to make up could raise insurance premiums for all customers,
governments might not be held responsible for their forcing the healthy to withdraw. The solution is for life
actions, especially those actions that carry out insurance providers is to perform thorough actuarial
economic policies. Even the "best" economic work and conduct detailed health screenings, and then
policies might not be effectively carried out by charge different premiums to customers based on their
government employees. honestly-disclosed risk profiles.
Asymmetric Information Regulation of Market – Collusion and
Asymmetric information, also known as "informa- Consumers’ Welfare
tion failure", occurs when one party to an economic In economics, collusion occurs when rival firms
transaction possesses greater material knowledge than agree to work together, e.g. setting higher prices in order
the other party. This typically manifests when the seller to make higher profits.
of a good or service possesses greater knowledge than
y
the buyer, however, the reverse dynamic is also possible.
Almost all economic transactions involve information MC AC
asymmetries.
Asymmetric information is the specialization and
division of knowledge, as applied to any economic trade. P2
For example, doctors typically know more about
medical practices than their patients. After all, P1
physicians have extensive medical school educational
backgrounds that their patients generally don't have.
This principle equally applies to architects, teachers,
police officers, attorneys, engineers, fitness instructors, AR
and other trained professionals. MR
x
Q2 Q1
Economic Advantages of Asymmetric
Information In the above example, a competitive industry will
Asymmetric information isn't necessarily a bad have price P 1 and Q1 competitive. If firms collude, they
thing. In fact, growing asymmetrical information is the can restrict output to Q2 and increase price to P2 .
desired outcome of a healthy market economy. As Collusion usually involves some form of agreement
workers strive to become increasingly specialized in to seek higher prices. This may involve—
their chosen fields, they become more productive, and ● Agreeing to increase prices faced by consumers.
can consequently provide greater value to workers in ● Deals between suppliers and retailers. For example,
other fields. For example, a stockbroker's knowledge is vertical price fixing e.g. retail price maintenance.
Economics (NET) | 437U
● Monopsony pricing – where retailers collude to Public Revenue
reduce the amount paid to suppliers.
● Collusion between existing firms in an industry to Sources of Public Revenue
exclude new firms from deals to prevent the market There is a distinction between public receipts and
becoming more competitive. public revenue. While public receipts includes income
● Sticking to output quotas. from all sources, public revenue is narrower concept
and does not include public borrowings, income from
● Collusive tendering. For example, ‘cover prices’ for
the sale of public assets, or income from the use of
competitive tendering in bidding for public
printing press.
construction contracts. This is when a rival firm
agrees to set artificially high price to allow the firm Public revenue is divided into two parts : tax
of choice to win with a relatively high contract revenue and non-tax revenue.
offer. (1) Tax Revenue—Tax revenue is divided into
Types of Collusion three sections—
(i) Tax on Income and Expenditure—This
● Formal Collusion—When firms make formal sections covers corporation tax, income tax, expenditure
agreement to stick to high prices. This can involve tax and similar other taxes.
the creation of a cartel. The most famous cartel is
(ii) Taxes on Property—Under this section estate
OPEC – an organisation concerned with setting
duty, wealth tax, gift tax, etc., are considered.
prices for oil.
(iii) Indirect Tax—This section includes taxes
● Tacit Collusion—Where firms make informal on commodities and services such as customs duties,
agreements or collude without actually speaking to excise duties, etc.
their rivals. This may be to avoid detection by
government regulators. (2) Non–Tax Revenue—Non-Tax Revenue is
similarly divided into three sections—
● Price Leadership—It is possible firms may try to
unofficially collude by following the prices set by (i) Receipts of currency notes, coinage and mint.
a market leader. This enables them to keep prices (ii) Interest receipts on loan by the central
high, without ever meeting with rival firms. This government, dividends and profits from public sector
kind of collusion is hard to prove whether it is undertakings and contribution from railways and posts
unfair competition or just the natural operation of and telegraphs.
markets. (iii) Revenue from various government activities
and services such as from administrative service, police,
Problems of Collusion transport and communications, public works, etc.
Collusion is seen as bad for consumers and
economic welfare, and therefore collusion is mostly Taxation
regulated by governments. Collusion can lead to : A tax is a compulsory levy and those who are taxed
● High prices for consumers. This leads to a decline in have to pay the sums irrespective of any corresponding
consumer surplus and allocative inefficiency (Price return of services or goods by the government.
pushed up above marginal cost) A tax is a liability imposed upon the tax assessees
● New firms can be discouraged from entering the who may be individuals, group of individuals, or other
market by types of collusion which act as a barrier legal entities. It is a liability to pay an amout on account
to entry. of the fact that the tax assessees have income of a
● Easy profits from collusion can make firms lazy and minimum amount and from certain specified sources, or
avoid innovation and efforts to increase that they own certain tangible or intangible property or
productivity. that they carry on certain economic activities which have
● Industry gets the disadvantages of monopoly (higher been chosen for taxation.
price) but none of the advantages (e.g. economies of
scale)
Nature (Elements) or Characteristics of
Taxes
Justification for Collusion The elements of taxes can be explained in terms of
● In times of unprofitable conditions, collusion may its four important characteristics as follows :
be a way to try and save the industry and prevent
firms going out of business, which wouldn’t be in 1. Compulsory Contribution—Tax is a compulsory
the long-term consumer interest. Dairy suppliers contribution from the people to the government to defray
tried to use this justification in 2002/03 after the expenses incurred in common interest.
problems from foot and mouth disease on farm 2. No Quid Pro Quo—A public receipt containing
incomes. an element of compulsion does not automatically
● Research and development. Profits from collusion become a tax. In order to be a tax, the absence of a quid
could, in theory, be used to invest in research and pro quo is necessary. There is no proportionate return
development. promised by the government to the tax payer.
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3. Personal Obligation—Tax is the duty of the tax– (ii) Canon of Certainty—The tax which each
payer to pay the taxes he is liable to pay. It imposes a individual is bound to pay ought to be certain, and not
personal obligation on the tax payer. arbitrary. The time of payment, the manner of payment,
4. General Benefit—Taxes collected by the the quantity to be paid, ought all to be clear and plain to
government are spent by it for the general welfare of the the contributor.
people. (iii) Canon of Convenience—The mode and
The Base of a Tax timings of tax payment should be, so far as possible,
convenient to the taxpayer.
The base of tax is the legal description of the object
with reference to which the tax applies. For example, the This canon recommends that unnecessary trouble
base of an income tax is the income of the assessee to the tax-payer should be avoided, otherwise various
defined and estimated in terms of certain rules laid down ill-effects may result.
for this purpose. The base of each tax has to be defined (iv) Canon of Economy—The cost of collection
legally and it is to be quantified for the purpose of of taxes should be minimum possible.
determining the tax liability of an individual tax payer.
A few more canons of taxation have been suggested
A tax base may have a dimension also. For by other economists in addition to Adam Smith’s four.
example, income tax is usually on an annual basis and (v) Canon of Productivity—Taxation should have
the law has to decide whether income would be taxed on productivity. The productivity of a tax may be observed
the basis of accrual or receipt. in two ways. First, the tax system should be able to yield
If new items are brought under taxation, we say the enough revenue for the government to meet its expenses
base of taxation has been widened. and requirement. Second, taxes should be imposed in
Buoyancy and Elasticity of a Tax such a manner as not to obstruct and discourage
If a tax revenue increases with the growth of its production.
base, but without an extension of the tax coverage or an (vi) Canon of Buoyancy and Elasticity—The
upward revision of the tax rates, then the tax is said to be canon of buoyancy implies that the tax revenue should
buoyant. For example, with given rates of income tax have an inherent tendency to increase along with an
and the definition of taxable income, if yield from increase in national income, even if the rates and
income tax increases as national income increases, it coverage of taxes are not revised.
would be termed as buoyant. Canon of elasticity stresses the fact that the yield of
The yield of a tax may also go up on account of the taxes can be easily increased or decreased according
extension of its coverage or a revision of its rates. Such a to the needs of the government.
characteristic of a tax is referred to as its elasticity. In (vii) Canon of Flexibility—It should be possible
other words, elasticity of a tax refers to its respon- for the tax authorities to easily revise the tax structure,
siveness to steps taken by authorities in increasing its both with respect to the coverage and rates, to suit the
yield through on extension of its coverage or revision of changing requirements of the economy and the govern-
its rates. Numerically, the elasticity of a tax is measured ment.
by the ratio of proportionate change in its yield to the
proportionate change in its coverage or rates. (viii) Canon of Simplicity—A tax should easily be
understood by the tax payer, i.e., its nature, its aim, time
Canons of Taxation of payment, method and basis of estimation should all be
A good tax system, in order to achieve various easily followed by each tax payer. The tax system
objectives, chooses and adheres to certain principles should not be too complicated.
which become its characteristics. Adam Smith gave us
(ix) Canon of Diversity—State should not depend
the most important set of principles, which he called the
upon too few a source of public revenue. If the tax
canons of taxation.
revenue comes from diversified sources, then any
The four canons of taxation as prescribed by Adam reduction in tax revenue on account of any one cause is
Smith are the following : bound to be very small. However, too much multiplicity
(i) Canon of Equality—This canon tries to observe of taxes is also to be avoided.
the objective of economic justice. It indicates that in
absolute terms the richer should pay more taxes. Two (x) Canon of Expediency—A tax should be based
possibilities emerge. If incomes are subject to constant on sound principles so that it requires no justification
marginal utility, then both the rich and the poor should from the side of the government and is not subject of
be subjected to proportional taxation–each person paying any criticism from the public. Tax payer should have no
a given percentage of his income as tax. On the other doubt about its desirability.
hand, if we agree with the more realistic proposition (xi) Canon of Co-ordination—There must be co-
that income is subject to diminishing marginal utility, ordination between different taxes that are imposed by
then the richer should pay a large proportion of their various tax authorities, i.e., central, state and local
incomes as taxes, i.e., the taxes should be progressive. governments.
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Classification of Taxes (ii) Administrative Aspect—Generally, direct taxes
Taxes can be classified on the basis of form, nature, are considered more costly than indirect taxes in
aim and methods of taxation. The following classifica- collecting taxes. Administration can not approach each
tions are commonly found in the modern tax system : individual through direct taxes. Hence, from the point of
view of administrative cost, indirect taxes are considered
1. Single and Multiple Taxes—A tax system
superior to that of direct taxes.
comprising of only one tax is known as single tax
system. Single tax system has been advocated in at times (iii) Effect on Redistribution—Direct taxes are
in the past. One simple form of a single tax is the poll considered as an important instrument to remove inequa-
tax, or the head tax which is imposed on a person lities of income and wealth, as they are generally
simply because he is there in the society and not because progressive in nature. On the other hand, indirect taxes
he has an income, or wealth, or is following any fall on all incomes, and hence, they are generally
particular trade or profession etc. Another form of a regressive in nature. Therefore, indirect taxes are
single tax was advocated by the physiocrats of France in generally not suitable from the point of view of
the 18 th century. They advocated that the state ought to removing inequalities of income and wealth.
levy a tax only on agriculture and nowhere else. Single 3. Ad Valorem and Specific Taxes—Ad valorem
tax system has several problems including, for example, tax is a kind of indirect tax which is expressed as
the identification and choice of an appropriate single tax, proportion of the price of a commodity. Hence, it is
the determination of rate schedule, the adequacy and levied on the value of commodity.
growth of revenue, and its role in promoting national A tax of an absolute amount levied per unit of a
objectives. commodity sold or produced is known as specific tax.
Under multiple tax system more than one tax are
4. Progressive, Proportional, Regressive and
levied with different tax base and rate. Income of a
Degressive Taxes. Proportional tax is a tax which is
modern economy originates from many sources. It
levied at the same rate at all income levels. A tax is
would be highly unjust to tax income originating from
any one source and leave out others. State should tax all called progressive when the rate of taxation increases as
the important sources of income in an equitable manner. the tax payer’s income increases. In this system the rate
of tax goes on increasing with every increase in income.
2. Direct and Indirect Taxes—A direct tax is
really paid by a person on whom it is legally imposed, A tax which takes a decreasing proportion of
while an indirect tax is imposed on one person, but paid income as income rises is known as regressive tax. In
partly or wholly by another, owing to a consequential this system the rate of tax falls with increase in income.
change in the terms of some contract or bargaining Lower income is taxed at high rate, whereas higher
between them. In other words, direct taxes are those income is taxed at a lower rate.
taxes levied immediately on the property and income of Taxes which are mildly progressive, hence not very
persons, and those that are paid directly by the steep, so that high income do not make a due sacrifice,
consumers to the state. Income tax, interest tax, wealth such taxes, on the basis of equity, are called degressive
tax, corporation tax are all examples of direct taxes. tax. In degressive taxation, a tax may be slowly
Indirect taxes are those that affect the income and progressive upto a certain limit, after that it may be
property of persons through their consumption expendi- charged at a flat rate.
tures. Customs duties, excise duties, sales tax, service
tax are all examples of indirect taxes. Indirect taxes are
Value Added Tax (VAT)
levied on the goods and services which people consume. VAT was adopted through historical evaluation by
Comparison of Direct and Indirect Taxes—Direct France in 1954 to replace turnover taxes. Since 1967
and indirect taxes are now compared on the basis of (i) other countries of the European Economic Community
allocation of resources, (ii) administration of taxes, and (EEC) also started opting for VAT. It is in use in some
(iii) effects on redistribution of income. underdeveloped countries as well. In India, it was
(i) Resource Allocation— An indirect tax is introduced on the recommendation of the Jha Committee
expected to cause a shift in the relative prices of goods (1978).
and therefore bring about a resource allocation which Meaning of VAT—Value added tax is levied on the
would be different from the allocation achieved by free sellers of goods and services based on value added by
market mechanism. If we assume that the resource them. According to L.K. Jha Committee, VAT in its
allocation in the absence of any tax is already optimum, comprehensive form is a tax on all goods and services
then an indirect tax would cause a distortion in it and (except export and government servcies), its special
would be burdensome to the economy. On the other characteristics being that it falls on the value added at
hand, a direct tax is expected to let the relative prices each stage from the stage of production to retail stage.
remain unchanged and therefore be neutral regarding The basic difference between VAT and a sales tax is
resource allocation. Thus, indirect taxes cause a greater that the tax liability under VAT is split up into stages.
distortion in the allocation of resources and for that Theoretically, the tax liability in the case of VAT and in
reason indirect taxes are more burdensome than direct the case of sales tax at the retail level should turn out to
taxes. be the same. This is because the total retail price is
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nothing but the value added to the raw materials at (iii) Minimum Scope for Tax Evasion—VAT
different stages of production and trade. minimises scope for tax evasion because : (a) the tax is
Forms of VAT—There are two important varieties divided into parts and therefore the incentive to evade
of VAT: the consumption variety and income variety. tax by any one firm is reduced, and (b) it is in the
The difference between these two varieties emerges interest of a firm to account for the taxes paid by earlier
from the treatment of capital depreciation. If a firm is firms through which the inputs have come. If any firm
allowed to deduct the entire credit when the capital understates its output, it will be caught by the
equipment is purchased, the system is termed as disclosures of the firms buying inputs from it.
consumption VAT. If the firm is allowed to deduct the (iv) Conducive to Efficiency—It is claimed that
credit as the equipment depreciates over time, the VAT is conducive to efficiency since a firm is not
system is termed as income VAT. exempted from its tax liability even if it runs into a loss.
Carl S. Shoup distinguishes between four possible It pays a tax not on its profits but on the value produced.
varieties of VAT. It, therefore, tries to improve its performance, and
1. Production VAT—In this variety of VAT to reduce the cost of production.
arrive at the value added by a firm, the value of the Demerits of VAT—VAT has some serious limita-
inputs purchased by it from other firms is not deducted tions which are as follows :
in full. Only the value of non-capital purchase is (i) Complicated System—In theory, it is a single
deducted. uniform rate tax without any exemption, but in practice,
No depreciation is allowed on the purchases of it has got to be multi-rate system with exemption to
capital goods even in subsequent years. For the economy certain industries. It is necessary that the country
as a whole, the value added becomes equal to the gross adopting it should also be sufficiently advanced in its
national product (GNP). The tax base for any firm financial and economic structure and the firms should be
will be just sales minus materials. in the habit of keeping proper accounts.
2. Consumption VAT—In this, the firm is allowed (ii) Less Revenue to the State—Unless the rates of
to deduct from gross value added not only the non- VAT are extraordinary high, the state would end up with
capital inputs but also the capital equipment so a smaller tax revenue as against the collection from sales
purchased. Therefore, aggregate base becomes GNP-I tax.
(investment), that is consumption in the economy. (iii) Maintaining Costly Accounts—VAT forces
All the European countries which have adopted traders to maintain elaborate and costly accounts. This
VAT have chosen the consumption variety. becomes uneconomical, especially for the smaller firms.
3. Wage-Type VAT—Under this system, the firm Theories of Taxation (The Division of
is able to deduct the net earnings from its capital in order Tax Burden)
to arrive at the tax base. Since earnings from capital Several theories have been advanced from time to
amount to profits plus interest, therefore, the balance time for achieving the principle of justice in taxation.
left to be taxed is equivalent to wages. Therefore, this 1. Physiocratic Theory—This is the earlier theory
variety of VAT is called wage-type VAT. regarding taxation and this is based on the view that
4. Income-Type VAT—Under this variety, the firm land is capable of producing a net surplus. Physiocrates
is allowed to deduct the full value of its non-capital maintained that agriculture alone could yield a net return
purchases from other firms and a depreciation on the and could add to the wealth of the country and hence
capital purchases from other firms. This gives proper net recommended that revenue of the state should be derived
value added. For the economy as a whole the aggregate from a single direct tax levied upon land.
tax base would be the net national product (NNP). In 2. Financial Theory—Financial theory of taxation
other words, the tax base is sales proceeds minus aims at obtaining maximum amount of revenue rather
materials used minus depreciation. The income variety is than on proper distribution of burden of taxation. The
the most complicated of all the varieties though greatest danger in following this theory is that the
logically it has a greater appeal. burden of taxation may fall mainly on week and
voiceless people rather than on rich and vocal.
Merits of VAT—Following are the main advantages
of VAT : 3. Horizontal and Vertical Equity Theory—
Equity involves two aspects : the treatment of people in
(i) Simple—It is easier to assess tax liability of a like and unlike circumstances. The like circumstances
firm by using the credit method. There is also a greater implies that those, who are equally well off should pay
scope for cross checking of returns submitted by firms. equal amount as taxes. It is called horizontal equity.
(ii) Neutral in Resource Allocation—A general The unlike circumstances implies that the people in
VAT is supposed to be neutral to the resource allocation, dissimilar circumstances should be subjected to
forms of production and business organisation. VAT is dissimilar treatment, i.e., the persons who are better off
also neutral between factor costs, because it taxes all should pay more as taxes than others. This is called
value added. vertical equity.
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4. Cost of Service Theory—This theory emphasizes expenditure process for the satisfaction of social wants
the semi-commercial relationship between the state and is determined by a competitive process similar to that
the citizens to a greater extent. The implication is that which applies in private goods market. Thus, Lindhal
the citizens are not entitled to any benefits from the state provides an answer to two out of three questions posed
and if they do receive any, they must pay the cost above. It shows the optimal level of state activity and
thereof. Thus, according to this theory, the basis of allocating tax burden among the tax payers.
taxation should be the cost incurred by government on
different services for the benefit of the individual tax –
payers.
5. The Benefit–Received Theory—According to
this theory, the state provides various goods and services
to the members of the society and they contribute to the
cost of these supplies in proportion to the benefits
received. The relationship between the tax-payer and the
state is in quid pro quo terms. It is on exchange
relationship.
Lindahl’s Solution—The most formal and rigorous
formulation of the benefits–received approach was
6. Ability to Pay Theory of Taxation—According
provided within a framework of voluntary exchange
to this theory, each person should contribute to the State
theory of public finance by Erik Lindahl.
in proportion to his ability to pay. The basic tenet of the
Lindahl took the case of two individuals by ability to pay doctrine is that the burden of taxation
assuming that they constitute the society and then tried should be shared among the members of society so as to
to work out the optimum level of state activities and the satisfy the principles of justice and equity.
corresponding equilibrium division of the tax burden There are two approaches for measuring ability to
between the two individuals. pay–subjective approach and objective approach.
Lindahl ignores the problem of equitable distribution (A) Objective Approach of Ability—In the
of income as such and keeping that distribution as it is, objective approach, the faculty theory has been evolved
he proceeds to discuss the solution of three problems.
to measure ability to pay.
The first one is the decision about the extent of the state
activity, i.e., its expenditure and taxation level. The (i) Property as an Index of Ability to Pay—
second one is that of allocating the total public Accumulated wealth and property was considered as the
expenditure amongst various good and services. The index of ability to pay a tax rather than income. By
third one is the allocation of the tax burden amongst the itself, however, it is not an adequate index. It is at the
tax – payers. most an index supplementary to other indices because of
following reasons : (a) All property do not yield income.
Lindahl’s theory can be explained with the help of (b) The income from property is not continuous.
the diagram.
(ii) Consumption Expenditure—Prof. Fisher and
On the left vertical axis, we measure the percentage Prof Kaldor advocated taxation on expenditure. It has
of total cost contributed by A and on the right vertical been argued that the consumption expenditure is a better
axis (inverted scale) we measure the percentage of total index to measure the ability to pay than income and
cost contributed by B. on the horizontal axis, we wealth which can be manipulated to evade by the tax
measure the quantity of social goods. The curve a 1 a 1 payers. Though various arguments can be put forth in
represents the demand schedule for A. Tax payer A is favour of consumption expenditure as an index of ability
willing to pay 100 per cent cost of output OG, he be to pay, this is not likely to be a satisfactory index at all.
willing to pay 50 per cent for OC. The curve b1 b 1 is a It is very difficult index to construct with a still more
similar demand schedule for B, the cost is measured now difficult tax to administer.
by the inverted scale of percentage contributions on the
right axis. (iii) Income Index of Ability—Income is one of the
most accepted indices of ability to pay, though it is
B is willing to contribute 100 per cent cost of usually supplemented by other tax indices also. Income
output, this amount is available free to A and B is itself, from the point of view of ability to pay, is subject
willing to contribute 75 per cent of OG. This amount is to different interpretations. There are various practical
available to A at 25 per cent of the cost of the output and difficulties also. However, of the various indices
so forth. available, this is the most acceptable single index.
The equilibrium output remains at OE where a 1 a1 According to this theory, a person receiving a larger
and b 1 b 1 intersect and both shares add up to 100 per income should pay larger tax bill and vice-versa. Income
cent. Here A contributes ED, B contributes DH per cent. may be divided into two parts: (a) earned Income, and
Lindhal concludes that both parties will vote for (b) unearned income. Unearned income includes capital
large amount, till until OE is reached. Thus, the revenue gains etc, and be subjected to heavier taxation.
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(B) Subjective Approach of Ability to Pay— least aggregate sacrifice is the superior principle of tax
The subjective approach is based on the psychological distribution, not because it is equitable, but because it is
or mental reactions of the tax payers. This appraoch derived directly from the basic utilaterian principle of
proceeds on the assumption that a tax payer undergoes a maximum happiness. According to this approach, the tax
hardship or suffers a sacrifice by paying the tax. It is burden should be apportioned in such a way that the
also assumed that a tax payer’s sacrifice depends upon marginal utility of income left after tax with any tax
his own tax liability and is not affected by the tax payer would be the same. It implies that the aggregate
liability of others. sacrifice imposed on the community by the taxation
In the subjective approach, we estimate the burden should be the least possible.
felt by the tax-payer or the sacrifice undergone by him. It implies that marginal sacrifice and not the total
Each tax payer should make equal sacrifice, if tax sacrifice for the different tax payers should be the same,
burden is to be evenly distributed. Equity approach will so that aggregate sacrifice for the community as a whole
dictate that each tax-payer should be made to undergo will be the least.
same amount of sacrifice irrespective of his income etc.
Equity approach consists of three interpretations: (i) Taxable Capacity
equal absolute sacrifice, (ii) equal proportional sacrifice Meaning of Taxable Capacity—Taxable capacity
and (iii) equal marginal sacrifice. refers to the maximum capacity that a country can
(i) Equal Absolute Sacrifice—This implies that contribute by the way of taxation both in ordinary and
different tax-payers are made to sacrifice the same extra–ordinary circumstances. The concept of taxable
amount of utility by way of taxes. In other words, the capacity is an expression of the common belief that there
utility of income before tax and the utility of income is always an upper limit to the level of taxation, though
after tax is the same for every tax payer. Thus, equal there has never been any agreement as to this limit. The
absolute sacrifice would require that persons with higher term taxable capacity refers to the sacrifice the commu-
income should pay more than those who have lower nity is able to sustain.
income in such a way that the sacrifice for each
individual is the same. But we still have to investigate The term taxable capacity can be stated in two
whether tax rates should be regressive, proportional or senses : (i) Absolute taxable capacity, and (ii) Relative
progressive. taxable capacity.
We may assume that the marginal utility of income (i) Absolute Taxable Capacity—It refers to a
are identical for all. If now we further assume that the single community and implies that the maximum
marginal utility of income is constant then it follows that amount that can be collected from a community without
each tax payer should pay the same absolute amount of causing any unpleasant effects.
income as tax, i.e., regressive taxation. On the other Relative Taxable Capacity—It is related to the two
hand, if the marginal utility of income falls as income or more communities. It refers to the taxable capacity of
rises, then tax amount will have to increase to represent one community as compared to that of another. It refers
the same amount of sacrifice, i.e., proportional taxation. to the proportion in which two or more nations or states
If the marginal utility of income falls a rate faster than in a federation should contribute to the common
the increase in income, then the equal absolute sacrifice expenditure through taxation.
will require progressive taxation. When the term taxable capacity is used, it always
(ii) Equal Proportional Sacrifice—According to implies to absolute taxable capacity.
this approach, each tax payer is supposed to sacrifice
It can concluded that the limit of taxable capacity is
the same percentage of the total satisfaction which he
not absolute or fixed, but it may vary from time to time
would have derived from his income. It means that the
in the same country and from country to country at the
satisfaction lost in terms of tax payment bears the same
same time.
proportion to the satisfaction from the pre-tax income in
each case. Factors Determining Taxable Capacity—Taxable
If the marginal utility of income remains unchanged, capacity depends on the following factors :
then equal proportional sacrifice would call for a (i) Income and Wealth Distribution—Income and
proportional taxation. On the other hand, if the marginal wealth distribution of the community will have an
income utility falls and if the decline in marginal utility important bearing upon the capacity, since it will affect
is of the same rate as the decline in the average utility the marginal utility of income and wealth and hence the
then proportional tax will satisfy this objective. If the sacrifice which the tax payers will have to bear.
fall in the marginal utility is at a rate faster than the fall (ii) Pattern and Rate Structure of Taxation—The
in the average utility, progressive taxation will be called pattern and rate structure of taxation and the mode
for. If the fall in the marginal utility is at a rate smaller of tax collection are important variables to influence
than the fall in average utility, then regressive taxation the taxable capacity. Taxes on unearned increments,
will be needed to satisfy this criterion. windfalls and capital gains are not expected to worsen
(iii) Equal Marginal Sacrifice (Least Aggregate the tax payers’ position as compared to the one in the
Sacrifice)—Edgeworth and later Pigou concluded that base period.
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(iii) Income Stability—The taxable capacity is Theories of Tax Shifting—There are mainly three
higher in those countries where income is stable. Income theories of tax shifting–(i) The concentration theory, (ii)
of the people is more stable in industrially developed the diffusion theory, and (iii) the demand and supply
countries than in agricultural countries. Agriculture is theory.
more easily influenced by some exogenous factors, such (i) The Concentration Theory—It was advocated
as monsoon, which in turn affects the income of by the Physiocrates and the classical economists. This
agriculturists and revenues of the government. Hence, approach maintains that there is an inherent tendency for
the taxable capacity of agriculture based countries is less the taxes to be absorbed by certain income classes.
than in industrial countries. Classical economists stated that there are two
(iv) The Nature of Public Expenditure—If the surpluses in the economy, namely, rent and profit.
public authorities are helping the economy through Accordingly, all tax incidence would get concentrated
capital accumulation, provision of social overheads, on these two surpluses and would be absorbed by these.
improving the productive efficiency of labour, encou- If, for example, a tax is impaired upon wages, the
raging the adoption of better techniques of production workers will have to be compensated through additional
and so on then taxable capacity will improve. money wages to give them a real subsistence. Those
(v) Psychology of the Tax-payers—People are who are appropriating profits will not be able to shift the
willing to undergo more sacrifices during war which tax incidence.
they believe to be a just one. Citizens who are more (ii) The Diffusion Theory—Some economists have
fervent in their religious and social obligations are ready maintained that because of the constant interaction of
to bear more taxes for financing such activities. sales or purchase transactions, eventually it becomes
Significance of the Concept of Taxable impossible to trace the final incidence of any tax and
Capacity—The concept of taxable capacity enables us that in reality all taxes get diffused in the economic
to know that how much money can be collected from the system. The assertion that the taxes get diffused in the
people to finance extraordinary expenditure like war. It economy is obviously based upon the implicit
may prevent a government from imposing unnecessary assumption that the market is sufficiently competitive.
taxes which may have adverse effects upon production (iii) Demand and Supply Theory—According to
and consumption. The concept may also be useful for this theory, tax incidence can be shifted only through
the purpose of comparison of the burden of taxation as sale and purchase transactions and only through a
between different states of a federal government. revision of the prices. A price revision is possible and is
determined by the relative values of demand and supply
The Impact, the Incidence and the elasticities. A tax can therefore, be shifted only through
Shifting of a Tax a shift in the demands and (or) supply curve and the
Impact of a tax is its first point of contact with the sharing of the incidence will be determined by the
tax payers. It is upon those who bear the first demand and supply elasticities. The tax burden will be
responsibility of paying it to the authorities, that is those shared between the buyer and seller in the ratio of the
who have the statutory responsibility of paying it to the elasticities of supply and demand.
government. The share of the tax borne by the seller will be the
Incidence of a tax is defined as its final resting larger if the elasticity of demand is larger, and the share
place. It is to be seen and judged in terms of the money of the tax borne by the buyer will be the larger if the
burden of the tax. Thus, the incidence of a tax is upon elasticity of supply is larger.
those economic unit which finally bear the money
burden of it and which are not able to pass it on to Incidence of Some Particular Taxes
others. (i) A Tax on Monopoly—A monopolist fixed the
Any particular (indirect) tax is likely to be borne by output and supply price of his product so as to get the
a large number of economic units through the means of maximum possible profits, which in turn are given by a
shifting of a tax. The task of tax shifting passes through position where marginal cost equals the marginal revenue
several stages and the final incidence of a tax can be (MC = MR). Now, if a tax is imposed upon monopoly
shifted, partially or fully, only through the means of profits, the monopolist cannot choose a better position of
price variations. supply and price so as to increase his profits out of
Forward and Backward Shifting—If a producer is which to pay the tax. This conclusion remains valid
asked to pay an excise duty on his product, he may whether the tax on monopoly profit is a lump sum or
enhance the sale price of the product. In this case it is a proportionate tax. Imposition of such a tax does into
called forward shifting because the producer is shift the demand or supply curve and so the sale price of
collecting a portion of the tax from his customer and is the commodity does not change. Without a sale price
shifting a portion of the tax burden forward. In the case variation the tax cannot be shifted.
of forward shifting, the price of the commodity will (ii) A Tax on Oligopoly—An oligopolist is
increase. confronted with a demand curve which has a kink at the
Backward Shifting will occur if the producer prevailing market price. This produces a vertical
reduces the purchase price (s) of inputs. discontinuation in the MR curve. So long as MC curve
444U | Economics (NET)
passes through this vertical portion of MR curve, the Difference Between Public and Private
price and output of the oligopolist remain unchanged. Expenditure
Therefore, if the authorities impose a specific or an ad
valorem tax which does not raise the MC curve so as to There are differences between public and private
make it move out of this vertical range of the MR curve, expenditure. Following are the main differences between
the incidence of the tax is borne by the oligopolist. On public and private expenditure :
the other hand, if the tax is high enough to push the MC 1. Private expenditure is determined by the income,
curve beyond this vertical range of MR curve, the price while public expenditure determines amount of income
would rise and the tax would be partly shifted to the necessary to meet that expenditure.
consumer. A lump sum tax does not shift the demand or 2. Private expenditure may be motivated by profit.
the cost curves of the oligopolist and therefore the But the motive underlying the public expenditure is
incidence of this tax remains on the oligopoist. social welfare.
3. The plans of private expenditure are made in
Problem of Double Taxation relation to the near future. Public expenditure, on the
Double taxation means when the taxing authority other hand, is generally planned with the objective of
taxes the same base in more than one way. For double long-term benefits rather than short-term benefit.
taxation, it is required that they should be levied on the 4. The benefits of private expenditure are mea-
same thing or on the same tax base. It is not necessary surable while those of public expenditure cannot always
for a case of double taxation that the two taxes should be so.
not be paid out of the same income.
Forms o f Double Taxation—Double taxation can Principles of Public Expenditure
be classified into two categories: (i) double taxation (1) Wagner’s Law of Increasing State
caused by two competing authorities, and (ii) double Activities—According to Wagner’s law, there exists a
taxation due to taxing the same thing twice. causal relationship between government expenditure and
If there are two governments either within the same economic development.
country or in different countries, and they both levy According to Wagner’s law, during the course of
income tax on a person, then it becomes a case of double economic development, government expenditure increa-
taxation by two competing authorities levying the tax. ses more than proportionally with per capita community
The second type of double taxation arises when a output. In other words, the income elasticity of demand
company’s profit is taxed before distribution and then for government expenditure is more than one. The
the shareholder’s dividend is taxed again. explanation is that the very growth of the economy gives
The second case of double taxation may arise when rise to complexities in economic life and government
debtors and creditors are both taxed on the amount of a has to incur increasing expenditure to deal with them.
loan. Wagner’s law was based upon historical facts. It did
The third case of double taxation may arise when not show the inner compulsions under which a
both capital and income are taxed. government had to increase its activities and public
expenditure as time passes. His law was applicable to
Public Expenditure modern progressive governments only in which the state
Meaning of Public Expenditure was interested in expanding the public sector of the
economy and undertake other activities for the general
Public Expenditure refers to the expenses of the benefit.
public authorities Central, State and Local Government
either for protecting citizens or promoting their social Wagner distinguished three types of activities which
and economic welfare. cause an increase in government expenditure. They are—
1. Maintenance and enforcement of law and order,
Reasons for Growth of Public Expendi- internally and externally.
ture 2. Participation in material production.
1. Every state must provide in the budget enough 3. Provision of social services.
resources to maintain big and strong defence forces.
2. Development of service and technology and Additional factors which contribute to this tendency
consequent expansion of armament in the nuclear field. of increasing public expenditure are—
3. The growth of the spirit of economic nationalism 1. Population itself is increasing in most cases which
and universal desire for economic self sufficiency have thus becomes a major contributory factor to the
increased state activities contributing enormous growth growth of public expenditure.
in the public expenditure. 2. An increasing shift of population to the urban areas
4. The increase in the population has further led to takes place. Existing cities grow and new ones come
increased state activity. up. Urbanisation implies a much larger per capita
5. There is a great increase in the volume of public expenditure on civic amenities.
debt and consequently payment of interest charges 3. Modern government have shown a tendency to run
called debt service charges. into debt and this lead to a subsequent increase in
Economics (NET) | 445U
public expenditure in the form of increasing cost of Public funds must be spent in those directions which are
debt servicing and repayment of the loans. most conducive to the public interest. It is possible only
(2) Wiseman-Peacock Hypothesis—The second when public authorities spend resources among different
theory of the growth of public expenditure was put forth uses in such a way that the marginal utility from all the
by Wiseman and Peacock. The main idea is that public uses is equal.
expenditure does not increase in a smooth and 4. Canon of Surplus—This canon implies that the
continuous manner, but in jerks or step like fashion. At state must avoid resort to deficit budgeting. State should
times some social or other disturbance takes place always try to be prudent and should aim at meeting its
creating a need for increased public expenditure which current expenditure needs out of its current revenue.
the existing public revenue cannot meet. The public
expenditure increases and makes the inadequacy of the
Classification of Expenditure
present revenue quite clear to everyone. The movement Classification of public expenditure implies, the
from the older level of expenditure and taxation to a systematic arrangement of various kinds of state outlays
new and higher level is the ‘displacement effect.’ The on some scientific and economic bases so that we may
inadequacy of the revenue as compared with the be able to know the effects and nature of each kind of
required public expenditure creates an ‘inspection effect. expenditure and could compare the effect of one
The government and the people review the revenue expenditure with the other.
position and the need to find a solution of the important 1. Productive and Unproductive Expenditures—
problems that have come up and agree to the required While some expenditures are in the nature of consump-
adjustments to finance the increased expenditure. They tion, others are in the nature of investment and help
attain a new level of tax tolerance. They are now ready the economy in improving its productive capacity.
to tolerate a greater burden of taxation and as a result the Under the laissez-faire system, the only productive
general level of expenditure and revenue goes up. In this public expenditures are those which are incurred to
way, the public expenditure and revenue get stabilized create and maintain social overheads. Expenditures on
at a new level till another disturbance occurs to cause administration, defence, justice, law and order, etc. are
a ‘displacement effect’? unproductive.
(3) Theory of Demand and Supply of Govern- 2. Transfer and Non-Transfer Expenditure—A
ment Services—A growing demand for private goods transfer expenditure is a payment without corresponding
necessiates a corresponding demand for public goods as receipt of goods and services by the state. Examples of
well. Complementarity between the two sets of good transfer expenditure are interest payment, old-age
increases with an increase in per capita income. pensions and unemployment benefits, etc.
Examples include demand for education and similar 3. Non-Transfer Expenditure is that by which the
other services. Further, growth of public services are state pays for its purchases or use of goods and services.
found to generate externalities which encourages private Such a use of resources by the state may be for
investment. In this reasoning, therefore, a dimension of consumption purposes or for investment purposes.
consumer theory is applied to explain the growth of Expenditure on defence, education and such like things
public expenditure. are all of non-transfer or real expenditure.
Canons of Expenditure 4. Revenue and Capital Expenditure—Revenue
expenditure of the Government includes all current
Like canons of taxation, people have propounded expenditure on administration including defence and
canons of public expenditure also which governs the public commercial undertakings such as, Railway, Post
public expenditure decision. and Telegraphs and grant in aid to the states. In other
Prof. Findlay Shirras has given four canons of words, expenditure which does not result is creation of
public expenditure. assets is treated as revenue expenditure.
1. Canon of Economy—It is essential that the 5. Capital Expenditures—It consist of acquisition
process of public expenditure should not involve the of assets like land of buildings, machinery equipment,
use of resources more than what are just necessary. The as also investments in shares, etc, and loans and advances
sole aim of this canon is to avoid extravagance and granted by central government to state and union
corruption. Techniques like programme and performance territory, government companies, corporation and other
budgeting and zero base budgeting has been developed parties.
to meet this canon. 6. Plan and Non–Plan Expenditure—Plan
2. Canon of Sanction—This canon implies that no expenditure is that public expenditure which represents
public expenditure should be incurred without the current development and investment outlays that arise
sanction of proper authority and further that funds must due to plan proposals.
be used only for the purpose for which they have been 7. Non-plan Expenditure is all other expendi-
sanctioned. ture for which the government is supposed to do or
3. Canon of Benefit—Any public expenditure is to committed to do or obliged to do. It includes both
be viewed against the benefits that will accrue from it. developmental and non-developmental expenditure.
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8. Developmental and Non-developmental (ii) Effect on Will to Work, Save and Invest-
Expenditure—Developmental expenditure includes ment—Public expenditure on old age pension, provident
plan expenditure of Railway, Posts and Tele-communi- fund benefit, insurance against sickness and employment
cations and non-departmental commercial undertakings provides security and safety to person and, therefore,
which are financed out of their internal and extra reduce his willingness to work and save. Hence, the
budgetary resources, including market borrowings and public expenditure should be regulated in such a way so
term loans from financial institutions to state govern- that it may not adversely affect the willingness to work
ments. of the people.
Non-development Expenditures include expenditures (iii) Effect on Distribution of Economic Resour-
on defence, interest payments, tax collection, police, and ces—The public expenditure on the construction of
other expenditures. Other expenditures includes that on infrastructure, like roads, railways, irrigation projects,
general administration, pensions, ex-gratia payments to etc. help in promoting economic growth and
former rulers, famine relief, subsidies an food and development of the country. The diversion of resources
controlled cloth, grants and loans to foreign countries from private to public sector for the construction of
and loans for non-development purpose to other parties infrastructure is very essential in a developing country.
etc. This type of public expenditure provides incentives to
Effects of Public Expenditure private investment by enlarging the size of markets for
various commodities and services. Public expenditure
Public expenditure is nowadays considered to have in the form of bounties and subsidies is helpful in
a considerable impact on the level of economic activity diverting the resources of the people to establish new
of the country. It influences the level of production, industries as well as to accelerate the production of
distribution of national income, the allocation of existing industries.
resources and the level of employment. The impact of When special facilities in the form of raw materials,
public expenditure may be discussed in detail under the accommodation, tax concessions, grant-in-aid, etc, are
following heads. given in a particular area, resources for industrial
1. Effects of Public Expenditure on Production— purposes are transferred to that area. As a result, new
Public expenditure can help the economy in numerous industries are developed and resources available in that
ways in attaining higher levels of production. area are used more intensively leading to increase in
A developed market economy may be suffering production.
from a deficiency of effective demand. Public expendi- 2. Effect of Public Expenditure on Distribution—
ture can add to the effective demand directly and thus A shift towards equality may be achieved through
generate conditions favourable for the market forces various forms of public expenditure especially those
to push up production. which are meant to help the poor sections of the society.
A number of welfare measures like free education,
In underdeveloped countries, there is a shortage health, water and other facilities can be given a top
of social overheads, skilled labour, capital equipment priority. Similarly, public expenditure through
and machinery. Public expenditure can be directly used appropriate subsidies and other ‘purchase and stores’
to create and maintain social overheads. It can also be policy can encourage labour–intensive techniques of
used to create human skills through education and production with reduce unemployment and improve
training. All these stimulate production in an income distribution.
underdeveloped economy. Public expenditure can be
used to create demand for various products, and thus Public Expenditure and Economic
stimulate private production. Growth
Dalton stated that a correct view of the effects of Through economic stabilization, stimulation of
public expenditure on production can only be evaluated investment activity and so on, public expenditure
by enquiring into its effect upon (i) people’s ability to maintains a rate of growth which is a smooth one. In an
work and save (ii) will to work and save, and (iii) underdeveloped country, public expenditure has an
distribution of resources. active role to play in reducing regional and personal
disparities. Thus, public expenditure has a great role to
(i) Effect on Ability to Work and Save— Public
play in the form of stimulating saving and capital
expenditure on education, medical services, cheap accumulation.
housing facilities, means of transport and communica-
tion, etc, will all increase the ability of people to work. Public Debt and Its Management
With the increase in public expenditure more money Meaning of Public Debt
comes in the hands of people which leads to increase in Public Debt is defined as the total outstanding
savings. With the increase in the ability to save, the borrowings of the central government exchequer. It
ability to invest also increases. These favourable effects represents the stock of borrowing, as opposed to the
of public expenditure on ability to work and save lead to annual increase in total borrowing, represented by the
increase in production. government deficit. In a broader sense, all kinds of
Economics (NET) | 447U
obligations of a government (including the currency 4. To Finance External Deficit—Under-developed
obligations) are included in public debt. countries need foreign exchange in the early stages of
According to Philip E. Taylor, Public Debt is a debt economic development to under-take high level of
in the form of promises by the Treasury to pay to the investment, purchase capital equipments and raw mate-
holders of these promises a principal sum and in most rials from abroad and to cover the balance of payments
instances interest on that principal. deficits. Therefore, resources have to be obtained from
abroad by way of external debt.
Public Debt and Private Debt
Classifications of Public Debt
There are similarities as well as dissimilarities
Public debt can be classified into various categories.
between public debt and private debt.
Different classification or forms of public debt are as
Similarities—In certain respects government follows :
borrowing resemble the private borrowing.
1. Internal and External Public Debt—Internal
(i) Like a private borrower, the government may
debt refers to the public loans floated within the country,
also borrow either for consumption or for investment
while external debt refers to the obligations of country to
purposes.
foreign governments, or foreign nationals or inter-
(ii) Both have to pay interest on loans that they have national institutions.
taken.
2. Marketable and Non-marketable Public
(iii) Private and public borrowings both imply
Debt—If loans can be sold by the existing holders to
diversion of funds from one use to another.
others, they would be called marketable loans. On the
Dissimilarities—Following are the main differences other hand, non-marketable loans are those which have
between public debt and private debt : been issued in favour of particular debt holders only and
(i) A private economic unit can repay its debt either cannot be sold to others.
out of its earnings or out of its accumulated assets or by
3. Productive and Unproductive Public Debt—
borrowing from the other. On the other hand, the
Productive debt is the debt which is used by the
government is the creator of currency and can pay its
government for directly productive purposes. For
debt straightway by creating more of it. The fact that it
instance, the loan may be used for the construction of
usually does not do so only reflects its concern for the
railways, irrigation and power projects and for the
welfare and stability of the economy and not the lack of
its power to do so and pay off its debt. establishment of heavy industries such as iron and steel,
cement and fertilizers. The principal and the interest
(ii) Excessive debt may lead the individual borrower both can be repaid out of the income derived from these
into a state of insolvency. The same may not be true for projects. Thus, the productive loans should not be
the government. considered as a burden upon the government. On the
(iii) Public borrowing have a profound effect on other hand, unproductive loans are those which are
various dimensions of the economy-distribution, capital incurred on those projects which do not yield any
accumulation, economic growth, income and employ- income. For instance loans taken for financing war and
ment stability, and so on. Thus, the government may for giving relief in times of flood and drought.
resort to borrowings as a matter of public policy, even, if
it does not need funds. But an individual may not 4. Interest-Bearing and Non-interest-Bearing
borrow, when he does not need them. Public Debt—There are two types of interest bearing
loans. In the first category, a loan carriers what is called
Objectives (Reasons) of Public Debt a coupon. The holder of such a loan is entitled to a given
Following are the reasons on account of which a interest payment periodically. The second category is
government might incur debt : where a loan is sold below its redemption value – at a
1. To Cover Budget Deficit—The Government discount. In India treasury bills are sold that way. Some
may borrow because its current revenue falls short of its loans, however, do not bear interest at all and are called
expenditure. Sometimes the government has to borrow non-interest bearing loans. There may be, for example,
to meet large expenditure arising because of some price bonds, certain deposits like earnest money for
unforeseen contingencies like floods, famines, epide- tenders, and so on.
mics, etc. 5. Redeemable and Irredeemable Debts—
2. To Finance War and Natural Calamities— Redeemable loans are those loans for which the
There could be wars, or natural calamities in which case government promises to pay off at some future date.
the government would be committed to a much larger Those loans, for which no such promise is made, are
expenditure and would therefore run into a debt. called irredeemable loans.
3. To Finance Development Plans—The govern- 6. Funded and Un-funded Debts—Funded debt is
ment of an underdeveloped country should play an that public debt for the payment of which the
active role in the development of the economy. This may government establishes a separate fund. On the other
be done through borrowing and investing those funds in hand, an unfunded debt is that debt for the repayment of
various projects. which the government creates no separate fund.
448U | Economics (NET)
Effects of Public Debt 4. Public Debt and Distribution of Income—
The purchasers of government securities are mostly rich
1. Effects on Consumption—When people people of the community. But the burden of taxes,
purchase government securities, it is not always imposed for finding money for interest payments fall on
necessary that they do it out of past savings. Sometimes the poorer classes also. Therefore, the tendency of public
people buy these securities out of their present income. debt would be to increase the inequalities of incomes
The small saving schemes in India is of this nature. and wealth.
Hence, the money invested in the National Saving
Certificates must, to certain extent, reduce the Redemption of Public Debt
expenditure of the people in the present. Therefore, in
this way the consumption is affected in the same way as Redemption means repayment of a loan. Following
it is affected by taxes. But, when the people buy are the methods of debt repayment.
government securities out of their past savings, it does 1. Repudiation of Debt—One simple way of
not affect the expenditure of the people at present. And, ending the debt obligations is to repudiate the debt.
when people buy government securities out of the idle Repudiation means refusal to pay a debt by the
savings, private investment also remains unaffected. If, government, as was done by the Soviet Government in
however, it comes from bank deposits, it reduces the 1917. This is, however, totally undesirable. It is usually
money with the bank. The banks have, therefore, less wrong on the part of the government to do so, and it hits
money to lend to private business. Hence, private the credit of the government with the result that it will
investment are affected. find very difficult to borrow in futures. If an external
2. Public Debt and Savings—In the case of debt is repudiated it may create a number of grave
borrowing from the market, the net effect on savings and difficulties for the repudiating country, such as
capital accumulation in the country will depend upon the economic blockade, military action, etc.
source out of which market borrowings come. One 2. Refunding—If a government sells its bonds to
possibility could be that the public reduces its own pay its floating obligations, the debt is said to be funded.
consumption and contributes its savings to the public It is the process by which the government raises new
loans. In this case there will be obviously a net increase bonds to pay off the maturing bonds. Thus, the
in the speed of savings and capital accumulation. government takes a fresh loan to repay an old debt.
Actually most savings are effected only by the richer 3. Conversion—In conversion method, the loan is
sections and firms from whom the contributions to actually not repaid but the form of debt is changed. The
public loans should be expected. Here, however, the process of conversion consists generally reconverting or
danger is that the savings which would have gone into altering a public debt from a higher to a lower rate of
investment on private account would be diverted to interest.
public loans. If that happens, then there would not be 4. Actual Repayment—While the first three
any net increase in the saving and investment activity. methods are not concerned with actual repayment of
But public loans will generate reallocative effects. public debt, the following measures may be taken for the
3. Public Debt and Inflation—Most governments repayment of public debt.
while raising loans claim that such an activity is not
(i) Sinking Fund—Under sinking fund, the
going to add to the inflationary forces. There is only a
diversion of demand, but no net addition to it. government regularly saves for the retirement of the debt
and uses the funds for this purpose when they have
Above reasoning is quite misleading because it tries
accumulated enough. Originally sinking funds are
to hide some of the basic facts. Even if public debt only
brings about a diversion in demand, it is bound to be accumulated, until debts are matured, but now they may
inflationary in character because the economy’s be used to retire debt as far as funds are available.
resources will be diverted from the production of (ii) Terminal Annuities—Under this method, the
consumption goods into those of capital goods. government, pays its debt in equal annual installments
When the government borrow from the central bank which include interest as well as the principal amount of
of the country, the effect is equivalent to restoring to the debt. The burden of debt is reduced every year.
printing press. By printing additional currency, the
(iii) Budgetary Surplus—A policy of surplus
authorities add to the demand forces in the market,
causing an upward pressure on prices. budget may be followed annually for clearing off public
debt gradually instead of creating a fund for its
In an underdeveloped country, a sizeable portion of
repayment.
the public debt is likely to be owned by the commercial
banks. The commercial banks consider their holdings of (iv) Capital Levy—Capital levy refers to a very
government securities as a good investment which can heavy tax on property and wealth. It is a once-for-all tax
be encashed at any time without much of capital imposed on capital assets above a certain value. It is
loss. This assured liquidity position, therefore, tempts imposed on rich and propertied individuals on a
them to increase their loans and advances and thus add progressive scale. This system is suggested to pay of the
to the inflationary pressures in the market. war time debts.
Economics (NET) | 449U
Public Budget and Budget Multiplier ● Progressive taxation of income and wealth will help
the government to mobilise more resources. These
Budget is a systematic record of the physical
resources can be sent on the social sector in the
proceedings of the government. It brings together the
economy. Free education, medical facilities
estimate of anticipated revenue and proposed expenditure
drinking water, sanitation, transport facilities add to
for the budget period and from these estimates the
the real income of the poor.
activities to be undertaken and the means of finance
them can be inferred. Budget is a term derived from the ● Tax concessions can be extended for offering job
French word Bougete which means a sack or pouch opportunities to weaker sections of the society.
Chancellor of the exchequer brings. ● Liberal grants for employment generating schemes
A budget comprises of three components : will provide a big help to the poor.
(1) Statement of the sums required for the conduct Price stability implies an absence of violent ups
of public affairs during the period to which and downs in the general price level.
such estimate relates. It does not imply that the general price level should
(2) A statement showing conditions of treasury in remain static. A normal rise in the price level is
terms of the assets and liabilities. desirable for economic growth. But there should not
be violent fluctuations.
(3) Estimate of the income from loans on the basis
of existing provisions. A budget can serve as an instrument to achieve
this objective.
A budget can be an effective instrument of
economic growth in following ways : ● The government can change the tax rates in
response to the needs of the economy. For example,
● By providing tax rebates and other incentives, it can
an increase in income tax rates would reduce the
stimulate savings and investment in the economy.
disposable income, this would cut down the demand
● A larger provision of public expenditure on
for goods and services, and thus prove anti-
infrastructure projects may stimulate production inflationary.
activity in different sectors of the economy.
● Similarly, the tax rates on commodities and services
● The government itself may set up production units;
can also be changed in response to the needs of the
these will add to the production potential and the economy.
volume of output.
● Public expenditure can also serve as an instrument
● Government expenditure generates demand for
to bring price stability. An increase in public
different types of goods and services. This may expenditure pumps in more money in the economy
work as a stimulant for producers in the private while public expenditure sucks in more money.
sector. Either way the size of economic activity, and more
By balanced regional growth we mean that different the general price level gets affected.
regions of the country should record economic Budget is a forceful instrument of economic growth.
growth simultaneously. It would require that the rate But a budget’s ability to give push and direction to
of economic growth in backward regions should be economy growth is limited by a number of factors.
faster than in the developed regions.
● The most severe constraint arises due to inability of
A budget is an important instrument to promote this
the government to mobilise financial resources.
pattern of growth :
This may be primarily due to the factors like :
● Tax concessions, rebates and other fiscal incentives
● Tax rates cannot be raised beyond a point. High tax
can be provided for investments in backward rates have adverse effects on production, consum-
regions in the country. ption, saving and investment.
● Subsidies can be provided on inputs and outputs of
● High tax rates may also distort production structure;
the production units set-up in backward regions. production of high value-added goods that cater to
● Public expenditure on building up of infrastructure high income groups may come to replace the
in backward regions will promote growth in such production of mass consumption goods.
regions. This will facilitate mobilisation of goods,
services and capital. Objectives of Budget
Equalities in income distribution primarily require The objectives that are pursued by the government
that the rate of growth of real income of the low- through the budget are as follows :
income sections of the society should be faster than
1. Activities to Secure a Reallocation of Resour-
the rate of growth of the high-income sections of the
society. ces—The government has to reallocate resources in line
A budget can be a useful instrument to achieve this with social and economic considerations in case the
goal. market fails to do so, or does so inefficiently.
● Tax concessions, excise rebates and similar 2. Redistributive Activities—The government
concessions and incentives can be granted for redistributes income and wealth to reduce inequalities,
production of goods of mass consumption; these by expenditures on social security, subsidies, public
could be available to poorer sections at lower prices. works etc.
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3. Stabilising Activities—The government tries to paid directly by the consumers. Income Tax, Interest
prevent business fluctuations and maintain economic Tax, Wealth Tax, Corporation Tax are all examples of
stability i.e., high level of employment and price stability. direct taxes. Indirect Taxes are those that affect the
4. Management of Public Enterprises—The income and property of perons through their consump-
Government undertakes commercial activities that are tion expenditures. Custom Duties, Excise Duties, Sales
by nature of natural monopolies, heavy manufacturing, Tax, Service Tax are all taxes are levied on the goods
through its public enterprises. and services, which people consume and are hence
There are three levels at which the budget impacts indirectly taxing income at the time when the income is
the economy. spent. Some examples of direct and indirect taxes of the
(1) First one is aggregate fiscal discipline. This Union Government are :
means having control over expenditures, given the (a) Corporation tax (b) Income tax
quantum of revenues. This is necessary for proper (c) Customers duties (d) Union excise duties
macro-economic performance. Non Tax Revenue consists of all other revenue
(2) Second one is the allocation of resources based receipts. They may be of following types :
on social priorities. (a) Interest receipts (b) Dividends and profits
(3) And the last one is the effective and efficient (c) External grants
provision of programmes and delivery of services.
Budget Classification B. Capital Receipts
The main items of capital receipts are loans raised
(1) Functional Classification—Classification of by the government from the public (these are called
budget items according to functions. It is a scheme for market loans), borrowings by the government from the
classifying the purpose for which expenditure is incurred RBI and other parties through the sale of treasury bills,
from the point of view of those covered with seeing that loans received from foreign governments and bodies
public money is spent to best advantage. (World Bank, Asian Development Bank etc.), recoveries
(2) Organisational Classification—It is a classifi- of loans, granted to state and union territory government
cation of the budget according to the organisational units and other parties, small savings and deposits in the
of the government like departments or ministries. Public Provident Fund (PPF) etc.
(3) Object Classification—This classification is a (a) Recoveries of loans
device to control expenditure at departmental level. It is (b) Market borrowing and other loans
a great technical step forward in budgeting since it (c) External assistance
permitted the installation of government. (d) Disinvestment
(4) Economic Classification—It is a classification
of government expenditure and receipts by economic C. Overall Receipts (A + B)
categories that are of significance for analysing the The various sources of government expenditure can
short-run effects of government transaction in the be as follows—
making of the economy.
(5) Programme and Performance Classifica- Expenditure
tion—A performance budget is one which presents the The concept of Plan Expenditure and Non-plan
purposes and objectives for which funds are requested, Expenditure in the budget of Central Government has
the cost of programme proposed for achieving these been replaced by scheme expenditure and Expenditure
objectives and quantitative data measuring the accomp- on other than schemes in the budget for 2017-18.
lishments and work performances under each pro-
gramme.
Scheme Expenditure
(i) On Revenue Account
Components of Budget (ii) On Capital Account
The overall budget of the government comprises
all the receipts and all the expenditure of the govern- Expenditure on Other than Schemes
ment. (i) On Revenue Account
The various sources of receipts are : (ii) On Capital Account
A. Revenue Receipts Balanced, Surplus and Deficit Budget
Revenue receipts may be divided into tax revenue
and non-tax revenue. Surplus Budget—If the receipts of the government
Tax Revenue Tax revenues consist of the proceeds are more than its expenditure the government will be
of taxes and other duties levied by the Union Gov- said to have a surplus budget.
ernment (Central Government). Relative sizes of Estimates Types of Budget
Taxes are of two types direct taxes and indirect Revenue < Expenditure Deficit
taxes :
Revenue = Expenditure Balanced
Direct Taxes are those taxes levied immediately
on the property and income of persons and those that are Revenue > Expenditure Surplus
Economics (NET) | 451U
Surplus budget implies that the government is (i) net sales of treasury bills to the RBI, and
printing out more money from the economic system. It (ii) reduction of its cash balances.
has a contractionary effect. 2. Revenue Deficit—The revenue deficit is the
Fall in the level of economic activity excess of government’s revenue expenditures over
↓ revenue receipts. It gives information on what the gov-
Fall in Investment ernment is borrowing for. The revenue deficit implies a
↓ repayment burden in the future, not matched by any
Fall in Employment benefits via investment.
Revenue Deficit = Revenue Expenditure
↓
– Revenue Receipts
Fall in Income
3. Fiscal Deficit—The fiscal deficit is the difference
↓
between the total expenditure of the government and the
Fall in Consumption and Savings revenue receipts plus those capital receipts which are not
Balanced Budget—A balanced budget is one where in the nature of borrowing but which finally accrue to
the estimated revenue equals the estimated expenditure. the government. Thus,
If the receipts of the government equal its expenditure Fiscal Deficit = Revenue Receipts + Capital Receipts –
the government will said to have balanced budget. A Total Expenditure
balanced budget will have a neutral effect on the level of
In simple terms, fiscal deficit is budgetary deficit
economic activity.
plus borrowing and other liabilities.
Deficit Budget—It occurs when the overall
Fiscal Deficit = Budget Deficit + borrowing and other
expenditure of the government exceeds the overall
liabilities.
receitps. Budgetary deficit is financed by printing of
new currency notes by the government. If the receipts of The extent of the fiscal deficit is an indication of
the government are less than its expenditure the how far the exchequer is living beyond its means. A
government will said to have a deficit budget. fiscal deficit indicates the amount of borrowing the
government has to do.
A deficit budget implies that the government is
pumping in more money in the economic system than it 4. Primary Deficit—It was introduced for the first
is pumping out. The process works as follows : time in the budget of 1993-94. The primary deficit is the
fiscal deficit minus interest payments. Thus,
Expansion in economic activity
Primary Deficit = Fiscal Deficit – Interest Payments.
↓
Primary deficit indicates, how much government
Rise in investment
borrowing is going to meet expenses other than interest
↓ payments. It reflects the extent to which current
Rise in employment government policy is adding to future burdens stemming
↓ from past policy.
Rise in income Zero Base Budgeting
↓
The chief idea in this concept is that for drawing up
Rise in consumption and savings.
a budget, the existing level of expenditure should not
This will move the economy further on the growth be taken for granted but should be critically examined.
path. Government in a developing economy always In other words, while evaluating every programme the
plans for a deficit budget. government must not think in terms of increases or
Types of Deficit decreases in spending but start from a zero base so that it
must be justified firstly. Zero base budgeting (ZBB)
There are four different concepts of deficit. They requires the evaluation and judgement on each item of
are budget deficit, revenue deficit, primary deficit and expenditure on its merit and desirability.
the fiscal deficit.
1. Budget Deficit—The budget deficit is the
Basic Features of the ZBB
(1) Examination of programmes at various levels of
difference between the total expenditure and total
resource allocation and performance.
receipts (current revenue and net internal and external
(2) Objectives to be formulated by each agency.
capital receipts) of the government. Thus,
(3) Activities of each agency to be converted into
Budget Deficit = Total Expenditure decision packages showing performance at various
– Total Receipts resource
In this case, total expenditure includes aggregate of (4) Decision packages to be evaluated and arranged
both revenue expenditure and capital expenditure. at level of management in the ranking order which
Likewise, total receipts are the addition of revenue enables the agencies to define the minimum efforts and
receipts and capital receipts. It is this budgetary deficit to indicate the incremental levels of effect above the
which is called deficit financing in India. minimum of a each programme.
The central government meets its overall budget ZBB is “Rational” budgeting. It is an emerging
deficit by— process. The ZBB technique involves a critical review of
452U | Economics (NET)
every scheme before a budgetary provision is made in its In other words, the balanced-budget multiplier
favour. The technique requires large mass of quantitative indicates the overall impact on aggregate production of a
data regarding the impact, targets, objective standards of change in government purchases that is matched (that is,
performance evaluation and a comparison among paid for) by an equivalent change in taxes. The
coming divergent activity. The basic idea behind ZBB is balanced-budget multiplier, as such, is actually the sum
that the agency should have to justify its entire budget of the expenditures multiplier (for government pur-
from scratch each year. In other words, ZBB is “the chases) and the tax multiplier.
process of throwing everything out and starting all over The balanced-budget multiplier is equal to one. The
again from scratch.” Unlike the traditional budget which "positive" impact on aggregate production caused by a
assumes that there is a budgetary base, the ZBB is change in government purchases is largely, but not
designed to determine the base or proceed to the budget completely, offset by the "negative" impact of the
from a Zero base. ZBB means the evaluation of all change in taxes. The only part of the impact of the
programme. This process leads to rethink and redirect change in government purchases NOT offset by the
programme. The ZBB approaches require each organ- change in taxes is the purchase of aggregate production
isation to evaluate and review all programmes and made by the initial injection. Hence, the change in
activities systematically whether current or new and to aggregate production is equal to the initial change in
review activities on the basis of output or performance government purchases.
as well as cost.
Algebraic Derivation of the Balanced
Balanced Budget Multiplier Budget Multiplier
A change in aggregate demand brought about by a Suppose the government’s net tax revenues are
change in government expenditure, which is exactly given by
matched by a change in revenues received from taxation T = T + tY …(1)
and other sources. The change in government expendi- where is the level of autonomous net tax revenues and t
ture has animmediate effect on aggregate demand and is the net tax rate. If the government policy is to leave
generates income of an equivalent size. By contrast, the the budget deficit (or surplus) unchanged, the total
change in taxation does not change aggregate demand by change in purchases must equal the total change in net
an equivalent amount because some of the increased/ tax revenues,
reduced disposable income will be offset by changes in ΔG = ΔT = ΔT + t · ΔY …(2)
saving. Now consider the condition that determines the
Consequently, an increase in government expendi- equilibrium level of GDP. Let A be the level of
ture and taxation of equal amounts will have a net autonomous spending. The equilibrium condition is that
expansionary effect on aggregate demand and incomes, GDP equals desired aggregate expenditure, or
while a decrease in government expenditure and taxation Y = A + MPC (1 – t) Y …(3)
of equal amounts will have a net contractionary effect. (We have simplified the model by assuming a
A measure of the change in aggregate production closed economy so that the marginal propensity to
caused by equal changes in government purchases and import does not appear in the aggregate expenditure
taxes, the balanced-budget multiplier is equal to one, function.) Following the change in government policy,
meaning that the multiplier effect of a change in taxes the change in equilibrium GDP is given by
offsets all but the initial production triggered by the ΔY = ΔA + MPC (1 – t) · ΔY …(4)
change in government purchases. This multiplier is the The change in autonomous desired spending, ΔA,
combination of the expenditures multiplier, which has two components. First, there is an increase in
measures the change in aggregate production caused by government purchases, ΔG. Second, the increase in
changes in an autonomous aggregate expenditure, and autonomous taxes , Δ , reduces disposable income by the
the tax multiplier which measures the change in same amount and leads to a reduction in desired
aggregate production caused by changes in taxes. consumption equal to MPC times ΔT. Thus, the total
The balanced-budget multiplier measures the change in autonomous desired expenditure is given by
change in aggregate production triggered by an ΔA = ΔG – MPC · ΔT …(5)
autonomous change in government taxes. This multiplier Substituting equation (5) into equation (4), we see
is useful in the analysis of fiscal policy changes that that the total change in GDP is given by
involves both government purchases and taxes. ΔY = ΔG – MPC · ΔT + MPC (1 – t) · ΔY …(6)
The logic behind this multiplier comes from the Finally, if the government’s budget deficit (or
government's budget, which includes both spending and surplus) is to remain unchanged, we know from equation
taxes. In general, a balanced budget has an equality (2) that
between spending and taxes. As such, the balanced- ΔT = ΔG – t · ΔY …(7)
budget multiplier analyzes what happens when there is Putting the value of ΔT from equation (7) into
an equality between changes in government purchases equation (6) our expression for the total change in GDP
and taxes, that is, actions that keep the budget becomes
"balanced." ΔY = ΔG – MP (ΔG – t · ΔY) + MPC (1 – t) · ΔY …(8)
Economics (NET) | 453U
Now we collect terms in ΔG and ΔY on the right- the gap between the income and expenditure must be
hand side to get— filled either by government expenditure or by increasing
ΔY = ΔG (1 – MPC) + MPC · ΔY the propensity to consume. For instance, during the
period of depression, the effective demand is not enough
→ ΔY (1 – MPC) = ΔG (1 – MPC) to absorb the available supply of goods and services,
→ ΔY = ΔG …(9) resulting in umemployment and under-employment.
The change in GDP generated by this balanced Therefore, according to modern economists, to
budget change in government purchases is determined maintain full employment and income, it is the duty of
by what is called the balanced budget multiplier. In this the government to increase public expenditure directly
simple model of national income determination (and by under taking public works programmes on large scale
assuming a closed economy), the balanced budget and thereby inducing people to spend more.
multiplier is exactly equal to one. If the government Thus, modern fiscal policy is the policy of
increases its purchases by R X and also increases its government under which the government uses its
autonomous taxes so that the total change in taxes (both expenditure and revenue programmes to produce
autonomous and induced) equals R X, the level of desirable of the increase in aggregate production and
equilibrium GDP will increase by precisely R X. employment. In other words, the modern fiscal policy is
a technique to attain and maintain full employment by
Fiscal Policy manipulating public expenditure and revenue in such a
Fiscal Policy relates to the governmental decision- way so as to keep an equilibrium between effective
making with respect to (1) taxation (2) government demand and supply of goods and services at that time.
spending (3) government borrowing and (4) the Thus, modern fiscal policy is nothing but the application
management of the government debt. of the principle of functional finance.
Classical Concept of Fiscal Policy Types of Fiscal Policy
Classical economists believed in the policy of
laissez faire. They believed that supply creates its own There are two types of fiscal policy.
demand and, therefore, general over production or Expansionary Fiscal Policy—The most widely-
involuntary unemployment is well high impossible. used is expansionary. It stimulates economic growth.
They believed that a free operation of market forces Government uses it to end the contraction phase of the
would achieve full employment and ensure an optimum business cycle. That's when public is clamoring for relief
allocation of resources in an economy. Thus, according from a recession. How does it work? The government
to classical economists, full employment is supposed to either spends more, cuts taxes, or both. The idea is to put
reach automatically and there is no necessity of any more money into consumers' hands, so they spend more.
interference. The increased demand forces businesses to add jobs to
Modern Concept of Fiscal Policy increase supply. Prof. J.M.Keynes suggested ‘pump
priming’ concept as a tool of expansionary fiscal policy
The classical concept of fiscal policy has not been to overcome the recessionary phase of the economy .
accepted by the modern economists like Keynes and Prof. Keynes advocated huge public spending , even on
Lerner. They believed that the government has to pay unproductive assets to inject the money in the market.
a positive role so as to regulate and control the economy
by means of taxes and expenditure, which they called as Politicians debate about which works better.
the principle of functional finance. Advocates of supply-side economics prefer tax cuts.
Modern economists rejected the concept of classical They say it frees up businesses to hire more workers to
economists, that supply creates it own demand and, pursue business ventures. Advocates of demand-side
therefore, there is no possibility of unemployment, and economics say additional spending is more effective
the equilibrium in the economy is automatically than tax cuts. Examples include public works
achieved due to the market forces. Contrary to this, projects, unemployment benefits, and food stamps. The
Keynes believed that in an advanced economy, the money goes into the pockets of consumers, who go right
propensity to consume tends to diminish as income out and buy the things businesses produce.
increases, in other words, propensity to save increases An expansionary fiscal policy is impossible for state
with the increase in income. Hence, a larger proportion and local government. They are mandated to keep a
of the additional incomes is saved and not spent. The balanced budget. If they haven't created a surplus during
tendency of less consumption and larger savings results the boom times, they must cut spending to match lower
in lowering the demand for goods and services tax revenue during a recession. That makes the
produced at that time; hence disequilibrium occurs in contraction worse. Fortunately, the federal/Union
the economy. Thus, to maintain income and employment government has no such constraints. It's free to use ex-
at the present level, it is necessary to offset the effects of pansionary policy whenever it's needed. Unfortunately,
decrease in demand for output due to decrease in it also means government created budget deficits even
consumption by a corresponding increase in public during economic booms. That's despite a national debt
expenditure. Hence, if unemployment is to be avoided, ceiling.
454U | Economics (NET)
Contractionary Fiscal Policy—The second type of
LM
fiscal policy is contractionary fiscal policy. It is rarely
used. Its goal is to slow economic growth. It is generally BD
used to control inflation. The long-term impact of
inflation can damage the standard of living as much as a E
I0
recession. The tools of contractionary fiscal policy are
used in reverse. Taxes are increased, and spending is cut.
You can imagine how wildly unpopular this is among
voters. Only lame duck politicians could afford to
implement contractionary policy. IS
Tools of Fiscal Policy
Tools of fiscal policy are following : Y0
1. Taxation Under Keynesian view, fiscal policy for output
2. Public Expenditure stabilization/control is—
3. Investment and disinvestment policy Fixed EX rate Flexible EX rate
4. Management of Public debt High K mobility Very effective Less effective
Low k mobility Less effective Very effective
Implications of Fiscal policy Effectiveness of Fiscal policy also depends upon :
Fiscal policy affects the economy through several ● Is the economy at full capacity
channels, with varying time lags. In the short run, it can ● Type of budgetary finance – debt or money
impact the level of activity in the economy by changing ● How coordinated are fiscal and monetary policy?
aggregate demand for goods and services. This means Effects on GDP : Neo-classical View—The govern-
that fiscal policy can play a role in stabilizing economic ment faces an inter-temporal budget constraint—
fluctuations.
G+G′ T+T′
In the medium run, fiscal policy will also influence =
(1+r) (1+r)
the structure of the economy, as well as the relative sizes
of the exposed and sheltered sectors. Thus it will affect an increase in spending today (G) requires that the
the economy’s ability to handle structural adjustments, government lower future spending (G’), or raise future
such as the petroleum sector’s declining importance for taxes (T’)
the Norwegian economy. Ricardian equivalence proposition—
Fiscal policy may also have an impact on long-term ● Rational agents anticipate that a tax cut today will
economic growth. Of major importance is the design of be paid off in the future
the tax and transfers system, which will affect the supply ● Rational agents smooth their consumption and
of labour and capital. Other parts of the budget also play saving now to pay off future taxes
a role. Under what circumstances fiscal policy retains its
The effects of fiscal policy are complex, and effectiveness?
policymakers have to balance a range of considerations. Recall that GDP = C + I + X - M
With this conference, the Panel hopes to contribute to Where
the public debate on fiscal policy – how we analyze its TR : net transfers (gifts)
impact on the economy, and what we can hope to YF : net factor income, labour and capital (receipts
achieve with it. minus payments)
Fiscal Policy and GDP— GNDI = GDP + YF + TR
GDP = C + I + G + X - M Fiscal policy affects Net factor income transfers
GDP— GNDI = (GNP = GNI) + net transfers
● Directly through G (Government expenditure) Policy implications
● Indirectly through C (taxes, expectations), I (interest GNDI < (C+I) CAB <0
rates, confidence), X and M (demand for imported Thus, domestic income < domestic demand
goods, the effect of fiscal policy on the exchange Policy Implications of fiscal policy on the GDP are
rate) following—
Fiscal policy affects C, I, X, and M. There are ● Domestic demand > income requires external
different theories on how fiscal policy affects GDP once financing and more external debt
all the effects on other variables are considered. ● If imprudent it may be impossible to finance Income
Effects on GDP : the Keynesian View—Since Demand If imprudent it may be impossible to
Keynes, fiscal policy has been recognized as a useful finance
tool for affecting aggregate demand (ISLM-BP frame- ● Reducing current account deficit may require fiscal
work) tightening and possible exchange rate action
Economics (NET) | 455U
Fiscal Policy and the External Sector—Decom- Borrowing From Domestic Commercial Banks—
pose GNDI, C and I into private and government The government sells bonds of different maturities to the
components— commercial banks at market interest rates market interest
GNDI = Yp +Yg rates
CAB = [Y p - Cp – Ip] + [Y g – Cg – Ig] ● It does not create high powered money, unless the
CAB = S p + Sg CB accommodates the extra demand for credit from
CAB = [Sp – Ip] + [Sg – Ig] commercial banks by supplying them with
Thus , CAB = Private sector gap + Public sector gap additional reserves (indirect CB financing of deficit)
● Commercial banks may be forced to reduce credit to
(Revenue-expenditure)
Fiscal policy affects the current account through— the private sector. This crowding out effect takes
● Direct impact through demand Impact through the place through interest rate increases
real exchange rate Borrowing From the Domestic Non bank
● Impact on interest rates and country premia Sector—The government sells bonds of different matu-
Expansionary fiscal policy may lead to increase in rities to the private sector at market interest rates interest
interest rates, capital inflows, and appreciation of rates
● It does not create high powered money
currency. In general a larger fiscal deficit corresponds to
● But it puts upward pressure on interest rates and
a worse savings. In general, a larger fiscal deficit
corresponds to a worse savings—investment balance thus crowds out the private sector
● It can also distort interest rates if the non-bank
(weaker current account)
CAB identity is an ex-post identity, behavioral sector is required to hold government bonds
relationships must to be taken into account— Fiscal Policy Effects on the BOP—Fiscal con-
● reducing transfers that are fully saved leads to a tractions help reduce the effects of large capital flows on
one-toone decrease in private savings—the CAB aggregate demand and the real exchange rate—
● By dampening aggregate demand, it allows lower
does not improve
● reducing spending on foreign goods causes lower interest rates and helps reduce incentives for inflows.
● It alleviates the appreciating pressures on the
output contraction than if reducing spending on
domestic goods exchange rate directly (public spending is biased
● a fiscal expansion may crowd out Ip or increase toward non-traded goods).
● It may provide greater scope for a countercyclical
savings if the private sector is Ricardian (little
evidence of this) fiscal response to cushion economic activity when
the inflows stop.
Financial Consequences of Fiscal Policy—The
Typically, fiscal policy in emerging markets
macroeconomic consequences of the deficit depends in
receiving capital inflows is pro-cyclical, because a fast-
part on the way it is financed. There are four forms of
growing economy generates revenues that feed higher
financing—
spending.
● Borrowing abroad
Effects on Inflation and the Financial sector—
● Borrowing from the central bank (seignorage) Central Bank Borrowing—inflationary effects
● Borrowing from the domestic commercial banks with implications for—
● Borrowing from the domestic nonbank sector ● Current account deficit
Borrowing in foreign currency implies, for most ● Depending on fiscal repressions nominal interest
developing and emerging countries, borrowing in rates Depending on fiscal repressions, nominal
foreign currency— interest rates
● changes in the exchange rate will affect the value of ● Real exchange rate
external debt in domestic currency Commercial Bank Borrowing—Crowds out private
● can cause an initial exchange rate appreciation, borrowing, raising interest rates (unless central bank
reducing the competitiveness of the tradable sector accommodates).
● for some countries, concerns about the sustainability Domestic Non-bank Borrowing—Crowds out
of debt and/or lack of creditworthiness severely private borrowing that could be used to finance
limit this 16 debt and/or lack of creditworthiness investment, less funding available for loans leads to
severely limit this source of financing higher interest rates.
Borrowing from the Central Bank entails the sale of Foreign Borrowing—Raises foreign debt and may
bonds to the Central Bank. Less frequently, the Central lead to BoP problems; exch. rt. risk; debt service needs
Bank allows the government to hold an overdraft may exert downward pressure on the exchange rate.
account government to hold an overdraft account Financing from Monetary Sector—Fiscal policy
● these loans are often at low interest rates determines the government’s demand for bank financing
● it is equivalent to the creation of high powered (NCG), which, in turn, affects total domestic credit
money, fueling inflation (DC), net domestic assets (NDA), and broad money (M)
● the CB can try to limit credit to the government, but Higher budget financing will require more money
it will be successful only if it is fully independent expansion unless credit to the private sector is less or
be successful only if it is fully independent NFA is lower (meaning a worse BOP).
456U | Economics (NET)
Objective Questions
1. GST means— 7. Which of the following statement is correct about
(A) Goods and Services Tax the insolvency and Bankruptcy Code ?
(B) Good and Simple Tax (A) The Code is implemented by The Insolvency
(C) Going Stronger Together and Bankruptcy Board of India (IBBI)
(B) The Code is operational since December 2016
(D) All of the above
(C) IBBI and National Company Law Tribunal
2. Major goods/sectors excluded from GST are— (NCLT) are in hands in gloves to complete the
I. Alcohol proceedings under the code
II. Petroleum and energy (D) All of the above
III. Electricity
8. Which of the following statement is correct about
IV. Land and real estate
DIPAM ?
V. Education
(A) It is a separate department under the Ministry
VI. Healthcare
of Finance
The correct code is :
(B) It’s key function is to implement the disinvest-
(A) II, V and VI (B) II, III and *IV ment policy of the Central Government
(C) I, II, III and IV (D) All of these (C) The Department of Disinvestment has been
3. Which Commitee recommended abolition of tax renamed as Department of Investment and
rebates under section 88 ? Public Asset Management (DIPAM) from 14th
(A) Chelliah Committee (B) Kelkar Committee April, 2016
(C) Shome Committee (D) None of these (D) All of the above
4. Goods and Services Tax is applicable in India 9. The age group of Senior Citizen for income tax
from— purpose now stands at—
(A) January 1, 2017 (B) April 1, 2017 (A) 60-75 years (B) 60-80 years
(C) July 1, 2017 (D) August 15, 2017
(C) 65-80 years (D) 62-80 years
5. Goods and Services Tax introduced in India from
10. Consider the following—
July 1, 2017 has its roots in the regime of Prime
Minister— Assertion (A) : According to Peacock-Wiseman
hypothesis, public expenditure increases overtime in
(A) H. D. Devegoda
a step by step manner.
(B) Atal Bihari Bajpayee
Reason (R) : This hypothesis is based on the
(C) Man Mohan Singh displacement effect, concentration effect and
(D) Narendra Modi inspection effect.
6. Consider the following statements about India’s Codes :
external debt and choose the correct code given (A) (A) is true, but (R) is false
below : (B) (A) is false, but (R) is true
I. India’s external debt has declined by 1·6% to (C) Both (A) and (R) are true, but (R) is not the
US $ 521·2 billion end Dec. 2018 over its level correct explanation of (A)
at March 2018. (D) Both (A) and (R) are true and (R) is the correct
II. The decline in external debt is primarily on explanation of (A)
account of a decrease in commercial borrow- 11. Which was the first country in the world to introduce
ings and trade credit. Goods and Services Tax (GST) ?
III. Commercial borrowings continued to be the (A) France (B) Italy
largest component of external debt. (C) U.K. (D) Japan
IV. The share of short-term debt in total external 12. In India, equity fund-of-funds are taxed in the same
debt increased to 19·9% at end-Dec. 2018 from manner as—
19·3% at end-March 2018. (A) Debt funds
The correct code is : (B) Equity-linked saving schemes
(A) I and IV (B) II and III (C) Real Estate
(C) I, II and III (D) I, II, III and IV (D) Fixed deposits
Economics (NET) | 457U
13. Goods and Services Tax, as passed by the Parliament 20. Who among the following is associated with the
contains an anti-profiteering clause. Prior to this theory of optional taxation ?
which country was the first to incorporate this (A) H. Dalton (B) R. A. Musgrave
clause into its GST laws ? (C) U. K. Hicks (D) G. Mankind
(A) Malaysia (B) France
21. Which of the following schemes has not been started
(C) Canada (D) Australia
with an objective of unearthing the black money ?
14. Which of the following statement is incorrect about I. Pradhan Mantri Garib Kalyan Deposit Yojana
insolvency and Bankruptcy Code (IBC) ? II. Demonetisation of R 500 and R 1000
(A) National Company Law Tribunal (NCLT) is
III. Income Declaration Scheme
the adjudicating authority under this Act
IV. Voluntary Income Disclosure Scheme
(B) It specifies a timeframe of 180 days after the
process is initiated and an additional 90-days (A) Only I (B) I and II
extension for resolving insolvency (C) All of these (D) None of these
(C) There are five stages in the resolution process 22. A study report of National Institute of Public Finance
through IBC and Policy has identified certain sectors as the key
(D) None of the above sources of unaccounted income ?
I. Professionals II. Education
15. By the Constitution (101st Amendment) Act 2016
Certain new Articles have been inserted in the Con- III. Health IV. Mining
stitution of India— V. Marketing of petroleum products
I. Article 246A II. Article 269A (A) I and V only (B) I, IV and V only
III. Article 279A (C) II and III only (D) All of these
(A) Only I (B) I and II 23. Which of the following is/are regarded as the safe
(C) I, II and III (D) Only IV hideouts of unaccounted wealth in India ?
16. Which of the following activities generate black (A) Gold, Silver and diamonds
money in an economy ? (B) Real Estate
I. Avoiding the payment of taxes (C) (A) and (B) both
II. Tax evasion (D) Neither (A) nor (B)
III. Transactions in cash without proper bill/invoice
24. A NIPFP study suggested a four point action plan to
IV. Avoiding social security provisions as enshrined
curb the generation of unaccounted income in real
in labour laws
estate sector. Which of the following is not among
(A) Only I (B) Only II and III
them ?
(C) I, II and III (D) I, II, III and IV
(A) The ITD should create its own system of noti-
17. Which of the following ways is adopted by rich fying area rates of urban immoveable pro-
people in India to avoid the payment of tax ? perties.
I. Availing various exemption of Income tax act (B) The Income Tax Act (ITA) should be amended
II. Availing various exemptions of Corporation to provide that the value mentioned in the area
Tax rates should be deemed to be the transfer value
III. Tax Holidays for taxation purposes in cases where the transfer
IV. A specified trust as a mask for personal business of property has taken place at a lower value.
(A) I and II (B) I, II and III (C) The difference between the area rate of a pro-
(C) I, II, III and IV (D) None of these perty and the actual consideration received for
18. Which of the following is/are the common practice the transfer should be treated as income of the
of tax evasion in India ? purchaser under the law.
I. Not filing the income tax return (D) Establishment of Directorate General of Income
II. Not disclosing the income to tax authorities Tax (Exemptions) (DGITE)
III. Using fake documents to claim exemption 25. Government of India has taken following initiatives
IV. Smuggling to unearth black money
(A) Only II (B) II and III I. The Black Money (Undisclosed Foreign
(C) I, II and III (D) I, II, III and IV Income and Assets) and Imposition of Tax
19. Agriculture income in India is ……………. Act, 2015 came into force on May 27, 2015.
(A) Taxable II. Pradhan Mantri Garib Kalyan Deposit Scheme,
(B) Not Taxable 2016.
(C) Taxable with certain riders (A) Only I (B) Only II
(D) Nothing is specific (C) I and II both (D) Neither I nor II
458U | Economics (NET)
26. FATCA is an effective tool to control black income 32. Which of the following agency effectively control
in which country ? the income and expenditure of central government ?
(A) USA (B) UK I. Comptroller and Auditor General of India
(C) Italy (D) Egypt (GAG).
27. Government of India has taken certain steps to II. Public Accounts Committee (PAC).
control the expansion of black money. III. Estimates Committee
I. Set up a Supreme court monitored Special In- Correct code is :
vestigation Team (A) Only I (B) II and III
II. Regeneration of tax treaties with tax haven (C) I and II (D) I, II and III
countries
III. Crackdown on Shell companies 33. Which of the following are indirect taxes ?
IV. Penalty on real estate transaction exceeding (i) Custom duties (ii) Excise duties
R 20,000 (iii) Sales-tax (iv) Estate duty
V. Cash donation to political parties restricted to (A) (i), (ii), (iii) and (iv)
R 2,000 (B) (ii), (iii) and (iv)
(A) I and III only (B) IV and V only (C) (i), (ii) and (iii)
(C) I, II and III only (D) All of these (D) (i), (ii) and (iv)
28. Which of the following pairs’ terms are positively 34. Zero based budgeting (ZBB) lays emphasis on—
correlated to each other ?
(I) Unlimited deficit financing.
(A) Money Laundering – Terror financing
(B) Unaccounted money – Black money (II) Preparing new budget right from the scratch.
(C) Tax gap in corporate sector- Black money (III) Preparing the budget neglecting history of
(D) All of the above expenditure.
(A) (I), (II) and (III) (B) (I) and (III)
29. Which of the following indicators can be used to
identify the sector which is/are more prone to (C) (II) and (III) (D) (I) and (II)
generate or utilize unaccounted income. 35. Which one of the following taxes is levied by the
I. Backward and forward linkages based input- State Government only ?
output framework (A) Wealth tax (B) Entertainment tax
II. Proportionate share of informal sector in the (C) Income tax (D) Corporation tax
economy 36. The maximum effect of direct taxes is on—
III. Sectors flagged by different government agen- (A) Price of food (B) Income
cies ( Such as CBI) (C) Capital goods (D) Consumer goods
(A) Only III (B) I and III
37. Which of the following taxes are levied by the
(C) I, II and III (D) None of these
centre and not divided between the Centre and the
30. The ‘Ad hoc Treasury Bill System’ of meeting States ?
budget deficit in India was replaced by ‘Ways and I. Income tax II. Union excise duties
Means Advances System’ which has come into III. Custom duties IV. Corporation tax
force on— (A) I, II and IV (B) I, II and III
(A) March 31, 1997 (B) April 1,1996 (C) III and IV (D) II, III and IV
(C) April 1, 1997 (D) None of these 38. States earn maximum revenue through—
31. Consider the following Assertion (A) and Reason (A) Land revenue
(R) and choose the correct answer given below— (B) Custom duties
Assertion (A) : Sales of spurious and substandard (C) Commercial taxes
drugs and under–reporting of sales by firms a com- (D) Excise duties on intoxicants
mon phenomenon in India. 39. Which of the following taxes is not a source of
Reason (R) : India’s pharmaceuticals sector gen- revenue of the Union Government ?
erates a large quantity of unaccounted income (A) Income tax (B) Corporation tax
(A) Both A and R are correct and R is the correct (C) Land revenue (D) Customs duties
explanation of A 40. The Indian income tax is—
(B) Both A and R are correct and R is the in- (A) Direct and proportional
correct explanation of A (B) Indirect and proportional
(C) A is correct, but R is incorrect (C) Indirect and progressive
(D) A is incorrect, but R is correct (D) Direct and progressive
Economics (NET) | 459U
41. The revenue of the state governments are raised 48. The Wanchoo Committee (1971) probed into—
from the following sources, except— (A) Direct taxes
(A) Entertainment tax (B) Indirect taxes
(B) Expenditure tax (C) Agricultural holding tax
(C) Agricultural income tax (D) Non-tax revenue
(D) Land revenue
49. The Raj Committee (1972) probed into—
42. Which of the following does not form the part of (A) Direct taxes
capital receipts of the Union Government ?
(B) Indirect taxes
(A) Loan recoveries
(C) Agricultural holding tax
(B) Net market borrowings
(C) Non-tax revenue (D) Non-tax revenue
(D) Net external assistance 50. The Choksi Committee was appointed to reco-
mmended measures to simplify the existing—
43. Expenditure tax was first imposed in India in 1957
(A) Indirect tax laws
on the recommendations of—
(B) Sale tax laws
(A) Hugh Dalton (C) Direct tax laws
(B) Nicholas Kaldor (D) Corporation tax laws
(C) B.R. Shenoy 51. Which of the following is/are the component of
(D) T.T. Krishnamachari fiscal policy ?
44. Which authority recommends the principles govern- I. Taxation
ing the grants-in-aid of the revenues of the states out II. Public Expenditure
of the Consolidated Fund of India ? III. Public Debt
(A) Public Accounts Committee IV. Deficit financing
(B) Union Ministry of Finance V. Determination of repo rate
(C) Inter-State Council Correct code is :
(A) I, II, III and IV (B) I, and II
(D) Finance Commission
(C) I, II and III (D) All of these
45. To reach an economically efficient output level, the
size of an excise tax impaired on a firm generating 52. Match List-I with List-II and select the correct
negative externality should be— answer using the codes given below the Lists :
(A) The firms marginal cost List-I (Setting up of)
(B) The social marginal cost (a) Monopolies and Restrictive Trade Practices
(C) The difference between the social marginal Commission.
cost and firm’s marginal cost (b) Long Term Fiscal Policy.
(D) The sum of the social marginal cost and the (c) Agricultural Prices Commission.
firm’s marginal cost (d) Industries (Development and Regulation) Act.
46. Assertion (A) : The Central Government cannot List-II (Year)
impose agricultural income tax. 1. 1951 2. 1965
Reason (R) : State Governments have refused to 3. 1970 4. 1985
allow the Centre to impose and collect agricultural (a) (b) (c) (d)
income tax as agriculture is a State subject.
(A) 1 2 3 4
(A) (A) is correct but (R) is incorrect
(B) 4 3 1 2
(B) (A) and (R) are wrong
(C) 3 4 2 1
(C) Both (A) and (R) are correct, but (R) does not
explain (A) (D) 2 3 4 1
(D) Both (A) and (R) are correct, but (R) correctly 53. Match List-I with List-II and select the correct
explains (A) answer-using the codes given below the List—
47. A state Government draws its revenue from— List-I (Committee)
(A) Taxes on agricultural income (a) Dutt Committee (1969)
(B) Taxes on road vehicles (b) Wanchoo Committee (1971)
(C) Taxes on advertisements and sale of goods (c) Rajamannar Committee (1971)
(D) All of the above (d) Chakravarty Committee (1985)
460U | Economics (NET)
List-II (Purpose) 58. Match the items given i n List-I with those in
1. Industrial Licensing List-II—
2. Direct Taxes List-I
3. Central-State Fiscal Relations (a) Committee on Taxation of Agricultural Wealth
4. Monetary System and Income, 1972
(a) (b) (c) (d) (b) Direct Taxes Enquiry Committee, 1970
(A) 4 3 2 1 (c) Tax Reform Committee, 1991
(B) 1 2 4 3 (d) Indirect Tax Enquiry Committee, 1976
(C) 1 2 3 4 List-II
(D) 4 1 3 2 1. Raja J. Chelliah 2. L. K. Jha
Directions : The following questions (54) consist of 3. K. N. Wanchoo 4. K. N. Raj
two statements, one labelled the ‘Assertion A ’ and Codes :
another labelled the ‘Reason R’. Examine these two (a) (b) (c) (d)
statements carefully and decide if the Assertion A and (A) 4 1 2 3
the Reason R are individually true and if so, whether the (B) 4 3 1 2
Reason is a correct explanation of the Assertion. Select (C) 3 2 1 4
your answer as per the following options : (D) 2 3 1 4
(A) Both A and R are true and R is the correct
explanation of A 59. The biggest holder of Government of India dated
securities—
(B) Both A and R are true but R is not a correct
explanation of A. (A) Reserve Bank of India
(C) A is true but R is false (B) Life Insurance Corporation of India
(D) A is false but R is true (C) Employees Provident Fund
(D) Commercial Banks
54. Assertion (A) : Indian economy is referred to as a
‘mixed economy’. 60. Arrange the introduction of the following taxes in
India in chronological order—
Reason (R) : Indian Government recognises the
relative importance of both public as well as private I. Service tax
sectors in the process of economic development. II. Income tax
55. Which one of the following taxes is also known as III. Banking cash transaction tax
the ‘Death Tax’ ? IV. Gift tax
(A) Octroi (B) Inheritance tax Codes :
(C) Estate Duty (D) (B) & (C) both (A) II, IV, I, III (B) II, I, III, IV
(C) II, III, I, IV (D) IV, II, I, III
56. Which one of the following tax is within the
jurisdiction of the Central Government as 61. Who amongst the following has not worked for
enumerated in List-I of Seventh Schedule of the estimation of Black Money in India ?
Constitution of India ? (A) N. Kaldor
(A) Taxes on mineral rights subject to any (B) Dr. D. K. Rangnekar
limitation imposed by the Parliament (C) O. P. Chopra
(B) Taxes on the consumption and sale of (D) Sukhamoy Chakravarthy
electricity
62. Deficit financing means—
(C) Taxes on sale and purchase of newspapers and
(A) Public expenditure in excess of public revenue
on advertisements therein
(B) Public revenue in excess of public expenditure
(D) Excise on alcoholic liquors for human
consumption, opium, Indian hemp and other (C) Both (A) and (B)
narcotics (D) None of the above
57. Grants from the Centre to the States under the 63. The Government may cover the deficit either by—
recommendations of Finance Commission are (A) Withdrawing its cash balances
known as—
(B) Borrowing from Central bank and Commercial
(A) Plan grants banks
(B) Development assistance (C) Creating new money by resorting to printing
(C) Statutory grants press
(D) Discretionary grants (D) All of the above
Economics (NET) | 461U
64. The internal debt comprises— 73. Cannon of equity in taxation is generally considered
(A) Market borrowing to be satisfied by—
(B) Treasury bills (A) Proportional taxation
(C) Special securities issued to RBI (B) Progressive taxation
(D) All of the above (C) Regressive taxation
(D) Lump sum tax
65. The important objectives of debt management in
India are— 74. Which one of the following is not a source of the
state tax revenue ?
(A) To promote savings and provide more funds for (A) Land revenue (B) Motor vehicles tax
investment in the public sector
(C) Entertainment tax (D) Corporate tax
(B) To ensure large borrowing and debt retirement
without sacrificing the objective of price 75. The receipts from disinvestment of public sector
stability undertakings are shown under which one of the
following sub-heads in the budget of the
(C) Both (A) and (B) Government of India ?
(D) None of the above (A) Revenue receipts
66. Development expenditure of the Central Govern- (B) Non-tax revenue receipts
ment does not include— (C) Non-debt capital receipts
(A) Expenditure on social and community services (D) Debt capital receipts
(B) Grants-in-aid to states and Union Territory 76. The Principle of Maximum Social Advantage is
(C) Interest payments concerned with—
(D) Expenditure on economic services (A) Taxation only
67. The tax which is not shared by states is— (B) Expenditure only
(A) Sales tax (C) Public debt only
(B) Income tax (D) Both taxation and public expenditure
(C) Corporation tax 77. Tobin tax is a tax on—
(D) Central Excise duty (A) exports
68. Rekhi Committee deals with— (B) imports
(A) Direct Taxes (C) transactions in foreign exchange
(B) Indirect Taxes (D) sales
(C) Banking Sector 78. Budgetary deficit does not take into account—
(D) Bank Scam (A) revenue deficit
69. The Zero Base Budgeting approach has been (B) capital budget deficit
adopted from— (C) balance of payment deficit
(A) April 1, 1986 (B) April 1, 1987 (D) interest payment on public debt
(C) April 1, 1988 (D) April 31, 1987 79. According to J.R. Hicks, technical progress is said
70. According to Raja J. Chelliah the black money is to be neutral if it raises—
generated at the rate of .......... the country’s GDP. (A) the marginal physical productivity of labour
(A) 30% (B) 40% and capital in the same proportion
(C) 20% (D) 15% (B) the average productivity of labour and capital
in the same proportion
71. The causes of black money are— (C) the wage rate and the interest rate in the same
(A) Public expenditure programme proportion
(B) Inflation (D) the interest-rate and the profit-rate in the same
(C) Political finance and standard of Public morality proportion
(D) All of the above 80. Which of the following taxes is an exclusive source
72. Measures to unearth black money are— of revenue for the state governments ?
(A) Demonetization (A) Excise duties (B) Customs duties
(B) Voluntary Disclosure Scheme (C) Land revenue (D) Wealth tax
(C) Special Bearer Bonds 81. Which one of the following is not a source of the
(D) Foreign Remittance Scheme and Gold Bond ‘Union Tax revenue’?
Schemes (A) Property taxes (B) Wealth tax
(E) All of the above (C) Corporate taxes (D) Customs duties
462U | Economics (NET)
82. Given a proportional income tax structure and 89. Consider the following statements—
balanced budget, an autonomous increase in in- 1. In the context of the classical model loan
vestment will increase the level of equilibrium finance may be a means of transferring
income and the budget will— the burden to the future generation.
(A) still be in balance 2. Foreign borrowing permits financing public
(B) have a surplus programmes without placing a burden on the
(C) have a deficit present generation.
(D) the outcome is uncertain 3. Foreign borrowing is not burden some to the
83. Provision of social goods possess problem future generations even if the funds are used
because— unproductively.
(A) Such goods tend to be non-rival in consump- Of the above statements—
tion (A) 1 alone is correct
(B) Consumption preferences with respect to such (B) 1 and 2 are correct
goods are not revealed (C) 2 and 3 are correct
(C) Market mechanism is not well suited for the (D) 1 and 3 are correct
provision of such goods
90. Distribution of the burden of paying a tax is
(D) All of the above
called—
84. The imposition of a Selective Sales Tax will raise (A) Sharing of tax burden
the price of the taxed product by equal amount if it
(B) Shifting of the tax
is produced under—
(A) constant cost (B) increasing cost (C) Incidence of a tax
(C) decreasing cost (D) imperfect competition (D) Tax capitalisation
85. Fiscal and Monetary Policies are intended to 91. The effect of deficit financing is—
combat— (A) Always inflationary
(A) Structural unemployment (B) Never inflationary
(B) Frictional unemployment (C) Sometimes inflationary and sometimes not so
(C) Cyclical unemployment depending on the response of output and the
(D) Both (A) and (B) dose of deficit financing
(D) Always inflationary unless accompanied by
86. Assuming a declining marginal utility of money effective counteracting measures
schedule, which one of the following principles will
call for “maximum progression” ? 92. The Economist on whose suggestions the Wealth
(A) Principle of equal absolute sacrifice Tax, Gift Tax and Expenditure Tax were introduced
(B) Principle of equal proportional sacrifice in India is—
(C) Principle of equal marginal sacrifice (A) V.K.R.V. Rao (B) Kaldor
(D) None of the above (C) Galbraith (D) None of these
87. In a many person economy with a public and a 93. Agricultural Income Tax is—
private goods, revenue allocation will be optimal at (A) Levied and appropriated by the respective
the point where— states
(A) the marginal rate of substitution (MRS) is equal (B) Levied and collected by the Union, but given
to the marginal rate of transformation (MRT) over to the respective states
for each individual considered separately (C) Levied by the Union, but collected and
(B) the summation of the MRS is equal to the MRT appropriated by the respective states
(C) the MRS is not equal to the MRT since we are (D) None of the above
dealing with a public goods
94. Indirect tax are objectionable because they—
(D) None of the above conditions obtain
(A) Are hard to collect
88. If supply is perfectly inelastic, then the short run (B) Are regressive
impact of a specific sales tax would be to shift the
(C) Do not raise enough revenue
tax burden—
(A) entirely on to the consumers (D) Are particularly hard on the rich
(B) entirely on to the producers 95. All the revenues received, loans raised and money
(C) equally between the producers and the consu- received in repayment of loans by the Union
mers government go into—
(D) on the other goods where the supply condition (A) Consolidated Fund of India
may be more elastic (B) Contingency Fund of India
Economics (NET) | 463U
(C) Public Account of India 104. Excise duties, which are the biggest source of
(D) Prime Minister’s Relief Fund revenue of the Union Government, are levied on—
(A) Sale of goods
96. Loans of Public enterprises is a part of—
(B) Production of goods
(A) Capital expenditure
(B) Revenue expenditure (C) Consumption of goods
(C) Both revenue and capital expenditure (D) Resale of goods
(D) None of the above 105. The incidence of which of the following will
97. Interest payment is an item of— entirely be on the monopolist—
(A) Revenue expenditure (A) lump-sum tax
(B) Capital expenditure (B) specific tax
(C) Plan expenditure (C) regulated monopoly pricing
(D) None of the above (D) None of the above
98. In India, the states get maximum income from— 106. If supply is perfectly inelastic and demand is highly
(A) Sales Tax elastic, then in the short run the incidence of a
(B) Land Revenue specific sales tax will be—
(C) Agricultures income tax (A) entirely on the consumes
(D) State excise duties (B) entirely on the sellers
99. In order to reduce inequalities, the government (C) equally distributed between the consumers and
should adopt— the sellers
(A) Proportional system of taxation (D) more on the consumers than on the sellers
(B) Progressive system of taxation 107. Provision of social goods poses problems because—
(C) Regressive system of taxation (A) such goods tend to be non-rival in consump-
(D) None of the above tion
100. Market borrowings of the Central Government are (B) individual consumer preferences with respect
included in— to these goods is not revealed
(A) Capital receipts (C) market mechanism is not well suited for the
(B) Nontax revenue provision of such goods
(C) Tax revenue (D) All of the above
(D) None of the above 108. Which one of the following is not an objective
101. Constitutionally, which of the following bodies has/ of fiscal policy—
have a right to levy a tax. (A) economic growth
1. Gram Panchayat (B) economic stability
2. Zila Panchayat (C) maximisation of employment level
3. Nagar Nigam (D) regulating of financial institutions
4. Nagar Palika Parishad 109. The concept of zero-Based-Budget (zBB) was given
Codes : by—
(A) Only 2 & 3 (A) R. A. Musgrave (B) J.M. Keynes
(B) Only 2 (C) Peter A. Pyhr (D) A.H. Hansen
(C) Only 1, 2, & 3 110. Which of the following concepts of Budget deficit
(D) 1, 2, 3 & 4 has become practically redundant in India ?
102. Which one of the following taxes is not levied by (A) Fiscal Deficit
the State Governments— (B) Budgetary Deficit
(A) Agricultural Income Tax (C) Primary Deficit
(B) Profession Tax (D) Revenue Deficit
(C) Excise on Liquor 111. The tax-multiplier is generally—
(D) Corporation Tax (A) greater than the government expenditure multi-
103. Who appoints the Finance Commission— plier
(A) President of India (B) equal to the government expenditure multi-
(B) Prime Minister of India plier
(C) Chairman of the Rajya Sabha (C) less than the government expenditure multiplier
(D) Speaker of the Lok Sabha (D) equal to the investment multiplier
464U | Economics (NET)
112. If personal income is R 57,000; personal income tax 12. (D) Despite they invest in equity schemes, unit
is R 9,000; consumption R 43,000; interest payment holders have to pay short-term capital gains as per
R 10,000; personal saving R 40,000; then the dispos- their income tax slab rate, and long term capital gain
able personal income would be equal to— tax @ 20% after availing indexation benefit.
(A) R 50,000 (B) R 47,000 13. (D) This clause was incorporated in 2000 by the
(C) R 48,000 (D) R 40,000 Australia government.
113. The difference between Total Public Revenue and 14. (D) 15. (C) 16. (D) 17. (C) 18. (D)
Total Public Expenditure in a particular year is 19. (C) 20. (D) 21. (D) 22. (D) 23. (C)
termed as—
24. (D) 25. (C) 26. (A) 27. (D) 28. (D)
(A) Primary deficit
(B) Revenue deficit 29. (C) 30. (C) 31. (B) 32. (D) 33. (C)
(C) Budgetary deficit 34. (C) 35. (B) 36. (B) 37. (C) 38. (C)
(D) Fiscal deficit 39. (C) 40. (D) 41. (B) 42. (C) 43. (B)
Answers with Hints 44. (D) 45. (C) 46. (D) 47. (D) 48. (A)
1. (D) Prime Minister Narendra Modi termed GST as 49. (C) 50. (C) 51. (A) 52. (C) 53. (C)
the ‘Good and Simple Tax’ at the time of launching 54. (A) 55. (D) 56. (C) 57. (C) 58. (B)
of the tax on the midnight of June 30, 2017. Again 59. (D) 60. (A) 61. (D) 62. (A) 63. (D)
the PM termed it as ‘Going stronger Together’ on
July 16, 2017. 64. (D) 65. (C) 66. (C) 67. (C) 68. (B)
2. (D) 3. (B) 4. (C) 69. (B) 70. (C) 71. (D) 72. (E) 73. (B)
5. (B) Prime Minister Atal Bihari Bajpayee constituted 74. (D) 75. (B) 76. (D) 77. (C) 78. (D)
an empowered committee in 2000 to work out a 79. (A) 80. (C) 81. (C) 82. (A) 83. (A)
model Goods and Services Tax for India. 84. (A) 85. (C) 86. (A) 87. (D) 88. (A)
6. (D) 7. (A) 8. (D) 9. (B) 10. (D) 89. (D) 90. (C) 91. (D) 92. (B) 93. (B)
11. (A) France was the first country to implement the 94. (C) 95. (C) 96. (B) 97. (D) 98. (A)
GST in 1954, followed by Germany, Italy, the UK,
99. (A) 100. (C) 101. (D) 102. (D) 103. (D)
South Korea, Japan, Canada and China implemented
GST in 1994 while Russia did it in 1991. Saudi 104. (A) 105. (A) 106. (B) 107. (D) 108. (D)
Arabia plans to do it in 2018. 109. (C) 110. (B) 111. (C) 112. (D) 113. (B)
●●
UNIT-7
Money and Banking
Components of Money Supply (2) Fixed Fiduciary System—Under this system
The main components of the supply of money are as the Central Bank of a country is permitted to issue a
follows fixed amount of notes without keeping any metallic
reserves. This portion is called fiduciary system. But all
Currency Component—Consisting of coins and notes issued above this amount must be converted by 100
currency notes issused by the central government, and per cent metallic reseserves.
Deposit Component—Consisting of deposits of (3) Maximum Fiduciary System—Under this
general public with the commercial banks. system, there is a maximum limit up to which the central
(I) Coins : The metallic coins are issued by the bank is authorised to issue notes without any gold
country’s monetary authority. There are two system of reserves. But there has to be full backing of gold
coinage. reserves beyond this limit.
(a) Free Coinage : Under this system anybody (4) Proportional Reserve System—Under this
could take a fixed quantity of the metal and get it minted system the Central Bank is required to keep a certain
at the mint. The mint, in other words, is open to the percentage of gold against the note issue and the
public. Free minted at the mint may be gratuitous or non remainder of their note issue is covered by securuties.
gratuitious. (5) The Minimum Reserve System—Under this
(i) Gratuitous Coinage is that where no fee is system the Central Bank is permitted to issue notes to
charged for mintage of a coin. any extent provided a fixed minimum reserves is
(ii) Non-gratuitious Coinage is that where a fee is maintained in gold and foreign securities.
charged for mintage. Non-gratuitous coinage are of two
types. Measures of Money Supply
(1) Brassage—When the government charges a fee Meaning of Money Supply—The supply of money
equal to the cost of minting coins it is called Brassage. is a stock at a particular point of time, though it conveys
The government makes no profit in this type of coinage. the idea of a flow over time. The term supply of money
(2) Seigniorage—When the government charges a at any moment is the total amount of money in the
fee which is higher than the cost of minting it is known economy. It is synonymous with such terms as ‘money
as seigniorage. The government makes some profit in stock’ and ‘quantity of money’.
this type of coinage. There are three alternative views regarding the
(b) Limited Coinage—Coinage is said to be limited definition or measures of money supply. The most
when coinage is done on government account only. common view is associated with the traditional and
Under this system the government enjoys the monopoly Keynesian thinking. According to this view, money
of minting coins. The government itself buying metals supply is defined as currency with the public and
and converts them into coins. demand deposits with commercial banks. Demand
(II) Paper Currency—The most important part of deposits with commercial banks plus currency with the
the money supply is the paper currency which is public are together denoted as M1 . This is regarded as a
obligation of Central Bank. The paper currency in narrower definition of the money supply.
country is regulated in accordance with the system laid The second view is associated with Friedman. Prof.
down by the monetary authority. Friedman defines the money supply at any moment of
time as “literally the number of dollars people are
Standard System of Note Issue carrying around in their pocket, the number of dollars
Following are the main systems of currency issue : they have to their credit at banks or dollars they have to
(1) Simple Deposit System—Under this system, their credit at banks in the form of demand deposits, and
the monetary authority is required to keep hundred per also commercial bank’s time deposits.” This defini-
cent of the bullion (gold or silver) for every note issued. tion includes M1 plus time deposits of commercial bank
That is why it is also known as the Full Reserve System. in the supply of money. This wider definition is
466U | Economics (NET)
characterised as M2 in America and M3 in Britain and If we devide equation (2) by M we get
India. It stresses the store of value function of money. H C+R C R
= = + …(3)
The third definition is the broadest and is associated M M M M
with Gurley and Shaw. They include in the supply of Since
money, M2 plus deposits of savings banks, building R R D M C D
societies, deposits of other credit and financial institu- = × , M ≡ C + D, ≡ × …(4)
M D M M M M
tions.
Determinants of Money Supply 1 ≡
C D
( )
+ , 1–
M M
C
D
D
( )
≡ , 1–
M
C
D
There are basically three determinants of money
supply.
R R R
≡ + ,
M D D ( ) 1–
C
D
≡
R
M
(1) The Required Reserve Ratio—The monetary Rewriting equation (4)
base or the Stock of High Powered Money, H, which is
the sum of currency in the hands of the public (c) and
reserves of commercial banks (R) Cash holdings and
M
H
≡
C R
+
M D ( )1–
C M
M H
,
deposits at the central bank. 1
≡
(2) The Level of Bank Reserves—The actual
reserve ratio of commercial banks (R/D) which is the
C R
+
M D ( ) 1–
C
M
ratio of their reserves to their deposit liabilities. 1
M ≡ × H or M = m H
(3) Public’s Desire to Hold Currency and C R C
+ 1–
Deposits : The currency ratio of the public (C/M) which M D M
is the ratio of the currency that they hold to their total Where,
money holding (M). 1
m = ≡ …(5)
Money Multiplier Theory of Money
Supply
C R
+
M D ( )1–
C
M
In its simplest form the theory says that the supply In equation (5) m is called the money multiplier H is
of money (M) is highly stable increasing function of called high powered money, (C/M) is the currency ratio
high powered money (H). In other words its says that. and (R/D) is the actual reserve ratio of commercial bank.
This money multiplier identity M = mH shows the
(a) as H changes M also changes in the same mechanical dependence of the money supply on the
direction. stock of high powered money, H, and on the money
(b) the most of the change in M is due to change in multiplier, m, which is determined by actual reserve
H. ratio of commercial banks (R/D) and by the currency
High-powered money H is the sum of commercial ratio of the general public (C/M).
banks’ reserves and currency (notes and coins) held by
the public. High-powered money is the base for the
Measures of Money Supply in India
expansion of bank deposits and creation of the money Till March, 1968, the RBI published only one
supply. The use of high-powered money consists of the measure of the money supply, M, defined as currency
demand of commercial banks for the legal limit or and demand deposits with the public. From April 1968,
required reserves with the central bank and excess the RBI also started publishing another measure of the
reserves, and the demand of the public for currency. money supply which it called Aggregate Monetary
Thus, Resources (AMR). This included M1 plus time deposits
H = C+R+E of bank held by the public. Since April 1977, the RBI
has been publishing data on four measures of the money
Where C represents currency, R the required supply which are discussed as under—
reserves and E the excess reserves.
M1 = currency with public (C) + demand
For simplification we may assume excess reserve to deposits of the public (DD) + other
be zero. Thus deposits (OD)
H = C+R Thus,
Algebraical Derivation of Money Multiplier—We M1 = C + DD + OD
have defined money (M) as currency (C) Plus demand
deposits. M2 = M1 + savings deposits with post office
savings banks
M = C+D …(1)
M3 = M1 + time deposits of the public with
H = C+R …(2)
banks
The only difference between M and H is that where M3 is known as broad money
as the former includes demand deposits the latter
includes reserves of Banks. M4 = M3 + Total post office deposits
Economics (NET) | 467U
New Monetary Equations. RBI working group on From the equation (4) expressing the determinants
Money Supply has now redefined its parameters for of money, it follows that money supply will increase :
measuring money supply. Saving bank deposits of post 1. When the supply high powered money H
offices, included previously in M 2 , and also all deposits increases;
with post offices, included in M4 have now been 2. When the currency- deposit ratio decreases;
dropped. Accordingly, there are now only three monetary 3. When the reserve-deposit ratio falls.
aggregates – M1 , M2 and M3 . RBI working group has The relation between the money supply and high-
introduced a new concept of liquid resources in India. powered money is illustrated in figure A. The horizontal
Revised Monetary Measures are : curve H shows the given supply of high powered money.
1. M1 = Currency + Demand Deposits + Other The curve Hs shows the demand for high-powered
Deposits with RBI money. The slope of the H d curve is equal to the term
Thus, there is no change in the calculation of money
supply with the public (M1 )
( )
r+K
l+K
. Given r, k and Hs , the equilibrium money
supply is OM. If the money supply is larger than this,
2. M2 = M1 + Time liabilities portion of Savings say OM1 , there will be excess demand of high-powered
Deposits with banks + Certificate of money. On the contrary, a less than OM money supply
Deposits (CDs) issued by banks + will mean less demand for high-powered money.
Term Deposits, maturing within a year.
3. M3 = M2 + term deposits with banks with
maturity of over one year + call/term
borrowing of the banking system.
The new M3 can be designated as broad money and
will be the significant monetary measure.
Liquid Resources in India are :
(i) L1 = New M3 + All Deposits of Post Office
Savings Banks excluding National
Savings Certificates (NSCs).
(ii) L2 = L1 + Term Deposits with term lending
Institutions and Refinancing Institutions
+ Term borrowing by Financial Institu-
tions (FIs)
Fig. A
(iii) L3 = L2 + public deposits of non-banking
financial companies (NBFCs) If there is an increase in any one of the ratios r and
The revised monetary aggregates consider only k, there would be an increase in the demand for high-
bank deposits and bank borrowings, liquidity aggregate powered money. This is shown by the H′ d curve in figure
consider also term deposits with and borrowings by FIs A where the increase in the demand for high-powered
and NBFCs. money leads to decline in the money supply to OM :
The supply of money varies directly with changes in
Money Supply and Its Determinants the high-powered money. This is shown in figure B. An
Rearranging money multiplier equation (3), we can increase in the supply of high-powered money by ΔH
know the determinants of money supply in the economy. shifts the Hs. curve upward to Hs. At E, the demand and
Thus supply of high-powered money is in equilibrium and
M l+K money supply is OM. With the increase in the supply of
= high-powered money to Hs the supply of money also
H r+K
or, M = H.m
M = H ( ) l+K
r+K
...(4)
It follows from (4) that money supply in an
economy is determined by-
(a) Supply of high—powered money (H)
(b) The value of money multiplier (m)
While the Central Bank of a country can control the
supply the supply of high powered money, the value of
multiplier is determined by two behaviour ratios,
currency deposit ratio (K) of the public and desired
reserve deposit ratio (r) of banks. Fig. B
468U | Economics (NET)
increases to OM1 at the new equilibrium point E1 . The Process of Credit Creation
Further B reveals the operation of the money multiplier. Let us explain the actual process of credit creation.
With the increase in the high-powered money by ΔH, the We have seen above that the ability of banks to create
money supply increases by m. ΔH = ΔM Where m is the credit depends on the fact that banks need only a small
money multiplier. percentage of cash to deposits. If banks kept 100 per
Factors Determining Money Supply in cent cash against deposits, there would be no credit
creation. Modern banks do not keep 100 per cent cash
India reserves. They are legally required to keep a fixed
Reserve Bank of India classifies factors determining percentage of their deposits in cash say 10, 15, or 20 per
money supply into the four following categories- cent. They lend and/or invest the remaining amount.
A. Government borrowing from the banking system; Thus it is the required cash reserve ratio that becomes
B. Borrowing of the private or commercial sector the basis of credit creation. The smaller the required
from the banking system; cash reserve ratio the larger the expansion of deposits or
C. Changes in net foreign assets held by the Reserve credit. Thus total deposits created by banking system is
Bank of India caused by changes in balance of payments l
= ·D
position; and r
D. Government’s currency liabilities to the public. where
D = deposits of the bank
The Creation of Credit r = required cash reserve ratio
The creation of credit or deposits is one of the most l
important functions of commercial banks. Like other In the above equation, is called the deposit
r
corporations, banks aim at earning profits. For this multiplier with determines the limits to deposit
purpose, they accept cash in demand deposits and expansion by a bank. If a bank has R 1000 in deposits
advance a loan on credit to customers. When a bank and its legal minimum ratio or the required cash
advances a loan, it does not pay the amount in cash. But reserves ratio (r) is 20 per cent; it can create credit to the
it opens a current account in his name and allows him to extent of R 5000.
withdraw the required sum by cheques. In this way, the l l
bank creates credit or deposits. = ·D= · 100
r 0·20
Demand deposits arise in two ways : One, when = 5000
customers deposits currency with commercial banks, The bank is “loaned up” to the limit of R 5000 and it
and two, when banks advance loans, discount bills, cannot create more deposits till its reserves increase
provide overdraft facilities, and make investments further.
through bonds and securities. The first type of demand We are now a position to state how much deposits
deposits are called “Primary deposits.” Banks of have been created by the banking system out of the
demand deposits are called “derivative deposits.” currency deposits of R 1000.
Banks actively create such deposits. Total Deposits = R 5000
Banks know by experience that all depositors do not Out of the total deposits of R 5000, the deposits of
withdraw their money simultaneously. Some withdraw R 1000 in cash was made in the bank system. The
money while others deposit on the same day. So by remaining deposits have been created by the banking
keeping a small cash in reserve for day-to-day system itself.
transactions, the bank is able to advance loans on the Deposits Created by the Banking System
basis of excess reserves. When the bank advances a loan = R 5000 – R 1000 – R 4000
it opens an account in the name of the customer. The
bank knows by experience that the customer will Limitations on the Power of Banks to
withdraw money by cheques which will be deposited Create Credit
by his creditors in this bank or some other bank, where We have been above how the banking system as a
they have their accounts. Settlements of all such cheques whole can create credit. But it does not mean that banks
are made in the clearing house. The same procedure is have unlimited powers to create credit. In fact, they have
to function under certain restrictions. The following are
followed in other banks. Thus banks are able to create
the limitations on the power of commercial banks to
credit or deposits by keeping a small cash in reserves create credit.
and lending the remaining amount. 1. Amount of Cash—The credit creation power of
The bank provides overdraft facility to a customer banks depends upon the amount of cash they posses. The
on the basis of some security. It enters the amount of the larger the cash, the larger the amount of credit that can
overdraft in the existing account of the customer and be created by banks. The amount of cash that a bank has
allows him to draw cheques for the overdraft amount in its vaults cannot be determined by it. It depends upon
agreed upon. It thus creates a deposit. the primary deposits with the bank.
Economics (NET) | 469U
2. Proper Securities—An important factor that central banks are formed in almost every country of the
limits the power of bank to create credit is the world. In India, RBI operates as a central bank.
availability of adequate securities. Of proper securities
are not available with the public, a bank cannot create Functions of the Central Bank
credit. 1. Issuing of Currency Notes—Central bank is the
ultimate authority to issue currency notes in almost
3. Banking Habits of the People—The banking
every country of the world. Currency notes are issued by
habits of the people also govern the power of credit
following any of the following principles—
creation on the part of banks. If people are not in the
habit of using cheques, the grant of loans will lead to the I. The Fixed Fiduciary System —Under this system,
withdrawal of cash from the credit creation stream of the the central bank can issue a certain quantity of
banking system. This reduces the power of banks to notes without any reserve, (i.e., without gold or
create credit to the desired level. silver backing). The upper limit to this quantity is
called fiduciary limits beyond which there has to be
4. Minimum Legal Reserve Ratio—The minimum a hundred per cent metallic reserve. Over the years,
legal reserve ration of cash to deposits fixed by the the system was following many other countries.
central bank is an important factor which determines the However, the fiduciary limit had to be raised from
power of banks to create credit. The higher this ratio (r), time to time in order to meet the growing needs of
the lower the power of banks to create credit; and the trade and industry.
lower the ratio, the higher the power of banks to create
II. The Maximum Limit System—Under this system
credit.
the State fixed an upper limit to note-issue without
5. Behaviour of Other Banks—The power of any reserve. But any issue of notes beyond the limit
credit creation is further limited by the behaviour of was possible only after obtaining necessary legal
other banks. If some of the banks do not advance loans sanction, i.e., permission from the legislature. This
to the extent required of the banking system, the chain of system was adopted in France and was in operation
credit expansion will be broken. upto 1928 (just a year before the great crash of
6. Economic Climate—Banks cannot continue to 1929).
create credit limitlessly. Their power to create credit III. The Proportional (Fractional) Reserve System—
depends upon the economic climate in the country. This system has been adopted in most of the
7. Credit Control Policy of the Central Bank— countries of the world. Under this system note issue
The power of commercial banks of create credit is also is conditioned by gold backing (varying from 25 to
limited by the credit control policy of the central bank. 40%). This means that a certain portion of note-
The central bank influences the amount of cash reserves issue has to be backed by gold reserve. The
with banks by open market operations, discount rate remaining part of the note issue has to be covered
policy and varying margin requirements. Accordingly, by government securities (which are highly liquid
it affects the credit expansion or contraction by assets) and approved commercial papers. There is
commercial banks. also the general provision that subject to certain
conditions and penalties the reserve rate may be
Central Bank permitted to fall below the legal minimum.
IV. Minimum Reserve System—Under this system,
Central Bank is a bank which regulates the entire the reserve limit is permanently fixed and the
monetary system of a country. According to the Bank of volume of the notes has no connection with the
International Settlement, “A Central Bank is the bank in amount of the reserve. To meet the ever- increasing
any country to which has been entrusted the duty of demand for currency, government can issue notes
regulating the volume of currency and credit in that up to any amount against the reserve but it is faced
country”. According to Samuelson, “Every Central Bank with the danger of the inflation. Reserve Bank of
has one function. It operates to control economy, supply India follows this system . Initially, it used to keep
of money and credit.” According to Vera Smith, “The 40% of the gold reserves in its total assets. But,since
primary definition of Central Bank is the banking system 1957, RBI has to maintain Only R 200 crore as
in which a single bank has either a complete or residuary minimum reserve. Out of this, R 115 crore should
monopoly of note issue.” According to Kent, “Central be in the form of gold coins or gold bullion and
Bank may be defined as an institution which is charged remaining R 85 crore in the form of foreign
with the responsibility of managing the expansion and currency reserves. The minimum reserve is a token
contraction of the volume of money in the interest of of confidence and doesn’t have any practical
general public welfare.” connection with amount new currencies issued by
Bank of England was the world’s first effective the RBI. Under the Minimum Reserve System, RBI
central bank that was established in 1694. It was decided can issue unlimited amount of currency by keeping
in Brussels Financial Conference, 1920, that all the reserve. But RBI follows some principle or rule
countries of the world should establish a central bank for for issuing new currencies based upon economic
the interest of world cooperation. Thus, since 1920, growth and transaction needs of the people.
470U | Economics (NET)
According to De Kock, following are the main III. It acts as a bank of central clearance, settlements
reasons for the concentration of the right of currency and transfers. Its moral persuasion is usually very
note issue in the central bank— effective so far as commercial banks are concerned.
● Uniformity in note circulation 5. Credit Control—It is one of the most important
● Better regulation functions of the central bank. It controls the flow of the
● It gives distinctive prestige to the note issue credit to all the sectors and sections of the economy.
Methods of credit control are following;
● It enables the state to exercise supervision over the
● Quantitative Credit Control—Central bank uses-
irregularities and malpractices committed by the
central bank in the issue of currency notes. Repo rate, Reverse Repo rate, Bank rate, Marginal
standing Facility Rate, Cash Reserve Ratio,
● It gives the central government some measures of
Statutory Liquidity Ratio – to control the flow of
control over undue credit expansion by the credit. All these instruments can be used collectively
commercial banks, since expansion of credit or individually to limit the credit disbursement
obviously leads to an increased. power of the banks. Besides these, open market
2. Banker to Government—Central bank functions operations – sale and purchase of securities and bills
as a banker to the government—both Federal and the in the market- are another tool to increase or
state governments, government departments, boards, decrease the loanable funds of the financial insti-
public enterprises. It performs the same functions as a tutions.
commercial bank ordinarily performs for its customers ● Qualitative Credit Control—The qualitative credit
(i.e., general public). It carries out all banking business control are also adopted by the Central Bank in its
of the government. Government keeps their cash pursuit of economic stabilisation and as part of
balances in the current account with the central bank. credit management. These are - Changes in margin
Similarly, central bank accepts receipts and makes requirements, Rationing of credit, Regulation of
payment on behalf of the governments. Also, central consumer credit , Moral suasion and credit monito-
ring arrangement
bank carries out exchange, remittance and other banking
● Selective Credit Control—These measures are
operations on behalf of the government. Central bank
adopted to affect the flow of credit to a particular
gives loans and advances to governments for temporary
sector or activity. These may be (a) minimum
periods, as and when necessary and it also manages the
margins, higher or lower, for lending against specific
public debt of the country. Remember, the central securities, ceilings on the amount of credit for
government can borrow any amount of money from RBI certain purposes, and differential rates of interest for
by selling its rupees securities to the latter. certain types of advances, and (b) regulation of
3. Advisor to the Government—As the central consumer credit for durable goods.
bank regulates the monetary sector of the economy and 6. Custodian of Foreign Exchange Reserves—
also functions as the banker to the government, so it also Central bank is the custodian of foreign exchange
advises the government from time to time . As agent of reserves- Foreign currency, gold, SDRs, reserve tranche
the government, it is entrusted with task of managing the with IMF. All the earnings are deposited with RBI at the
public debt and issue of new loans and treasury bills on time of foreign exchange transactions. RBI can bring the
behalf of the government. It also underwrites unsold external value of currencies at par with internal value in
government securities. The central bank also functions the sale and purchase of foreign currencies. RBI helps
as a representative of the State in international financial the government to pursue a coordinated policy towards
balance of payment situation in a country.
matters.
4. Banker’s Bank and Supervisor—There are 7. Promoter of Economic Development—
usually hundreds of banks in a country. There should be Although, the central bank does not take part directly in
some agency to regulate and supervise their proper any of the developmental activities of the government,
functioning. This duty is discharged by the central bank. but it acts as a catalyst in those activities of various
Central bank acts as banker’s bank in three stakeholders which play a crucial role in the economic
capacities— development.
I. It is the custodian of their cash reserves. Banks of ● The central bank is regarded as an inevitable agency
the country are required to keep a certain percentage for promoting the economic growth of the country.
of their deposits with the central bank; and in this ● It maintains economic stability through exchange
way the central bank is the ultimate holder of the rate stabilization and price stabilization
cash reserves of commercial banks. ● It is responsible for the development of an adequate,
II. Central bank is lender of last resort. Whenever and sound banking system.
banks are short of funds, they can take loans from
the central bank and get their trade bills discounted. Meaning of Commercial Bank
The central bank is a source of great strength to the They are unique as financial intermediaries in that
banking system. their main function is generally accepting chequeable
Economics (NET) | 471U
deposits. A deposit with a commercial bank serves as (7) Provision of income tax consultancy
money as it can be transferred by means of cheques from (8) Acting as correspondent, agent or representative
one depositor account to another for making a payment. of customers as well as securing documentations
Commercial bank is an institution which accepts for air and sea passage.
chequeable deposit from the public and in turn advance
loans for the purpose of investment. Banking Systems
There are four types of banking systems found in
Functions of Commercial Banks the world. They are : unit banking, branch banking,
(1) Accepting Deposits—This is the most important group banking, and chain banking.
function of commercial banks. Deposits are of three Unit Banking—Unit banks are independent, one-
forms— office banks. Their operations are confined in general to
(a) Saving Account—Deposits in this account earn a single office. The unit banking is peculiar to the USA.
interest at nominal rates as the banks can always be The unit banks operate in small towns and cities and are
called upon by a depositor to release his account.
called country banks and city banks respectively. The
(b) Current Account—These are also known as various types of country banks and city banks are able to
demand deposits, since any sum or any number of
operate efficiently through a correspondent relationship
withdrawals can be presented by such an account holder.
with one another. The country banks have deposits with
(c) Fixed Deposits—These are also known as time
city banks and city banks have deposits in state banks in
deposits or term deposits since the amount deposited
with a bank cannot be withdrawn before the maturity of the same and other cities. The centre of correspondent
the period for which they have been contracted. banking is New York city, followed by Chicago and
(2) Extending Loans—This is the second important other regional centres in big American cities.
function of the commercial banks. Loans and advances Branch Banking—Branch banking is found in the
may take different forms like (a) provision of over draft majority of countries such as England, Australia Canada,
facilities (b) discounting bills of exchange (c) advancing India, etc.
outright loans and advances. Under branch banking system, a big bank has a
The different types of loans and advances are : number of branches in different parts of the country and
(i) Cash Credit—In this arrangement, an eligible even many branches within a cosmopolitan city. Small
borrower is first sanctioned a credit limit upto which he commercial banks also carry on branch banking
may borrow from the bank. operations within a state or region.
(ii) Demand Loans—A demand Loan is one that Group Banking—Group banking is a type of
can be recalled on demand. It has no stated maturity. multiple office banking consisting of two or more banks
The entire loan is paid in lumpsum by crediting it to the under the control of a holding company. The term ‘Bank
loan account of the borrower. Thus the entire loan holding company’ is based on 25 per cent ownership or
amount becomes chargeable to interest. control of two or more banks. The holding company is
(iii) Short Term Loans—Short term loans may called the parent company and the banks under the
be given as personal loans, loans to finance working parent company are called operating companies. This
capital or as priority sector advances. These are secured system of banking is found in the USA.
loans against some security. It is chargeable to interest. Chain Banking—It is a banking system where the
(3) Transfer of Funds—Trade and commerce in same individual or group of individuals controls two or
the modern world is becoming increasingly more more banks, as against control by a holding company
under group banking. This is done by stock ownership in
complex. Its complexity requires the transfer of funds
from one place to another. two or more banks.
(4) Agency Functions—Commercial banks are Types of Commercial Banking
increasingly acting as financial agents for their clients. Commercial banks are classified into two catego-
They collect and make all sorts of payments for their ries.
client like insurance premium, pension claims, dividend
claims or capital demand. The agency services provided (a) Scheduled Banks—Scheduled Commercial
by the banks are : banks are those commercial banks which are included in
the second schedule of the Reserve Bank of India Act,
(1) Transfer of funds
1934. Before a Bank is included in the second schedule
(2) Collection of funds it has to satisfy the following conditions :
(3) Purchase and sales of shares and securities (i) It must have a paid up capital reserves of an
(4) Collection of dividends and interest aggregate value of not less than rupees five lakh.
(5) Payment of bills and insurance premmia as per (ii) It must satisfy the Reserve Bank that its affairs
customer’s directions are not being conducted in a manner detrimental to the
(6) Acting as executors and trustees of wills interest of its depositors.
472U | Economics (NET)
On the basis of ownership, scheduled commercial banks are classified into—
(i) Banks in the Public Sector money. The liabilities of a bank are large in relation to
(a) The State Bank of India its assets because it holds a small proportion of its asset
in cash. But its liabilities are payable on demand at a
(b) 17 Nationalised Banks
short notice. Therefore the bank must hold a sufficiently
(c) 56 Regional Rural Banks large proportion of its asset in the form of cash and
(d) IDBI Bank liquid assts.
(ii) Banks in the Private Sector (ii) Safety—A commercial bank always operates
(a) Joint stock banks in private sector in India under conditions of uncertainty and risk such as market
number 20 at present 13 old and 9 new. risk and risk by default. In the light of these risks and
(b) Foreign banks in private sector are branches uncertainty, a commercial bank has to maintain the
of banks incorporated in foreign countries. safety of its assets. But if the bank-follows the safety
There are 43 such banks with 314 branches. principle strictly by holding only the safest asset it will
Besides there 45 foreign Banks have repre- not be able to create more credit. It will thus loose the
sentative offices in India. customers to other banks and its income will be low. On
the other hand, if the bank takes too much risk, it may be
(c) Payments Banks : Airtel Payments Bank,
highly harmful for it. Therefore a bank must strike a
India Post Payments bank, Paytm Payments
balance between risk an safety.
bank and Fino Payments bank, Aditya Birla
India Payment Banks and Jio Payment (iii) Profitability—Profit is essential for any bank
Banks have started their commercial opera- for the purpose of paying interest to depositors, wages to
tion. 3 applicants surrendered their license. the staff, dividend to share-holders and meeting other
expenses.
(d) Small Finance Banks : 10 entities that
received RBI licence to start small Finance Conflicts between the Different Objectives of
Bank are now operational. Portfolio Management—If the bank keeps liquidity the
uppermost, its profit will be low. On the other hand, if it
(b) Non-Scheduled Banks—are all those banks ignores liquidity and aims at earning more, it will be
which are not included in the second schedule. The disastrous for the bank. Thus in managing its investment
number of non-scheduled banks are at present stands at portfolio a bank must strike a balance between the
only 4. objectives of liquidity and profitability. The balance
Bank’s Portfolio Management must be achieved with a relatively high degree of safety.
Portfolio management refers to the prudent manage- Theories of Portfolio Management
ment of a bank’s asset and liabilities in order to seek Various theories of portfolio management govern
some optimum combination of income or profit, the distribution of assets between liquidity and safety.
liquidity, and safety.
Commercial Loan (Real Bill) Theory—According
Portfolio is defined as the sum of bank’s income to this theory, a commercial bank should advance only
earning assets and bank’s cash. short-term self-liquidating productive loans to business
Objectives of Portfolio Management enterprises. Self liquidating loans are those which are
meant to finance the production, and movements of
There are three conflicting objectives of portfolio goods through the successive stages of production,
management–liquidity, safety and profitability. storage, transportation, and distribution. When such
(i) Liquidity—Liquidity of an asset is the degree to goods are ultimately sold, the loans are considered to
which an asset can be quickly and cheaply turned into liquidate themselves automatically. This principle
Economics (NET) | 473U
ensures proper degree of liquidity for each bank and the 6. Expansion—It is only by widespread expansion
proper money supply for the whole economy. of the banking system that the deposits can be mobilised
Moulton’s Shiftability Theory—According to this and credit facilities can be made available to trade,
theory, an asset to be perfectly shiftable must be industry, agriculture etc.
immediately transferable without capital loss when the 7. Profitability—Profits are essential for the bank
need for liquidity arises. This is particularly applicable to be viable. A bank pays interest to its depositors,
to short-term market investments, such as treasury bills dividend to share holders, salaries to the staff and meet
and bills of exchange, which can be immediately sold other expenses. So unless the bank earns, it can not
whenever it is necessary to raise funds by banks. operate soundly.
Shares and debentures of large companies are
accepted as liquid assets along with treasury bills and Credit Creation
bills of exchange. This has encouraged term lending by Creation of credit is one of the most important
banks. functions of modern banks. In fact, a modern bank is
Prochnow’s Anticipated Income Theory— also called a factory for the manufacture of credit.
According to this theory, bank plans the liquidation of Credit creation is the process by which a group of
the term-loan from the anticipated income of the deposit-taking and lending institutions, which operate on
borrower. At the time of granting a loan, the bank takes fractional reserve ratios, can on the basis of an increase
into consideration not only the security but the in their reserve assets, produce an increase in the volume
anticipated earnings of the borrower. Thus a loan given of their lending and associated deposit liabilities of an
by the bank gets repaid out of the future income of the amount greater than the increase in the reserve.
borrower in instalments, instead of in a lump sum at the Credit means obtaining purchasing power with a
maturity of the loan. promise to repay it sometime in future.
Liabilities Management Theory—According to Credit like money creates purchasing power or ability to
this theory, there is no need for banks to grant self purchase goods and services.
liquidating loans and keep liquid assets because they can Credit is an exchange which is completed after the
borrow reserve money in the money market in case of expiry of a certain period of time after transactions.
need. A bank can acquire reserves by creating additional Sources of Credit—In Indian economy credit is
liabilities against itself from different sources. These provided by wide variety of sources.
sources include the issuing time certificates of deposit,
borrowing from the central bank, raising of capital funds Those sources can be classified under two heads
by issuing shares, and by ploughing back of profits. like (a) Institutional, (b) Non-Institutional.
Institutional credit is supplied by banks and non
Essentials of a Sound Banking System banking financial intermediaries.
Following are the main essentials of a sound Non-institutional credit is supplied by money lenders
banking system : and commodity sellers.
1. Liquidity—A bank should have a high degree of
liquidity. Apart from cash, a bank’s other assets must
Instruments of Monetary Policy
possess the criterion of liquidity so that they may be Monetary policy refers to the policy of the central
turned into such liquid assets easily. bank with regard to the use of monetary instruments
under its control to achieve the goals specified in the
2. Stability—For a sound banking system there
Act..Formation and implementation of monetary policy
should neither be undue contraction nor expansion of
is the sole responsibility of the central bank. The
credit. The banking system should follow a stable
Reserve Bank of India (RBI) is vested with the
lending policy.
responsibility of conducting monetary policy. This
3. Elasticity—The banking system should have responsibility is explicitly mandated under the Reserve
sufficient elasticity in its lending operations. It should be Bank of India Act, 1934.
in a positon to expand and contract the supply of
lonable funds with ease in accordance with the directives The Goal(s) of Monetary Policy
of the central bank of the country. ● The primary objective of monetary policy is to
4. Reserve Management—Though the money maintain price stability while keeping in mind the
kept in reserve is idle money, yet the banks should keep objective of growth. Price stability is a necessary
some amount in reserve for meeting the demand of its precondition to sustainable growth.
customers in case of emergency. The bank should ● In May 2016, the Reserve Bank of India (RBI) Act,
manage its reserve policy effectively and efficiently 1934 was amended to provide a statutory basis for
without keeping too much or too little cash. the implementation of the flexible inflation targeting
5. Safety—Since the bank keeps the deposits of the framework.
people, it must ensure the safety of their money. So it ● The amended RBI Act also provides for the
should make safe loans and investments and avoid inflation target to be set by the Government of
unnecessary risk. India, in consultation with the Reserve Bank, once
474U | Economics (NET)
in every five years. Accordingly, the Central 4. Shri Chetan Ghate, Professor, Indian Statistical
Government has notified in the Official Gazette 4 Institute (ISI) – Member.
per cent Consumer Price Index (CPI) inflation as the 5. Professor Pami Dua, Director, Delhi School of
target for the period from August 5, 2016 to March Economics – Member; and
31, 2021 with the upper tolerance limit of 6 per cent 6. Dr. Ravindra H. Dholakia, Professor, Indian
and the lower tolerance limit of 2 per cent. Institute of Management, Ahmedabad – Member.
● The Central Government notified the following as (Members referred to at 4 to 6 above, will hold office for
factors that constitute failure to achieve the inflation a period of four years or until further orders, whichever
target:(a) the average inflation is more than the is earlier.)
upper tolerance level of the inflation target for any ● The MPC determines the policy interest rate
three consecutive quarters; or (b) the average required to achieve the inflation target. The first
inflation is less than the lower tolerance level for meeting of the MPC was held on October 3 and 4,
any three consecutive quarters. 2016 in the run up to the Fourth Bi-monthly
● Prior to the amendment in the RBI Act in May Monetary Policy Statement, 2016-17.
2016, the flexible inflation targeting framework was ● The Reserve Bank’s Monetary Policy Department
governed by an Agreement on Monetary Policy (MPD) assists the MPC in formulating the monetary
Framework between the Government and the policy. Views of key stakeholders in the economy,
Reserve Bank of India of February 20, 2015. and analytical work of the Reserve Bank contribute
The Monetary Policy Framework to the process for arriving at the decision on the
policy repo rate.
● The amended RBI Act explicitly provides the
● The Financial Markets Operations Department
legislative mandate to the Reserve Bank to operate
the monetary policy framework of the country. (FMOD) operationalises the monetary policy,
mainly through day-to-day liquidity management
● The framework aims at setting the policy (repo) rate operations. The Financial Markets Committee
based on an assessment of the current and evolving (FMC) meets daily to review the liquidity
macroeconomic situation; and modulation of liqui- conditions so as to ensure that the operating target
dity conditions to anchor money market rates at or of the weighted average call money rate (WACR).
around the repo rate. Repo rate changes transmit
● Before the constitution of the MPC, a Technical
through the money market to the entire the financial
system, which, in turn, influences aggregate demand Advisory Committee (TAC) on monetary policy
– a key determinant of inflation and growth. with experts from monetary economics, central
banking, financial markets and public finance
● Once the repo rate is announced, the operating advised the Reserve Bank on the stance of monetary
framework designed by the Reserve Bank envisages policy. However, its role was only advisory in
liquidity management on a day-to-day basis through nature. With the formation of MPC, the TAC on
appropriate actions, which aim at anchoring the Monetary Policy ceased to exist.
operating target – the weighted average call rate
(WACR) – around the repo rate. Instruments of Monetary Policy
● The operating framework is fine-tuned and revised There are several direct and indirect instruments
depending on the evolving financial market and that are used for implementing monetary policy.
monetary conditions, while ensuring consistency ● Repo Rate—The (fixed) interest rate at which the
with the monetary policy stance. The liquidity Reserve Bank provides overnight liquidity to banks
management framework was last revised signifi- against the collateral of government and other
cantly in April 2016. approved securities under the liquidity adjustment
facility (LAF).
The Monetary Policy Process
● Reverse Repo Rate—The (fixed) interest rate at
● Section 45ZB of the amended RBI Act, 1934 also which the Reserve Bank absorbs liquidity, on an
provides for an empowered six-member monetary policy overnight basis, from banks against the collateral of
committee (MPC) to be constituted by the Central eligible government securities under the LAF.
Government by notification in the Official Gazette. ● Liquidity Adjustment Facility (LAF)—The LAF
Accordingly, the Central Government in September consists of overnight as well as term repo auctions.
2016 constituted the MPC as under— Progressively, the Reserve Bank has increased the
1. Governor of the Reserve Bank of India – proportion of liquidity injected under fine-tuning
Chairperson, ex officio. variable rate repo auctions of range of tenors. The
aim of term repo is to help develop the inter-bank
2. Deputy Governor of the Reserve Bank of India, term money market, which in turn can set market
in charge of Monetary Policy – Member, ex officio. based benchmarks for pricing of loans and deposits,
3. One officer of the Reserve Bank of India to be and hence improve transmission of monetary policy.
nominated by the Central Board – Member, ex officio. The Reserve Bank also conducts variable interest
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rate reverse repo auctions, as necessitated under the ● The resolution adopted by the MPC is published
market conditions. after conclusion of every meeting of the MPC in
● Marginal Standing Facility (MSF)—A facility accordance with the provisions of Chapter III F of
under which scheduled commercial banks can the Reserve Bank of India Act, 1934.
borrow additional amount of overnight money from ● On the 14th day, the minutes of the proceedings of
the Reserve Bank by dipping into their Statutory the MPC are published which include—
Liquidity Ratio (SLR) portfolio up to a limit at a (a) the resolution adopted by the MPC;
penal rate of interest. This provides a safety valve
against unanticipated liquidity shocks to the (b) the vote of each member on the resolution,
banking system. ascribed to such member; and
● Corridor—The MSF rate and reverse repo rate (c) the statement of each member on the resolution
determine the corridor for the daily movement in the adopted.
weighted average call money rate. ● Once in every six months, the Reserve Bank is
● Bank Rate—It is the rate at which the Reserve required to publish a document called the Monetary
Bank is ready to buy or rediscount bills of exchange Policy Report to explain—
or other commercial papers. The Bank Rate is (a) the sources of inflation; and
published under Section 49 of the Reserve Bank of (b) the forecast of inflation for 6-18 months ahead.
India Act, 1934. This rate has been aligned to the
MSF rate and, therefore, changes automatically as Working of Monetary Policy
and when the MSF rate changes alongside policy
repo rate changes. The Reserve Bank of India, being primarily concer-
ned with money matters, so organizes currency and
● Cash Reserve Ratio (CRR)—The average daily credit that it subserves the broad economic objectives of
balance that a bank is required to maintain with the the country. In the performance of this task, it
Reserve Bank as a share of such per cent of its Net formulates and executes a monetary policy with clear-
demand and time liabilities (NDTL) that the cut goals and tools to be used for this.
Reserve Bank may notify from time to time in the
Meaning and Objectives of Monetary Policy—
Gazette of India.
Monetary policy, was known as the credit policy
● Statutory Liquidity Ratio (SLR)—The share of statements till 1992—the year which marked the
NDTL that a bank is required to maintain in safe initiation of financial sector reforms. With the move
and liquid assets, such as, unencumbered govern- towards a more market oriented financial system and
ment securities, cash and gold. Changes in SLR operating procedures for monetary policy, the policy
often influence the availability of resources in the was renamed as Monetary and Credit Policy concerns
banking system for lending to the private sector. itself with the supply of money as also of credit to the
● Open Market Operations (OMOs)—These include economy. This is a statement, announced twice in a year
both, outright purchase and sale of government (October. for October to March, and April, for April to
securities, for injection and absorption of durable September, to coincide with the busy and the lean
liquidity, respectively. seasons respectively of agriculture) till recently (1998-
99). With the decline in the share of agricultural credit,
● Market Stabilisation Scheme (MSS)—This instru-
and a rise in that of the industrial credit, the RBI has
ment for monetary management was introduced in
started making an annual policy statement in April, with
2004. Surplus liquidity of a more enduring nature
arising from large capital inflows is absorbed a review of the same in October. Beginning with 1999-
through sale of short-dated government securities 2000, the RBI has decided that the policy announcement
and treasury bills. The cash so mobilised is held in a will be an annual affair.
separate government account with the Reserve The policy-statement gives an overview of the
Bank. working of the economy. In this light, it specifies the
measures that the RBI intends to make influence on
Open and Transparent Monetary Policy such key factors as money supply, interest rates, and
Making inflation, so as to ensure price stability. It also lays down
Under the amended RBI Act, the monetary policy norms for financial institutions (like banks, finance
making is as under— companies etc.) governed by the RBI. These pertain to
such matters as cash reserve ratio, capital adequacy etc.
● The MPC is required to meet at least four times in a In short, it is a sort of blue-print containing a description
year. of aims and means.
● The quorum for the meeting of the MPC is four Two sets of objectives have been pursued for long.
members. One is controlled expansion of money. It sought to
● Each member of the MPC has one vote, and in the achieve the twin objectives of meeting in full the needs
event of an equality of votes, the Governor has a of production and trade, and at the same time moderating
second or casting vote. the growth of money supply to contain the inflationary
476U | Economics (NET)
pressures in the economy. Second is sectoral deployment banking sector, there-by reducing resources available
of funds. Depending upon the priorities laid down in the with the banks for lending. The opposite happens when
plans, the RBI has determined the allocation of funds, as the RBI purchases securities. The stock of securities
also the interest-rates, among the different sectors. The with the seller banks is reduced and the cash with them
sectors which have received special attention are: core expands. This augments credit-creating capacity of the
industries (coal, iron, steel and engineering etc.); banks. Another device to influence money supply is the
foodgrains (rice, wheat etc.); priority sectors (agriculture Cash Reserve Ratio (CRR). It is the ratio of a bank’s
small-scale industry etc.); and weaker sections of cash holdings to its total deposit liabilities. A higher
population. ratio means that the amount of cash available for
Implementing Measures—The objectives, listed creating credit is reduced, and vice-versa. In addition,
above, have been sought to be achieved through various the government imposes an obligation on the banks to
monetary instruments, as also by selective controls. use a proportion of cash to buy government securities
Their use has, however, varied from time to time, known as Statutory Liquidity Ratio (SLR). This device
depending upon circumstances. has been used for long by the Government to get bank
Several means, at the disposal of RBI, have been funds against its securities carrying low rates of interest.
used to influence the three aspects of money, namely, Now with the market-orientation of the economy,
the rate of interest or price of money, the quantity or government securities have become attractive on
supply of money, and the access to or demand for commercial consideration. As such the SLR is becoming
money. One principal instrument used has been the redundant as far as the Central Government is concerned.
Bank Rate or Discount Rate i.e., the rate at which the However, since the State Governments depend on this
RBI lends to the banking system (through the rediscount source, the SLR is not to be eliminated. It has, however,
of eligible papers). Through changes in it, the RBI been brought down to 25 per cent of bank deposits with
affects the short-term interest rates in the money market, effect from 1996-97.
and through it the long-term rates, and through it the Various measures have also been adopted by the
level of economic activity in the economy. It also RBI to achieve the objective of sectoral deployment of
influences the international capital movements: higher credit. For this a certain percentage of credit has been
rates attract capital inflows, and vice-versa. earmarked for the purpose. For example, 40 per cent of
Another important instrument is the open market the total net bank credit has been earmarked to the
operations. The operations involve the sale or purchase priority sectors. Similarly structure of interest rates has
of Government securities. Through the sale of securities been so used to provide low-interest loans to certain
the RBI withdraws a part of the deposit resources of the sectors like agriculture and export. Weaker sections of
Economics (NET) | 477U
population too have been helped through loans at low profile is necessary. According to I.G. Patel, the role of
interest. Selective credit controls have also been monetary policy in combating inflation in our country is
introduced from time to time to ease or tighten the strictly limited and that monetary policy can be effective
conditions of access to credit in respect of certain only if it is a part of an overall frame work of policy
commodities. This instrument of administered/dif- which includes not only fiscal and foreign exchange
ferential interest rate will, however, decline in policy but also what is described as income policy.
importance with the market-orientation of the economy. Predominance of Currency—In India Limitations
Lags of Monetary Policy on the effective use of monetary policy arises from the
predominance of currency in the total money supply.
Changes in monetary policy do not have a direct This fact inhibits the credit creating capacity of the
Linkage with the changes in aggregate spending. The banking system.
important links between the two are the supply of money Underdeveloped Money Market—Another weak-
cost and availability of money. This is because of lags ness of Indian economy is the weak money market. This
which are involved between the time when the monetary is not organised. The monetary policy is effective only if
policy is varied. The longer the time taken by the the money market is organised one, consisting of Reserve
commercial banks in effecting adjustment the longer Bank, the State Bank, foreign banks, the Indian joint
one the lags in monetary policy. stock banks etc. And the non banking institution provide
The Lag can be split up into several components a considerable proportion of total credit and link between
(1) Recognition Lag—It involves some time to the two sectors are not well developed.
recognise that the economy has changed in existing Existance of Black Money—The major obstacle of
policy. the efficient working of monetary policy is the circula-
(2) Action Lag—Once the need for a policy changes tion of large amount of money in the black market. So
is recognised, sometimes must elapse before there are the supply and demand of money do not remain desired
suitable adjustments or alternative in the policy. The by RBI. This means that a significant part of money eco-
duration of action lag is conditioned by number of nomy remain outside the orbit of RBI’s monetary policy.
factors. Government Policies—The scope of monetary
(i) Sometime is likely to be taken for working policy is further restricted because the RBI could not
out details for change. persue independent line in monetary affairs. The crea-
(ii) Disagreements among the policy makers. tion of new money to meet government deficits will
cause inflationary pressure in the economy. The govern-
(iii) The action may be delayed because of political
ment intervention in open market operation, statutory
pressure.
reduce the power of RBI and that may restricted the
(iv) The action may be delayed due to the desirable scope of monetary policy.
change in monetary policy.
Whatever would be the limitations, India's monetary
policy help much to maintain economic stability and at
the same time the economy needs more modernisation in
the fields of money market, banking and non-banking
institutional fields etc, to work and implement monetary
policy effectively.
Non-banking Financial Institution
A non-bank financial institution (NBFI) is a
financial institution that does not have a full banking
license and cannot accept deposits from the public.
(3) Inside Lag—The sum of recognition lag and However, NBFIs do facilitate alternative financial
action lag is referred to as inside lag. The duration is not services, such as investment (both collective and
only determined by the ability of the policy makers to individual), risk pooling, financial consulting, brokering,
recognise and respond to some economic changes, its money transmission, and check cashing. NBFIs are a
length depends also upon what is used as a basis for source of consumer credit (along with licensed banks).
measurement and in what way this base is related to Examples of nonbank financial institutions include
changes in other condition that influence policy decisions. insurance firms, venture capitalists, currency exchanges,
(4) Outside Lag—Once policy is changed some some microloan organizations, and pawn shops. These
additional time must elapse before these changes will non-bank financial institutions provide services that are
work their way through the system and affect aggregate not necessarily suited to banks, serve as competition to
spending and income. banks, and specialize in sectors or groups.
Limitations of Monetary Policy Types of Non-banking Financial Institutions
Restricted scope of policy—For an effective of the Non–banking financial institutions can be catego-
monetary policy to fight inflation, a much large policy- rized mainly into two categories.
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1. Risk Pooling Institutions—Insurance companies Shareholders can liquidate their shares by selling
underwrite economic risks associated with death, illness, them back to the open-end fund at the net asset
damage to or loss of property, and other risk of loss. value.
They provide a contingent promise of economic ● Closed-end funds issue a fixed number of shares in
protection in the case of loss. There are two main types an IPO. The shareholders capitalize on the value of
of insurance companies—life insurance and general their assets by selling their shares in a stock
insurance. General insurance tends to be short-term, exchange.
while life insurance is a longer contract, ending at the Mutual funds can be delineated along the nature of
death of the insured. Both types of insurance, life and their investments. For example, some funds make high-
property, are available to all sectors of the community. risk, high return investments, while others focus on tax-
Because of the nature of the insurance industry exempt securities. Still others specialize in speculative
(companies must access a plethora of information to trading (i.e., hedge funds), a specific sector, or cross-
assess the risk in each individual case), insurance border investments.
companies enjoy a high level of information efficiency. Pension funds are mutual funds that limit the
Life insurance companies insure against economic investor’s ability to access their investment until after a
loss of the insured’s premature death. The insured will certain date. In return, pension funds are granted large
pay a fixed sum as an insurance premium every term. tax breaks in order to incentivize the working public to
Because the probability of death increases with age set aside a percentage of their current income for a later
while premiums remain constant, the insured overpays date when they are no longer amongst the labor force
in the earlier stages and underpays in the later years. The (retirement income).
overpayment in the early years of the agreement is the 3. Other Non-banking Financial Institutions—
cash value of the insurance policy. Market makers are broker-dealer institutions that quote
General insurance is further divided into two categories : both a buy and sell price for an asset held in inventory.
market and social insurance. Such assets include equities, government and corporate
● Social insurance is against the risk of loss of income debt, derivatives, and foreign currencies. Once an order
due to sudden unemployment, disability, illness, and is received, the market maker immediately sells from its
natural disasters. Because of the unpredictability of inventory or makes a purchase to offset the loss in
these risks, the ease at which the insured can hide inventory. The difference in the buying and selling
pertinent information from the insurer, and the quotes, or the bid-offer spread, is how the market-maker
presence of moral hazard, private insurance makes profit. Market makers improve the liquidity of
companies frequently do not provide social any asset in their inventory.
insurance, a gap in the insurance industry which Specialized sectoral financiers provide a limited
government usually fills. Social insurance is more range of financial services to a targeted sector. For
prevalent in industrialized Western societies where example, leasing companies provide financing for
family networks and other organic social support equipment, while real estate financiers channel capital to
groups are not as prevalent. prospective homeowners. Leasing companies generally
● Market insurance is privatized insurance for damage have two unique advantages over other specialized
or loss of property. General insurance companies sectoral financiers. They are somewhat insulated against
take a single premium payment. In return, the the risk of default because they own the leased
companies will make a specified payment contingent equipment as part of their collateral agreement.
on the event that it is being insured against. Additionally, leasing companies enjoy the preferential
Examples include theft, fire, damage, natural tax treatment on equipment investment.
disaster, etc.
Other financial service providers include brokers
2. Contractual Savings Institutions—Contractual (both securities and mortgage), management consultants,
savings institutions (also called institutional investors) and financial advisors. They operate on a fee-for-service
provide the opportunity for individuals to invest in basis. For the most part, financial service providers
collective investment vehicles in a fiduciary rather than improve informational efficiency for the investor.
a principle role. Collective investment vehicles invest However, in the case of brokers, they do offer a
the pooled resources of the individuals and firms into transactions service by which an investor can liquidate
numerous equity, debt, and derivatives promises. The existing assets.
individual, however, holds equity in the CIV itself rather
what the CIV invests in specifically. The two most Role of Non-banking Financial Institu-
popular examples of contractual savings institutions are tions in Financial System
mutual funds and private pension plans.
NBFIs supplement banks in providing financial
The two main types of mutual funds are open-end services to individuals and firms. They can provide
and closed-end funds. competition for banks in the provision of these services.
● Open-end funds generate new investments by While banks may offer a set of financial services as a
allowing the public buy new shares at any time. package deal, NBFIs unbundle these services, tailoring
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their services to particular groups. Additionally, companies) toward a greater cross-sector integration of
individual NBFIs may specialize in a particular sector, financial supervision . This had an important impact on
gaining an informational advantage. By this unbundling, the practice of supervision and regulation around the
targeting, and specializing, NBFIs promote competition globe.
within the financial services industry. Three broad models are being used around the
Having a multi-faceted financial system, which world—
includes non-banking financial institutions, can protect ● A three-pillar or “sectoral” model (banking,
economies from financial shocks and recover from those insurance, and securities);
shocks. NBFIs provide multiple alternatives to transform ● A two-pillar or “twin peak” model (prudential and
an economy's savings into capital investment, which act business conduct); and
as backup facilities should the primary form of ● An integrated model (all types of supervision under
intermediation fail. one roof).
However, in countries that lack effective regulations, One of the arguably most remarkable developments
non-banking financial institutions can exacerbate the of the past 10 years, confirmed by the World Bank’s
fragility of the financial system. While not all NBFIs are Bank Regulation and Supervision Survey, has been a
lightly regulated, the NBFIs that comprise the shadow trend from the three-pillar model toward either the two-
banking system are. In the runup to the recent global pillar model or the integrated model (with the twin peak
financial crisis, institutions such as hedge funds and model gaining traction in the early 2000s). A recent
structured investment vehicles, were largely overlooked study, examined the drivers of supervisory structures for
by regulators, who focused NBFI supervision on pension prudential and business conduct supervision over the
funds and insurance companies. If a large share of the past decade in 98 countries, finding among other things
financial system is in NBFIs that operate largely that countries advancing to a higher stage of economic
unsupervised by government regulators and anybody development tend to integrate their supervisory
else, it can put the stability of the entire system at risk. structures, small open economies tend to opt for more
Weaknesses in NBFI regulation can fuel a credit bubble integrated supervisory structures, financial deepening
and asset overpricing, followed by asset price collapse makes countries integrate supervision progressively
and loan defaults. more, and the lobbying power of the concentrated and
highly profitable banking sector acts as a negative force
Bank/Non-banking Financial Institutions against business conduct integration.
Integration and Supervisory Integration
The banking, securities, and insurance markets have
Non-Banking Financial Institutions in
become increasingly integrated, with linkages across the India
markets rapidly increasing. In response, one of the most Non-banking financial institutions (NBFIs) comprise
notable developments in financial sector regulation in a heterogeneous group of financial intermediaries. Those
the past 20 years has been a shift from the traditional under the regulatory purview of the Reserve Bank
sector-by-sector approach to supervision (with separate consist of all-India financial institutions (AIFIs), non-
supervisors for banks, securities markets, and insurance banking financial companies (NBFCs) and primary
Structure of NBFIs under Reserve Bank Regulation
(At end-September 2018)
Non-Banking Financial Institutions
All India Financial Non-Banking Financial
Primary Dealers
Instituions Companies
(21)
(4) (10, 190)
SIDBI NHB EXIM NBFCs-D NBFCs-ND Bank PDs
NABARD Bank (108) (10,082) (14)
Standalone PDs
Notes : 1. Data are provisional. Systemically Important Othe NBFCs-ND (7)
2. Figures in parentheses indicate the NBFCs-ND (NBFCs-ND)
number of institutions. (NBFCs-ND-Si) (276) (19,806)
Source : RBI.
1. Although housing finance companies, merchant banking companies, stock exchanges, companies engaged in the business of stock-
broking/sub-broking, venture capital fund companies, nidhi companies, insurance companies and chit fund companies are also NBFCs, they have
been exempted from the requirement of registration with the Reserve Bank under Section 45-IA of the RBI Act, 1934.
480U | Economics (NET)
dealers (PDs) ,AIFIs are apex institutions established 9. NBFC-Non-Operative Financial Holding
during the development planning era to provide long- Company (NOFHC)—Facilitation of promoters/pro-
term financing/refinancing to specific sectors such as (i) moter groups in setting up new banks.
agriculture and rural development; (ii) trade; (iii) small 10. Mortgage Guarantee Company (MGC)—
industries; and (iv) housing. NBFCs are dominated by Undertaking of mortgage guarantee business.
joint stock companies catering to niche areas ranging
from personal loans to infrastructure financing. PDs play 11. NBFC-Account Aggregator (NBFC-AA)—
an important role as market makers for government Collecting and providing information about a customer’s
securities. financial assets in a consolidated, organised and
retrievable manner to the customer or others as specified
Non-Banking Financial Companies by the customer.
NBFCs are classified on the basis of 12. NBFC–Peer to Peer Lending Platform
(a) Their liability structures; (NBFC-P2P)—Providing an online platform to bring
lenders and borrowers together to help mobilise funds.
(b) The type of activities they undertake; and
(c) Their systemic importance. Capital Market
In the first category, NBFCs are further subdivided The capital market is a market where buyers and
into— sellers participate in the trading of financial securities.
● NBFCs-D–which are authorised to accept and hold Financial securities are generally of long-term
public deposits– and investment nature. They may be shares of a company or
bonds. Besides trading, corporates issue bonds and
● NBFCs (NBFCs-ND)– which do not accept public shares for the first time in the capital market to raise
deposits but raise debt from market and banks. funds for their need. Now-a-days, trading takes place
Among NBFCs- ND, those with an asset size of R 5 electronically. Stock exchange facilitates such trading
billion or more are classified as NBFCs-ND-SI. with various intermediaries like brokers etc.
NBFCs can also be categorised on the basis of
activities undertaken as they typically focus on niche Types of Capital Market
segments and fulfill sector–specific requirements. Based on the instruments life and duration of its
Consequently, their varied business models require trading, the capital market is of two types.
appropriate modulation of the regulatory regime. Till Primary Markets—The primary capital market is a
2010, the NBFC sector was divided into five categories part of a capital market. This market is basically for
viz., asset finance companies; loan companies; residuary issuing new securities in the market. Private companies,
non-banking companies; investment companies and governments or public sector companies participate in
mortgage guarantee companies. Since then, however, primary markets. They come up with an initial public
newer types of activity have been added to the NBFC offering (IPO). These companies and institutions can
space. also come up with right issues and debt instruments
through primary market.
Type of NBFC Activity
Through IPO, companies, and institutions raise
1. Asset Finance Company (AFC)—Financing of money for the first time from the capital market. On the
physical assets including automobiles, tractors and other hand, if a company wishes to raise money from
generators. their existing shareholders only, they do so through a
2. Loan Company—Provision of loan finance. right issue. Whereas in place of making shareholder, if
institutions and companies wish to raise money, the
3. Investment Company—Acquisition of securities issue different bonds in the primary market. These bonds
for purpose of selling. generally carry interest rate on them. Also, these
4. NBFC-Infrastructure Finance Company instruments are for longer periods. It is also called the
(NBFC-IFC)—Provision of infrastructure loans. new issue market (NIM).
5. NBFC-Systemically Important Core Invest- Secondary Markets—A secondary market is the
ment Company (CIC-ND-SI)—Makes investments and part of the capital market where financial instruments
loans to group companies. already issued in primary markets are traded. Stock
6. Infrastructure Debt Fund-NBFC (IDF- exchanges like NSE, BSE provides the facility for such
NBFC)—Facilitation of flow of long-term debt into trading. Financial instruments like stocks, bonds,
derivatives etc. are traded in the secondary market.
infrastructure projects.
Sometimes, it is also called the aftermarket and follow-
7. NBFC-Micro Finance Institution (NBFC- on public offering (FPO). In FPO, an existing company
MFI)—Credit to economically dis-advantaged groups. or institutions that already have raised money through
8. NBFC-Factor—Acquisition of receivables of an IPO can raise money.
assignor or extending loans against the security interest Commodity Future Market—Commodities futu-
of the receivables at a discount. res are agreements to buy or sell a raw material at a
Economics (NET) | 481U
specific date in the future at a particular price. The long-term assets, which are those with maturities of
contract is for a set amount. The three main areas of greater than one year.
commodities are food, energy, and metals. The most Capital markets include the equity (stock) market
popular food futures are for cereals, pulses, oilseeds, and debt (bond) market. Together, money markets and
cotton etc. Most energy futures are for oil and gasoline. capital markets comprise a large portion of the financial
Metals using futures include gold, silver, and copper. market and are often used together to manage liquidity
Buyers of food, energy, and metal use futures contracts and risks for companies, governments, and individuals.
to fix the price of the commodity they are purchasing. The money market is often accessed alongside the
That reduces their risk that prices will go up. Sellers of capital markets. While investors are willing to take on
these commodities use futures to guarantee they will more risk and have the patience to invest in capital
receive the agreed-upon price. They remove the risk of a markets, money markets are a good place to "park"
price drop. That’s because the prices of commodities funds that are needed in a shorter period, usually one
change on a weekly or even daily basis. Contract prices year or less. The financial instruments used in capital
change as well. That’s why the cost of meat, gasoline, markets include stocks and bonds, but the instruments
and gold changes so often. used in the money markets include deposits, collateral
loans, acceptances, and bills of exchange. Institutions
Instruments in the Capital Market operating in money markets are central banks,
The broad categories of tradable instruments of commercial banks, and acceptance houses, among
capital market are— others.
Equities—The equity market instruments are Money markets provide a variety of functions for
common stocks, Exchange traded funds, Indices, Initial individual, corporate, or government entities. Liquidity
public offerings, In Mutual funds, Offer for sale, is often the main purpose for accessing money markets.
Security lending, and borrowings. When short-term debt is issued, it's often to cover
● Equities operating expenses or working capital for a company or
● Exchange Traded Funds government and not for capital improvements or large-
● Indices scale projects. Companies may want to invest funds
● Initial Public Offerings overnight and look to the money market to accomplish
● Institutional Placement Program
this, or they may need to cover payroll and look to the
money market to help.
● Mutual Funds
The money market plays a key role in
● Offer for Sale
assuring companies and governments maintain the
● Security Lending and Borrowing Scheme appropriate level of liquidity on a daily basis, without
Derivatives Instruments— falling short and needing a more expensive loan or
● Equity Derivatives without holding excess funds and missing the opportu-
● Currency Derivatives nity of gaining interest on funds.
● Global Indices Derivatives Investors, on the other hand, use money markets to
● NSE Bond Futures invest funds in a safe manner. Unlike capital markets,
Debt instruments—The debt instruments includes money markets are considered low risk; risk-averse
corporate bonds and other debt instruments of central investors are willing to access them with the anticipation
and state governments, Local bodies, Institutions, Public that liquidity is readily available. Those individuals
sector units, and Banks. living on a fixed income often use money markets
● Debt Segment because of the safety associated with these types of
investments.
● Corporate Bonds
Together, money markets and capital markets are
● Commodity Futures
used to manage liquidity and risks for companies,
Difference Between Money Market and governments, and individuals.
Capital Market Capital markets are perhaps the most widely
followed markets. Both the stock and bond markets are
A financial market brings buyers and sellers closely followed, and their daily movements are
together to trade in financial assets such as stocks, analyzed as proxies for the general economic condition
bonds, commodities, derivatives, and currencies. The of the world markets. As a result, the institutions opera-
purpose of a financial market is to set prices for global ting in capital markets—stock exchanges, commercial
trade, raise capital, and transfer liquidity and banks, and all types of corporations, including non-bank
risk. Although there are many components to a financial institutions such as insurance companies and mortgage
market, two of the most commonly used are money banks—are carefully scrutinized.
markets and capital markets. The institutions operating in the capital markets
Government and corporate entities use money access them to raise capital for long-term purposes, such
markets as a means for borrowing and lending in the as for a merger or acquisition, to expand a line of
short term, usually for assets being held for up to a year. business or enter into a new business, or for other capital
Conversely, capital markets are more frequently used for projects. Entities that are raising money for these long-
482U | Economics (NET)
term purposes come to one or more capital markets. In The first move towards regulating the Indian capital
the bond market, companies may issue debt in the form market was fallout of the panic which was created in
of corporate bonds, while both local and federal 1865 in BSE. ‘Share mania’ crisis of 1865 left the
governments may issue debt in the form of government brokers, small investors, bankers and creditors in chaos.
bonds. This was the first time that Indian capital markets
Similarly, companies may decide to raise money by underwent a crash. In response to this, a ‘Bill for the
issuing equity on the stock market. Government entities relief of Insolvent Debtors in the Presidency of Bombay’
are typically not publicly held and, therefore, do not was introduced in then Bombay Legislative
usually issue equity. Companies and government entities Council’.This bill was sent to the ‘Select Committee’,
that issue equity or debt are considered the sellers in but it remained unnoticed for almost two years. In
these markets. September 1867, the Bill was withdrawn and thus, the
The buyers (or the investors) buy the stocks or first attempt to regulate the Indian capital markets failed.
bonds of the sellers and trade them. If the seller Before independence, i.e., prior to 1947, Britishers did
(or issuer) is placing the securities on the market for the not institute any legal mechanism or system which could
first time, then the market is known as the primary regulate the capital markets in India.
market. After independence, socialistic pattern of
Conversely, if the securities have already been governance and the development was adopted in India .
issued and are now being traded among buyers, this is The government tried to control the entire economy with
done on the secondary market. Sellers make money off various laws which were enacted during 1950’s. As the
the sale in the primary market, not in the secondary markets were not open for foreign as well as private
market, although they do have a stake in the outcome players, the need for regulation did not arise strongly.
(pricing) of their securities in the secondary market. But due to increasing participation of small investors,
The buyers of securities in the capital market tend to numbers of scams, manipulation by brokers the policy
use funds that are targeted for longer-term investment. makers were forced to think about regulatory system in
Capital markets are risky markets and are not usually the Indian capital market.
used to invest short-term funds. Many investors access Initially , the RBI , controlled the capital market in
the capital markets to save for retirement or education, India indirectly. The enactment of the Companies Act
as long as the investors have lengthy time horizons. ,1956 was the major step towards the regulation of
Regulation of Capital Market Indian capital market. This act is one of the important
functionaries in governing the entire corporate sector.
A well regulated market has the prospective to boost
From the formation of the companies, to the liquidation
additional investors to participate, and contribute in,
of the companies, everything is regulated and governed
promoting the development of the economy. Capital
as per the provisions of the Companies Act, 1956.
Market Regulatory Authorities Worldwide: The chief
When these developments were taking place, the
capital market regulatory authorities worldwide are as
rules and procedure to be followed for recognition of the
follows—
stock exchanges were also needed to be formalized.
● U.S. Securities and Exchange Commission
With this intention, Securities Contracts (Regulation)
● Canadian Securities Administrators, Canada
Rules, 1957 came into existence. These rules contained
● Australian Securities and Investments Commission
provisions relating to recognition of stock exchanges,
● Securities and Exchange Commission, Pakistan
periodical returns and annual reports of these exchanges,
● Securities and Exchange Board of India
listing requirements etc. These rules were made statutory
● Securities and Exchange Commission, Bangladesh
standardized formalities which should be applicable to
● Securities and Exchange Surveillance Commission all recognized stock exchanges. Later on, after SEBI’s
● Securities and Futures Commission, Hong Kong formation, some of these provisions were shifted and
● Financial Supervision Authority, Finland SEBI was made more powerful to apply these rules.
● Financial Supervision Commission, Bulgaria
● Financial Services Authority, UK
Securities and Exchange Board of India
● Comision Nacional del Mercado de Valores, Spain (SEBI): Principal Regulator of Capital
● Authority of Financial Markets Markets
SEBI was established, as a non- statutory body , in
Regulatory Structure of Capital Market 1988 on the recommendations of M. J. Pherwani
in India Committeee (1985). It was given statutory status in 1992
The formal operations of the stock exchanges in through an Act passed by the Parliament.
India commenced in 1875. Throughout the various In order to curb the malpractices, SEBI was
phases of development in the capital market, lot of promoted on the same lines in which Securities
changes have taken place in trading operations. When Exchange Commission (SEC) was promoted in the
this was happening, slowly, the small investors also USA. Some of the malpractices which frequently
were attracted towards the capital market. Still the disturbed the primary market were brokers/consultants’
securities market was largely unregulated, particularly, speculative motive, grey market, delay in listing and
prior to independence. allotment in shares. Apart from this, some malpractices
Economics (NET) | 483U
frequently found in the secondary markets (stock (While nominating these members of the Board, it is
exchanges) were lack of transparency, delay in emphasized that these members have good
settlement, insider trading etc. In order to curb these knowledge or experience in the areas of finance,
malpractices, a strong regulator was needed for law, accountancy, economics etc.).
development of capital market. ● SEBI is also a member of IOSCO (International
SEBI, which has been entrusted with such Organization of Securities Commissions) which is
regulatory functions, was formed with the following an international body comprising of financial
broad objectives. market regulators throughout the world. SEBI also
● Investor protection to ensure steady flow of savings is actively engaged in the development Committee
into the capital market. of IOSCO which provides platform for the regulators
● Ensuring the fair practices by the issuers of from emerging markets to share the views and
securities, namely companies so that they can raise exchange of information with each other.
resources at least cost After getting a status of an autonomous and strong
● Promotion and efficient services by brokers, regulatory authority, SEBI started functioning to protect
merchant bankers and other intermediaries so that the interest of the investors. While performing the
they become competitive and professional. functions, SEBI works through six different departments
Functions of SEBI—As per Section 11 of the SEBI which are entrusted specific functions.
Act, the functions which are entrusted to the SEBI are These departments are—
classified into Regulatory and Developmental Functions.
1. The Primary Market Department—It looks
Regulatory Functions—
after policy matters and regulatory issues regarding
● Registration of brokers, sub-brokers and other
primary markets, registration, merchant bankers,
players in the market
portfolio management services, underwriters etc.
● Registration of collective investment schemes and
mutual funds 2. The Issue Management Department—It is
● Regulation of stock exchanges, merchant banks and responsible for granting the prospectuses and letters of
portfolio managers offers for public issue. It coordinates with primary
● Prohibition of all fraudulent and unfair trade market policy for monitoring of issue related inter-
practices mediaries.
● Controlling insider trading and take-over bids and 3. The Secondary Market Department—It looks
imposing penalties for such practices after regulatory issues for secondary market. It also
Developmental Functions— regulates the registration and monitors the members of
● Investor education -Training of intermediaries stock exchanges. Monitoring of insider trading, price
● Promotion of fair practices and a code of conduct movement, EDP and SEBI’s data base is also maintained
for all Self Regulatory Organizations (SROs) by this Department.
● Conducting research and publishing information 4. The Institutional Investors’ Department—It
useful to all market participants. stresses on policy, registration, regulation and
Organizational Structure monitoring of FIIs, domestic mutual funds, international
relations etc.
The Head Office of the SEBI is situated at Mumbai
(Bandra Kurla Complex). It also has three regional 5. The Legal Department—It looks after all the
offices at New Delhi, Kolkata and Chennai for northern, legal matters arising out of functioning of the SEBI.
eastern and southern region respectively. While issuing various guidelines or regulating the
SEBI, being a Board , has the composition of nine financial markets, some legal complications may come
distinguished members. The composition is as under. out which are looked after by the Legal Department.
● The Chairman (The Chairman of SEBI is appointed 6. The Investigation Department—It carries out
by the Central Government. While appointing the inspection and investigation. Such investigation may be
Chairman and the nominated members, the Central on its own or as ordered by the Central Government.
Government has to see that these persons should 7. The Commodity Derivatives Market Regula-
have ability, integrity and standing who have shown tion Department—This department is responsible for
capacity in dealing with problems of the securities supervising the functioning and operations of Commo-
markets. They are required to have good knowledge dity Derivative exchanges. This department was created
or experience in administration also.). in the consequence of the merger of commodity exchange
● Two officials from Central Government (These are market regulator–Forward Market Commission with the
nominated from Ministry of Finance, Law and SEBI on 28 September 2015. The following Divisions
Company Affairs). perform the functions of the Department—
● One official is nominated by the Reserve bank of 1. Division of New Products and Market Policy.
India.
2. Division of Exchange Administration.
● Five other members are nominated by the Central
Government out of which at least three should be 3. Division of Inspection.
whole time members. 4. Division of Risk Management.
484U | Economics (NET)
5. Division of Complaints 1. Treasury and Accounts Division
6. Division of Products 2. Facilities Management Division
8. The Corporation Finance Department : It deals 3. Official Language Division
with matters relating to— 4. Office of the Secretary to the Board
(i) Issuance and listing of securities, including initial 5. Protocol and Security Division
and continuous listing requirements. 14. The Human Resources Division—It performs
(ii) Scheme of arrangements involving merger/ all the functions in its role as the principal personnel and
demerger, amalgamation, reduction in capital corporate human resources authority in SEBI.
governance and accounting/auditing standards. 15. Other Departments/Divisions—Other depart-
(iii) corporate restructuring through Takeovers/ buy ments/ divisions of SEBI are following—
backs. ● Division of Foreign Portfolio Investors & Custo-
(iv) Delisting, etc. dians (Division of Foreign Portfolio Investors &
9. Department of Economic and Policy Analysis Custodia).
● Information Technology Department.
(DEPA)—The Department handles its functions through
● Integrated Surveillance Department.
the following Divisions—
● Market Intermediaries Regulation and Supervision
1. Statistics Division Department.
2. Publication Division ● Market Regulation Department.
3. Regulatory Research Division Investor protection is the major responsibility of the
4. History Cell SEBI. For this purpose lot of guidelines have been
5. Policy Research Division issued by the SEBI to control and regulate the capital
6. Systematic Stability Unit market in India and thereby, to shoulder the responsi-
7. Division Of Commodity Research (Agriculture) bility of protecting the interest of the investors in the
8. Division Of Commodity Research (Non Agricul- capital market. To perform this job, SEBI has formed
ture) two non statutory advisory committees—
10. The Department of Debt and Hybrid Secu- I. Primary Market Advisory Committee and
rities—It is responsible for matters related to Corporate II. Secondary Market Advisory Committee.
Bonds, listed debt securities, Real Estate Investment These committees have members from the categories
Trust, Infrastructure Investment Trust, deemed public like market players, recognized investors’ associations
issues of debt securities and complaints in respect of and other eminent persons in the financial markets.
aforementioned areas of work. The following Divisions Securities Appellate Tribunal
perform the functions of the Department : Securities Appellate Tribunal is a statutory body
1. Primary Issuance and Policy established under the provisions of Section 15K of the
2. Post Issuance, Compliance and Monitoring Securities and Exchange Board of India Act, 1992 to
11. Enforcement Department I—It performs hear and dispose of appeals against orders passed by the
through Securities and Exchange Board of India or by an
(i) File and Database Management Division, and adjudicating officer under the Act; and to exercise
jurisdiction, powers and authority conferred on the
(ii) Recovery Divisions.
Tribunal by or under this Act or any other law for the
12. Enforcement Department II—Enforcement time being in force. SAT hears and disposes of appeals
Department-2 (EFD-2) is responsible for handling against orders passed by the Pension Fund Regulatory
Appeals against SEBI orders filed before the Hon’ble and Development Authority (PFRDA) under the PFRDA
Securities Appellate Tribunal (SAT), Appeals filed Act, 2013. SAT also hears and disposes of appeals
against the SAT order in the Hon’ble Supreme Court, against orders passed by the Insurance Regulatory
Criminal Complaints filed by SEBI in appropriate Development Authority of India (IRDAI) under the
Courts and Settlement Proceedings. EFD-2 Comprises Insurance Act, 1938, the General Insurance Business
of three divisions, namely— (Nationalization) Act, 1972 and the Insurance Regulatory
1. SAT Litigation Division and Development Authority Act, 1999 and the Rules and
2. Prosecution Division Regulations framed there under.
3. Settlement Division Depository
13. The Enquiries and Adjudication Depart- A depository is an entity which helps an investor to
ment—It handles quasi-judicial matters and provide buy or sell securities such as stocks and bonds in a
timely hearings and initiates adjudication brought by the paper-less manner. Securities in depository accounts are
other Departments against alleged violators who are similar to funds in bank accounts. A depository works as
within SEBI's disciplinary jurisdiction. a link between the listed companies which issue shares
General Service Department—This department and shareholders. It issues these shares through agents
supports all of the internal operations of SEBI. The associated with it called depository participants or DPs.
Department has the following divisions : A DP can be a bank, financial institution, a broker, or
Economics (NET) | 485U
any entity eligible as per SEBI norms and is responsible convertible debentures, on the due date, the
for the final transfer of shares from the depository to securities are converted into company shares.
investors. The investor, at the end of a transaction 9. Depository acts as collateral security for the raising
receives a confirmation from the depository. of 1oans from any financial institution.
A depository eliminates the risk associated with National Depository Services Ltd. (NSDL)
holding physical securities. Earlier, the buyer would
have to keep checking if the shares have been transferred NSDL, the first and largest depository in India,
safely to his account, and ensure that theft, damage or established in August 1996 and promoted by institutions
loss has not happened. After the depository system came of national stature-Industrial Development Bank of India
about, such risks have been greatly reduced since the Limited (IDBI) , Unit Trust of India (now, Administrator
shares are held in and transferred in an electronic of the Specified Undertaking of the Unit Trust of India)
manner. They also reduce the paper work involved in and National Stock Exchange of India Limited (NSE).
trading and fasten the transfer of shares. In 1998, demat has established a state-of-the-art infrastructure that
or electronic trading was made compulsory for insti- handles most of the securities held and settled in
tutional investors, which led to a spike in the overall dematerialized form in the Indian capital market.
trading volumes in the Indian market. Foreign investors Although India had a vibrant capital market which is
felt more confident about trading in the Indian market more than a century old, the paper-based settlement of
due to the depository system as there were far fewer trades caused substantial problems like bad delivery and
incidents of forgery, delay and unscrupulous transfer of delayed transfer of title, etc. The enactment of
shares. Depositories Act in August 1996 paved the way for
establishment of NSDL.
A Depository Participant (DP) is an agent of the
depository through which it interfaces with the investor Using innovative and flexible technology systems,
and provides depository services. Public financial NSDL works to support the investors and brokers in the
institutions, scheduled commercial banks, foreign banks capital market of the country. NSDL aims at ensuring
operating in India with the approval of the Reserve Bank the safety and soundness of Indian marketplaces by
of India, state financial corporations, custodians, stock- developing settlement solutions that increase efficiency,
brokers, clearing corporations /clearing houses, NBFCs minimize risk and reduce costs. At NSDL, we play a
and Registrar to an Issue or Share Transfer Agent central role in developing products and services that will
complying with the requirements prescribed by SEBI continue to nurture the growing needs of the financial
can be registered as DP. Banking services can be availed services industry. In the depository system, securities are
through a branch whereas depository services can be held in depository accounts, which is more or less
availed through a DP. similar to holding funds in bank accounts. Transfer of
ownership of securities is done through simple account
Advantages of Depository system transfers. This method does away with all the risks
1. Depository system takes hold of all securities in the and hassles normally associated with paperwork.
country listed in that particular stock exchange. Consequently, the cost of transacting in a depository
environment is considerably lower as compared to
2. Introduction of electronic system enables speedy
transacting in certificates.
transactions and accuracy.
3. In a depository system, the security holders can sell NSDL provides bouquet of services to end
and buy securities by which liquidity is brought to investors, stock brokers, stock exchanges, custodians,
the securities. issuer companies etc. through its network of more than
276 Depository Participants / Business Partners. NSDL
4. Blank transfers are avoided and holding of shares in
has been able to win the trust of crores of investors and
Benami names is also prevented.
other intermediaries, thus standing true to its tag line—
5. Registration and stamp charges for the sale of Technology, Trust and Reach. We at NSDL believe
securities could be easily collected by the that ‘Every Indian should not only become an ‘Investor’
government which was evaded under the previous but a ‘Prudent Investor’ indeed.
system.
Central Depository Services Ltd.—CDSL was set
6. Depository promotes more activity in the capital up in February 1999 with the objective of providing
market as trading in genuine share is ensured under convenient, dependable and secure depository services
Depository system. at affordable cost to all market participants. CDSL was
7. Depository avoids use of stationery and prevents promoted by Bombay Stock Exchange Limited (BSE
delay in registration of transfers. jointly with State Bank of India, Bank of India, Bank of
8. Dividend and interest on securities are properly Baroda, HDFC Bank, Standard Chartered Bank, Axis
distributed through this system and in the case of Bank and Union Bank of India.
486U | Economics (NET)
Objective Questions
1. Which of the following is/are the components of (B) Only I, II and III
money supply ? (C) Only II, III and IV
I. Currency notes with the public (D) I, II, III and IV
II. Coins in circulation with the public 8. Credit creation is a function of—
III. Deposits with the banks (A) Central Bank
IV. Deposits of banks with the Central Bank (B) Commercial Banks
(A) Only I and II (C) Government
(B) Only I, II and III (D) Co-operative credit societies
(C) Only II, III and IV
(D) I, II, III and IV 9. Supply of money over a period of time is a function
of—
2. Which of the following system has been adopted by I. M (Quantum of money)
the RBI to issue currency notes ?
II. V (Velocity of money)
(A) Simple deposited system
III. T (Number of transaction)
(B) Proportional Reserve System
(A) Only I and II (B) Only II and III
(C) Minimum Reserve System
(C) I, II and III (D) Only I and III
(D) Fixed Fiduciary System
10. Liquidity approach to the concept of money supply
3. Which of the following measure of money supply is advocated by—
termed as Reserve Money ?
(A) Milton Friedman
(A) M0 (B) M1
(B) The RBI
(C) M2 (D) M3
(C) The Radcliffe Committee
4. Which of the following measure of money supply is (D) Gurley and Shaw
termed as broad money—
11. Consider the List-I (Approaches of Money Supply
(A) M1 (B) M2
and List-II (Name of the Approach/Propounder)—
(C) M3 (D) M4
List-I
5. Which of following is a determinant of money (a) Traditional approach
supply ? (b) Monetarist approach
I. Stock of high powered money
(c) Gurely-Shaw approach
II. Actual reserve ratio of commercial banks
(d) Liquidity approach
III. Public’s desire to hold currency and deposit
List-II
(A) I, II and III (B) Only I and II
(C) Only I (D) Only II and III 1. Chicago school
2. Radcliffe approach
6. If H is high powered money, K is the currency
deposit ratio, r is the desired deposit ratio and l is 3. Totality of financial liabilities and non-
the quantity to total legal tenders, then value of monetary
money multiplier is— 4. Money is a medium of exchange (financial
intermediarin)
(A) M = ( )
1 l+K
H r+K
(B) M = H ( )l+K
r+K (a) (b) (c) (d)
(A) 1 4 3 2
(C) M = H ( )
r+K
l+K
(D) M = H (l + K) · (r + K)
(B) 3 2 1 4
7. Certain factors affect the money supply such as— (C) 4 1 3 2
I. Government borrowing from the banking (D) 4 3 2 1
sector. 12. Match the List-I and List-II and choose the correct
II. Borrowing of the private or commercial sector code given below.
from the banking sector. List-I
III. Changes in net foreign assets held by the
(a) Federal Reserve
central bank caused by changes in balance of
payments. (b) People’s Bank
IV. Government’s currency liability to the public (c) Bank Central Republic
(A) Only I and II (d) Bank Negara
Economics (NET) | 487U
List-II III. Coastal Local Area Bank—Payments Bank
1. Indonesia 2. Malaysia IV. Citibank India—Foreign Bank
3. USA 4. China Correct code is—
(a) (b) (c) (d) (A) I, II and IV
(A) 3 4 2 1 (B) Only I, II and III
(B) 4 3 1 2 (C) Only I, II and IV
(C) 4 3 2 1 (D) All I, II, III and IV
(D) 1 2 3 4 20. Since April 1, 2019 which of the following Banks
13. Which of the following is not a function of Central is/are not in operation ?
Bank ? I. Vijaya Bank II. Dena Bank
(A) Issuing currency III. Indian Bank
(B) Custodian of foreign exchange assets (A) All I, II and III (B) Only I and II
(C) Credit creation (C) Only I and III (D) Only II and III
(D) Banker of the banks 21. According to a notification of Central government,
14. Credit control is a function of— which of the following is the lower and upper
tolerance limit of consume Price Index base
(A) Federal government
inflation rate for the purpose of deciding the policy
(B) State government Repo Rate—
(C) Central Bank (A) 1 per cent, 5 per cent
(D) Commercial Banks (B) 2 per cent, 6 per cent
15. Which of the following is not an instrument of (C) 3 per cent, 7 per cent
monetary policy ? (D) None of the above
(A) Cash Reserve Ratio
22. Policy Repo Rate in India is decided by—
(B) Tax-GDP Ratio
(A) Ministry of Finance
(C) Open Market Operations
(B) Governor of RBI
(D) Repo Rate
(C) Monetary Policy Committee
16. Which of the following is a measure of selective (D) Indian Bank’s Association
credit control ?
23. Which of the following statement is correct about
(A) Minimum margin’s for lending against specific
the Monetary Policy Committee (MPC) ?
securities
I. MPC was constituted on the recommendation
(B) Ceiling on the amount of credit for foodgrain of Urjit Patel Committee
purchasing
II. MPC was constituted on 29 September, 2016
(C) Regulation of consumer credit for durable III. MPC has 6 members, 3 from the RBI and 3
assets nominated by the government of India
(D) All of the above IV. The term of office of the government nomi-
17. Which of the following is not a Central Bank of a nated members is 4 years
country ? (A) Only I
(A) State Bank of Pakistan (B) Only I and III
(B) Federal Reserves (C) All I, II, III and IV
(C) Central Bank of India (D) Only I, II and III
(D) Reserve Bank of New Zealand 24. Match the List-I and List-II and choose the correct
code given below—
18. Which of the following is not a Commercial Bank ?
List-I
(A) Central Bank of India
(a) Liquidity Adjustment Facility (LAF)
(B) Bandhan Bank (b) Marginal Standing Facility (MSF)
(C) Bank of Baroda (c) Bank Rate
(D) Standard Chartered Bank (d) Open Market Operations
19. Which of the following pair is/are matched List-II
correctly ? 1. Rediscount bills of exchange
I. State Bank of India—Government of India’s 2. Purchase and sale of government securities
Bank 3. Repo rate
II. IDFC First Bank—Private Sector Bank 4. Borrowing of additional amount of money
488U | Economics (NET)
(a) (b) (c) (d) 31. Which of the following is/are the instruments in the
(A) 4 3 2 1 capital market ?
(B) 1 2 3 4 I. Equitiers and Bonds
(C) 2 1 3 4 II. Exchange Traded Funds
(D) 3 4 1 2 III. IPOs
25. Bench mark inflation target limit of CPI based IV. Securities lending and borrowing scheme
inflation rate, notified by the government of India (A) Only I and III
will be ending on— (B) Only I, II and III
(A) March 31, 2020 (C) All I, II, III and IV
(B) March 31, 2021 (D) Only III
(C) March 31, 2022
32. Which of the following is/are derivatives instru-
(D) March 31, 2023 ments ?
26. Which of the following is a non-banking financial I. Equity derivatives
institution ? II. Currency derivatives
I. National Housing Bank III. Global indices derivatives
II. NABARD IV. NSE bond futures
III. Export-Import Bank (A) Only I, II and III (B) Only I and III
IV. SIDBI (C) Only I (D) All I, II, III and IV
(A) Only II (B) Only I and III 33. Which of the following is/are an instruments used in
(C) Only II and III (D) All I, II, III and IV money market ?
27. Which of the following is not a characterstics of a I. Deposits II. Collateral loans
non-banking financial institution (NBFC) ? III. Acceptances IV. Bills of exchanges
(A) NBFC cannot accept deposits from the public (A) Only I and II (B) Only III and IV
(B) Pawn shops are a type of NBFCs (C) Only I, II and III (D) All I, II, III and IV
(C) NBFCs provide services that are not necessa- 34. In order to curb the malpractices in the capital
rily suited to banks markets, SEBI has been promoted on the same lines
(D) NBFC can accept deposits from the public in which………was promoted.
(A) Securities and Exchange Commission (U.S.)
28. Which of the following pairs is/are matched (B) Australian Securities and Investments Commi-
correctly ? ssion
I. Risk Pooling Institution—Life Insurance Cor- (C) Canadian Securities Administrator
poration of India (D) Financial Supervision Authority, Finland
II. Contracted Saving Institutions—Foreign Insti-
35. Which of the following depository has been by the
tutional Investors
Bombay Stock Exchange ?
(A) Only I (B) Only II
I. National Depository Services Ltd.
(C) Both I and II (D) Neither I nor II II. Central Depository Services Ltd.
29. The banking, securities and insurance markets have (A) Only I (B) Only II
become increasingly integrated. Which of the (C) Both I and II (D) Neither I nor II
following pair is/are matched correctly in regard to
36. Which of the following measure of money supply is
an approach to supervision ?
termed as narrow money ?
I. A three-pillar or sectoral model—Banking (A) M0 (B) M1 (C) M2 (D) M3
II. A two-pillar or twin peak model—Prudential
and business conduct. Answers
(A) Only I (B) Only II 1. (D) 2. (C) 3. (A) 4. (C) 5. (A)
(C) Both I and II (D) Neither I nor II 6. (B) 7. (D) 8. (B) 9. (A) 10. (C)
30. Which of the following is the regulator of capital 11. (C) 12. (A) 13. (C) 14. (C) 15. (B)
markets in India ? 16. (D) 17. (C) 18. (A) 19. (A) 20. (A)
(A) Reserve Bank of India 21. (B) 22. (C) 23. (C) 24. (D) 25. (B)
(B) Securities and Exchange Board of India 26. (D) 27. (D) 28. (C) 29. (C) 30. (B)
(C) Registrar of Companies 31. (C) 32. (D) 33. (D) 34. (A) 35. (B)
(D) Ministry of Corporate Affairs 36. (B)
●●
UNIT-8
Growth and Development Economics
Economic Growth and Economic Deve- (a) the distribution of income and wealth,
lopment (b) the sociological and cultural structure,
It is defined as the expansion of a nations’s (c) the legal structure of the country and
capability to produce the goods and services its people (d) the dominant forms of business organisations.
want. (3) Intermediate factors refer to those factors
In the words of Peterson, “Economic Growth which enter into the determination of level of aggregate
involves an increase over time in the actual output of demand.
goods and services as well as increase in the economy’s
capability to produce goods and services.” Concept of Economic Development
Some economists define economic growth as the Economic development means economic growth
increase in per capita income of the country at constant with structural changes in favour of non-agricultural
price. A higher per capita income would mean that activities. This implies that the share of agriculture in
people are better off and enjoy a higher standard of GDP should decline and the share of industrial sector
living. Raising the existing level of living is the main and services should increase. This is a reflection of
objective of economic development. An increase in changing demand for goods and services on the one
national income and per capita income is therefore hand and changing demand for labour by production
implicit in the theory of economic growth. Literally the technology in different sectors on the other.
term Economic Growth means an increase in the Some economists pointed out the necessity of
country’s Net National Product (NNP). This improve- attitudinal changes in people – a leap from traditional
ment in income leads to higher savings, increased capital value system to modern value system. In this context,
formation and improved technology. economic development can be defined as economic
Economic Growth means transformation of an growth plus, that is, something more than economic
economy from a state of under-development to a state of growth.
development, from an agrarian to highly industrialised There were attempts to emphasize technological
society from a low saver to a high saver and from rural dimension of development. Then we could define
to urban. This transformation is mainly reflected in a economic development as economic growth accompanied
sustained and steady rise in national and per capita by rise in productivity.
income. An economist asserted in a world conference in
Delhi : The questions to ask about a country’s develop-
Factors of Growth ment are : what has been happening to unemployment?
The important factors that stimulate the growth What has been happening to inequality? What has
process are classified into three groups : (1) Fundamental been happening to poverty? Keeping this in view, some
Factors, (2) Socio-Economic Factors and Intermediate economists prefer to define economic development as
Factors. economic growths with redistribution of resources in
(1) Fundamental factors are those which attempt to favour of the relatively worse off.
define the potential for production of any economy in a Concepts of ‘Growth’ and ‘Development’
fundamental sense. It includes :
The term ‘economic growth refers to increases over
(a) the quantity and quality of national resources,
time in a country’s real output of goods and services—
(b) the quantity and quality of real capital, or more appropriately product per capita. The term
(c) the quantity and quality of labour force and ‘economic development’, in contrast, is more compre-
(d) the level of technological attainment of the hensive. It implies progressive changes in the socio-
society. economic structure of a country. Viewed in this way,
(2) Socio economic factors are those which are economic development involves a steady decline in
related to the socio economic structure of the society. agriculture’s share in GNP and a corresponding increase
These include : in the share of industries, trade, banking, construction
490U | Economics (NET)
and services. This transformation in economic structure steady change in the long-run which comes about by a
is invariably accompanied by a shift in the occupational gradual increase in the rate of savings and population.
structure of the labour force and an improvement in its According to Kindleberger, Economic growth means
skill and productivity. more output while economic development implies both
In fact, the terms ‘development’ and ‘growth’ have more output and changes in the technical and
nothing to do with the type of economy. The distinction institutional arrangements by which it is produced and
between the two relates to the nature and causes of distributed. Friedmann defines growth as an expansion
change. Schumpeter makes the distinction clearer when of the system in one or more dimensions without a
defines development as a discontinuous and spontaneous change in its structure and development as an innovative
change in the stationary state which forever alters and process leading to the structural transformation of social
displaces the equilibrium state previously existing; while system.
growth is a gradual and steady change in the long run Thus economic growth is related to a quantitative
which comes about by a gradual increase in the rate of sustained increase in the country’s per capita output
savings and population. This view of Schumpeter has or income accompanied by expansion in its labour force,
been widely accepted and elaborated by the majority of consumption, Capital and volume of trade. On the other
economists. According to Kindle Berger, “Economic hand, economic development is a wider term. It is
growth means more output, while economic development related to qualitative changes in economic wants, goods,
implies both more output and changes in the technical incentives and institutions. Despite these apparent
and institutional arrangements by which it is produced differences, some economists use these terms as
and distributed. Growth may well involve not only more synonym A. Lewis in his theory of economic growth
output derived from greater amounts of inputs but also writes that most often we shall refer only to growth but
greater efficiency, i.e., an increase in output per unit of occasionally for the sake of variety to progress or to
input. Development goes beyond this to imply changes development.
in the composition of output and in the allocation of
inputs by sectors.” Concept of Sustainable Development
Friedman defines growth as an expansion of the Sustainable development implies that economic
system in one or more dimensions without a change in development should proceed at a pace and in a manner
its structure, and development as an innovative process which will conserve the environment and deployable
leading to the structural transformation of social natural resources. In its extreme form (stready state
systems. growth), population would be stabilized and renewable
resources only would be employed.
Thus economic growth is related to a quantitative
sustained increase in the country’s per capita output or The more goods were produce, the more pollution is
income accompanied by expansion in its labour force, produced and more non-renewable natural resources are
consumption, capital and volume of trade. On the other exhausted. If non-renewable natural resources deplete
hand, economic development is a wider term. It is fast, future generations may not have enough stock for
related to qualitative change in economic wants, goods its use. Sustainable development may, therefore, requrie
incentives and institutions. the preservation of stocks of resources, including
environmental resources and natural exhaustible natural
Economic Development Versus Economic resources.
Growth Concerned with environmental degradation a world
commission was set up, which defines sustainable
Economic development refers to the problems of
development as that level which takes care of the needs
underdeveloped countries and economic growth to those
of the present generation without compromising the
of developed countries. Maddison makes the distinction
needs of the future generations.
between the two terms in this sense when he writes “The
raising of income levels is generally called economic Measurement of Growth or Development
growth in rich countries and in poor ones it is called When economic development takes place, invest-
economic development”. Mrs. Hicks points out in this ment increases and the stock of capital increases, as a
connection that the problems of underdeveloped result of which national income increases. When total
countries are concerned with the development of unused output increases, per capita consumption may increase
resources even though their uses are well known, while or decrease. Since some economists suggest that
those of advanced countries are related to growth, most economic growth and development means an increase in
of their resources being already known and developed to total output then we can think of measuring economic
considerable extent. development in terms total output or per capita output or
In fact the terms development and growth have per capita consumption. Therefore, Real National
nothing to do with the type of the economy. Schumpeter Income can be considered deemed to be a measure of
makes the distinction when he defines development as a economic development. However, other economists
discontinuous and spontaneous change in the stationery view that measures of economic development could be
state which forever alters and displaces the equilibrium consumption per capita. We may discuss each view
state previously existing. While growth is gradual and point in the succeeding paragraphs.
Economics (NET) | 491U
1. National Income as an Index—Professors economic variables implinging upon industrialization,
Kuznets, Meier and Baldwin hold the view that an urbanization and modernization. The indicators they use
increase in real national income is the most convenient are :
measure of economic development because a larger real (i) Expectation of life at birth
national income is normally a pre-requisite for an (ii) Percentage of population in localities of
increase in real per capita. It is true that, it is the increase 20,000 and over
in national income which is the most important criterion (iii) Consumption of animal protein per capita per
for determining development. But the use of the index day
has been criticised due to aggregative grounds. Also
it ignores the consumption and distribution of output (iv) Combined primary and secondary enrolment
which actually reflect the quality of development. ratio
Moreover it does not account for population trends as (v) Vocational enrolment ratio
does per capita income. (vi) Average number of persons per room
2. Per Capita Income as an Index—It is said (vii) Newspaper circulation per 1000 population
that economic growth is meaningless if it does not (viii) Percentage of economically active population
improve the standard of living of the people especially with electricity, gas, water etc
in underdeveloped countries. If national income (ix) Agricultural production per male agricultural
increases faster than the rate of growth of population, it worker
is undoubtedly a mark of economic development, taking
(x) Percentage of adult male labour in agriculture
the country as a whole. Similarly, an increase in the
aggregate output may be sign of development but not in (xi) Electricity consumption, per capita
all cases, the problem arises when the rate of growth of (xii) Steel consumption per capita
population is greater than the rate of increase in real (xiii) Energy consumption, kg. of coal equivalent
national income. In developing countries which are per capita
characterised by population pressure, a rise in per capita (xiv) Share of manufacturing in GDP
real income will always mean a rise in aggregate real (xv) Per capita foreign trade
output, hence the criterion of per capita real income is
better than that of aggregate real income in the measure- (xvi) Percentage of salaried and wage earners to
ment of economic development. total economically active person
3. Per Capita Level of Consumption—Some Economic and Non-economic Factors of
economists think that if improving the standard of living Economic Growth
of the people is the ultimate objective of economic
The process of economic growth is determined by
development, then the per capita consumption level is
two types of factors : economic and non-economic
the most appropriate index of economic development.
factors.
As we know that increase in per capita income will
improve the standard of living of the people, thus (A) Economic Factors
pushing upward the per capita consumption level. But it
cannot be ignored that an increase in per capita output (1) Natural Resources—The principal factor
need not always increase per capita consumption. affecting the development of an economy is natural
Actually in developing economies, when output roses resources or land. Land includes natural resources such
consumption has to be restricted to release resources for as the fertility of land, its situation and composi-
capital formation and the entire output is not consumed. tionforest, wealth, minerals, climate. A country which is
When total output increases, the consumption level may deficient in natural resources will not be in a position to
be suppressed by the government in order to get develop rapidly. In LDCs natural resources are either
resources for economic development. unutilized, underutilised or misutilised. Thus for
economic growth the existence of abundant natural
Economic development, as is known, is multi- resources is not enough what is essential is their proper
dimensional process and a unit dimensional means of exploitation through improved techniques so that there is
measurement, such as real national income or real per little wastage and they could be utilised for longer
capita income or per capita consumption level, alone period of time.
cannot be quite satisfactory. Inspite of its limitations the
per capita real income criterion indicates the standard of (2) Capital Accumulation—Capital means stock of
economic development attained by different countries. physical reproducible factors of production. When the
Hence it is accepted as the index of economic develop- capital stock increases with the passage of time this is
ment. called capital accumulation. The process of capital
formation is cumulative and self-feeding and includes
4. UNRISD Indicator of Socio-economic Deve- three inter related stages :
lopment—There is an UN institution called United
Nations Research Institute for Social Development (a) the existence of real savings and rise in them.
(UNRISD). In this institute, people tried to develop such (b) the existence of credit and financial institutions
indices as would encompass social, political and to mobilise savings.
492U | Economics (NET)
(c) to use these savings for investment in capital labour of various kinds such as scientists, managers,
goods. engineers, administrators etc., poses a serious problem in
It is the main key to economic growth and it creates LDCs. It requires the setting up of scientific
productive efficiency for future production. technological and managerial research and training
(3) Organisation—It is an important part of the institutes in the take-off stage.
growth process. It relates to the optimum use of factors (B) Non-economic Factors
of production in economic activities. Organisation is
These factors influence economic growth along with
complement to capital and labour and helps in increasing
economic factors. According to Nurkse, economic
their productivities. In modern economic growth, the
development has much to do with human endowments,
entrepreneur has been performing the task of an
social attitudes, political conditions etc. The essential
organiser and undertaking risks and uncertainties. The
non-economic factors are :
shortage of skilled personnel of various kinds such as
workers, scientists poses a serious problem in the (1) Social Factors—Social attitudes, values and
success of an entrepreneurship. Facilities to finance institutions also influence economic growth. The term
such techniques and the supply of raw materials and attitude means the totality of beliefs and values that
wider markets will help in increasing supply of cause human behaviour to be what it is. The term values
entrepreneurs. refers to motivations of human behaviour towards
(4) Technological Progress—It is regarded as the particular ends. These social attitudes, values and
most important factor in the process of economic institutions should be changed or modified for economic
growth. They are related to changes in the methods of development to take place. Social organizations like the
production which are the result of some new techniques joint family, caste system, kinship and religious dogmas
of research or innovation. should be modified so that they may be more favourable
to development. Modernisation ideals also require
Kuznets traces five distinct pattern in the growth of changes in institutions and attitudes in order to increase
technology in modern economic growth. They are : a labour efficiency and diligence effective competition,
scientific discovery or an addition to technical know- mobility and enterprise, permit greater equality of
ledge, an invention, an innovation, an improvement and opportunities.
the spread of invention usually accompanied by
improvements. The barriers of caste, colour, religion, ethnic origin,
culture, language and provincial loyalties should be
LDCs should, therefore, benefit from the vast fund broken down, and property and education should not
of technical knowledge of the advanced countries. LDC be so unequally distributed as to represent social
needs careful processing and adaptation in accordance monopolies.
with its social, economic and technical absorption,
capacities and requirements. (2) Human Factors—Human resources have
been an important factor in modern economic growth.
(5) Division of Labour and Scale of Pro- Economic growth does not depend on the mere size of
ductions—Specialisation and division of labour lead human resources but on their efficiency. The phenomenal
to increase in productivity. They lead to economies of increase in developed countries’ GNP per capita is
large scale production which further help in industrial attributed to the development of the human factor which
development. They increase the rate of economic is reflected in the increased efficiency or productivity of
development. Division of labour leads to improvement their labour force. This is called human capital
in the productive capacities of labour. Every labourer formation. Increasing population is a great hindrance to
becomes more efficient than before. He saves time. He is the economic development of LDCs. With their low per
capable of inventing new machines and processes in capita incomes and low rate of capital formations, it
production. But division of labour depends upon the size becomes difficult for them to support the increase in
of the market. population.
(6) Structural Changes—Structural changes (3) Political and Administrative Factors—It also
imply the transition from a traditional agricultural helped in modern economic growth. The weak
society to a modern industrial economy involving a administrative and political structure is a big hindrance
radical transformation of existing institutions, social to the economic development of LDCs. A strong,
attitudes and motivations. Such structural changes lead efficient and incorrupt administration is therefore
to increasing employment opportunities, higher labour essential for economic development. The behaviour of
productivity and the stock of capital, exploitation of new government plays an important role in stimulating or
resources and improvements in technology. discouraging economic activity.
When agricultural production increases, it increases
money incomes in the agricultural sector. This, in turn, Growth, Distribution and Welfare
expands rural demand for consumer goods and agri- Welfare is a state of mind which reflects human
cultural inputs which act as stimulants to the expansion happiness and satisfaction. The increase in economic
of the industrial sector. The industrial sector itself welfare results in the increase of total welfare and vice-
affects the agricultural sector. The shortage of skilled versa.
Economics (NET) | 493U
Growth and Welfare—Economic growth increases such a way as to keep a poor country in a state of
the volume of national income, which leads to increase poverty. For example, a poor man may not have enough
in economic welfare. But this relationship depends on a to eat; being under fed, his health may be weak; being
number of factors : Physically weak, his working capacity is low, which
(i) If the change in national income were due to means that he is poor, which in turn means that he will
change in prices, it would be difficult to not have enough to eat; and so on. A situation of this
measure the real change in economic welfare. sort relating to a country as a whole, can be summed up
in the trite proposition. “A country is poor because it is
(ii) The economic welfare cannot be said to have
poor.”
increased, if the increase in national income is
due to exploitation of labour. The basic vicious circle stems from the fact that in
LDCs total productivity is low due to deficiency of
(iii) It is possible that with the increase in national
capital, market in perfections, economic backwardness
income, the population may increase at the
and under development. However, the vicious circles
same pace and thus the per capita income may
operate both on the demand side and the supply side,
not increase at all. In such a situation, the
increase in national income will not result in The demand side of the vicious circles is that the low
increase in economic welfare. level of real income leads to a low level of demand
which, in turn, leads to a low rate of investment and
(iv) Even with the increase in national income and hence back to deficiently of capital, low productivity by
per capita income, the economic welfare may and low income. This is shown in figure A. Low
decrease. This is the case when as a result of productivity is reflected in low real income. The low
the increase in national income, income of the level of real income means low saving. The low level of
richer sections of the society increases and the saving leads to a low investment and to deficiency of
poor do not gain at all from it. In this case the capital. The deficiency of capital, in turn, leads to a low
total economic welfare decreases. level of productivity and back to low income. Thus the
Amartya Sen’s Measure of Welfare—Prof. vicious circle is complete from the supply side. It is
Amartya Sen has combined the dimensions of level and depicted in figure B. The low level of real income,
distribution of income to produce the measure of welfare. reflecting low investment and capital deficiency is a
In mathematical terms, common feature of both the vicious circles.
W = μ (1G)
Where W is welfare, μ is per capita income, and G
is a measure of inequality.
W will increase when μ grows and G diminishes.
When one remembers that μ is NNP divided by
population, it is clear that NNP should rise at higher rate
than the population. The more the growth rate of NNP
relative to that of population, the better it is.
Characteristics of an Under Developed
Country A third vicious circle envelops underdeveloped
1. General Poverty human and natural resources. Development of natural
2. Agriculture, the Main Occupation resources is dependent upon the productive capacity of
3. A Dualistic Economy the people in the country. If the people are backward and
illiterate, lack in technical skill, knowledge and entre-
4. Underdeveloped Natural Resources preneurial activity, the natural resources will tend to
5. Demographic Features remain unutilized, underutilized or even misutilized. On
6. Unemployment and Disguised Unemployment the other hand, people are economically backward in a
7. Economic Backwardness country due to under developed natural resources.
Under-developed natural resources are, therefore, both a
8. Lack of Enterprise and Initiative consequence and cause of the backward people.
9. Insufficient capital Equipment
10. Technological Backwardness Modern Economic Growth
11. Foreign Trade orientation Professor Simon Kuznets defined modern economic
growth “as a long-term rise in capacity to supply
Vicious Circles of Poverty increasingly diverse economic goods to its population,
There are circular relationships known as the this growing capacity based on advancing technology
‘vicious circles of poverty’ that tend to perpetuate the and the institutional and ideological adjustments that it
low level of development in LDCs. Nurkse explains the demands.” This definition has three components :
idea in these words : “It implies a circular constellation First, the economic growth of a nation is identified
of forces tending to act and react upon one another in by the sustained increase in the supply of goods.
494U | Economics (NET)
Second, advancing technology is the permissive Economic growth of developed nations has been
factor in economic growth which determines the growth accompanied by the long-term decline in number of
of capacity in supplying diverse goods to the population. man-hours per capita. This tendency reflects increase in
Third, for an efficient and wide use of technology efficiency or productivity. Leaving the exceptional case
and its development, institutional and ideological of Italy where man-hours per capita declined by 7·5 per
adjustments must be made to effect the proper use of cent per decade, the overall decline in man-hours per
innovations generated by advancing stock of human capita per decade for all other developed countries
knowledge. For example, modern technology is ranged between 4·1 per cent for Great Britain, 2 to 2·4
incompatible with the rural mode of life, the large and per cent for Belgium. Germany, Denmark, Sweden,
extended family pattern, family enterprise and illiteracy. Norway and the United States, 2·8 to 3·5 per cent for
Canada, France and Australia and 4·1 per cent for
Characteristics Switzerland and 4·5 per cent for Netherlands.
Professor Simon Kuznets has pointed out six 3. High Rate of Structural Transformation—
characteristics of modern economic growth that have Structural transformations in modern economic growth
emerged in the analysis based on national product and include the shift away from agriculture to non-
its components, population, labour force and the like. agricultural activities and from industry to services, a
1. High Rates of Growth of per capita Product change in the scale of productive unit and a related shift
and Population—Modern economic growth, as from personal enterprises to impersonal organization of
revealed by the experience of the developed countries economic firms, with a corresponding change in the
since the late eighteenth or early nineteenth century, is occupational status of labour.
characterised by the high rates of increase in per capita 4. Urbanisation—Modern economic growth has
product accompanied by substantial rates of population been characterised by the movement of an increasing
growth. The extremely high rate of increase are at least proportion of the population in developed countries from
five times as high for population and at least ten times as rural areas to urban areas. This is urbanisation.
high for production as observed in the post. Professor Urbanisation is largely a product of industrialisation.
Kuznets has shown that the rates of population growth The economies of scale arising from nonagricultural
of thirteen countries, excluding France, have been high pursuits as a result of technological changes led to the
in modern times than in pre-modern times. Leaving movement of a large proportion of labour and population
France with a population increase of 2·5 per cent per from the rural to the urban area. As the technical means
decade, the rates of population growth range from 6-7 of transportation, communication and organisation grew
per cent for UK, Sweden, Italy and the former USSR, to more effective, there was the spread of increasing
8 per cent for Switzerland and Norway to 10-14 per cent optimum scale units. All these processes affected the
for Denmark, Germany, Japan and the Netherlands grouping of population by social and economic status
and to 19-20 per cent for Canada, the United States and and transformed the basic pattern of life. The effects of
Australia” urbanisation on modern economic growth of developed
The decade rates of growth in per capita product of nations led to the decline in birth-rate and the shift
all these developed countries, except Australia with 8 toward the small family. It brought people together from
per cent decade rate, are above 13 per cent. They range different rural areas who initiated and learnt from each
from 13·5-14·1 per cent for the Netherlands and the UK, other and from those already living in towns. It
to 16-15 per cent for Switzerland, the United States, facilitated the development of impersonal relations of
France, Germany, Canada, Italy, Norway and Denmark modern life and also taught cooperation. Above all, it
and to above 26 per cent for Japan, 28·3 per cent for created conditions for the intense intellectual activity
Sweden and 43·9 per cent for the former USSR. associated with modern civilisation and there by created
2. The Rise in Productivity—Modern economic favourable conditions for the increase in knowledge.
growth is characterised by a rise in the rate of per capita
product due to improvements in the quality of inputs Indicators of Underdevelopment
which led to greater efficiency or rise in productivity per Generally, the term underdevelopment is to refer to
unit of input. This is traceable either to an increase in backward and poor countries. The term conveys that a
input of resources of labour and capital or to an increase country is poor and that an enormous amount to effort
in efficiency or to both. Increase in efficiency implies has to be made to bring about any appreciable degree of
greater out-put per unit of input. economic development. Famous economist Prof. R.
The growth of national product has been due to the Nurkse defined underdevelopment in these words,
enormous addition to population which led to a large “underdeveloped countries are those which compared to
increase in labour force. The increase in national product the advanced countries are under equipped with capital
in turn led to a considerable increase in capital in relation to their population and natural resources”.
accumulation and hence in reproducible capital. The But this too is not a wholly satisfactory definition. The
proportions of labour force to total population showed Indian planning commission defines an underdeveloped
an upward trend for all developed countries except country as one which is characterised by the coexistence
Switzerland, Italy and Australia. in greater or lesser degree of unutilized or under utilized
Economics (NET) | 495U
manpower on the one hand and of unexploited natural The low level of capital formation in an under-
resources on the other. “The existence of idle resources, developed country is due to both the weakness of the
as stressed by this definition, is undoubtedly an inducement to invest and to the low propensity and
important characteristic of an underdeveloped economy. capacity to save. In such an economy the low level of
But there is a snag in it, it does not clearly indicate the per capita income limits the size of the market demand
causes of the existence of idle resources. for manufactured output, which weakened the induce-
Resources may be, and are very often, idle even in ment to invest. The low level of investment also arises as
the highly developed capitalist countries, particularly in a result of the lack of dynamic entrepreneurship, which
times of depression. But such countries cannot be was regarded by Schumpter as the focal point in the
classed as underdeveloped on that ground. If the process of economic development.
resources are idle because they have not been properly In under-developed countries, generally we find
exploited or developed, it indicated a state of economic inequity in the distribution of income. Most often the
under-development. sector in which the greatest concentration of income lies
Hence, an economy will be considered under- is the one which derives its income primarily from non-
developed : entrepreneurial sources, such as unearned rent and
(a) If its per capita income is low, interest. The attitude and social values of this sector are
(b) If the natural resources and manpower in the often such that is prone to use its income for
country remain unutilised, conspicuous consumption. If these surplus were
(c) If it is possible to raise its level of national channelled into productive investment, they would tend
income and per capita income by properly to increase substantially the level of capital formation.
utilising its natural resources and manpower. (ii) Excessive Dependence on Agriculture—The
From the above discussion, it is obvious that primary sector i.e., agricultural sector dominates t h e
defining an underdeveloped country is by no means a economy. A great majority o f population, usually
simple task. In recent discussion all low-income between 70 and 80 per cent are engaged in agriculture
countries are generally classified as underdeveloped. In and allied occupations, whereas in the developed
general all those countries with per capita income less countries 15 per cent or even less draw their sustenance
than 25 per cent of the United States level are included from agriculture. This excessive dependence in
under underdeveloped countries. agriculture is due to the fact that non-agricultural
occupations have not grown at a rate commensurate with
Characteristics of Underdeveloped Coun- the increase in population owning to lack of sufficient
tries investment outside agriculture. Hence a growing labour
At present many countries are the underdeveloped force has had to be absorbed to agriculture. So the
countries. Most developing countries are poor and their labour-land ratio being high, agricultural holdings
present level of productivity is neither good enough to have become sub-divided into small plots which do not
ensure a satisfactory level of consumption, nor does it permit the use of modern mechanical methods of
generate economic surplus that may be adequate for production.
sustained development. For the past five decades in all (iii) Inequalities of Income and Wealth—Another
these countries the population has been growing rapidly distinguishing characteristic of the underdeveloped
and dependency burdens have been high. Rapid growth economies is the disparities in income and wealth
of population has also resulted in chronic unemploy- enjoyed by the rich and poor sections of society. The
ment. As far as the nature of the economy in these lower national income of the economically backward
countries is concerned. It is essentially agrarian and the countries is more inequitably distributed than in the
dependence on agricultural production and primary advanced countries.
product export is substantial. In the underdeveloped countries there is con-
We shall now describe the most common centration of incomes in a few hands yet in absolute
characteristics of developing countries. terms such incomes are too small to meet the
(i) Deficiency of Capital—Shortage of capital requirements of the economy. Besides, such incomes are
is reflected in the very low capital-labour ratio in the low usually diverted to non-economic investments such as
income countries. According to a survey by the United jewellery and real estate, etc., therefore, not available to
Nations Department of Economic Affairs in 1949 real finance economic development.
capital per worker in Asia and Far East excluding Japan (iv) Foreign Trade Orientation—An under-
was only 10 per cent of that of the U.S.A. Not only is the developed economy is generally foreign trade oriented.
capital stock extremely small, but the current rate of Traditionally underdeveloped countries have exported
capital formation is also very low. raw materials and imported consumer goods and
In most under-developed countries investment is machinery or capital goods. This has basically two
only 5 per cent to 8 per cent of the national income. consequences for these economies. First, such exchange
Whereas in the United States, Canada and Western has discouraged the growth of industries in these
Europe it generally varies from 15 per cent to 18 per countries, and second these countries have come to
cent. depend on their export of primary products. Many of the
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growth-oriented underdeveloped economies are trying to Causes of Underdevelopment
break free of this Strait-Jacket of foreign trade in which
Following are the main causes of under-
they had been placed by their foreign rulers.
development :
(v) Rapid Population Growth and Disguised (1) Market Imperfections—Market imperfection
Unemployment—Another characteristic is that of rapid
refer to all those forces and elements which undermine
population growth and disguised unemployment. An
important consequence of the high rate of population the smooth working of the economy. They are also
growth is that much of the economic progress achieved known as bottlenecks. These forces are so strong and
by these countries is neutralized by the rising powerful that any one of them can disturb the smooth
population. And the resultant pressure of population on functioning of the economy. These factors are :
land thus gives rise to “disguised unemployment.” It (a) Price rigidity
means that there are more persons engaged in agriculture (b) Factor immobility
than are actually needed. So that the addition of such
persons does not add to land’s productivity, even if some (c) Ignorance of market conditions
of the persons are withdrawn from land, no fall in (d) Monopolistic practices
production will follow from such withdrawal. (e) Rigid social structure
(vi) Under-utilisation of Natural Resources—The The country produces two commodities A and B
natural resources in an underdeveloped economy are shown on X and Y axes respectively. ab is the actual
either unutilised or under-utilised. Generally, under- production curve and a'b' is potential production curve.
developed countries are not deficient in land, water, These curves are also known as production frontier.
minerals, forest or power resources though they be
They indicate the maximum amounts of various
untapped. The main problems in their case is that such
resources have not been fully and properly utilised due combination A and B that the country can produce.
to various difficulties such as shortage of capital,
primitive techniques and the small size of the market.
This means that they have the potentialities for the
development but the level and character of their
economic performance is too poor to take them forward.
(vii) Economic Backwardness of the People—
The people in under-developed countries are economi-
cally backward, that is, the quality of the people as
productive agents is low.
(viii) Dualistic Economy—The underdeveloped
countries present sharp contrast in all walk of life. There
is the old and new, developed and underdeveloped, the
rich and poor existing side by side. It is both a (2) Vicious Circle of Poverty—Underdeveloped
bullockcart and motor car economy. There are efficient countries are caught in vicious circles. In the words of
modern industries and the languishing indigenous Prof. Nurkse, It implies a circular constellation of forces
handicrafts and so on. tending to act and react upon one another in such a way
(ix) Inadequate Infrastructure—The under- as to keep a poor country in the state of poverty. In
developed countries are also characterised by the lack of underdeveloped countries on account of economic
sufficient economic and social over-heads. The means of backwardness the total output is low and after
transport and communication, irrigation and power, the consumption needs are fulfilled little remains as a
banking system, the educational and medical facilities surplus for capital accumulation. Capital deficiency
are all imperfectly developed and they are utterly
leads to less investment and as a resultant low level of
inadequate to serve the existing population.
income. It can be explained with the help of following
(x) Lack of Entrepreneurial Ability and Skilled circular diagram.
Technicians—In the underdeveloped countries gene-
rally, there are very few people, who can be described as
daring and dynamic entrepreneurs.
(xi) Peculiar Demographic and Social Charac-
teristics—There are certain demographic and social
characteristics typical of the under-developed countries.
There is a very high proportion of the population in the
age-group 0-15, and a lower proportion in the working
group 20-60 years. Average expectation of life is low
and infant mortality is very high.
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A low level of real income may act in another way 6. Underdeveloped Human Resources—Under-
to perpetuate a vicious circle. This time it acts on the developed countries lack in people possessing critical
demand side of capital unlike the previous one which skills and knowledge required for all round development
acted on the supply side. The low level of real income of the economy.
in the economy presents only limited market oppor-
tunities for entrepreneurs and generates only a limited Adam Smith’s Theory Of Economic
demand for capital or investment purposes, resulting in Development
low investment.
Adam Smith was the first economist to propound
The figure explains this constellation of forces. the theory of economic development in a meaningful
A third vicious circle encompasses under-developed way. Adam Smith considered land, labour, and the
resources and the backwardness of people. The capital as the three components of production. Thus, he
development of national resources depends on the used following simple model of economic growth :
character of human productivity and resources. Y = ƒ(L, K, T)
1. Low productivity — low real income — low where Y is output, L is labour, K is capital and T is land,
saving — low investment —hence Low productivity. so output is related to labour and capital and land inputs.
Consequently output growth (gY) was driven by
population growth (gL), investment (gK), land growth
(gT) and increases in overall productivity (gƒ).
gy = φ (gf, gK, gL, gT)
Assumptions—Smith’s theory is based on the
following assumptions—
(a) Population growth, in the traditional manner of
the time, is an endogenous factor which depends on the
2. Deficiency of capital — low investment — sustenance available to accommodate the increasing
low real income — low saving — low demand — low workforce.
investment. (b) Investment is an endogenous factor which is
3. Backward people — this leads to unutilised, determined by the rate of savings (mostly by capitalists)
human and national resources. (c) Land growth was dependent on conquest of new
4. International Forces—The international forces lands (e.g. colonisation) or technological improvements
have provided substantial position gains to the of fertility of old lands.
developed countries. These forces have made rich (d) Technological progress could also increase
countries richer and poor countries poorer. growth overall; Smith's famous thesis that the division of
labour or specialisation improves growth was a funda-
mental argument.
(e) Improvements in machinery as it facilitates
further specialisation
(f) International trade is an engines of growth as it
facilitates further specialisation.
(g) Perfect competition in the economy-means every
producer and purchaser is price taker.
Key Features of Adam Smith’s Theory—
Natural Law : Lassiez-faire and Self Interest
Leads to Development—Adam Smith believed in the
In some countries foreign trade has worked as an
doctrine of ‘Natural law’ in economics affairs. Adam
agent of growth. These forces made the gains from trade
go mainly to the developed countries even though Smith regarded every person as the best judge of his
foreign investor and foreign government did not own interest who should be left to pursue it to her own
deliberately exploit the underdeveloped countries. advantage. In furthering her own self interest she/he
would also further the common good. In pursuance of
5. Low Rate of Capital Formation—The most
pertinent obstacle to economic development is the this, each individual was led by an ‘invisible hand’.
shortage of capital. Small sums of millions of farmers Since every individual if left free will seek to maximise
may be able to save are often hoarded in the form of his own wealth, therefore all individuals, if left free, will
currency or used in purchasing gold and jewellery etc. maximise aggregate wealth. Smith was opposed to any
The inclination to hoard money is due to the absence of state interventions in economic activities. He was a
banking facilities in rural areas. Thus, there is little staunch supporter of free trade and advocated the policy
capital formation in underdeveloped countries. of laissez-faire in economics affairs.
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Division of Labour—Division of labour increases progress and the establishment of Theories of Develop-
productivity which depends upon the size of the market. ment manufactured industries. On the other hand, their
Division of labour is the starting point of Smith’s theory development leads to increase in agricultural pro-
of economic growth. It is division of labour that results ductions when farmers use advanced production
in the greatest improvement in the productive powers of techniques.
labour. The attributes of this increase in productivity are Shortage of Natural Resources Stops Growth—
(i) the increase in the dexterity of every worker; (ii) the The process of growth is cumulative. When there is
saving in time to produce goods; and (iii) to the pros-perity as a result of progress in agriculture, manu-
inventions of large number of labour saving machines. facturing industries and commerce, it leads to capital
The last cause to increase in productivity stems not from accumulations, technical progress, increase in popu-
labour but from capital. Therefore in Smith’s scheme; it lation expansions of markets, division of labour and rise
is improved technology that leads to division of labour in profits continuously. But this process is not endless. It
which, however, depends on the size of the market. is the scarcity of natural resources that finally stops
Process of Capital Accumulation—Division of growth. Competition among businessmen would bring
labour leads to capital accumulation and capital profits as low as possible. Once profits fall, they
accumulation leads to economics of development. continue to fall. Investment also starts declining and the
Capital accumulation must precede the introduction of end result of capitalism is the stationary state. When this
happens capital accumulation stops; populations
division of labour. But since almost all saving resulted
becomes stationery, profits are the minimum; wages are
from capital investments or the renting of land; only at the subsistence level; there is no change in per capita
capitalists and landlords were held to be capable of income and production, and the economy reaches the
saving. state of stagnation.
Why Do Capitalists Make Investment ?—Invest-
Ricardo’s theory of Economic Develop-
ment is made to earn profits. According to classical
economists, investments were made because the
ment
capitalists expected to earn profits on them; and future David Ricardo did not develop any new theory of
expectations with regard to profits depended on the economic development. He ,however , reformed the
present climate for investment as well as actual profit. economic theory propounded by Adam Smith.
But what is the behaviour of profits during the Assumptions—The assumptions of Ricardo’s theory
development process? Smith believed that profits tend to of economic development are following—
fall with economic progress when the rate of capital (a) all land is used for production of corn,
accumulation increases. Increasing competitions among (b) law of diminishing returns operates,
capitalists tends to lower profits. Thus with the growth (c) supply of land is fixed,
of economy’s capital stock, competition among (d) demand for corn is perfectly is elastic,
entrepreneurs for scarce labour tends to bid up wages (e) labour and capital are variable inputs,
and thereby lowers profits. (f) state of technical knowledge is given,
Interest—With the increase in prosperity, progress (g) all workers are paid a subsistence wage,
and populations the rate of interest falls and as a result (h) supply price and labour is given and constant,
the supply of capital is augmented. The reason being that (i) demand for labour depends upon accumulations,
with the fall in interest rate the moneylenders will lend (j) capital accumulation results from profit and
more to earn more interest. Thus the quantity of capital (k) there is perfect competition.
for lending will increase with the fall in the rate of Main Features—The Ricardian model is based on
interest. But when the rate of interest falls considerably the interrelation between three groups in the economy-
the moneylenders are unable to lend more in order to land (landlords), Capital (capitalists) and Labour
earn more to maintain their standard of living. Under the (labourers) among whom the entire produce of land is
circumstances they will themselves start investing and distributed.
become entrepreneurs. Thus even with the fall in the rate
Rent, Profit and Wages—(a) rent is that portion of
of interest there is increase in capital accumulation and
the produce of earth which is paid to the landlord for the
economic progress.
use of original and indestructible powers of the soil. It is
Agents of Growth—Farmers, producers and busi- the difference between average and marginal product. If
nessman are the agents of progress and economic
all the land had the same properties of unlimited in
growth. The functions of these three are, however,
interrelated. To Smith, development of agriculture leads supply and uniform in quality, no charge would make
to increase in construction works, and commerce. When for its use. (b) The wage rate is determined by wage
agricultural surplus arises as a result of economics of fund divided by number of workers employed at the
development, the demand for commercial services and subsistence level. According to the model, out of the
manufactured articles rises. This leads to commercial total corn produced rent has the first right and the
Economics (NET) | 499U
residual is distributed between wage and profit while increase in profits; production increases which raises the
interest is included in profit. wage fund; population increases, which raise the
Capital Accumulation—According to Ricardo demand for corn and its price. Inferior grades of land are
capital accumulation is the outcome of profit because brought into cultivated. Rents on superior land increase
profit leads to saving of wealth which is used for capital and reduce the share of the capitalists and labourers.
formations. Capital formation depends upon will and Profits decline and wages fall to subsistence. The
capacity to save. The larger the surplus i.e., profit, the process of rising rents and falling profits continues till
larger will be capacity to save. the output from the marginal land just covers the wages
of labour employed and profits are zero. There is no
(i) The Profit Rate— The rate of profit is equal to accumulation of capital, no increase in population and
the ratio of profit to capital employed. But since capital wage rate but rent is extremely high and there is
consists of only working capital, it is equal to the wage economic stagnation.
bill. So long as the rate of profit is positive, capital
accumulation will take place. In reality, profits depend B. The Marxian Theory of Economic
upon wages, wages on price of corn and the price of Development
corn depends upon the fertility of the marginal land. So Marx contributed to the theory of economic
there is an inverse relation between wages and profits. development in three respects, namely, in broad respect
When due to improvement in agriculture, production of providing an economic interpretation of history, in the
increases, the price of corn falls and subsistence wages narrower respect of specifying the motivating forces of
also fall and profits will increase leading to capital capitalist development, and in the final respect of
accumulation. This will raise demand for labourers suggesting an alternative path of planned economic
raising wage rate and reducing profits. development.
(ii) Increase in Wages – The wage rate increases Marx uses his theory of surplus value as the
when the prices of commodities forming the subsistence economic basis of the ‘class struggle’ under capitalism
of the workers increase. As the demand for food and it is on the basis of his theory of surplus value that
increases, less fertile land is brought under cultivation he builds the superstructure of his analysis of economic
and more labourers are needed, consequently wage rate development. The surplus value, believes Marx, arises
increases. Thus wages would rise with the increase in because labour, which is the absolute and ultimate
the price of corn. In a situation rent also increases, with source of all economic or exchange value, produces
the decline of capitalists’ profit capital accumulation more economic value than the cost of labour itself as
also declines. measured by the supply price of labour or, the
(iii) Declining Profits in other Industries – The subsistence wage that barely maintains the labour force
profits of the farmer regulate the profits of all other intact. Exploitation does exist since workers fail to
trades. receive the whole of the value of the output. The
difference between the value of total output and the
(iv) Other Sources of Capital Accumulation—
supply price of labour represents the surplus value which
According to Ricardo economic development depends
upon difference between production and consumption. is expropriated by the capitalists, who are the owners of
Capital may be increased by an increased production or non-human instruments of production, capital equipment
by a diminished unproductive consumption. However, and land. It is the ownership to these instruments of
the productivity of labour may be increased through production that enables the capitalists to extract surplus
technological changes and better organisation. value from labour by forcing them to work longer hours
(a) Taxes—According to Ricardo, taxes are to be and receive subsistence wage and thus grab a
levied to reduce conspicuous consumption. Otherwise disproportionately large slice of the national cake for
the imposition of taxes on capitalists land lords and themselves. The theory of surplus value thus, implies
labourers will transfer resources from these groups to the that there is an antagonism between the share of wages
government, adversely effecting investment. So he does and profits. More profits are clearly at the expense of
not favour the imposition of taxes. workers since their magnitude is determined directly by
(b) Free Trade—Ricardo is in favour of free trade. the magnitude is determined directly by the magnitude
The profit rate can be saved from declining by importing of surplus value that capitalists extract from labour. In
corn. The capital accumulation therefore continues to be the Words of Peterson :
high. In this way the resources of the world can be used “The notion of surplus value is crucial to the
more efficiently through trade. Marxian theory of economic development; surplus value
Stationary State—According to Ricardo there is is the source of all profit and thus the amount of surplus
natural tendency for the rate of profit to fall in the value that can expropriated by the capitalistic class will
economy so that the country ultimately reaches the determine the relative share of profit in the income
stationary state. When capital accumulation rises, with total”.
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According to Marx, it is surplus value that leads to wage rate on the vertical axis. D is the demand curve for
capital accumulation. The capitalist’s main motive is to labour and S is the supply curve of labour.
increase the surplus value which goes to swell his
profits.
To explain the origin of profit and to analyses the
relation between wages and profits, Marx separates
capital into Constant capital and Variable capital.
Capital invested in stocks or raw materials or equipment
which directly assists the productivity of labour, Marx
calls constant capital (C). Capital devoted to the
purchase of labour power in the form of wages or direct
subsistence, he terms variable capital (V). The Surplus
value is denoted by (S). So the total value of product = At the wage rate W, there is an increase in the
c+v+s. industrial reserve army equal to RA (LL 1 ). As the
In order to analyse the nature of capitalist industrial reserve army expands, capitalists start
accumulation, Marx establishes certain relationships adopting labour-saving machines and reduce the wage
between c, v and s. The ratio of constant capital to total rate to minimum subsistence level OM in order to have
capital( ) c
c+v
is termed as the organic composition of more surplus value.
But when the capitalist is replacing the workers by
capital. The ratio of surplus value (S) to the variable machines, he is killing the goose that laid the golden
capital (V) has been termed the rate of exploitation by
eggs. There is a continual reduction of the surplus value.
Marx.
Marx believes that technological progress tends to
S
Rate of Exploitation = increase the organic composition of capital. Since the
V
rate of profit is inversely related to the organic
According to Marx the rate of profit is not composition of capital the former tends to decline with
dependent solely on the rate of exploitation. The rate of accumulation. Marx explained this tendency of falling
profit can change even though the rate of exploitation rate of profit in terms of the following equation :
remains constant, if a change occurs in the organic
The rate of profit is equal to the ratio of total surplus
composition of capital. The influence of technical value (S) to the total capital (C + V).
progress is to alter the organic composition of capital,
S
generally in the direction of raising the ratio of constant Thus P =
C+V
to total capital. Hence the tendency of industrial
progress is to lower the rate of profit-even though there where P stands for the rate of profit
is no decrease in the rate of exploitation. S
Now P = ...(i)
One of the consequences of capital accumulation is C+V
the concentration of capital in gigantic enterprised. Multiplying both the numerator and the denomi-
Competition among capitalists forces them to cheaper nator by V we get
their products. This can be done by introducing labour
S×V S V
saving machines which increase labour productivity. P= = × ...(ii)
Those capitalists who are unable to replace labour by V(C + V) V (C + V)
machines are ‘squeezed out’ and their enterprises are S V
Here is the rate of exploitation and is the
taken over by big capitalists. Capital accumulation and V C+V
concentration involve increase in constant capital and V
decline in variable capital. The rapid growth of constant ratio of variable capital to total capital can also
C+V
capital as Compared with variable capital leads to a be expressed as :
relative decrease in the demand for labour. This process
of supplanting labour by machines creates an industrial
reserve army which increase as capitalism develops. The C+V
V
(
= 1–
V
C+V ) ...(iii)
larger the industrial reserve army, the worse are the substituting (iii) in (ii)
conditions of the employed workers, since the capitalist
can dismiss dissatisfied and troublesome workers, being
able to replace them from the ranks of the reserve army.
P =
S
V ( 1–
C
C+V )
Capitalists are also able to cut down wages to a semi-
starvation level and appropriate more and more surplus
Now given the rate of exploitation ()
S
V
, the rate of
value. This is the law of the increasing misery of the profit is related inversely with the organic composition
masses under capitalism. This is shown in Figure where
the labour force is taken on the horizontal axis and the
of capital ( C+V
C
) .
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C stationary state, there is perfect competitive equilibrium :
The greater the , the lesser will be the rate of no profits, no interest rates, no savings, no investments
C+V
profit and vice versa. As greater accumulation and and no involuntary unemployment. This equilibrium is
technology results in a more capital-intensive productive characterised by what Schumpeter terms the “circular
process or as there is an increase in the capital-output flow” which continues to repeat it self in the same
ratio, the rate of profit tends to decline. From this manner year after year, similar to the circulation of the
follows the Marxian conclusion about the inevitable blood in an animal organism. In the circular flow, the
eventual, collapse of the capitalist economic super- same products are produced every in the same manner.
structure. Summing up the Marxian views about the According to Schumpeter, “development is
collapse of capitalism, W.C. Peterson remarks, “The spontaneous and discontinuous change in the channels
process of capital accumulation and growth leads of the circular flow, disturbance of equilibrium, which
inevitably to a severe economic crisis. This crisis is the for ever alters and displaces the equilibrium state
result of both the “falling rate of profit”, which must previously existing”. These ‘spontaneous and
sooner or later adversely affect capital accumulation it discontinuous’ changes in economic life are not forced
self and second, over-production because of an upon it from without but arise by its own initiative from
insufficiency of aggregate demand. The latter stems within the economy and appear in the sphere of
from the progressive decline in the relative share of industrial and commercial life. Development consists in
wage income in the output total. Marx thought the the carrying out of new combinations for which
capitalist system would be increasingly wrecked by possibilities exist in the stationary state. New
crises of greater and greater severity until finally it combinations come about in the form of innovations.
would collapse amidst an uprising of the working class An innovation may consist of :
that would usher in the era of communism.” 1. the introduction of a new product;
Criticisms 2. the introduction of a new method of production;
Marx’s theory of capitalist development has been 3. the opening up of a new market;
accepted by his followers as a gospel truth while it has 4. the conquest of a new source of supply of raw
been severely criticised by his opponents for the materials or semi-manufactured goods; and
following reasons : 5. the carrying out of the new organisation of any
1. Surplus Value Unrealistic industry like the creation of a monopoly.
2. Technological Progress Helpful in Increasing According to Schumpeter, it is the introduction of a
Employment. new product and the continual improvements in the
3. Falling Tendency of Profits not Correct existing ones that lead to development. Schumpeter
4. Marx could not Understand Flexibility in assigns the role of an innovator not to the capitalist but
capitalism to the entrepreneur. The entrepreneur is not a man of
5. Static Analysis ordinary managerial ability, but one who introduces
something entirely new. He does not provide funds but
Conclusion directs their use. To perform his economic function, the
Despite these weaknesses, some to the Marxian entrepreneur requires two things: First, the existences of
tools pertaining to his theory of economic development technical knowledge in order to produce new products,
have ever since become part and parcel of the theory of second, the power of disposal over the factors of
economic growth. Technological progress and innova- production in the form of credit. According to
tions are the main stay of any theory of economic Schumpeter, reservoir of untapped technical knowledge
development. Similarly capital accumulation is the exists which he can make use of. Therefore, credit is
fundamental idea behind economic growth. Profits essential for development to start.
are still regarded as both the hallmark of capitalist Schumpeter’s model starts with the breaking up the
development and its Achilles’ heal. Marx showed that circular flow with an innovation in the form of a new
economic development does not follow a smooth course product by an entrepreneur for the purpose of earning
but comes about in “fit and starts.” Business cycles are profits. In order to break the circular flow, the
inevitable. He pointed output that a state of under- innovating entrepreneurs are financed by bank-credit
consumption was the main cause of depression and that expansion. Since investment in innovations is risky, they
for stable growth a proper balance between investment must pay interest on it. Once the new innovation
and consumption was essential. He also indicated that becomes successful and profitable, other entrepreneurs
too low or too high wages in relation to total output can follow it in “Swarm-like clusters”. Innovations in one
adversely affect investment and thus stifle economic field may induce other innovations in related fields. The
growth. emergence of a motor car industry may, in turn stimulate
a wave of new investments in the construction of
C. The Schumpeterian Theory highways, rubber tyres and petroleum products, etc. But
Schumpeter assumes a perfectly competitive the spread of an innovation is never cent per cent. Since
economy which is in stationary equilibrium. In such a investment is assumed to be financed by creation of
502U | Economics (NET)
bank-credit, it increases money incomes and prices and Thus, entrepreneurs are the key figures in the
helps to create a cumulative expansion throughout the Schumpeterian analysis. They bring about economic
economy. With the increase in the purchasing power of development in spontaneous and discontinuous manner.
the consumers, the demand for the products of the old “Can capitalism survive? No, I do not think it can”,
industries increases in relation to supply. Prices rise, wrote Schumpeter, as his final appraisal of the future of
profits increase and old industries expand by borrowing capitalism. To him, the very success of capitalism
from the banks it induces a secondary wave of credit “undermines the social institutions which protect it, and
inflation which is super-imposed on the primary wave of “inevitably” creates conditions in which it will not be
innovation. Over-optimism and speculation add further able to live and which strongly point to socialism as the
to the boom. After a period of gestation the new heir-apparent”.
products start appearing in the market displacing the old According to Schumpeter, capitalism can maintain
products and enforcing a process of liquidation, re- itself only so long as entrepreneurs behave like knights
adjustment and absorption. The demand for the old and pioneers. But such daring innovators are being
products is decreased. Their prices fall. The old firms destroyed by the capitalist system itself which rests on a
contract output and some are even forced to run into rational attitude. This enquiring, sceptical and rational
liquidation. As the innovators start repaying bank loans attitude permeates the entire capitalist society. As a
out of profits, the quantity of money is decreased and result, three forces are discernible, that are the beginning
prices tend to fall. Profits decline Uncertainty and of the creeping death of capitalism. They are :
risks increase, the in pulse for innovation is reduced and 1. the decadence of the entrepreneurial function;
eventually comes to an end. Depression ensues. 2. the disintegration of the bourgeois family;
Schumpeter believes in the existence of the 3. the destruction of institutional framework of the
Kondratieff long-wave of upswings and downswings in capitalist society.
economic activity. Each long-wave upswing is brought
about by an innovation in the form of a new product Criticisms of the Theory
which leads to further innovations in the methods of Schumpeter’s theory has certain weaknesses.
production, new forms of business organisation, new 1. Schumpeter’s analysis of the process of transition
sources of supply of raw materials and intermediate from capitalism to socialism is not correct.
products and new markets. Thus there is abundance 2. Schumpeter gives too much importance to bank-
of goods available for the masses. Once the upswing credit in his theory.
ends, the long-wave downswing begins and the painful 3. The downswings and the upswings are not
process of readjustment to the “point of previous essential for economic development.
neighbourhood of equilibrium” starts. Ultimately the
4. Economic development not only depends on
natural forces of recovery bring about a revival. Once
innovations but also on many economic and social
again equilibrium is restored. Then some enterprising
changes.
entrepreneurs begin with a new set of innovations,
others follow and a new boom begins. Schumpeter 5. Schumpeter’s contention that cyclical changes are
describes this process of capitalist development as one due to innovations is also not correct.
of “creative destruction”, where in the old economic To conclude with Meier and Baldwin, “Schum-
structures of society are being continually destroyed and peter’s broad socio-economic analysis of capitalist
the new structures are being continually created in their process is generally admired. Yet few seem prepared to
place. Schumpeter’s cyclical process of economic accept its conclusions. His arguments are stimulating but
development is illustrated in figure where the secondary not completely convincing….. Although Schumpeter’s
wave is super imposed on the primary wave of analysis is provocative, it seems one-sided and over-
innovation with over-optimism and speculation, emphasized”.
development proceeds more rapidly in the prosperity Schumpeter’s Analysis and Underdeve-
phase. When recession starts, the cycle continues
downward below the equilibrium level to the depression loped Countries
phase. Ultimately; another innovation brings about The applicability of Schumpeter’s theory to
revival. underdeveloped countries is limited for the following
reasons :
1. Different Socio-Economic Order
2. Lack of Entrepreneurship
3. Not Applicable to Socialist Countries
4. Not Applicable to Mixed Economies
5. Neglects Population Growth
6. Neglects External Effects
7. Neglects Savings
8. Neglects Consumption
9. Unsatisfactory Explanation of Inflationary Forces.
Economics (NET) | 503U
Conclusion referred to as neo-classical growth models, and Mrs.
Joan Robinson’s model is one such. An important
All the same, Schumpeter’s theory underlines the feature of the neo-classical models is that they invariably
importance of inflationary financing and innovations as incorporate the population factor in the explanation of
the main factors in economic development. Inflationary growth. Mrs. Joan Robinson’s model, which deals with a
financing is one of the potent methods which every developing economy, clearly brings out the effect of
underdeveloped country tries to use at one time or population on the rate of capital accumulation and
another. His analysis is relevant to underdeveloped growth of output. Her model is based on two
countries from the standpoint of long range increase in
fundamental factors :
productivity and absorption of surplus labour in gainful
employment as a result of innovations. Though it (i) T he capital formation is conditioned by the
purports to analyses the problems of western capitalism, manner in which income is distributed in the economy,
“it can certainly give clues to problems that may arise in and
underdeveloped countries, once the process of (ii) The rate at which labour is utilised is a function
industrialisation begins, as well as provide a lesson for of the supply of capital and supply of labour.
avoiding waste and extra hardships that attend an un-
planned uncoordinated development.” Assumptions
M. Rostow’s Growth Model Mrs. Robinson’s model is based upon the following
assumptions :
Professor W.W. Rostow has sought an historical
approach to the process of economic development. He a. There is a laissez-faire closed economy.
refers to five stages of economic growth. They are : b. In such an economy capital and labour are the
1. The traditional society which rests on static only productive factors.
equilibrium until it is disturbed by some mechanism. c. In order to produce a given output, capital and
2. The pre-conditions for the take-off, which involve labour are employed in fixed proportions.
slow changes, especially in attitudes and organisation. d. There is neutral technical progress.
3. The take-off it is a watershed in the life of a e. There is no shortage of labour and entrepreneurs
society. It involves a rapid increase in the rate of change can empty as much labour as they wish.
as to involve discontinuity. The period of take-off is the
f. There are only two classes-the workers and the
interval when the old blocks to steady growth are finally
entrepreneurs-between whom the national income is
overcome. The changes during this period are characte-
distributed.
rised by a wave-like expansion.
4. The drive to maturity it is a period of sustained g. Workers save nothing and spend their wage
growth extending over four decades after the end of income on consumption.
take-off. h. Entrepreneurs consume nothing but save and
5. The age of mass consumption-during this period, invest their entire income (from profits) for capital
the leading sectors of the economy shift towards the formation.
durable consumer goods and a large share of the i. Total wage-bill is the real wage-rate multiplied
population acquires a high level of living. by the number of workers.
Criticism j. Total profit is the profit-rate multiplied by the
amount of capital.
1. Traditional Society not Essential for Deve-
k. Total national income is the sum of total wage-
lopment.
bill and total profit.
2. Overlapping in the Stages.
Symbolically, the total national income may be
3. The Stage of Drive to Maturity Puzzling and expressed as
Misleading.
Y = Wn + PK
4. The Stage of High Mass Consumption not
Chronological. where Y = total income, net
W = wage-rate, real
N. Mrs. Joan Robinson’s Growth Model P = profit rate
(Capital Accumulation Model) K = capital
In all the classical theories of economic growth, a N = the number of workers employed
good deal of attention was devoted to the analysis of the
The profit rate, according to Mrs. Joan Robinson, is
part played by population, savings, technology and
the most strategic factor in the theory of capital
social institutions in the growth of the capitalist
accumulation. Symbolically, the rate of profit would be
economy. So modern economists have accepted these
classical ideas of economic growth and presented then in Y – wN
p =
the form of growth models by using the Keynesian and K
the Harrod-Domar technology. Such growth models are Divided by N.
504U | Economics (NET)
y wN Y employment of both labour and capital in the economy.
– –w Mrs. Joan Robinson calls this the Golden Age.
n N N
p = =
K K The Golden Age is explained diagrammatically.
N N K
Capital labour ratio or Q is measured along the
Y 1–w N
By putting =1 and θ, we have p = horizontal axis and per capita output on the vertical axis.
N Q
Thus, the profit ratio is the ratio of labour The growth rate of labour force is taken to the left of O
productivity minus the total real wage bill to the amount along the horizontal axis. The curve OP shows the
of capital utilised per unit of labour. In other words, the production function. Every point on this curve shows the
profit rate (p) depends on income (y), labour productivity ration of capital to labour. In order to final out the
(l), the real wage rate (w) and the capital-labour ratio θ. capital-labour ratio and the wage profit relation, we draw
a tangent NT which touches the production function OP
On the expenditure side, net national income (Y) at point G and cuts the vertical axis at W. Point G shows
equals consumption expenditure (C) plus investment the capital-labour ratio for the golden age which is
expenditure (I), measured by OK. Per capita output is OA, out of this
Y = C+I OW is paid as wages and WA or EG is the surplus
Since Joan Robinson assumes zero saving out of which is the rate of profit on capital.
wages but attributes saving to entrepreneurs, profits are ΔK
meant for investment only, we have S = I. This also proves that the growth rate of capital ( )
K
This saving investment relation may be shown as : ΔN EG ΔK
S = PK equals the growth rate of labour ( ) N EW
reflects
K
and I = ΔK OW ΔN
and reflects . Thus
[Δk is increase in real capital] ON N
∴ PK = ΔK EG OW
= [∴ tan α = tan β]
ΔK 1 – w EW ON
[Q S = I] or P = =
K Q If an account of disequilibrium, the economy goes
The growth rate of capital (Δk/k) being equal top, it off the path of the Golden Age, there is every possibility
depends on the ratio of the net return on capital relative of its returning to this path under certain conditions.
to the given stock of capital. If income remains constant ΔN ΔK
If = ; i.e., if the rate of growth of population
and the wage rate decreases or income increased and N K
the wage rate remains constant, the profit rate would exceeds the rate of growth of capital, a return to the
tend to increase. The profit rate can also increase if the Golden Age would be possible under certain conditions.
capital-labour ratio falls. In this way the entrepreneurs The excess of labour supply would lower the money
maximize profits. wage-rate, and assuming that prices do not change, the
ΔK real wages would also be reduced. The reduction in real
( )
Besides the growth rate of capital
K
, another wages would increase the amount of profits which, in
factor which determines the growth rate of an economy turn, would stimulate the rate of growth of capital, and
ΔN would enable it to catch up with the increase in
is the growth rate of population ( )N
. An increase in population. The parity between the two rates would be
restored. Ultimately, the economy would come back to
population and labour force unaccompanied by an
the position of the Golden Age. This return would be
increase in capital would reduce labour productivity. If
possible only if the real wages declines. If the real wages
real wages are hold constant, the reduction in labour
do not decline, either because the money wage-rate,
productivity would lower the rate of profit. A lowering
are rigid, or because prices decline in the same
of the rate of profit would adversely affect the supply of
proportion as the money wage-rate, the Golden Age
capital and thus, widen the different between capital and
would not be restored. On the contrary, than would be
labour supply.
increasing unemployment in the economy. Generally
An increase in labour supply without a proportionate speaking, a rise in prices helps to promote capital
increase in capital supply would cause unemployment in formation.
the economy. To maintain full employment of labour On the contrary, if the rate of growth of capital
resources it is essential, according to this model, that the ΔK ΔN
growth rate of population (labour supply) should be exceeds the rate of growth of populations i.e., > ,
K N
equal to the growth rate of capital,
there is a possibility of Golden Age equilibrium being
ΔN ΔK restored through technological improvements leading to
i.e., =
N K higher capital-output ratio. This would absorb the excess
If the growth rate of population is equal to the capital and restore the parity between the rate of growth
ΔN ΔK of capital and the rate of growth of population. Any way
growth rate of capital, i.e., = , there will be full
N K parity between the growth rate of capital and growth
Economics (NET) | 505U
rate of population is an essential prerequisite for the 4. Mrs. Robinson assumes that capital and labour
attainment of the Golden Age. are employed in fixed proportions; this is unrealistic
Mrs. Robinson makes a distinction between the because in a dynamic economy there are no fixed
desired rate of growth and the possible rate of growth. coefficients of production. Substitutability between
The desired growth rate is the rate of accumulation factors takes place through times, the degree of
which makes the firm satisfied with the situation in substitutability being dependent upon the nature of
which it finds itself. The desired growth rate is technological changes.
determined by the rate of profit caused by the rate of
accumulation and the rate of accumulation induced by Its Applicability to Underdeveloped
that rate of profit. She uses the following figure to Countries
explain it. Mrs. Robinson’s model has a special attraction for
The curve A represents the expected rate of profit as underdeveloped countries for the following reason :
a function of the rate of accumulation. The curve I 1. The theory studies the problem of population
represents the rate of accumulation as a function of the and its effect on the rate of capital accumulation. There
rate of profit. In a situation to the right of point D, the is a “golden age” which any country can achieve
expected rate of profit is less than the rate of through planned economic development.
accumulation. Any further investment is not likely to
be profitable and the rate of accumulation will fall. 2. An underdeveloped country faces the problem if
Between the points S and D the accumulation is less ΔN Δ K
> . It reveals the tendency of progressive
than the expected rate of profit. Therefore, there will be N K
a tendency to increase investment and the rate of underemployment in such economies.
accumulation will rise to point D. This point D represents 3. In an underdeveloped economy, the rate of capital
the desired growth rate. accumulation is always less than its potential growth
ratio; that is why it is backward and possesses surplus
labour force. It, therefore rests with the planning
authority to increase the rate of accumulation to the level
of the growth ratio of the economy. An underdeveloped
country cannot, however, match the two by following
the ‘capitalist rules of the game.’ On the contrary, it
devolves on the planning authority to take the initiative
in controlling and regulating not only private invest-
ment, but also public investment in such countries.
H. The ‘Big Push’ Theory
On the other hand, the possible growth rate depends
on the physical conditions resulting from the growth of The theory of the “big push” is associated with the
population and technical knowledge. name of Professor Paul N. Rosenstein-Rodan. The thesis
is that a “big push” or a large comprehensive programme
When the desired growth rate equals the possible is needed in the form of a high minimum amount of
growth rate at near full employment, the economy is in a investment to over-come the obstacles to development in
golden age. an underdeveloped economy and to launch it on the path
The real wage rate is rising with increasing output to progress.
per head due to technological progress. But the rate of
The theory states that proceeding “bit by bit” will
profit on capital remains constant, and techniques of
not launch the economy success fully on the develop-
production appropriate to the rate of profit are chosen.
ment path; rather a minimum amount of investment is a
Mrs. Robinson’s model with its stress on parity necessary condition for this. It necessitates the obtaining
between the growth rate of capital and the growth rate of of external economies that arise from the simultaneous
population, conforms closer to the realities of an establishment of technically interdependent industries.
underdeveloped economy. Mrs. Robinson’s main Thus, indivisibilities and external economies flowing
contribution lies in the fact that she has integrated the from a minimum quantum of investment are a prere-
classical value and distribution theory with the quisite for launching economic development success-
Keynesian saving investment theory. fully.
Defects Rosenstein-Rodan distinguishes between three diffe-
1. The model is based on the assumption of a closed rent kinds of indivisibilities and external economies.
economy. This is an unrealistic assumption. 1. indivisibilities in the production function,
2. The role of institutional factors as one of the especially the indivisibility of the supply of social
determinants of economic growth is neglected. overhead capital;
3. The model is based on the unrealistic assumption 2. indivisibilities of demand;
of constant prices. 3. indivisibilities in the supply of savings.
506U | Economics (NET)
Given these three indivisibilities and the external income is a reflection of low productivity, which in turn
economies to which they give rise, a “big push” or a is due largely to lack of capital. The lack of capital is the
minimum quantum of investment is required to over- result of the small capacity to save and so the circle is
come the obstacles to development in under-developed complete,” On the other hand, inducement to invest is
countries. “There may be finally a phenomenon of limited by the size of the market. This creates another
indivisibility in the vigour and drive required for a vicious circle on the demand side.
successful development policy,” writes Rodan. But To break the vicious circle, Naurkse favours a more
proceeding bit by bit in an isolated and small way does or less synchronised application of capital to a wide
not lead to a sufficient impact on growth. A climate range of different industries. This will lead to an over-all
for development is only created when investment of a enlargement of the market. Most of the industries
minimum speed or size is made with in an producing mass consumption goods are complementary.
underdeveloped economy.
Nurkse’s Version depends on the principle of
I. The Doctrine of Balanced Growth complimentarily in various directions between wants,
The theory of balanced growth implies that there between factors of production and between products at
should be simultaneous investment in a variety of various stages of production. This kind of
enterprises and there should be harmonious growth of complementarily leads to the emergence of several
the different parts of the economy. It implies balance external economies. Here, external economies refer
between different consumer goods industries and to the economies which raise out of the establishment of
capital goods industries. It also implies balance a new industry, or from the expansion of an existing
between agriculture and industry, between domestic and industry and those available to other industries. The
export sectors, between economic and social over heads scarcity of factor supply ensures that the relationship is
and between vertical and horizontal external economies. mostly competitive. The supplies of skilled labour,
The theory of balanced growth implies that the state capital and entrepreneur are comparatively in elastic.
must ensure simultaneous investments. It also implies J. The Concept of Unbalanced Growth
controlled planning.
The theory of unbalanced growth is the opposite
The theory of balanced growth has been of the doctrine of balanced growth. According to this
developed by Rosenstein Rodan, Ragnar Nurkse, Arthur concept, investment should be made in selected sectors
Lewis, Scitovsky and Harvey Leibenstein. rather than simultaneously in all economy. No
Main Versions of the Theory of Balanced underdeveloped country possesses capital and other
Growth resources in such quantities as to invest simultaneously
in all sectors. Therefore, investment should be made in a
Rosenstein Rodan’s Version—RosensteinRodan few selected sectors or industries for their rapid
was the first economist who propounded the theory of development and the economies accruing from them can
balanced growth without using these words in his article. be utilized for the development of other sectors. Thus
He realised the importance of pecuniary external the economy gradually moves from the path of
economic. In underdeveloped economies, lack of market unbalanced growth to that of balanced growth.
is a serious obstacle. No investor anticipates a market Economists like Singer, Kindleberger, Streeten, etc,
large enough to justify an investment, even though have expressed their view in favour of the unbalanced
investment project is profitably based upon the growth doctrine which are in fact the criticisms of the
availability of pecuniary external economies. theory of balanced growth. It is, however, Hirschman
In addition to the lack of demand, Rodan mentions who has propounded the doctrine of unbalanced growth
two difficulties on the supply side. Lack of infrastructure in a systematic manner.
makes other investments uneconomic and huge capital Hirschman’s View—The concept of ‘unbalanced
required to build these infrastructures is not available. In growth’ has been popularized by Hirschman. It is his
addition, the absence of ability to save is another contention that deliberate unbalancing the economy,
limitation. according to a predestined strategy, is the best way to
To tackle these problems on the demand and supply achieve economic growth in an underdeveloped country.
sides, Rodan favours a comprehensive investment According to Hirschman, investments in strategically
programme. This will cause an overall rise in demand selected industries or sectors of the economy will lead to
which will make all projects profitable. At the same new investment opportunities and so pave the way to
time, infrastructural facilities will be made available further economic development. He maintains that
for the use of industries. This investment programme “development has of course proceeded in this way, with
must of course be carried out by a central planning growth being communicated from the leading sectors of
agency or a central authority. the economy to the followers, from one industry to
Ragnar Nurkse’s Version—Nurkse’s Version another, from one firm to another.” He regards
given in his book “Problems of capital Formation in development as a “chain of disequilibria” that must
Underdeveloped Countries” broadly follows the keep alive rather than eliminate the disequilibria, of
approach of Rodan. According to Nurkse “low real which profits and losses are symptoms in a competitive
Economics (NET) | 507U
economy. If the economy is to be kept moving ahead, sequence from SOC to DPA and political pressures from
the task of development policy is to maintain tensions, DPA to SOC.
disproportions and disequilibria. This “seesaw advance” Hirschman refers to two routes in the path of
is induced by one disequilibrium that in turn leads to a development. The first sequence is by expanding SOC.
new disequilibrium and so on ad infinitum. It is called by him the process of ‘development’ vice
According to Hirschman, history show only excess capacity of SOC.” The second sequence is by
unbalanced growth in many countries. Balanced growth expanding DPA. It is called by him the process to
was the result of the flow of innovations and changing “development via shortage of SOC.” According to
factor combinations. It was not created by the Hirschman, “development via shortage is an instance
simultaneous expansion of mutually supporting sectors of disorderly, compulsive sequence, while via excess
as assumed by the authors of balanced growth. SOC capacity is essentially permissive.” It is pointed out
Hirschman considered that balanced growth was not a that development via excess capacity is more continuous
process but a goal to be achieved through a series of and smoother and Hirschman calls this self-propelling.
imbalances over a period of time. But the process of development via shortage of SOC
Hirschman stresses three aspects of unbalanced capacity is not so.
growth : Linkage—Hirschmang also analyses the problem
A. Chain of unbalanced growth sequences initiated of finding out what kind of imbalance is likely to be
by private entrepreneurs and the state. more effective. Any particular investment can have both
B. Unbalance in the direction of shortage of social effects called the ‘forward linkage’ and ‘backward
overheads. linkage’. The former will encourage investment in
C. Development to be initiated in those sectors subsequent stages of production, while the latter will
which are linked to the maximum extent with other encourage investment in earlier stages of production.
sector. The problem is to choose projects which will have these
greatest “total” linkage. The projects with greatest
Development can only take place by un-balancing linkage vary from country to country and they can be
the economy. This is possible by investing either in found out only through empirical studies of input-
Social Overhead Capital (SOC) or in Directly Pro- output tables. Hirschman says, “The industry with the
ductive Activities (DPA). The former creates external highest combined linkage score is iron and steel.”
economies while the latter appropriates external Hirschman points out that operations some where in
economies. the middle of the production process may have higher
Unbalancing the Economy with Social total linkage effects than operations at the beginning or
end of the production process. This is because in
Overhead underdeveloped countries the inter-dependence and
Capital (SOC)—SOC has been defined as linkage effects are weak. Primary production in
“comprising those basic services without which primary, underdeveloped countries has weak backward and
secondary and tertiary productive activities cannot forward linkage. According to Hirschman, a meaningful
function.” A large investment in SOC will encourage concept of linkage would be investment decisions up or
private investment later in direct productive activities down the line, which are prompted by creation of a
(DPA). For example cheaper supply of electric power particular industry.
may encourage the establishment of small industries. In the case of underdeveloped countries, backward
Unless SOC investment provide cheap or improved linkage is more reliable than forward linkage. In this
services, private investments in DPA will not be connection, Hirschman is not in favour of too early
encouraged. Thus, the SOC approach to economic encouragement of import-replacing industries. He
development is to ‘unbalance’ the economy so that regards forward linkage as “an important, powerful
subsequently investment in DPA are stimulated. As reinforcement to backward linkage” rather than as ‘an
Hirschman puts it, “Investment in SOC is advocated not independent inducement mechanism.’
because of its permits and in fact invites DPA to come
in. Some SOC investment is required as a prerequisite of
Models of Economic Growth
DPA investment.” A. Harrod-Domar Model
Unbalancing the Economy with DPA—An R.F. Harrod and E. Domar have made a distinct
unbalance can also be created vice DPA. A government contribution in evolving dynamic models to suit the
might directly or indirectly invest in DPA instead of changing conditions of an economy. Both these models
are very similar, and to answer the questions posed by
investing in SOC. If DPA investment is undertaken first,
the post—Keynesians. In fact, one can say that Domar’s
the shortage of soc facilities is likely to raise production model is the American version of Harrod’s model, or
costs substantially. In course of time, political pressures alternatively Harrod’s model is the English Version of
might stimulate investment in SOC also. Investment Domar’s model. Both these models stress on the
sequences are generated by profit expectations and conditions which are very essential for achieving and
political pressures. Profit expectations generate the maintaining steady growth.
508U | Economics (NET)
Like classical economists, Harrod and Domar assign So and Io are observed saving and observed
a crucial role to capital accumulation and investment in investments respectively.
the process of growth. Investment plays a double role. So and Ic are expected saving and expected
On the one hand, investment (through the operation of investments respectively.
multiplier) generates income and, on the other hand, it
increases the productive capacity, by enlarging the Domar’s Model
capital stock. In other words, investment affects the level
Domar’s analysis shows, that he is very emphatic
of income as well as production. The effect of
about the necessity of viewing growth from the demand
investment on income is known as ‘Multiplier Effect’
as well as the supply side. He is of the opinion that pre-
and that on production is known as ‘Productivity Effect’
Keynessian analysis emphasised the capacity (supply
or ‘Sigma Effect’. In mathematics sigma is denoted by.
side) of the problem and the Keynesian approach
Multiplier effect is the Keynesian tool and productivity
concentrated on the demand side alone. But his
effect is the classical tool. Harrod-Domar analysis takes
emphasis on the dual character of the investment process
into consideration both the tool. In short, Harrod-Domar
makes the approach to the equilibrium rate of growth
model strikes a synthesis between the multiplier effect
from investment (capital) point of view more promising.
and productivity effect. The simultaneous operation of
Investment increases the productive capacity and also
these two effects is an essential condition for dynamic
generate income, thus providing us both sides of the
equilibrium.
equation, the solution of which yields the required rate
Assumptions—The main assumptions of Harrod- of growth.
Domar model are as follow :
The following symbols are used in Domar’s model :
1. An initial full-employment level of income has
Yα = level of net national income or level of
already been achieved.
effective demand at full-employment
2. There is no government interference in the (demand side)
functioning of the economy, i.e., the policy of
laissezfaire prevails. Ys = level of productive capacity or supply at
full-employment level (supply side) K=
3. The model is based on the principle of “closed real capital
economy”, there are no exogenous factors or forces
influencing the growth variables of the economy. In I = net investment, which results in the
short, government restrictions on trade and the compli- increase of real capital i.e., Δk
cations caused by international trade are ruled out. α = marginal propensity to save, which is the
4. There are no lags in adjustment, i.e., the 1
reciprocal of multiplier i.e.,
Economic Variables, such as saving, investment, income multiplier
and expenditure adjust themselves in the same period of σ = sigma or productivity, of capital or of net
time. To make it cleaver, it can be stated that any change investment
in saving brings about corresponding changes in the It would be interesting to explain Domar’s model
level of investment in the same period of time. All these with the help of equations used by K.K. Kurihara and
variables relate to the same period of time. the above notations are used in the equations, given
5. The average propensity to save (APS) and the below :
marginal propensity to save (MPS) are equal to each 1
S ΔS Yα =
α
…(1)
other. In other words, APS = MPS or = ; i.e., the
Y ΔY
absolute change in saving is equal to the relative change This equation explains (a) that the level of effective
in saving. demand (yα) is directly related to the level of investment
(I). Any increase in the level of investment will directly
6. Propensity to save and “Capital Coefficient” (i.e., increase the level of effective demand and vice versa, (b)
capital-output ratio) are constant. The law of constant The effective demand is inversely related to the MPS(α).
returns operates in the economy because the capital- Any increase in MPS(α) will decrease the level of
output ratio is assumed constant. effective demand and vice versa. This is the demand
7. Income, investment and saving are all defined in side.
the net sense, i.e., they are over and above depreciation. Ys = σK ...(2)
In other words, depreciation charges are not included in
these variables. This equation explains that the supply of output
(Ys) at full employment depends upon two factors, i.e.,
8. Saving and investment are equal in ex-ante as well productive capacity of the capital (σ) and the amount of
as in ex-post sense, i.e., there is accounting as well as the capital (K). Any increase or decrease in any of these
functional equality between saving and investment. The two factors will raise or reduce the supply of output. If
equality can be expressed as the productivity of capital (σ ) increase, that will
So = Io (accounting equality) favourably affect the supply. Similar will be the effect of
Sc = Ic (functional equality) real capital on supply of output. This is the supply side.
Economics (NET) | 509U
For equilibrium, the demand and supply should be maintain a continuous state of full employment is that,
equal. Therefore, investment and real income must grow at a constant
Yα = Ys annual percentage rate (or compound interest rate) equal
to the product of the propensity to save and the average
1
= αK productivity of investment (the inverse of capital
α coefficient or accelerator).”
or I = ασK …(3) Domar’s equation of steady growth rate can be
This is the condition for “achieving the steady explained with the help of a numerical example.
growth”. Now we proceed further to explain the Suppose the productivity of capital (σ) is 25% and the
condition for maintaining the steady growth. For that we marginal propensity to save ‘α’ is 12% then, the growth
have to add increments to the demand as well as to the ΔI
supply equations discussed above. The demand and
supply equations in the incremental form can be written
rate of investment () I
would be equal to σα i.e.,
25 12 3
as follows : × = = 3%
100 100 100
ΔI
ΔYα = …(4) Thus income or investment must grow at the annual
α
rate of 3% if full employment growth rate or steady
Increments have been shown in the level of growth rate is to be maintained. In brief, “Full
effective demand and investment, because they are employment requires that investment and income grow
variables, but increment has not been shown in ‘a’ at a constant annual relative rate equal to the product of
because it remains constant on the basis of the propensity to save and the average productivity of
assumptions employed. investment”.
ΔYs = σΔk …(5) Path of Disequilibrium—If the investment grows at
Change in the supply of output (ΔYs) can take a constant percentage rate σα, the productive capacity,
place because of change in real capital (ΔK), as the although continually growing, will be fully used. On the
productivity of capital (σ) remains constant. Moreover other hand, if investment grows at a greater or lesser rate
the change in real capital is equal to net investment. than the σα, then the following two types of situations
Therefore will arise—
ΔK = I ΔI ΔY
substituting the value of ΔK in (S) we get (i) When or > σα
I Y
ΔYs = σI ...(6) ΔI ΔY
(ii) When or < σα
The equality between (4) and (6) will provide us the I Y
conditions for the maintenance of steady growth. Under the first situation, inflation will appear in
Equating these two equations (4) and (6) we get, economy because as higher rate of income it will
ΔI ΔI provide greater purchasing power to the people. This
ΔYs = Δ ys or = σI or = σα. will result in the expansion of demand, leading to the
α I
emergence of inflation as the productive capacity (act)
This shows that the rate of growth of net investment will not cope with the increased level of income or
ΔI
() I
should be equal to the product of marginal investment. The first situation will, therefore, create
inflation in economy.
propensity to save (a) and the productivity of capital (σ). The second situation, under which growth rate of
This equality must be ensured to maintain the stable and ΔY ΔI
steady growth of the economy. In Kurihara’s words, “It
is an increase in productive capacity (ΔYs) due to
income or investment ( Y
of
I) , is lagging behind
the productive capacity, will result in over-production.
increment of real capital (ΔK), which must be matched
The lesser growth rate of income will put a constraint on
by an equal increase in effective demand (ΔYα) due to
the purchasing power of the people, thus reducing the
an increment of investment (ΔI), if a growing economy
level of demand and resulting in the overproduction of
with an expanding stock of capital is to maintain
goods.
continuous full employment.” So, the essential and
sufficient condition for maintaining the steady growth of So, under these situations, the maintenance of stable
an expanding economy is and steady growth is impossible and economy will be
under the constant strain of either inflation or
ΔI
= σα overproduction and unemployment.
I
ΔY Harrod’s Model
or = σα
I So far, we have discussed Domar’s model, which
ΔY ΔI
( ∴
Y
is also equal to )
I
explains the conditions for achieving and maintaining
the dunamic equilibrium Harrod’s growth model also
In the words of Meier and Baldwin, “The answer to concentrates on these issues. Broadly speaking R.F.
the problem of what rate of growth is necessary to Harrod, has raised three sets of issues :
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1. How can steady growth rate be achieved in the denoted by Gw and has been defined by Meier and
model with a fixed capital-output ratio (capital- Baldwin in these words, “Gw is interpreted as the rate of
coefficient) and the fixed saving income ratio (propensity income growth required for the full utilisation of a
to save) ? growing stock of capital, so that entrepreneurs will be
2. How can the steady growth rate be maintained ? satisfied with the amount of investment actually made”.
or what are the conditions for maintaining the stable Warranted growth rate (Gw) is determined by two
growth ? factors :
3. How do natural factors put a ceiling on the (i) capital-output ratio
growth rate of the economy ? (ii) saving-income ratio
In order to discuss these three sets of issues, Harrod The relationship between the warranted growth
has explained three growth rates. The growth rates rate and its determinants can be expressed in the form of
are : an equation Gw Cr = S
(a) Actual growth rate Where Gw refers to warranted growth rate,
(b) Warranted growth rate Cr denotes the amount of capital required to maintain
(c) Natural growth rate the warranted growth rate or the growth rate of output. S
Now we discuss these growth rates sepaprately. is the saving-income ratio.
(a) Actual Growth Rate—It is the growth rate,
Having discussed the two rates of growth
which is determined by the actual amount of saving and
(i.e., actual and warranted), we now discuss the issue, as
investment in the country. In other words, it can be
how to achieve the steady growth. According to Harrod,
defined as the ratio of change in income (AY) to the
the economy can achieve stable growth if G = Gw and C
total income (Y) in the given period. If actual AY
= Cr i.e., actual growth rate must be equal to the
ΔY
growth rate is denoted by G, then G = . warranted growth rate. In other words, growth rate of
Y income must be equal to the growth rate of output.
According to Harrod, actual growth rate G is Secondly, the capital-output ratio needed to achieve G,
determined by two factors, saving-income ratio and must be equal to the required capital-output to maintain
capital-output ratio, which remain fixed in a given Gw, given the saving coefficient (S). This amounts to
period. The relationship between the actual growth rate saying that actual investment (ex-post investment) must
and its determinants, can be expressed in the form of an be equal to the expected investment (ex-ante invest-
equation given below : ment), if an economy were to achieve the objectives of
GC = S ...(1) stable growth.
Where G is the actual rate of growth, C represents
Instability of Growth—We have just discussed
ΔK
the capital output ratio or , S refers to the saving- that the stable growth of economy requires an equality
Y between G and Gw on the one hand, and C and Cr on the
income ratio (S/Y). This equation explains the simple other. But the reader should bear in mind that this type
truism that saving and investment (in the ex-post sense) of equality is rarely found in the economy, however
are equal to each other. This simple truism is explained planned and regulated it may be. Harrod analyses this
below : situation, when these conditions are not satisfied.
ΔY ΔK
Since G = and C = (i) when G > Gw, then C < Cr
Y Y
(ii) when G < Gw, then C > Cr
1 S
or C= [Q ΔK = 1] and S = Proof— G C = S and Gw Cr = S
ΔY Y
Substituting the values of G, C and s in equation s s
or GC = or Gw =
(1), we get c Cr
ΔY 1 S If G > Gw
× =
Y ΔY Y s
=
s 1
or >
1
= or cross multiplying
1 S c Cr C Cr
= or I = S
Y Y Cr > C or C < Cr
Thus, equation (1) explains that the condition for Similarly it can be proved
achieving the steady growth rate or dynamic equilibrium When Gw < G, then C > Cr
is that ex-post saving must be equal to ex-post We take up the discussion of the first situation when
investment. In other words, there should be accounting G is greater than Gw. Under this situation the growth
equality between saving and investment, if dynamic rate of income being greater than the growth rate of
equilibrium is to be achieved. output, the demand for output (because of higher level of
(b) Warranted Growth Rate—Warranted growth income) will exceed the supply of output (because of
rate refers to that growth rate of the economy, when it is lower level of output) and the economy will experience
working at full capacity by making full and optimum use a chronic inflation. It can be explained in another way
of machine and manpower. It is also known as “Full too when C < Cr. Under this situation the actual
capacity growth rate” or “Full-employment growth amount of capital falls short of the required amount of
rate” or “Potential growth rate”. This growth rate is capital. This will lead to deficiency of capital, which in
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turn would adversely affect the volume of goods to be Interactions of G, Gw , Gn— While dis-
produced. Fall in the level of output will result in the cussing the interaction of three rates if growth, Harrod
scarcity of goods and hence inflation and the growth of points out that in the years after recession G may be
economy under inflation can never be stable. higher man Gn for a considerable period of time, but it
If, on the other hand, G is less than Gw, then the will not continue to rise indefinitely. In other words, the
growth rate of income will be less than the growth rate process of expansion cannot go on indefinitely, as it
of output. Under this situation there would be more is limited by the availability of natural factors. The
goods for sale, but the income would not be sufficient to ceiling fixed by labour and natural resources prevent
purchase those goods. In Keynesian terminology we can further rise. This has been, shown in above figure.
say that there would be deficiency of demand and the The economy cannot remain at the ceiling level; it has
economy will face the problem of chronic deflation. either to rise or fall.
This situation can also be explained when C is greater When G touches Gn, Gw cannot lag behind, but will
than Cr. Under this situation, the actual amount of tend to catch up with it. Since the rate of rise of G
capital is more than the required amount of capital for cannot be maintained, Gn will exceed G and then the
investment, when the capital amount available is more, it downtrend starts. The downtrend will result in over-
would dampen the marginal efficiency of capital and production, which in turn will lead to a cumulative
lead to chronic depression and unemployment. Thus downswing. The economy will face the problem of
growth of the economy under the situation of chronic secular stagnation and chronic unemployment. This has
depression can never be stable. been shown in the diagram. But this down trend cannot
On the basis of the above discussion, we can continue indefinitely. The reason is that the lower limit
conclude that stable growth or steady-state growth can of depression is set by the minimum consumption level.
occur only when G = Gw. Any deviation of G from Gw As the consumption level cannot fall below a minimum
will result in cumulative departure from the path of level, so the fixed capital too cannot fall though working
steady growth. In other words, the economy will be in a capital may be reduced. In this way gross investment
state of instability when G and Gw are not equal to each cannot be negative. This position, combined with the
other. The equilibrium between G and Gw is called investor’s expectation for the bright future generated by
steady-state equilibrium or knife-edge equilibrium. the actual resources position, will gradually set the
Harrod also states that deviations of G from Gw are wheels of recovery in motion. The economy will once
unstable. If G departs from Gw then it will depart farther again be in the upward phase. This has been shown in
and farther from it, as departure from the path of steady figure :
growth is self-sustaining. It feeds on itself.
In contrast, if G is less than Gw, then desired saving
would exceed desired investment, the entrepreneurs will
be pessimistic about the future and they will keep the
level of output below Gw, and this would further retard
the growth.
(c) Natural Growth Rate—If it is assumed that
propensity to save or capital-output ratio does not
change, what will stop income from shooting up or
down without limit? Harrod points out that generally Analysis of Business Cycle—From the study of
there is an upper limit to the expansion of output, which this model, it is quite evident, that the process of growth
is determined by natural conditions such as size of the of a capitalist economy is never steady because of its in-
labour force, natural resources, capital equipment and herent characteristics. There cannot be a steady growth
state of technical knowledge. This limit is called “full of income and output in such an economy. There will
employment ceiling”. This upper limit may change as always be ups and downs in a capitalist economy.
the factors of production grow, and technological pro- Therefore cyclical fluctuations are implicit in the
gress takes place. Harrod calls the growth in this upper phenomena of growth in such an economy.
full employment ceiling the natural growth rate. In other Business cycles are not free to vary without limit. In
words, it is the maximum growth rate, which an upward direction Gn provides a limit in the form of a
economy can achieve with its available natural “full employment ceiling” beyond which real income
resources. Natural growth rate is denoted by Gn. cannot expand in short period because of the shortage of
labour and capital. In the downward direction there is
also a limit set by a floor of autonomous investment,
because gross investments cannot be negative.
Main Point—The main points of the Harrod-Domar
analysis can be summarised as below :
1. Investment is the centre of the problem of steady
and stable growth, because investment plays a double
role; on the one hand, it generates income and on the
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other, it increases the productive capacity of the in Harrod’s model it is denoted by S. Both α and s are
economy. the propensities to save expressed as ratios.
2. The increased capacity can result in greater (ii) In Domar’s model, the productivity of capital is
output or greater unemployment depending on the represented by σ (Sigma), which means that, it is the
behaviour of income. inverse of capital-output ratio. In Harrod’s model
3. Conditions can be stated for the behaviour of capital-output ratio is represented by C, which is less
income, that will allow full employment to be 1
than one. So Domar’s σ is equal to (reciprocal of C) in
maintained over time. These conditions specify the C
growth rates, which can ensure full employment of Harrod’s model. The only numerical difference between
labour and full utilisation of capital stock. Domar’s co-efficient is that the one is the inverse of the
4. These conditions, however, designate only a other. This co-efficient belongs to the supply side and is
steady line of growth for the economy. The actual known as the acceleration coefficient. When investors
growth rate may differ from the warranted rate of invest an additional amount in production, it accelerates
growth. If the actual growth rate is greater than the the increase of income.
warranted rate of growth, the economy will experience (iii) Though Harrod and Domar have employed
chronic inflation. If the actual growth rate is less than the same acceleration coefficient with only different
the warranted growth rate, the economy will slide symbols in their models, yet there is a hidden difference
towards chronic deflation. between c and σ. Harrod’s acceleration coefficient may
5. The business cycles are viewed as the deviation be called psychological and Domar’s technological.
from the path of steady growth. These deviations Harrod is of the opinion that producers invest C times
become self-aggravating and self-cumulating, but are the increment of the income. It means that, when income
limited in the upward trend by the “full employment increases, the producer’s psyshology is to make net
ceiling” and in the down-ward direction by the floor of investment C time of that increase. It is true that there
autonomous investment and consumption. are technical considerations behind the operation, but
immediately it is the producer’s psychology that
Comparison of Harrod and Domar determines how much to invest. Hence the acceleration
Models coefficient is psychological.
Now we discuss in what sense these models are Domar’s acceleration coefficient is technological.
similar and in what sense they are different. Domar has used productivity of capital (σ) in his model
Similarities and it explains the relationship between investment and
output. Investment is the independent variable and
( i ) Both the models are based on similar output or income is the dependent variable. Since output
assumptions. It is for this reason that the names of is determined by the nature of technology it is
Harrod and Domar are bracketed together in the context technological. It is the technology that determines the
of growth models. amount of income or output to be obtained by given rise
(ii) Both the models employ the Keynesian saving- of investment.
investment equality as the equilibrium condition for the Limitations of these Models—Some of the assum-
steady growth of economy. ptions made by these models make it quite unrealistic.
(iii) Harrod’s warranted growth rate Gw signifies 1. The constancy of the propensity to save and the
the same thing as the product of marginal propensity to capital-output ratio are unrealistic as they tend to change
save (α) and the productivity of capital (σ) in Domar’s in the long-run.
model. In other words Gw = oασ. Both these models
2. The assumption that labour and capital are used
stress that knife edge equilibrium path for an economy
in fixed proportions is untenable. In normal practice,
is highly unstable. It is due to the inherent characteristic
labour and capital enjoy a certain degree of
of a capitalist economy.
substitutability.
(iv) Both the models have been discussed in the
3. Both the models overlook changes in price levels.
context of advanced economies, where capital is fund in
In the words of Meier and Baldwin, “If allowance is
abundance. So, these models solve the problems of
made for price changes and variable proportions in
advanced economies rather than these of backward and
production, then the system may have much stronger
poor economies.
stability than the Harrod model suggests”.
Differences 4. The assumption regarding constancy of interest
rates is irrelevant to the analysis. A reduction in interest
No doubt both the models have been evolved in a rates during periods of over-production can make capital
similar set of circumstances, yet slight differences intensive processes more profitable by in creasing the
between the two models are explained below. demand for capital and there by reduce excess supply of
( i ) Harrod and Domar have used marginal goods.
propensity to save in their models, but this is represented 5. The model ignores developmental programmes
by the different notations. In Domar’s model the under taken by the government which help to speed up
marginal propensity to save is denoted by α (Alpha) and the process of development.
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6. The model has not dealt with the distinguishing In equation (3), L represents total employment.
factors between capital and consumer goods. Since population is growing exogenously, the labour
Despite their limitations, these models form an force increases at a constant relative rate n. Thus
important aspect in the field of economic growth because Lt = Loe et ...(4)
“they represent a stimulating attempt to dynamise and N = Harrod’s natural rate of growth in the absence
secularise keynes’ static short-run saving and investment of technological change
theory”. Lt = the available supply of labour at time (t) the
B. The Solow Model (Long-Run Growth right hand side of equation (4) shows the compound rate
of the growth of labour force from period O to period T.
Model) Equation (4) can be regarded as a supply curve of
Prof R.M. Solow builds his model as an alternative labour. By inserting equation (4) in (3), Solow gives the
to the Harrod-Domar model. The latter model is at best a basic equation
knife-edge balance built on three key parameters viz., the K = SF (K, Loent) ...(5)
saving ratio, the capital-output ratio and the rate of Solow regards this basic equation as deter-
increase of the labour force. If the magnitudes of these mining the time path of capital accumulation, K, that
parameters change the consequence would be gloomy, must be followed if all available labour is to be fully
perpetuating growing unemployment or chronic inflation. employed. It also provides the time profile for capital
The balance itself is poised on the equality between stock. Once the time paths of capital stock and of the
Gw and Gn which is very delicate. If once the fixed labour force are known, the corresponding time path of
proportions assumption of the Harrod-Domar model is real output can be computed from the production
abandoned, the knife-edge balance also disappears with function.
it.
Possible Growth Patterns—In order to find out if
Assumptions—Solow builds his model around
there is always a capital accumulation path consistent
the following assumptions :
with any rate of growth of the labour force towards
(a) One composite commodity is produced. steady state, Solow introduced his fundamental equation.
(b) Output is measured in net terms.
R = SF (r, I)-nr ...(6)
(c) Constant returns to scale.
In this equation r is the ratio of capital to labour
(d) There are only two factors-labour and capital. (K/L), n is the relative rate of change of the labour force
They are paid according to their marginal physical (L/L). The function SF(r, 1) represents output per
productivities. They are substitutable for each other. worker as a function of capital per worker. In other
(e) Prices and wages are flexible. words, it is the total product curve as varying amounts r
(f) There is not only perpetual full employment of of capital are employed with are unit of labour. Equation
labour but also full employment of the available stock of (6) states that the rate of change of capital-output ratio
capital. –
(g) There is neutral technical progress. (r ) is the difference of two terms, one representing the
On the basis of these assumptions Solow’s model increment of capital SF (r, 1) and the other increment of
shows that there would be a tendency for capital-labour labour (nr).
ratio to adjust itself through time in the direction of The possible growth patterns based on his
equilibrium ratio. If the initial ratio of capital to labour is fundamental equation (6) are illustrated in the following
more, capital and output would grow more slowly than figure.
labour force and vice-versa. The straight line passing through the origin is the
Solow takes output as a whole, the only commodity, function nr. The other curve represents the function
in the economy. Its annual rate of production is SF(r, 1). It is so drawn as to show diminishing marginal
designated as Yt Which represents the real income of the productivity of capital. At the point of intersection of the
community, part of it is consumed and the rest is saved two curves nr = SF (r, 1) and –r = 0, then r = –r . When
and invested. That which is saved is a constant S, and r– = 0 the capital-labour ratio is a constant and the
the rate of saving is S.Yt. Kt is the stock of capital. Thus capital stock must expand at the same rate as the b
net investment is the rate of increase of this stock of
labour force, i.e., n. Once the capital-labour ratio r– is
dk
capital i.e., or K. So the basic identity is K = S.Y established. It will be maintained, and capital and labour
dt
will grow in proportion. Assuming constant returns to
...(1)
scale real output will also grow at the some relative and
Since output is produced with capital and labour, output per hand of labour force will be constant. At r’
technological possibilities are represented by the then will be the balanced growth equilibrium.
production function
What will be the behaviour of the capital-labour
Y = F (K, L) ...(2)
That shows constant returns to scale. Inserting ratio if then is a divergence between r– and R. If r lies to
equation (2) in (1) we have the right of r– or r > –r , n r < SF (r; 1), and R will
K = SF (K, L) ...(3) decrease toward r– . On the contrary, if r lies to the left
514U | Economics (NET)
of r– or r < r– , nr < sF (r, 1), and r will increase toward unproductive system i n which the full employment
path leads to ever diminishing per capita income.
r– . Thus the equilibrium value r– is stable.
However, aggregate income rises in this system
But the strong stability shown in the above figure is because net investment is always positive and the labour
not inevitable. It depends on the shope of the supply is increasing. It is to be noted that both the
productivity curve SF(r , 1). In figure below the systems have diminishing marginal productivity
productivity curve SF (r, 1). In this Figure the throughout.
productivity curve SF (r, 1) intersects the curve nr at Professor Solow concludes his model thus : “When
three points r1 , r2 , r3 , But r1 and r3 are stable equilibrium production takes place under the usual neo-classical
positions because the total productivity curve SF (r, 1) is conditions of variable proportions and constant returns
above nr but at r2 it is below nr. Therefore, r2 is an to scale, no simple opposition between natural and
unstable equilibrium position. warranted rates of growth is possible. There may not
be…..any knife…..edge.
The system can adjust to any given rate of growth
of the labour force, and eventually approach a state
of steady proportional expansion”. i.e.,
ΔK ΔL ΔY
= =
K L Y
Critical Appraisal
Solow is a pioneer in constructing a neo-classical
model. The solow model is a major improvement over
“Depending on the initial observed capital-labour the Harrod-Domar model. He takes a continuous
ratio, the system will develop either to balanced growth production function which has come to be known as the
at capital-labour ratio r1 or r3 . In either case labour new-classical production in analysing the process of
supply, capital stock and real output will asymptomati- growth. The assumption of substitutability between
cally expand at raten, but around r1 there is less capital labour and capital gives the growth process an
than around r3 , hence the level of output per head will be adjustability and provides a touch of realism.
lower in the former case than in the latter. The relevant
The aim of the Solow model “was to examine what
balanced growth equilibrium is at r1 for an initial ratio
might be called the fight-rope view of economic growth
any where between O and r2 , it is an r 3 for any initial and to see where more flexible assumptions about
ratio greater r2 . The ratio r 2 is itself an equilibrium production would lead to a simple model”. Still the
growth ratio, but an unstable one, any accidental solow model is weak is weak in many respects.
disturbance will be magnified over time. Figure has been
drawn so that production is possible without capital; 1. The model takes up only the problem of balance
hence the origin is not an equilibrium ‘growth’ between Harrod’s Gw and Gn and leaves out the
configuration.” problem of balance between G and Gw.
Solow points out that figure does not exhaust all 2. There is the absence of an investment function in
possibilities, the shows two more possibilities, as shown this model. If the investment function is introduced than
in below figure. The curve NR depicts the equilibrium the model would present all instabilities noticeable in the
growth path where the warranted and natural rates of Harrodian model. Prof. A. Sen mentions in this
growth are equal. The curve S1 F 1 (r, 1) which is above connection that the assumption of substitutability
nr represents a highly productive system in which between labour and capital does not seem to be a key
capital and income increase more rapidly than the labour difference between neo-classical and neo-Keynesian
supply. In this system, which is of perpectual full studies of growth and the main difference seems to lie in
employment, income and saving increase so much that the investment function and the consequent failure to
the capital-labour ratio increases limitlessly. On the assign a major role to entrepreneurial expectations about
other hand, the curve S2F (r, 1) depicts a highly the future.
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3. The labour-augmenting technical progress on Given these assumptions, the model operates under
which the theory is based is a special case of Harrod- two stages :
Domar neutral technical progress of the Cobb-Douglas A. Constant Working Population
production function which does not posses any empirical
justification. B. Expanding Population
4. Flexibility of factor prices assumption of solow In the first case, the proportionate growth rate of
may bring difficulties in the path towards steady growth. total real income will be the same as the proportionate
growth rate of output per head. In the second case, the
5. The model is based on the unrealistic assumption
proportionate change in total real income is the sum of
of homogeneous and malleable capital. Capital goods
the proportionate change in output per head and the
are of aggregation.
proportionate change in the total working population.
6. The model leaves out the causative process of We discuss these two versions of the model below.
technical progress and treats the latter as an exogenous
A. Constant Working Population—For the opera-
factor in the growth process. Solow ignores the problem
tion of the model, Kaldor postulates three functions :
of inducing technical progress through learning,
investment research and capital accumulation. (i) the saving function .
(ii) the investment function, and
K. Kaldor’s Model of Growth (iii) the technical progress function
Professor Kaldor in his Model of Economic Growth The three functions are explained in terms of linear
Follows the Harrodian dynamic approach and the equations as under :
keynesian techniques of analysis. The other neo-
classical models treat the causation of technical progress (i) Saving function
as completely exogenous, but Kaldor attempts “to S t = αPt + β(Yt – P t) ...(1)
provide a framework for relating the genesis of technical where 1>α>β>0
progress to capital accumulation.” In equation (1), savings (St) consist of savings (α)
Assumptions—The basic properties or assumptions out of profits (Pt) and savings (β) out of wages (Yt – Pt)
of Kaldor’s model are as follows— in period t. The inequalities 1 > α > β > 0 show that α
1. It is based on the Keynesian full employment and β lie between O and 1, that α is greater than β.
assumption in which the short-period supply of aggregate (ii) Investment function
goods and services is inelastic and irresponsive to any
increase in monetary demand.
2. It assumes that technical progress depends on the
Kt = α Yt – I + β′( ) Pt – 1
kt – 1
Yt – 1 …(2)
rate of capital accumulation. For this, Kaldor postulates It = Kt + l – Kt …(2.1)
“the technical progress function” which is a joint where α′ > 0 and β′ > 0
product of two tendencies : growth of capital and growth Equation (2) shows that the stock of capital (Kt) at
of productivity. The capital-output ratio will depend time t is a coefficient α′ of the output of the previous
upon the relation between the two. period (Yt – 1) and coefficient β′ of the rate of profit on
3. Income consists of wages and profits where ⎛P ⎞
wages comprise salaries and earning of manual labour, capital of the period ⎜ t – 1 ⎟ multiplied by the output of
and profits comprise incomes of entrepreneurs as well as ⎝ Kt – 1 ⎠
property owners. the previous period (Yt – 1 ). Equation 2·1 shows the
4. Total savings consist of savings out of wages and investment function where investment in period t equals
savings out of profits. the stock of capital in the next period (Kt +1) minus the
stock o f capital in the current period (Kt). The
5. It is assumed that the share of profits in total
inequalities α′ > 0. and β′ > O reveal that the value of
income is a function of investments, given the
the coefficient α′ and β′ are greater than zero.
propensity to save out of profits.
(iii) Technical Progress function
6. All macro-economic concepts of income, wages,
profits, capital, saving and investment used in the model Yt – 1 – Yt I
= a" + b" · t …(3)
are expressed at constant prices. Yt Kt
7. Monetary policy plays a passive role in the model where
in that money wages may be rising faster than α" > 0 and 1 > β" > 0
productivity or pari passes with productivity, or money Equation (3) shows that the rate of growth of
wages may be constant. income is an increasing function of the rate of net
8. It is assumed that there are no effects of a change investment expressed as the proportion of the stock of
in the share of profits and wages, and of a change in I
capital t in period t multiplied by the capital per head
interest rates on the choice of techniques adopted. Kt
9. The choice of techniques is assumed to alter with β˝ plus the coefficient of technical progress α˝ there the
the accumulation of capital and the progress of tech- value of the coefficient of technical progress is greater
niques in the capital goods making industries. than zero but of capital per head lies between 0 and 1.
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Given these functions, if we start from a point of
time, t = 1, the existing stock of capital K1 can be
regarded as a datum, inherited from the past. Taking Y0
and K0 as the income and capital of the previous period,
Y1 can be taken as the given income which the fully
employed labour force (constant population) produces
with the help of the capital stock K1.
The technical progress function as given by
equilibrium (3) shows the growth of income and capital
from period t + 1 onwards where by the economy
gradually moves from a short-period equilibrium to a
long-period equilibrium of steady growth. Taking the Starting from period t1 where the growth of output
identity S t = It, it is the level of profits which brings
about the equality of saving and investment : For a state
G1 is greater than the growth of capital () It
Kt
, the rate
equilibrium path the following condition should be of investment will increase in the subsequent period so
fulfilled. as to make I2 /K2 equal G1 at A. This will, in turn, raise
Y the growth of output in period t2 to G2 . The rate of
α = β > β′ t …(4) I
Kt investment will increase further to 3 in period t3 , so as
K3
This implies that the growth rate of savings should
I3
be greater than that of investment for the stable to make equal G2 at B. Similarly, the growth of
equilibrium. But this is only a necessary conditions. The K3
sufficient conditions for the stable equilibrium path output in subsequent periods will rise till point G is
reached. This process will be reinforced by changes in
should be
the rate of profit on capital (P t/Kt). An associated change
P t ≤ (Y t – w) ...(5) P I
Pt in t will make the increase in t even greater.
≥m ...(6) Kt Kt
Yt B. Expanding Population—Leaving the assump-
In fact, equation (5) and (6) are inequalities which is tion of constant working population, Kaldor studies
act as constraints on the stability of the equilibrium path. the relation between growth in population and growth
Equation (5) indicates that the level of profits (Pt) should in income. Starting from the Malthusian contention that
not exceed income minimum wages (Yt – w). While the growth rate of population is a function of the rate of
equation (6) indicates that the rate of profit (Pt/Yt) increase of the means of subsistence, he assumes that:
should be greater than the minimum margin of profits (a) “For any given fertility rate…..the percentage rate of
(m) so that the entrepreneurs should continue to make growth in population cannot exceed a certain minimum
further investments. Equation (4), (5) and (6), imply that however real income is rising,” and (b) “the rate of
the equilibrium brought about by the equality of saving population growth will rise moderately as a function of
and investment through the mechanism of profits would the rate of growth of income over some interval of the
not be a stable one. However, the steady growth path latter before that maximum is reached.”
would depend on the ‘technical dynamism’ of the Given these assumptions the relation of population
economy, i.e., on the technical progress function, as growth with the growth in income is expressed by
given by the following condition— Kaldor algebraically as under :
α" It = gt(gt ≥ λ) and It = λ
G = ...(7)
1 – β" Where it is the percentage rate of growth of popula-
Where G is the growth rate of output which is tion, g t is the percentage rate of growth of income, and λ
determined by the technical progress function, as given is the maximum rate of population growth. If gt < λ and
on the right of the equation. so is I t > λ, the rate of growth of income and population
This is illustrated in figure where the proportionate will continue to rise till the growth rate of population
⎛ K – Kt⎞ equals λ.
growth of capital ⎜ t + 1 ⎟ is measured horizontally This relation between population growth and
⎝ Kt ⎠ income growth is represented in figure, where
⎛ Yt + 1 – Y⎞t the proportionate rate of growth of population
and the proportionate growth of income ⎜ Y ⎟
⎝ ⎠
vertically. Point G as determined by the technical
t
( )
1 dt
·
L dt
is measured vertically and proportionate rate
progress function TT′ and the 45° line is one of steady
growth where the proportionate growth of income
of growth of income ( ) 1 dy
·
Y dt
is measured horizontally.
equals the proportionate growth of capital. OY is the growth path of income PL λ is the curve of the
Economics (NET) | 517U
growth rate of population. As the growth rate of income maximum rate of population increase λ and (ii) the
increase, the growth rate of population also rises till rate of technical progress which causes a certain per cent
the λ curve becomes horizontal as a level where the age increase in productivity, α˝ in equation (3) above,
rate of growth of income (OY) exceeds the former, as at when both population and capital per head are held
point E. In the long run, population would grow at its constant.”
maximum rate indicated by ∠λ portion of the dotted
population-growth rate curve. This assumes that the
A Critical Appraisal
shape and position of the technical progress function, Kaldor’s model is based on the Keynesian tools of
as given by the coefficients α˝ and β˝ in equation (3) analysis and follows Harrod’s dynamic approach in
are not affected by the changes in population. The regarding the rates of change in income and capital as
implies that there are constant returns to scale, that is, the dependent variables of the system. But his model is
“an increase in numbers, given the amount of capital per quite different from the Harrodian and other models.
head, leaves output per head unaffected.” Moreover, the model explains not only the steady
growth path of the economy but also certain features of
the growth process which are not explicitly dealt with by
the other neo-classical model builders.
Again, the division of the model in to two stages-
constant population and expanding population is an
attempt to reconcile the Harrodian warranted and natural
rates of growth by demonstrating the longrun tendency
for the two to coverage by mutual interaction. The
expanding population version of the model is particularly
useful in demonstrating the effect of population growth
on the growth of income in underdeveloped countries.
But in an underdeveloped economy with a low One of the highlights of Kaldor’s model is the
capacity to absorb technical changes due to the scarcity introduction of the ‘technical progress function’ in place
of land and capital, the technical progress function will of the usual production function. The technical progress
be lowered with the increase in the growth rate of function relates technical progress to growth of
population. In this situation, the technical progress productivity and capital accumulation, while the usual
function will cut the capital axis positively as at A in production function relates output per head to capital per
figure. This implies that in order to maintain output per head. Thus, the former is superior to the latter in that it
head at a constant level a certain percentage growth in brings in the role of income, wages, profits, capital,
capital per head will be required. We have therefore, two saving and investment.
points of intersection P′ and P of the technical progress Further, the technical progress function can be
function. Point P’ is of unstable equilibrium and point P equally applied to an underdeveloped economy, having
of stable long-run equilibrium. If the rates of growth of low capacity to absorb technical change due to the
income and capital continue to diminish in the economy, scarcities of capital and other resources. Thus, Kaldor’s
both the output per head and capital per head may cease growth model is more realistic than the earlier neo-
to grow. classical models because it is equally applicable to
developed as well as underdeveloped economies.
Despite these virtues of the Kaldor model it is not free
certain weaknesses.
The Kaldor model does not explain the deter-
mination of the rate of growth of the economy, as has
been explained in the Harrod-Domar models in terms of
the volume of investment, saving income ratio and the
capital-output ratio.
Unlike the Harrod-Domar models, this model does
not give the reasons for stability or instability in the
This may happen if the economy is to the left of economic system. Rather, it analyse certain features of
point P. If this situation persist, the technical progress the growth process which emphasise ‘Convergence and
function TT′ may slip down as the dotted curve T˝T˝ in stability.’
figure. In this situation, there will not be any long-run Technical Progress : Disembodied and
equilibrium. Rather, there may be stagnation in the Embodied Technical Change
economy.
The conclusion emerges from the above analysis Disembodied Technical Change
that growth in population will lead to long-run In 1956, Abramkovitz wrote the first paper followed
equilibrium growth in income depending upon the by Kendrick and Solow in an attempt to measure the
relative strength of the following two factors.’ (i) the contribution of technical change to economic growth.
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They treated technical change as ‘disembodied.’ homogeneous, in the model of embodied technical
Disembodied technical change is purely organisational change new machines are better than old machines and
which permits more output to be produced from technological progress is embodied in the new machines.
unchanged inputs, without any new investment. In the former approach, capital-labour ratios change at
Disembodied technical change refers to any kind of shift all times along the Cobb-Douglas production function.
in the production function that leaves the balance But in the latter approach, once a machine is
between capital and labour undisturbed in the long run. constructed it has fixed labour requirements. In other
The production function for such technical change is words, each machine is designed to be worked with a
Q = F(K, L, t) ...(1) given crew of men, and the size of the crew cannot
where Q = output thereafter be changed.
K = capital input Endogenous Growth Theory
L = labour input The endogenous growth theory is an economic
t = technical change theory which argues that economic growth is generated
from within a system as a direct result of internal
Taking Hicks-neutral technical change as the basis,
processes. More specifically, the theory notes that the
Solow postulated the production function in the special
enhancement of a nation's human capital will lead to
form as
economic growth by means of the development of new
Q = A(t) F(K, L) ...(2) forms of technology and efficient and effective means of
Where A(t) is an index of technical change or production. Endogenous growth economists believe that
measures the cumulated effects of shifts over time. improvements in productivity can be linked directly to a
“Such a production function implies that technical faster pace of innovation plus investment in human
progress is organisational in the sense that its effect on capital.
productivity does not require any change in the quantity ● They stress the need for strong government and
of the inputs. Existing inputs are improved or used more private sector institutions to nurture innovation, and
effectively.” provide incentives for individuals and businesses to
The growth rate of output (Q/Q) is equal to the rate be inventive.
of technical change (A/A) plus a weighted average of the ● Knowledge Industries—Typically they are in
growth rate of capital (K/K) and the growth rate of telecommunications, software or biotechnology -
labour (L/L). Assuming linear homogeneous production are becoming hugely important in many developed
function, these weights add to one and we have, and developing countries.
Q A K L The main features of the endogenous growth
= + at + (1 – at) …(3)
Q A K L theory are as follows—
where dots indicate time derivates and at is the ● Government policies can raise a country’s growth
capital elasticity of output. rate if they lead to more intense competition in
markets and help to stimulate product and process
Embodied Technical Change-Vintage innovation.
Approach ● There are increasing returns to scale from capital
I n an alternative model entitled Investment and investment especially in infrastructure and invest-
Technical Progress (1960), Solow himself modified the ment in education and health and telecommu-
residual approach based on disembodied technical nications. A recent report from the World Bank
change in which capital stock is regarded as found that, for low and middle income countries
homogeneous and technical change floats down from the every 10% increase in broadband accelerated GDP
outside. “In this model new capital accumulation is growth by 1·38%.
regarded as the vehicle to technical progress. Technical ● Private sector investment in research & develop-
progress increases the productivity of machines built in ment is a key source of technical progress.
the previous period, but it does not increase the ● The protection of property rights and patents is
productivity of machines already in existence. Technical essential in providing incentives for businesses and
progress is ‘embodied’ in new machines. Machines entrepreneurs to engage in research and develop-
unalterably embody the technology of their date of ment.
construction. Machines built at different dates…. are ● Investment in human capital (the quality of the
therefore qualitatively dissimilar, and cannot in the labour force) is a key ingredient of growth.
general case be aggregated into a single measure of ● Government policy should encourage entrepreneur-
capital. A separate production function is needed for ship as a means of creating new businesses and
each vintage. Total output is the sum of output of all the ultimately as an important source of new jobs,
vintage in use.” investment and innovation.
Its Appraisal Measurement of Growth or Development
Unlike the model of disembodied technical change When economic development takes place, invest-
in which the capital stock is assumed to be completely ment increases and the stock of capital increases, as a
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result of which national income increases. When total measurement, such as real national income or real per
output increases, per capita consumption may increase capita income or per capita consumption level, alone
or decrease. Since some economists suggest that cannot be quite satisfactory. Inspite of its limitations the
economic growth and development means an increase in per capita real income criterion indicates the standard of
total output then we can think of measuring economic economic development attained by different countries.
development in terms total output or per capita output or Hence it is accepted as the index of economic develop-
per capita consumption. Therefore, Real National ment.
Income can be considered deemed to be a measure of 4. UNRISD Indicator of Socio-economic Deve-
economic development. However, other economists lopment—There is an UN institution called United
view that measures of economic development could be Nations Research Institute for Social Development
consumption per capita. We may discuss each view (UNRISD). In this institute, people tried to develop such
point in the succeeding paragraphs. indices as would encompass social, political and
1. National Income as an Index—Professors economic variables implinging upon industrialization,
Kuznets, Meier and Baldwin hold the view that an urbanization and modernization. The indicators they use
increase in real national income is the most convenient are :
measure of economic development because a larger real (i) Expectation of life at birth
national income is normally a pre-requisite for an
increase in real per capita. It is true that, it is the increase (ii) Percentage of population in localities of
in national income which is the most important criterion 20,000 and over
for determining development. But the use of the index (iii) Consumption of animal protein per capita per
has been criticised due to aggregative grounds. Also day
it ignores the consumption and distribution of output (iv) Combined primary and secondary enrolment
which actually reflect the quality of development. ratio
Moreover it does not account for population trends as (v) Vocational enrolment ratio
does per capita income. (vi) Average number of persons per room
2. Per Capita Income as an Index—It is said (vii) Newspaper circulation per 1000 population
that economic growth is meaningless if it does not
(viii) Percentage of economically active population
improve the standard of living of the people especially
with electricity, gas, water etc
in underdeveloped countries. If national income
increases faster than the rate of growth of population, it (ix) Agricultural production per male agricultural
is undoubtedly a mark of economic development, taking worker
the country as a whole. Similarly, an increase in the (x) Percentage of adult male labour in agriculture
aggregate output may be sign of development but not in (xi) Electricity consumption, per capita
all cases, the problem arises when the rate of growth of (xii) Steel consumption per capita
population is greater than the rate of increase in real (xiii) Energy consumption, kg. of coal equivalent
national income. In developing countries which are per capita
characterised by population pressure, a rise in per capita (xiv) Share of manufacturing in GDP
real income will always mean a rise in aggregate real (xv) Per capita foreign trade
output, hence the criterion of per capita real income is (xvi) Percentage of salaried and wage earners to
better than that of aggregate real income in the measure- total economically active person
ment of economic development.
5. Physical Quality of Life Index—David Morris
3. Per Capita Level of Consumption—Some tried to look for those indicators, which were the results
economists think that if improving the standard of living of the development efforts. Out of hundred and odd
of the people is the ultimate objective of economic indicators, he could find only three which could have
development, then the per capita consumption level is universal appeal as ends in themselves and meet the
the most appropriate index of economic development. criteria laid down. These are :
As we know that increase in per capita income will
(i) Life Expectancy (LE)
improve the standard of living of the people, thus
pushing upward the per capita consumption level. But it (ii) Infant Mortality (IM), and
cannot be ignored that an increase in per capita output (iii) Basic literacy (BL)
need not always increase per capita consumption. David Morris called this combined index as physical
Actually in developing economies, when output roses quality of Life Index (PQLI).
consumption has to be restricted to release resources for Morris suggested that since infant mortality refers to
capital formation and the entire output is not consumed. death before age one, therefore, life expectancy at age
When total output increases, the consumption level may one should be used instead of life expectancy at birth.
be suppressed by the government in order to get These three indicators, LEI, IMI and BLI, are
resources for economic development. averaged to give PQLI. Thus,
Economic development, as is known, is multi- 1
PQLI = (LEI + IMI + BLI)
dimensional process and a unit dimensional means of 3
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Human Development Index exceed the $75,000 income per capita ceiling. Having
defined the minimum and maximum values, the
The Human Development Index—a composite dimension indices are calculated as :
measure of income, education and health—was presented
Dimension index
in 1990 as an alternative to GDP. Its widespread
(actual value – minimum value)
adoption reflects countries’ desire to understand whether, =
how and why people are doing better. Since its intro- ( maximum value – minimum value) . (1)
duction, human development measures of inequality, For the education dimension, equation 1 is first
gender and poverty have been added to the arsenal. applied to each of the two indicators, and then the
arithmetic mean of the two resulting indices is taken.
The Human Development Index (HDI) is a Using the arithmetic mean allows perfect substitutability
summary measure of human development. It measures between mean years of schooling and expected years of
the average achievements in a country in three basic schooling. Many developing countries have low school
dimensions of human development : a long and healthy attainment among adults but are eager to achieve
life, access to knowledge and a decent standard of universal primary and secondary school enrolment.
living. The HDI is the geometric mean of normalized Because each dimension index is a proxy for capabilities
indices measuring achievements in each dimension. in the corresponding dimension, the transformation
Step 1. Creating the Dimension Indices— function from income to capabilities is likely to be
Minimum and maximum values (goalposts) are set concave that is, each additional dollar of income has a
in order to transform the indicators expressed in smaller effect on expanding capabilities. Thus for
different units into indices between 0 and 1. These income, the natural logarithm of the actual, minimum
goalposts act as the “natural zeros” and “aspirational and maximum values is used.
targets,” respectively, from which component indicators Step 2. Aggregating the Dimensional Indices to
are standardized (see equation 1 below). They are set at Produce the Human Development Index—
the following values— The HDI is the geometric mean of the three dimen-
Dimension Indicator Minimum Maximum sional indices—
Value Value HDI = [IHealth * IEducation* IIncome]1/3
Health Life Expectancy 20 85 Sustainable Development Goals
(years)
The Sustainable Development Goals (SDGs), other-
Education Expected Years of 0 18 wise known as the Global Goals, are a universal call to
Schooling action to end poverty, protect the planet and ensure that
Mean Years of 0 15 all people enjoy peace and prosperity. These 17 Goals
schooling (Years) build on the successes of the Millennium Development
Standard of Gross National 100 75000 Goals, while including new areas such as climate
living Income per capita change, economic inequality, innovation, sustainable
(2011PPP$) consumption, peace and justice, among other priorities.
The justification for placing the natural zero for life The goals are interconnected – often the key to success
expectancy at 20 years is based on historical evidence on one will involve tackling issues more commonly
that no country in the 20th century had a life expectancy associated with another. The Sustainable Development
of less than 20 years. Maximum life expectancy is set at Goals (SDGs) were born at the United Nations
85, a realistic aspirational target for many countries over Conference on Sustainable Development in Rio de
the last 30 years. Due to constantly. Improving living Janeiro in 2012. The objective was to produce a set of
conditions and medical advances, life expectancy has universal goals that meet the urgent environmental,
already come very close to 85 years in several political and economic challenges facing our world.
economies—Hong Kong, China (Special Administrative The SDGs replace the Millennium Development
Region) (84·1 years) and Japan (83·9 years). Goals (MDGs), which started a global effort in 2000 to
tackle the indignity of poverty. The MDGs established
Societies can subsist without formal education, measurable, universally-agreed objectives for tackling
justifying the education minimum of 0 years. The extreme poverty and hunger, preventing deadly diseases,
maximum for expected years of schooling, 18, is and expanding primary education to all children, among
equivalent to achieving a master’s degree in most other development priorities.
countries. The maximum for mean years of schooling, For 15 years, the MDGs drove progress in several
15, is the projected maximum of this indicator for 2025. important areas : reducing income poverty, providing
The low minimum value for gross national income much needed access to water and sanitation, driving
(GNI) per capita, $100, is justified by the considerable down child mortality and drastically improving maternal
amount of unmeasured subsistence and non-market health. They also kick-started a global movement for
production in economies close to the minimum, which is free primary education, inspiring countries to invest in
not captured in the official data. The maximum is set at their future generations. Most significantly, the MDGs
$75,000 per capita. Currently, only four countries made huge strides in combatting HIV/AIDS and other
(Brunei , Darussalam, Liechtenstein, Qatar and Singapore) treatable diseases such as malaria and tuberculosis.
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The SDGs came into effect in January 2016, and meaning success in one affects success for others.
they will continue to guide UNDP policy and funding Dealing with the threat of climate change impacts how
until 2030. As the lead UN development agency, UNDP we manage our fragile natural resources, achieving
is uniquely placed to help implement the Goals through gender equality or better health helps eradicate poverty,
our work in some 170 countries and territories. and fostering peace and inclusive societies will reduce
Our strategic plan focuses on key areas including inequalities and help economies prosper. In short, this is
poverty alleviation, democratic governance and peace the greatest chance we have to improve life for future
building, climate change and disaster risk, and economic generations.
inequality. UNDP provides support to governments to The SDGs coincided with another historic agreement
integrate the SDGs into their national development plans reached in 2015 at the COP21 Paris Climate Conference.
and policies. This work is already underway, as we Together with the Sendai Framework for Disaster Risk
support many countries in accelerating progress already Reduction, signed in Japan in March 2015, these
achieved under the Millennium Development Goals. agreements provide a set of common standards and
Our track record working across multiple goals achievable targets to reduce carbon emissions, manage
provides us with a valuable experience and proven the risks of climate change and natural disasters, and to
policy expertise to ensure we all reach the targets set out build back better after a crisis.
in the SDGs by 2030. But we cannot do this alone.
Achieving the SDGs requires the partnership of The SDGs are unique in that they cover issues that
governments, private sector, civil society and citizens affect us all. They reaffirm our international commitment
alike to make sure we leave a better planet for future to end poverty, permanently, everywhere. They are
generations. ambitious in making sure no one is left behind. More
The SDGs are a bold commitment to finish what we importantly, they involve us all to build a more
started, and tackle some of the more pressing challenges sustainable, safer, more prosperous planet for all
facing the world today. All 17 Goals interconnect, humanity.
Sustainable Development Goals
SDG Goal
SDG Goal Target/Discription
Number
1 No Poverty : End Poverty in all Poverty is more than the lack of income and resources to ensure a
forms and Everywhere sustainable livelihood. Its manifestations include hunger and malnutrition,
limited access to education and other basic services, social discrimination
and exclusion as well as the lack of participation in decision-making.
2 Zero Hunger : Investments in agriculture are crucial to increasing the capacity for
agricultural productivity and sustainable food production systems are
necessary to help alleviate the perils of hunger.
3 Good Health and Wellbeing : Ensuring healthy lives and promoting the well-being at all ages is essential
Ensure Healthy Lives and Promote to sustainable development.
Well-being for all at all ages
4 Quality Education : Obtaining a quality education is the foundation to creating sustainable
development. In addition to improving quality of life, access to inclusive
education can help equip locals with the tools required to develop
innovative solutions to the world’s greatest problems.
5 Gender Equality : Achieve Gender Gender equality is not only a fundamental human right, but a necessary
Equality and Empower all Women foundation for a peaceful, prosperous and sustainable world.
and Girls
6 Clean Water and Sanitation : To improve sanitation and access to drinking water, there needs to be
Ensure Access to Clean Water and increased investment in management of freshwater ecosystems and
Sanitation to All sanitation facilities on a local level
7 Affordable and Clean Energy : Focusing on universal access to energy, increased energy efficiency and
Ensure Access to Affordable, the increased use of renewable energy through new economic and job
Reliable, Sustainable and Modern opportunities is crucial to creating more sustainable and inclusive
Energy communities and resilience to environmental issues like climate change.
8 Decent Work and Economic Sustainable economic growth will require societies to create the conditions
Growth : Promote Inclusive and that allow people to have quality jobs that stimulate the economy while not
Sustainable Economic Growth, harming the environment.
employment and decent work for all
9 Industry, Innovation and Infra- Investments in infrastructure – transport, irrigation, energy and information
structure : Build Resilient Infra- and communication technology – are crucial to achieving sustainable
structure, Promote Sustainable development and empowering communities in many countries.
Industrialisation and Foster
Innovation
10 Reduced Inequalities : Reduce To reduce inequality, policies should be universal in principle, paying
Inequality within and among attention to the needs of disadvantaged and marginalized populations.
Countries
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11 Sustainable Cities and Commu- There needs to be a future in which cities provide opportunities for all, with
nities : Make cities inclusive, safe, access to basic services, energy, housing, transportation and more.
resilient and sustainable
12 Responsible Consumption and Since sustainable consumption and production aims at “doing more and
Production : Ensure Sustainable better with less,” net welfare gains from economic activities can increase
Consumption and Production by reducing resource use, degradation and pollution along the whole life
Pattern cycle, while increasing quality of life.
13 Climate Action : Take Urgent Climate change is now affecting every country on every continent
Action to Combat Climate Change
and its Impact
14 Life Below Water : Conserve and The world’s oceans – their temperature, chemistry, currents and life – drive
Sustainably Use the Oceans, Seas global systems that make the Earth habitable for humankind
and Marine Resources
15 Life on Land : Sustainably Manage Forests cover 30·7 per cent of the Earth’s surface and, in addition to
Forests, Combat Desertification, providing food security and shelter, they are key to combating climate
halt Biodiversity Loss change, protecting biodiversity and the homes of the indigenous
population.
16 Peace, Justice and Strong Institu- The threats of international homicide, violence against children, human
tion : Promote just, peaceful and trafficking and sexual violence are important to address to promote
inclusive societies peaceful and inclusive societies for sustainable development. They pave
the way for the provision of access to justice for all and for building
effective, accountable institutions at all levels.
17 Partnership for the Goals : Revi- A successful sustainable development agenda requires partnerships
talise the global partnership for between governments, the private sector and civil society. These inclusive
sustainable development partnerships built upon principles and values, a shared vision, and shared
goals that place people and the planet at the centre, are needed at the
global, regional, national and local level.
Poverty and Inequality Ultra-poverty—Ultra-poverty is said to occur when
a household cannot meet 80% of the FAO-WHO
Poverty minimum calorie requirements, even when using 80% of
Narrow definitions of poverty see poverty in its income to buy food.
economic terms as about income, whilst broader Incidence of Poverty—The incidence of poverty,
definitions see poverty as being multi-dimensional. The expressed as a headcount ratio, is simply an estimate of
poor are deprived not just because they lack money but the percentage of people below the poverty line. It does
because they are disadvantaged in a range of ways that not indicate anything about the depth or severity of
might include poor access to education and health, little poverty and thus does not capture any worsening of the
sense of participation in social and political life, low conditions of those already in poverty.
self-worth, and so on. Whilst it is often convenient to
compare poverty in terms of income, especially at higher Depth of Poverty—The depth of poverty can be
levels of aggregation across nations and regions for measured as the average distance below the poverty line,
instance, it is important to remember that this is an expressed as a proportion of that line. This average is
extremely partial picture. formed over the entire population, poor and non-poor.
Comparing poverty at a societal level using Because this measure-also called the poverty gap-shows
economic measures can be done in a number of ways - the average distance of the poor from the poverty line, it
through counting the poor, through measuring inequality is able to capture a worsening of their conditions.
or through looking at the level of average incomes. Severity of Poverty—The severity of poverty can
Methods of counting the poor rely on identifying an be measured as a weighted average of the squared
appropriate poverty line and categorising the numbers distance below the poverty line, expressed as a
falling below this line in terms of per capita household proportion of that line. The weights are given by each
incomes. Whilst some poverty line measures identify individual gap. Again, the average is formed over the
absolute poverty, such as a dollar a day for developing entire population. Since the weights increase with
countries, others focus on relative poverty, commonly poverty, this measure is sensitive to inequality among
set at less than 50 or 60% average national disposable the poor. Weights increase with poverty, this measure is
income. sensitive to inequality among the poor.
Absolute and Relative Poverty—Absolute poverty
refers to some absolute standard of minimum require- Transient and Chronic Poverty—Transient pove-
ment, while relative poverty refers to falling behind rty refers to short-term, temporary or seasonal poverty,
most others in the community. With respect to income, a and chronic poverty to long-term or structural poverty.
person is absolutely poor if her income is less than the Vulnerability—Vulnerability has two faces—
defined income poverty line, while she is relatively poor external exposure to shocks, stress and risk; and internal
if she belongs to a bottom income group (such as the defencelessness, a lack of means to cope without
poorest 10%). suffering damaging loss.
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Poverty lines— line. Many countries have adopted income poverty lines
Poverty Lines for International Comparison—A to monitor progress in reducing poverty incidence. Often
poverty line set at $1 (1985 PPP$) a day per person is the cut-off poverty line is defined in terms of having
used by the World Bank for international comparison. enough income for a specified amount of food.
This poverty line is based on consumption A poverty II. Basic Needs Perspective—Poverty is depri-
line of $2 (PPP$) a day is suggested for Latin America vation of material requirements for minimally acceptable
and the Caribbean. For Eastern Europe and the CIS fulfilment of human needs, including food. This concept
countries, a poverty line of $4 (1990 PPP$) has been of deprivation goes well beyond the lack of private
used. For comparison among industrial countries, a income : it include the need for basic health and education
poverty line corresponding to the US poverty line of and essential services that have to be provided by the
$14·40 (1985 PPP$) a day per person has been used. community to prevent people from falling into poverty.
At present people living below a poverty line don't It also recognizes the need for employment and parti-
have enough to meet their basic needs. Countries cipation.
typically define national poverty lines, and the World III. Capability Perspective—Poverty represents the
Bank uses the lines of a group of the poorest countries absence of some basic capabilities to function-a person
to define the international extreme poverty line of $1·90 lacking the opportunity to achieve some minimally
per day. acceptable levels of the full functioning. The functioning
● According to the most recent estimates, in 2015, 10
relevant to this analysis can vary from such physical
per cent of the world’s population lived on less than
ones as being well nourished, being adequately clothed
US$1·90 a day, compared to 11 per cent in 2013.
That’s down from nearly 36 per cent in 1990. and sheltered and avoiding preventable morbidity, to
● Nearly 1·1 billion fewer people are living in extreme more complex social achievements such as partaking in
poverty than in 1990. In 2015, 736 million people the life of the community. The capability approach
lived on less than $1·90 a day, down from 1·85 reconciles the notion of absolute and relative poverty,
billion in 1990. since relative deprivation in incomes and commodities
National Poverty lines—Developing countries that can lead to an absolute deprivation in minimum
have set national poverty lines have generally used the capabilities.
food poverty method. These lines indicate the insuffi-
ciency of economic resources to meet basic minimum Subjective Understandings of Poverty
needs in food. There are three approaches to measuring Participatory and qualitative research involving
food poverty. more than 20,000 poor people from 23 countries sought
to investigate the reality of poor people's experiences. It
Poverty Has Many Dimensions confirmed that the subjective experience of poverty went
Concern with identifying people affected by poverty beyond material concerns to include multiple and inter-
and the desire to measure it have at times obscured the locking dimensions that combined to sustain powerless-
fact that poverty is too complex to be reduced to a ness. The dimensions identified were :
single dimension of human life. It has become common
● physical hunger, fatigue, and illness
for countries to establish an income-based or consump-
tion-based poverty line. Although income focuses on an ● insufficient, seasonal and insecure assets and
important dimension of poverty, it gives only a partial livelihoods
picture of the many ways human lives can be blighted. ● spatial isolation in places that are marginalised,
.Someone can enjoy good health and live quite long but excluded and vulnerable
be illiterate and thus cut off from learning, from ● inequitable gender relations
communication and from interactions with others.
Another person may be literate and quite well educated ● discriminatory and abusive social relations
but prone to premature death because of epidemiological ● lack of security (protection and peace of mind)
characteristics or physical disposition. Yet a third may ● disempowering institutions
be excluded from participating in the important decision
● weak social networks and social organisations
making processes affecting her life. The deprivation of
none of them can be fully captured by the level of their ● lack of skills and capabilities
income. Also, people perceive deprivation in different
ways-and each person and community define the
Measurement of Poverty
deprivation and disadvantage that affect their lives. ● Cost-of-basic-needs Method—This approach sets
Poverty of live and opportunities –or human poverty-is the poverty line at the cost of a basic diet for the
multidimensional in character and diverse rather than main age, gender and activity groups, plus a few
uniform in content. essential non-food items. A survey then establishes
the proportion of people living in households with
Three Perspectives on Poverty consumption (or sometimes income) below this line.
I. Income perspective—A person is poor if, and The basic diet may consist of the least expensive
only if, her income level is below the defined poverty foods needed to meet basic nutritional requirements,
524U | Economics (NET)
the typical adult diet in the lowest consumption Inequality
quintile or the investigator's notion of a minimal but
decent diet. The choice of both the food and the Inequality—the state of not being equal, especially
non-food components included is necessarily in status, rights, and opportunities 1 —is a concept very
arbitrary. much at the heart of social justice theories. However, it
● Food Energy Method—This method focuses on the is prone to confusion in public debate as it tends to mean
consumption expenditure at which a person's typical different things to different people. Some distinctions
food energy intake is just sufficient to meet a are common though. Many authors distinguish “econo-
predetermined food energy requirement. Dietary mic inequality”, mostly meaning “income inequality”,
energy intake, as the dependent variable, is “monetary inequality” or, more broadly, inequality in
regressed against household consumption per adult “living conditions”. Others further distinguish a rights-
equivalent. The poverty line is then set at the level
based, legalistic approach to inequality—inequality of
of total consumption per person at which the
statistical expectation of dietary energy intake rights and associated obligations (e.g. when people are
exactly meets average dietary energy requirements. not equal before the law, or when people have unequal
The problem with this method is the caviar caveat: political power). Concerning economic inequality, much
groups that choose a costly bundle of foods are of the discussion has boiled down to two views. One is
rewarded with a higher poverty line than that for chiefly concerned with the inequality of outcomes in the
more frugal eaters. material dimensions of well-being and that may be the
● Food Share Method—This method derives the cost result of circumstances beyond one’s control (ethnicity,
of a consumption plan to acquire just sufficient family background, gender, and so on) as well as talent
nutrients. If the cost of basic nutrients is a third of and effort. This view takes an ex-post or achievement-
total consumption, the poverty line is fixed at three oriented perspective. The second view is concerned with
times that cost. All three approaches are sensitive to the inequality of opportunities, that is, it focuses only in
the price level used to determine the cost of the
the circumstances beyond one’s control, that affect one’s
bundle. And all three concentrate mainly on calories
or dietary energy, because protein deficiency due to potential outcomes. This is an exante or potential
inadequate economic resources is perceived to be achievement perspective.
rare in most societies. In industrial countries too Inequality of Outcomes
national poverty lines are used to measure relative
poverty. The European Commission has suggested a Inequality of outcomes occurs when individuals do
poverty line for these countries of half the median not possess the same level of material wealth or overall
adjusted disposable personal income. living economic conditions. Development theory has
largely been concerned with inequalities in standards of
Criteria of Ill-Being living, such as inequalities in income/wealth, education,
The following criteria, drawn from various parti- health, and nutrition. However, the lens through which
cipatory studies, were used by local people in Asia and economists gauge progress in these fronts has typically
Sub-Saharan Africa for defining poverty and ill-being : been income or consumption. Historically, development
● Being disabled (for example blind, crippled, theory was concerned with income inequalities, in so
mentally impaired, chronically sick). much as it affected or was affected by the economic
growth of the average income of the nation.
● Lacking land, live tock, farm equipment, a grinding
Distributional concerns were mostly put aside, as growth
mill. was thought to eventually “lift all boats” (Kuznets
● Being unable to decently bury their dead. curve). Slowly, studies began showing that growth had
● Being unable to send their children to school. inconclusive effects on inequality, but income inequality
● Having more mouths to feed, fewer hand to help. was detrimental for economic growth. Further, as
● Lacking able-bodied family members- who can feed income inequality rose in many countries, a
their families in a crisis. distributional bias in the growth process was made
evident. Startling levels of poverty in the late 1990s
● Having bad housing.
pushed the income inequality debate to refocus on
● Suffering the effect· of destructive behaviours (for poverty reduction. Pro-poor growth approaches made
example, alcoholism). their debut and growth and equity (through income
● Being "poor in people", lacking social support. redistribution) were seen as separate policy instruments,
● Having to put children in employment. each capable of addressing poverty. The central concern
● Being single parents. was in raising the incomes of poor households. By the
● Having to accept demeaning or low status work.
early 2000s, it was clear that growth and inequality were
not separable, and the previous decade’s focus on
● Having food security for only a few months each
extreme poverty was seen as falling short (indeed, there
year. was progress in extreme poverty, but income inequalities
● Being dependent on common property resource . were rising in many developing countries). Inclusive
Economics (NET) | 525U
growth approaches emerged, advocating broadly-shared inequality in terms of opportunity is defined on an ex-
well-being and the extension of disproportionate benefits ante basis and is concerned with ensuring a common
of growth to a wider share of the population . starting place, inequality of outcomes is concerned with
the finish line and depends on both circumstances
Inequality of Opportunity beyond one’s control as well as talent and effort.
In the late 1970s, Amartya Sen’s capability
framework brought a new way of thinking about human
Measurement of Inequality
well-being, its measurement, and inter-personal Comprehending the impact of policy changes on the
comparisons. He proposed that well-being should be distribution of income first requires a good portrayal of
defined and measured in terms of the beings and doings that distribution. There are various ways to accomplish
valued by people (functionings) and the freedom to this, including graphical and mathematical approaches
choose and to act (capabilities). This approach that range from simplistic to more intricate methods. All
emphasizes the freedom to choose one type of life rather of these can be used to provide a complete picture of the
than another. In this framework, equalizing income concentration of income, to compare and rank different
should not be the goal, because not all people convert income distributions, and to examine the implications of
income into well-being and freedom in the same way. alternative policy options. An inequality measure is
What’s more, this relationship seems highly dependent often a function that ascribes a value to a specific
on “contingent circumstances, both personal and social” distribution of income in a way that allows direct and
that include the individual’s age, gender, family objective comparisons across different distributions. To
background and disability. It also depends on climatic do this, inequality measures should have certain
conditions, societal conditions (health care, education properties and behave in a certain way given certain
systems, prevalence of crime, community relationships), events. For example, moving $1 from a richer person to
customs and convention, among other factors. Hence, a poorer person should lead to a lower level of
what should be equalized is not means of living, but the inequality. No single measure can satisfy all properties
actual opportunities of living that give people the though, so the choice of one measure over others
freedom to pursue a life of their own choosing. Frances involves trade-offs.
Stewart has made the case for going beyond a focus on The following measures differ with regards to the
individuals and examining as well the inequalities that properties they satisfy and information they present.
arise between individuals due to the group(s) they None can be considered superior, as all are useful given
identify with (cultural, gender, age, etc.) and that may be certain contexts. A well-balanced inequality analysis
the cause of prejudice, discrimination, marginalization, should look at several of these measures.
or advantage—a phenomenon she named horizontal
inequalities. To conclude, a society can be said to Graphical Representation of Inequality
provide equal opportunities when circumstances do not Lorenz Curve—It is one of the simplest representa-
determine the differences in life outcomes . In practice, tions of inequality. On the horizontal axis is the
equality of opportunity exists when policies compensate cumulative number of income recipients ranked from the
the individuals facing disadvantageous circumstances. poorest to the richest individual or household. The
Economic Inequality refers to how economic vertical axis displays the cumulative percentage of total
variables are distributed—among individuals in a group, income. The Lorenz curve reveals the percentage of
among groups in a population, or among countries. income owned by x per cent of the population. It is
Development theory has largely been concerned with usually shown in relation to a 45-degree line that
inequalities in standards of living, such as inequalities in represents perfect equality where each x percentile of the
income/wealth, education, health, and nutrition. Much of population receives the same x percentile of income.
this discussion has boiled down to a debate between two Thus the farther the Lorenz curve is in relation to the 45-
perspectives: the first is primarily concerned with the degree line, the more unequal the distribution of income.
inequality of opportunities, such as unequal access to Indices
employment or education; and the second with the Gini Index—It is the most widely cited measure of
inequality of outcomes in various material dimensions of inequality; it measures the extent to which the
human well-being, such as the level of income, distribution within an economy deviates from a perfectly
educational attainment, health status and so on. equal distribution. The index is computed as the ratio of
Equality of Opportunity exists when life outcomes the area between the two curves (Lorenz curve and 45-
depend only on factors for which persons can be degree line) to the area beneath the 45-degree line. In the
considered responsible, and not on disadvantageous figure above, it is equal to A/(A+B). A higher Gini
attributes outside of their control. It argues that gender, coefficient represents a more unequal distribution.
ethnicity, family background, etc. should not determine According to World Bank data, between 1981 and 2013,
outcomes. In practical terms, it exists when individuals the Gini index ranged between 0·3 and 0·6 worldwide.
are compensated in some way for their disadvantageous The coefficient allows direct comparison of two
circumstances. Equality of outcome describes a state in populations’ income distribution, regardless of their
which people have similar economic conditions. While sizes. The Gini’s main limitation is that it is not easily
526U | Economics (NET)
decomposable or additive. Also, it does not respond in households above the mean to those below the mean to
the same way to income transfers between people in achieve equality in the distribution of incomes. Higher
opposite tails of the income distribution as it does to values indicate more inequality and that more
transfers in the middle of the distribution. Furthermore, redistribution is needed to achieve income equality. It
very different income distributions can present the same can be graphically represented as the maximum vertical
Gini coefficient. distance between the Lorenz curve and the 45-degree
Atkinson’s Inequality Measure (or Atkinson’s line that represents perfect equality of incomes.
Index)—This is the most popular welfare-based Theil Index and General Entropy (GE)
measure of inequality. It presents the percentage of total Measures—The values of the GE class of measures
income that a given society would have to forego in vary between zero (perfect equality) and infinity (or one,
order to have more equal shares of income between its if normalized). A key feature of these measures is that
citizens. This measure depends on the degree of society they are fully decomposable, i.e., inequality may be
aversion to inequality (a theoretical parameter decided broken down by population groups or income sources or
by the researcher), where a higher value entails greater using other dimensions, which can prove useful to
social utility or willingness by individuals to accept policy makers. Another key feature is that researchers
smaller incomes in exchange for a more equal can choose a parameter α that assigns a weight to
distribution. An important feature of the Atkinson index distances between incomes in different parts of the
is that it can be decomposed into within and between- income distribution. For lower values of α, the measure
group inequality. Moreover, unlike other indices, it can is more sensitive to changes in the lower tail of the
provide welfare implications of alternative policies and distribution and, for higher values, it is more sensitive to
allows the researcher to include some normative content changes that affect the upper tail . The most common
to the analysis. values for α are 0, 1, and 2. When α = 0, the index is
called “Theil’s L” or the “mean log deviation” measure.
Lorenz Curve and Robin Hood Index
When α = 1, the index is called “Theil’s T” index or,
100% more commonly, “Theil index”. When α = 2, the index
is called “coefficient of variation”. Similarly to the Gini
Cumulative Percentage
coefficient, when income redistribution happens, change
A in the indices depends on the level of individual incomes
of Income
Perfect distribution involved in the redistribution and the population size.
line (45°)
Ratios
Robin Hood
Index Ratios constitute the most basic inequality measures
B available. They are simple, direct, easy to understand,
and they offer few data and computation challenges.
Lorenz Curve
Accordingly, they do not provide as much information
100%
Cumulative Percentage as the complex measures described above.
of Households Decile Dispersion Ratio (or Inter-decile Ratio)—It
Lorenz Curve and Robin Hood Index is the ratio of the average income of the richest x per
cent of the population to the average income of the
100% poorest x per cent. It expresses the income (or income
share) of the rich as a multiple of that of the poor.
However, it is vulnerable to extreme values and outliers.
ine
Cumulative Percentage
Common decile ratios include : D9/D1 : ratio of the
)L
A
5°
income of the 10 per cent richest to that of the 10 per
(4
of Income
od cent poorest; D9/D5 : ratio of the income of the 10 per
n
Ho
tio
bin dex cent richest to the income of those at the median of the
bu
o
tri
R In earnings distribution; D5/ D1 : ratio of the income of
dis
those at the median of the earnings distribution to the 10
ct
rfe
B per cent poorest. The Palma ratio and the 20/20 ratio are
Pe
Lorenz Curve other examples of decile dispersion ratios.
100% Palma Ratio—It is the ratio of national income
Cumulative Percentage shares of the top 10 per cent of households to the bottom
of Households
40 per cent. It is based on economist José Gabriel
Hoover index (also known as the Robin Hood Palma’s empirical observation that difference in the
Index, Schutz Index or Pietra Ratio)—It shows the income distribution of different countries (or over time)
proportion of all income which would have to be is largely the result of changes in the ‘tails’ of the
redistributed to achieve a state of perfect equality. In distribution (the poorest and the richest) as there tends to
other words, the value of the index approximates the be relative stability in the share of income that goes to
share of total income that has to be transferred from the ‘middle’.
Economics (NET) | 527U
20/20 Ratio—It compares the ratio of the average and it identified primary health care as the key to the
income of the richest 20 per cent of the population to the attainment of the goal of “Health for All by 2000AD”.
average income of the poorest 20 per cent of the The following are excerpts from the Declaration—
population. Used by the United Nations Development ● The Conference strongly reaffirms that health,
Programme Human Development Report (called “income which is a state of complete physical, mental, and
quintile ratio”). social well-being, and not merely the absence of
disease or infirmity, is a fundamental human right
Social Sector Development and that the attainment of the highest possible level
Social sector development constitutes the edu- of health is a most important world-wide social goal
cational development, development of health and family whose realization requires the action of many other
welfare and gender development. Education, health are social and economic sectors in addition to the health
the fundamental issues to the overall development of an sector.
individual in terms of his or her capabilities, while issues ● The existing gross inequality in the health status of
related to gender development are basic parameters of the people, particularly between developed and
equitable society. Besides these, provision of safe and developing countries as well as within countries, is
clean water, sanitation, nutrition, abolition of all types of politically, socially, and economically unacceptable
discrimination against women and socially deprived and is, therefore, of common concern to all
sections of the society. countries.
Social sector development can be understood ● The people have a right and duty to participate
through following approaches— individually and collectively in the planning and
1. Human Resources Development Approach— implementation of their health care.
This approach emphasizes investment in education, ● Primary health care is essential health care based on
health and nutrition as a means of enhancing the quality practical, scientifically sound, and socially accep-
of human capital which may be defined as “the stock of table methods and technology made universally
skills and productive knowledge embodied in people”. accessible to individuals and families in the
The human capital approach attracted attention during community through their full participation and at a
the 1960s when Schultz (1961) and Becker (1962) cost that the community and country can afford to
highlighted the viewpoint that education, health and maintain at every stage of their development in the
nutrition cannot be considered merely as consumption spirit of self-reliance and self-determination. It
goods. forms an integral part both of the country's health
The expenditure on schooling, health, on-the job system, of which it is the central function and main
training, and searching for information about job focus, and of the overall social and economic
opportunities and migration constitutes an investment development of the community. It is the first level
that people make in themselves. Simultaneously, state of contact of individuals, the family, and
also makes huge investments in health and education as community with the national health system bringing
a measure of creation of a welfare state. Investment in health care as close as possible to where people live
these sectors is emphasized as a means to higher and work, and constitutes the first elements of a
productivity of the labour force and is justified on the continuing health care process.
basis of either financial rate of return (as in the case of ● An acceptable level of health for all the people of
education) or estimates emerging from production the world by the year 2000 can be attained through a
functions (as in the case of Health). fuller and better use of the world's resources, a
2. Human Development Approach—The term has considerable part of which is now spent on
been defined by the UNDP as ‘the process of enlarging armaments and military conflicts. A genuine policy
people’s choices’. The concept encompasses empower- of independence, peace, détente, and disarmament
ment, co-operation, equity in basic capabilities and could and should release additional resources that
opportunities, sustainability and security. In this could well be devoted to peaceful aims and in
approach people occupy centre stage, and measures such particular to the acceleration of social and economic
as education, health and nutrition are emphasized from development of which primary health care, as an
their intrinsic value and not for their role in enhancing essential part, should be allotted its proper share.
their basic capabilities of people. Millennium Development Goals (MDGs)
Health and Health
Health, as a component of social sector, got Health is an important component of UN’s MDGs.
prominence with the establishment of World Health The United Nations Millennium Development Goals are
Organisation (WHO) and the United Nations Children’s eight goals that all 191 UN member states have agreed
Emergency Fund (UNICEF). It further got international to try to achieve by the year 2015. The United Nations
support through ‘Alma Ata’ declaration (1978). The Millennium Declaration, signed in September 2000
Alma-Ata Declaration of 1978 emerged as a major commits world leaders to combat poverty, hunger,
milestone of the twentieth century in the field of health, disease, illiteracy, environmental degradation, and
528U | Economics (NET)
discrimination against women. The MDGs are derived 3.2 : By 2030, end preventable deaths of newborns
from this Declaration, and all have specific targets and and children under 5 years of age, with all countries
indicators. aiming to reduce neonatal mortality to at least as low as
The Eight Millennium Development Goals are : 12 per 1,000 live births and under-5 mortality to at least
1. to eradicate extreme poverty and hunger; as low as 25 per 1,000 live births.
2. to achieve universal primary education; 3.3 : By 2030, end the epidemics of AIDS, tuber-
3. to promote gender equality and empower women; culosis, malaria and neglected tropical diseases and
4. to reduce child mortality; combat hepatitis, water-borne diseases and other
5. to improve maternal health; communicable diseases.
6. to combat HIV/AIDS, malaria, and other diseases; 3.4 : By 2030, reduce by one third premature
7. to ensure environmental sustainability; and mortality from non-communicable diseases through
8. to develop a global partnership for development. prevention and treatment and promote mental health and
The MDGs are inter-dependent; all the MDG well-being.
influence health, and health influences all the MDGs. 3.5 : Strengthen the prevention and treatment of
For example, better health enables children to learn and substance abuse, including narcotic drug abuse and
adults to earn. Gender equality is essential to the harmful use of alcohol.
achievement of better health. Reducing poverty, hunger 3.6 : By 2020, halve the number of global deaths
and environmental degradation positively influences, but and injuries from road traffic accidents.
also depends on, better health.
3.7 : By 2030, ensure universal access to sexual and
Sustainable Development Goals and reproductive health-care services, including for family
Health planning, information and education, and the integration
of reproductive health into national strategies and
In September 2015, the General Assembly adopted programmes.
the 2030 Agenda for Sustainable Development that
includes 17 Sustainable Development Goals (SDGs). 3.8 : Achieve universal health coverage, including
Building on the principle of “leaving no one behind”, the financial risk protection, access to quality essential
new Agenda emphasizes a holistic approach to achieving health-care services and access to safe, effective, quality
sustainable development for all. These goals are and affordable essential medicines and vaccines for all.
following— 3.9 : By 2030, substantially reduce the number of
The 17 sustainable development goals (SDGs) to deaths and illnesses from hazardous chemicals and air,
transform our world— water and soil pollution and contamination.
GOAL 1 : No Poverty 3. (a) : Strengthen the implementation of the World
GOAL 2 : Zero Hunger Health Organization Framework Convention on
Tobacco Control in all countries, as appropriate.
GOAL 3 : Good Health and Well-being
GOAL 4 : Quality Education 3. (b) : Support the research and development of
vaccines and medicines for the communicable and non-
GOAL 5 : Gender Equality communicable diseases that primarily affect developing
GOAL 6 : Clean Water and Sanitation countries, provide access to affordable essential medi-
GOAL 7 : Affordable and Clean Energy cines and vaccines, in accordance with the Doha
GOAL 8 : Decent Work and Economic Growth Declaration on the TRIPS Agreement and Public Health,
GOAL 9 : Industry, Innovation and Infrastructure which affirms the right of developing countries to use to
the full the provisions in the Agreement on Trade-
GOAL 10 : Reduced Inequality
Related Aspects of Intellectual Property Rights
GOAL 11 : Sustainable Cities and Communities regarding flexibilities to protect public health, and, in
GOAL 12 : Responsible Consumption and Pro- particular, provide access to medicines for all.
duction 3. (c) : Substantially increase health financing and
GOAL 13 : Climate Action the recruitment, development, training and retention of
GOAL 14 : Life below Water the health workforce in developing countries, especially
GOAL 15 : Life on Land in least developed countries and small island developing
GOAL 16 : Peace and Justice Strong Institutions States.
GOAL 17 : Partnerships to achieve the Goal 3. (d) : Strengthen the capacity of all countries, in
Out of these goals, Goal 3 and Goal 6 are directly particular developing countries, for early warning, risk
related to the development of health of the people. The reduction and management of national and global health
targets under these goals are as under : risks.
Goal 3 : Targets Goal 6 : Targets
3.1 : By 2030, reduce the global maternal mortality 6.1 : By 2030, achieve universal and equitable
ratio to less than 70 per 100,000 live births. access to safe and affordable drinking water for all.
Economics (NET) | 529U
6.2 : By 2030, achieve access to adequate and From a historical perspective, the world went
equitable sanitation and hygiene for all and end open through a great expansion in education over the past two
defecation, paying special attention to the needs of centuries. This can be seen across all quantity measures.
women and girls and those in vulnerable situations. Global literacy rates have been climbing over the course
6.3 : By 2030, improve water quality by reducing of the last two centuries, mainly though increasing rates
pollution, eliminating dumping and minimizing release of enrollment in primary education. Secondary and
of hazardous chemicals and materials, halving the tertiary education have also seen drastic growth, with
proportion of untreated wastewater and substantially global average years of schooling being much higher
increasing recycling and safe reuse globally. now than a hundred years ago. Despite all these
6.4 : By 2030, substantially increase water-use worldwide improvements, some countries have been
efficiency across all sectors and ensure sustainable lagging behind, mainly in sub-Saharan Africa, where
withdrawals and supply of freshwater to address water there are still countries that have literacy rates below
scarcity and substantially reduce the number of people 50% among the youth.
suffering from water scarcity. The Evolution of Education Outcomes
6.5 : By 2030, implement integrated water resources 1. Literacy—Literacy is a key skill and a key
management at all levels, including through trans- measure of a population’s education. UNESCO
boundary cooperation as appropriate. operationalizes the measurement of literacy as the ability
6.6 : By 2020, protect and restore water-related to both read and write a short, simple statement about
ecosystems, including mountains, forests, wetlands, one's own life. Literacy rates grew constantly but rather
rivers, aquifers and lakes. slowly until the beginning of the twentieth century. And
6. (a) : By 2030, expand international cooperation the rate of growth really climbed after the middle of the
and capacity-building support to developing countries in 20th century, when the expansion of basic education
water- and sanitation-related activities and programmes, became a global priority. All countries outside Africa
including water harvesting, desalination, water effi- (with the exception of Afghanistan) have literacy rates
ciency, wastewater treatment, recycling and reuse above 50%. Despite progress in the long run, however,
technologies. large inequalities remain, notably between sub-Saharan
6. (b) : Support and strengthen the participation of Africa and the rest of the world. In Burkina Faso, Niger
local communities in improving water and sanitation and South Sudan – the African countries at the bottom of
management. the rank – literacy rates are still below 30%. In most
countries, and certainly in virtually all developing
Since each and every member country of the UN is countries, there are large generational gaps: younger
committed towards these goals, so the individual generations are progressively better educated than older
countries have designed their policies and programmes generations. This indicates that in these countries the
of health sector accordingly. literacy rate for the overall population will continue to
Education increase. Figures, from The International Institute for
Applied Systems Analysis (IIASA), suggest that rates of
Education is the corner stone of the economy. education increasing as the world develops – and by
Whole of the edifice of the socio-politico, economic, 2050, only five countries are likely to have a rate of no
cultural structure of a country rests upon it. Education education above 20%: these are Burkina Faso, Ethiopia,
helps an individual to enhance his or her capabilities. Guinea, Mali and Niger.
Collectively education develops a primitive and under 2. School Enrolment and Attendance—School
develop economy into a knowledge economy. Regarding enrollment and attendance are two important measures
the consequences of education, a growing body of of educational attainment.
empirical research suggests that better education yields ● The rate of primary school enrollment is defined as
higher individual income and contributes towards the the number of children enrolled in primary school
construction of social capital and long-term economic who belong to the age group that officially corres-
growth. Development of education has remained a top ponds to primary schooling, divided by the total
population of the same age group.
priority under the agenda of almost all the multilateral
● The rate of attendance is defined as the percentage
agencies at international level. UNESCO, a specialized of children in the age group that officially
agency of the United Nations chartered several plans for corresponds to primary schooling who are reported
the development of education . as attending primary school.
Education is widely accepted to be a fundamental The growth in access to primary education across
resource, both for individuals and societies. Indeed, in developing countries was achieved through an important
most countries basic education is nowadays perceived increase in government expenditure on education in
not only as a right, but also as a duty – governments are these countries. In the majority of developing countries,
typically expected to ensure access to basic education, net enrollment rates are higher than attendance rates.
while citizens are often required by law to attain This reflects the fact that many children, who are
education up to a certain basic level. officially enrolled, do not regularly attend school.
530U | Economics (NET)
For 2014 , at the primary school age the number of 6. Learning Outcomes—Learning outcomes tend
girls that are out of school is higher than for boys. At the to be much higher in richer countries; but differences
secondary school age the reverse is true, more boys than across countries are very large, even among countries
girls are out of secondary school. with similar income per capita. Majority of countries
3. Years of Schooling—The average number of have seen improvements in learning outcomes over the
years spent in school is another common measure of a last couple of decades. This is a great accomplishment it
population's education level. It is a helpful measure, shows that policies matter and learning outcomes can,
because it allows aggregation of attainment across and often do improve.
education levels. This allows an analysis of the 'stock of The Consequences of Education
human capital' that a population has at any given point in
time. Education is a valuable investment, both indivi-
dually and collectively. Here we analyse available
Average, or mean years of schooling of a evidence of the private (i.e., individual) and social (i.e.,
population, is typically calculated from data on (i) the collective) returns to education.
distribution of the population by age group and highest The most common way to measure the private
level of education attained in a given year; and (ii) the returns to education is to study how attainment improves
official duration of each level of education. individual labor market outcomes – usually by attempt-
UNESCO data suggests that the average number ing to measure the effect of education on wages.
of years spent in school has gone up around the world. Regarding social returns, the most common approach is
Early-industrialized countries pioneered the expansion to measure the effect of education on pro-social
of education in the 19th century, but this process became behaviour (e.g. volunteering, political participation,
a global phenomenon after the second World War.The interpersonal trust) and economic growth.
experience of some countries, such as South Korea, ● Higher the level of education, the greater the relative
shows how remarkably quickly educational attainment earnings.
can increase. ● The countries with the greatest returns to tertiary
The rise in mean years of schooling is the result of education (Brazil, Chile and Colombia) are also
increased appreciation of the benefits of education to the those where tertiary education is less prevalent
individual and society, as well as and increased among the adult population. This is indicative of the
government provision. There has been a continuous demand-and-supply dynamics that contribute to
increase in average years of schooling worldwide : as the determine wage differentials across different
share of the uneducated population fell over time, the countries.
concentration at the lower level became less pronounced. ● For both genders, at any given age, individuals with
4. Gender Inequalities in Education—Since 1950 more education perceive higher wages.
there has generally been a strong upward trend in the ● Many empirical estimates suggest that the incre-
gender ratios across all world regions, which indicates mental benefit from additional education grows with
that the inequality between men and women in access to experience : the differences in wages between
education has been declining. In fact, Latin America and people with varying degrees of education become
Eastern Europe caught up with the group of 'advanced larger as they advance in their careers.
economies' in the 1980s, and the gender gaps in these
regions have already been closed almost completely Social Returns to Education
(i.e., the gender ratios approximate the 100% benchmark ● Adults with higher qualifications are more likely to
for education gender parity). Gender gap in primary report desirable social outcomes, including good or
education as well as upper primary education has almost excellent health, participation in volunteer activities,
been bridged in India. In the period 1960-2010, interpersonal trust, and political efficacy.
education inequality went down every year, for all age ● A long-standing theory in political science stipulates
groups and in all world regions. that a country's level of education attainment is a
5. Educational Attainment by Levels—The highest key determinant of the emergence and sustainability
level of education that individuals complete is another of democratic political institutions, both because it
common measure of educational attainment. This promotes political participation at the individual
measure is used as an input to calculating years of level, and because it fosters a collective sense of
schooling, and allows clear comparisons across levels of civic duty.
education. Education at higher levels, mainly secondary
● Countries with higher educational attainment in the
and tertiary, is becoming increasingly important around
past are more likely to have democratic political
the world, as the number of people without education
regimes today.
goes down. The world will be inhabited by more and
more educated people : while in 1970 there was only ● Women's education leads to lower child mortality
around 700 million people in the world with secondary because it contributes towards healthier habits and
or post-secondary education, by 2100 this figure is choices, including child spacing.
predicted to be 10 times larger. ● Education outcomes predict economic growth.
Economics (NET) | 531U
Recent Initiatives For the Development of education for sustainable development and
Education sustainable lifestyles, human rights, gender equality,
promotion of a culture of peace and non-violence,
1. Millennium Development Goals, adopted by the global citizenship and appreciation of cultural
United Nations in 2000, gave new impetus to diversity and of culture’s contribution to sustainable
educational development world wide. Every member development.
country was committed to attain various targets of MDG ● 4. (a) : Build and upgrade education facilities that
2- to achieve universal primary education.” To ensure are child, disability and gender sensitive and provide
that children universally – including both boys and girls safe, non-violent, inclusive and effective learning
– will be able to complete a full course of primary environments for all.
education by 2015” was the target of MDG goal 2.
● 4. (b) : By 2020, substantially expand globally the
Some of the achievements under MDG 2 are
number o f scholarships available to developing
following—
countries, in particular least developed countries,
● An increase in the primary school net enrolment in small island developing States and African
the developing world from 83 per cent in 2000 to 91 countries, for enrolment in higher education,
per cent in 2015. including vocational training and information and
● Nearly 50 per cent decrease in the number of out-of- communications technology, technical, engineering
school children or primary school age globally, and scientific programmes, in developed countries
from 100 million in 2000 to around 57 million in and other developing countries.
2015. ● 4. (c) : By 2030, substantially increase the supply of
● Remarkable improvement in primary education in qualified teachers, including through international
Sub-Saharan Africa since the establishment of the cooperation for teacher training in developing
MDGs. The net enrolment rate increased from 8 per countries, especially least developed countries and
cent in the period between 1990 and 2000 to 20 per small island developing States.
cent in the period between 2000 and 2015.
● Global increase in the literacy rate among youth Gender
aged 15 – 24 from 83 per cent in 1990 to 91 per cent Women constitute about half of the population of
in 2015. At the same time, the gap between men and the world. Despite the strong wave of fundamental rights
women has lessened. based democracy, around the world, a lot of women still
2. Sustainable Development Goals : 17 SDGs face discrimination in every walk of life–social,
have been Adopted by UN Assembly in the Year 2015. economic, political, religious- in majority of the
GOAL 4: Quality Education has following targets : countries. Their labour and dignity exploited. They are
● 4.1 : By 2030, ensure that all girls and boys treated as the second grade citizens. More than eighty
complete free, equitable and quality primary and per cent of their labour is unpaid and unaccounted.
secondary education leading to relevant and Democratic setup of the government recognizes the
effective learning outcomes. human rights of the women across the world. Various
● 4.2 : By 2030, ensure that all girls and boys have policies and programmes of gender development
access to quality early childhood development, care chartered out on international forums, subsequently those
and pre-primary education so that they are ready for were adopted and implemented by the individual
primary education. countries. Issues related to gender development hovers
● 4.3 : By 2030, ensure equal access for all women around the following key areas :
and men to affordable and quality technical, voca- ● Gender Equality—equality before law, equality of
tional and tertiary education, including university. opportunities, equality in participation in decision
● 4.4 : By 2030, substantially increase the number of making process, equality in social and religious
youth and adults who have relevant skills, including matters, equality in rights on the property etc.
technical and vocational skills, for employment, ● Gender Development—Capacity building mea-
decent jobs and entrepreneurship. sures—health, education, and skill development etc.
● 4.5 : By 2030, eliminate gender disparities in ● Gender Empowerment—Social empowerment,
education and ensure equal access to all levels of economic empowerment, political empowerment,
education and vocational training for the vulnerable, religious empowerment, cultural empowerment etc.
including persons with disabilities, indigenous
peoples and children in vulnerable situations. Fourth World Conference on Women
● 4.6 : By 2030, ensure that all youth and a substantial 1995
proportion of adults, both men and women, achieve The United Nations has organized four world
literacy and numeracy. conferences on women. These took place in Mexico City
● 4.7 : By 2030, ensure that all learners acquire the (1975), Copenhagen (1980), Nairobi (1985) and Beijing
knowledge and skills needed to promote sustainable (1995). The last was followed by a series of five-year
development, including, among others, through reviews.
532U | Economics (NET)
The 1995 Fourth World Conference on Women in on population and development in Cairo(1994) and
Beijing marked a significant turning point for the global on social development in Copenhagen (1995) with
agenda for gender equality. The Beijing Declaration and the objective of achieving equality, development
the Platform for Action, adopted unanimously by 189 and peace;
countries, is an agenda for women’s empowerment and 4. Achieve the full and effective implementation of the
considered the key global policy document on gender Nairobi Forward-looking Strategies for the Advance-
equality. It sets strategic objectives and actions for the ment of Women;
advancement of women and the achievement of gender 5. The empowerment and advancement of women,
equality in 12 critical areas of concern : including the right to freedom of thought, con-
● Women and poverty science, religion and belief, thus contributing to the
● Education and training of women moral, ethical, spiritual and intellectual needs of
● Women and health women and men, individually or in community with
others and thereby guaranteeing them the possibility
● Violence against women
of realizing their full potential in society and
● Women and armed conflict shaping their lives in accordance with their own
● Women and the economy aspirations.
● Women in power and decision-making Participating Countries were convinced that—
● Institutional mechanism for the advancement of 6. Women's empowerment and their full participation
women on the basis of equality in all spheres of society,
● Human rights of women including participation in the decision-making
● Women and the media process and access to power, are fundamental for
● Women and the environment the achievement of equality, development and
● The girl-child
peace;
The Beijing conference built on political agreements 7. Women's rights are human rights;
reached at the three previous global conferences on 8. Equal rights, opportunities and access to resources,
women, and consolidated five decades of legal advances equal sharing of responsibilities for the family by
aimed at securing the equality of women with men in men and women, and a harmonious partnership
law and in practice. More than 17,000 participants between them are critical to their well-being and
attended, including 6,000 government delegates at the that of their families as well as to the consolidation
negotiations, along with more than 4,000 accredited of democracy;
NGO representatives, a host of international civil 9. Eradication of poverty based on sustained economic
servants and around 4,000 media representatives. A growth, social development, environmental pro-
parallel NGO Forum held in Huairou near Beijing also tection and social justice requires the involvement
drew some 30,000 participants. of women in economic and social development,
equal opportunities and the full and equal partici-
Beijing Declaration pation of women and men as agents and benefi-
Participating countries declared that they were ciaries of people-centred sustainable development;
committed towards— 10. The explicit recognition and reaffirmation of the
1. The equal rights and inherent human dignity of right of all women to control all aspects of their
women and men and other purposes and principles health, in particular their own fertility, is basic to
enshrined in the Charter of the United Nations, to their empowerment;
the Universal Declaration of Human Rights and 11. Local, national, regional and global peace is
other international human rights instruments, in attainable and is inextricably linked with the
particular the Convention on the Elimination of All advancement of women, who are a fundamental
Forms of Discrimination against Women and the force for leadership, conflict resolution and the
Convention on the Rights of the Child, as well as promotion of lasting peace at all levels;
the Declaration on the Elimination of Violence 12. It is essential to design, implement and monitor,
against Women and the Declaration on the Right to with the full participation of women, effective,
Development; efficient and mutually reinforcing gender-sensitive
2. Ensure the full implementation of the human rights policies and programmes, including development
of women and of the girl child as an inalienable, policies and programmes, at all levels that will
integral and indivisible part of all human rights and foster the empowerment and advancement of
fundamental freedoms; women;
3. Build on consensus and progress made at previous 13. The participation and contribution of all actors of
United Nations conferences and summits - on civil society, particularly women's groups and
women in Nairobi( 1985), on children in New York networks and other non-governmental organizations
(1990), on environment and development in Rio de and community-based organizations, with full
Janeiro(1992), on human rights in Vienna (1993), respect for their autonomy, in cooperation with
Economics (NET) | 533U
Governments, are important to the effective 25. Intensify efforts to ensure equal enjoyment of all
implementation and follow-up of the Platform for human rights and fundamental freedoms for all
Action; women and girls who face multiple barriers to their
14. The implementation of the Platform for Action empowerment and advancement because of such
requires commitment from Governments and the factors as their race, age, language, ethnicity, cul-
international community. By making national and ture, religion, or disability, or because they are
international commitments for action, including indigenous people;
those made at the Conference, Governments and the 26. Ensure respect for international law, including
international community recognizes the need to take humanitarian law, in order to protect women and
priority action for the empowerment and advance- girls in particular;
ment of women. 27. Develop the fullest potential of girls and women of
Participating Countries were determined to— all ages, ensure their full and equal participation in
15. Intensify efforts and actions to achieve the goals of building a better world for all and enhance their role
the Nairobi Forward-looking Strategies for the in the development process.
Advancement of Women by the end of this century; 28. Ensure women's equal access to economic resources,
including land, credit, science and technology,
16. Ensure the full enjoyment by women and the girl
vocational training, information, communication
child of all human rights and fundamental freedoms
and markets, as a means to further the advancement
and take effective action against violations of these
and empowerment of women and girls, including
rights and freedoms;
through the enhancement of their capacities to enjoy
17. Take all necessary measures to eliminate all forms the benefits of equal access to these resources, inter-
of discrimination against women and the girl child alia, by means of international cooperation;
and remove all obstacles to gender equality and the 29. Ensure the success of the Platform for Action,
advancement and empowerment of women; which will require a strong commitment on the part
18. Encourage men to participate fully in all actions of Governments, international organizations and
towards equality; institutions at all levels. We are deeply convinced
19. Promote women's economic independence, includ- that economic development, social development and
ing employment, and eradicate the persistent and environmental protection are interdependent and
increasing burden of poverty on women by address- mutually reinforcing components of sustainable
ing the structural causes of poverty through changes development, which is the framework for our efforts
uneconomic, ensuring equal access for all women, to achieve a higher quality of life for all people.
including those in rural areas, as vital development Equitable social development that recognizes
agents, to productive resources, opportunities and empowering the poor, particularly women living in
public services; poverty, to utilize environmental resources
20. Promote people-centred sustainable development, sustainably is a necessary foundation for sustainable
including sustained economic growth, through the development. We also recognize that broad-based
provision of basic education, life-long education, and sustained economic growth in the context of
literacy and training, and primary health care for sustainable development is necessary to sustain
girls and women; social development and social justice. The success
of the Platform for Action will also require adequate
21. Take positive steps to ensure peace for the
mobilization of resources at the national and
advancement of women and, recognizing the international levels as well as new and additional
leading role that women have played in the peace resources to the developing countries from all
movement, work actively towards general and available funding mechanisms, including
complete disarmament under strict and effective multilateral, bilateral and private sources for the
international control, and support negotiations on advancement of women; financial resources to
the conclusion, without delay, of a universal and strengthen the capacity of national, sub regional,
multilaterally and effectively verifiable compre- regional and international institutions; a commit-
hensive nuclear-test-ban treaty which contributes to ment to equal rights, equal responsibilities and equal
nuclear disarmament and the prevention of the opportunities and to the equal participation of
proliferation of nuclear weapons in all its aspects; women and men in all national, regional and
22. Prevent and eliminate all forms of violence against international bodies and policy-making processes;
women and girls; and the establishment or strengthening of mecha-
23. Ensure equal access to and equal treatment of nisms at all levels for accountability to the world's
women and men in education and health care and women;
enhance women's sexual and reproductive health as 30. Ensure also the success of the Platform for Action
well as education; in countries with economies in transition, which
24. Promote and protect all human rights of women and will require continued international cooperation and
girls; assistance.
534U | Economics (NET)
Millennium Development Goals and ● Ensure universal access to sexual and reproductive
Gender Development health and reproductive rights as agreed in
accordance with the Programme of Action of the
Millennium Development Goals, as adopted by the International Conference on Population and Deve-
United Nations General Assembly in 2000, focused on lopment and the Beijing Platform for Action and the
gender development through MDG 3-“ to promote outcome documents of their review conferences.
gender equality and empower women”. However , the
● Undertake reforms to give women equal rights to
following other MDGs were also inter-alia related to
gender development— economic resources, as well as access to ownership
and control over land and other forms of property,
MDG 1 : to eradicate extreme poverty and hunger; financial services, inheritance and natural resources,
MDG 2 : to achieve universal primary education; in accordance with national laws.
MDG 4 : to reduce child mortality; ● Enhance the use of enabling technology, in parti-
MDG 5 : to improve maternal health; cular information and communications technology,
MDG 6 : to combat HIV/AIDS, malaria, and other to promote the empowerment of women.
diseases; ● Adopt and strengthen sound policies and enfor-
MDGs have shown remarkable performance in the ceable legislation for the promotion of gender
following areas : equality and the empowerment of all women and
● More than 1 billion people have been lifted out of girls at all levels.
extreme poverty (since 1990)
Progress Of Goal 5 In 2018
● Child mortality dropped by more than half (since
1990) While some forms of discrimination against women
and girls are diminishing, gender inequality continues to
● The number of out of school children has dropped
hold women back and deprives them of basic rights and
by more than half (since 1990)
opportunities. Empowering women requires addressing
● HIV/AIDS infections fell by almost 40 per cent structural issues such as unfair social norms and
(since 2000) attitudes as well as developing progressive legal
Sustainable Development Goals frameworks that promote equality between women and
men.
The legacy and achievements of the MDGs provide
● Based on 2005–2016 data from 56 countries, 20 per
us with valuable lessons and experience to begin work
on the new goals. But for millions of people around the cent of adolescent girls aged 15 to 19 who have ever
world the job remains unfinished. We need to go the last been in a sexual relationship experienced physical
mile on ending hunger, achieving full gender equality, and/or sexual violence by an intimate partner in the
improving health services and getting every child into 12 months prior to the survey.
school beyond primary. The SDGs are also an urgent ● Globally, around 2017, an estimated 21 per cent of
call to shift the world onto a more sustainable path. women between 20 and 24 years of age reported
SDG GOAL 5: is specifically related to “Gender that they were married or in an informal union
Equality”. Targets of this goal are following— before age 18. This means that an estimated 650
● End all forms of discrimination against all women million girls and women today were married in
and girls everywhere. childhood. Rates of child marriage have continued
to decline around the world. In Southern Asia, a
● Eliminate all forms of violence against all women
girl’s risk of marrying in childhood has dropped by
and girls in the public and private spheres, including over 40 per cent since around 2000.
trafficking and sexual and other types of exploi-
tation. ● Around 2017, one in three girls aged 15 to 19 had
● Eliminate all harmful practices, such as child, early been subjected to female genital mutilation in the 30
and forced marriage and female genital mutilation. countries where the practice is concentrated,
compared to nearly one in two around 2000.
● Recognize and value unpaid care and domestic
work through the provision of public services, ● Based on data between 2000 and 2016 from about
infrastructure and social protection policies and the 90 countries, women spend roughly three times as
promotion of shared responsibility within the many hours in unpaid domestic and care work as
household and the family as nationally appropriate. men.
● Ensure women’s full and effective participation and ● Globally, the percentage of women in single or
equal opportunities for leadership at all levels of lower houses of national Parliament has increased
decisionmaking in political, economic and public from 19 per cent in 2010 to around 23 per cent in
life. 2018.
Economics (NET) | 535U
Objective Questions
1. As economic growth takes place, inequalities of 9. Who among the following held views on economic
product per worker— development similar to H. Leibenstein ?
(A) Are aggravated (A) A.O. Hirschman (B) W.A. Lewis
(B) Are reduced (C) R.R. Nelson (D) W.W. Rostow
(C) Remain unchanged 10. Agriculture has an important role to play in the
(D) None of the above development process because—
2. The larger the proportion of capital formation in a (A) A balanced approach to growth is necessary
country, means the rate of growth will be— (B) The vast majority of an underdeveloped country
(A) Higher (B) Lower is engaged in agriculture
(C) Constant (D) None of these (C) Agriculture may be a major bottleneck in the
process of development
3. All underdeveloped countries are— (D) All of the above
(A) Not developing at all
11. In Rostow’s theory, the drive to maturity—
(B) Developing but slowly
(A) Starts the development process
(C) Developing at different rate
(B) Completes the development process
(D) Receding backwards
(C) Comes before the take-off
4. If tax considerations are added to Kuznets findings,
the spread in income distribution between rich and (D) Follows the take-off
poor becomes— 12. Rosenstein-Rodan propounded which of the follow-
(A) Greater in less developing countries than in ing indivisibilities ?
developed countries (A) Lumpiness of capital
(B) Greater in developed countries than in less (B) Complementarity of demand
developed countries (C) Kink in the supply of savings
(C) Meaningless (D) All of the above
(D) Unmeasurable 13. The book “The Theory of Economic Growth” was
5. The underdeveloped countries of the world are— written by—
(A) Homogeneous (A) Maddison (B) A. Lewis
(B) Heterogeneous (C) Schumpeter (D) J.R. Hicks
(C) Homogeneous in a broad sense only but MPK
heterogeneous in many respects 14. A technical change is neutral if remains
MPL
(D) All of the above K
unchanged at constant ratio—
6. According to H. Leibenstein, the “growth agents” L
in the process of economic development include (A) Harrod (B) Hicks
the— (C) Solow (D) Kaldor
(i) Entrepreneur (ii) Investor
15. The term ‘Economic growth’ refers to the prob-
(iii) Saver (iv) Innovator lems of—
(A) (i) and (iv) only (B) (ii) and (iii) only (A) Developed countries
(C) (i) and (iii) only (D) All of these (B) Underdeveloped countries
7. The share of the highest 20 per cent in national (C) Democratic countries
income is— (D) Socialist countries
(A) Close to 90 (B) Over 75
(C) Between 40 and 75 (D) Less than 35 16. Which one of the following criteria can be used to
judge or compare the level of a country’s develop-
8. Neglect of agriculture in the development process ment ?
will lead to— (A) Percentage of national income originating in
(A) Insufficient savings agriculture
(B) Shortages of foreign exchange (B) Percentage of GNP connected with trade
(C) Lower levels of production (C) Per capita energy consumption
(D) Severe bottlenecks in overall development (D) All of the above
536U | Economics (NET)
17. The generally accepted index of a country’s (B) Replacing worn-out durables quickly before
development is— incomes fall further
(A) More and more industries (C) Reducing the fraction of consumption devoted
(B) Higher standard of living to durable goods
(C) Higher real per capita income (D) Reducing purchases of non-durables and
(D) Improved means of transport services more quickly than purchases of
18. Concept of disembodied technical change is durables
associated with— 24. The Physical Quality of Life Index (PQLI) is based
I. Abramovitz II. Kaldor on—
III. Kendrick IV. Solow (A) Percentage of literacy, infant mortality and life
(A) I and II (B) III and IV expectancy
(C) I, III and IV (D) II, III and IV (B) Adequate supply of food, water shelter and
19. The Hicks-Kaldor-Scitovsky welfare criterion states health services
that— (C) Provision for sanitation, education for all
welfare measures
(A) If gainers could potentially bribe the losers
then the change is desirable (D) All of the above
(B) If the gainers could not bribe the losers but the 25. In the dual economy, as viewed by Lewis, the
state could, then the change is desirable capitalist sector absorbs the surplus labour provided
(C) If the gainers could potentially bribe the losers the—
and the prospective losers could not profitably (A) Capitalist surplus is generated
bribe the gainers then the change is desirable (B) Capitalist surplus is generated and reinvested
(D) Bribery is an evil and, therefore, any change (C) Subsistence sector has an elastic labour supply,
based on bribery is socially undesirable the capitalist surplus is generated and reinvested
20. The hypothesis that the degree of inequality of (D) The subsistence sector has an inelastic labour
income increases at the initial stages and declines at supply
the later stages in the development history of 26. The basic principle emphasised by Harrod and
nations has been advanced by— Domar and incorporated in all modern growth
(A) R.F. Harrod (B) Simon Kuznets theories is the—
(C) J.R. Hicks (D) T.W. Schultz (A) Dual effect of net investment
(B) Capacity effect of net investment
21. In Keynes’ General Theory, investment and savings
are brought to equality primarily through changes in (C) Saving effect a net investment
the— (D) Crowding out effect of net investment
(A) Rate of Interest 27. In the early stages of planning, industrialisation is
(B) Income velocity of money weighted in favour of consumer goods industries
(C) National Income rather than capital goods industries. This hypothesis
was advocated by—
(D) Level of prices
(A) Chenery (B) W.G. Hoffmann
22. Which of the following are true about disguised (c ) Kuznets (D) A. Gerschenkron
unemployment ?
28. An underdeveloped economy is generally charac-
I. It represents potential savings.
terised by a—
II. The marginal productivity of labour is zero or (A) High ratio of commercial farming to sub-
extremely low. sistence farming
III. It is due to the existence of joint family system. (B) High ratio of industrial output to total output
IV. It is confined to the rural areas. (C) High utilisation of existing capital in the
Select the correct answer using the codes given economy
below— (D) Coexistence of under-utilised labour with
Codes : unexploited national and other resources
(A) I, II, III and IV (B) II and IV 29. Which one of the following statements correctly
(C) III and IV (D) I, II and III defines the term Natural Rate of Growth ?
23. During a recession, consumers typically react to (A) It is the minimum rate at which output can be
falling incomes by— advanced with full employment of labour
(A) Increasing the fraction of consumption devoted (B) It is the natural rate at which output can be
to durable goods advanced with full employment of labour
Economics (NET) | 537U
(C) It is the maximum rate at which output can be (C) Diversion of savings to productive uses
advanced with full employment of labour (D) All of the above
(D) It is the actual rate at which output can be 36. In Rostow’s theory the ‘Drive to maturity’—
advanced with full employment of labour
(A) Starts the development process
30. In the Lewis model of economic development, the (B) Completes the development process
capitalist sector generates and reinvests surplus and,
(C) Comes before the take-off
in turn, absorbs labour withdrawn from the
subsistence sector. The process continues till— (D) Follows the take-off
(A) MPL In the capitalist sector is greater than 0 37. The process of acquiring and increasing the number
(B) MPL in the capitalist sector is less than MPL in of persons who have the skills in education and
the subsistence sector experience which are critical for the economic and
the political development of a country is known
(C) MPL in the capitalist sector is greater than wage
as—
rate in that sector and MPL in the subsistence
sector is now positive (A) Capital formation
(D) MPL = APL in the capitalist sector (B) Human capital formation
(C) Both (A) and (B)
31. Consider the following statements :
(D) None of the above
According to Nurkse disguised unemployment is
a source of capital formation in an underdeveloped 38. Which of the following factors helps human capital
economy, if all unproductive workers are— formation ?
I. Maintained by productive workers. (A) Promotion of education
II. Provided assets through loans. (B) Promotion of health services
III. Mobilised on works immediately raising (C) Health and adequate diet promotion
productivity.
(D) All of the above
Of the above statements—
(A) I, II and III are correct 39. According to India’s planning commission an
underdeveloped country is one which—
(B) I and II are correct
(A) Has good potential prospects for using more
(C) I and III are correct capital or labour, to support its present popula-
(D) II and III are correct tion at higher standard of living
32. Besides poverty, developing economies have many (B) Has low per capita real income when compared
other common characteristics like : with the per capita real income of the USA,
(A) Percentage of their population engaged in Canada, Australia and Western Europe
agriculture is generally very high (C) Is characterised by the co-existence of
(B) Technological dualism prevails unutilised or underutilised manpower on the
(C) The capital-labour ratio is low one hand and of unexploited natural resources
on the other
(D) All of the above
(D) Those which compared to the advanced
33. A backward poor country faces vicious circle in countries are under-equipped with capital in
relation to— relation to their population and natural
(A) Population growth resources
(B) Social backwardness 40. Which theory emphasises that underdeveloped
(C) Supply of and demand for capital countries require large amounts of investment to
(D) All of the above break the shackles of backwardness and launch up
34. In which period the forces of economic progress economic development ?
expand and come to dominate the society ? (A) Big push theory
(A) The drive to maturity period (B) Theory of balanced growths
(B) The high mass consumption stage (C) Theory of unbalanced growth
(C) The take-off stage (D) None of the above
(D) The preconditions of take-off period
41. The originator of ‘Big push theory’ was—
35. A country can meet its deficiency of capital (A) Prof. Arthur Lewis
through— (B) P.N. Rosenstein Rodan
(A) Internal savings (C) Ragnar Nurkse
(B) Foreign capital (D) Prof. Hirschman
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42. The basic rational of the theory of ‘big push’ is 50. Technological dualism means—
based up on the idea of— (A) Use of different production functions in the
(A) Internal economies advanced and traditional sectors in UDCs
(B) External economies (B) Use of different production functions in the
(C) Size of population advanced sector in UDCs
(C) Prevalence of different technologies only in the
(D) All of the above
agricultural sector in UDCs
43. The balanced growth theory sees the primary cause (D) Use of different production functions only in
of underdevelopment is the— industrial sector in UDCs
(A) Small size of the market
51. Social dualism implies—
(B) Foreign domination
(A) Fatalism, resignation and superstition in
(C) Low level of technology traditional societies, adventure and rational-
(D) Lack of savings ity in the small western sector
44. Prof. Hirschman and other economists like him (B) Low wages in eastern and high wages in
plead for growth— western countries
(A) Industrial (B) Unbalanced (C) Existence of an advanced imported western
(C) Agricultural (D) Balanced system and indigenous precapitalist agricultural
system
45. Who is nicknamed as the American Keynes ? (D) All of the above
(A) Marx (B) Hicks
52. ‘Trickle-down’ strategy implies—
(C) Marshall (D) Hansen
(A) Reduction in the income of the upper class by
46. Schumpeterian financial dualism refers to—
deliberate distribution
(A) the existence of different rates of interest in the
(B) Higher GNP taking care of poverty
private money and capital markets
(C) Direct achievement of better nourishment,
(B) the existence of difference interest rates in
health, education etc., instead of growth of
unorganised money markets in UDCs
GNP first
(C) the existence of both money market and capital
(D) None of the above
market
(D) the existence of different interest rates on the 53. Joan Robinson’s growth model deals with—
organised and unorganised money and capital I. Desired growth rate
markets in LDCs II. Possible growth rate
47. Which one of the following is not correct regarding III. Natural growth rate
the assumptions of Harrod-Domar model ? IV. Warranted growth rate
(A) Initially there is full employment level of Codes :
income (A) I and III (B) II and IV
(B) There is absence of government (C) I and II (D) III and IV
(C) The economy is an open economy
(D) There are no lags in adjustment between 54. A country’s rate of growth is determined by—
investment and creation of productive capacity (A) The average propensity to save
48. Financial dualism refers to— (B) The law of comparative costs
(A) The existence of short-run and long-run (C) The interaction of supply and demand
financial markets (D) The rate of capital accumulation
(B) The existence of different interest rates in 55. The important feature of modern economic growth
unorganised money market in UDCs has been—
(C) The existence of both share market and bond (A) Increasing use of modern scientific Knowledge
market
(B) Increased productivity per unit of labour Input
(D) The existence of different interest rates on the
organised and unorganised money and capital (C) Substantial rise in product per capita
markets in LDCs (D) All of the above
49. According to the theory of social dualism, goods 56. Capital-output ratio—
valued on the basis of— (A) Is an active agent of growth
(A) Value in exchange (B) Is the most important determinant of growth
(B) Their prestige value rate
(C) Value in use (C) Is one of the important determinants of growth
(D) Both value in use and value in exchange (D) Is not at all relevant for growth rate
Economics (NET) | 539U
57. Economic development may be defined as a process 64. Investment in education has—
whereby the real per capita income of a country (A) Future consumption component
increases— (B) Future earnings component
(A) Subject to the condition that the number below (C) Both (A) and (B)
an absolute poverty line does not increase (D) Future savings components
(B) Over a long period of time 65. As economic growth takes place inequalities of
(C) Subject to the condition that the distribution of product per worker—
income does not become more unequal (A) Are aggravated
(D) All of the above (B) Are reduced
58. The economy will face depression if the— (C) Remain unchanged
(A) Natural rate of growth is higher than warranted (D) None of the above
rate of growth 66. Scientific knowledge has the following sequence.
(B) Actual rate of growth is higher than the Which of the following is correct ?
warranted rate of growth
(A) Discovery, innovation, improvements, inven-
(C) Warranted rate of growth is higher than the tions and spread
natural rate of growth
(B) Discovery, invention, innovation, improvement
(D) The actual rate of growth is higher than the
and spread
natural rate of growth
(C) Innovation, discovery, improvement and spread
59. Economic development can be defined simply as— (D) Innovation, improvement, spread, discovery
(A) An increase in the national income from one and innovation
year to another
67. All underdeveloped countries are—
(B) Increase in the real investment over many years
(A) Not developing at all
(C) An increase in real per capita income over an (B) Developing but slowly
extended period of time
(C) Developing at different rate
(D) National income keeping up with population
(D) Receding backwards
increases
68. Bowley’s law refer to—
60. A country’s rate of growth is determined by—
(A) Constancy of wage share
(A) The average propensity to save
(B) Technical progress
(B) The marginal propensity to save and capital-
output ratio (C) Elasticity substitute on
(C) The interaction of supply and demand (D) Population growth
(D) The law of comparative costs 69. Who among of the following has dealt economy
model of under-developing ?
61. In the process of economic growth, the rates,
duration of phases and the extent of acceleration and (A) Harrod (B) Ricardo
retardation have— (C) Domar (D) Jorgenson
(A) Been identical in all countries 70. A country’s rate of growth is determined by—
(B) Been different in different countries (A) The interaction of supply and demand
(C) Shown on similarity whatsoever (B) The average propensity to save
(D) None of the above (C) Law of comparative costs
(D) The choice it makes between consumption and
62. The economic growth of developed nations has investment
been associated with—
71. A capitalist economy adheres to the technique of
(A) Long-term rise in number of man hours
planning by—
(B) Short term rise in the income per capita
(A) Inducement (B) Direction
(C) Both (A) and (B)
(C) Central authority (D) None of these
(D) Long term decline in the number of persons in
tertiary sector 72. Assertion (A) : To Marx, it is surplus labour that
lead to capital accumulation.
63. According to Hirschman, development via SOC
shortage is— Reason (R) : The difference between actual labour
and subsistence labour that a labourer puts in for
(A) A disorderly sequence which he receives nothing is surplus labour.
(B) Permissive Codes :
(C) A cumulative sequence (A) (A) is correct, but (R) is not the correct reason
(D) A orderly sequence for (A)
540U | Economics (NET)
(B) (A) is correct and (R) is incorrect 81. Developing countries rely on industry—
(C) Both (A) and (R) are correct (A) To grow rapidly
(D) Both (A) and (R) are incorrect (B) To train labour and absorb it into high paying
73. Who among the following is not associated with the jobs
balanced growth theory ? (C) For reasons of security and national pride
(A) Nurkse (B) Rodan (D) For all of the above
(C) P. Streeten (D) Lewis
82. Khan was among the first to include in his model—
74. India will be world’s youngest country by the year
………. with an average age 29 years. (A) The importance of exports for a developing
country
(A) 2020 (B) 2025
(B) An estimate of the difference between private
(C) 2030 (D) 2035 and social costs and benefits
75. Which one of the following statements is incorrect (C) The marginal per capita reinvestment quota
about average age in various countries by 2020 ?
(D) None of the above
(A) The average age in USA is expected to be 40
years 83. The ‘critical minimum effort’ theory is due to—
(B) The average age in Europe is expected to be (A) H. Leibenstein (B) Rosenstein-Rodan
46 years (C) W.A. Lewis (D) J.H. Boeke
(C) The average age in Japan is expected to be 47 84. The economist who stressed the role of the
years entrepreneur in development was—
(D) The average age in China is expected to be (A) Hirschman (B) Nurkse
42 years
(C) Rosenstein-Rodan (D) Schumpeter
76. Surplus labour theory assumes that—
85. Galenson and Leibenstein advocate investment
(A) Less developed countries are overpopulated
projects that are—
(B) Labour contributes nothing to output in less
developed countries (A) Labour-intensive because they will help the
working class
(C) The marginal product of labour is close to zero
in less developed countries (B) Capital-intensive because this is the only way
the economy can become competitive inter-
(D) There is too much unemployment in less
nationally
developed countries
(C) Labour-intensive because they will stimulate
77. According to Lewis the subsistence sector is that consumer demand
part of the economy which— (D) Capital-intensive because they will lead to
(A) Makes use of reproducible capital greater saving and investment in the future
(B) Does not make use of reproducible capital 86. Which one of the following is not consistent with
(C) Employs labour for wages in mines, factories, Rosenstein-Rodan’s theory of ‘big push’?
and plantations for earning profits (A) It is primarily a theory of investment
(D) None of the above (B) It is concerned with imported market in under-
78. In the underdeveloped countries death rate has developed countries
sharply declined due to— (C) International trade cannot itself obviate the
(A) Increase in the per capita income need for ‘big-push’ altogether
(B) Increase in the level of education (D) It highlights the efficiency of the price system
to signal out the desirable direction of invest-
(C) Improvement in the medical facilities ment
(D) Increase in the people's concern for their life
87. Social marginal productivity theory—
79. The famous article “Economic Development with (A) Overcomes all of the weaknesses of marginal
Unlimited Supplies of Labour” published in the productivity theory
Manchester School in 1954 is due to—
(B) Is not different from marginal productivity
(A) W.A. Lewis (B) J.H. Boeke theory
(C) W.W. Rostow (D) R. Nurkse (C) Accounts for all the interconnections in the
80. Development is impossible without— economies including externalities
(A) Incentive to profit (B) Foreign aid (D) Is subjective and does not supplant the need for
(C) Domestic savings (D) Inflation linear programming and input-output analysis
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88. Which type of indivisibilities did Rosenstein- 95. According to H. Leibenstein—
Rodan distinguishes in his theory of economic (A) The underdeveloped countries are poor because
development ? they have a low capital to save and invest
(i) Lumpiness of capital, especially in the (B) The population upsurge is the main obstacle to
creation of social overhead capital. the economic growth of underdeveloped
countries
(ii) Complementarity of demand.
(C) Due to their subsistence structure the
(iii) Indivisibility of savings.
underdeveloped countries are caught in the
(A) (i) only (B) (i) and (iii) only Malthusian ‘low equilibrium trap’
(C) (i) and (ii) only (D) All the three (D) All of the above
89. How can the nation close a saving gap ? 96. Which one of the following is not necessarily a
(A) By reducing its incremental capital output- characteristic of an underdeveloped economy ?
ratio (A) Low per capita income
(B) By reducing domestic consumption (B) Insufficiency of natural resources
(C) By obtaining more foreign aid (C) Inadequate capital resources
(D) All of the above (D) Widespread unemployment
90. The vicious circle argument points out the connec- 97. Investment projects should be capital intensive
tion between— because they would lead to greater savings and
(A) Income and population investment in future. This is advocated by—
(B) Investment and technology (A) H. Leibenstein
(C) Productivity and income (B) H. Leibenstein and W. Galenson
(D) Saving and capital
(C) W. Galenson
91. Classical investment theory advocates normally (D) W. Galenson and R. Nurkse
all of the following except—
(A) Perfect competition 98. Kuznets found that when compared to the upper 10
(B) Absence of externalities per cent of income recipients in developed
countries, the upper 10 per cent of income recipients
(C) A living wage
in less developed countries receive—
(D) A state of general equilibrium
(A) A smaller percentage of national income before
92. The basic rationale of the theory of “big push” is taxes
based upon the idea of— (B) A large percentage of national income before
(A) Internal economics (B) External economics taxes
(C) Size of population (D) None of these (C) The same percentage of national income after
93. The balanced growth theory sees the primary cause taxes
of underdevelopment as the— (D) An insignificant percentage of national income
(A) Small size of the market
99. Underdevelopment has been a result of ………
(B) Lack of savings factors.
(C) Low level of technology
(A) Economic
(D) Foreign domination
(B) Social
94. Economists point out several possible sources of
untapped private domestic savings in less developed (C) Political
countries. Which of the following is not one of (D) Economic, social and political
them ? 100. If the K/O ratio is 5 the population growth rate is 2
(A) There can be voluntary reduction in consump- per cent and society wants to achieve a per capita
tion, thereby freeing additional resources for growth rate of 3·5 per cent, what is the value of
investment saving ratio ?
(B) Unemployed or underemployed labour can be
(A) 3·5 (B) 5·5
absorbed in the productive economy, increasing
national income and the possibility of savings (C) 10·5 (D) 27·5
(C) The government can require citizens to 101. Arrange the “Structural Development Processes” in
purchase long-term, non-negotiable bonds, and a sequential order—
finance national investment programmes
I. Resource Allocation Processes
through private savings
II. Accumulation Process
(D) Establishment of a State Marketing Board
for exports which may enable the government III. Distributional Processes
to purchase domestic goods IV. Demographic Processes
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Codes : Codes :
(A) I, IV, II, III (B) II, I, IV, III (A) (A) is correct, but (R) is not the correct reason
(C) III, II, I, IV (D) IV, III, I, II of (A)
102. Match the items in List-I with List-II— (B) (A) is not correct, but (R) is correct
List-I (C) Both (A) and (R) are correct
(a) MPL is zero in overpopulated economies. (D) Both (A) and (R) are not correct
(b) Two gap model 106. UNDP has introduced a new poverty index known
(c) Critical growth rate as—
(d) Backwash effects (A) Human Poverty Index
List-II (B) Poorest among Poor Index
1. Gunnar Myrdal (C) Social Poverty Index
2. J. E. Mead (D) Multi-dimensional Poverty index
3. Arthur Lewis 107. Solow built his model as an alternative to—
4. Hollis Chenery & others (A) Kaldor’s model of growth
Codes : (B) Ranis-Fei model of growth
(a) (b) (c) (d) (C) Harrod-Domer model of growth
(A) 1 3 4 2 (D) Mead’s model of growth
(B) 3 4 2 1 108. The unbalanced growth model was propounded first
(C) 2 1 3 4 by—
(D) 4 2 1 3 1. Albert O. Hirschman
2. H. S. Singer and Raul Prebisch
103. After merger of Air India and Indian Airlines, the
new entity is now known as — 3. Kindelberger and Ragnar Nurkse
4. W. W. Rostow and Paul Streeton
(A) India Airlines (B) Air India
Codes :
(C) Indian (D) Indian Airways
(A) 1 and 2 (B) 1 and 3
104. Match the items in List-I with List-II— (C) 1 and 4 (D) 1
List-I 109. In the context of steady state growth in Solow’s
(a) Learning by doing model, the output growth rate overtime will be—
(b) Biased Technical Progress (A) Increasing (B) Decreasing
(c) Co-efficient of sensitivity of income distribu- (C) Constant (D) Fluctuating
tion 110. Who among the following economists assume
(d) Theory of Demographic Transition : Four dualism in the economy ?
stages of Population growth I. Ranis and Fie II. D. Ricardo
List-II III. Robert Solow IV. R. Harrod
1. Kaldor Answer from the codes given below :
2. Karl Sax Codes :
(A) All the four above (B) Only I and II
3. Kenneth J. Arrow
(C) Only IV (D) I, II and III
4. Joan Robinson
111. Who among the following, originally, formulated
Codes :
the ‘Turnpike Theorem’ ?
(a) (b) (c) (d) (A) Dorfman, Samuelson and Solow
(A) 3 4 1 2 (B) Radner
(B) 1 3 2 4 (C) Koopmans
(C) 2 1 4 3 (D) Von Neumann and Morgenstern
(D) 4 2 3 1 112. Backward and forward linkages are relevant for
which kind of growth strategy ?
105. Assertion (A) : Solow model is a major improve-
ment over Harrod-Domar model. (A) Unbalanced growth
(B) Trickle down growth
Reason (R) : Solow built a model of long run
growth without the assumption of fixed proportion (C) Balanced growth
in production. (D) Equilibrium growth
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113. ‘Reserve Army of Labour’ term was used by who 120. Which of the following fact is incorrect about Agri-
among the following economists ? Udaan ?
(A) J. Schumpeter (B) J. R. Hicks (A) It is managed by ICAR-NAARM’s technology
(C) Karl Marx (D) T. R. Malthus incubator, a-IDEA a long with IIM Ahmeda-
114. Which among the following is the reason for bad’s Centre for Innovation
convergence exhibited by the Solow growth model ? (B) Anybody from an innovative farmer to agri-
(A) Static Capital-output Ratio culture graduate to a person with minimal edu-
(B) Declining marginal productivity of capital cational qualification can apply for the scheme
(C) Neutral technical progress (C) The accelerator programme is funded mainly
(D) Constant rate of growth of population through the Department of Science and Tech-
nology
115. Who among the following economists was not
(D) It is a scheme, recently launched by Depart-
concerned with the problem of surplus labour ?
ment of Agriculture, Cooperation and Farmers’
(A) W. A. Lewis (B) Gustav Renis and Fei
welfare
(C) R. Nurkse (D) J. S. Mill
121. In Solow’s model of growth, the output per capita is
116. For the Harrod’s model of growth, which among the a function of—
following production functions best matches with
(A) Labour-capital ratio
the assumptions of the model—
(A) Leontief production function (B) Rate of change of capital-labour ratio
(B) Homogeneous production function (C) Capital output ratio
(C) CES production function (D) Technical progress
(D) Well-behaved production function 122. For Hick’s technical progress, consider the follow-
ing statements and choose the correct answer from
117. Demonetisation affected the Indian economy through the codes given below—
three different channels. It is potentially :
1. The capital-labour ratio is constant.
J. An aggregate demand shock because it reduced
the supply of money and affected private 2. It occurs in short period.
wealth, especially of those holding unaccounted 3. It can be labour saving or labour using.
money; 4. It can only be neutral.
K. An aggregate supply shock to the extent that Codes :
economic activity relies on cash. (A) 1, 2 and 3 are true (B) 2 and 4 are true
L. An uncertainty shock because economic agents (C) Only 2 is true (D) 2 and 4 are true
faced imponderables related to the magnitude
and duration of the cash shortage and the policy 123. Which of the following is an obstacle to economic
responses development ?
M. Consumers deferred or reduce discretionary con- (A) Low rate of capital formation
sumption (B) Vicious circles of poverty
N. Firms scaled back investments (C) Socio cultural barriers
(D) All of the above
Correct code is :
(A) All are correct 124. The classical model of economic development
emphasises—
(B) I, K, L are correct
(A) Laissez-Fair policy
(C) M and N are correct (B) Capital accumulation
(D) K, L, M and N are correct (C) Both (A) and (B)
118. Which of the following country has emerged as (D) None of the above
serious competitors of India in the international 125. Harrod model does not talk about—
markets of a range of manufacturing and services ?
(A) Actual growth rate
(A) Vietnam (B) Bangladesh (B) Critical minimum growth rate
(C) The Philippines (D) All of these (C) Warranted growth rate
119. Kisan Sampada Yojana is being implemented by the (D) Natural growth rate
Ministry/Department of ....... 126. Entrepreneurship is most closely associated with—
(A) Agriculture, Cooperation and Farmers’ welfare (A) Inventions
(B) Micro, Small and Medium Enterprises (B) Innovations
(C) Food Processing Industries (C) Management
(D) Commerce and Industries (D) Public Administration
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127. Lewis theory explains the process of development 134. Match List-I with List-II and select the correct
considering a—sector economy— answer using the codes given below the lists—
(A) One (B) Two List-I (Doctrine)
(C) Four (D) None of these (a) Neo-classical theory of economic growth.
128. “A country is poor because it is poor” are the words (b) Big-push theory of economic development.
of— (c) Critical minimum effort thes is.
(A) Singer (B) Nurkse (d) Social Dualism.
(C) Hicks (D) Myrdal List-II (Name of Economist)
129. According to Kuznets, during the process of deve- 1. Leibenstein 2. J.H. Boeke
lopment the income inequalities tend to— 3. Hirschman 4. Rosentein Rodan
(A) Increase 5. Meade
(B) Decrease
Codes :
(C) Increase first and then decrease (a) (b) (c) (d)
(D) Decrease first and then increase (A) 2 3 4 5
130. A technical change which permits more output to (B) 5 4 1 2
be produced from unchanged inputs is considered to (C) 3 5 2 1
be— (D) 1 3 5 2
(A) Embodied
135. Consider the following statements :
(B) Disembodied
According to Nurkse, disguised unemployment is a
(C) Both, embodied and disembodied source of capital formation in an underdeveloped
(D) None of the above economy, if all unproductive workers are—
131. An underdeveloped economy is generally characte- 1. Maintained by productive workers.
rised by a— 2. Provided assets through loans.
(A) High ratio of commercial farming to sub- 3. Mobilised on works immediately raising pro-
sistence farming ductivity.
(B) High ratio of industrial output to total output Of the above statements—
(C) High utilization of existing capital in the (A) 1, 2 and 3 are correct
economy (B) 1 and 2 are correct
(D) Coexistence of underutilised labour will un- (C) 1 and 3 are correct
exploited national and other resources (D) 2 and 3 are correct
132. Which one of the following statements correctly 136. Consider the following statements regarding indica-
defines the term Natural Rate of Growth ? tive planning :
(A) It is the minimum rate at which output can be 1. It was followed in Russia.
advanced with full employ of labour 2. It was used in France.
(B) It is the natural rate at which output can be 3. It has been used in all the Five year Plans of
advanced with full employment of labour India.
(C) It is the maximum rate at which output can be 4. It is being used in India’s Eight Five year Plan.
advanced with full employment of labour Of these statements—
(D) It is the actual rate at which output can be (A) 1 and 2 are correct
advanced withfull employment of labour
(B) 1, 2 and 4 are correct
133. In the Lewis model of economic development, the (C) 2 and 4 are correct
capitalist sector generates and reinvests surplus and (D) 2, 3 and 4 are correct
in turn, absorbs labour withdrawn from the
subsistence sector. The process continues till— 137. Consider the following statements :
(A) MPL in the capitalist sector is greater than O 1. Disguised unemployment is present only in
agriculture.
(B) MPL in the capitalist sector is less than MPL in
2. Disguised unemployment is a major cause of
the subsistence sector
the low standard of living in the rural areas of
(C) MPL in the capitalist sector is greater than wage India.
rate in that sector and MPL in the subsistence 3. Disguised unemployment can be useful in
sector is now positive India’s developmental process as a source of
(D) MPL = APL in the capitalist sector potential saving.
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4. Disguised unemployment occurs because 144. The development process under capitalism has been
people in village do not have motivation to described as ‘creative destruction’ by—
work. (A) Karl Marx (B) A.N. Hansen
Of these statements— (C) R. Luxemburg (D) J. Schumpeter
(A) 1, 2 and 3 are correct 145. In Harrod model—
(B) 2, 3 and 4 are correct (A) If the actual growth rate is higher than the
(C) 2 and 3 are correct warranted growth rate, there will be inflation
(D) 1 and 2 are correct (B) If the actual growth rate is higher than the
138. The concept of “economic growth” is— warranted growth rate, there will be deflation
(A) Uni-dimensional in nature measuring growth in (C) The economy will be in equilibrium when
national income actual and warranted growth rates are equal
(B) Multi-dimensional in corporating non-econo- (D) Higher growth is the consequence of econo-
mic aspects also mising on labour
(C) Related to development but not to deprivation 146. In Domar’s model—
(D) Related to resource development but not to (A) Investment is the solution for both inflation and
human development deflation
139. Now-a-days we talk about “sustainable develop- (B) Higher investment is solution only to control
ment” which relates to— inflation
(A) Control of population to suit natural resources (C) Higher investment is solution only to control
deflation
(B) Development for sufficiency and efficiency
which is bio-friendly (D) A high growth rate is preferable to a relatively
lower compound growth rate
(C) Development which is within the central and
state budgetary resources 147. In Harrod model, investment demand is a function
(D) Development which takes into account the of which of the following ?
taxable capacity of people (A) National income
(B) Rate of change in price level
140. The best indicator of economic development is—
(C) Rate of change in national income
(A) Rising savings
(D) Interest rate
(B) Rising investment
(C) Rising capital-output ratio 148. Who among the following Economists held the
(D) Rising levels of living behaviour of population as an obstacle to economic
growth in initiating the process of economic
141. Growth in developed countries is now mostly the growth—
result of— (A) P.N. Rosenstein Rodan
(A) Rising labour productivity (B) W.W. Rostow
(B) Rising capital accumulation
(C) R. Nurkse
(C) Innovation and technology
(D) H. Leibenstein
(D) Government assistance in exports
149. A number of indivisibilities hinder the process of
142. In Harrod-Domar models, “over production” is a economic growth in the initial stages. This view was
condition where— emunciated by—
(A) All producers are producing too much (A) R. Nurkse
(B) All producers are producing less than the (B) H.W. Singer
warranted output
(C) RN. Rosenstein Rodan
(C) All producers are producing higher than the
warranted output (D) W.W. Rostow
(D) Where excess capacity has been created 150. Development process has been viewed as a ‘chain
of disequilibria’ by—
143. In Domar’s model—
(A) R.N. Rosenstein Rodan
(A) Investment is needed to increase demand as
(B) R.E. Baldwin
well as supply
(C) H. Leibenstein
(B) There is great emphasis on increasing the
capital-output ratio (D) A.O. Harschman
(C) The classical economics is completely rejected 151. The growth of population has a bearing on the—
(D) The Keynesian economics is completely rejected (A) Natural rate of growth
546U | Economics (NET)
(B) Actual rate of growth 160. In Harrod growth model, the rate of advance with
(C) Warranted rate of growth the increase in population and technological change
(D) All the above allow over the long period of time is called the—
(A) Warranted Growth Rate
152. Nurkse was of the opinion that developing countries
(B) Actual Growth Rate
will have serious and adverse effect on their balance
of payments due to— (C) Natural Growth Rate
(A) Backwash effect (B) Demonstration effect (D) “Take-off Growth Rate
(C) Multiplier effect (D) Spread effect 161. The‘Theory of Stages of Growth’is associated with
the name—
153. Who among the following Economists held that a
growing economy is essentially unstable— (A) Simon Kuznets (B) Colin Clark
(A) R.F. Harrod (B) D. Ricardo (C) Paul Samuelson (D) W.W. Rostow
(C) R.M. Solow (D) T. Swau 162. The concepts of ‘forward linkage’ and ‘backward
linkage’ were used mainly in the developmental
154. In developing economies, investment is limited due
theory propounded by—
to insufficiency of demand. Who among the
following Economists, has criticised this view ? (A) Myrdal (B) Hirschman
(A) E.D. Domar (B) R.F. Harrod (C) Boeke (D) Leibenstein
(C) R. Nurkse (D) J. Viner 163. The phrase ‘demonstration effect’, was coined by—
155. In developing economies, surplus labour exists in the (A) J.K. Galbraith
sense that each labour is working for hours less than (B) J.M. Keynes
the normal working hours. This view has been (C) James Dussenberry
expressed by— (D) Joan Robinson
(A) J. Robinson (B) M. Dobb
(C) R. Nurkse (D) A.K. Sen 164. The stage of growth in which (1) basic needs are no
longer a problem, and (2) there is popular consump-
156. In Harrod’s model of economic growth, Ga is actual tion of durable goods is known as—
rate of growth Gw is warranted rate of growth and (A) The age of high mass consumption
Gn is natural rate of growth. Steady rate of growth is (B) The drive to maturity
ensured when— (C) The take-off
(A) Ga = Gn (B) Gw = Gn (D) The pre-conditions for change
(C) Ga = Gw (D) Gw > Gn
165. One of the conditions of take-off, as laid down by
157. Who among the following Economists, developed Rostow is—
the ‘theory of circular causation ? (A) Rise in the rate of productive investment
(A) G. Myrdal (B) R. Nurkse (B) One or more manufacturing sector with high
(C) J. Robinson (D) J.R. Hicks rate of growth
158. Assertion (A) : The neoclassical growth theory (C) Changes in social and institutional frame work
believes that there is substantial difference in the (D) All of the above
growth pattern of less developed countries and the 166. In Rostow’s theory, the drive to maturity—
developed countries. (A) Starts the development process
Reason (R) : This is mostly due to the market (B) Completes the development process
failure in the less developed countries caused by a
(C) Comes before the take-off
variety of imperfections existing in such economies.
(D) Follows the take-off
(A) Both (A) and (R) are individually true and R is
the correct explanation of (A) 167. Which one of the following is not an assumption of
(B) Both (A) and (R) are individually true but (R) Harrod-Domar models ?
is a not the correct explanation of (A) (A) MPS is greater than APs
(C) (A) is true but (R) is false (B) MPS remains constant
(D) (A) is false but (R) is true (C) There is no depreciation of capital goods
159. The process of economic development refers to— (D) None of the above
(A) Growth of national income over time 168. The Harrod-Domar growth model suggests that
(B) Growth of per capita income and standards of growth is—
living (A) Directly related to savings and inversely related
(C) Full employment of the entire population to the capital-output ratio
(D) Growth of national income with structural (B) Directly related to the capital-output ratio and
changes in the economy inversely related to savings
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(C) Indirectly related to savings and the capital 177. Disguised unemployment generally means—
output ratio (A) Large number of people remaining unemplo-
(D) Directly related to savings and the capital yed
output ratio (B) Alternative employment is not available
(C) MPL is zero
169. The ‘warranted growth’ rates as defined by Harrod
is the— (D) None of the above
(A) Full capacity growth rate of income of an 178. In the Lewis’ theory, capitalist surplus results
economy because the marginal productivity of labour in the
(B) Rates which producers will be content with capitalist sector is—
what they are doing (A) Higher than the capitalist wage
(C) Path on which the supply and demand for (B) Higher than that in the subsistence sector
goods and services will remain in equilibrium (C) Positive
given the propensity to save (D) Ever increasing
(D) All the above 179. Which one of the following is not the one of the
170. The basic rationale of the theory of “big push” is indivisibilities as prescribed by Rodan for launching
based upon the idea of— economic development ?
(A) Internal economics (B) External economics (A) Indivisibilities in the Production Function
(C) Size of population (D) None of these (B) Indivisibilities in the Consumption Function
(C) Indivisibilities of Demand
171. In both the laspeyres and Paasche indices—
(D) Indivisibilities in the supply of savings
(A) The growth components are the same
(B) The weighting factors are the same 180. Which among the following has the highest forward
linkage?
(C) Both growth and weight factors are the same
(A) Food grains (B) Guns
(D) The growth component in the Laspayres index
is larger for countries at the start of the (C) Iron Ore (D) Machinery
industrialisation process 181. The actual growth rate is defined by Harrod as the
172. According to Domar’s model, in order to maintain rate which is—
full employment the growth rate of net autonomous (A) Determined by the saving ratio and marginal
investment must be equal to— capital-output ratio
(A) Growth rate of savings (B) The full capacity growth rate of income of an
(B) Marginal propensity to save economy
(C) Marginal propensity to save and productivity (C) The welfare optimum rate
of capital (D) None of the above
(D) Growth rate of population 182. Who believed that a deliberate unbalancing of the
economy according to a predesigned strategy is
173. Rostow’s condition for a country to achieve the
the best way to achieve economic growth—
take-off stage was a rise in the proportion of net
investment to over— (A) Rosenstein Rodan
(A) 7% (B) 5 – 10% (B) A.O. Hirschman
(C) J. Schumpeter
(C) 12% (D) 14%
(D) J.H. Boeke
174. Nurkse says in the context of an underdeveloped
country inducement to invest is limited by— 183. In Lewis’ Theory, capital formation depends upon—
(A) The size of the market (A) Capitalist surplus
(B) Bank credit
(B) Lack of investment opportunities
(C) Both of (A) and (B)
(C) Lack of savings
(D) None of the above
(D) The policy of the government
184. The ‘critical minimum effort’ theory is due to—
175. The concept of technological dualism has been put
(A) H. Leibenstein (B) Rosenstein Rodan
forward by—
(C) W.A. Lewis (D) J.H. Boeke
(A) B. Higgins (B) J.H. Boeke
185. The classical model of economic development
(C) A. Lewis (D) R. Rodan considers—
176. Who put forward the theory of ‘financial dualism’? (A) Profits as incentive to investment
(A) J.H. Beoke (B) B. Higgins (B) Tendency of profits to decline with larger
(C) A. Lewis (D) H. Myint capital accumulation
548U | Economics (NET)
(C) Both (A) and (B) 194. Which one of the following is not included by J.E.
(D) None of the above Meade in the three principal means whereby an
economy can grow—
186. “Golden age” corresponds to a situation where—
(A) Capital accumulation
(A) Natural rate of growth exceeds warranted rate
(B) Foreign trade
of growth
(C) Growth of working population
(B) Actual rate of growth exceed warranted rate of
growth (D) Technical progress.
(C) Warranted rate of growth exceeds natural rate 195. The term ‘golden age’ as used by Joan Robinson
of growth refers to—
(D) Natural, warranted and the actual rate of (A) Primitive economics
growth of national income are all equal (B) The situation of smooth and steady growth with
full employment
187. The ‘Financial dualism’ refers to coexistence in the
(C) The economy which uses gold coins
less developed countries of—
(D) All of the above
(A) Commercial banks and non bank financial
institutions 196. When the planning authority formulates the central
plan, fixes objectives, targets and priorities for
(B) Scheduled and non-scheduled commercial every sector of the economy, the system of planning
banks is known as—
(C) Stock exchange and new issue market (A) Physical (B) Financial
(D) None of the above (C) Centralised (D) Decentralised
188. Harrod-Domar models of economic growth are 197. Shadow prices are particularly useful in—
based on the experiences of— (A) Consumer’s purchase decision
(A) Underdeveloped economics (B) Firm’s sale decisions
(B) Developing economics (C) Project evaluation and cost benefit analysis
(C) Advanced capitalist economics (D) None of the above
198. The capital-output ratio in a country during different
(D) Socialist economics phases of growth—
189. Which one of the following represents, at least in (A) Changes widely
part, investment in human capital ? (B) Remains uniform and unchanged
(A) Formal education (B) On the Job training (C) Changes with in narrow limits
(C) Better health care (D) All of these (D) Declines Secularly
199. Which of the following does not measure income
190. Economist who first defined the concept of Shadow
inequality ?
Prices is—
(A) Lorenz curve
(A) Rosenstein-Rodan (B) H. Leibenstein (B) Per capita income
(C) J. Tinberger (D) G. Myrdal (C) Ginni’s coefficient
191. Solow’s model or long run growth is a major (D) Percentage of population in different income
improvement over that of— groups
(A) Harrod-Domar (B) J. Robinson 200. A production possibility frontier (PPF) is shown in
(C) J. E. Meade (D) None of these the given diagram. A less developed country (LDC)
will be—
192. Centralised planning refers to—
y
(A) Complete governmental control over the eco-
Industrial Output
nomy PPF
(B) Planning specific projects
(C) The provision of the general frame work for the
Five-year plans
(D) The provision of economic projections and y
O Agricultural Output
voluntary guidelines
193. The book entitled “The Accumulation of Capital” (A) inside the PPF
has been written by— (B) on the PPF
(A) J. Robinson (B) N. Kaldor (C) above the PPF
(C) J. E. Meade (D) Rosenstein Rodan (D) at a point which coincides with the origin
Economics (NET) | 549U
201. Match List-I (concepts) with List-II (Economists) Reason (R) : A good portion of the national income
and select the correct answer using the codes given in poor countries is unreported.
below the lists— 206. Assertion (A) : In the unbalanced theory of growth,
List-I (Concepts) different sectors grow at different rates.
(a) Critical minimum effort Reasons (R) : This allows utilization of inter-
(b) Unlimited supply of labour dependence of economic sectors.
(c) Theory of balanced growth 207. Assertion (A) : Technological change is regarded
(d) Warranted growth rate as an important factor in the process of economic
List-II (Economists) growth.
1. Rosenstein Rodan 2. Harrod-Domars Reason (R) : Changes in the technology lead to
3. W. A. Lewis 4. H. Leibenstein increases in the productivity of labour, capital and
Codes : other factors of production.
(a) (b) (c) (d) 208. Assertion (A) : In developing countries, government
(A) 1 2 4 3 borrowing is preferred over taxation in financing
(B) 4 3 1 2 public expenditure.
(C) 1 3 4 2 Reason (R) : Taxation would require a curtailment
(D) 4 2 1 3 in current consumption.
202. Marx refers to the concept of organic composition 209. Assertion (A) : According to Schumpeter, deve-
of capital. Which one of the following ratios stands lopment is a spontaneous and discontinuous change
for this (where c is constant capital, V is variable in the channels of the circular flow.
capital and S is surplus value) ? Reason (R) : The entrepreneur is the agent of this
C C change.
(A) (B)
V+S V 210. Perfectly elastic supplies of labour play a crucial
C (C + V) role in—
(C) (D)
(C + V) V (A) Malthus’ model of growth
203. The ‘Big push’ strategy of development was first (B) Kuznets’ model of growth
advocated by— (C) The Prebisch hypothesis
(A) Rosenstein Rodan (B) Simon Kuznets (D) Lewis model of growth
(C) W.A. Lewis (D) A.O. Hirschman 211. Consider the following statements : The correct
Directions (Q. 204-209)—The following items order of specific stages of demographic transition
consist of two statements, one labelled as ‘Assertion A’ associated with economic development is—
and the other labelled as ‘Reason R’. You are to 1. low birth rate with low death rate.
examine these two statements carefully and decide if the 2. high birth rate with high death rate.
Assertion A and the Reason R are individually true and 3. high birth rate with low death rate.
if so, whether the reason is a correct explanation of the Which of the above statements are correct ?
assertion. Select your answers to these items using the
(A) 1, 2, 3 (B) 2, 1, 3
codes given below and mark your answer sheet
accordingly— (C) 2, 3, 1 (D) 3, 2, 1
Codes : 212. Consider the following statements for the Balanced
(A) Both A and R are true and R is the correct Growth theory propounded by Ragnar Nurkse and
explanation of A select the correct answer from the code given
below—
(B) Both A and R are true but R is NOT a correct
Statements :
explanation of A
1. A package of industries be developed by
(C) A is true but R is false
private initiative.
(D) A is false but R is true
2. A package of industries be developed by state
204. Assertion (A) : Non-economic factors play an initiative.
important role in the process of economic develop- 3. If needed foreign capital be used to augment
ment. the capital supply.
Reason (R) : Accumulation of capital takes the Codes :
form of human capita formation also.
(A) 1, 2 and 3 are correct
205. Assertion (A) : Per capita income figures are poor (B) 1 and 3 are correct
tools of ordinal ranking of countries with respect to (C) 2 and 4 are correct
the real well being. (D) 2, 3 and 4 are correct
550U | Economics (NET)
213. Human Development Index (HDI) is a composite 218. Match List-I (Investment criteria) with List-II
index of— (Authors) and select the correct answer using the
(A) health, literacy and employment codes given below the lists—
(B) national income, size of population and the List-I
general price level (a) Capital turnover criterion
(C) national income, per capita income and per
(b) Social marginal productivity criterion
capita consumption
(D) physical resources, monetary resources and (c) Time series criterion
population size (d) Ratio of reinvestment criterion
214. “Development is a continuous and spontaneous List-II
change in the stationary state which forever atters 1. Galenson-Leibenstein
and displaces the equilibrium state previously 2. A.K. Sen
existing; while growth is a gradual and steady
change in the long run which comes about by a 3. Kahn-Chenery
gradual increase in the rate of savings and 4. Buchanan-Polak
population”, is the well-known definition of Codes :
development and growth attributed to—
(a) (b) (c) (d)
(A) C.P. Kindelberger (B) U. Hicks
(A) 4 3 2 1
(C) J. A. Schumpeter (D) Ragner Nurkse
(B) 4 2 3 1
215. Consider the following statements : According to (C) 1 2 3 4
Joan Robinson, “golden age” refers to a situation
where— (D) 1 3 2 4
1. there is full employment at a high standard of 219. The original interpretation of balanced growth
living. relates to—
2. there is full utilisation of capacity. (A) large-scale expansion of activities to over come
3. the rate of growth of population is higher than divergence between private and social benefits
the rate of growth of the economy. (B) all sectors growing at the same rate
4. the per capita income increases at an increasing
(C) equal amount to investment in all sectors
rate.
Of these statements— (D) absence of shortages or excesses
(A) 3 and 4 are correct (B) 1 and 4 are correct 220. The vicious circle of poverty can be broke with
(C) 1 and 3 are correct (D) 1 and 2 are correct synchronised application of capital rather than
investment in any single line production taken by
216. Consider the following : The process which itself. In this statement ‘single line of production’
enables— implies—
1. individuals of a country to accumulate more (A) investment in the production of particular type
capital. of commodity
2. increasing the knowledge, skill and capacities (B) specialising in a particular process of produc-
of the people of the country. tion
3. accumulation of tangible wealth. (C) investment in a particular region of the
4. accumulation of intangible wealth. Human economy
capital formation as a concept is better (D) None of the above
explained in terms of
221. Match List-I with List-II and select the correct
(A) 1, 2 and 4 (B) 1, 2 and 3 answer using the codes given below the lists—
(C) 3 and 4 (D) 2 and 4 List-I
217. According to Hirschman, ‘convergent’ series (a) P.N. Rosenstein Rodan
comprises investment projects that appropriate more (b) H. Leibenstein
external economies than they create and ‘divergent’ (c) R. Nurkse
series comprises investment projects that create
more external economies than what they appro- (d) W.W. Rostow
priate. In terms of this, investments in power and List-II
transport as—
1. The critical minimum effort
(A) convergent series
(B) divergent series 2. The big push theory
(C) respectively convergent and divergent series 3. Take-off into self-sustained growth
(D) Both (A) and (B) 4. Vicious circle of poverty
Economics (NET) | 551U
Codes : 227. Consider the following statements—
(a) (b) (c) (d) On the supply side, the argument for a Big Push
(A) 2 1 4 3 theory is tied up with assumed existence of—
(B) 3 4 2 1 1. small size of market
(C) 3 1 4 2 2. externalities
(D) 2 4 1 3 3. indivisibilities
222. Consider the following statements : ‘Economic 4. high growth of population
Development’ is a— Of these statements
1. continuous process (A) 1 and 2 are correct
2. short-term process (B) 1, 3 and 4 are correct
3. long-term process (C) 2, 3 and 4 are correct
Of these statements (D) 2 and 3 are correct
(A) 2 is correct
(B) 1 and 3 are correct 228. According to Friedrich List, the different stages of
development follow the sequence—
(C) 3 is correct
(D) 1 and 2 are correct (A) pastoral, agriculture, agricultural manufactu-
ring
223. The index which combines social indicators of life (B) savage, agriculture, agricultural manufacturing
expectancy and literacy with a measure of basic
(C) agriculture, agricultural manufacturing, indus-
income adjusted to reflect purchasing power
try
sufficient to raise the people above the poverty line
is called— (D) savage, pastoral, agriculture, agricultural
(A) Basic Needs Index manufacturing, commerce
(B) Purchasing Power Index 229. Match List-I with List-II and select the correct
(C) Human Development Index answer using the codes given below the lists—
(D) Welfare Index List-I
224. In W.W.Rostow’s ‘stages of Growth’ the Drive to (a) Economic Growth and Structure
Maturity stage— (b) Readings in the Theory of Income Distribution
(A) follows take-off stage (c) An essay Marxian Economics
(B) starts development
(d) The Theory of Geographical Location of
(C) completes development Economic Activity
(D) follows High Mass Consumption stage
List-II
225. Capital deepening is a process in which— 1. Fellner 2. Kuznets
(A) output remains constant
3. W.H. Dean 4. Joan Robinsons
(B) capital intensity remains constant
Codes :
(C) technology changes with an increase in output
per worker (a) (b) (c) (d)
(D) None of the above (A) 2 1 4 3
(B) 2 1 3 4
226. Match List-I with List-II and select the correct
answer using the codes given below the lists— (C) 1 2 3 4
List-I (D) 1 2 4 3
(a) Absorptive capacity of capital 230. Generally speaking the optimum population of a
country refers to the size of the population which—
(b) Technological dualism
(A) maximises output per head
(c) Permissive and compulsive sequences
(B) maintains constant rate of growth of popula-
(d) Physical Quality of Life Index tion
List-II (C) leads to an increase in the proportion of
1. A.D. Hirschman 2. M. Kalecki workers in the industry
3. B. Higgins 4. D. Morris (D) provides gainful employment to the rural
Codes : population
(a) (b) (c) (d) 231. The most important objective of development
(A) 2 3 4 1 planning is to—
(B) 2 3 1 4 (A) ensure a greater degree of economic equality
(C) 3 2 1 4 (B) ensure a higher degree of economic growth
(D) 3 2 4 1 and development
552U | Economics (NET)
(C) make available larger provisions for capital 238. “Economic Development with Unlimited Supplies
formation and investment of labour” is a model of development enunciated
(D) provide greater opportunities for full employ- by—
ment (A) A.O. Hirschman (B) W.W. rostow
232. Consider the following statements— (C) W.A. Lewis (D) Holis Chenery
Mahalanobis model of planning can be described as 239. Leibenstein in his Critical Minimum Effort thesis
a— treats population as a factor that is—
1. sectoral planning model (A) income – generating
2. bi-sector model (B) income – depressing
3. consistency model (C) investment – inducing
4. growth model (D) market – expending
Of these statements—
240. The First Five Year Plan of the Government of
(A) 1 and 2 are correct
India was based on—
(B) 2 and 3 are correct
(A) Leontief input – output model
(C) 1 and 3 are correct
(B) Harrod – Domar model
(D) 3 and 4 are correct
(C) Mahalanobis two – sector model
233. According to Kuznets, during process of deve- (D) Mahalanobis four – sector model
lopment the income inequalities tend to—
241. According to Fisher-Clark thesis which one of
(A) decrease following is the correct sequence of shift of
(B) increase resources from one sector to the other for the
(C) increase first and then decrease continuity of development ?
(D) decrease first and then increase (A) Agriculture → Services → Manufacturing
234. Which one of the following pairs is not correctly (B) Agriculture → Manufacturing → Services
matched ? (C) Manufacturing → Services → Agriculture
Author Book (D) Manufacturing → Agriculture → Services
(A) Siman Kuznets Asian Drama 242. Consider the following statements—
(B) J. Robinson Essays on the Theory of In the estimates of growth of the United states,
Economic Growth ‘residual growth’ is attributed by Denison to—
(C) Karl Marx Das Capital 1. technological improvement
(D) Arthur W. Lewis Theory of Economic Growth 2. growth of capital
235. The mercantilist theory of economic growth is 3. growth of labour
primarily concerned with an increase in the— 4. combined growth of labour and capital.
(A) Volume of money in circulation through the Of these statement—
import of gold (A) 1 alone is correct
(B) 1 and 2 are correct
(B) Size of population
(C) 1, 2, and 3 are correct
(C) State intervention for the creation of conditions (D) 1, 2, 3, and 4 are correct
for efficient entrepreneurial functions
(D) Surplus in the balance of trade 243. According to the Harrod-Domar model, the
warranted rate of growth, given the incremental
236. Assuming capital-output ratio to be 3 : 1 and capital-output ratio, depends on the—
population grown to be 2·5% per annum, a 10·5% (A) rate of growth of labour force
increase in investment will lead to an increase in per (B) marginal productivity of investment
capita income to the extent of— (C) marginal efficiency of capital
(A) 0% (B) 1·0% (D) saving-income ratio
(C) 3·0% (D) 7·0%
244. Which one of the following growth models was the
237. Harrod’s natural rate of growth is— basis of the planning strategy during the second and
(A) the rate of growth which the increase of third Five-year plans of India ?
population and technical improvement allow (A) Harrod-Domar Growth Model
(B) the rate of growth which will satisfy profit (B) The Mahalanobis Two-Sector model
makers that they have done the right thing (C) Alan manne and Ashok Rudra’s 30-sector
(C) the actual rate of growth consistency model
(D) the increase in the rate of capital accumulation (D) Kaldor’s model of growth
Economics (NET) | 553U
245. Which of the following was/were assumed in the 251. Consider the following statements—
neo classical growth model as propounded by The Knife-edge problem in the Harrod-Domar
Solow ? growth model implies a constant—
1. A variable savings rate 1. rate of population 2. output
2. A constant population growth rate 3. rate of saving 4. capital-output ratio
3. A variable capital-output ratio Of these statements—
Select the correct answer using the codes given (A) 4 alone is correct
below— (B) 1 and 2 are correct
Codes : (C) 1, 2 and 3 are correct
(A) 1 alone (B) 1 and 2 (D) 1, 3 and 4 are correct
(C) 3 alone (D) 2 and 3
252. In the analysis by Hirschman, the industry with the
246. The rate of growth of national income is equal to highest combined linkages turned out to be—
National income—
(A) Cement (B) Textiles
National income
(A) (C) Iron and Steel (D) Food processing
Growth of population
Investment ratio 253. The utilisation of disguised unemployment as a
(B) source of savings potential in underdeveloped
Capital-output ratio
countries was suggested by—
Capital-output ratio
(C) (A) R. Nurkse (B) P. Baran
Investment ratio
(D) None of these (C) R. Harrod (D) W.W. Rostow
247. Hick’s neutral technical change implies that— 254. Match list I (Authors) with list II (concepts) and
select the correct answer using the codes given
(A) the unit isoquant undergoes a parallel shift below the lists—
upwards
(B) the unit isoquant undergoes a parallel shift List-I List-II
downwards (a) Domar 1. Golden Age
(C) curvature of the unit isoquant changes (b) Rosenstein- 2. Big-Push
(D) None of the above Rodan
(c) Rostow 3. Stages of growth
248. Capital deepening means—
(d) Joan Robinson 4. Required rate of growth
(A) using larger amount of labour as compared
Codes :
to capital
(a) (b) (c) (d)
(B) using more of the same type of capital due to
increase number of workers (A) 4 2 3 1
(B) 2 4 3 1
(C) increase in capital per worker in already
existing production (C) 2 4 1 3
(D) using more of human capital (D) 4 2 1 3
255. Match List I (Authors) with List II (Theories) and
249. Which one of the following pairs of Economists select the correct answer using the codes given
and doctrines they advocated, is correctly matched ? below the Lists—
(A) A.W. Lewis... “Big Push” theory List-I List-II
(B) A.O. Hirschman...strategy of unbalanced
(a) Solow 1. Neutral technological change,
growth
under which despite the change
(C) Rosenstein Rodan...stages of economic in output, the capital labour
growth ratio remains constant.
(D) W.W. Rostow... Theory of development with (b) Hicks 2. Neutral technological change,
unlimited supplies of labour under which the labour output
250. If the marginal productivity of labour in agri- ratio remains constant, so that
culture is zero, then the labour supply curve for the factor proportions are baised
industry as assumed by Arthur Lewis will be— in favours of saving capital.
(A) upward rising (c) Harrod 3. Neutral technological change,
(B) perfectly in elastic under which, the capital output
ratio remains constant, so that
(C) backward bending the factor proportions are baised
(D) perfectly elastic in favour of saving labour.
554U | Economics (NET)
Codes : (C) W. Galenson
(a) (b) (c) (D) W. Galenson and R. Nurkse
(A) 2 1 3 263. According to Lewis the subsistence sector is that
(B) 1 2 3 part of the economy which—
(C) 3 2 1 (A) Makes use of reproducible capital
(D) 3 1 2 (B) Does not make use of reproducible capital
256. The two-gap theory as applied to development (C) Employs labour for wages in mines, factories,
planning refers to— plantations for earning profits
(A) inflationary gap and investment gap (D) None of the above
(B) saving gap and deflationary gap 264. Myrdal builds his theory of economic develop-
(C) foreign exchange gap ment around the idea of—
(D) saving constraint and foreign exchange (A) Regional inequalities on the national plane
constraint (B) Regional inequalities on the international
257. Demographic transition refers to— plane
(A) migration of population from rural to urban (C) Both (A) and (B)
areas (D) None of the above
(B) change in the male/female ratio of the 265. If you like to increase the rate of economic
population development of a country, increase in which of the
(C) shift from a stable population at high birth following would you suggest—
and death rates to one of low birth and death (A) Government expenditure
rates
(B) Standard of living
(D) shift from high birth and low death rates to
low birth and low death rates (C) Consumption
(D) Saving
258. Which one of the following is NOT an assumption
of the Harrod-Domar model ? 266. Economic Survey 2016-17 Volume-2 mooted a
(A) Fixed capital-output ratio three-element reform package for banking sector—
(B) Variable marginal and average propensity to I. Selective rescue of banks.
save II. Expanded role for private sector.
(C) Closed economy III. Specific measures such as recapitalisation,
(D) Capital is the only factor of production strengthening lending and risk management
framework.
259. The concept of unbalanced growth has not been
advocated by— IV. Consolidation of best performing banks.
(A) H. W. Singer (B) A. Lewis Correct code is :
(C) A, O. Hirschman (D) C.P. Kindleberger (A) Only III (B) I and III
260. The idea of balanced growth is related to the (C) III and IV (D) I, II and III
classical— 267. To break the vicious circle on the demand side of
(A) idea of the nature of economic science capital, Nurkse has pleaded for—
(B) idea of full employment equilibrium (A) Balance growth
(C) law of markets (B) Unbalanced growth
(D) school of thought (C) Agricultural growth
261. The difficulties of comparing growth of different (D) Industrial growth
countries are—
268. Incremental capital-output ratio (ICOR) is defined
(A) Lack of empirical data
as—
(B) Choice of a common denominator
Increment in capital
(C) Assigning weights to the various items of (A)
Increment in output
output
(D) All of these Increment in output
(B)
Increment in capital
262. Investment projects should be capital intensive
because they would lead t o greater saving and Increment in income
(C)
investment in future advocated by— Increment in consumption
(A) H. Leibenstein Increment in saving
(D)
(B) M. Leibenstein and W. Galenson Increment in consumption
Economics (NET) | 555U
269. The criticism of the balanced growth theory is 276. Which one of the following is not an assumption
mainly based on the considerations of— of Neoclassical’s Growth theory ?
(A) Market-size (A) Perfect competition in commodity and factor
(B) External economies markets
(C) Scarcity of resources (B) Factor payment equal their marginal revenue
(D) Large population productivity
(C) A capital-output ratio
270. Unbalanced growth hypothesis is formulated on
the assumption that— (D) Full employment in the economy
(A) Expansion takes place simultaneously on 277. Foreign aid is needed to—
several routes (A) Supplement the domestic savings of develop-
(B) Supplies of capital and labour are fixed ing nations
(C) There are unlimited supplies of labour and (B) Assure the capital imports needed for
capital development
(D) Underdeveloped countries impose ceiling on (C) Prevent the absolute gap between rich and
their rates of growth poor nations from widening further
(D) All of the above
271. Balanced growth, which is associated with Nurkse
and Rosentein Rodan, means— 278. “Underdeveloped countries are the slums of the
(A) Equal increase in resources allocated world economy” is the statement given by—
(B) Equal percentage growth in output (A) David Ricardo (B) G. Myrdal
(C) Different parts of the economic growth in (C) Cairncross (D) Arthuer Lewis
harmonious manner 279. Dualistic economy is one where—
(D) Different fields of growth at a natural rate (A) Public and private sectors exist side by side
272. Who of the following supported the theory of (B) Modern industrial sector and traditional
balanced growth ? subsistence sector exist side by side
(A) Ragnar Nurkse (C) Agriculture and industrial sectors are equally
(B) Hans Singer developed
(C) Hirschman (D) Indigeneous industries are developed in
collaboration with foreign companies
(D) None of the above
280. Fei-Ranis theory of economic development is
273. Who has suggested that economic development of based on—
developing countries can be accelerated by (A) Balanced growth during the take off process
weakening the ‘back wash effects’ and strengthen- (B) Importance of agricultural product in capital
ing the “Spread effects” ? accumulation in underdeveloped countries
(A) N. Kaldor (B) J. Robinson (C) Dualistic approach to development
(C) G. Myrdal (D) J.H. Boeke (D) All of the above
274. If the capital-output ratio is 3 per cent, the savings 281. According to Myrdal, the main cause of regional
rate 5 per cent and the economy is growing at 4 inequalities in the underdeveloped countries has
per cent in simple terms and 1·5 per cent in per been—
capita terms, what is the percentage of the rate of (A) Weak back-wash effects and strong spread
population growth ? effects
(A) 1·5 (B) 2·5 (B) Weak back-wash and spread effects
(C) Strong back-wash and spread effects
(C) 3·5 (D) 4·5
(D) Strong back-wash and weak spread effects
275. Lewis means by an unlimited supply of labour— 282. The technique of input-output analysis has been
(A) The supply of labour is more than the demand popularised by—
for labour (A) Nurkse (B) Samuelson
(B) Infinite labour is available at whatever wage (C) Leontief (D) Lange
determined by the market 283. According to Solow, the long-run rate of growth
(C) The supply of labour at the subsistence wage on an advanced economy equals Harrod’s—
is greater than the demand for labour (A) Warranted rate of growth
(D) The economy adopts only labour intensive (B) Actual rate of growth
techniques of production (C) Natural rate of growth
(E) None of the above (D) None of the above
556U | Economics (NET)
284. In terms of Harrod-Domar growth model, for (C) Rate of growth of actual output is equal to the
achieving a postulated rate of growth an economy rate of growth of ceiling output
requires— (D) None of the above
(A) Increase in the investment ratio 292. According to Colin Clark the third and final stage
(B) Reducing the capital-output ratio of development is characterised by the predomi-
(C) Restricting the growth of population nance of—
(D) All of the above (A) Manufacturing sector
(B) Services sector
285. Harrod-Domar model of economic development (C) Agriculture sector
presupposes—in the economy— (D) Exports sector
(A) Low level of consumption 293. With economic growth the share of the second-
(B) High level of consumption ary sector in National Product—
(C) Unemployment (A) Rises
(D) Full employment (B) Falls
286. Who believed that the people in less developed (C) Remains constant
countries are not economically motivated to- (D) Does not necessarily rise
wards work and does not respond to normal 294. The idea of a ‘Big Push’ is associated with which
monetary incentive ? of the following theories ?
(A) A. Marshall (B) D. Ricardo (A) Economic development with unlimited
(C) J.H. Boeke (D) R. Nurkse supply of labour
(B) Theory of Balanced growth
287. With economic growth there is— (C) Theory of Unbalanced growth
(A) A shift away from agriculture (D) None of the above
(B) A shift away from manufacturing 295. Accumulation of capital involves—
(C) A shift in favour of agriculture (A) Increase in real saving
(D) A shift away from services (B) Mobilisation of saving
288. Despite being a high saving economy, a de- (C) Investment of saving
veloping country may still NOT grow fast (D) All of the above
primarily due to— 296. Boeke, the originator of the theory of Sociological
(A) week administrative machinery Dualism was—
(B) illiteracy (A) An English Civil Servant
(C) high population density (B) A French Civil Servant
(D) high capital-output ratio (C) A Dutch Civil Servant
289. An economy will face depression if the— (D) None of the above
(A) Warranted rate of growth is higher than the 297. Crop intensity and productivity are critically
actual rate of growth dependent on—
(A) Irrigation
(B) Actual rate of growth is higher than the
warranted rate of growth (B) Tenancy reforms
(C) Crop loans
(C) Natural rate of growth is higher than the
actual rate of growth (D) Remunerative price for agriculture produces
(D) Actual rate of growth is higher than the 298. Consider the list I and II choose the correct code
natural rate growth given below :
List
290. The condition of steady growth, in terms of rate of (Country)
growth, in the Harrod growth model is— (a) Brazil (b) China
(A) Actual growth rate = Warranted growth rate (c) Indonesia (d) South Korea
(B) Actual growth rate = “Take off’ growth rate List-II
(C) Actual growth rate = Natural grown rate (Percentage of Urban population)
(D) Warranted growth rate = Natural growth rate 1. 82% 2. 86%
291. According to the Hicksion theory, growth is 3. 54% 4. 56%
checked when— (a) (b) (c) (d)
(A) Rate of growth of actual output exceeds rate (A) 1 4 3 1
of growth of ceiling output (B) 4 3 2 1
(B) Rate of growth of actual output is less than (C) 1 2 3 4
the rate of growth of ceiling output (D) 3 2 1 4
Economics (NET) | 557U
Answers 146. (A) 147. (A) 148. (D) 149. (C) 150. (D)
151. (A) 152. (A) 153. (D) 154. (C) 155. (D)
1. (D) 2. (A) 3. (B) 4. (B) 5. (C)
156. (B) 157. (A) 158. (A) 159. (D) 160. (C)
6. (D) 7. (B) 8. (D) 9. (C) 10. (D)
161. (D) 162. (B) 163. (C) 164. (B) 165. (D)
11. (D) 12. (B) 13. (B) 14. (B) 15. (A)
166. (D) 167. (A) 168. (A) 169. (D) 170. (B)
16. (D) 17. (C) 18. (C) 19. (C) 20. (B)
171. (A) 172. (C) 173. (B) 174. (B) 175. (A)
21. (C) 22. (A) 23. (C) 24. (D) 25. (C)
176. (D) 177. (C) 178. (A) 179. (B) 180. (C)
26. (B) 27. (C) 28. (D) 29. (C) 30. (C)
181. (A) 182. (B) 183. (C) 184. (A) 185. (C)
31. (D) 32. (D) 33. (D) 34. (C) 35. (D)
186. (D) 187. (A) 188. (C) 189. (D) 190. (C)
36. (D) 37. (B) 38. (D) 39. (A) 40. (A)
191. (A) 192. (A) 193. (A) 194. (B) 195. (B)
41. (B) 42. (D) 43. (A) 44. (B) 45. (B)
196. (C) 197. (C) 198. (C) 199. (B) 200. (A)
46. (C) 47. (C) 48. (D) 49. (B) 50. (A)
201. (B) 202. (B) 203. (A) 204. (B) 205. (A)
51. (D) 52. (B) 53. (C) 54. (D) 55. (D)
206. (A) 207. (A) 208. (B) 209. (A) 210. (D)
56. (C) 57. (D) 58. (B) 59. (C) 60. (B)
211. (C) 212. (C) 213. (A) 214. (C) 215. (D)
61. (B) 62. (C) 63. (A) 64. (C) 65. (B)
216. (D) 217. (B) 218. (B) 219. (C) 220. (A)
66. (D) 67. (B) 68. (A) 69. (D) 70. (D)
221. (A) 222. (B) 223. (C) 224. (A) 225. (C)
71. (A) 72. (C) 73. (C) 74. (A) 75. (D)
226. (B) 227. (D) 228. (D) 229. (B) 230. (A)
76. (C) 77. (B) 78. (C) 79. (A) 80. (C)
231. (B) 232. (A) 233. (B) 234. (A) 235. (D)
81. (D) 82. (D) 83. (A) 84. (D) 85. (C) 236. (B) 237. (A) 238. (C) 239. (A) 240. (B)
86. (D) 87. (A) 88. (D) 89. (D) 90. (C) 241. (B) 242. (A) 243. (D) 244. (B) 245. (D)
91. (C) 92. (B) 93. (A) 94. (D) 95. (D) 246. (B) 247. (B) 248. (C) 249. (B) 250. (D)
96. (B) 97. (D) 98. (B) 99. (D) 100. (C) 251. (D) 252. (C) 253. (A) 254. (A) 255. (A)
101. (B) 102. (B) 103. (B) 104. (A) 105. (C) 256. (D) 257. (D) 258. (B) 259. (B) 260. (B)
106. (D) 107. (B) 108. (A) 109. (C) 110. (B) 261. (D) 262. (B) 263. (B) 264. (C) 265. (A)
111. (A) 112. (A) 113. (C) 114. (B) 115. (D) 266. (D) 267. (A) 268. (A) 269. (C) 270. (B)
116. (A) 117. (A) 118. (D) 119. (A) 120. (D) 271. (C) 272. (A) 273. (C) 274. (B) 275. (C)
121. (A) 122. (A) 123. (D) 124. (C) 125. (B) 276. (C) 277. (D) 278. (C) 279. (B) 280. (D)
126. (B) 127. (B) 128. (B) 129. (A) 130. (B) 281. (D) 282. (C) 283. (C) 284. (D) 285. (D)
131. (D) 132. (C) 133. (C) 134. (B) 135. (A) 286. (C) 287. (A) 288. (D) 289. (A) 290. (A)
136. (B) 137. (A) 138. (B) 139. (B) 140. (D) 291. (A) 292. (B) 293. (A) 294. (B) 295. (D)
141. (C) 142. (C) 143. (A) 144. (D) 145. (A) 296. (C) 297. (A) 298. (A)
●●
UNIT-9
Environmental Economics and
Demography
Environment As a Public Good useful for understanding the causes of many environ-
mental problems and potential solutions.
Environment consists of all those things which may
affect the survival and growth of human beings, animals From an economics perspective, public goods are of
and plants . In a narrow sense land, mountains, forests, interest because—unlike private goods—they are a
air, water, sound, soil, etc , which have been provided by source of market failure. The problem is ‘free riding’:
the nature are key components of environment. While, in individuals have little incentive to voluntarily provide
broader sense, besides the above natural factors, econo- public goods when they can simply enjoy the benefits of
mic, social, political, religious, demographic, and cultural non-rival and non-excludable pubic goods provided by
insititutions are also regarded the components of the others. To see free riding at work, consider the challenge
environment. of constructing a bridge where the societal benefits of
doing so would exceed the costs. How successful do you
Pure public goods have two defining features.
think a campaign would be to finance the bridge with
(i) ‘non-rivalry,’ meaning that one person’s enjoy- voluntary donations? It is not hard to imagine how such
ment of a good does not diminish the ability of other a campaign would fail, because many (if not most)
people to enjoy the same good. individuals would choose to make no donation, hoping
(ii) ‘non-excludability,’ meaning that people cannot others would contribute enough to finance the bridge for
be prevented from enjoying the good. everyone to enjoy. In this scenario, the market failure
After closely examining the nature of environmental would be that no bridge is constructed despite the fact
factors in relation to above connotations, it appears that that a bridge would make everyone better off.
environmental factors can be designated as public goods. Seeking to prevent such under-provision of public
Air quality is an important environmental example of a goods is one of the primary economic rationales for
public good. Under most circumstances, one person’s government. While markets allocate private goods
breathing of fresh air does not reduce air quality for efficiently, governmental intervention is usually required
others to enjoy, and people cannot be prevented from for the efficient (or even reasonable) allocation of public
breathing the air. Public goods are defined in contrast to goods. Indeed, this explains why goods such as bridges,
private goods, which are, by definition, both rival and parks, police protection, and fire departments are usually
excludable. A Pizza is a private good because one financed with tax revenues that governments collect.
person’s consumption clearly diminishes its value for Governments can thus serve as a coordinating
someone else, and Pizzas are typically excludable to all mechanism that provides public goods for the benefit of
individuals not willing to pay. (This scenario does, of society.
course, assume the proverbial no free lunch.) The same public-goods rationale applies to environ-
Many environmental resources are characterized as mental protection. Because individuals and firms face
public goods, including water quality, open space, free-riding incentives when it comes to protecting the
biodiversity, and a stable climate. These examples stand environment, policies are often put in place to limit
alongside the classic public goods of lighthouses, pollution, restrict resource exploitation, or create the
national defense, and knowledge. In some cases, how- right incentives to promote or protect environmental
ever, it is reasonable to question whether environmental quality. Environmental policies that promote economic
resources (and even the classic examples) are public efficiency are those for which the societal benefits
goods in a fully pure sense. With open space, for exceed the costs. Social cost-benefit analysis is the tool
example, congestion among those enjoying it may cause that economists use to make such determinations. Yet,
some degree of rivalry, and all open spaces are not with most environmental public goods, special
accessible to everyone. Nevertheless, many environ- techniques are often required to estimate the economic
mental resources come close to satisfying the definition benefits or costs because environmental quality is rarely
of pure public goods, and even when not exact (possibly traded in markets and therefore does not have directly
closer to an impure public good), the basic concept is observable prices. For example, there are certainly
Economics (NET) | 559U
benefits of improving air quality, but how are such or a wind turbine potentially imposes a cost on people
benefits to be quantified ? who are neither consumers nor producers of these items.
(Technically, this externality comes about because it's
Environment and Market Failure not well defined who owns the noise spectrum.)
When free markets do not maximise society's In the case of the wind turbine, for example, it's
welfare, they are said to 'fail' and policy intervention efficient to let the turbine make noise if the value of
may be needed to correct them. Many economists have operating the turbine is greater than the noise cost
described climate change(a component of environment) imposed on those who live near it. On the other hand, it's
as an example of a market failure . efficient to shut the turbine down if the value of
The core one is the so-called 'greenhouse-gas operating the turbine is less than the noise cost imposed
externality'. Greenhouse gas emissions are a side-effect on nearby residents.
of economically valuable activities. Most of the impacts Since the potential rights and desires of the turbine
of emissions do not fall on those conducting the company and the households are clearly in conflict, it's
activities – instead they fall on future generations or possible that the two parties will end up in court to
people living in developing countries, for example – so figure out whose rights take precedence. In this instance,
those responsible for the emissions do not pay the cost. the court could decide that the turbine company has the
The adverse effects of greenhouse gases are therefore right to operate at the expense of the nearby households
'external' to the market, which means there is usually or that the households have the right to quiet at the
only an ethical – rather than an economic – incentive for expense of the turbine company's operations. Coase's
businesses and consumers to reduce their emissions. As main thesis is that the decision reached regarding the
a result, the market fails by over-producing greenhouse assignment of property rights has no bearing on whether
gases. the turbines continue to operate in the area as long as the
Economists concerned about this market failure parties can bargain without cost.
argue for policy intervention to increase the price of
activities that emit greenhouse gases, thereby providing Application of Coase Theorem
a clear signal to guide economic decision-making at the Why is this? Let's say that it's efficient to have the
same time as stimulating innovation of low-carbon turbines operating in the area, i.e., that the value to the
technologies. In order to ensure that emissions cuts are company of operating the turbines is greater than the
spread out across the economy as inexpensively as cost imposed on the households. Put another way, this
possible, economists tend to favour policies that ensure means that the turbine company would be willing to pay
that all businesses and households face the same price the households more to stay in business than the
on carbon – such as a tax on emissions or an emissions households would be willing to pay the turbine company
trading scheme. to shut down. If the court decides that the households
The greenhouse gas externality is accompanied by a have a right to quiet, the turbine company will probably
number of other market failures, including those arising compensate the households in exchange for letting the
from a lack of information about how to reduce turbines operate. Because the turbines are worth more to
emissions, network effects and a lack of innovation the company than quiet is worth to the households, some
incentives. These call for a package of interventions offer will be acceptable to both parties, and the turbines
including, but not restricted to, a price on carbon, will keep running.
according to economists concerned about climate On the other hand, if the court decides that the
change. company has the right to operate the turbines, the
turbines will stay in business and no money will change
Coase Theorem hands. This is because the households aren't willing to
The Coase Theorem, developed by economist pay enough to convince the turbine company to cease
Ronald Coase, states that when conflicting property operation.
rights occur, bargaining between the parties involved In summary, the assignment of rights in this
will lead to an efficient outcome regardless of which example didn't affect the outcome once the opportunity
party is ultimately awarded the property rights, as long to bargain was introduced, but the property rights did
as the transaction costs associated with bargaining are affect the transfers of money between the two parties.
negligible. Specifically, the Coase Theorem states that This scenario is realistic: In 2010, for example, Caith-
"if trade in an externality is possible and there are no ness Energy offered households near its turbines in
transaction costs, bargaining will lead to an efficient Eastern Oregon $5,000 each not to complain about the
outcome regardless of the initial allocation of property noise that the turbines generated.
rights.” It's most likely that in this scenario, the value of
The Coase Theorem is most easily explained via an operating the turbines was greater to the company than
example. It's clear that noise pollution fits the typical the value of quiet was to the households, and it was
definition of an externality, or a consequence of an probably easier for the company to proactively offer
economic activity on an unrelated third party, because compensation to the households than it would have been
noise pollution from, say, a factory, a loud garage band, to get the courts involved.
560U | Economics (NET)
Limitations of the Coase Theorem Measuring the benefits of a policy can involve
In practice, there are a number of reasons why the anything from additional income, to an increased quality
Coase Theorem may not hold (or apply, depending on of life, or even to a cleaner environment; costs may
context). In some cases, the endowment effect could consist of forgone opportunities, internal and external
cause the valuations elicited in negotiation to depend on costs, and externalities. However, in measuring costs, it
the initial allocation of property rights. In other cases, is important not to confuse externalities with secondary
negotiation may not be feasible either due to the number effects: externalities result in real output changes
of parties involved or social conventions. whereas secondary effects do not. An example of this
would be electricity generation, pollution is an
Cost Benefit Analysis externality while a secondary effect would be the
increased cost of doing business when the price of
Most would agree that in decision-making, any electricity rises. The pollution actually generates new
actions that maximize benefits are preferable; however, costs, such as the need to scrub sulfur dioxide from
disagreements arise as to how to quantify benefits so smokestacks. The increased business costs reflect the
they can be compared to the cost of an action. What fluctuation in the price. In order to avoid double-
rupee value, for example, should be used for a small, counting, only true externalities can be included in a
endangered fish? Although it may be difficult to value CBA.
many intangibles with respect to the environment, After all benefits and costs have been given a
policymakers must do so in order to make choices. common unit of measurement, options can be evaluated.
Cost-benefit analysis (CBA) is an analytical way for The ideal situation will result in Pareto improvement,
society to make decisions about complicated issues such some are made better-off while no one is made less well
as education, health care, transportation, or the off. But—since this is rare—CBA is based on ‘potential’
environment. Like most personal decisions, it involves a Pareto improvement and economic efficiency, where the
comparison of the costs of an action compared with possibility exists for compensation to those who are less
considerations of the benefits of that action. However, well off, whether or not it actually happens.
for public policy it is formalized and quantitative. For A final result of a CBA is where marginal benefits
instance, a public policy can be evaluated by calculating and marginal costs are equal. In the graph below, this is
and weighing the benefits against the costs, once all at point Q. The surplus is illustrated by the shaded area
factors have been given a common unit of measurement. in the graph. At equilibrium, the surplus is greatest,
When policymakers have to choose among various making it the best possible solution. If the quantity were
alternatives, they require a tool that will allow them to to increase to point 1, the marginal costs would exceed
distinguish between the options. Decision makers can the marginal benefits, meaning it would not econo-
then choose the policy with the largest surplus, or mically efficient. If the quantity were to decrease to
overall net benefits. For example, the U.S. government point -1, some of the surplus would be lost, which would
is increasingly seeking more cost-effective policies in also indicate inefficiency. CBA aims to maximize
order to balance the budget. Yet, while the overall economic efficiency at point Q, where marginal benefit
concept of CBA is simple, the steps taken to evaluate and marginal cost are equal.
each benefit and cost can become quite complicated.
The most important component of a CBA is the
base situation—or what would happen if no changes
were made. All other decisions are compared to this base
situation. The first step is to identify the relevant time
period : when would the costs and benefits be realized?
Once the base and relevant time period are established,
benefits and costs can be calculated in terms of human
well-being. In this case, a benefit is defined as anything
that increases human well-being, and a cost is anything
that decreases it. These definitions and their respective The uncertainty of these forecasts can create a
calculations tend to provoke controversy due to the use fundamental problem when policymakers rely entirely
of valuation and discounting, which involves applying a on CBA to make a decision. Critics argue that the
mathematical formula to determine the present value of analysis does not take into account equity considera-
future benefits and costs. For example, a dollar today tions. Ecological valuation and discounting are also
will not be worth the same amount in 50 years, its value
controversial because there are many different values
will decrease due to inflation. Also, today’s dollar could
be put to other uses (foregone opportunities) which that certain natural resources could assume, and the
decreases its net future value in the chosen use. To discount rate chosen can have significant implications
account for the inevitable change in value, costs and for the resulting analysis. These arguments are perhaps a
benefits in the future are ‘discounted’ – or made smaller good illustration of why CBA can best be used when
– by the value of foregone opportunities. combined with other forms of analysis.
Economics (NET) | 561U
Compensation Criteria view, while Kaldor had formulated his criterion from
gainers’ point of view. Thus the two criteria are really
Prof. Nicolas Kaldor, J.R. Hicks and Scitovsky have the same though they are clothed in different words.
made efforts to evaluate the changes in social welfare That is why they are generally called by a single name
resulting from any economic reorganisation which ‘Kaldor-Hicks criterion’.
harms somebody and benefits the others. These
economists have sought to remove indeterminacy in the Kaldor-Hicks criterion can be explained with the
analysis of Pareto optimality. Their criterion is known as help of the utility possibility curve. In figure 1, ordinal
the ‘compensation principle’ utility of two individuals A and B is shown on X and Y
axis respectively. DE is the utility possibility curve
Assumptions which represents the various combinations of utilities
1. The satisfaction of an individual is independent of obtained by individuals A and B. As we move
the others and he is the best judge of his welfare. downward on the curve DE, utility of A increases while
that of B falls. On the other hand, if we move up on the
2. There exist no externalities of consumption and utility curve ED, utility of B increases while that of A
production. falls.
3. The tastes of the individuals remain constant. Utility Possibility
4. The problems of production and exchange can be Y Curve
D T
separated from the problems of distribution. R
B'S Utility
Compensation principle accepts the level of social G
welfare to be a function of the level of production.
S
Thus it ignores the effects of a change in Q
distribution on social welfare.
5. Utility can be measured ordinally and interpersonal O
comparisons of utilities are not possible. A'S Utility E X
According to Kaldor’s compensation criterion, if a Fig. 1. Kaldor-Hicks Criterion Explained with
certain change in economic organisation or policy makes Utility Possibility Curve
some people better off and others worse off, then a Suppose the utilities obtained by A and B from the
change will increase social welfare if those who gain distribution of income or output between them is
from the change could compensate the losers and still be represented by point Q inside the utility possibility curve
better off than before. In the words of Prof. Baumol, DE. Let us assume that as a result of some change in
“Kaldor’s criterion states that a change is an economic policy, the two individuals move from point Q
improvement if those who gain evaluate their gains at a to point T on the utility possibility curve DE.
higher figure than the value which the losers set upon
their losses.” As a result of this movement, utility of individual B
Thus, if any policy change benefits any one section has increased while the utility of A has declined, that is,
of the society (gainers) to such an extent that it is better B has been become better off and A has become worse
off even after the payment of compensation to the other off than before. Therefore, this movement from point Q
sections of the society (losers) out of the benefits to point T cannot be evaluated by means of Pareto
received, then that change leads to increase in social criterion. Of course, points such as R, G, S or any other
welfare. In Kaldor’s own words, “In all cases…. where a point on the segment RS of utility-possibility curve DE
certain policy leads to an increase in physical are socially preferable to point Q on the basis of Pareto
productivity and thus of aggregate real income… it is criterion.
possible to make everybody better off without making However, the compensation principle propounded
anybody worse off. It is quite sufficient…. to show that by Kaldor-Hicks enables us to say whether or not social
even if all those who suffer as a result are fully welfare has increased as a result of movement from Q to
compensated for their loss, the rest of the community T. According to Kaldor-Hicks criterion, we have to see
will still be better off than before.” whether the individual A who gains with the movement
Prof. J.R. Hicks supported Kaldor for employing from position Q to position T could compensate the
compensation principle to evaluate the change in social individual A who is loser and still be better off than
welfare resulting from any economic reorganisation that before.
benefits some people and harms the others. This Now, it will be seen from Figure 1 that utility
criterion states that, “If A is made so much better by the possibility curve DE passes through points R, G and S.
change that he could compensate B for his loss and still This means that by mere redistribution of income
have something left over, and then the reorganisation is between the two individuals, that is, if individual B
unequivocal improvement.” gives some compensation to individual A for the loss
In other words, a change is an improvement if the suffered, they can move from position T to the position
losers in the changed situation cannot profitably bribe R.
the gainers not to change from the original situation. It is evident from the figure that at position R
Hicks have given his criterion from the losers’ point of individual A is as well off as at the position Q but
562U | Economics (NET)
individual B is still better off as compared to the position utility possibility curve and Q represents the position at
Q. It means due to a policy change and consequent which the two individuals are initially placed. Now,
movement from position Q to position T, the gainer suppose utility possibility curve shifts outward to the
(individual B) could compensate the loser (individual A) new position, U’V, and the two individuals are placed at
and is still better off than at Q. point R on it.
Therefore, according to Kaldor-Hicks criterion, In movement from Q on the utility possibility curve
social welfare increases with the movement from UV to point R on the utility possibility curve U ‘V’ the
position Q to position T, because from T they could utility of A has increased and that of B has declined. But
move to the position R through mere redistribution of position R denotes greater social welfare on the basis-of
income (i.e., compensation). Kaldor’s criterion when compared to the position Q on
It is noteworthy that, according to Kaldor-Hicks the original utility possibility curve UV because with
criterion, compensation may not be actually paid to UV as the utility possibility curve it is possible to move
judge whether or not social welfare has increased. It is through mere redistribution of income from position R
enough to know whether the gainer could compensate to position S where the individual B has been fully
the loser for the loss of welfare and still be better off. compensated for his loss of utility, the individual A is
still better off as compared to position Q. To conclude,
Whether redistribution of income (that is, payment any change in the economy that moves the individuals
of compensation) should be actually made following the from a position on a lower utility possibility curve to a
change in policy is left for the Government to decide. If position on a higher utility possibility curve increases
it is possible for the gainer to compensate the loser and social welfare.
still be better off, the economists can say that social
welfare has increased.
Y
It may be noted that gainer can compensate the
losers and still be better off only when the change in U′
economic policy leads to the increase in output or real U
income. That is why Kaldor and Hicks claim that they
have been able to distinguish between changes in output
from change in distribution.
When their criterion is satisfied by a change in the
situation, it means that the economy has moved to a
Fig. 2. Kaldor-Hicks Welfare Criterion
potentially more efficient position and as a result social
welfare can be said to have increased. Now, whether
redistribution of income is actually made through
Valuation of Environmental Goods
payment of compensation by the gainers to the losers, Valuation can simply be defined “as an attempt to
according to them, is a different matter. put monetary values to environmental goods and
services or natural resources”. It is a key exercise in
Now, the implications of Kaldor-Hicks criterion
economic analysis and its results provide important
become more clear if through redistribution the position
information about values of environmental goods and
of the two individual changes from T to G (see Fig. 1). It
services. This information can be used to influence
is quite manifest that at position G both the individuals
decisions about wise use and conservation of forests and
A and B are better off than at the position Q. Thus, the
other ecosystems. The basic aim of valuation is to
position T to which the two individuals moved as result
determine people’s preferences by gauging how much
of a certain change in economic policy is superior to the
they are willing to pay (WTP) for given benefits or
initial position Q from the viewpoint of social welfare,
certain environmental attributes e.g. keep a forest
since from position T movement can be made merely
ecosystem intact. In other words, valuation also tries to
through redistribution of income to position G where
gauge how much worse off they would consider
both are better off as compared to the position Q.
themselves to be as a result of changes in the state of the
It may be noted that in the situation depicted in environment such as degradation of a forest.
Figure 1, the change in economic policy brings about a Economic valuation never refers to a stock, but only
movement from a position inside the utility possibility the change in a stock. If one speaks of the economic
curve to a point on it. Now let us see what happens to value of biodiversity, then one always means the
social welfare if as a result of the adoption of a certain economic value of a change of biodiversity. It is not a
economic policy the utility possibility curve moves question of determining the ‘true’ value of biodiversity
outward and the two individuals move from a point on a or ecosystems but valuing changes and comparing
lower utility possibility curve to a point on a higher them with their alternatives, e.g. with a golf course vs
utility possibility curve. without a golf course. Thus it is non-sense to ask “how
It can be shown that, according to Kaldor-Hicks much are the African National Parks worth?”. A
criterion, such a movement causes an improvement in plausible question in this case would be : ‘WWF has
social welfare. Consider figure 2, UV is the original proposed a new policy to prevent the huge losses of
Economics (NET) | 563U
wildlife species from African National Parks. What is writings, An Essay on the Principle of Population.He
the monetary value of the benefits of this policy (i.e., the believed that through preventative checks and positive
economic damages avoided)? Economists thus stress checks, the population would be controlled to balance
that the valuation should focus on changes rather than the food supply with the population level. These checks
levels of biodiversity or ecosystem. Non-economists would lead to the Malthusian catastrophe.
have frequently tried to value biodiversity levels, for 1. Population and Food Supply—Thomas Malthus
instance, the recent example of value assessment of theorized that populations grew in geometric progression.
ecosystem services and natural capital for the entire A geometric progression is a sequence of numbers
biosphere level . However, economic-theoretical support where each term after the first is found by multiplying
for such a valuation approach is weak. The reasons are the previous one by a fixed, non-zero number called the
that willingness to pay (WTP), or willingness to accept, common ratio. For example, in the sequence 2, 10, 50,
are based on compensation or equivalence variations 250, 1250, the common ratio is 5.
of a change, and that change should be relatively small Additionally, he stated that food production
in comparison with income levels. increases in arithmetic progression. An arithmetic
The policy relevance of valuation information is progression is a sequence of numbers such that the
extensive, but might include : difference between the consecutive terms is constant.
● demonstrating the value of biodiversity: awareness For example, in series 2, 5, 8, 11, 14, 17, the common
raising; difference of 3. He derived this conclusion due to
● land use decisions: for conservation or other uses; the Law of Diminishing Returns. From this, we can
● setting priorities for biodiversity conservation conclude that populations will grow faster than the
(within a limited budget); supply of food. This exponential population growth will
lead to a shortage of food.
● limiting biodiversity invasions;
2. Population Control—Malthus then argued that
● assessing biodiversity impacts of non-biodiversity
because there will be a higher population than the
investments; availability of food, many people will die from the
● determining damages for loss of biodiversity: shortage of food. He theorized that this correction would
liability regimes; take place in the form of Positive Checks (or Natural
● limiting or banning trade in endangered species; Checks) and Preventative Checks. These checks would
● revising the national economic accounts; lead to the Malthusian catastrophe, which would bring
● choosing economic instruments for saving the population level back to a ‘sustainable level.’
biodiversity (e.g. taxes, subsidies). (A) Positive Checks or Natural Checks—He
Valuation has an important role to play in environ- believed that natural forces would correct the imbalance
mental planning and management activities because it between food supply and population growth in the form
helps to answer many questions including the following of natural disasters such as floods and earthquakes and
about any given natural resource : human-made actions such as wars and famines.
● What is the value of conserving a certain natural (B) Preventative Checks—To correct the
resource (e.g. forest)? (see for example Box 5) imbalance, Malthus also suggested using preventative
● To whom does the value accrue? measures to control the growth of the population. These
● How does degradation and loss of the natural measures include family planning, late marriages, and
resource lead to costs to different segments of celibacy.
society?
● Who gains and who loses when a natural resource is
conserved or degraded?
Food Supply
● How can natural resource conservation be
Population
At the point where
efficiently and equitably financed? population reaches
ply
● How can people be motivated to take into account up its limit of food
ods tio
n
supply there will be
natural resource benefits and costs of its loss in the Fo p ula
Po war, famine and
course of their economic activities. disease.
● How can policy, planning and decision making with
regard to natural resources be better influenced? Time
Malthusian Theory is criticized on the following
Theories of Population grounds—
Malthusian Theory of Population 1. Population Growth—The gloom and doom
The Malthusian Theory of Population is a theory of forecasts put forward by Malthus have not played out. In
exponential population growth and arithmetic food Western Europe, populations have grown (not at the rate
supply growth. Thomas Robert Malthus, an English Malthus predicted) and food production has also risen
cleric, and scholar published this theory in his 1798 because of technological advancements.
564U | Economics (NET)
2. Food Production—Thanks to many technologi- there are two classes of people—the bourgeoisie
cal advancements, food production has dramatically (capitalists) and the proletariat (the workers)
increased over the past century. Often, the food ● To Malthus, population was an independent variable
production rate has grown higher than the population creating distress (poverty).
growth rate. For example, during the 1930s in the US, ● To Marx, population was the dependent variable.
25% of the population worked in the agricultural sector
while the total GDP was less than $100 billion to Birth rate
(per 1,000 people per year)
the GDP. Today, less than 2% of the population works 40
Birth and death rates
in the agricultural sector while the total GDP is over $14 Death rate
trillion. 30
3. Global Trade—The limited availability of land Natural
20 Increase
at the time was the basis for Malthus’ theory on food
production constraints. However, thanks to globalization Total
we can trade good and services for food, which increases 10 Population
the amount of food a country can consume. Natural
4. Calculations—Malthus did not provide calcula- decrease
tions for the geometric growth of populations and the Stage 1 Stage 2 Stage 3 Stage 4 Stage 5
arithmetic growth of food. Since then, experts have
Demographic Transition
pointed out that the growth rates are not consistent with
Malthus’ predictions. According to Karl Marx—
● Capitalism is the main cause of poverty, not the
Demographic Transition Theory population.
postindustrial. Demographic transition theory ● Regardless of fertility level, bourgeoisie benefits the
(Cald well and Caldwell 2006) suggests that future most – Population growth can be a problem
population growth will develop along a predictable four ● However, the potential difficulty can be regulated in
stage model. communist society Source: Poston,
Stage 1—Birth, death, and infant mortality rates are ● Each society at each point in history has its own law
all high, while life expectancy is short. of population that determines population growth.
Stage 2—As countries begin to industrialize, they ● For capitalism, the consequences are overpopulation
enter Stage 2, where birthrates are higher while infant and poverty.
mortality and the death rates drop. Life expectancy also ● For socialism, population growth is readily absorbed
increases. by the economy with no side effects.
Stage 3—It occurs once a society is thoroughly Thomas Doubleday’s Diet Theory—Thomas
industrialized; birthrates decline, while life expectancy Doubleday, a social philosopher and an English econo-
continues to increase. Death rates continue to decrease. mist, was born in 1790. He expressed his views regarding
various natural laws which govern population. According
Stage 4—In the final phase, we see the post
to him, the rate of population increase will be less when
industrial era of a society. Birth and death rates are low,
the quantity of food supply is greater.
people are healthier and live longer, and society enters a
phase of population stability. Overall population may It means that the increase in population and food
even decline. For example, Sweden is considered to be supply are inversely related. Doubleday mentions two
in Stage 4. states of food supply, i.e., (i) The Plethoric state having
good food supply where the fertility is low, and (ii) the
The United Nations Population Fund (2008) cate-
Deplethoric state in which due to food shortage we find
gorizes nations as high fertility, intermediate fertility, or
diminution of proper nourishment where the fertility is
low fertility. The United Nations (UN) anticipates the
high.
population growth will triple between 2011 and 2100 in
high-fertility countries, which are currently concentrated According to Doubleday, fertility is affected by
in sub-Saharan Africa. For countries with intermediate leanness in all plants and animals. An overfed plant can
fertility rates (the United States, India, and Mexico all be revived only when the plants are depleted either by
fall into this category), growth is expected to be about ringing the bark or by extreme lopping or the trenching
26 per cent. And low-fertility countries like China, of the roots.
Australia, and most of Europe will actually see Besides, the sterility in plant life is possible when
population declines of approximately 20 per cent. The the application of fertilizers is excessive. He also
graphs below illustrate this trend. believes that thin birds or animals give birth to more
offspring, while bulky or fat birds or animals give birth
Karl Marx’s theory of Population to less. Similarly, this becomes true about trees and
Karl Marx, an economist and philosopher, disagreed plants. It means that fertility depends on the fatness of
with Malthus about his theory. According to Karl Marx living beings, according to Doubleday.
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Moreover, Doubleday also observes that high the excess estrogens which the ovaries throw into the
fertility has been found in those persons who are blood stream. Fatty degeneration of the liver and the
vegetarians, or who eat more rice or whose staple diet is tendency to cirrhosis are some of the characteristic result
rich, whereas fertility will be low in non-vegetarian of protein deficiency when degeneration of the liver
persons. occurs, it begins to operate less efficiently, and is less
Doubleday divides society into three groups— effective at its job of inactivating excess oestrogents.
The result is a marked increase in the women’s
(1) The first group includes those who are in a state
reproductive capacity.”
of affluence and are well supplied with luxuries. Their
number is on constant decrease. While the number of Michael Thomas Sadler’s Destiny Theory—
those who are engaged in mental or physical activities Michael Thomas Sadler, an Economist and a British
and are living busy life, is on the increase. social reformer, was born in 1780. He was a contem-
(2) The second group consists of the poor people porary of Malthus. He expressed his ideas about
who have less supply of food. Their number is increasing population in his book ‘The Law of Population’.
rapidly. In other words, the constant increase in According to Sadler, the law which regulates the growth
population is found in the group where people are worst of animals and plants is primarily the same as the law
supplied with food. This happens in all societies. which regulates the growth of human population.
(3) The third group has those people who form the He was of the opinion that “The fecundity of human
mean and median between two opposite states and who beings is in the inverse ratio of the condensation of their
numbers.”
fall under the average income group and those who are
tolerably well supplied with good food or who get a Moreover, the fertility rate decreases with the
normal diet and do not overwork and yet are not idle. increase in the density of population. In the agriculture
Their number is stationary. based or pastoral countries where the density of
Doubleday concludes that “it is upon the numerical population is low, the fertility rate of the population
proportion which these three states bear to each other in becomes high. In such countries, people have the
any society that increase or decrease on the whole capacity to work hard and hardworking people give birth
depends.” to more children.
Jouse De Castro’s Protein Consumption With the passing of time, when there is industriali-
Theory— sation and the population becomes more civilized and
literate, the density of population increases. Here people
ouse De Castro expressed his views in his famous would limit the size of family and in such socio-
book The Geography of Hunger regarding the economic conditions they will be happier and there will
correlation between the fertility and the consumption of be prosperity.
protein. Castro accepted the findings of R.J. Solankar
who conducted experiments on rats in 1920. In these Sadler was a great critic of Malthus. He did not
experiments Solankar found that with the increase in accept Malthus’s view that population increases in
geometrical progression and food supply increases in
protein consumption in diet, the fecundity will decrease
arithmetical progression. According to Sadler, such
and it will increase with low protein content in diet.
increase of population and food supply in mathematical
His experiment led to the following conclusions— terms just cannot happen, because when population
(i) When 10 per cent protein was given to a female increases density too will increase.
rat, per mated female rat gave 23·3 births; And when density increases, the capacity to produce
(ii) When 18 per cent protein was given to each children goes down and thus with the increase in
female rat, per mated female rat gave 17·4 births; and density, the fertility rate declines. He believed that
(iii) When the quantity of protein was increased to a population adjusts itself with the times.
level of 22 per cent to each female rat, the birth per He did not accept the fear of Malthus that positive
mated female rat reduced to 13·8 births. checks by nature take place with the growth of
Through these experiments Castro came to the population. He also did not believe in the preventive
conclusion that the fatness is affected by the measures of birth control described by Malthus. Sadler
consumption of protein. The fatness increases with the was very optimistic and he tried to establish a link
protein rich diet, which leads to lower fertility. This between population and food supply.
concept of Castro is similar to the Doubleday’s diet He was of the view that if the fertility rate of
theory that the rate of population increase is influenced population increases, people will be able to produce
by food supply. food according to their needs and the food supply and
Moreover, Castro also found a direct relation population will get adjusted to each other.
between the functioning of the liver and that of the Sadler also believed that when the density of
ovaries. population increases the unhealthy atmosphere also
In the words of Castro, “It is known that there is a increases which leads to the increase in the death rate.
direct connection between the functioning of the liver Further, if the death rate is high, it will lead to increase
and the ovaries, the role of the liver being to inactivate in the birth rate. This happens to compensate for the loss
566U | Economics (NET)
of population. And if the death rate is low, the birth rate thousands, while big compound cells in hundreds and
also goes down still bigger cells lose their productive capacity. In the
Herbert Spencer’s Biological Theory—Herbert same manner, Spencer explained the fertility of human
Spencer, a famous English philosopher and sociologist, beings.
propounded the biological theory of population in his According to him, people can be divided in three
book The Principles of Biology. Spencer argued that groups—
fecundity decreases when the complexity of life (i) Poor people who live a simple life whose fertility
increases. is high;
According to him, changes in the growth of popu- (ii) Middle class people whose fertility is corres-
lation occur due to natural change in the reproductive pondingly low; and
capacity of human beings. Therefore, his theory has (iii) People who live developed or complex life
been known as a natural theory of population which is whose fertility is fairly low.
similar to the theory of Sadler and Doubleday.
According to Spencer, in societies where people,
Spencer believed that “there exists antagonism especially woman, are educated and belong to rich
between individuation (survival) and genesis (repro- families, their reproductive power is low, as compared to
duction)”. When any individual does hard work for his the poor who are uneducated and whose reproductive
personal development at his work place, the desire for power is high.
reproduction decreases.
In the words of Spencer, “In its full sense, the
In other words, when more energy has been utilised reproductive power means the power to bear a well-
for one’s self-development, the energy available for developed infant, and to supply that infant with the
reproduction will be less and consequently the population natural food for the natural period. Most of the flat
growth will be less. Thus, with the development of chested girls who survive their high- pressure education
society and for one’s success and survival (individua- are incompetent to do this. Were their fertility measured
tion), life becomes more complex which results in by the number of children they could rear without
reduction in the capacity of reproduction. artificial aid, they would prove relatively very infertile.”
This is observed from the fact that fertility is more Spencer believed that if population increases we get
in rural individuals whose life is not complex, whereas more manpower through which natural resources can be
fertility is low in an industrial society where life is more exploited and the socio-economic and cultural standards
complex, the pressure of education is more and the of the people can be raised. Thus, he was of the opinion
brains are overtaxing. that increase in population was beneficial rather then
We have four different situations which explain harmful.
the relation between individuation and genesis— Further, as per Spencer, a determining factor for
(i) The individuation will automatically below when birth rate and death rate is longevity. The expectancy of
there is high genesis. This situation we find among the life increases and the death rate decreases when life
poor. becomes more complex. He, therefore, suggested
(ii) The genesis will be low when there is high increase in life expectancy in order to reduce the birth
individuation. Such a situation we find among the rich. rate.
Corrado Ginnis’s Biological Population Theory—
(iii) The individuation will improve when the Corrado Ginnis, a sociologist, was born in Italy in 1884.
genesis is low. He had deep interest in the study of population changes
(iv) The genesis will be high when the individuation which affect the evolution of society and that of a
is low. In poor people, we find less individuation and nation. According to Ginni, fertility will be very high in
more genesis. a nation when it is in the primary stage. Due to high
Moreover, because of high fertility the individuation fertility, the population increases and consequently
will be low and therefore the death rate will increase. At social and economic problems become complex.
the same time because of low individuation, the Further, the problems of trade and industry also
expectancy of life will also decrease. To Spencer, the become more complex.
expectancy of life can be increased, when the birth rate At this time, fertility starts declining. “He thought
decreases. that the evolution of a nation or any society was closely
Spencer’s theory of population is based on the linked to the changes in their rates of population growth
theory of evolution. According to Spencer, the fertility and to the varying propositions of this growth coming
rate is higher in small creatures. In the words of Spencer, from the different social classes.”
“The minutest organisms multiply asexually (without Ginni was of the opinion that only biological factors
sex) in their millions.” Many small cells do not reach the are responsible for the increase in population and
maturity period. therefore his theory of population can be characterised
If this happens and small cells grow in number as a natural law theory. According to Thomson and
twice or thrice, population will rapidly increase and Lewis, “Ginni invokes some mystical biological changes,
multiply itself. Small compound cells get increased in quite beyond man’s control, as the basic factors deter-
Economics (NET) | 567U
mining not only man’s quantitative growth, i.e., his In the words of Dumont, “The development of
fertility, fecundity, and survival but also his qualitative number in a nation is in inverse ratio to the
development, i.e., the distinctive characteristics of man’s development of individual.”
different civilization.” According to him, “The direct cause of decline in
Moreover, the biological traits of population change birth rate was the movement of individual from the
at various rates of increase in the different classes of lower to the upper class. The individual tends to rise to
population. According to Ginni, “There is first a period higher levels in his social environment by process
of slower growth and mature achievement which, in similar to physical capillarity.” Further, “what gravity is
turn, passes into a period of senescence, during which to the physical world, capillarity is to the social order.”
numbers decline and the quality of utilization deterio- According to Dumont, there are three principles
rates.” of population that are related to the stages of social
Ginni was of the view that social and economic development—
factors can influence the population growth but the 1. In the preventive stage, the Malthusian theory of
reasons for the increase or the decrease in population population applies where human beings live like animals.
growth are only biological. Thus this theory is based on On what they can find, they increase in geometrical
biological aspects. progression.
According to Thomson and Lewis, “Ginni believed 2. In the intermediate stage, Quillard’s principle of
that the biological factor in declining fertility was the population applies. According to this, “Population
fundamental factor, that it really underlays the influence proportions itself automatically.” In such a society,
of economic and social factors, which only apparently population increases as food supply increases because
determined the decline in fertility.” population can produce food itself. Here positive checks
do not become necessary.
Ginni believed that the population growth is similar
to the cyclical growth of an individual. In the first stage, 3. In a modern civilised society, Dumont applies his
the growth of population is very rapid while in the social capillarity principle. In such a society, every
second stage, the growth is comparatively slow. In the individual wants to achieve higher economic and social
third stage which is known as senescence, population status. For this, a small family is imperative, because
decreases and there is deterioration in the quality of one cannot climb high on the social ladder with the
civilization. burden of more children on its back.
As pointed out by Thomson and Lewis, “Every When an individual earns more income and wealth,
nation in its youth is simple and undifferentiated in his ambition for better position and higher social
structure and has a high rate of fertility, because each prestige goes up and consequently the number of
generation springs from the people who are hereditarily children decreases. Therefore, in a civilized society due
most prolific, i.e., highly fecund.” to social capillarity, fertility goes down. When people
migrate to cities from rural or backward areas, their
Ginni was of the opinion that due to high fertility fertility declines.
population increases and consequently social and
economic problems become complex. Along with that Thus social capillarity has direct relation with social
industrial and trade problems also become more development, and birth rate and social capillarity are
complex, the pressure of population is ultimately inversely related to each other. The number of children
reduced through war or colonisation or both. is less when people become more civilized. In the words
According to Ginni, first the fertility rate declines of Dumont, “Just as a column of liquid must be thin in
among the rich. After that when the energetic and order to rise under the force of capillarity so must a
prolific poor people enter the rich class, their fertility family be small to rise in the social scale.” According to
also decreases. When the whole society or country Dumont, the poor can achieve capillarity if they divert
becomes rich, there is decline in population growth due their time, energy and wealth for vertical mobility.
to the weakening of the reproductive instinct. This is possible only when they restrict their families
Ginni concludes—“It is a providential mechanism to one or two children. According to him, the birth rate
for the elimination of those family stocks which have in rural areas is high while it is low in urban areas. The
fulfilled the cycle of their evolution.” reasons for high birth rate in rural areas are poverty,
Dumont’s Theory of Social Capillarity—Arsene illiteracy, orthodoxy and lack of vigour.
Dumont (1849-1902) has propounded the Theory of The reasons for low birth rate in urban areas are
Social Capillarity. Social attraction or repulsion to a people’s ambition for vertical mobility, liberal
thing is known as Social Capillarity. Dumont studied the environment, high standard of living, more income and
growth of population in France in the later part of wealth, capacity of rational thinking, high socio-
nineteenth century and found that the reason for low economic status of women, progressive ideals, high cost
fertility in France was high intellectual and aesthetic of living, the desire of middle class to move into the
development. upper class, etc.
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As enough opportunity for social capillarity is not Leibenstein explains these three effects in relation
available in a socialist society, Dumont believes that to the utilities and costs during the process of economic
socialism leads to the destruction of social capillarity. development. We first explain the per capita income
Leibenstein’s Motivational Theory of Population effect in figure.
Growth—Leibenstein’s theory of population growth
Utility or Cost Attributable to
a Child of Given Birth Order
Direct and
forms part of his Critical Minimum Effort Thesis on Indirect Cost
economic development. It is based on his empirical
evidence that the rate of population growth is a function
of the level of per capita income which, in turn, depends C
Consumption
on the stage of economic development. Utility
S S
Leibenstein’s view is based on Dumont’s “Social- Pro ecurity Utility
capillarity Thesis” which states that with the increase in du
Ut ctiv
ilit e P
per capita income, the desire to have more children as 45° y
productive agents declines. O Per Capita Income
This means that as per capita income rises with Per capita income of the family is shown on the
economic development, the fertility rate declines. horizontal axis while utilities and costs per child are
Similarly, the mortality rate also declines, as there is taken on the vertical axis. The consumption utility curve
improvement in public health measures with economic is assumed as constant because it is independent of the
development. But the decline in the mortality rate is fast family per capita income. It is the pleasure and
as compared to the decline in the fertility rate. This satisfaction that the parents get in rearing a child which
creates a “fertility gap” which continues to widen for has nothing to do with their per capita income. This is
quite some time. shown by the horizontal curve C in the figure.
Leibenstein explains the fertility gap in terms of the The curves S and P depict security utility and
cost-benefit analysis of bringing up an additional child. productive utility respectively which decline as the per
There are three types of benefits or utilities which capita income increases. As the per capita income
parents derive from an additional child. increases, parents become wealthier to provide for their
They are—(a) consumption utility which they get own security and depend less on the child in old age.
out of love and pleasure by rearing a child; Similarly, as the per capita income increases, there
(b) productive utility when the child starts earning is no need for the child in the family to earn during
from childhood and is a source of income for his childhood in order to support the family. Schooling is
parents; and extended and the child is less valuable as a productive
agent. Thus the P curve also slopes downward as per
(c) old age security utility which the child possesses capita income increases.
when he supports his parents in old age who are unable
The direct and indirect costs of bringing up an
to earn.
additional child increase in proportion to the rise in per
The costs of bringing up an additional child are of capita income of the family. This is shown by the 45°
two types – direct and indirect. The direct costs relate to straight line curve through the origin.
expenditure on feeding, clothing, education, etc. These So far as the survival effect is concerned, the
expenses are incurred by parents till the child starts increased survival rates raise the three utility curves. The
earning and become self-supporting. reason is that when an additional child is expected to
The indirect costs relate to the opportunities survive for long years of life, there are more expected
foregone by parents when an additional child is born. years of satisfaction for the parents. But the survival
Such opportunities foregone are earnings lost by the effect reduces the motivation to have an additional child
mother during and after the pregnancy, less social and on the part of parents.
spatial mobility of parents due to additional Lastly, the occupational distribution effect adds to
responsibility in bringing up the additional child, etc. the direct and indirect costs of an additional child. As
Lack of spatial mobility means potential loss of per capita income increases, economic and social
income. On the whole, the cost of bringing up an mobility increases. There is spread of urbanisation and
additional child is less to parents with low per capita specialisation which lead to the expansion of job oppor-
income and high with high per capita income. tunities. Parents are required to provide professional and
There are three types of effects which influence the costly education to the children. This prohibits parents to
utilities and costs of bringing up an additional child have an additional child.
during the process of economic development. They are Leibenstein’s motivational theory, as explained
the income, survival and occupational distribution above, is closely related to the different stages of
effects. With economic development, as per capita economic development. To start with, at the subsistence
income increases, the chances of survival increase and equilibrium level of income, fertility and mortality rates
there are changes in the occupational distribution. are the maximum consistent with the survival rate of
Economics (NET) | 569U
population. If the per capita income is raised above the population growth starts declining. Point e is the 3 per
subsistence equilibrium position, the mortality rate falls cent maximum biologically determined growth rate of
without any drop in the fertility rate. The result is an population assumed by Leibenstein. OYe is thus the
increase in the growth rate of population. critical minimum per capita income level which can
Thus, an increase in per capita income tends to raise sustain itself and generate the process of sustained
the growth rate of population. But it is only up to a economic development.
point. Beyond that the increase in the per capita income
lowers the fertility rate and as development gains Concepts and Measures : Fertility, Mor-
momentum, the rate of population growth declines. This bidity and Mortality
is because with the increase in per capita income, the Crude Birth Rate
desire to have more children to supplement parental This measure is a simple ratio of the number of
incomes, declines. births in a particular period (usually a year) divided by
Increased specialization following rising income the total population size.
levels and the consequent social and economic mobility Crude Birth Rate
make it a difficult and costly affair to rear a large family.
Birth in a stated period
Therefore, the growth rate of population becomes = × 100
constant and then starts declining gradually as the Mean population over that period
economy advances towards the path of sustained The denominator is technically the person-years
development, as has happened in the case of Japan and lived in the year, but this is usually estimated as the
Western countries. mid-period population, which is itself estimated as the
There is, according to Leibenstein, a biologically mean of the population at start and end of the period.
determined maximum growth rate of population between The CBR is commonly quoted per 1,000 population.
3 and 4 per cent. In order to overcome this population It is a measure well suited to construction from vital
hump, there should be a larger increase in per capita registration providing the numerator and census data
income. This is discussed with the help of figure where providing the denominator. As such it is easily and
the rate of population growth or national income growth accurately calculated in developed countries with well-
is measured along the horizontal axis and level of per developed vital registration systems and good census
capita income on the vertical axis. data. It is less well estimated from survey data , although
it can be done.
Level of per Capita Income
Y
P N The denominator needs to be an average population
size for the period concerned and this is often estimated
Ye e as a mid-year population – that is the average of the
population at the start of the period and at the end of the
Yc c period.
g
Yb Child/Woman Ratio
b
This simple measure is not an accurate measure of
a fertility, it is more a measure of population structure.
But it has its uses, one being that it is very easy to
X
O 1% 2% 3% calculate in simple small area surveys and therefore
Rate of Population Growth or quite attractive to certain NGOs wanting to make a
of National Income Growth simple assessment of the burden of support that young
The curve N measures the level of per capita children place on families in a community.
income which generates a level of national income It is constructed as follows, for a stated period or
growth equal to the growth rate of population. The curve from a cross-sectional survey—
P indicates the rate of population growth at each level of Living children aged 0 – 4
Child/Woman Ratio =
per capita income. Starting from point a which Women aged 15 – 49
represents the subsistence equilibrium point where there Its problem as a true measure of fertility is with the
is absence of population and income growth, if the per numerator – it misses children who have died. In a high
capita income is raised to OYb, the population growth mortality situation numbers of these could be substantial
rate is 1 per cent, while the income growth rate is less and fertility will therefore be underestimated.
than 1 per cent. At the OY c level of per capita income, So as a fertility measure it is rather rough-and-ready
the rate of population growth is higher than the rate of but it can still tell you about the burden of children in a
national income growth, i.e., ycg>ycc, the former is 2 community. It is also used demographically as a measure
per cent while the latter is 1 per cent. of "youngness" in a population and is useful for that
Therefore, the per capita income level should be so purpose. Another advantage of its simplicity is that it
raised as to increase the national income by more than can be constructed from census data alone; it does not
the rate of population growth. This is only possible after require information about births – but that means that it
OY e level of per capita income whence the rate of is not a true fertility measure.
570U | Economics (NET)
It is normally a figure below one – considerably usually there are very few births in this range and it adds
below one for low fertility countries, just under one for little advantage – but be aware that it can be done.
high fertility countries. This may seem a low figure for The construction of the first rate of the series would
high fertility countries but even in these countries more be—
than two children below 5 at any one time is relatively Age – specify fertility rate 15 – 19
uncommon and this will be offset by numbers of very Births to women aged 15 – 19 in a stated period
young women with no children and a considerable =
Number of women aged 15 – 19 in the same period
number of older women with no children under age 5.
and the other six rates would be constructed accordingly.
High fertility countries are also likely to have higher
Quite often they are expressed per thousand women i.e.,
rates of child mortality, which would further reduce the
multiplied by 1,000 but this is not essential.
ratio.
General Fertility Rate The Total Fertility Rate
Useful as it is to see patterns there comes a time
This measure addresses the crude nature of the CBR
when it would be nice to have a single measure of
by focusing on that section of the population at risk of
fertility that captures all the information in the ASFRs –
having births – women aged 15-49.
this is the Total Fertility Rate (TFR) – and is a very
It is constructed as follows— important measure.
General Fertility Rate Its importance is due to the fact that it is a measure
Births in a stated period that is effectively independent of age structure and so
= measures fertility – the number of births that women
Number of women aged 15 – 49 in the same period
give birth to – in a purer way than measures mentioned
It can easily be constructed from vital registration,
so far, devoid of confounding factors such as different
census or survey data and does not rely on exact ages
proportions of women at particular ages. This means that
(except at beginning and end of age range).
TFRs can be compared internationally without concern
This measure is a step above the previous two about age structure effects. This is very useful and the
measures and a potentially useful and reasonably TFR is the standard way to compare fertility levels
accurate measure of fertility because the numerator and internationally.
denominator are focused and well specified and the Total Fertility Rate = ∑a = 17ASFR × 5
denominator is truly those at risk of producing the where—a = 1 - 7 refer to the seven 5yr age groups
numerator.
It is worth talking through this equation. Quite
The General Fertility Rate (GFR) has specific uses simply it is constructing each of the seven ASFRs and
in certain circumstances when one wants to know a total then summing them. The result is multiplied by five –
number of births for all women in the fertile ages. An why? Because the age groups are 5 years wide and each
example would be in calculations of maternal mortality ASFR represents the babies one woman will have at a
– see PAPP104_S01. But in general it is not widely used
particular single-year age, say age 30. But another
because it still suffers a disadvantage concerning the
woman aged 31 will be having the same fertility and
structure of the population – similar to the problem with
indeed there will be five woman-years of experiencing
the CBR although on a smaller scale.
that level of fertility – hence the multiplication by 5. The
This problem is that the fertile ages – nominally 15- multiplication adjusts the sum of the ASFRs so that they
49 years – is 35 years wide and so within that range then simulate a cohort, albeit a hypothetical one.
there can be substantial differences in age structure
It is possible to use single year age groups, although
between populations. Because fertility is concentrated at
this is not common. In that case there would be 35
certain ages populations can appear to have different ASFRs to be calculated and summed – but there would
levels of fertility simply because they have different age be no need for multiplication.
structures between ages 15-49 years. For international or
secular comparisons one wants to have a measure that is Nowadays the TFR is conventionally expressed as a
independent of age structure and the GFR is not quite figure relating to a single woman. For nations it mostly
there. We need to move on to the Total Fertility Rate ranges between about 1·5 to 6. Historically it could
and a precursor to that is the construction of Age- range up to about 8 but that is unusual today. However,
specific Fertility Rates. for selected communities it is quite possible to have
TFRs both higher and lower than the normal range.
Age-specific Fertility Rates The highest recorded and verified TFR is that of the
To examine fertility in detail it is necessary to North American Hutterite religious community during
construct age-specific fertility rates (ASFRs). These are the 1920s. This was 9·2 for all women and 12·4 if only
simply fertility rates limited to certain age-groups of married women were used for the denominator. The
women. The groups could be of any width, or single latter figure is an example of a Total Marital Fertility
years of age, but the convention is to form seven 5-year Rate (TMFR) and has been used as a standard for very
age groups, which cover the range 15-49 years. One can high (but verified) fertility. Marital (including
add an eighth group of 10-14 year old women but cohabiting) fertility is naturally a considerably higher
Economics (NET) | 571U
figure than the general TFR because it utilises only distribution of a illness can aid in controlling its spread
women who are in family-forming partnerships. The and, in some cases, may lead to the identification of its
measure has its uses but it is not so common a figure as causes. Following indicators are used to measure
the general TFR. morbidity :
Incidence Rate—It measures rapidity of a particular
Parity Progression Ratios disease. It is expressed in number of persons contracting
The most widely used measures of fertility are a disease during a given time period per 1000 population
period measures - age-specific fertility rates and the total at risk. It refers only to new cases during a defined
fertility rate (TFR). These are very useful measures but period. High incidence rate means high risk for the
they do suffer from one failing - they are not very good population. For example
at detecting real changes in fertility in the short term. Incidence for malaria will be given by—
That is because they are affected by the timing of births Number of persons developing
(tempo effects). malaria during a given time periodX k
In developed countries one cannot be completely =
Population at risk
sure, for several years, that an apparent decline in Prevalence Rate—It tells about extent/ Status of a
fertility is not at least partially due to delaying of births particular disease at a point of time. It is expressed in
until older ages, to fit in with careers and a fashion for number of persons who have a particular disease/
establishing households and financial security before condition at a given point in time per 1,000 population.
childbearing. Of course there is often a concurrent It provides a snapshot of an existing health situation. It
real fertility decline as well, not least because delaying includes all known cases of a disease that have not
childbearing until later ages reduces the time in which to resulted in death, cure or remission. High prevalence
conceive and bear many children, and takes some rate shows the chronic condition of disease in the area.
women past periods of optimum fecundity. But even if For example Prevalence of HIV/AIDS among adults
women end up having the same number of children as at a given point in time will be
women of an earlier cohort (i.e., fertility remains
Number of persons in the age
constant), delaying having those births will produce
group 15-49 with HIV/AIDS Xk
an apparent drop in fertility as measured by period rates, =
at least for a while. Total population in age group 15-49
Concepts and Measures—Mortality
In developing countries too a phenomenon known
as the Potter effect can suggest fertility declines that are Crude Death Rate—CDR is the total number
in fact unreliable. In cultures where dates of birth are not of deaths to residents in a specified geographic area
considered important - and therefore children’s ages are (country, state, county, etc.) divided by the total
not accurately known - women asked in surveys to population for the same geographic area (for a specified
report dates of birth of recent borne children frequently time period, usually a calendar year) and multiplied by
push the date of birth back in time; that is, they report 100,000.
children as older than they really are. Researchers CDR =
calculating period fertility rates from these reports Number of Deaths in a Year in a particular Area
× 100
invariably see a declining trend in period fertility in the Mid year Population of that particular area
years leading up to the survey. This decline is of Standardize Death Rate—The standardised death
course false, only occurring because of misreporting of rate, abbreviated as SDR, is the death rate of a
dates, and raises false hopes of a real decline in fertility. population adjusted to a standard age distribution. It is
Period fertility is therefore affected by two different calculated as a weighted average of the age-specific
components of fertility - the timing of births, which death rates of a given population; the weights are the age
demographers call tempo effects, and the real level of distribution of that population.
(cohort) fertility, as measured by how many births a As most causes of death vary significantly with
woman eventually produces, which demographers call people’s age and sex, the use of standardised death rates
the quantum of fertility. improves comparability over time and between
countries. The reason is that death rates can be measured
It would therefore be useful to have measures of independently of the age structure of populations in
fertility that are largely insensitive to tempo effects. different times and countries (sex ratios usually are more
Parity progression ratios go a long way to meeting this stable).
need, and are also robust to misreported dates of birth. ∑ (Amx SP x)
They can be very useful when trying to establish SDRA = x ,
∑x SP x
evidence for real fertility decline as distinct from
apparent fertility decline produced by tempo effects on where, SDRA = age standardised death rate for
period measures. population in region A
A m = age specific death rate at age x last birthday
x
Concepts and Measures : Morbidity in population in region A
SP = the population exposed to the risk of death at
Morbidity refers to the diseases and illness, injuries, x
and disabilities in a population. Data on frequency and age x last birth day in the standard population
572U | Economics (NET)
Maternal Mortality—The definition of a maternal 3. Life Time Risk (L TR) of Maternal Death—
death according to the Tenth Revision of the Inter- LTR reflects the chances of a woman dying from
national Classification of Diseases follows: maternal causes over her 35 year reproductive life span.
“A maternal death is the death of a woman while In doing so, it accounts for the probability of a death due
pregnant or within 42 days of termination of pregnancy, to maternal causes each time a woman experiences a
irrespective of the duration and the site of the pregnancy, pregnancy. Although it is interpreted as a cohort
from any cause related to or aggravated by the measure, it is calculated using period data for practical
pregnancy or its management but not from accidental or reasons. For ease of interpretation, the reciprocal of the
incidental cause (WHO, 1993)”. L TR is more frequently used than the LTR itself. For
A pregnancy-related death is defined as— “A example, an LTR of ·028 is interpreted as—one in 35
pregnancy-related death is the death of a woman while women will experience a death from maternal causes
pregnant or within 42 days of termination of pregnancy, throughout her reproductive lifetime. The calculation of
irrespective of cause (WHO, 1993).”A pregnancy- L TR will vary according to the MM Ratio estimation
related death, therefore, is determined solely by timing technique selected. These differences are described
of death relative to pregnancy, childbirth, and the below in the notes on indirect and direct estimation.
postpartum period. However, two commonly used equations for the
approximation of LTR are—
A number of different indicators have been
developed for the measurement of maternal mortality. LTR = 35 × MM Rate
The four most commonly used indicators are following : (1 – LTR) = (1 – MMR)TFR
1. Maternal Mortality Ratio—The most commonly Infant Mortality Rate—Infant mortality rate,
used indicator is t h e maternal mortality ratio (MM abbreviated as IMR is the measure of number of death
Ratio), which is defined as— rates of infants (children) before reaching 1 year of age
Number of Maternal Deaths per 1000 live births. It can also be termed as child
MM Ratio = × 1,00,000
Number of Live Births mortality rate. This IMR rate statistics helps to identify
By expressing maternal deaths per live birth, rather and compare the health level of one country with the
than per woman of reproductive age, the MM Ratio was other one. Below is the IMR formula to find the child
designed to express obstetric risk. In fact, the MM Ratio death rate
overestimates obstetric risk by excluding from the Infant Mortality Rate
denominator pregnancies which do not terminate in a
Number of deaths in 0-1 year age group in a year
live birth, but which may be responsible for a maternal = × 100
Total number of live births
death. Though in theory it would be desirable to refine
the MM Ratio by including all pregnancies in the Neo-natal Mortality Rate—The NMR is a key
denominator, in practice, suitable data on pregnancies outcome indicator for newborn care and directly reflects
that do not result in a live birth are rarely available. prenatal, intrapartum, and neonatal care. In addition, as
Because the MM Ratio is not an age-standardized infant mortality rates decline, the proportion of infant
measure (as is the total fertility rate, for example), MM deaths that occur in the neonatal period typically
Ratios across countries are not completely comparable. increases. The NMR differs from the perinatal mortality
By convention, the MM Ratio is expressed per 100,000, rate in that it focuses only on deaths among live births
in contrast to all other mortality indicators which are and covers a longer period after birth. Information on
expressed per 1,000. live births is generally thought to be easier to obtain than
2. Maternal Mortality Rate—The MM Ratio is information on non-live births and is more widely
frequently, though erroneously, referred to as the available, because many population-based surveys such
maternal mortality rate (MM Rate). The MM Rate is an as the DHS typically only collect information on live
indicator of the risk of maternal death among women of births. Early neonatal deaths are more closely associated
reproductive age. It is the equivalent of a cause-specific with pregnancy-related factors and maternal health,
death rate. This indicator conceals the effect of differing whereas late neonatal deaths are associated more with
levels of fertility in cross-country comparisons. How- factors in the newborn’s environment.
ever, because it is a woman-based statistic, it does The number of neonatal deaths per 1000 live births.
provide an indication of the burden of maternal death in A neonatal death is defined as a death during the
the adult female population. The MM Rate is defined first 28 days of life (0-27 days).
as—
Number of Maternal Deaths Number of neonatal deaths × 1000
MM Rate = × 100 Total number of live births
Number of Women in the Age Group 15-49
The relationship between the MM Rate and the MM The NMR is often broken down into early and late
Ratio is as follows— mortality rates. The Early Neonatal Mortality rate
Maternal Mortality Ratio (ENMR) is calculated as follows—
Maternal Mortality Rate Number of neonatal deaths 0-7 days × 1000
=
General Fertility Rate Total number of live births
Economics (NET) | 573U
The late neonatal mortality rate (LMNR) is calcu- sometimes called a population pyramid, but it is not
lated as follows— always pyramidal in shape). This diagram shows thed
Number of neonatal deaths 8-27 days × 1000 istribution by ages of females and males within a certain
Total number of live births population in graphic form. Figure 1 shows a diagram in
Under Five Mortality Rate—The probability of a which the ages and sexes for the United States
child born in a specific year or period dying before population are arranged so that ages are grouped
reaching the age of 5 years, if subject to age-specific together such as 0 – 4 years, 5 – 9 years, and so on. The
mortality rates of that period, expressed per 1000 live population of each is group is represented as a bar
births. The under-five mortality rate as defined here is, extending from a central vertical line, with the length of
strictly speaking, not a rate (i.e., the number of deaths each bar dependent upon the population total for that
particular group. The centerline separates the females
divided by the number of population at risk during a
from the males. The female and male populations for
certain period of time) but a probability of death derived
each group are represented by the distance from the
from a life table and expressed as a rate per 1000 live
centerline, with females on the right and males on the
births.
left.
Under 5 Mortality Rate =
100+ Male 0.0% 0.0% Female
Number of deaths among children aged 0–4 years 95-99 0.0% 0.1%
(0–59 months of age)‚broken down by age groups 90-94 0.2% 0.4%
× 1000
Number of live births (person-years of exposure) 85-89 0.5% 0.7%
80-84 0.8% 1.1%
Age Specific Death Rate— 75-79 1.2% 1.4%
Number of deaths in a specific Age Group 70-74 1.8% 2.1%
ASDR = × 1000 65-69 2.5% 2.7%
Mid year population of that age group 60-64 3.0% 3.2%
55-59 3.4% 3.5%
Mid year population of that age group.
50-54 3.4% 3.4%
45-49 3.2% 3.1%
Age Structure 40-44 3.1% 3.1%
35-39 3.2% 3.1%
The age structure of a population is the distribution 3.4%
30-34 3.5%
of population among various ages. It is a useful tool for 25-29 3.6% 3.4%
social scientists, public health and health care experts, 20-24 3.6% 3.4%
15-19 3.2% 3.1%
policy analysts, and policy-makers because it illustrates 3.3% 3.2%
10-14
population trends like rates of births and deaths. These 5-9
3.2% 3 .1%
.1% .0%
are important to understand because they have a host of 0-4 3 3
social and economic implications in society, like 10% 8% 6% 4% 2% 0% 2% 4% 8% 8% 10%
understanding the resources that must be allocated for Unite States of America-2017
childcare, schooling, and healthcare, and the familial and Population : 326,474,013
greater social implications of whether there are more
children or elderly in society. In graphic form, age 100+ Male 0.0% 0.0% Female
95-99 0.0% 0.0%
structure is portrayed as an age pyramid that shows the 0.0% 0.0%
90-94 0.0%
youngest age cohort at the bottom, with each additional 0.0%
85-89 0.0% 0.0%
layer showing the next oldest cohort. Typically males 80-84
0.1% 0.1%
are indicated on the left and females on the right, like 75-79 0.2% 0.2%
70-74 0.4% 0.4%
that pictured above ? 65-69 0.6% 0.7%
Both age structure and age pyramids can take a 60-64 0.8% 0.9%
variety of forms, depending on the birth and death trends 55-59 1.1% 1.2%
50-54 1.4% 1.4%
within the population, as well as a host of other social 1.8%
45-49 1.8%
factors. They can be stable, meaning that patterns of 40-44 2.3% 2.2%
birth and death are unchanging over time; stationary, 35-39 2.8% 2.7%
which signals both low birth and death rates (they slope 30-34 3.3% 3.2%
25-29 3.8% 3.6%
gently inward and have a rounded top); expansive, 4.5% 4.2%
20-24
which slope dramatically inward and upward from the 15-19 5.4% 5.1%
base, indicate that a population has both high birth and 10-14 6.4% 6.1%
death rates; or constrictive, which signal low birth and 7.5% 7.1%
5-9
.
0-4 8 6% 8.2%
death rates, and expand outward from the base before
sloping inward to achieve a rounded peak at the top. 10% 8% 6% 4% 2% 0% 2% 4% 8% 8% 10%
One of the tools that demographers use to Nigeria-2017
understand population is the age structure diagram (it is Population : 191,835,936
574U | Economics (NET)
100+ 100+ Male
Male 0.0% 0.0% Female Male 0.0% 0.0% Female 0.0% 0.0% Female
95-99 95-99 0.1% 0.3%
0.0% 0.0% 0.1% 0.2%
90-94 0.1% 0.1% 0.4% 0.6%
90-94 0.3% 0.9%
85-89 0.2% 0.3% 1.1% 1.4% 85-89 0.9% 1.7%
80-84 0.5% 0.6% 2.3% 2.7% 80-84 1.6% 2.4%
75-79 0.9% 0.9% 3.1% 3.2% 75-79 2.3% 2.9%
70-74 1.3% 1.4% 2.9% 2.9% 70-74 3.1% 3.5%
65-69 2.3% 2.4% 3.3% 3.2% 65-69 3.5% 3.8%
60-64 2.7% 2.7% 4.6% 4.3% 60-64 3.1% 3.2%
55-59 3.2% 3.1% 3.9% 3.6% 55-59 2.9% 3.0%
50-54 4.2% 4.1% 3.0% 2.6% 50-54 3.2% 3.2%
45-49 4.5% 4.4% 2.9% 2.5% 45-49 3.7% 3.6%
40-44 3.8% 3.6% 3.1% 2.6% 40-44 3.7% 3.7%
35-39 3.4% 3.2% 3.2% 2.8% 35-39 3.2% 3.1%
30-34 4.4% 4.2% 3.1% 2.7% 30-34 2.9% 2.8%
25-29 4.5% 4.1% 2.7% 2.3% 25-29 2.7% 2.5%
20-24 3.3% 3.0% 2.4% 2.2% 20-24 2.4% 2.3%
15-19 2.9% 2.5% 2.4% 2.1% 15-19 2.4% 2.3%
10-14 3.0% 2.5% 2.4% 2.2% 10-14 2.2% 2.1%
3.2% 2.7% 2.4% 2.2% 2.2% 2.1%
5-9 5-9
3.1% 2.7% 2.3% 2.1% 2.1% 2.0%
0-4 0-4
6% 4% 2% 0% 2% 4% 6% 4% 2% 0% 2% 4% 6% 10% 8% 6% 4% 2% 0% 2% 4% 8% 8% 10%
China-2018 China-2050 Japan
Population : 1,393,686,493 Population : 1,348,056,330 100+ Male Female
95-99
90-94
In China, the age and sex distribution is cause for 85-89
alarm. Efforts there to reduce the birth rate have 80-84 0.2% 0.1%
apparently contributed to a prominent male majority. 75-79 0.2% 0.2%
Since the early 1980’s, a thrust by the government to 70-74 0.5% 0.5%
65-69 0.7% 0.8%
reduce population growth in the most populous country 60-64 1.1% 1.2%
in the world has resulted in many parents actively trying 55-59 1.4% 1.5%
to have a male child if they are to have only one child. 50-54 1.7% 1.8%
Cultural traditions there tend to cause parents to see a 45-49 2.0% 2.3%
40-44 2.4% 2.5%
male child as more beneficial to the family than a female 35-39 2.8% 3.0%
child; therefore, a striking imbalance has resulted 30-34 3.2% 3.3%
between the numbers of males and females. There are 25-29 3.5% 3.8%
4.0% 4.2%
concerns that the imbalance could lead to instabilities. 20-24
15-19 6.0% 5.5%
Figure 3 shows the age structure diagrams for 10-14 6.1% 6.2%
6.5% 6.9%
Mexico, Iceland, and Japan. The different shapes seen in 5-9 .
8.0%
the diagrams reflect different population characteristics. 0-4 7 0%
The diagram for Mexico shows the unmistakable 10% 8% 6% 4% 2% 0% 2% 4% 8% 8% 10%
pyramidal shape caused by ever-increasing number of India-1970
births. Japan’s diagram has the classic shape of a Population-553,943,226
shrinking population. In it, you should note how 100+ Male Female
0.0% 0.0%
95-99
100+ Male Female 0.0% 0.0%
95-99 0.0% 0.0% 90-94
0.0% 0.0%
0.0% 0.0% 85-89 0.1% 0.1%
90-94
0.0% 0.0% 80-84
85-89 0.3% 0.3%
0.1% 0.1% 75-79
80-84 0.5% 0.5%
0.3% 0.3% 70-74
75-79 0.8% 0.8%
0.5% 0.4% 65-69
70-74 1.2% 1.2%
0.8% 0.8%
65-69
60-64 1.7% 1.7%
1.2% 1.2% 55-59 2.0% 2.0%
60-64 1.7% 1.7%
50-54 2.4% 2.5%
55-59 2.1% 2.0% 45-49 2.7% 2.8%
50-54 2.5% 2.4% 40-44 3.0% 3.2%
45-49 2.8% 2.7% 35-39 3.5% 3.7%
40-44 3.2% 3.0% 30-34 3.9% 4.2%
35-39 3.7% 3.5%
25-29 4.1% 4.5%
30-34 4.2% 3.9%
20-24 4.2% 4.7%
25-29 4.5% 4.1%
15-19 4.4% 4.9%
20-24 4.7% 4.2%
10-14 4.5% 5.0%
15-19 4.9% 4.4%
4.4% 4.9%
5.0% 4.5% 5-9
10-14 4.3% 4.8%
4.9% 4.4% 0-4
5-9
4.8% 4.3% 10% 8% 6% 4% 2% 0% 2% 4% 8% 8% 10%
0-4
10% 8% 6% 4% 2% 0% 2% 4% 8% 8% 10% India-2017
India 1,342,512,705
Economics (NET) | 575U
100+ Male Female per capita income grows more rapidly during this time
0.0% 0.0%
95-99
0.1% 0.0% too. This economic benefit is the first dividend received
90-94
85-89
0.3% 0.2% by a country that has gone through the demographic
0.8% 0.5% transition.
80-84
1.1% 0.9%
75-79 1.6% The first dividend period generally lasts for a long
1.5%
70-74 2.2% 2.1% time-typically five decades or more. Eventually,
65-69 2.6% 2.5%
60-64 2.9% 3.0%
however, the reduced birth rate reduces the labour force
55-59 3.1% 3.3% growth. Meanwhile, improvements in medicine and
50-54 3.2% 3.5% better health practices leads to an ever-expanding elderly
45-49 3.2% 3.5% population, sapping additional income and putting an
40-44 3.2% 3.5%
35-39 3.3% 3.6% end to the demographic dividend. At this stage, all else
30-34 3.2% 3.6% being equal, per capita income grows at a decelerated
25-29 3.2% 3.5% rate and the first demographic dividend becomes
20-24 3.1% 3.4%
3.0%
negative.
15-19 3.3%
10-14 3.0% 3.2% An older working population facing an extended
2.9% 3.1%
5-9
2.8% 3.0%
retirement period has a powerful incentive to accumulate
0-4
assets to support themselves. These assets are usually
10% 8% 6% 4% 2% 0% 2% 4% 8% 8% 10%
invested in both domestic and international investment
India-2057 vehicles, adding to a country's national income. The
1,736,685,152 increase in national income is referred to as the second
dividend which continues to be earned indefinitely.
prereproductive age groups (0 – 14 years) have smaller
populations than the reproductive age groups (15 - 44 The benefits gotten from a demographic transition is
years). Iceland shows a more stable population. Except neither automatic nor guaranteed. Any demographic
for the post-reproductive groups (45+ years), the dividend to be gotten depends on whether the govern-
populations for the age groups extend generally the same ment implemented the right policies in areas such as
lengths. education, health, governance, and the economy. In
addition, the amount of demographic dividend that a
Demographic Dividend country receives depends on the level of productivity of
young adults which, in turn, depends on the level of
The demographic dividend is the name given by schooling, employment practices in a country, timing
Harvard economists David Bloom and David Canning to and frequency of childbearing, and economic policies
the boost in economic growth that can result from that make it easier for young parents to work. The
changes in a country’s population age structure. As dividend amount is also tied to the productivity of older
fertility rates decrease, a country’s working-age adults which depends on tax incentives, health
population grows larger relative to the young dependent programs, and pension and retirement policies.
population. With more people in the labour force and There are four main areas where a country can find
fewer children to support, a country has a window of demographic dividends—
opportunity for rapid economic growth if the right social
and economic investments and policies are made in 1. Savings—During the demographic dividend period,
health, education, governance, and the economy. A personal savings grow and can be used to stimulate
demographic dividend is the accelerated economic the economy.
growth that can result from improved reproductive 2. Labour supply—More workers are added to
health, a rapid decline in fertility, and the subsequent the labour force, including more women.
shift in population age structure. With fewer births each 3. Human capital—With fewer births, parents are
year, a country’s working-age population grows larger able to allocate more resources per child, leading to
relative to the young dependent population. With more better educational and health outcomes.
people in the labour force and fewer children to support, 4. Economic growth—GDP per capita is increased
a country has a window of opportunity for economic due to a decrease in the dependency ratio.
growth if the right social and economic investments and
policies are made in health, education, governance, and Life Table
the economy. A life table is a table which shows, for a person at
To receive a demographic dividend, a country must each age, what the probability is that they die before
go through a demographic transition where it switches their next birthday. From this starting point, a number of
from a largely rural agrarian economy with high fertility statistics can be derived and thus also included in the
and mortality rates to an urban industrial society table is :
characterized by low fertility and mortality rates. In the ● The probability of surviving any particular year of
initial stages of this transition, fertility rates fall, leading age.
to a labour force that is temporarily growing faster than ● The remaining life expectancy for people at
the population dependent on it. All else being equal, different ages.
576U | Economics (NET)
● The proportion of the original birth cohort still obtained by subtracting the number of deaths in the
alive. previous age group from its corresponding lx. In other
Life tables are usually constructed separately for words,
men and for women because of their substantially lx+n = lx – n d x
different mortality rates. Life tables are also used in or l x + n = l x + n pn
biology. Survival rates are used extensively in In case of a cohort or generation life table, this
demographic projection techniques. Survival rates are column is already known and the rest of the columns are
derived from life tables or census data, and are used to generated from it.
calculate the number of people that will be alive in the
future. Column 5— Ndx is the number of deaths in the age
group ‘x to x + n’. It is obtained in the following
Age specific mortality rates are applied to a notional
manner—
population, typically of 100,000. Starting at birth, the
probability of dying in each period is applied to the n dx = l x· n qx
number of people surviving to the beginning of the Column 6— n L x is the person years lived by
period, so that the initial figure slowly reduces to zero. lx persons in the age group ‘x to x + n’. This column is
There are several types of life tables. A generation the equivalent to the population and hence it is called the
or cohort life table is a life history of the mortality life table population.
experiences of an actual cohort of individuals. The
cohort begins at birth and their mortality experiences are Column 7—Tx is the total number of years, lived
recorded through the death of the last member of that
by the cohort after exact age x, and is obtained by
cohort
cumulating the nLx column upward from the last row.
Current or Period Life Tables—Period life tables
Column 8—ex is the end product of a life table. It is
are based on the mortality experience of a hypothetical
cohort of newborn babies, usually 100,000 newborns, the average number of years a person aged x years is
who are subject to the age-specific mortality rates on expected to live. This column is worked out in the
which the table is based. It traces the cohort of newborn following manner—
babies throughout their lifetime under the assumption T
ex – x
that they are subject to the age-specific mortality rates of lx
a region or country. Life expectancy at birth is thus denoted by e°. It is a
There are two types of current life tables— summary measure of mortality conditions in a population
● Unabridged, for single years of life as a whole. It has been found that life expectancy, except
● Abridged, for 5-year cohorts of life for the early age groups in a life table, tends to decline
with increase in age. With a somewhat greater risk of
Columns of a Life Table deaths at age 0, life expectancy is lower at this age than
A life table is usually presented in a tabular form that at age 1.
consisting of different columns. All these columns are In the construction of a life table n q x is the crucial
interrelated, and once a crucial column is known, the column, and once this column is known, columns corre-
rest of the columns can be generated from it. sponding to n dx and lx can be generated. It has also been
Column 1—Age x to x + n—The first column of a noted that the values of nqx are approximated from age-
life table relates to age represented by x. Age here means specific death rates. Thus, all that is need for the
‘exact age’. In an abridged life table it is expressed as ‘x construction of a life table is the data on age-specific
to x + n’, where n is the age interval. death rates in the population concerned. It should be
Column 2— n q x is the probability of dying of a noted that while age-specific death rates relate to mid-
person between the age group ‘x to x + n’. When the age year population, n q x as probability relates to the popu-
interval is 1 year it is denoted as q x. In a current life lation at the beginning of the age interval.
table this is the crucial column. The values of this Migration
column are obtained from the age-specific death rates of
the population. Since the earliest times, humanity has been on the
move. Some people move in search of labour or
Column 3— Npx is the probability of survival of a economic opportunities, to join family, or to study.
person between the age x to x + n. A person will either Others move to escape conflict, persecution, terrorism,
survive or die, hence Npx is equal to 1 – Nqx – Since is or human rights violations. Still others move in response
not required in the generation of other columns, it is to the adverse effects of climate change, natural
generally not included in most of the life tables. disasters, or other environmental factors.
Column 4—lx is the number of persons surviving at Today, more people than ever before live in a
the beginning of age x. This column starts with l0, the country other than the one in which they were born. In
size of the birth cohort, and undergoes decline through 2017, the number of migrants reached 258 million,
deaths at each subsequent age of life. The value of lx is compared to about 173 million in 2000. However, the
Economics (NET) | 577U
proportion of international migrants in the world Causes of Migration—In an examination of root
population is only slightly higher than that recorded over causes that drive people to migrate it is helpful to fully
the past decades, equaling 3·4% in 2017, compared to understand global migration. A root cause is the
2·8% in 2000 and 2·3% in 1980. fundamental reason for the occurrence of an event, in
While many individuals migrate out of choice, this case, migration. Often, in the migration context,
many others migrate out of necessity. There are there are both push and pull factors with push
approximately 68 million forcibly displaced persons, factors being reasons why people would want to leave
including over 25 million refugees, 3 million asylum their home country and pull factors being reasons why
seekers and over 40 million internally displaced persons. people would want to come to a new country. In
migration, push and pull factors can be economic,
Migrant environmental, social and political. They include some
The UN Migration Agency (IOM) defines a mig- of the following—
rant as any person who is moving or has moved across
an international border or within a State away from Causes of Migration
his/her habitual place of residence, regardless of (1) the Push Factor Pull Factor
person’s legal status; (2) whether the movement is Persecution, Violence, War Safety , Stability, Freedom
voluntary or involuntary; (3) what the causes for the Poor wages, Lack of jobs Higher wages, Better job
movement are; or (4) what the length of the stay is. prospectus
Types of Migration Crop failure, Natural disas- Food availability, Better
ters, Famine , Pollution environment
The relatively permanent movement of people
Limited opportunities, Lack Family Re-unification,
across territorial boundaries is referred to as in- of services, Family separa- Better quality of life,
migration and out-migration, or immigration and emi- tion Availability of services
gration when the boundaries crossed are international.
Epidemics Better educational and
The place of in-migration or immigration is called health services
the receiver population, and the place of out-migration
or emigration is called the sender population. There are Safety Factors
two basic types of migration studied by demographers—
Safety factors can cause danger to individuals,
1. Internal Migration—This refers to a change of prompting them to migrate. Persecution and discrimi-
residence within national boundaries, such as between nation based on nationality, race, religion, political
states, provinces, cities, or municipalities. An internal beliefs, or membership status in a particular social group
migrant is someone who moves to a different will prompt people to move large distances in search of
administrative territory. a safer living location where they can have freedom over
2. International Migration—This refers to their lives. Danger can be imposed upon individuals by
change of residence over national boundaries. An inter- something formal, like war, or informal, such as
national migrant is someone who moves to a different widespread gang activity. In 2016, the Northern
country. International migrants are further classified as Triangle, composed of Guatemala, Honduras and El
legal immigrants, illegal immigrants, and refugees. Salvador, was named one of the most violent regions in
Legal immigrants are those who moved with the legal the world. All three Northern Triangle countries record
permission of the receiver nation, illegal immigrants are thousands of crimes by local and international gangs and
those who moved without legal permission, and refugees armed criminal groups, and most crimes are met with
are those crossed an international boundary to escape impunity. It is estimated that 10% of the Northern
persecution. Triangle’s population has already left, and it is likely
Jay Weinstein and Vijayan Pillai (2001) denote a that many more will flee in part due to extreme violence.
third classification : forced migration. Forced migration
exists when a person is moved against their will (slaves),
Economic Factors
or when the move is initiated because of external factors Economic migration, whether permanent or
(natural disaster or civil war). The distinction between seasonal, is a commonly cited reason for migration. In
general, it is believed that in economic migration people
internal and international migration is crucial because
move from poorer developing areas into richer areas
they happen for different reasons. Because structural where wages are higher and more jobs are available. It
barriers are more likely to impede the mobility of a is also common for people from rural areas to move to
potential international migrant than an internal more competitive urban areas in order to find more
migrant—international migration involves more opportunities.
administrative procedures, greater expense, and more Mexican migration into the United States portrays
difficulties associated with obtaining employment, the importance of both push and pull factors in
accessing state services, learning a new language, and economic migration. All throughout the 20th century,
the like—the motivations behind international migration seasonal Mexican laborers have crossed the border in
are usually stronger than those behind internal migration. search of work in the American agricultural industry, as
578U | Economics (NET)
the economic state of Mexico did not match the level of indicators that are relevant to migration or mobility. The
economic prosperity found in America. In the Agenda's core principle is to "leave no one behind,"
21st century however, Mexican migration has slowed including migrants.
down significantly, and after the American recession of The SDGs’ central reference to migration is made
2009, economic migration from Mexico to the United in target 10·7 : to facilitate orderly, safe, regular and
States began to decline. Studies show that Mexican responsible migration and mobility of people, including
household economies have improved due to factors like through the implementation of planned and well-
increases in access to education. As Mexico’s financial managed migration policies. Other targets that directly
state improved and the United States temporarily reference migration mention trafficking, remittances,
struggled, both push and pull factors eroded, causing the international student mobility and more. In addition to
dwindling of migration. this, migration is indirectly relevant to many more
Environmental Factors targets across topics.
Migration caused by environmental factors is The International Organization for Mig-
increasingly involuntary. Environmental factors cause ration (IOM)
displacement, or the forced movement of people by Established in 1951, IOM is the leading inter-
social or environmental factors. Crop failure for
governmental organization in the field of migration.
example, often results in both food scarcity and a drop in
agricultural jobs, prompting people to move to a place IOM works to help ensure the orderly and humane
with better job opportunities and climate. Pollution of management of migration for the benefit of all, to
water, air and soil in both urban and rural settings can promote international cooperation on migration issues,
also create a serious health risk to locals, forcing them to to assist in the search for practical solutions to migration
look for a better life for themselves and their children. problems and to provide humanitarian assistance to
Devastating natural disasters such as tsunamis, migrants in need, including refugees and internally
hurricanes and earthquakes are environmental factors displaced people. In 2016 IOM entered into an
that the news most often cover. In January 2010 for agreement with the United Nations becoming one of its
example, a deadly earthquake hit Haiti, claiming the specialized agencies. To promote diversity and inclusion
lives of over 90,000 people, and displacing over 1·5 of migrants in society, IOM has developed the platform
million others. Despite humanitarian aid, many suffered ‘i am a migrant,’ which features first-hand accounts
from disease and a lack of proper shelter and basic from individuals, providing insights into the experiences
supplies. Likewise, recent studies cite global warming as
of migrants of all backgrounds and throughout their
a cause for the increase in violent conflict around the
world. The recent example of the Syrian drought from migratory journeys.
2006 to 2011 was catastrophic, causing many families to Data on Migration
lose their farms and move into big cities. The drought
also increased food prices, facilitating poverty. Although In 2017, the number of international migrants
global warming did not create the conflict we are worldwide – people residing in a country other than their
witnessing today, environmental factors are important in country of birth – reached 258 million (from 244 million
human migration. in 2015). Female migrants constituted 48% of this
international migrant stock. There are an estimated 36·1
Social Factors million migrant children, 4·4 million international
Social factors motivating migration grow from the students and 150·3 million migrant workers. Appro-
human needs and desires to achieve a better quality of ximately 31% of the international migrant stock world-
life. Migrants often move to ensure better opportunities wide reside in Asia, 30% in Europe, 26% in the
for themselves or their family, like sending their child to Americas, 10% in Africa and 3% in Oceania
a better, safer school or finding a job that would have [Source : Global Migration Data Portal]
not only a sufficient salary, but also important benefits It can be a challenge to make sense of available
and career growth prospects. In terms of education, the migration data, as this is often scattered across different
United States graduate programs have been a particu- organisations and agencies, and not easily comparable.
larly strong attraction for young, talented individuals IOM’s Global Migration Data Analysis Centre runs
around the world. Individuals can also migrate in search the Global Migration Data Portal, which serves as a
of services, such as life-saving surgery and medical unique access point to timely, comprehensive migration
treatment that are inaccessible in their home area. statistics and reliable information about migration data
Migrants and the SDGs globally. The site presents migration data from diverse
The 2030 Agenda for Sustainable Development sources and is designed to help policy makers, national
recognizes for the first time the contribution of migration statistical officers, journalists and the general public
to sustainable development. 11 out of the 17 Sustainable interested in migration to navigate the increasingly
Development Goals (SDGs) contain targets and complex landscape of migration data.
Economics (NET) | 579U
Global Action In March 2017 the UN Secretary-General appointed
Large-scale movements of refugees and migrants Louise Arbour of Canada as his Special Representative
affect all UN Member States and they require closer for International Migration to lead the follow-up to the
cooperation and responsibility-sharing. In 2016 the UN migration-related aspects of the high-level summit.
General Assembly convened a high-level plenary As a result of the New York Declaration, UN
meeting on addressing large movements of refugees and Member States agreed to cooperate in the elaboration of
migrants. The UN Secretary-General prepared the report a Global Compact for Safe, Orderly and Regular
'In Safety and Dignity: Addressing Large Movements of Migration, expected to be adopted at an intergovern-
Refugees and Migrants' with recommendations on the mental conference on international migration in
issue. December 2018 in Morocco. The GCM covers
UN member states adopted a set of commitments, diverse issues such as strengthening labour rights for
known as the New York Declaration for Refugees and migrant workers, improving migration data as a basis for
Migrants , recognizing the need for a comprehensive evidence-based policies, saving lives and establishing
approach to migration. The New York Declaration
international efforts on missing migrants, and many
acknowledges the positive contribution of migrants to
sustainable and inclusive development, and commits to others. The implementation of the GCM will represent
protecting the safety, dignity and human rights and progress in governing migration in a way that increases
fundamental freedoms of all migrants, regardless of their its benefits for individuals, communities and countries
migratory status. alike, and reduces its risks for all.
Objective Questions
1. Which of the following characteristics makes 6. Which of the following is not an assumption of
environment a public good ? compensation criteria ?
I. Non-rivalry (A) Every individual is the best judge of his
II. Non-Excludability welfare
(A) Only I (B) The problem of production and exchange can
(B) Only II be seperated from the problem of distribution
(C) Both I and II (C) There exist no externalities of consumption and
(D) Neither I nor II production
(D) Utility can be measured cardinally
2. Problem of ‘Free Riding’ is associated with—
(A) Public goods 7. Kaldor-Hicks criterion can be explained with the
help of………
(B) Private goods
(A) Indifference curve
(C) Consumer durables
(B) Utility possibility curve
(D) Consumer non-durables
(C) Phillips curve
3. Which of the following is an example of market (D) Production possibility curve
failure ?
I. Climate change 8. Which of the following defines the policy relevance
of valuation of environmental goods ?
II. Greenhouse gas emissions
I. Demonstration of value of biodiversity
III. Coastal Pollution
II. Land use decisions
(A) Only I (B) Only I and II III. Revising the national economic accounts
(C) Only II and III (D) All I, II and III IV. Choosing economic instruments for saving bio-
4. Coase theorem is related to……… diversity
(A) Wealth Inequality (A) Only I and II (B) Only IV
(C) Only II, III and IV (D) I, II, III and IV
(B) Environmental pollution
(C) Vicious circle of poverty 9. Malthus’ observations regarding are based on—
(A) Law of diminishing returns
(D) Consumption pattern
(B) Law of constant returns
5. Which of the following economist has/have deve- (C) Law of increasing returns
loped compensation criteria ? (D) None of the above
I. Nicolas Kaldor II. J.R. Hicks 10. Malthus percieved certain measures to check the
III. Scitovsky growth of population.
(A) Only I (B) Only III I. Late marriages II. Celibacy
(C) Only I and II (D) All I, II and III III. Use of contraceptives
580U | Economics (NET)
(A) Only I (B) Only I and II List-II
(C) I, II and III (D) Only I and III 1. Protein consumption theory
11. Which of following country is passing through the 2. Diet theory
fourth stage of demographic transition theory ? 3. Destiny theory
(A) India (B) U.K.
4. Biological theory
(C) Sweden (D) Brazil
Code—
12. Which of the following economist did not develop a
population theory ? (a) (b) (c) (d)
(A) J.M. Keynes (B) Malthus (A) 1 3 4 2
(C) Karl Marx (D) Thomas Doubleday (B) 1 3 2 4
13. Consider the following statements in relation to the (C) 3 1 2 4
low of population and choose the correct code given (D) 4 3 2 1
below.
17. Biological theory of population was propounded
I. For capitalism, the consequences of population
by…………
growth are over population and poverty.
(A) Corrado Ginnis
II. For socialism, population growth is readily
absorved by the economy with no side. (B) Herbert Spencer
(A) Only I is correct (C) Assene Dumont
(B) Only II is correct (D) Michael Thomas Sadler
(C) I and II both are correct 18. Which of the following statement is correct about
(D) Neither I nor II is correct Herbert Spencer’s biological theory of population ?
I. Fecundity decreases when the complexity of
14. Which of the following statement is correct about
life increases.
Thomas Doubleday’s diet theory of population ?
II. There exists antagonism between individuation
I. Increase in population and food supply are (survival) and genesis (reproduction).
inversely related.
III. When any individual does hard work for his
II. The Plethoric state having good food supply personal development at his work place, the
where the fertility is low. desire for reproduction decreases.
III. The deplethoric state in which due to food IV. When more energy has been utilised for one’s
shortage we find dimination of proper nourish- self-development, the energy available for
ment, where the fertility is high. reproduction will be less and consequently the
(A) Only I is correct population growth will be less.
(B) Only II and III are correct (A) Only IV (B) Only II and III
(C) I, II and III all are correct (C) I, II, III and IV (D) Only I, III and IV
(D) None of the above is correct 19. Which of the following statement is incorrect about
15. Which of the following statement is correct about the relationship between individuation and genesis ?
Michael Thomas Sadler’s theory of population ? (A) The individuation with automatically below
I. Michael Thomas Sadler’s theory is known as when there is high genesis
destiny theory of population. (B) The genesis will be low when there is high
II. The fecundity of human beings is in the inverse individuation
ratio of the condensation of their numbers. (C) The individuation will improve when the
III. The fertility rate decreases with the increase in genesis is low
the density of population. (D) In poor people, we find high individuation and
(A) Only I (B) Only II more genesis
(C) Only I and II (D) I, II and III 20. Which of the following statement is correct about
16. Consider the List I and II and choose the correct Corrado Ginnis’s theory of population ?
code given below— (A) Growth of population is cyclical growth
List-I (B) Third stage of growth of population is known
(a) Michael Thomas Sadler as ‘senescene’
(C) Fertility, fecundity and survival as well as
(b) Jouse De Castro
qualitative development are determining factors
(c) Thomas Doubleday of men’s quantitative growth
(d) Herbert Spencer (D) All of the above
Economics (NET) | 581U
21. Which of the following is not a stage of social 27. Maternal Mortality Rate is measured by—
development as propounded by Arsene Dumont ? No. of maternal deaths
(A) MM Rate = × 100
(A) Malthusian theory of population applies where No. of women in
human beings line live animals 15-49 yrs age group
(B) Quillard’s principle of population applies in No. of maternal deaths
intermediate stage (B) MM Rate = × 1000
No. of women in
(C) Cut throat competition is a norm of social and 15-49 yrs age group
economic life, in third stage of population Maternal mortality ratio
(C) MM Rate =
(D) In the fourth stage, every individual wants to General fertility ratio
achieve higher economic and social status (D) None of the above
22. Consider the following statements in relation to 28. Which of the following indicator is used to estimate
Leibenstein’s motivational theory of population and physical quality of life Index ?
choose the correct code given below— (A) Maternal mortality rate
I. Leibenstein’s theory of population growth (B) Infant mortality rate
forms part of his critical minimum effort theory (C) Under five mortality rate
of economic development. (D) Standarised death rate
II. Leibenstein’s theory of population growth is
29. Which of the following indicator is used to estimate
based on Dumont’s “social-capillarity thesis”.
Human Development Index ?
III. According to Leibenstein, as per capita income (A) Maternal mortality rate
rises with economic development, the fertility
rate declines. (B) Infant mortality rate
(C) Under five mortality rate
(A) Only I (B) Only I and II
(D) Expectancy of life at birth
(C) I, II and III (D) None of these
30. Which level of total fertility rate is considered
23. Crude birth rate is quoted per………
Replacement Level Fertility Rate—
(A) 100 population
(A) 1·1 (B) 1·5
(B) 1,000 population
(C) 2·1 (D) 2·5
(C) 10,000 population
(D) 1,00,000 population 31. Total fertility rate is………
(A) Average number of children born per women
24. Infant mortality rate is quoted in per………
(B) Total number of children born per women
(A) 1,000 population (C) Median number of children born per women
(B) 1000 live births in a particular year (D) None of the above
(C) 10,000 live births in a particular year 32. Life table has…………colomns.
(D) 1,00,000 live births in a particular year (A) 6 (B) 7
25. Maternal Mortality Ratio is expressed in terms of— (C) 8 (D) 9
(A) 1,00,000 live birth’s in a particular year 33. Life table is used to measure………
(B) 1,000 live births in a particular year I. Mortality
(C) 10,000 live births in a particular year II. Survivorship
(D) 1,00,000 population in a particular year III. Life expectancy of a population of varying ages
(A) Only III (B) Only I and III
26. Total fertility rate is measured by ……… if i = 5. (C) All I, II and III (D) Only II and III
(A) TFR = ∑i AS F R × 5
Number of births per female
Answers
(B) TFR = × 100 1. (C) 2. (A) 3. (D) 4. (B) 5. (D)
Total population of
female in 15-49 age group 6. (D) 7. (B) 8. (D) 9. (A) 10. (B)
Number of births of girl child 11. (C) 12. (A) 13. (C) 14. (C) 15. (D)
(C) TFR = × 100
Total population of 16. (C) 17. (B) 18. (C) 19. (D) 20. (D)
women age group 15-49 yrs 21. (C) 22. (C) 23. (B) 24. (B) 25. (A)
∑i ASFR 26. (A) 27. (B) 28. (B) 29. (D) 30. (C)
(D) TFR = × 100
i 31. (A) 32. (C) 33. (C)
●●
UNIT-10
Indian Economy
A Few Facts : At a Glance
Area Population
● Total Area of the Country 3287263 sq. km ● Total Population of the Country
● Reporting Area for Land (Census 2011) 121·0854 crore
Utilisation Statistics 307·818 million hectare ● Total population (2019) 137 crore
● Length of Coast line 8118 km (projected)
● Exclusive Economic Zone 2·02 million sq. km ● Decadal Growth Rate (2001–11) 17·7%
● Continental Shelf Area 0·53 million sq. km ● Rural Population Growth 12·3%
● Urban Population Growth 31·8%
● Percentage of World Area 2·42 per cent (7th Place)
● Percentage of World Population (2011) 17·5%
● Forest & Tree Cover Area (2017) 802088 sq. km
● Total Rural Population (2011) 83·37 crore
(24·39% of the total area)
● Total Urban Population (2011) 37·71 crore
● Total Forest Cover Area (2017) 708273 sq. km ● Rural-Urban Population Ratio (2011) 68·84 : 31·16
(Including 4662 km2 area under (21·54% of the total ● Sex Ratio (2011) 943
mangroves) geographical area) (Female per thousand male)
● Agricultural Land/Cultivable Land (2014-15) ● Child Sex Ratio (2011) (0–6 years) 919
181·886 million hectare ● State with highest Female-Male
Ratio (2011) Kerala (1084)
● Cultivated Land (2014-15) 155·221 million hectare
● Labour Force (2009–13) World Bank 48·43 crore
● Net Area sown (2014-15) 140·130 million hectare
● Total workers (2011 census) 48·17 crore
● Per Capita Agricultural Land (2014-15)
Male 33·18 crore
0·143 hectare
Female 14·98 crore
● Gross Irrigated Area 96·457 million hectare
● Density of Population (2011) 382 per sq. km
(2014-15) (48·6% of total cropped area)
● Birth Rate (2017) 20·2 per thousand population
● Rainfed Area as % of net ● Death Rate (2017) 6·3 per thousand population
sown area (2014-15) 51·4% ● TFR per woman (2017) 2·2
● Largest State (Areawise) Rajasthan ● Maternal Mortality Rate 130
● Smallest State (Areawise) Goa (Per 100000 live births) (2014–16)
● State touching boundaries of Uttar Pradesh ● Infant Mortality Rate (2017) 33 per thousand
live births
Maximum States (Touches boundaries of 8 States–
Rural (2017) 37
Uttarakhand, Himachal Pradesh, Haryana, Urban (2017) 23
Rajasthan, M.P., Chhattisgarh, Jharkhand and Bihar) Males (2017) 32
● Area under foodgrains (2018-19) Female (2017) 34
122·7 million hectare ● Child (0 – 5) Mortality Rate 2017
(91·06% of net sown area) (Per 1000 Children) 37
Economics (NET) | 583U
CENSUS 2011 GVA Growth in Various Sectors of the
Economy
Figures At a Glance–India
(At Basic Prices 2011-12)
Population Persons 1210·8 million 100·00 (in %)
Rural 833·7 million 68·8
Sector 2017-18 2018-19
Urban 377·1 million 31·2
(PE)
Decadal Population Absolute Percentage
Growth 2001–11 growth rate (A) Agriculture & Allied Services 5·0 2·8
Persons 18,19,89,496 17·7 1. Agriculture Forestry and Fishing 5·0 2·6
Males 99·97 million 12·3 (B) Industry 5·9 6·9
Females 99·99 million 31·8 2. Mining and Quarying 5·1 1·3
Density of Population (per 382 3. Manufacturing 5·9 6·9
sq. km) 4. Electricity, Gas, Water Supply and 8·6 7·0
Sex Ratio (Females per 943 Other Utility Services
1000 males) 5. Construction 5·6 8·7
Percentage (C) Services 8·1 7·5
Population in the age
Absolute to total
group 0–6 6. Trade, Hotel Transport, Commu- 7·8 6·9
population nication
Persons 164·5 million 13·6 7. Financial Real Estate and Pro- 6·2 7·4
Rural 121·3 million 14·6 fessional Services
Urban 43·2 million 11·5 8. Public Administration Defence 11·9 8·6
Literacy rate Persons 73·0 and Other Services
Males 80·9 GVA at Basic Prices 6·9 6·6
Females 64·6
(D) Overall GDP 7·2 6·8
(The census 2011 results of Mao-Masam, Paomata and Parul
subdivisions of Senapati district of Manipur were with-held due to
administrative reasons. The figure have now been finalized and Growth Rates
declared by office of the registrar General of India on 07-01-2014. (At Constant Prices)
Above given census data is after the inclusion of the census of three (in %)
subdivisions of Senapati District of Manipur.)
2017-18 2018-19
● Life Expectancy (at the time of birth)-2017 (World
Bank) 68·56 years Provisional (PE)
Estimates
Male 67·074 years
1. GDP 6·7 6·8
Female 70·17 years 2. NDP 6·7 6·8
● Literacy Rate (2011) 73·0 per cent 3. GVA at Basic Prices 6·5 6·6
Male 80·9 per cent 4. GNI 6·7 6·9
Female 64·6 per cent 5. NNI 6·8 6·9
● Literacy (2011) 6. Per Capita Income 5·4 5·6
Rural Male 77·2%
Urban Male 88·8% National Income Estimates
Rural Female 57·9% ● New Base Year 2011-12
Urban Female 79·1% ● Real GDP or GDP at
● Religionwise Population (2011) Current Price
(i) Hindu population (%) 79·8% 2018-19 (PE) R 190·10 lakh crore
(ii) Muslim population (%) 14·2% 2017-18 R 170·95 lakh crore
● Gross Value Added at
(iii) Christian population (%) 2·3%
Basic Price (on Constant Prices 2011-12)
(iv) Sikh population (%) 1·7%
2018-19 (PE) R 129·07 lakh crore
● Population Growth % (2001–11) 2017-18 R 121·04 lakh crore
(i) Hindu 16·8% ● GDP at Constant Prices (2011-12)
(ii) Muslim 24·6% 2018-19 (PE) R 140·77 lakh crore
(iii) Christian 15·5% 2017-18 R 131·79 lakh crore
(iv) Sikh 8·4% ● GNI at Constant Price (2011-12)
● Religionwise Sex-ratio (2011) 2018-19 (PE) R 139·32 lakh crore
(i) Hindu 939/1000 males 2017-18 R 130·34 lakh crore
(ii) Muslims 951/1000 males ● NNI at Constant Price (2011-12)
● State having maximum Muslim population 2018-19 (PE) R 123·29 lakh crore
Assam 2017-18 R 115·31 lakh crore
584U | Economics (NET)
● Per Capita Income at Constant Price (2011-12) ● Number of Industries Reserved for Public Sector 02
2018-19 (PE) R 92565 ● Atomic Energy (Production, separation or enrich-
2017-18 R 87623 ment of special fissionable material and substances
and operation of the facilities).
● GNI at Current Price
2018-19 (PE) R 188·16 lakh crore ● Railway operations only : Private investment has
been allowed in Railways for other construction,
2017-18 R 169·10 lakh crore operation and maintenance.
● NNI at Current Price ● Number of Industries Requiring Compulsory
2018-19 (PE) R 168·37 lakh crore License 04
2017-18 R 151·28 lakh crore (i) Cigars and Cigarettes of tobacco and manufac-
● Per Capita Income at Current Prices tured tobacco substitutes.
2018-19 (PE) R 126·406 (ii) Electronic Aerospace and defence equipments.
2017-18 R 114·958 (iii) Industrial Explosives including detonating
fuses, safety fuses, gun-powder, nitrocellulose
Economic Indicators and matches.
(iv) Specified Hazardous chemicals i.e.,
● Index of Industrial Production (May 2019) 140·2
(a) Hydrocyanic Acid its derivatives
(Average Base 2011-12)
(b) Phosgene and its derivatives.
● Share of Industrial Sector in GVA at Current Price
(2017-18) 27·0% (c) Isocyanates and disocyanates of hydrocarbons.
● Share of Agriculture sector in ● Micro, Small and Medium Enterprises
GVA at current price in 2017-18 19·5% (MSMEs) Contribution in country’s GDP 37·5%
● Share of Service sector in ● Main Food Crop of India Rice
GVA at current price in 2017-18 53·5% ● India’s place in the World Production of
● Index of Agricultural Production (2018-19) 132·7 (i) Sugar and Sugarcane First
(Base : 2007-08 = 100) (ii) Milk First
● Wholesale Price Index June 2019 (iii) Banana First
(Base : 2011-12 = 100) 121·5 (iv) Jute First
● Consumer Price Index for Industrial Workers 287 (v) Steel Third
(2017-18) (Base : 2001 = 100) (vi) Manufacturing Sixth
(vii) Fish Second
● Consumer Price Index for agricultural labourers
(viii) Rice Second
(2017-18) (Base 1986-87 = 100) 902
(ix) Fruits Second
● Consumer Price Index for Rural Labour
● First Three States in the Production (2016-17)
(2017-18) (Base 1986-87 = 100) 894
Wheat Uttar Pradesh, M.P., Punjab
● Consumer Price Index (Base : 2012 = 100) 142·9
Rice West Bengal, U.P., Punjab
Combined (June 2019)
Pulses Madhya Pradesh, Maharashtra, Rajasthan
● Consumer Price Index (Base : 2012 = 100) 143·6 Coarse Cereals Maharashtra, Rajasthan, Karnataka
Rural (June 2019) Total Foodgrains Uttar Pradesh, M.P., Punjab
● Consumer Price Index (Base : 2012 = 100) 142·1 Oilseeds Madhya Pradesh, Rajasthan, Maharashtra
Urban (June 2019) Sugarcane Uttar Pradesh, Maharashtra, Karnataka
● Consumer Price Index based inflation Rate ● State with Highest Production of Cotton
(June 2019) (2016-17) Maharashtra
Combined 3·18% ● State with Highest Production of
Sixth Economic Census (2014) Potato (2016-17) Uttar Pradesh
● Total Enterprises 5·847 crore ● State with Highest Production of
Rural 3·502 crore (59·9%) Onion (2016-17) Maharashtra
Urban 2·345 crore (40·1%) ● State with Highest Production of
● Top 5 states having maximum Uttar Pradesh Jute and Mesta (2016-17) West Bengal
Enterprises (In Descending Order) Maharashtra
● Krishi Vigyan Kendra (2014-15) 641
West Bengal
Tamil Nadu ● Agriculture Universities (2014-15) 70
Andhra Pradesh ● Horticulture Crops 341
Economics (NET) | 585U
Annual Rate of Growth of GDP ● Total Vehicles (2015-16) 23,960,940
(At constant prices) (i) Passenger Vehicles 34,13,959
First Plan (1951–56) 3·6% (ii) Commercial Vehicles 7,82,814
Second Plan (1956–61) 4·1% (iii) Three Wheeler 9,33,950
Third Plan (1961–66) 2·5% (iv) Two Wheeler 1,88,29,786
Three Annual Plan (1966–69) 3·8% ● Power Generation-installed Capacity
Fourth Plan (1969–74) 3·3% (March 2019) : 356100·19 MW
Fifth Plan (1974–78) 5·0% (i) Thermal Power 226279·34 MW
Annual Plan (1979-80) 6·0% (A) Coal and Lignite Based 200704·50 MW
Sixth Plan (1980–85) 5·4% (B) Gas Based 24937·22 MW
Seventh Plan (1985–90) 5·8% (C) Diesel Based 837·63 MW
Annual Plan (1990–92) 3·0% (ii) Nuclear Power 6780·00 MW
Eighth Plan (1992–97) 6·7% (iii) Hydro Power 45399·22 MW
Ninth Plan (1997–2002) 5·5% (iv) Renewable Energy Source 74081·66 MW
Tenth Plan (2002–07) Target 8·0% ● Power Generation (Billion kWh 2017-18) :
Achieved 7·8% 2017-18 2018-19
Eleventh Plan (2007–12) Target (Original) 9% Total 1206·31 1249·34
Target (Revised) 8·1% (i) Thermal Power 1037·06 1072·22
Achieved 7·9% (ii) Hydro Power 126·12 134·89
12th Plan (2012–17) Target 8·0% (iii) Nuclear Power 38·35 37·81
(iv) Bhutan Import 4·78 4·41
Main Production
Foodgrains (2014-15) 252·02 million tonnes Renewable Energy Sources
(Installed Capacity 31 March, 2019)
Foodgrains
(in MW)
2015-16 251·57 million tonnes
2016-17 275·11 million tonnes Wind Power 35625·97
2017-18 285·01 million tonnes Solar Power 28180·71
Small Hydro Power 4593·15
2018-19 (IV AE) 284·95 million tonnes
Biomass Power 9103·50
Horticulture Crop Production
Water to Energy 138·30
2017-18 311·7 million tonnes
Horticulture Production 2018-19 Agriculture Production
(IIIrd Adv. Est.) 313·85 million tonnes (Million Tonnes)
Crude Steel (2017-18) 103·13 million tonnes
2016-17 2017-18 2018-19
Production of Selected Commodities (2015-16) : (Final) (IV AE)
● Coal Reserves 306·60 billion tonnes Total Foodgrains 275·11 285·01 284·95
● Lignite Reserves 43·25 billion tonnes Total Pulses 23·13 25·42 23·40
● Coal Production (2018-19) 730·354 million tonnes Total Oilseeds 31·28 31·31 31·50
● Lignite Production (2017-18) 46·20 million tonnes Rice 109·70 112·76 116·42
● Cement Production (2018-19) Wheat 98·51 99·87 102·19
337·3 million tonnes Coarse Cereals 43·77 46·97 42·15
● Fertilizer’s Production (2016-17) Minimum Support Prices for Rabi Crops of
(i) Urea 24·20 million tonnes 2018-19 Season to be Marketed in 2019-20
(ii) DAP 4·37 million tonnes (R per quintal)
(iii) Mixed (Other than DAP) 7·97 million tonnes
MSP for 2019-20
(iv) SSP 4·355 million tonnes Commodity
Marketing Season
● Crude Oil (2018-19) 34·203 million tonnes Wheat 1840
● Refining Capacity 247·56 million tonnes per annum Barley 1440
4·62 million tonnes per day Gram 4620
● Refinery Throughpul (2018-19) Masur (Lentil) 4475
257·205 million tonnes Rapeseed/Mustard 4200
● Natural Gas (2018-19) 32·873 billion cubic meter Safflower 4945
586U | Economics (NET)
Minimum Support Prices for Kharif Crops Foreign Exchange Reserves
for 2019-20 Season (As on August 23, 2019) Aprox.
(R per quintal) ● Foreign Currency Assets 397·129 billion dollar
Commodity Variety MSP for 2019-20 ● Gold 26·867 billion dollar
Season ● Reserve Tranche with IMF 3·621 billion dollar
Paddy Common 1815 ● SDR 1·434 billion dollar
Grade A 1835 Total Foreign Exchange Reserved 429·051 billion dollar
Jowar Hybrid 2550
Maldandi 2570 Transport
Bajra — 2000 ● Total Rail Route (March 31, 2018) 68,442 km
Maize — 1760 ● Electrified Rail Route (March 31, 2018)
Ragi — 3150
29376 km (42·92% of Total)
Tur (Arhar) — 5800
● Percentage of passenger traffic operated
Moong — 7050
Urad — 5700 on electric traction (Approximate) 50·5%
Groundnut in-shell — 5090 ● Percentage of freight traffic operated
Soyabean Yellow 5710 on electric traction (Approximate) 65·2%
Sunflower Seed — 5650 ● Rail operating ratio 2015-16 90·5%
Sesamum — 6485 ● Rail operating ratio 2016-17 96·9%
Nigerseed — 5940 ● Rail operating ratio 2017-18 (R.E.) 98·4%
Cotton Medium Staple 5255 ● Rail operating ratio 2018-19 (R.E.) 96·2%
Long Staple 5550
● Rail operating ratio 2019-20 (B.E.) 95·0%
● Asia’s First and World’s Second
Foreign Trade Largest Rail System Indian Railways
(In $ billion)
● Largest Railway Zone Northern Railway
2016-17 2017-18 2018-19
● Total Road Network (Dec. 31, 2017) 58,97,671 km
Exports 275·85 330·53 330·07
● Total Length of National Highways/
Imports 384·36 465·58 514·03
Expressways (31 March, 2019) 132499 km
Trade Balance – 108·50 – 162·05 – 183·96
● Total Length of State Highways
● Establishment of First Trade Point in India (31 March, 2017) 175036 km
New Delhi ● Total Length of Other Roads
(August 16, 1994) (31 March, 2017) 5608477 km
● Sector with Highest Share in Total Export ● Number of Major Ports 13
Value (2018-19) 24·3%
● Number of Non-Major Ports 200
● Country with Highest Foreign Trade
with India (2018-19) USA Monetary and Credit Policy
● % Share of Indian (Status as on August 7, 2019)
exports in total world exports (2017) 1·68% Bank Rate 5·65%
● India’s share in world imports (2017) 2·48% Marginal Standing Facility Rate 5·65%
Cash Reserve Ratio (CRR) 4·0%
● WTO Profile India (2018) :
Statutory Liquidity Ratio (SLR) 18·75%
Merchandise Export (f.o.b., 2017) $ 298·376 billion
Repo Rate 5·40%
Merchandise Import (c.i.f., 2017) $ 447·241 billion
Reverse Repo Rate 5·15%
Rank in World Trade
(2017) Exports Imports External Debt (End-March 2019)
Merchandise 20th 11th ● Total External Debt $ 543·0 billion
Commercial Services 8th 10th ● Long-term External Debt $ 434·6 billion
Trade in Commercial (80·03% of total debt)
Services (2017) $ 183·359 $ 153·378 ● Short-term External Debt $ 108·4 billion
billion billion (19·96% of total debt)
Economics (NET) | 587U
India’s Key External Debt Indicators Development and Employment
(Status at March 2019) Programme
1. External debt to GDP 19·7% Beginning of Jawahar Rojgar
2. Debt Service Ratio 6·4% Yojana (JRY) April 1, 1989
3. Concessional Debt to Total Debt 8·7% Beginning of Employment Assurance
4. Share of Commercial Borrowings in External 37·93% Scheme (EAS) October 2, 1993
Debt Percentage of Wage Factor in Total
5. Short-term External Debt to Foreign 26·3% Expenditure under JRY 60%
Exchange Reserves Beginning Year of IRDP 1978-79
6. Short-term External Debt to Total Debt 19·96% Minimum Percentage of SC/ST People in
Currency Composition of External Debt Target Group of IRDP 50%
(At March 2019) Head Office of CAPART New Delhi
(% share) Beginning of Nehru Rojgar Yojana (NRY)
1. US Dollar 50·9 Oct. 1989
2. Indian Rupee 35·7 Beginning of Swaran Jayanti Shahari
3. Japanese Yen 5·0 Rojgar Yojana (SJSRY) December 1, 1997
4. SDR 4·9 Annapurna Yojana March 19, 1999
5. Euro 3·0
Beginning of Swaran Jayanti
Banking in India (April, 2019) Gram Swarojgar Yojana April 1, 1999
● Development Banks Jan Shree Bima Yojana August 10, 2000
* NABARD Estd.—July 12, 1982; HQ—Mumbai Beginning of Antyodaya Anna Yojana
* NHB Estd.—July 1988; HQ—New Delhi Dec. 25, 2000
* SIDBI Estd.—April 2, 1990; HQ—Lucknow Beginning of Sampurna Gramin
* EXIM Bank Estd.—Jan. 1, 1982; HQ—Mumbai Rojgar Yojana Sept. 25, 2001
Beginning of Pradhan Mantri Gram
Foreign Direct Investment Sadak Yojana Dec. 25, 2001
● Cumulative FDI inflows
(April 2000-March 2019) US $ 609·838 billion Social Security Scheme for Labours
(Including re-invested earnings & other capital) of Unorganised Sector January 23, 2004
National Food for Work Programme Nov. 14, 2004
● Cumulative Portfolio Foreign Investment
National Rural Employment Guarantee
(April 2000-March 2019) $ 212·888 billion Programme February 2, 2006
● FDI inflows 2015-16 US $ 55·457 Aam Aadmi Bima Yojana August 31, 2007
● FDI inflow (2016-17) US $ 60·082 billion National Rural Livelihood Mission June 2011
● FDI inflow 2017-18 $ 61·96 billion National Urban Livelihood Mission 2013-14
● FDI inflow (2018-19) US$ 64·37 billion Pradhan Mantri Jan Dhan Yojana August 28, 2014
Make in India Campaign September 25, 2014
● FDI Equity inflow (2018-19) US $ 44·37 billion
Pt. Deendayal Upadhyay Antyodaya Yojana
● FDI Equity Inflow (2016-17) US $ 43·478 billion
September 25, 2014
● FDI Equity Inflow (2017-18) $ 44·857 Clean India Campaign October 2, 2014
● Maximum FDI inflow from (Country) Pt. Deendayal Upadhyay Shramev
Mauritius (33·0%) Jayate Programme October 16, 2014
Singapore (17%) National Mission on Pilgrimage Rejuvenation and
● Maximum FDI inflow in (Sector) Spiritual Augmentation Drive (PRASAD) 2014-15
National Heritage Development and Augmentation
Services Sector (18·0%) followed by
Yojana January 21, 2015
Telecommunication (8·0%)
Sukanya Samriddhi Yojana January 22, 2015
and Computer Software and Hardware Beti Bachao Beti Padhao
● Maximum FDI inflow in (State/Region) Campaign January 22, 2015
RBI's Mumbai Regional Office (30%) Pradhan Mantri Kaushal Vikas Yojana : 2015-16
[(Maharashtra, Dadra & Nagar Haveli, Daman & Diu) HriDAY : 2015-16
followed by NCR Delhi (20%) and Bengaluru (8%)] Atal Pension Yojana : 2015-16
588U | Economics (NET)
Important World’s/Global Index and India
Index Releasing Organization/Firm Top Country India’s Rank
Global Innovation Index (GII)– 2019 World Intellectual Property Organization Switzerland 52
(WIPO)
Economic Freedom Index (EFI)–2018 ‘The Heritage Foundation’ and ‘Wall Hong Kong 130
Street Journal’
World Press Freedom Index (WPFI)–2019 Reporters Without Borders Norway 140
World Happiness Index (WHI)–2019 Unsustainable Development Solutions Finland 140
Network
International Intellectual Property Index (IIPI) World Intellectual Property Center America (USA) 36
–2019
Global Democracy Index (GDI)–2018 Economist Intelligence Unit (EIU) Norway 42
Global Environment Performance Index World Economic Forum (WEF) Switzerland 177
(GEPI)–2018
Inclusive Development Index (IDI)–2018 World Economic Forum (WEF) Norway 62
Global Peace Index (GPI)– 2019 Institute of Economics and Peace Iceland 141
Global Real Estate Transparency Index Jones Lang Lasalle (A real estate advisory United Kingdom 35
(GRETI)– 2018 firm)
Foreign Direct Investment Confidence Index Global consultancy Firm ‘A. T. Kearney’ America 16
(FDIC)–2019
Global Talent Competitiveness Index (GTCI)– WEF INSEAD B-School, AEDICO Group Switzerland 81
2019 and TATA Communications
International Corruption Perception Index Transparency International (Berlin, New Zealand 78
(ICPI) – 2019 Germany)
Global Manufacturing Index (GMI)–2018 World Economic Forum (WEF) Japan 30
Global Entrepreneurship Index (GEI)–2018 World Economic Forum (WEF) United States 68
Climate Change Performance Index (CCPI)– German Watch and Climate Change Sweden 11
2019 Network
Ease of Doing Business Index (EDBI)–2019 World Bank/International Financial Cor- New Zealand 77
poration
IMD World Competitiveness Index (GCI)– IMD School Singapore 43
2019
Sustainable Development Goal Index (SDGI)– Sustainable Development Solutions Net- Sweden 116
2018 work
Human Development Index (HDI)-2017 United Nations Development Programme Norway 130
(UNDP)
Global Cyber Security Index (GCSI)–2018 International Telecommunication Union UK 47
Global Hunger Index-2018 International Food Policy Research Belarus 103
Institute (IFPRI)
Global Liveability Index (GLI)–2018 The Economist Intelligence Unit (EIU) Vienna Delhi was
ranked 112
Energy Transition Index (ETI)–2018 World Economic Forum (WEF) Sweden 78
Global Slavery Index (GSI)–2018 Walkfree Foundation (WFF) North Korea 53
Global Talent Ranking-2018 IMD Business School Switzerland 53
Human Capital Index-2018 World Bank Singapore 115
World Logistic Performance Index-2018 World Bank Germany 44
Global Gender Gap Index-2018 World Economic Forum Iceland 108
Branches of Scheduled Commercial Banks Pradhan Mantri Vaya Vandana Yojana
(As on March 2019) July 21, 2017
Banks Total Unnat Bharat Abhiyan
(i) SBI 22106 (2017-18) January 12, 2017
(ii) Nationalised Banks 65934 Sampada May 3, 2017
(iii) IDBI Bank 1998 Aajeevika Gramin Express 2017-18
(iv) Private Sector Banks 32378 SAUBHAGYA Yojana September 25, 2017
(v) Foreign Banks 300
RKVY—RAFTAAR Yojana 2018-19
(vi) Regional Rural Banks 21840
(vii) Local Area Banks 86 Ayushman Bharat Yojana April 14, 2018
(viii) Small Finance Banks 3150 GOBARDHAN Yojana April 30, 2018
(ix) Payment Banks 795 UDAN (Ude Desh ka Aam Nagrik) Yojana
All Banks 146601 April 27, 2017
Economics (NET) | 589U
New Development Programmes
● Deen Dayal SPARSH Yojana
Deen Dayal SPARSH YOJANA was launched on November 3, 2017 to start a Pan India scholarship to school children interested in
Philately. The SPARSH (Scholarship for Promotion of Aptitude and Research in Stamps as a Hobby) provide annual scholarship to students of
class VI to IX.
● Swavalamban Abhiyan
‘Swavalamban Abhiyan’ which includes a set of 11 new pro-poor initiatives of the Gujarat Government was launched by the Prime
Minister Shri Narendra Modi. This abhiyan includes pro-poor initiatives for the benefit of shramyog is, especially women and youth, so that
they are empowered to fight poverty. While launching the ‘Swavalamban Abhiyan’ on the Vishwakarma Day, Prime Minister mentioned three
things which are important for the shramyogi : self-reliance (swavalamban), self-independence (swashray) and self-dignity (swabhimaan).
● Pt. Deen Dayal Upadhyay Shramev Jayate Scheme
Prime Minister Narendra Modi launched a new scheme named Pandit Deendayal Upadhyay Shramev Jayate scheme that seeks to improve
employability, skill development and other conveniences for labour.
● Pradhan Mantri Jan Dhan Yojana
Prime Minister Narendra Modi has launched government’s mega scheme 'Jan DhanYojana' with the aim of eradicating the financial
untouchability by providing bank accounts to the poor.
On the inaugural day of the scheme itself, a record 1·5 crore bank accounts were opened across the country. The government has put the
target to cover 7·5 crore people under the scheme by January 26, 2015.
● Sansad Aadarsh Gram Yojana
Prime Minister Narendra Modi has announced a new initiative under which each MP would develop a model village in his area. Prime
Minister Modi had announced to launch this scheme in his Independence Day speech on August 15 from the Red Fort in New Delhi. The
‘Sansad Aadarsh Gram Yojana’ has been launched on the Oct. 11 birth anniversary of Jayaprakash Narayan.
● Shyama Prasad Mukherjee Rurban Mission
Launched on February 16, 2016. Its main objective is to create 300 rural clusters across the country and strengthen financial, job and
lifestyle facilities in rural areas.
● Pradhan Mantri Ujjwala Yojana
Launched on May 2016. Its main objective is to distribute free LPG connections to the women belonging to 5 crore BPL families across the
country.
● ‘JIGYASA’
Jigyasa, a student-scientist connect programme was officially launched in New Delhi in July 2017. Council of Scientific and Industrial
Research (CSIR), has joined hands with Kendriya Vidyalaya Sangathan (KVS) to implement this programme. The focus is on connecting
school students and scientists so as to extend student’s classroom learning with that of a very well planned research laboratory based learning.
The ‘JIGYASA’ would inculcate the culture of inquisitiveness on one hand and scientific temper on the other, amongst the school students and
their teachers.
● Pradhan Mantri Vaya Vandana Yojana (PMVVY) Launched on July 21
The Union Minister for Finance, Defence and Corporate Affairs formally launched the Pradhan Mantri Vaya Vandana Yojana (PMVVY)
on July 21, 2017. PMVVY is a Pension Scheme announced by the Government of India exclusively for the senior citizens aged 60 years and
above which is available from 4th May, 2017 to 3rd May, 2018. The Scheme can be purchased offline as well as online through Life Insurance
Corporation (LIC) of India. Scheme provides an assured return of 8% p.a. payable monthly (equivalent to 8·30% p.a. effective) for 10 years.
● Aajeevika Grameen Express Yojana
It is a sub-scheme of Deendayal Antyodaya Yojana—National Rural Livelihoods Mission (DAY-NRLM) the main objective of AGEY is to
provide an alternative source of livelihoods to members of Self Help Groups (SHGs) under DAY-NRLM by facilitating them to operate public
transport services in backward rural areas. This will provide safe, affordable and community monitored rural transport services like e-
rickshaws, 3 and 4 wheeler motorised transport vehicles to connect remote villages with key services and amenities including access to
markets, education and health for the overall economic development of the area.
● Nai-Roshni
Nai-Roshni for Leadership Development of Women, specially for women belonging to notified minority communities namely Muslims,
Christians, Sikhs, Buddhists, Parsis and Jains with an aim to empower and instill confidence among them by providing knowledge, tool and
techniques for interacting with Government system and others at all levels. The scheme is implemented through selected Non-Governmental
Organizations (NGOs) all over the country.
● Pradhan Mantri Kisan Sampada Yojana
Ministry of Food Processing launched SAMPADA (Scheme for Agro-Marine Processing and Development of Agro-Processing Clusters) as
ÒPradhan Mantri Kisan Sampada Yojana (PMKSY) Òfor the period of 2016-20 coterminous with the 14th Finance Commission cycle. The
objective of PMKSY is to supplement agriculture, modernize processing and decrease Agri-Waste.
● Saubhagya Yojana
Prime Minister Narendra Modi on September 25, 2017 launched a R 16,320 crore scheme–Pradhan Mantri Sahaj Bijli Har Ghar Yojana
‘Saubhagya’–to provide electricity connections to over 4 crore families in rural and urban areas by December 2018.
● Zero Hunger Programmes
Three districts—Gorakhpur (UP), Korapat (Odisha) and Thane (Maharashtra) have initiated India’s ambitions ‘Zero Hunger’ Programme
through interventions in farm sector on October 16, 2017. (World Food Day).
● Adopt a Heritage Scheme
The ‘Adopt a Heritage Scheme’ of Ministry of Tourism was launched on World Tourism Day i.e. 27th September, 2017 by the President of
India. Seven shortlisted companies were given ‘Letters of Intent’ for fourteen monuments under ‘Adopt a Heritage Scheme.
● Safe Cities Plan
A comprehensive ‘safe city’ plan for women kicked off in eight cities where a robust emergency response system and police-verified public
transport will come into place. Union Home Secretary Rajiv Gauba reviewed the plans which will be implemented in Delhi, Mumbai, Kolkata,
Chennai, Ahmedabad, Bengaluru, Lucknow and Hyderabad.
● Sampoorna Bima Gram Yojana
The Minister for Communications Shri Manoj Sinha on October 13, 2017 launched the Sampoorna Bima Gram (SBG) Yojana and an
initiative for expansion of clientele base of Postal Life Insurance. All villages under the Saansad Adarsh Gram Yojana will be brought under
its ambit. Under Sampoorna Bima Gram (SBG) Yojana, at least one village (having a minimum of 100 households) will be identified in each of
the revenue districts of the country, wherein endeavour will be made to cover all households of that identified village with a minimum of
one RPLI (Rural Postal Life Insurance) policy each. Coverage of all households in the identified Sampoorna Bima Gram village is the
primary objective of this scheme.
590U | Economics (NET)
● Pension Scheme for Small and Marginal Farmers
Government of India anounced on May 31, 2019 Pension Scheme for small and marginal farmers on the similar line of PM-Shram Yogi
Mandhan. Eligible farmers of 18-40 yrs of age group will be entitled to receive R 3000 PM. as pension after 60 years of age.
● Secure Himalaya project
The Centre on October 2, 2017 launched a six-year project to ensure conservation of locally and globally significant biodiversity, land and
forest resources in the high Himalayan ecosystem spread over four states in India. The SECURE (Securing Livelihoods, Conservation,
Sustainable Use and Restoration of High Range ) - Himalayan ecosystems - is meant for specific landscapes. It include Changthang (Jammu
and Kasmir), Lahaul - Pangi and Kinnaur (Himachal Pradesh), Gangotri - Govind and Darma - Byans Valley in Pithoragarh (Uttarakhand)
and Kanchenjunga - Upper Teesta Valley (Sikkim).
● Pension Scheme for Traders
A contributory pension scheme for all shopkeepers, retail traders and self employed pensons anounced on May 31, 2019. The scheme
covers there categories of traders of 18-40 yrs of age. They are entitled to receive R 3000 PM pension after 60 yrs.
● Shaadi Shagun Scheme
Meritorious Muslim girls who go on to complete graduation before marriage will get a special gift of R 51,000 from the Central
government. This proposal by the Maulana Azad Education Foundation has now been cleared by the Ministry of Minority Affairs. The Shaadi
Shagun—as the scheme is called—is aimed at incentivising higher education among minority groups.
● ‘Swasth Bachche, Swasth Bharat’
‘Swasth Bachche, Swasth Bharat’ Programme, an initiative of Kendriya Vidyalaya Sangathan to prepare a physical Health and Fitness
Profile Card for more than 12 lakhs of Kendriya Vidyalaya students was launched in Kochi. Union Minister for Human Resource Development
Shri Prakash Javadekar unveiled the Profile Card in a function held at Kendriya Vidyalaya at KV NAD, Aluva (Kochi) on 21 August, 2017.
● Livestock Vaccination Programmes for Foot and Mouth Discan
Central government will bear the entire cost of 100% vaccination of 30 crore bonines and 20 crore sheep/goats and 1 crore pigs.
● Maternity Benefit Programme
The Union Cabinet chaired by the Prime Minister Shri Narendra Modi has given ex-post facto approval to Pan-India implementation of
Maternity Benefit Programme which now has been extended to all districts of the country w.e.f. 01.01.2017. The Prime Minister in his address
to the nation on 31.12.2016 had announced Pan-India implementation of Maternity Benefit Programme. The Maternity Benefit Program will
provide compensation for the wage loss in terms of cash incentives so that the women can take adequate rest before and after delivery and not
be deprived of proper nutrition.
● Pradhan Mantri Gramin Digital Saksharta Abhiyan
The Union Cabinet chaired by the Prime Minister Shri Narendra Modi has approved 'Pradhan Mantri Gramin Digital Saksharta Abhiyan'
(PMGDISHA) to make 6 crore rural households digitally literate. The outlay for this project is R 2,351.38 crore to usher in digital literacy in
rural India by March 2019. This is in line with the announcement made by Finance Minister in the Union Budget 2016-17.
● Kisan Urja Suraksha Evam Utthaan Mahabhiyan – Kusum Scheme
Prime Minister Narendra Modi has announced Kisan Urja Suraksha evam Utthaan Mahabhiyan – Kusum Scheme for farmers.
Subsequently, govt. will provide subsidy on setting up pf solar power plants on their barren land. Accordingly, Kusum Scheme will solarize
agricultural pump sets to double the income of farmers by 2022. Central govt. has allocated R 48,000 crore in Union Budget 2018-19 for
upcoming 5 years for successful implementation of this scheme.
● Gobar-Dhan Scheme
In an effort to make the villages open defecation free and improving the lives of villagers, the Finance Minister in his budget speech
February 1, 2018 announced the launch of Galvanizing Organic Bio-Agro Resources Dhan (GOBAR-DHAN) . The Minister added that this
will manage and convert cattle dung and solid waste in farms to compost, bio-gas and bio-CNG.
● NABH Nirman
The Finance Minister is seeking to provide a big push to the country's civil aviation sector, aiming at five-fold growth in passenger traffic
to a billion trips a year. The Minister said the Airport Authority of India (AAI) has 124 airports and it is proposed to expand by more than five
times the airport capacity to handle a billion trips a year under a new initiative—NextGen Airports for Bharat (NABH) Nirman .
● RISE Scheme
A n e w initiative known a s ‘RISE’ was announced by the Finance Minister on February 1, 2018. RISE stands for ‘Revitalising of
Infrastructure and Systems in EducationÓ. While talking about the same, FM Jaitley said the scheme known as RISE will be launched in the
country with a total investment of R 1 lakh crore in the next four years.
● Ayushman Bharat programme
Finance Minister Arun Jaitly in his budget speech 2018-19 announced two major initiatives in health sector , as part of Ayushman Bharat
programme. It has two components.(i) Health and Wellness Centre: Under this 1.5 lakh centres will bring health care system closer to the
homes of people. (ii) National Health Protection Scheme-Pradhan Mantri Jan Aarogya Yojana : It will cover over 10 crore poor and
vulnerable families (approximately 50 crore beneficiaries) providing coverage upto 5 lakh rupees per family per year for secondary and
tertiary care hospitalization.
● PM Research Fellowships (PMRF) Programme
The Union Cabinet has cleared the PM Research Fellowships (PMRF) for students of higher education institutions like the IITs, IISERs and
NITs. The PMRF includes monthly scholarships of R 70,000 to R 80,000 and annual research grants of R 2 lakh for select scholars.
● PM Kisan Samman Nidhi (PM-KISAN) has been announced in Union Budget 2019-20. R 6,000 will be transferred in the accounts of all
the eligible farmers in three equal instalment of R 2,000 each. Effective date is February 1, 2019. However, for transferring the first
instalment of R 2,000 before March 31, 2019, the cut of date is December 1, 2018 on May 31, the scheme extended to all farmers subject to
certain riders.
● PM Shram-Yogi Maandhan Yojana has been announced in Union Budget 2019-20. It is a mega insurance scheme for workers of
unorganised sector with annual income of R 15,000. Eligible worker will be entitled to receive R 3,000 per month pension after 60
years of age. Monthly contribution ranges from R 55 per month to R 200 per month.
● PM Kisan Maandhan Yojana is a contributory voluntary pension scheme for small and marginal farmers in the age group of 18 to 40 yrs.
Eligible farmers well receive R 3000 PM as pension for whole life with a monthly contribution of R 55 to R 200, depending upon the age of
the beneficiary at the time of registration.
● PM Laghu Vyapari Maandhan Yojana is a contributory voluntary pension scheme for shop-keepers, self employed, small traders,
retailers having annual GST ternover less than R 1·5 crore. Eligible beneficiary of 18 to 40 yrs of age will receive R 3000 monthly pension
for whole life after attaining the age of 60 yrs. Monthly contribution, with equal contribution of Central government rangers R 55 to R 200
depending upon the age of beneficiary at the time of registration.
● One Nation-One Ration Card Yojana is a scheme of portability of ration card across the country. As on September 1, 2019 14 states have
implemented the scheme. The scheme will be operational throughout India w.e.f. July 1, 2020.
Economics (NET) | 591U
Bharatmala Pariyojana October 24, 2017 indicating a glaring inequality in the country though
Van Dhan Yojana April 14, 2018 'millions have been lifted out of poverty'.
Samagra Shiksha Yojana May 24, 2018 The UNDP report stated that with an HDI value of
Rashtriya Gram Swaraj Abhiyan April 1, 2018 0·64 compared to last year’s 0.636, India is categorised
Pradhan Mantri Kisan Samman NIDHI (PM-KISAN) as a medium human development and that its rank rose
(Effective from December 1, 2018) Feb. 1, 2019 one spot compared to the 2017 HDI.
Pradhan Mantri Shram Yogi Mandhan According to the Human Development Report, 2018
(Effective from Feb. 15, 2019) Feb. 1, 2019 findings, between 1990 and 2017, India’s HDI value
Pradhan Mantri Laghu Vyapari Maandhan Yojana increased from 0·427 to 0·640, an almost 50 per cent
22 July, 2019 increase, which is 'an indicator that millions have been
One Nation-One Ration Card Yojana 2019-20 lifted out of poverty'. India’s HDI went up from 0.636 in
Finance Commission 2016 to 0.64 in 2017, but grew at a slower pace, at 0·63
Appointment of Finance Commission per cent, compared with 1·4 per cent in each of the
President (Under Article 280) preceding two years. This is in line with the slow HDI
No. of Finance Commissions setup by now 15 growth at the global level, from above 0·5 per cent in
Chairman of 12th Finance Commission preceding two years to 0·3 per cent in 2017. The value
Dr. C. Rangarajan of India’s Inequality-adjusted HDI (IHDI) in 2017 falls
Chairman of 13th Finance Commission to 0.468, a 26.8 per cent decrease, far worse than the
Vijai L. Kelkar global average decrease in the global HDI value due to
Chairman of 14th Finance Commission Y.B. Reddy inequality at 20 per cent.
Chairman of 15th Finance Commission N.K. Singh The HDI is the composite measure of every
Some Aspects of Indian Economy country’s attainment in three basic dimensions : (i)
Standard of living measured by the gross national
Classification Per Capita GNI income (GNI) per capita, (ii) Health measured by the life
(Effective from 1st July, 2019 Calculated using the World expectancy at birth, and (iii) Education levels calculated
Bank Atlas Methods)
1. Low income economy US $ 1025 or less than it by mean years of education among the adult population
2. Low middle income economy US $ 1026–US $ 3995 and the expected years of schooling for children.
3. Upper middle income economy US $ 3996–US $ 12375 Human Development Indicators of India
4. High income economy US $ 12375 or more Between 1990 and 2017
According to ‘Annual Employment and Unemployment (Since 1990, the Steady Climb)
Survey Report 2015-16’ the unemployment rates for Life
different categories based on Usual Principal Status (UPS) Expected Mean GNI per
Expec- HDI
in India during 2015-16 was : (in %) years of Years of capita
tancy at Value
Sector Male Female Transgender Person Schooling Schooling (2011)*
Birth
Rural 4·2 7·8 2·1 5·1 1990 57·9 7·6 3·0 1733 0·427
Urban 3·3 12·1 10·3 4·9 1995 60·4 8·2 3·5 2015 0·460
Rural + Urban 4·0 8·7 4·3 5·9 2000 62·6 8·3 4·4 2470 0·493
Human Development Index 2017 : 2005 64·6 9·7 4·8 3157 0·535
Rising Inequalities 2010 66·6 10·8 5·4 4357 0·581
2015 68·3 12·0 6·3 5691 0·627
India ranks a low at 130th out of 189 countries in 2016 68·6 12·3 6·4 6026 0·636
the Human Development Index (HDI), 2018 data update 2017 68·8 12·3 6·4 6353 0·640
released by the United Nations Development Programme
Note : PPP in $
(UNDP) on September 1 4 , 2018, with the findings
Top Ten Countries in UNDP’s Human Development Index, 2017 (HDR, 2018)
Life Expectancy at Expected Years of Mean Years of GNI per capita
Rank Country HDI Value
Birth (yrs.) SDG-3 Schooling SDG-4·3 Schooling SDG-4·6 (PPP$) SDG-8·5
1 Norway 0·953 82·3 17·9 12·6 68,012
2 Switzerland 0·944 83·5 16·2 13·4 57,625
3 Australia 0·939 83·1 22·9 12·9 43,560
4 Ireland 0·938 81·6 19·6 12·5 53,754
5 Germany 0·936 81·2 17·0 14·1 46,136
6 Iceland 0·935 82·9 19·3 12·4 45,810
7 Hong Kong, 0·933 84·1 16·3 12·0 58,420
China (SAR)
8 Sweden 0·933 82·6 17·6 12·4 47,766
9 Singapore 0·932 83·2 16·2 11·5 82,503
10 Netherlands 0·931 82·0 18·0 12·2 47,900
592U | Economics (NET)
India and BRICS Countries alongwith Neighbouring Countries in Human Development Index,
2017
Life Expectancy at Expected Years of Mean Years of GNI per capita
Rank Country HDI Value
Birth (yrs) SDG-3 Schooling SDG-4·3 Schooling SDG-4·6 (PPP$) SDG-8·5
79 Brazil 0·759 75·7 15·4 7·8 13755
49 Russia 0·816 71·2 15·5 12·0 24233
86 China 0·752 76·4 13·8 7·8 15270
130 India 0·640 68·8 12·3 6·4 6353
113 South Africa 0·699 63·4 13·3 10·1 11923
150 Pakistan 0·562 66·6 8·6 5·2 5311
136 Bangladesh 0·608 72·8 11·4 5·8 3677
134 Bhutan 0·612 70·6 12·3 3·1 8065
76 Sri Lanka 0·770 75·5 13·9 10·9 11326
149 Nepal 0·574 70·6 12·2 4·9 2471
101 Maldives 0·717 77·6 12·6 6·3 13567
Gender Inequality Index, 2018 State Specific Poverty Line as Proposed by
Rangarajan Expert Group
Globally, the average HDI for women is six per cent
lower than for men, due to women’s lower income and States/UTs Poverty Line 2011-12
educational attainment in many countries. India ranks Rural Urban
127 out of 160 countries on the Gender Inequality
Index, 2018 which reflects gender-based inequalities in Andhra Pradesh 1031.74 1370.84
reproductive health, empowerment (political and Arunachal Pradesh 1151.01 1482.94
educational), and economic activity. Assam 1006.66 1420.12
In India women hold only 11·6 per cent of Bihar 971.28 1229.3
parliamentary seats, while only 39 per cent of adult Chhattisgarh 911.8 1229.72
women have reached at least a secondary level of Delhi 1492.46 1538.09
Goa 1200.6 1470.07
education as compared to 64 per cent men. India’s worst
Gujarat 1102.83 1507.06
performance on the gender scale is with regard to its
Haryana 1127.82 1528.31
female participation in the labour market which is 27·2
Himachal Pradesh 1066.6 1411.59
per cent compared to 78.8 per cent for men even as
Jammu & Kashmir 1044.48 1403.25
globally 49 per cent women are part of the labour force
Jharkhand 904.02 1272.06
as compared to 75 per cent men.
Karnataka 975.43 1373.28
Another area that India needs to focus on, to ensure Kerala 1054.03 1353.68
sustained HDI growth, is climate resilience. This is one
Madhya Pradesh 941.7 1340.28
factor that can constrain HDI. Norway at 0·95 has been
Maharashtra 1078.34 1560.38
ranked the highest on the HDI scale while Niger is the
Manipur 1185.19 1561.77
bottom at 0.35. The greatest increase in HDI rank over
Meghalaya 1110.67 1524.37
the last five years is by Ireland followed by Turkey
Mizoram 1231.03 1703.93
while the worst decline was seen in conflict-hit countries
Nagaland 1229.83 1615.78
of Syria, Libya and Yemen.
Odisha 876.42 1205.37
New Poverty Line : R 32 in Rural Punjab 1127.48 1479.27
Areas, R 47 in Urban Areas Rajasthan 1035.97 1406.15
Sikkim 1126.25 1542.67
Those spending over R 32 a day in rural areas and Tamil Nadu 1081.94 1380.36
R 47 in towns and cities should not be considered poor, Tripura 935.52 1376.55
an expert panel headed by former RBI governor C.
Rangarajan said in a report submitted to the BJP govern- Uttar Pradesh 889.82 1329.55
ment last week. Based on the Suresh Tendulkar panel’s Uttarakhand 1014.95 1408.12
recommendations in 2011-12, the poverty line had been West Bengal 934.1 1372.68
fixed at 27 in rural areas and 33 in urban areas, levels at Puducherry 1130.1 1382.31
which getting two meals may be difficult. All India 972 1407
Economics (NET) | 593U
Committee Year Poverty Ratio Number of Poor(Million)
Total Rural Urban Total Rural Urban
Rangarajan 2011-12 29.5 30.9 26.4 363 260.5 102.5
2009-10 38.2 39.6 35.1 456.6 325.9 128.7
Reduction 8.7 8.7 8.7 91.6 65.4 26.2
Tendulkar 2011-12 21.9 25.7 13.7 269.8 216.7 53.1
2009-10 29.8 33.8 20.9 354.7 278.2 76.5
Reduction 7.8 8.1 7.2 84.9 61.5 23.4
2004-05 37.2 41.8 25.7 407.1 326.3 80.8
1993-94 45.6 50.1 31.8 403.7 328.6 74.5
Poverty Line
Per capita Expenditure Per capita All India Poverty Line (Average
Committee Year Average Monthly
per day(R) Expenditure (R)
Monthly Expenditure per Family of 5)
Rural Urban Rural Urban Rural Urban
Rangarajan 2011-12 32.4 46.9 972 1407 4760 7035
2009-10 26.7 39.9 801 1198 4005 5990
Tendulkar 2011-12 27.2 33.3 816 1000 4080 5000
2009-10 22.4 28.7 673 860 3365 4300
Poverty Ratio and Number of Poor in 2011-12 based on Proposed Methodology by Rangarajan
Committee
Rural Urban Total
No. of No. of No. of
S. % age of % age of % age of
States/UTs Persons Persons Persons
No. Persons Persons Persons
(lakhs) (lakhs) (lakhs)
1. Andhra Pradesh 12·7 71·5 15·6 45·7 13·7 117·3
2. Arunachal Pradesh 39·3 4·3 30·9 1·0 37·4 5·3
3. Assam 42·0 114·1 34·2 15·4 40·9 129·5
4. Bihar 40·1 376·8 50·8 61·4 41·3 438·1
5. Chhattisgarh 49·2 97·9 43·7 26·9 47·9 124·8
6. Delhi 11·9 0·5 15·7 26·3 15·6 26·7
7. Goa 1·4 0·1 9·1 0·8 6·3 0·9
8. Gujarat 31·4 109·8 22·2 58·9 27·4 168·8
9. Haryana 11·0 18·4 15·3 14·0 12·5 32·4
10. Himachal Pradesh 11·1 6·9 8·8 0·6 10·9 7·5
11. Jammu & Kashmir 12·6 11·7 21·6 7·6 15·1 19·3
12. Jharkhand 45·9 117·0 31·3 25·5 42·4 142·5
13. Karnataka 19·8 74·8 25·1 60·9 21·9 135·7
14. Kerala 7·3 12·3 15·3 26·0 11·3 38·3
15. Madhya Pradesh 45·2 241·4 42·1 86·3 44·3 327·8
16. Maharashtra 22·5 139·9 17·0 88·4 20·0 228·3
17. Manipur 34·9 6·7 73·4 6·3 46·7 12·9
18. Meghalaya 26·3 6·4 16·7 1·0 24·4 7·4
19. Mizoram 33·7 1·8 21·5 1·2 27·4 3·1
20. Nagaland 6·1 0·8 32·1 1·9 14·0 2·8
21. Odisha 47·8 169·0 36·3 26·0 45·9 195·0
22. Punjab 7·4 12·9 17·6 18·7 11·3 31·6
23. Rajasthan 21·4 112·0 22·5 39·5 21·7 151·5
24. Sikkim 20·0 0·9 11·7 0·2 17·8 1·1
25. Tamil Nadu 24·3 91·1 20·3 72·8 22·4 163·9
26. Tripura 22·5 6·1 31·3 3·2 24·9 9·3
27. Uttar Pradesh 38·1 600·9 45·7 208·2 39·8 809·1
28. Uttarakhand 12·6 8·9 29·5 9·4 17·8 18·4
29. West Bengal 30·1 188·6 29·0 86·8 29·7 275·4
30. Puducherry 5·9 0·2 8·6 0·7 7·7 1·0
31. Andaman & Nicobar Island 6·6 0·2 4·9 0·1 6·0 0·2
32. Chandigarh 12·0 0·0 21·5 2·3 21·3 2·3
33. Dadra & Nagar Haveli 55·2 1·0 15·3 0·3 35·6 1·3
34. Daman & Diu 0·0 0·0 17·6 0·4 13·7 0·4
35. Lakshadweep 0·6 0·0 7·9 0·0 6·5 0·0
All India 30·9 2605·2 26·4 1024·7 29·5 3629·9
594U | Economics (NET)
Criteria for Not Including in BPL Group
2002 criteria Proposed criteria
● Operating more than 2 hectares of ● Owns double the district average of agri-land per agri-household if partially or
land. wholly irrigated (3 times if completely unirrigated).
● Having a pucca house. ● Owns two-wheeled or more than three-wheeled motorised vehicles.
● Any member with yearly income more ● Owns at least one running borewell or mechanised farm equipment like tractor,
than R 20,000. power tiller, thresher, harvester.
● Owns TV/fridge/ceiling fan / two- ● Pays income tax.
wheeler / three-wheeler.
● Owns tractor/power tiller/ combined ● With any member drawing salary of over R 5,000 per month in non-
thresher/ harvester. government/private organisations or is employed with the government
(including parastatals) on a regular basis (including parateachers but excluding
Anganwadi workers, helpers accredited social health activists).
The New Proposed Score System for BPL (Highest score achievable is 10)
Points Category
4 Landless agricultural worker.
3 SC/ST, agriworker with some land.
2 Most backward castes, self-employed artisans, fisher-folk or casual workers.
1 Muslim/OBC; household where no adult studied up to class 5; any member of the house with TB, leprosy,
disability, mental illness or AIDS; household headed by a person of age 60 years and above or by a single woman
with major son(s).
Multidimensional Poverty Index
The Oxford Poverty and Human Development Initiative (OPHI) has developed a new international measure of
poverty – the Multidimensional Poverty Index or MPI – for the 20th Anniversary edition of the United Nations
Development Programme’s flagship Human Development Report. The new innovative index goes beyond a
traditional focus on income to reflect the multiple deprivations that a poor person faces with respect to education,
health and living standard.
The indicators and the criteria for some-one to be considered deprived in each indicator are presented as
under—
1. Education (each indicator is weighted equally at 1/6 )
● Years of Schooling : deprived if no household member has completed five years of schooling
● Child Enrolment : deprived if any school-aged child is not attending school in years 1 to 8
2. Health (each indicator is weighted equally at 1/6)
● Child Mortality : deprived if any child has died in the family
● Nutrition : deprived if any adult or child for whom there is nutritional information is malnourished
3. Standard of Living (each indicator is weighted equally at 1/18)
● Electricity : deprived if the household has no electricity
● Drinking water : deprived if the household does not have access to clean drinking water or clean water is more
than 30 minutes walk from home
● Sanitation : deprived if they do not have an improved toilet or if their toilet is shared
● Flooring : deprived if the house-hold has dirt, sand or dung floor
● Cooking Fuel : deprived if they cook with wood, charcoal or dung
● Assets : deprived if the household does not own more than one of: radio, TV, telephone, bike, or Motor bike, and
do not own a car accounting for almost entire
United Nations Development Programme has released data regarding Multidimensional Index, 2018. For India,
these data have been presented in table 1 and 2.
Economics (NET) | 595U
Multidimensional Poverty Index, Headcount Ratio, Intensity and Reduction in MPI and
Headcount Ratio between 2005-6 & 2015-16
2015-16 Absolute Reduction 2005-6 & 2015-16
MPI H A Population Change in MPI Change in H
Incidence Intensity Share
2016
India 0·121 27·5% 43·9% 100·0% – 0·158* – 27·2%*
Andhra Pradesh 0·065 15·8% 40·9% 6·8% – 0·17* – 34·1%*
Arunachal Pradesh 0·106 24·0% 44·1% 0·1% – 0·203* – 35·7%*
Assam 0·16 35·8% 44·6% 2·4% – 1·152* – 24·8%*
Bihar 0·246 52·2% 47·2% 8·9% – 0·2* – 25·0%*
Chhattisgarh 0·151 36·3% 41·4% 2·3% – 0·203* – 33·7%*
Delhi 0·016 3·8% 42·3% 1·3% – 0·035* – 7·7%*
Goa 0·021 5·6% 37·2% 0·1% – 0·066* – 14·8%*
Gujarat 0·09 21·4% 42·2% 4·7% – 0·095* – 17·1%*
Haryana 0·046 11·0% 42·3% 2·3% – 0·135* – 27·5%*
Himachal Pradesh 0·031 8·2% 37·4% 0·5% – 0·098* – 22·9%*
Jammu & Kashmir 0·063 15·2% 41·7% 1·0% – 0·126* – 25·6%*
Jharkhand 0·205 45·8% 44·7% 2·7% – 0·221* – 28·8%*
Karnataka 0·068 17·1% 39·8% 4·9% – 0·156* – 31·0%*
Kerala 0·004 1·1% 37·4% 2·9% – 0·048* – 12·2%*
Madhya Pradesh 0·18 40·6% 44·2% 6·5% – 0·178* – 27·1%*
Maharashtra 0·069 16·8% 41·3% 9·6% – 0·113* – 22·6%*
Manipur 0·083 20·7% 40·3% 0·2% – 0·123* – 24·4%*
Meghalaya 0·145 32·7% 44·5% 0·2% – 0·188* – 27·8%*
Mizoram 0·044 9·7% 45·2% 0·1% – 0·095* – 21·2%*
Nagaland 0·097 23·3% 41·7% 0·1% – 0·196* – 33·6%*
Odisha 0·154 35·5% 43·3% 3·4% – 0·176* – 28·0%*
Punjab 0·025 6·0% 41·2% 2·3% – 0·083* – 18·0%*
Rajasthan 0·143 31·6% 45·2% 5·5% – 0·183* – 30·0%*
Sikkim 0·019 4·9% 38·1% 0·0% – 0·157* – 32·7%*
Tamil Nadu 0·028 7·4% 37·5% 6·6% – 0·127* – 29·6%*
Tripura 0·086 20·1% 42·7% 0·3% – 0·179* – 34·3%*
Uttar Pradesh 0·18 40·4% 44·7% 15·7% – 0·18* – 28·5%*
Uttarakhand 0·072 17·1% 41·8% 0·8% – 0·107* – 21·6%*
West Bengal 0·109 26·0% 41·9% 7·6% – 0·189* – 31·4%*
Scheduled Caste 0·145 32·9% 44·1% 20·7% – 0·193* – 32·2%*
Schedule Tribe 0·229 50·0% 45·8% 9·4% – 0·218* – 29·8%*
Other Backward Class 0·117 26·9% 43·5% 42·9% – 0·174* – 31·0%*
Other Caste Group 0·065 15·3% 42·5% 22·7% – 0·111* – 20·8%*
Hindu 0·12 27·7% 43·5% 80·2% – 0·156* – 27·2%*
Muslim 0·144 31·1% 46·4% 14·1% – 0·187* – 29·3%*
Christian 0·069 16·1% 42·9% 2·4% – 0·122* – 22·7%*
Other Religion 0·067 15·5% 43·0% 3·3% – 0·105* – 19·7%*
Age 0–9 Years 0·189 40·9% 46·3% 18·2% – 0·182* – 27·3%*
Age 10–17 Years 0·121 27·3% 44·1% 15·8% – 0·169* – 28·7%*
Age 18–60 Years 0·102 23·6% 43·9% 57·5% – 0·142* – 25·6%*
Age 60+ Years 0·105 25·4% 41·3% 8·5% – 0·122* – 23·8%*
* All changes are significant at 1% level. Source : UNDP
H–Incidence is the percentage of people who are poor (or Headcount Ratio in %)
A–Intensity is the average share of indicators in which poor people are deprived
MPI–Multidimensional Poverty Index (MPI) = H × A
596U | Economics (NET)
India in Multidimensional Poverty Index, 2018
Sub-indicator India China Pakistan Bangladesh Nepal
(2015-16) (2014) (2012-13) (2014) (2016)
1. Value of Multidimensional Poverty Index (2015-16) 0·090 0·017 0·228 0·194 0·154
2. Population in Multidimensional Poverty :
(a) Head Count (%) 27·51 4·02 43·88 41·07 35·25
(b) Intensity of Deprivation (%) 43·90 41·38 52·04 47·33 43·58
(c) Number of Poor (2016) (Thousands) 364,225 55,825 84,773 66,916 10,217
3. Population Valunerable to Multidimensional Poverty (%) 19·12 17·98 14·53 21·54 24·33
4. Population in Severe Multidimensional Poverty (%) 8·59 0·35 24·74 16·21 11·99
5. Contribution of deprivation in dimension to overall
poverty (% share) :
(a) Health 31·63 36·13 28·67 22·92 32·26
(b) Education 23·59 38·37 38·53 29·59 26·46
(c) Standard of living 44·79 25·50 32·80 47·49 41·28
6. Population living below income poverty line (%)
(a) National Poverty Line 21·9 3·10 29·50 24·30 25·20
(b) World Bank Poverty Line (PPP) $ 1·9 a day 21·2 1·40 6·10 14·80 15·00
Source : UNDP
Mineral Resources of India
India’s Achievements in New and Renewable Sources of Energy : 2018-19
● India attains global 4th and 5th positions in wind and solar power installed capacities; India now at 5th global position
for overall installed renewable energy capacity.
● A total of 101·83 billion units of power were generated in the country during the year 2017-18 from renewable energy.
● Keeping in view India’s commitment to its Nationally Determined Contributions as per the Paris Accord on Climate
Change, India made a pledge that by 2030, 40% of installed power generation capacity shall be based on clean sources, it
was determined that 175 GW of renewable energy capacity will be installed by 2022. This includes 100 GW from solar, 60
GW from wind, 10 GW from bio-power and 5 GW from small hydro power.
● A total of around 74·08 GW of renewable energy capacity has been installed in the country as on December 31, 2018 from
all renewable energy sources which includes around 35·19 GW from Wind, 25·21 GW from solar, 4·5 GW from Small
Hydro Power and 9·07 GW from Bio-power.
● Further, projects worth 46·75 GW capacity have been bid out/under installation. The Government has declared the
trajectory of bidding 60 GW capacity of solar energy and 20 GW capacity of wind energy till 31.03.2020. Projects worth
each 30 GW solar power and 10 GW wind power capacity would be bid out each in the year 2018-19 & 2019-20.
● A total of 101·83 billion units of power were generated in the country during the year 2017-18 from all renewable energy
sources as compared to 61·78 billion units generated in 2014-15 (increase of around 65% during the four years). Share of
renewable energy in terms of overall power generation has reached to around 8% from 5·5% in 2014-15.
Forest Resources of India
India State of Forest Report 2017, released by the Union Environment Minister Harsh Vardhan and Mahesh
Sharma, Minister of State, Ministry of Environment & Forests and Climate Change (MoEFCC). The 15th State of
Forest Report shows that India’s total forest cover increased by 0·94 per cent, from 7,01,673 square kilometers to
7,08,273 square kilometers since its last assessment in 2015· The biannual report is prepared by The Forest Survey
of India (FSI).
Class Area (sq kms) % of geographical area % of geographical
2017 area (SFR 2015)
Very dense forest 98,158 2·99 2·26
Moderately dense forest (all lands with tree cover-including 3,08,318 9·38 9·59
mangrove cover of canopy density between 40-70%)
Open forest (all lands with tree cover - including mangrove 3,01,797 9·18 9·14
cover of canopy density between 10% and 40%)
Total Forest Cover 7,08, 21·54 21·34
ISFR : 2017 : Key Findings
● The increasing trend of forest and tree cover is largely due to the various national policies aimed at conservation
and sustainable management of forests like Green India Mission, National Agro-Forestry policy (NAP), REDD
plus policy, Joint Forest Management (JFM), National Afforestation Programme and funds under Compensatory
Afforestation to States.
Economics (NET) | 597U
● Successful agro-forestry practices, better conservation of forests, improvement of scrub areas to forest areas,
increase in mangrove cover, conservation and protection activities have also led to increase in the forest and tree
cover.
● Green Highways (Plantations & Maintenance) Policy to develop 1,40,000 km long tree line with plantation
along with both sides of national highways will go a long way in enhancing the forest and tree cover.
● Top 5 states where maximum forest cover has increased are Andhra Pradesh (2,141 sq kms), Karnataka (1,101
sq kms), Kerala (1,043 sq kms), Odisha (885 sq kms) and Telangana (565 sq kms).
● Top 5 states where forest cover has decreased are Mizoram (531 sq km), Nagaland (450 sq km), Arunachal
Pradesh (190 sq km), Tripura (164 sq km) and Meghalaya (116 sq km). It is important to mention here that these
states are in the North Eastern region of the country where the total forest cover is very high i.e., more than 70%
in each state.
● The main reasons for the decrease are-shifting cultivation, other biotic pressures, rotational felling, diversion of
forest lands for developmental activities, sub-mergence of forest cover, agriculture expansion and natural
disasters. Water bodies inside forests have increased over a decade.
Forest Cover in States/UTs in India : 2017
(Based on India State of Forest Report : 2017)
(Area in sq km)
Geo- Per cent
State/UT graphical 2017 Assessment Total of Geo- Scrub
Area VDF MDF OF Forest graphical Area
Andhra Pradesh 1,62,968 1,957 14,051 12,139 28,147 17·27 9,560
Arunachal Pradesh 83,743 20,721 30,955 15,288 66,964 79·96 247
Assam 78,438 2,797 10,192 15,116 28,105 35·83 217
Bihar 94,163 332 3,260 3,707 7,299 7·75 228
Chhattisgarh 1,35,192 7,064 32,215 16,268 55,547 41·09 552
Delhi 1,483 6·72 56·24 129·45 192·41 12·97 0·67
Goa 3,702 538 576 1,115 2,229 60·21 0
Gujarat 1,96,244 378 5,200 9,179 14,757 7·52 2,194
Haryana 44,212 28 452 1,108 1,588 3·59 154
Himachal Pradesh 55,673 3,110 6,705 5,285 15,100 27·12 308
Jammu & Kashmir* 2,22,236 4,075 8,579 10,587 23,241 10·46 573
Jharkhand 79,716 2,598 9,686 11,269 23,553 29·55 669
Karnataka 1,91,791 4,502 20,444 12,604 37,550 19·58 4,484
Kerala 38,852 1,663 9,407 9,251 20,321 52·30 23
Madhya Pradesh 3,08,252 6,563 34,571 36,280 77,414 25·11 6,279
Maharashtra 3,07,713 8,736 20,652 21,294 50,682 16·47 4,160
Manipur 22,327 908 6,510 9,928 17,346 77·69 1,111
Meghalaya 22,429 453 9,386 7,307 17,146 76·45 505
Mizoram 21,081 131 5,861 12,194 18,186 86·27 0
Nagaland 16,579 1,279 4,587 6,623 12,489 75·33 503
Odisha 1,55,707 6,967 21,370 23,008 51,345 32·98 306
Punjab 50,362 8 806 1,023 1,837 3·65 33
Rajasthan 3,42,239 78 4,340 12,154 16,572 4·84 4579
Sikkim 7,096 1,081 1,575 688 3,344 47·13 307
Tamil Nadu 1,30,060 3,672 10,979 11,630 26,281 20·21 657
Telangana 1,12,077 1,596 8,738 10,085 20,419 18·22 3,238
Tripura 10,486 656 5,246 1,824 7,726 73·68 15
Uttar Pradesh 2,40,928 2,617 4,069 7,993 14,679 6·09 551
Uttarakhand 53,483 4,969 12,884 6,442 24,295 45·43 383
West Bengal 88,752 2,994 4,147 9,706 16,847 18·98 136
A&N Islands 8,249 5,678 684 380 6,742 81·73 1
Chandigarh 114 1·36 13·82 6·38 21·56 18·91 0·02
Dadra & Nagar Haveli 491 0 80 127 207 42·16 5
Daman & Diu 111 1·40 5·82 13·27 20·49 18·46 0·27
Lakshadweep 30 0 17·04 10·06 27·10 90·33 0
Puducherry 490 0 17·60 36·07 53·67 10·95 0
Grand Total 32,87,469 98,158 3,08,318 3,01,797 7,08,273 21·54 45,979
* Includes Jammu & Kashmir area outside LoC that is under illegal occupation of Pakistan and China. UDF–Veri Dense
Forests; MDF-Moderately Dense Forest; OF-Open Forests.
598U | Economics (NET)
Sectoral Share in GVA at basic Prices at
Economic Growth in India : Pattern Current Prices (%)
and Structure (2011-12 Series)
Acronyms Used in the New Methodology of 2017-18 2018-19
National Income Estimation 1. Agriculture 17·2 16·1
2. Industry 29·3 29·6
GDP: Gross Domestic Product
2.1. Mining and quargery 2·3 2·4
GVA: Gross Value Added
2.2. Manufacturing 16·4 16·4
GNI: Gross National Income 2.3. Electricity, gas and water 2·7 2·8
NDP: Net Domestic Product supply
NNI: Net National Income 2.4. Construction 7·8 8·0
3. Services 53·5 54·3
GNDI: Gross National Disposable Income PFCE: Private 4. GVA at basic Prices 100·00 100·0
Final Consumption Expenditure
GFCE: Government Final Consumption Expenditure Provisional Estimates of National
CFC: Consumption of Fixed Capital Income for 2018-19
GFCF: Gross Fixed Capital Formation India’s economic growth fell to 5·8 per cent in the
CIS: Changes in Stock January-March period of 2018-19, the lowest in 20
CE: Compensation of Employees quarters, due to a sharp slowdown in investment and
OS: Operating Surplus manufacturing growth as well as a contraction in
MI: Mixed Income agricultural production. This pulled down the gross
domestic product (GDP) expansion to 6·8 per cent in
ROW: Rest of the World
2018-19, the slowest in the first stint of the Modi
Formulae of National Income government. Growth in the gross fixed capital formation
(GFCF), which denotes investments, declined to 3·4 per
1. GVA at basic prices = CE + OS/MI + CFC + cent, the lowest in several quarters. With private invest-
Production taxes less Production subsidies ment already low, the government’s curtailment of
2. GVA at factor cost (earlier referred to as GDP at factor capital spend in the fourth quarter to meet the fiscal
cost) = GVA at basic prices – Production taxes less deficit target could be blamed for the sharp fall in the
Production subsidies GFCF growth, which was over 10 per cent in the
previous three quarters.
3. GDP = ÂGVA at basic prices + Product taxes - Product
The National Statistical Office (NSO), Ministry of
subsidies Statistics and Programme Implementation, has released
4. NDP/NNI = GDP/GNI - CFC the Provisional Estimates of National Income for the
5. GNI = GDP + Net primary income from ROW
financial year 2018-19 on May 31, 2019.
(Receipts less payments)
GDP growth rates for 2018-19 and Q1, Q2, Q3 and
Q4 of 2018-19 at Constant (2011-12) and Current Prices
6. Primary Incomes = CE + Property and Entrepreneurial are given below :
Income
Constant Prices Current Prices
2018-19
7. NNDI = NNI + other current transfers from ROW, net (2011-12)
(Receipts less payments) Q1 (April-June) 8·0 11·2
8. GNDI = NNDI + CFC = GNI + other current transfers Q2 (July- September) 7·0 12·6
from ROW, net (Receipts less payments) Q3 (October-December) 6·6 12·0
9. Gross Capital Formation= Gross Savings+ Net Capital Q4 (January-March) 5·8 11·0
Inflow from ROW Financial Year 6·8 9·4
10. GCF = GFCF + CIS + Valuables + “Errors and I. (a) Estimates at Constant (2011-12) Prices
Omissions” Gross Domestic Product : Real GDP or GDP at
11. Gross Disposable Income of Govt. = GFCE + Gross Constant (2011-12) Prices for the year 2018-19 is now
Saving of GG estimated at R 140·78 lakh crore showing a growth rate
of 6·8 per cent over First Revised Estimates of GDP for
12. Gross Disposable Income of Households = GNDI – the year 2017-18 of R 131·80 lakh crore, released on
GDI of Govt. – Gross Savings of All Corporations 31st January, 2019.
Economics (NET) | 599U
Provisional Estimates of GVA at Basic Price by have attained a level of R 92,565 as compared to
Economic Activity R 87,623 for the year 2017-18. The growth rate in Per
Capita Income is estimated at 5·6 per cent during 2018-
Percentage Percentage
Change Over Change Over 19, as against 5·7 per cent in the previous year.
Industry
Previous Year Previous Year Price Indices used as Deflators : The Wholesale
(at Constant (at Constant Price Index (WPI), in respect of the groups Food
Price 2011-12) Price 2011-12) Articles, Minerals, Manufactured Products, Electricity
2017-18 2018-19 2017-18 2018-19 and all commodities, has risen by 0·4 per cent, 11·3 per
1. Agriculture, 5·0 2·9 7·0 4·0 cent, 3·7 per cent, 6·0 per cent and 4·3 per cent, res-
forestry & fishing pectively during April-March, 2018-19. The Consumer
2. Mining & 5·1 1·3 9·1 16·8 Price Index has shown a rise of 3·4 per cent during
quarrying April-March, 2018-19.
3. Manufacturing 5·9 6·9 8·9 10·9 II. (b) Estimates at Current Prices
4. Electricity, gas, 8·6 7·0 19·7 13·4 Gross Domestic Product : GDP at Current Prices
water supply & for the year 2018-19 is estimated at R 190·10 lakh crore,
other utility showing a growth rate of 11·2 per cent over the First
services Revised Estimates of GDP for the year 2017-18 of
5. Construction 5·6 8·7 12·1 13·4 R 170·95 lakh crore.
6. Trade, hotels, All sectors, except Agriculture, i.e., ‘Mining &
transport, 7·8 6·9 11·2 11·6 Quarrying’, ‘Manufacturing’, ‘Electricity, Gas, Water
communication and Supply and Other Utility Services’, ‘Construction’,
services related to ‘Trade, Hotels, Transport, Communication and Services
broadcasting
Related to Broadcasting’, 'Financial, Real Estate &
7. Financial, real Professional Services', and ‘Public Administration,
estate & pro- 6·2 7·4 11·7 12·7
fessional services
Defence and Other Services’ have registered growth rate
of over 9·0 per cent and above at Current Prices.
8. Public
Administration, 11·9 8·6 16·4 14·3
National Income : The GNI at Current Prices is
defence and other estimated at R 188·17 lakh crore during 2018-19, as
services compared to R 169·10 lakh crore during 2017-18,
GVA at Basic Price 6·9 6·6 11·1 11·1 showing a rise of 11·3 per cent.
Per Capita Net National Income: The Per Capita
PE : Provisional Estimates
Income at Current Prices during 2018-19 is estimated to
Gross Value Added (GVA) at Basic Prices : Real have attained a level of R 1,26,406 as compared to the
GVA, i.e, GVA at Basic Constant (2011-12) Prices for estimates for the year 2017-18 of R 1,14,958 showing a
the year 2018-19 is now estimated at R 129·07 lakh rise of 10·0 per cent.
crores showing a growth rate of 6·6 per cent over First Gross Fixed Capital Formation : Gross Fixed
Revised Estimates of GVA for the year 2017-18 of Capital Formation (GFCF) at Current Prices is estimated
R 121·04 lakh crore, released on 31st January, 2019. at R 55·70 lakh crore in 2018-19 as against R 48.97 lakh
The sectors which registered growth rate of over 7·0 crore in 2017-18. At Constant (2011-12) Prices, the
per cent are 'public administration, defence and other GFCF is estimated at R 45·48 lakh crore in 2018-19 as
services’ (8·6 per cent), construction (8·7 per cent), against R 41·37 lakh crore in 2017-18. In terms of GDP,
'financial, real estate and professional services' (7·4 the rates of GFCF at Current and Constant (2011-12)
percent), ‘electricity, gas, water supply & other utility Prices during 2018-19 are estimated at 29·3 per cent and
services (7.0 percent)’. The growth in the ‘agriculture, 32·3 per cent, respectively, as against the corresponding
forestry and fishing’, ‘mining & quarrying’, ‘manu- rates of 28·6 per cent and 31·4 per cent, respectively, in
facturing’ and ‘trade, hotels, transport, communication 2017-18.
and services related to broad-casting’ is estimated to be
2·9 per cent, 1·3 per cent, 6.9 per cent and 6.9 percent Sectorwise Growth Estimates
respectively. % Growth Rate at Constant Prices
Gross National Income : The Gross National Sector
(2011-12)
Income (GNI) at 2011-12 Prices is now estimated at
R 139·32 lakh crore during 2018-19, as against the 2017-18
(In Review
2018-19
(Provisional
previous year’s estimate of R 130·34 lakh crore. In terms Estimates) Estimates)
of growth rates, the Gross National Income is estimated
to have risen by 6·9 per cent during 2018-19, in Agriculture and
Allied Services 5·0 2·9
comparison to the growth rate of 7·2 per cent in 2017-
18. Industry 5·9 6·9
Per Capita Income : The Per Capita Income in real Services 8·1 7·5
terms (at 2011-12 Prices) during 2018-19 is estimated to Overall GDP 6·9 6·6
600U | Economics (NET)
India’s Population At A Glance : 2011 (Final Population)
Popu- Sex
Total Population Literacy Rate (%) % share
lation Ratio Per- in total
Density centage
(No. of popula-
(Persons Decadal tion of
Female
per sq. Growth the
per 1000
km) Rate
Males) country
Name Persons Male Female Persons Male Female
India (Incuded 3 1210854977 623270258 587584719 382 943 73 80.9 64.6 17.7 100.00
Sub-divisions of
Senapati Distt. of
Manipur)
Jammu & Kashmir 12,541,302 6,640,662 5900640 124 889 67.2 76.8 56.4 23.6 1.04
Himachal Pradesh 6,864,602 3,481,873 3382729 123 972 82.8 89.5 75.9 12.9 0.57
Punjab 27,743,338 14,639,465 13103873 551 895 75.8 80.4 70.7 13.9 2.29
Chandigarh 1,055,450 580,663 474787 9258 818 86 90 81.2 17.2 0.09
Uttarakhand 10,086,292 5,137,773 4948519 189 963 78.8 87.4 70 18.8 0.83
Haryana 25,351,462 13,494,734 11856728 573 879 75.6 84.1 65.9 19.9 2.09
NCT of Delhi 16,787,941 8,987,326 7800615 11320 868 86.2 90.9 80.8 21.2 1.39
Rajasthan 68,548,437 35,550,997 32997440 200 928 66.1 79.2 52.1 21.3 5.66
Uttar Pradesh 199,812,341 104,480,510 95331831 829 912 67.7 77.3 57.2 20.2 16.51
Bihar 104,099,452 54,278,157 49821295 1106 918 61.8 71.2 51.2 25.4 8.60
Sikkim 610,577 323,070 287507 86 890 81.4 86.6 75.6 12.5 0.05
Arunachal Pradesh 1,383,727 713,912 669815 17 938 65.4 72.6 57.7 26 0.11
Nagaland 1,978,502 1,024,649 953853 119 931 79.6 87.8 76.1 – 0.6 0.16
Manipur 2,570,390 1,290,171 1280219 115 992 79.2 86.1 72.4 – 18·6 – 0·21
Mizoram 1,097,206 555,339 541867 52 976 91.3 93.3 89.3 23.5 0.09
Tripura 3,673,917 1,874,376 1799541 350 960 87.2 91.5 82.7 14.8 0.30
Meghalaya 2,966,889 1,491,832 1475057 132 989 74.4 76 72.9 27.9 0.25
Assam 31,205,576 15,939,443 15266133 398 958 72.2 77.8 66.3 17.1 2.58
West Bengal 91,276,115 46,809,027 44467088 1028 950 76.3 81.7 70.5 13.8 7.54
Jharkhand 32,988,134 16,930,315 16057819 414 948 66.4 76.8 55.4 22.4 2.73
Odisha 41,974,218 21,212,136 20762082 270 979 72.9 81.6 64 14 3.47
Chhattisgarh 25,545,198 12,832,895 12712303 189 991 70.3 80.3 60.2 22.6 2.11
Madhya Pradesh 72,626,809 37,612,306 35014503 236 931 69.3 78.7 59.2 20.3 6.00
Gujarat 60,439,692 31,491,260 28948432 308 919 78 85.8 69.7 19.3 4.99
Daman & Diu 243,247 150,301 92946 2191 618 87.1 91.5 79.5 53.8 0.02
Dadra & Nagar 343,709 193,760 149949 700 774 76.2 85.2 64.3 55.9 0.03
Haveli
Maharashtra 112,374,333 58,243,056 54131277 365 929 82.3 88.4 75.9 16 9.28
Andhra Pradesh 84,580,777 42,442,146 42138631 308 993 67 74.9 59.1 11.6 6.99
Karnataka 61,095,297 30,966,657 30128640 319 973 75.4 82.5 68.1 15.6 5.05
Goa 1,458,545 739,140 719405 394 973 88.7 92.6 84.7 8.2 0.12
Lakshadweep 64,473 33,123 31350 2149 946 91.8 95.6 87.9 6.3 0.01
Kerala 33,406,061 16,027,412 17378649 860 1084 94 96.1 92.1 4.9 2.76
Tamil Nadu 72,147,030 36,137,975 36009055 555 996 80.1 86.8 73.4 15.6 5.96
Puducherry 1,247,953 612,511 635442 2547 1037 85.8 91.3 80.7 28.1 0.10
Andaman & Nicobar 380,581 202,871 177710 46.137 876 86.6 90.3 82.4 6.9 0.03
Islands
Note : Change in Final Population Data due to some addition in the Population of Manipur.
Economics (NET) | 601U
Religion Based Census 2011
Population (Crore) % Share in Total Growth Rate
Religion Population
Hindu 96·63 79·8 % 16·8%
Muslim 17·22 14·2% 24·6%
Christian 2·78 2·3% 15·5%
Sikh 2·08 1·7% 8·4%
Buddhist 0·84 0·7% 6·1%
Jain 0·45 0·4% 5·4%
Other Religions & Persuasions (ORP) 0·79 0·7%
Religion Not Stated 0·29 0·2%
Agriculture
The performance of the agricultural sector influences the growth of the Indian economy. Agriculture has been a
way of life and continues to be the single most important livelihood of the masses. Agricultural policy focus in India
across decades has been on self-sufficiency and self-reliance in foodgrains production. Considerable progress has
been made on this front. Foodgrains production rose from 52 million tonnes in 1951-52 to 264·77 million tonnes in
2013-14 but slightly declined to 252·22 million tonnes in 2015-16.
As per the new series (with base year 2011-12), the growth in GVA in agriculture and allied sector was
estimated at 4·2 per cent for the year 2013-14. For 2014-15, this estimate stands at – 0·2 per cent. For 2015-16, it was
estimated at 1·2% for 2016-17 it stood 6·3%. For the year 2017-18 this growth rate has been estimated at 3·4%.
Besides, the share of agriculture and allied sector in total GDP was estimated to be 17·4 per cent.
Agriculture Sector : Key Indicators
(per cent change at constant 2011-12 prices)
2018-19
Item 2015-16 2016-17 2017-18
(PE)
Growth in GVA in Agriculture & Allied Sectors# 0·7 6·3 5·0 2·9
Share of Agriculture & Allied Sectors in total GVA at current 17·5 17·9 17·2 16·1
prices#
Share of Agriculture & Allied Sectors in total Gross Capital 7·8 6·8 N.A. N.A.
Formation*
Share of Crops* 6·5 N.A. N.A. N.A.
Share of Livestock* 0·8 N.A. N.A. N.A.
Share of Forestry and Logging* 0·1 N.A. N.A. N.A.
Share of Fishing* 0·5 N.A. N.A. N.A.
Source : Central Statistics Office
Note : * in GVA of Agriculture and allied sectors; Calculations have been based on National Accounts Statistics, First
Revised Estimates, 31st January, 2017.
# Based on provisional estimates released on 31st May, 2007.
For 2016-17 (Ist advance estimates) it has been estimated at 17·0%. The share of agriculture and allied sectors in
total Gross Capital Formation (GCF) has been estimated at 7·7% for the year 2014-15.
Gross Capital Formation in Agriculture Sector
(in R crore)
GVA in
Agriculture GCF in Agriculture & Allied Sectors as
Year GCF in Agriculture & Allied Sectors percentage of GVA of Agriculture &
& Allied
Sectors Allied Sectors
Public Private Total Public Private Total
2015-16 39105 193734 232839 1616146 2·4 12·0 14·7
2016-17 45981 219371 265352 1717467 2·7 12·8 15·6
2017-18 NA NA 273755 1803039 NA NA 15·2
Source : Central Statistics Office (CSO), M/o Statistics & Programme Implementation.
* As per First Revised Estimates of National Income, Consumption Expenditure, Saving and Capital Formation 2015-16 (latest
available) released on 31st January 2017.
602U | Economics (NET)
The agriculture sector registered an annual growth of 3·8 per cent in value added in the decade since 2004-05 on
the back of increase in real prices (31 per cent during 2004-05 to 2011-12).
Production of Important Crops in Three Largest Producing States in 2017-18*
(Production in Million Tonnes)
Per cent Share of
Crops/Groups of Crops States Production Production to All India
(1) (2) (3) (4)
I. Foodgrains
Rice West Bengal 14·97 13·26
Punjab 13·38 11·85
Uttar Pradesh 13·27 11·75
Wheat Uttar Pradesh 31·88 31·98
Punjab 17·85 17·90
Madhya Pradesh 15·91 15·96
Maize Karnataka 3·55 12·36
Maharashtra 3·54 12·33
Madhya Pradesh 3·54 12·32
Total Nutri/Coarse Cereals Rajasthan 6·57 13·99
Karnataka 6·27 13·35
Maharashtra 6·09 12·96
Tur Maharashtra 1·07 25·24
Madhya Pradesh 0·84 19·74
Karnataka 0·77 18·08
Gram Madhya Pradesh 4·60 40·92
Maharashtra 1·78 15·89
Rajasthan 1·67 14·87
Total Pulses Madhya Pradesh 8·11 32·15
Rajasthan 3·39 13·42
Maharashtra 3·30 13·09
Total Foodgrains Uttar Pradesh 51·3 17·99
Madhya Pradesh 33·5 11·74
Punjab 31·7 11·13
II. Oilseeds
Groundnut Gujarat 3·94 42·88
Rajasthan 1·26 13·72
Andhra Pradesh 1·04 11·34
Rapeseed & Mustard Rajasthan 3·40 40·88
Haryana 1·11 13·32
Madhya Pradesh 0·98 11·73
Soyabean Madhya Pradesh 5·32 48·46
Maharashtra 3·89 35·41
Rajasthan 1·07 9·74
Sunflower Karnataka 0·10 47·35
Bihar 0·02 10·47
Odisha 0·02 7·35
Total Oilseeds Madhya Pradesh 6·95 22·20
Rajasthan 5·97 19·07
Gujarat 5·86 18·71
III. Other Cash Crops
Sugarcane Uttar Pradesh 177·06 46·98
Maharashtra 83·13 22·06
Karnataka 28·26 7·50
Cotton a Gujarat 12·64 36·22
Maharashtra 6·55 18·76
Telangana 4·75 13·63
June & Mestab West Bengal 7·64 75·32
Bihar 1·45 14·32
Assam 0·84 8·25
Source : Directorate of Economics & Statistics, Department of Agriculture, Cooperation & Farmers Welfare.
Notes : * : 4th Advance Estimates, a : Production in million bales of 170 kgs,
b : Production in million bales of 180 kgs.
Economics (NET) | 603U
Table 11 : Area, Production and Yield (2018–19*)
Group/Commodity Area (Million ha) Production (Million tonnes) Yield (kg/ha)
Foodgrainsa 122·7 284·95 2292
Rice 43·4 116·42 2665
Wheat 29·1 102·19 3408
Jowar 4·0 3·76 935
Maize 6·7 27·23 1144
Bajra 9·1 8·61 3046
Pulses 28·3 23·40 849
Gram 4·3 10·13 861
Tur 9·7 3·59 1067
Oilseeds 25·5 32·26 1234
Groundnut 4·9 6·69 1436
Rapeseed and Mustard 6·2 9·34 1346
Cotton b 12·3 28·71 414
Sugarcane 5·1 400·16 75000
Source : Directorate of Economics & Statistics, Department of Agriculture, Cooperation and Farmers Welfare.
Note : * : Fourth Advance Estimates; # : tonnes/ha, a : Includes cereals and pulses; b : Million Bales of 170 kg each.
Mission 2022 : The Challenges of (2) Raising productivity; (3) Reforming agriculture land
policy; and (4) Relief measures.
Doubling Indian Farmers’ Incomes
in Five Years Production of Foodgrains/ Oilseeds/
Prime Minister Narendra Modi on March 28, 2017 Other Crops
unveiled a seven-point strategy to double the income of (million tonnes)
farmers in five years with measures to step up irrigation,
Final IV Advance
provide better quality seeds and prevent post-harvest
Crop Estimate Estimate
losses. 2017-18 2018-19
Seven point strategies has been listed by the Prime
Minister : Rice 112·76 116·42
● Big focus on irrigation with large budgets, with the Wheat 99·87 102·19
aim of ‘per drop, more crop’. Jowar 4·80 4·00
● Provision of quality seeds and nutrients based on Bajra 9·21 8·61
soil health of each field. Maize 28·75 27·23
● Large investments in warehousing and cold chains Coarse Cereals 46·97 42·95
to prevent post-harvest crop losses. Gram 11·38 10·13
● Promotion of value addition through food Tur 4·29 3·59
processing. Moong 2·02 2·35
● Creation of a national farm market, removing Urad 3·49 3·26
distortions and e-platform across 585 stations. Total Pulses 25·42 23·40
● Introduction of a new crop insurance scheme to Total Foodgrain 285·01 284·95
mitigate risks at affordable cost Ragi 1·99 1·22
● Promotion of ancillary activities like poultry, Groundnut 9·25 6·69
beekeeping and fisheries. Rapeseed/Mustard 8·43 9·54
Accordingly the NITI Aayog came out with its Soyabean 10·93 13·79
‘Three Year Action Agenda’–2017-2020. In its chapter
on agriculture titled ‘Agriculture: Doubling Farmer’s Saflower 0·55 0·02
Incomes’, the economic think-tank has put forth a four- Sunflower 0·22 0·22
point action plan to double the incomes of India’s Total 9 oilseeds 31·46 32·26
farmers. The four point action plan includes the Cotton 32·81 28·71
following measures : (1) Remunerative prices for
farmers by reforming the existing marketing structure; Jute and Mesta 10·03 9·77
604U | Economics (NET)
Minimum Support Prices (MSP) and Bonus for Kharif Crops of 2018-19 Season
Government has approved for the increase in the Minimum Support Prices (MSPs) for all Kharif Crops of 2018-
19 Season. The decision of government for increasing MSP is a historic one as it redeems the promise of the
predetermined principle of fixing the MSPs at a level of atleast 150 per cent of the cost of production announced by
the Union Budget for 2018-19. The details of MSPs and bonus for all Kharif Crops of 2018-19 season are given in
table below—
Big Hike in Minimum Support Prices of Kharif Crops (Marketing Session 2018-19)
The Cabinet Committee for Economic Affairs cleared on July 9, 2019 an increase in the Minimum Support Price (MSP)
for kharif crops for the 2019-20 season.
Minimum Support Price(Per Increase in MSP (Per Quintal) Return
Quintal) Over
Commodity 2018-19 2019-20 Cost (%)
Absolute Percentage
Session Session
Paddy (Common) 1750 1815 65 3·7 50·00
Paddy (Grade A) 1770 1835 65 3·7 —
Jowar (Hybrid) 2430 2550 65 4·9 50·00
Jowar (Maldani) 2450 2570 120 4·9 51·33
Bajra 1950 2000 50 2·6 85·00
Ragi 2897 3150 253 8·7 50·00
Maize 1700 1760 60 3·5 50·00
Arhar(Tur) 5675 5800 125 2·2 60·00
Moong 6975 7050 75 1·1 50·00
Urad 5600 5700 100 1·8 64·00
Groundnut 4890 5090 200 4·1 50·00
Sunflower seed 5388 5650 262 4·9 50·00
Soyabean 3399 3710 311 9·1 50·00
Sesamum 6249 6485 236 3·8 50·00
Nigerseed 5877 5940 63 1·1 50·00
Cotton (Medium Staple) 5150 5255 105 2·0 50·00
Cotton (Long Staple) 5450 5550 100 1·8 —
Minimum Support Price of Rabi Crops (Announced on October 3, 2018)
(R Quintal)
Crops Crop year (2017-18) or Crop year (2018-19) Increase
Marketing year (2018-19) or Marketing year (2019-20) Absolute %
R/Quintal Increase
Wheat 1735 1840 105 6·05
Barley 1410 1440 30 2·12
Gram 440 4620 220 5·00
Masoor (Lentil) 4250 4475 225 5·29
Rapeseed/Mustard 4000 4200 200 5·00
Safflower 4100 4945 845 20·61
Trends in Minimum Support Price of Rabi Crops (Crop Year)
A Steady Rise (Rabi MSP prices in R quintal)
2014-15 2015-16 2016-17 2017-18 2018-19
Wheat 1,450 1,525 1,625 1,735 1840
Barley 1,150 1,225 1,325 1,410 1440
Gram 3,175 3,500* 4,000* 4,400 4620
Masur (lentil) 3,075 3,400* 3,950* 4,250 4475
Rapeseed/Mustard 3,100 3,350 3,700 4,000 4200
Safflower 3,050 3,300 3,700 4,100 4945
* Includes bonus
Economics (NET) | 605U
Govt. Hikes Sugarcane Price by stability in different states are the twin objectives of the
R 20/Quintal food security system. In fulfilling its obligation towards
distributive justice, the government incurs food subsidy.
The government has announced its decision to The programme covers over 65 million BPL households
increase the minimum price sugar mills pay cane serviced through 4,50,000 fair price shops. While the
growers by R 20 per quintal to R 275 per quintal for the economic cost of wheat and rice has continuously gone
2018-19 marketing year starting October 2018. The up, the issue price has been kept unchanged since July 1,
price that has been approved by the Cabinet for the 2002. On account of implementation of the NFSA, the
2018-19 season is around 77·42 per cent more than CIP has further gone down for the APL and BPL
estimated cost of production. It is in line with the categories. The government, therefore, continues to
Centre’s commitment to giving a fair price to farmers. provide large and growing amounts of subsidy on
The fair and remunerative price (FRP) of R 275 a foodgrains for distribution under the TDPS/NFSA and
quintal will be linked to the 10 per cent recovery rate other nutrition-based welfare schemes and open market
and for every additional 0·1 per cent rise in recovery a operations. The food subsidy bill has increased
premium of R 2·75 will be paid. Presently, for the 2017- substantially in the past few years putting severe strain
18 season, the FRP price is linked to a basic recovery on the public exchequer.
rate of 9·5 per cent, subject to a premium of R 2·68 per Quantum of Food Subsidies
quintal for every 0·1 per cent point increase in the
recovery rate. It shows that better quality sugarcane with Food subsidy Annual growth
Year
higher recovery rates would fetch the farmers a higher (R in crore) (percentage)
price. For sugarcane, which is below 9·5 per cent 2005-06 23071·00 – 10·39
recovery, that is, of inferior quality, the price paid to 2006-07 23827·59 3·28
farmers would be R 261·25 per quintal in 2018-19, 2007-08 31259·68 31·19
against the existing price of R 255 a quintal. 2008-09 43668·08 39·69
2009-10 58242·45 33·37
BITTERSWEET CHALLENGE 2010-11 62929·56 8·05
Sugarcane FRP and basic recovery rate 2011-12 72370·90 15·00
2012-13 84554·00 16·83
Sugar Season Basic recovery FRP (R/quintal) 2013-14 89740·02 6·13
rate (%)
2014-15 1,13,171·16 26·11
2009-10 9·5 129·84 2015-16 1,39,419 23·19
2010-11 9·5 139·12 2016-17 1,10,173 (–) 20·98
2011-12 9·5 145 2017-18 1,00,281·69 (–) 8·97
2012-13 9·5 170 2018-19 (RE) 1,71,298 (+) 70·82
2013-14 9·5 210 2019-20 (BE) 1,84,220 (+) 7·54
2014-15 9·5 220 Source : Department of Food and Public Distribution
2015-16 9·5 230 Organic Farming
2016-17 9·5 230 With the view to promote organic farming practices
2017-18 9·5 230 to reduce the burden on chemical fertilisers, to insure
2018-19 10 275 effective utilisation of farm resources and to cater
domestic and international growing Organic Food
Note : Sugar season runs from October to September
Source : Government of India. Market, a National Project on Organic Farming was
launched during 10th Plan with an outlay of 115·00
Prevalence of Undernourishment in India crore. This scheme was continued in 11th Plan with an
outlay of 101 crore. The earlier scheme ‘‘National
No. of Person Proportion of Project on Development and Use of Biofertilizers’’ has
Year Undernourished (in Undernourished in total been merged w i t h the ‘National Project on Organic
Million) Population
Farming’. The main objective of the scheme includes :
(in %) 1. Capacity Building through Service Providers.
1990-92 210·1 23·7 2. Financial and Technical support for setting up of
2000-02 185·5 17·5 organic input production unit such as Fruits and
2005-07 233·8 20·5 Vegetable market waste compost, Biofertilizers and
2010-12 189·9 15·6 bio-pesticides and vermiculture hat-cheries.
2014-16 194·6 15·2 3. Human resource development through training and
demonstration.
Food Subsidy 4. Awareness creation and market development.
Provision of minimum nutritional support to the 5. Quality Control of Organic Inputs.
poor through subsidized foodgrains and ensuring price 6. Biological assessment of Soil Health.
606U | Economics (NET)
Major Producing States 0·69% higher than Horticulture Production in 2017-
18.
(i) Foodgrains—Uttar Pradesh, Punjab, Madhya Pradesh
and West Bengal. ● Fruits Production is estimated to be around 98·57
(ii) Wheat—Uttar Pradesh, Punjab, Haryana and Madhya million tonnes, compared to 97·36 million tonnes in
Pradesh. last year.
(iii) Rice— West Bengal, Uttar Pradesh, Punjab and Andhra ● Vegetables Production is estimated to be around
Pradesh. 185·88 million tonnes, which is 0·81% higher than
(iv) Coarse Cereals—Maharashtra, Karnataka, Rajasthan Production in 2017-18.
and Uttar Pradesh. ● Onion Production is estimated to be around 23·48
(v) Pulses—Madhya Pradesh, Uttar Pradesh, Maharashtra million tonnes, which is slightly higher than
and Rajasthan . production in 2017-18.
Horticulture ● Potato Production is estimated to be around 53·03
million tonnes, which is 3·4% higher than Pro-
India is bestowed with varied agro-climate, which is duction in 2017-18.
highly favourable for growing a large number of
horticultural crops such as fruits, vegetables, root tuber, ● Tomato Production is estimated to be around 19·39
ornamental aromatic plants, medicinal spices and million tonnes, which is 1·8%, lower than Pro-
plantation crops like coconut, areca-nut, cashew and duction in 2017-18.
cocoa. India is the second largest producer of fruit (46 ● Spices Production is estimated to be around 9·22
million tonnes) and vegetables (103 million tonnes) in million tonnes, which is 13·44% higher than
the world. Production in 2017-18.
Horticulture sector comprising a wide array of crops 2018-19
from fruits and vegetables to nuts, spices, medicinal Total Horticulture 2017-18 (Third Advanced
plants, flowers, and plantation crops, provides many Estimate)
opportunities for income generation. Globally India is Area (Million Ha) 25·43 25·49
the second largest producer of fruits and vegetables; the
largest producer of mango, banana, coconut, cashew, Production 300·64 313·85
papaya, and pomegranate; and the largest producer and (Million Tonnes)
exporter of spices.
Land Use
Mission for Integrated Development of Land utilisation statistics are available for 92·9% of
Horticulture total geographical area of 3287·3 lakh hectares. In other
A Centrally Sponsored Scheme has been launched for words, the total geographical area of India is about 328·7
the holistic development of horticulture in the country million hectares but statistical information regarding
during XII Five Year Plan. The scheme, which has taken land classification is available for only about 305 million
take off from 2014-15, integrates the following ongoing hectares. According to the land use statistics available
schemes : from states, area under forests had increased from 404·8
● National Horticulture Mission. lakh hectares in 1950-51 to 695·5 lakh hectares in 2003-
● Horticulture Mission for North-East and Himalayan 04. Net sown area increased from 1187·5 lakh hectares to
States. 1410 lakh hectares during the same period. Broad
● National Bamboo Mission. cropping pattern indicates that though foodgrains have a
preponderance in gross cropped area as compared to
● National Horticulture Board.
non-foodgrains, their relative share came down from 76·7
● Coconut Development Board. per cent during 1950-51 to 65·6 per cent during 2003-04.
● Central Institute for Horticulture.
Land Use Pattern in India (2014-15)
(million ha)
Third Advanced Estimate of Area
Classification 2014–15 % Share
and Production of Various I. Geographic area 328·73 —
Horticulture Crops 2018-19 II. Reporting area for land utilisation 307·818 100·00
Department of Agriculture, Cooperation and statistic (1 to 5)
Farmers Welfare released the Second Advanced 1. Forests 71·794 23·32
Estimate (2018-19) of Area and Production of various 2. Not available for cultivation 43·880 14·26
Horticulture Crops, as compiled from information
3. Other uncultivated land exclu- 25·832 8·39
received from different State/ UTs and source agencies. ding fallow land
Highlights : (a + b + c)
● The Total Horticulture Production of the country is (a) Permanent pastures and 10·258 3·33
estimated to be 313·85 million tonnes which is other grazing land
Economics (NET) | 607U
(b) Miscellaneous tree crops 3·187 1·04 TRIFED
and groves The Government established TRIFED (Tribal Co-
(c) Culturable waste land 12·388 4·02 operative Marketing Development Federation of India Ltd.)
4. Fallow land (a + b) 26·182 8·51 in August 1987. The basic aim of TRIFED was to save
tribals from exploitation by private traders and to offer
(a) Fallow land other than 11·092 3·60 them remunerative prices for their minor forest produce
current fallow and surplus agriculture products. TRIFED started
(b) Current fallow 15·091 4·90 functioning since April 1988. TRIFED has also been
5. Net area sown 140·130 45·52 declared an important agency for collecting, processing,
storing and developing of oil seeds products. TRIFED plays
6. Area sown more than once 58·230 18·92 a role of an agent of FCI for Government purchase of
7. Gross cropped area (5 + 6) 198·360 64·44 wheat and rice. It is also an agent of agriculture and co-
8. Cropping intensity* 141·6 — operation department for Government purchase of cereals,
pulses and oil-seeds. Agriculture Ministry gives aid to
III. Net irrigated area 68·383 — TRIFED for compensating loss incurred due to price
IV. Gross irrigated area 96·457 — fluctuations.
V. % of Gross irrigated area over 48·6 — NAFED
Gross Cropped area NAFED (National Agricultural Co-operative Marketing
Federation of India Ltd.) has been established in co-
Note : * Cropping intensity is percentage of the gross cropped operative sector at national level for marketing of
area to the net sown. agriculture products.
Source : Agricultural Statistics At a Glance, 2011, Directorate New Agency for Land Reforms
of Economics and Statistics, Ministry of Agriculture, Govt. of
Government is planning to establish a separate agency
India (Website : http://www. dacnet.nic.in/eands).
for land reforms & upgradation of wasteland. New agency
Land Reforms Programmes named ‘Jai Prakash Mission for Land Reforms & Waste-
land Development’ will work under Ministry of Rural
Land reform programmes in India include— Development. This body will be authorised for making
(i) Elimination of intermediaries. policies and implementing them for land reforms &
wasteland upgradation.
(ii) Tenancy Reform.
(iii) Determination of ceiling of holdings per family Agriculture Marketing
and to distribute surplus land among landless Organised marketing of agricultural commodities
people. has been promoted in the country through a network of
(iv) Consolidation of holdings. regulated markets. Most of the State governments and
The legislation for abolition of intermediaries was Union Territories have enacted legislations (APMC Act)
aimed at providing land to the tiller. to provide for regulation of agricultural produce
Measures of tenancy reform pertain to— markets. While by the end of 1950, there were 286
regulated markets in the country, but as on March 31,
(i) regulation of rent. 2014 the number stands at 7,114. Besides, the country
(ii) security of tenure. has 22,759 rural periodical markets, about 15 per cent of
(iii) confirment of ownership on tenants. which function under the ambit of regulation. The
Laws for land ceiling were enforced in various average area served by a market is 114·45 sq. km while
States during fifties and sixties which were modified on the average area served by a regulated market is 462·08
the directives of Central Government in 1972. Legis- sq. km. The National Commission on Agriculture (2004)
lation for ceiling on existing holdings and unit of had recommended a norm of one market to cover with
application has been enacted in two phases. Under both 80 sq. km. The advent of regulated markets has helped
the phases, 73·95 lakh acres of land was declared surplus in mitigating the market handicaps of producers/sellers
(upto September 30, 1995) out of which 65·58 lakh acres at the wholesale assembling level. But, the rural periodic
of land was taken over by the government and 51·68 markets in general, and the tribal markets in particular,
lakh acres of land was distributed among 50·33 lakh remained out of the developmental ambit of APMC Act.
landless labourers (including 36% SC and 14% ST Agriculture Produce Market Committee
beneficiaries). No land is declared as surplus under land (APMC) Act
ceiling laws in the states of Bihar, Karnataka, Odisha and The Government of India has circulated model
Rajasthan, which shows the loop holes in the law. legislation titled “The State Agricultural Produce
1875·37 lakh acres of land were brought under the Marketing (Development and Regulation) Act 2003 to bring
process of land consolidation upto November 1995. about reforms in agricultural marketing contract farming,
Successful effects have been made in various states like direct marketing and publicprivate partnership in
management and development of agricultural markets are
Maharashtra, Uttar Pradesh, Punjab and Haryana in land the major instruments of change among others.
consolidation work. Twenty Five States/UTs have already amended their
Legislation for ceilings provides a financial APMC Acts and made varying provisions for the purpose
assistance of R 2500 per hectare for cultivation on the while the remaining states are in the process of amending
low quality land taken over under ceiling laws. their respecting APMC Acts.
608U | Economics (NET)
e-NAM : National Agriculture Market family. In other words, economic holding is a minimum
essential area for profitable agriculture.
21 major wholesale markets in India have been
integrated electronically by Prime Minister Narendra 2. Family Holding—Family holding is that holding
Modi on April 14, 2016 as the National Agriculture which gives work to average size family having one
Market (NAM). The NAM is a unified market where plough under traditional farming system. In other words,
farm goods are being sold without any mandi tax. A family holding is a ‘plough unit’ which is neither less
major objective of the NAM is to kill price differentials nor more for an average size family to cultivate it
across the country to moderate food inflation. If properly.
completed successfully, it could moderate inflation and 3. Optimum Holding—Maximum size of the
do away with the ill-effects of the Agriculture Produce holding which must be possessed and owned by a family
Marketing Committee (APMC) Act. 21 mandis that have is called optimum holding.
been selected are significant trading platforms for one or As per Agriculture Census 2010-11, total number of
more commodities. Bhopal deals in black chana, agricultural holdings in India were 138·35 million and
mustard is traded in Sirsa, wheat in Karnal, and castor the total area under these holdings was 159·59 million
seed in Pattan. India has 2,477 principal mandis and hectare. Out of these operational holdings 67·10 per cent
4,843 sub-markets set up by the APMCs. With 200 holdings (92·83 million) were marginal holdings (less
crore to be spent over three years, the plan is to link 585 than one hectare), Area under these holdings was only
major mandis in the first phase of the NAM over the 22·50 per cent. Number of small holdings was 24·8
next three years. The integration could also curb million (17·91 per cent) having area o f 35·2 million
malpractices a s APMCs, through which state govern- hectare. Then 17·91 per cent operational holdings have
ments exercise control over wholesale markets. APMCs only 22·08 per cent area. On the contrary only 0·70 per
were established to provide an organised marketplace to cent holdings (i.e., large holdings of more than 10
farmers for better price discovery. As on July 1, 2018, hectares) have 10·59 per cent area.
479. Mandis of 14 states have been integrated with e-
NAM 90 Agricultural commodities are traded in e- New National Agricultural Policy
NAM. Union Government has announced new National
Krishonnati Yojana Agricultural Policy in the Parliament on July 28, 2000. This
policy has been planned under the provisions of World
Krishonnati Yojana is a new umbrella scheme in which
the following existing schemes have been included— Trade Organisation so as to face the challenges of
1. National Food Security Mission. agriculture sector. This policy gives emphasis on promoting
2. National Food Security Mission-Commercial Crops. agricultural exports after fulfilling domestic demand.
3. Mission for Integrated Development of Horticulture. The salient features of this policy are :
4. National Mission on Oilseeds and Oil Palm. ● 4% growth rate p.a. for the next two decades.
5. National Mission for Sustainable Agriculture.
● Land reforms to provide land to poor farmers.
e-NAM Trade Till Dec. 2018 Over ● Consolidation of holdings in all states of the nation.
R 58,930 Crore ● Promoting private investments in agriculture.
Indian farmers have traded R 2·25 crore tonnes of ● To provide insurance umbrella for crops to farmers.
agricultural commodities worth R 58,930 crore on the e- ● To promote biotechnology.
NAM (National Agriculture Market) portal till December ● Promoting research for developing new varieties and
31, 2018. The online trade has benefited as many as ensuring protection to the developed varieties.
63·75 lakh farmers. New Agriculture Policy has been described as
Out of 774 Farmer Producer Organisations (FPOs) ‘Rainbow Revolution’ which includes the followings revolu-
formed by Small Farmers’ Agri-Business Consortium tions :
(SFAC), 634 FPOs in 16 States are connected to e- ● Green (Food Grain Production)
NAM. They have sold 549 tonnes of agricultural
commodities worth R 1·89 crore. About 5,000 FPOs ● White (Milk)
have been formed by various organisations such as the ● Yellow (Oilseeds)
SFAC, NABARD and State Governments. SFAC alone ● Blue (Fisheries)
constituted 551 FPOs from 2014-18, while 223 were set
● Red (Meat/Tomato)
up between 2011 and 2014. About 7·52 lakh small,
medium and marginal farmers have been connected with ● Golden (Fruits-Apple)
SFAC FPOs. Till now, 349 FPOs have been provided ● Grey (Fertilizer)
capital subsidy of R 20 crore and 38 FPOs have taken ● Black/Brown (Non-conventional Energy Sources)
advantage of the Credit Guarantee Fund scheme. ● Silver (Eggs)
Agriculture Holdings ● Round (Potato)
Agricultural holdings are termed as follows— The above Rainbow Revolution also includes “Food
1. Economic Holding—It is that holding which Chain Revolution” to put a check on destroying foodgrains,
ensures a minimum satisfactory standard of living to a vegetables and fruits.
Economics (NET) | 609U
Animal Husbandry & Dairy : Highlights Percentage Share of Each Type of
● Animal husbandry & dairing play an important role in Operational Holdings in Total Operational
national economy and in socio-economic development Holding (2015-16 : 10th Agricultural Census)
of the country.
● Animal husbandry output constitutes about 30% of the Category of Operational Percentage share to total
country’s agricultural output. Holdings Operational Holdings
● The fisheries sector contributed 1·3% of the total GDP at 2010-11 2015-16
factor cost and 4·6% of GDP at factor cost from Total Operational Holdings 138 146
agriculture, forestry and fishing in the year 2015-16. (Million)
● The share of livestock and fisheries in Gross Capital Operated Area (Million 159·59 157·14
Formation (2016-17) stood 0·8% and 0·5% respectively. Hectare)
● Livestock sector provides regular employment to 11 Small & Marginal Holdings 84·97 86·21
million in principal status and 9 million in subsidiary (0-2 Hectare) (%)
status. Percentage share of Small & 44·31 47·34
● Women constitute 70% of the labour force in livestock Marginal Holdings in Total
sector as against 35% in crop farming. Operational Area (%)
● The 18th livestock census has been conducted Semi-medium and medium 14·29 13·22
throughout the country with reference date of October operational holdings (2-10
15, 2007. This census places the total livestock hectare) (%)
population at 529·7 million and poultry birds at 648·8 Percentage share in area 45·1 43·61
million. under semi-medium and
● India ranks first in respect of buffalo, 2nd in cattle and medium operational holdings
goats, 3rd in sheep, 4th in ducks, 5th in chickens and 6th (%)
in camel population in the world. large holding (10 hectare and 0.71 0·57
● India has become the largest producer of milk in the above) (%)
world. Percentage share in area 10·59 9·04
● A centrally sponsored scheme for livestock insurance is under large holdings
being implemented in air the states with the twin Average Size of Holding (%) 1·15 Hectare 1·08 Hectare
objectives of providing a protection mechanism to
farmers and cattle rearers against loss of their animals Percentage share of Female 12·79 13·87
due to death and to demonstrate the benefit of livestock operational holders
insurance to the people. Percentage share of Female 10·36 11·57
● About 14·5 million people get their livelihood from the operational holders in the
fisheries sector. total area under operational
● Poultry development in India has made impressive holdings
progress during the last three decades. At present India According to an official statement, the percentage
ranks among the top 5 nations in egg production in the share of female operational holders increased from 12·79
world. per cent in 2010-11 in total holdings to 13·87 per cent in
● India is the sixth largest producer of fish and second 2015-16 while the corresponding figures of 10·36 per
largest producer of inland fish in the world. cent and 11·57 per cent in the operated area. This shows
that more and more females are participating in the
10th Agricultural Census (2018) : Provi- management and operation of agricultural lands.
sional Data Released The average operational holding was highest in
The average size of the Indian farmland shrank by Nagaland (5·06 ha) and lowest in Kerala (0·18 ha). The
over six per cent between 2010-11 and 2015-16, with latest data show UP at 23.82 million, had the highest
Operational holding in the country dropping to 1·08 number of operational holdings, followed by Bihar
hectares from 1·15 hectares in 2010-11, provisional esti- (16·41 million), Maharashtra (14·71 million), Madhya
mate of the first phase of the 10th agricultural census Pradesh (10 million), Karnataka (8·68 million). In the
released on October 1, 2018 showed. With land holding operated area, Rajasthan reported highest of 20·87 mha,
getting smaller, the share of small and marginal holdings followed by Maharashtra (19·88 mha), Uttar Pradesh
in the country, (between zero and two hectares) has risen
to 86·21 per cent of total operational holding in 2015-16, (17·45 mha), MP (15·67 mha) and Karnataka (11·72
which comes to around 126 million, as against 84·97 per mha). The highest variation in the number of operational
cent in 2010-11. On the other hand, the share of semi- holdings was reported in MP at 12·74 per cent, followed
medium and medium operational holdings (2-10 by Andhra Pradesh (11·85 per cent).
hectares) in total land holdings dropped from 14·29 per
cent to 13·22 per cent, while that of large holding (10 Call for Evergreen Revolution
hectares and above) fell from 0·71 per cent in 2010-11 to The pioneer of Indian green revolution Mr. M.S.
0·57 per cent in 2015-16. Swaminathan, presently chairman of National Commission
on Farmers gave a new call for ‘Evergreen Revolution’ for
Total operated area, which includes both cultivated doubling the present production level of foodgrains from 210
and uncultivated, provided part of it, is put to farm use, million tonnes to 420 million tonnes. For making ‘Evergreen
fell from 159·59 million hectares in 2010-11 to 157·14 Revolution’ a success, he stressed on adopting best scientific
million hectares in 2015-16. According to the census, techniques and promoting organic farming. He also
there was a loss of 2·45 million hectares (mha) of mentioned four pre-requisites for getting the success.
cultivated land due to urban sprawl and other (i) Promoting soil health.
developmental activities. The operated area in 2015-16 (ii) Promoting ‘Lab to Land’ exhibitions.
has come down to 157·14 mha. The sharpest fall in (iii) Making rainwater harvesting compulsory.
operational holdings happened in Goa, at 28 per cent. (iv) Providing credit to farmers on suitable conditions.
610U | Economics (NET)
White Revolution and Operation India ranks first in milk production, accounting for
18·5 per cent of world production. During 2017-18, milk
Flood in India production peaked at 176·35 mt, thus becoming an
White revolution is associated with a sharp increase important secondary source of income for 70 million
in milk production. During 1964-65, Intensive Cattle rural households engaged in dairying and for 70 per cent
Development Programme (ICDP) was introduced in the
of the workforce that comprised women. The average
country in which a package o f improved animal
husbandry was given to cattle owners for promoting year-on-year growth rate of milk at 4·18 per cent vis-a-
white revolution in the country. Later on, to accelerate vis the world average of 2·2 per cent shows sustained
the pace of white revolution, a new programme named growth in availability of milk and milk products for the
‘Operation Flood’ was introduced in the country. The growing population.
Operation Flood Programme, which is the world's
largest integrated dairy development programme has National Livestock Mission (NLM)
made considerable progress in achieving its outlined Department of Animal Husbandry, Dairying and
objectives. During 2014-15, 146·3 million tonnes of Fisheries is implementing National Livestock Mission
milk was produced in the country. India stands first in for sustainable development of Livestock Sector,
the world in milk production. USA stands second in especially for poultry, goats, sheep, pig, pack animals,
the world. etc.
Dr. Varghese Kurien is the pioneer of operation All components under the NLM are made flexible
flood in India. All credit for its implementation and and modular, looking into the needs of farmers and stake
successful operation goes to him only. Operation flood
holders, and as per the geographical and regional
programme was started in 1970 by National Dairy
Development Board (NDDB). The programme has requirements so that even the small and marginal
completed its III phase in April 1996. farmers can also avail the benefits of the activities
proposed under NLM. The distribution of resources and
Milk Production and per capita Availability subsidies are also made equitable with considerations for
APL, BPL beneficiaries and beneficiaries of North
Milk Production Per capita Availability Eastern Region, Hilly, Left Wing Extremism areas so
Year
(Million Tonnes) (Grams/Day)
that the beneficiaries in more disadvantageous position
1950-51 17 124 get equitable benefits for sustainable livelihood.
1960-61 20 124
The National livestock Mission is organised into the
1970-71 22 112
1980-81 31·6 128 following four sub-Missions :
1990-91 53·9 176 1. Sub-Mission on Livestock Development.
2000-01 80·6 220 2. Sub-Mission on Pig Development in North-eastern
2005-06 97·1 241 Region.
2009-10 116·4 273
3. Sub-Mission on Fodder and Feed Development.
2010-11 121·8 281
2011-12 127·9 290 4. Sub-Mission on Skill Development, Technology
2012-13 132·4 298 Transfer and Extension.
2013-14 137·7 311
2014-15 146·3 322 Yellow Revolution
2015-16 146·31 302 Green revolution established many landmarks in the
2016-17 164·0 351 production of foodgrains. The next step in the series of
2017-18 176·35 374 agriculture research and development came in operation
with the name ‘Yellow Revolution’. This yellow
Fisheries Sector revolution is associated with the objective of achieving
India is the second largest producer of fish in the self-dependence in the production of oil-seeds. Oilseeds
world. technological mission was introduced for ensuring
Fisheries is an important source of livelihood and fish, optimum utilisation of production, processing and
are an important source of protein. There are 14·4 million management technology in oil-seed crops during the
fishermen in the country. India ranks second in world fish Prime Ministership of (Late) Rajeev Gandhi by his
production, contributing about 6·4 per cent of global fish scientific Advisor Mr. Sam Pitroda. It was one of six
production. It is also a major producer of fish through
aquaculture. Total fish production during 2016-17 is missions started simultaneously. At present 337 districts
estimated at 11·41 mt. The sector contributes about 1·3 per of 23 States are associated with oilseed production
cent to overall GDP and represents 4·6 per cent of agri programme. Yellow revolution in India ensured
GDP. India’s sea food exports cross $ 6 billion level in remarkable achievements in production of oilseeds and
2017-18. edible oils.
Economics (NET) | 611U
Revolutions in Indian Economy List of Industries Requiring Compulsory
Licence
Revolutions Area
With the introduction of New Industrial Policy in 1991,
Green Revolution Agriculture (Food Production) a substantial programme of deregulation has been
Yellow Revolution Oil Seeds production undertaken. Industrial licensing has been abolished for all
White Revolution Milk items except for a short list of five industries related to
Blue Revolution Fish security, strategic or environmental concerns. These are :
Pink Revolution Shrimp 1. Cigar Cigarettes and other substitutes of prepared
tobacco.
Brown Revolution Masaaley
2. Electronic, Aerospace and all types of defence
Red Revolution Meat/Tomato equipment.
Golden Revolution Fruits/Apple 3. Industrial Explosive including match boxes.
Grey Revolution Fertilizers 4. Hazardous chemicals.
Silver Revolution Eggs
IIP-based Growth Rates of Board Sectors/Use-
Institutional Credit Flow to Agriculture & based Classification (per cent)
Allied Services 2017-18 2018-19
( Billion)
R
General index 4·3 3·6
2016-17 2017-18 Mining 2·3 2·9
Credit Source Amount % Share Amount % Share Manufacturing 4·5 3·5
Commercial 7998 75·04 8772 75·07 Electricity 5·4 5·2
Banks
Primary goods 3·7 3·5
Regional Rural 1232 11·56 1410 12·07
Banks Capital goods 4·4 2·8
Cooperative 1428 13·40 1504 12·87 Intermediate goods 2·2 – 0·6
Banks Consumer Durables 0·6 5·3
Total 10658 100·00 11685 100·00 Consumer Non-durables 10·3 3·8
Infrastructure/ Construction Goods 5·5 7·5
Industry Source : CSO
New Industrial Policy
IIP-Based Industrial Performance
Industrial Policy 1991 : An Overview
(A) Main Features (Objectives) The Index of Industrial Production (IIP) which
● to maintain a sustained growth in productivity. provides quick estimates of the performance of key
● to enhance gainful employment. industrial sectors have started showing upward
● to achieve optimum utilisation of human resources. momentum. As per IIP, the industrial sector broadly
● to attain international competitiveness. comprising mining, manufacturing and electricity
● to transform India into a major partner and players in attained 5·0 per cent growth during 2016-17 as
the global arena. compared to 2·4 per cent during 2015-16 due to the
(B) Main Focus on higher growth in mining and manufacturing sectors. The
● deregulating Indian industry. mining, manufacturing and electricity sectors grew by
● allowing the industry freedom & flexibility in 5·4 per cent, 4·9 per cent, and 5·8 per cent respectively
responding to market forces and during 2016-17.
● providing a policy regime which facilitates and fosters
growth of Indian industry. IIP Growth Slumps to 3·6% in 2018-19
(C) Policy Measures According to the data released by CSO, the IIP for the
(i) Liberalisation of Industrial Licensing Policy. financial year 2018-19, slipped down to 3·6% from 4·4%
(ii) Introduction of Industrial Entrepreneur’s registered during 2017-18.
Memorandum (i.e., no industrial approval is During 2018-19, the manufacturing sector recorded a
required for industries not requiring compulsory growth of 3·5%, marginally down from 4·6% in 2017-18.
licensing). The mining sector as well as power generation reported
(iii) Liberalisation of Locational Policy. 2·9% and 5·2% growth respectively during 2018-19.
(iv) Liberalised policy for Small Scale Sectors.
(v) Non-Resident Indians Scheme (NRIs are allowed Base year 2004-05 Base year 2011-12
to invest upto 100% equity on non-repatriation
Sector
basis in all activities except for a small negative
list). Weights Item Weights Item
(vi) Electronic Hardware Technology Park (EHTP)/ (%) groups (%) groups
Software Technology Park (STP) Scheme for Mining 14·157 1 14·373 1
building up strong electronic industry to enhance
exports. Manufacturing 75·527 397 77·633 405
(vii) Liberalised policy for Foreign Direct Investment Electricity 10·316 1 7·994 1
(FDI). Total 100 399 100 407
612U | Economics (NET)
Key Findings of 6th Economic Census 2014 (Provisional Data)
S. No. Rural Urban
Item India
India India
1. (a) Number of establishments (in 000) 35,023 23,447 58,470
(b) Percentage share 59·9% 40·1% 100·0%
2. (a) Number of establishments (in 000) :
(i) Outside household without fixed structure 7,333 4,646 11,979
(ii) Handicraft/Handloom 1,294 899 2,193
(b) Percentage share in total establishments :
(i) Outside household without fixed structure 20·94% 19·81% 20·49%
(ii) Handicraft/Handloom 3·69% 3·83% 3·75%
3. Growth rate (%) in number of establishments over Fifth Economic Census* 39·28% 45·57% 41·73%
4. (a) Number of persons employed (in 000) 66,289 61,419 127,708
(b) Percentage share 51·9% 48·1% 100·0%
5. Percentage of hired workers in the total persons employed 34·67% 57·59% 45·69%
6. Percentage of total female workers in the total persons employed 30·90% 19·80% 25·56%
7. Growth rate (%) in total employment over Fifth Economic Census* 31·59% 37·46% 34·35%
● Number of Establishments (Top 5 States) ● Total Employment (Top 5 States)
Uttar Pradesh 6700736 (11·46%) Maharashtra 14374619 (11·26%)
Maharashtra 6125902 (10·48%) Uttar Pradesh 13750866 (10·77%)
West Bengal 5901521 (10·09%) West Bengal 11544664 (9·04%)
Tamil Nadu 5052444 (8·64%) Tamil Nadu 10809878 (8·46%)
Andhra Pradesh 4237310 (7·25%) Gujarat 9063569 (7·10%)
Top 3 UTs Top 3 UTs
Delhi 893177 (1·53%) Delhi 2984850 (2·34%)
Chandigarh 83964 (0·14%) Chandigarh 238974 (0·19%)
Puducherry 59309 (0·10%) Puducherry 217694 (0·17%)
● Percentage Growth in Total No. of Estalishment (Between 6th and 5th Economic Census)
Top 5 States Top 3 UTs
Manipur 109·37% A & N Islands 84·89%
Sikkim 102·92% Chandigarh 31·14%
Assam 100·17% D & N. Haveli 28·11%
Nagaland 78·74%
Telangana 78·70%
● Percentage Growth in Total Employment (Between 6th and 5th Economic Census)
Top 5 States Top 3 UTs
Manipur 83·29% A & N Islands 75·08%
Assam 78·84% D & N. Haveli 47·79%
Sikkim 77·14% Daman & Diu 35·81%
Uttar Pradesh 75·26%
Himachal Pradesh 68·81%
Gross Capital Formation by Industry of Use at Constant (2011-12) Prices (R crore)
% change over
Item 2016-17 2017-18 previous year
2016-17 2017-18
1. Agriculture, forestry and fishing 267,836 273,755 12·7 2·2
2. Industry 1,321,542 1,421,706 – 0·7 7·6
(i) Mining and quarrying 57,091 61,170 16·4 7·1
(ii) Manufacturing 704,118 760,529 1·3 8·0
(iii) Electricity, gas and water supply and other utility services 323,159 342,833 – 12·9 6·1
(iv) Construction 237,175 257,175 10·1 8·4
3. Services 2318488 2591527 7·2 11·8
(i) Trade, repair, hotels and restaurants 402,093 431,854 11·1 7·4
(ii) Transport, storage, communication and services related to broadcasting 351,577 407,045 7·1 15·8
(iii) Financial services 24,530 103,654 – 60·6 322·6
(iv) Real Estate, ownership of dwellings and professional services 892,486 909,672 7·0 1·9
(v) Public administration and defence 387,688 435,318 11·9 12·3
(vi) Other services 260,113 303,984 12·7 16·9
4. Total GCF by industry of use** 3,907,866 4,286,988 4·7 9·7
Economics (NET) | 613U
Contribution of MSMEs in Country’s Economy (At Current Prices)
(In R crore)
Share of Share of
Year MSME GVA Growth % Total GVA MSMEs in Total GDP MSME in
GVA (%) GDP %
2011-12 2583263 — 8106946 31·86 8736329 29·57
2012-13 2977623 15·27 9202692 32·36 9944013 29·94
2013-14 3343009 12·27 10863153 32·26 11233522 29·76
2014-15 3658196 9·43 11481794 31·86 12445128 29·39
2015-16 3936788 7·62 12458642 31·00 13682035 28·77
Various Schemes for Boosting MSMEs proposed amendments to the Micro, Small and Medium
Enterprises Development Act, 2006, come into effect.
The MSME sector contributing 37·5 per cent of the
country’s GDP, have a critical role in boosting industrial The decision, taken at the Cabinet meeting on February
growth and ensuring the success of the Make in India 8, 2018, classified MSMEs on the basis of their annual
programme. A number of schemes are being implemented turnover. The current classification was based on
for the establishment of new MSMEs and growth and investment in plant and machinery for goods companies
development of existing ones. These include : (a) The Prime and in equipment for services firms. Micro enterprises
Minister’s Employment Generation Programme, (b) Micro would now be those with annual turnover of R 50
and Small Enterprises Cluster Development Programme, (c) million. The earlier criteria for goods companies was
Credit Guarantee Fund Scheme for Micro and Small investment of up to R 2.5 million in plant and
Enterprises, (d) Performance and Credit Rating Scheme, (e) machinery.
Assistance to Training Institutions, and (f) Scheme of Fund
for Regeneration of Traditional Industries.
National Manufacturing
Government Changing Definition of Competitiveness Programme
MSMEs to be in Sync with GST The Government has launched an all-India campaign
The government is changing the criteria to define under the National Manufacturing Competitiveness
micro, small and medium enterprises (MSMEs), to make Programme (NMCP) for MSMEs, which has specific
these in sync with the goods and services tax (GST) components that are aimed at enhancing the
regime, by making the norms common for good and competitiveness of the enterprise in this sector-so as to
services. The announcement came on a day when the withstand global and organized competition and to
Reserve Bank of India announced some relief to the thrive through better technologies and skills. The
sector. But the change would be effective when the components of the NMCP seek to introduce the best
Category of Current Proposed elements of industrial competitiveness in the SME
Industries Classification Classification sector, which has often been unable to afford such
based on based on Annual practices and techniques. The ten components of the
Investment in Turnover National Manufacturing Competitiveness Programme
plant and (NMCP) to be implemented by the Ministry of MSME
machinery
during XXI Plan are :
Manufacturing
(i) Lean Manufacturing,
Micro Not Exceed R 25 lakh R 5 crore
Enterprises (ii) Design Clinics,
Small More than R 25 lakh but More than R 5 (iii) Setting up of New Mini Tool Rooms (MTR)
Enterprises not exceed R 5 crore crore but not (iv) Promotion of Information and Communication
exceed R to R 75
Technology (ICT) in MSMEs,
crore
(v) Support for Entrepreneurial and Managerial
Medium More than R 5 crore but More than R 75
Enterprises does not exceed R 10 crore but does not Development of MSMEs through Incubators.
crore exceed R 250 crore (vi) Marketing Assistance of MSMEs & Technology
Services Upgradation Activities,
Micro Not Exceed R 10 lakh R 5 crore (vii) Quality Management Standards and Quality
Enterprises Technology Tools for MSMEs,
Small More than R 10 lakh but More than R 5 (viii) National Campaign for investment in
Enterprises not exceed R 2 crore crore but not Intellectual Property Rights (IPR),
exceed R 75 crore
(ix) Energy Efficiency and Quality Upgradation
Medium More than R 2 crore but More than 75 core
Enterprises does not exceed R 5 but does not exceed support for MSMEs and
crore R 250 crore (x) Marketing Support/Assistance for MSMEs.
614U | Economics (NET)
More Power to Maharatna and (c) An average annual turnover of more than
R 25,000 crore during the last 3 years.
Navratna PSUs for Overseas Buyouts (d) An average annual net worth of more than
According to a new policy approved by union R 15,000 crore during the last 3 years.
cabinet, the government will facilitate faster acquisition
(e) An average annual net profit after tax of more
of raw material from abroad for those Central Public
than R 5,000 crore during the last 3 years.
Sectors Enterprises (CPSEs) with a track record of
netting profit for three consecutive years. Maharatna and (f) Should have significant global presence/inter-
Navratna PSUs will also get more power for overseas national operations.
buyouts after the new acquisition policy comes into Eligibility Criteria for Grant of Navaratna
force. Status
The new policy will pave the way for Navratna The Central Public Sector Enterprises (CPSEs)
firms to invest upto 3,000 crore in such assets without fulfilling the following criteria are eligible to be
government approval, as against the present limit of considered for grant of Navaratna status :
R 1,000 crore. For Maharatna PSUs, this limit will be
(i) Having Schedule ‘A’ and Miniratna Category-1
R 5,000 crore. The policy will facilitate easier acquisition
status.
of coal, iron ore and other assets abroad.
(ii) Having atleast three ‘Excellent’ or ‘Very Good’
A coordination committee will soon be formed
Memorandum of Understanding (MoU) ratings during
under the cabinet secretary to examine proposals
the last five years.
involving investment beyond the prescribed limits for
such acquisitions by CSPEs. (iii) Having a composite score of 60 or above out of
100 marks based on its performance during the last three
It is expected that the changes in the new policy will
years on the following six identified efficiency para-
make Indian CPSEs wise and capable enough to make
meters :
foreign acquisitions.
Eligibility Criteria for Grant of Maharatna Eligibility Criteria for Miniratna Status
Status As per criteria, the CPSEs having profit in the last
three years continuously, with pretax profit of R 20 crore
The CPSEs meeting the following eligibility criteria
or more in at least one of the three years, and having
are proposed to be considered for Maharatna status :
positive net worth are eligible to be considered for grant
(a) Having Navratna status. of Miniratna Category-I status. The CPSEs having profit
(b) Listed on Indian stock exchange with minimum in the last three years continuously and having positive
prescribed public shareholding under SEBI regulations. net worth are eligible to be considered for grant of
Miniratna Category-II status.
‘Maharatna’ and ‘Navratna’ Companies
(Status as on August 2018) Mini Ratna Scheme
I. Maharatna Companies The Government had introduced the Miniratna scheme
1. Oil and Natural Gas Corporation (ONGC) in 1997 in pursuance of the policy objective to make the
2. National Thermal Power Corporation (NTPC) public sector more efficient and competitive and to grant
3. Steel Authority of India Ltd. (SAIL) enhanced autonomy and delegation of powers to the profit
4. Indian Oil Corporation (IOC) making public sector enterprises. The enhanced powers
5. Coal India Ltd. (CIL) given to Miniratna CPSEs include the power to (i) incur
6. Bharat Heavy Electricals Ltd. (BHEL) capital expenditure, (ii) enter into joint ventures, (iii) set up
7. Gas Authority of India Ltd. (GAIL) technological and strategic alliances and (iv) formulate
8. Bharat Petroleum Corporation Ltd. (BPCL) schemes of human resources management. The adminis-
II. Navratna Companies trative Ministries are empowered to declare a CPSE as a
1. Hindustan Petroleum Corporation Ltd. (HPCL) Miniratna if it fulfils the eligibility conditions. Presently,
2. Mahanagar Telephone Nigam Ltd. (MTNL) there are 71 Miniratna CPSEs (53 category-I and 18
3. Bharat, Electronics Ltd. (BEL) category-II).
4. Hindustan Aeronautical Ltd. (HAL)
5. Power Finance Corporation (PFC) Central Public Sector Enterprises
6. National Mineral Development Corporation (NMDC) Survey 2017-18
7. Power Grid Corporation of India Ltd. (PGCIL)
8. Rural Electrification Corporation (REC)
The Public Enterprises Survey 2017-18 on the
9. National Aluminium Company (NALCO) performance of Central Public Sector Enterprises,
10. Shipping Corporation of India (SCI) brought out by the Department of Public Enterprises,
11. Rashtriya Ispat Nigam Ltd. (RINL) Ministry of Heavy Industries & Public Enterprises, was
12. Oil India Ltd. (OIL) tabled in both the Houses of Parliament on December
13. Neyveli Lignite Corporation Ltd. 27, 2018. There were 339 Central Public Sector
14. Engineers India Ltd. Enterprises (CPSE) in 2017-18, out of which 257 were
15. National Building Construction Corporation Ltd. in operation. Remaining 82 of the CPSEs were under
16. Container Corporation of India Ltd. construction.
Economics (NET) | 615U
Performance of Central Public Sector Enterprises expenditure stood at R 4,96,581 crore in 2017-18 as
during the FY 2017-18 at a glance are as follows : against R 4,38,996 crore in 2016-17, showing an
increase of 13·12%. 10·88 lakh persons (excluding
2017-18 2016-17 casual and contractual workers) were employed in
Overall net profit of 257 Overall net profit of 257 2017-18 compared to 11·35 lakh in 2016-17,
Operating CPSEs is operating CPSEs is showing a reduction in strength of employees by
R 1,28,374 crore R 1,25,498 crore
4·14%.
184 Operating CPSEs posted 175 Operating CPSEs posted
net profit of R 1,59,635 crore net profit of R 1,52,978 crore ● Salary and wages in all CPSEs stood at R 1,57,621
71 Operating CPSEs posted 81 Operating CPSEs posted crore in 2017-18 against R 1,40,956 crore in 2016-
net loss of R 31,261 crore net loss of R 27,480 crore 17 showing growth of 11·82%. T o t a l Market
Total Investment in all Total Investment in all Capitalization (M-Cap) of 52 CPSEs traded on stock
CPSEs (339) stood at CPSEs (331) stood at exchanges of India is R 15,22,041 crore as on
R 13,73,412 crore R 12,45,819 crore
31.03.2018 as compared to R 15,18,920 crore as on
Dividend declared/paid by Dividend declared/paid by 31.03.2017 showing an increase of 0·21% M-Cap of
CPSEs during the 2017-18 is CPSEs during financial year CPSEs as per cent of BSE M-Cap decreased from
R 76,578 crore 2016-17 is R 78,129 crore
12·50% as on 31.3.2017 to 10·70% as on 31.3.2018.
The major highlights of the performance of
CPSE are : Department of Disinvestment
● Total paid up capital in 339 CPSEs as on Renamed as ‘DIPAM’
31.3.2018 stood at R 2,49,988 crore as a compared to The Department of Disinvestment has been renamed
R 2,32,161 crore as on 31.3.2017 (331 CPSEs), as DIPAM i.e., Department of Investment and Public
showing a growth of 7·68%. Total investment Asset Management. This decision is aimed at proper
(financial) in all CPSEs was at R 13,73,412 crore as management of Centre’s investments in equity including
on 31.3.2018 compared to R 12,45,819 crore as on its disinvestment in central public sector undertakings.
31.3.2017, recording a growth of 10·24%. Capital Disinvestment in Public Sector Undertaking
Employed in all CPSEs stood at R 23,15,707 crore
on 31.3.2018 compared to R 21,66,801 crore in the Year Target Receipt for Actual Receipts
previous year showing a growth of 6·87%. the year
● Total Gross Revenue from operation of all CPSEs 1991-92 2500 3038
during 2017-18 stood at R 21,55,948 crore 1992-93 2500 1913
compared to R 19,55,675 crore in the last financial 1993-94 3500 Nil
year showing a growth of 10·24%. Total income of 1994-95 4000 4843
all CPSEs during 2017-18 was at R 20,33,732 crore 1995-96 7000 362
compared to R 18,22,184 crore in 2016-17, showing 1996-97 5000 380
a growth of 11·61%. Profit of profit making CPSEs 1997-98 4800 902
(184 CPSEs) stood at R 1,59,635 crore during 2017- 1998-99 5000 5371
18 compared to R 1,52,978 crore in 2016-17 1999-2000 10000 1860
showing a growth in profit by 4·35%. Loss of loss
2000-01 10000 1871
incurring CPSEs (71 CPSEs) stood at R 31,261
crore in 2017-18 as against R 27,480 crore in 2016- 2001-02 12000 5632
17 showing increase in loss by 13·76%. 2002-03 12000 3348
● Overall net profit of all 257 CPSEs stood at 2003-04 14500 15547
R 1,28,374 crore compared to R 1,25,498 crore
2004-05 4000 2765
showing a growth in overall profit of 2·29%. 2005-06 — 1570
Reserves and surplus of all CPSEs stood at 2006-07 3840 534
R 9,42,295 crore as on 31.3.2018 compared to 2007-08 41651 36125
R 9,20,981 as on 31.3.2017, registering an increase 2008-09 10165 566
by 2·31%. Net worth of all CPSEs went up from 2009-10 1120 24581
R 10,83,942 crore to R 11,26,782 crore showing an
2010-11 25000 22744
increase of 3·95%. Contribution of CPSEs to 2011-12 40000 18087·63
Central Exchequer decreased from R 3,60,815 crore 2012-13 30000 25889·00
to R 3,50,052 crore showing a decrease of 2·98%. 2013-14 40000 15819·46
Foreign exchange earnings through exports of goods 2014-15 43425 24348·71
and services stood at R 86,980 crore in 2017-18 as 2015-16 41000 21400·84
against R 87,768 crore in 2016-17, showing 2016-17 56500 47742
decrease of 0·90%. 2017-18 100000 100045
● Foreign exchange expenditure of imports and 2018-19 (RE) 80000 —
royalty, know-how, consltancy, interest and other 2019-20 (BE) 105000 —
616U | Economics (NET)
New department has been mandated to advise the Printing of Securities and Minting in India
government in the matters of financial restructuring of 1. India Security Press (Nasik Road)—Postal Material,
central public sector enterprises and for attracting Postal Stamps, Non-postal Stamps, Judicial and Non-
investment through capital markets. judicial Stamps, Cheques, Bonds, NSC, Kisan Vikas
The DIPAM will work under Finance Ministry. It Patra, Securities of State Governments, Public Sector
Enterprise and Financial Corporations.
will also deal with “all matters relating to sale of central 2. Security Printing Press (Hyderabad)—Established in
government equity through offer for sale or private 1982 for meeting the demand for postal material by
placement or any other mode in the erstwhile central Southern States. It also fulfils the demand for Union
public sector undertakings.” Excise Duty Stamps of the Country.
Official notification further says that all other post 3. Currency Notes Press (Nasik Road)—Since 1991, this
press prints currency notes of 1, 2, 5, 10, 50,
disinvestment matters, including those relating to and and 100. (Earlier printing of 50 and 100 currency
arising out of the exercise of call option by the strategic notes was not done here).
partner in the erstwhile central public sector 4. Bank Notes Press (Dewas)—Currency notes of 2 0 ,
undertakings, shall continue to be handled by the 50, 100 and 500 are printed here.
administrative ministry or department concerned, where 5. Modernised Currency Notes Press—Two new
necessary, in consultation with the DIPAM. modernised currency notes press are under estab-
lishment at Mysore (Karnataka) and Salboni (West
Bengal).
Money and Banking 6. Security Paper Hoshangabad (Established in 1967-
Reserve Bank of India 68) makes production of Bank and Currency notes
paper.
It is the Central Bank of the country. The Reserve 7. Coins are minted at four places–Mumbai, Kolkata,
Bank of India was established in 1935 with a capital of Hyderabad and Noida.
5 crore. This capital of R 5 crore was divided into 5 lakh 5. Custodian of Foreign Reserves—For the
equity shares o f R 100 each. I n t h e beginning the purpose of keeping the foreign exchange rates stable the
ownership of almost all the share capital was with the Reserve Bank buys and sells the foreign currencies and
non-govern-ment shareholders. In order to prevent the also protects the country’s foreign exchange funds.
centralisation of the equity shares in the hands of a few
6. Other Functions—The bank performs a number
people, the Reserve Bank of India was nationalised on
of other developmental works. These works include the
January 1, 1949.
function of clearing house arranging credit for
Functions of Reserve Bank agriculture (which has been transferred to NABARD)
1. Issue of Notes—The Reserve Bank has the collecting and publishing the economic data, buying and
monopoly of note issue in the country. It has the sole selling of Government securities and trade bills, giving
right to issue currency notes of various denominations loans to the Government buying and selling of valuable
except one rupee note. The Reserve Bank acts as the commodities etc. It also acts as the representative of
only source of legal tender money because the one rupee Government in I.M.F. and represents the membership of
note issued by Ministry of Finance are also circulated India.
through it. The Reserve Bank has adopted the Minimum Commercial Banks in India (January 31, 2019)
Reserve System for the note issue. Since 1957, it
maintains gold and foreign exchange reserves of 200 (A) Public Sector Banks–21
crore, of which at least 115 crore should be in gold. (i) SBI–1
2. Banker to the Government—The second (ii) Nationalised–17
important function of the Reserve Bank is to act as the (iii) IDBI Bank–1
Banker, Agent and Adviser to the Government. It
performs all the banking functions of the State and (B) Private Sector Banks–30
Central Government and it also tenders useful advice to (i) Old–13
the Government on matters related to economic and (ii) New–9
monetary policy. It also manages the public debt for the (iii) Payment Banks–6
Government.
3. Banker’s Bank—The Reserve Bank performs the (Airtel Payment Bank Ltd, India Post Payment
same function for the other banks as the other banks Bank, Paytm Payment Bank, Fino Payments Bank, Jio
ordinarily perform for their customers. It is not only a Payments Banks, NSDL Payments Bank).
banker to the commercial banks, but it is the lender of (iv) Small Finance Banks–10
the last resort. (Capital Small Finance Bank Ltd., Suryoday Small
4. Controller of Credit—The Reserve Bank Finance Bank Ltd., Equitas Small Finance Bank Ltd.,
undertakes the responsibility of controlling credit Utkarsh Small Finance Bank Ltd., Ujjvan Small Finance
created by the commercial banks. To achieve this Bank Ltd., AU Small Finance Bank Ltd., RGUN Small
objective it makes extensive use of quantitative and Finance Bank Ltd., ESAF Small Finance Bank Ltd.).
qualitative techniques to control and regulate the credit Fincare Small Finance Bank Ltd., North-East Small
effectively in the country. Finance Bank Ltd.)
Economics (NET) | 617U
Non Performing Assets of Public Sector Banks RBI Replaces Base Rate System by
Bad loans of public sector banks declined by more than MCLR System
R 31,000 crore to R 8,64,433 crore in the first nine months Reserve Bank of India introduced Base Rate system
of 2018-19 as compared to end of March 2018. Non- from July 1, 2010 by replacing the Prime Lending Rate
Performing Assets (NPAs) or bad loans of the banks stood at
system. Again the Base Rate System has also been
R 8,95,601 crore at the end of 2017-18. Bad loans fell to
R 8,75,619 crore as on June 2018 and further to R 8,64,433
replaced by Marginal Cost of Funds based Lending Rate
crore in December 2018 (as per provisional data). Bad (MCLR) system from April 1, 2016.
loans fell by R 31,168 crore in April-December 2018-19 Base Rate system was introduced to ensure that
compared to NPAs worth R 8,95,601 crore at March-end banks can not lend below a certain benchmark. Also, to
2018. ensure that the changes in interest rate policy is
(C) Regional Rural Bank–56 effectively transmitted to bank customers. However
(D) Foreign Banks (with Branch offices)–46 policy transmission could not become very effective as
(E) Foreign Banks (with Representative Office)–39 banks adopted various methods in calculating their costs
of funds.
PSU Banks’ Losses Due to Bank Frauds in 2017-18 As per RBI’s new guidelines, it is mandetory for
Total losses due to bank banks to consider the repo rate while calculating MCLR
Public Sector Banks frauds in 2017-18 with effective from April 1, 2016. The main components
(R crore)
of MCLR calculation are :
Punjab National Bank 6,461·13
State Bank of India 2390·75 ● Operating expenses.
Bank of India 2,224·86 ● Cost of maintaining CRR.
Bank of Baroda 1,928·25 ● Marginal cost of funds (after considering interest
Allahabad Bank 1,520·37
Andhra Bank 1,303·30 rates offered on savings/current/term deposits
UCO Bank 1,224·64 account/based on cost of borrowing i.e. short term
IDBI Bank 1,116·53 borrowing rates which is repo rate and also. On long
Union Bank of India 1,095·84 term borrowing rates; return on net worth.
Central Bank of India 1,084·50 ● Tenor Premium.
Bank of Maharashtra 1,029·23
Indian Overseas Bank 1,015·79 RBI has directed commercial banks on September 4,
Corporation Bank 970·89 2019 to link their lending rates on floating rate loans to
United Bank of India 880·53 retail, personal and MSMEs borrowers to any of the
Oriental Bank of Commerce 650·28 following external benchmark from October 1, 2019.
Canara Bank 190·77 ● Repo Rate
Punjab and Sind Bank 90·01
Dena Bank 89·25 ● Government of India’s three month treasury bill
Vijaya Bank 28·58 yield published by the Financial Benchmarks India
Indian Bank 24·23 Pvt. Ltd. (FBIL).
Profit/Loss of PSU Banks 2018-19 ● GoI’s six-monthly treasury bill yield published by
(R crore) the FBIL.
State Bank of India (+) 862 ● Any other benchmark market interest rate published
Oriental Bank (+) 55 by the FBIL.
IDBI Bank (–) 15116
Corporation Bank (–) 6333
RBI’s Monetary Policy Committee
Bank of Baroda (+) 433 Constituted
Canara Bank (+) 347 Adopting a model followed in developed countries
UCO Bank (–) 4321 like US and UK, the union government has constituted
United Bank of India (–) 2316 Monetary Policy Committee (MPC) of the Reserve Bank
Union Bank of India (–) 2948 of India (RBI) in which three outside experts have been
Central Bank (–) 6617 nominated as members. The six-member MPC—the
other three members are from RBI—will conduct its first
Bank of Maharashtra (–) 4784
monetary policy review on October 4, Urjit Patel’s first
Syndicate Bank (–) 2588
as RBI governor.
Bank of India (–) 5547
The Appointments Committee of the Cabinet on
Allahabad Bank (–) 8334
September 22, 2016 approved the names of Chetan
Punjab & Sind Bank (–) 543
Ghate, a Professor at Indian Statistical Institute; Pami
Andhra Bank (–) 2784 Dua, Director at Delhi School of Economics (DSE); and
Indian Overseas Bank (–) 3738 Ravindra Dholakia, Professor at Indian Institute of
Punjab National Bank (–) 9975 Management, Ahmedabad, as MPC members. Ghate and
618U | Economics (NET)
Dua were chosen because they are macro-economists of Small Finance Bank
repute. Dholakia was selected because he has a broader
The Reserve Bank of India (RBI) has today decided
view on issues related to agriculture, poverty and food
to grant ‘in-principle’ approval to the following 10
inflation. The experts will serve for four years and are
applicants to set up small finance banks under the
not eligible for re-appointment. Outsider members’
‘Guidelines for Licensing of Small Finance Banks in
names are recommended by a search committee headed
the private sector’ (Guidelines) issued on November
by Cabinet Secretary, the other members being the RBI
27, 2014. 72 players had applied for small finance banks
Governor and Secretary of Economic Affairs GoI.
licence.
The members of the committee from RBI are Names of selected applicants are : As on July 31,
Governor Shaktikant Das, Deputy Governor Viral V. 2018 all the 10 Small Finance Banks are in operation—
Acharya, who is also in charge of the monetary policy,
1. Au Small Finance Bank Ltd. (AU BANK)
and Executive Director Michael Patra. The RBI governor
will have a casting vote in case of a tie. 2. Capital LAB Small Finance Bank
3. Equitas Small Finance Bank
Payment Banks 4. ESAF Small Finance Bank
Opening the way for revolutionising cashless 5. FINCARE Small Finance Bank (Disha Micro
Finance Ltd.)
payments services in the country, the Reserve Bank of
India has granted payment bank licences to 11 firms. 6. Janalakshmi Small Finance Bank
These11 applicants that have got ‘in principle’ approval 7. NE Small Finance Bank (RGVN Micro Finance
for setting up payments banks will provide barebones Ltd.)
facilities aimed at covering the vast population that has 8. Suryoday Small Finance Bank
no access to financial services. They take deposits, 9. Ujjivan Small Finance Bank
convey remittances and dispense payments to recipients, 10. Utkarsh Small Finance Bank.
making them ideal for migrant workers who need to All of the above have started banking operations.
send money home, for instance. These 11 licence Small Finance Banks are similar to the existing
commercial lenders and undertake basic banking acti-
obtaining firms include telecom companies Vodafone
vities of accepting deposits and lending to unserved and
and Airtel; non-banking financial company Cholaman- underserved sections. The maximum loan size and
dalam Distribution Services Ltd; large conglomerates investment limit exposure to single and group obligators
Reliance Industries a n d A d i t y a Birla Nuvo; and cannot be more than 10 per cent and 15 per cent of its
individuals Vijay Shekhar Sharma, founder of Paytm, capital funds, respectively.
and Dilip Shanghvi, Managing Director of Sun Apart from this, at least 50 per cent of their loan
Pharmaceuticals. The Department of Posts, FinoPaytech, portfolio has to include loans and advances of up to R 25
Tech Mahindra and National Securities Depository Ltd lakh, as per RBI regulations. The regulator had also said
also got place in the list. that small bankcan convert themselves into universal
Payments banks differ from conventional banks as banks, though the transition would not be automatic and
they are not allowed to lend to customers or issue credit will depend on the regulator’s approval.
cards. They can, however, accept deposits of up to 1 MUDRA Bank
lakh and can offer current and savings account deposits.
The Micro Units Development and Refinance
They can also issue debit cards and offer internet Agency (known as the MUDRA Bank) has been
banking. launched on April 8, 2015 which would primarily be
Of the 11 companies that were given in-principle responsible for regulating micro and small enterprise
nod by RBI to set up Payments Bank in August 2015, financing business, and supporting them. The roles
three–Tech Mahindra, Cholamandalam Finance and envisaged for MUDRA include laying down policy
Dilip Shanghvi–IDFC Bank–Telenor JV, have already guidelines for micro enterprise financing business and
dropped out. As on July 31, 2018 following Payments registration of MFI entities as well as their accreditation
Banks have started their operations : and rating.
Prime Minister Narendra Modi launched the
1. Airtel Payments Bank Ltd. (India’s first Payments
R 20,000 crore ( R 200 billion) MUDRA Bank that aims
Bank). to provide refinancing to small and medium enterprises,
2. Paytm Payments Bank Ltd. particularly those belonging to members of scheduled
3. Fino Payments Bank Ltd. castes and scheduled tribes. According to Narendra
4. India Post Payments Bank Ltd. Modi, the bank would help over six crore families. The
bank would also get an additional R 3,000 crore (R 30
5. Jio Payments Bank Ltd.
billion) in the budget to create a credit guarantee corpus
6. Aditya Birla Idea Payments Bank Ltd. for guaranteeing loans being provided to the micro
7. NSDL Payments Bank Ltd. enterprises.
Economics (NET) | 619U
MUDRA Bank will offer loans under three schemes- ● Kishor : In this stage, the entrepreneur will be
Shishu-upto R 50,000, Kishor upto R 5 lac and Tarun eligible for a loan ranging from R 50,000 to R 5
upto R 10 lac-based on stage of micro business. MUDRA lakh.
Bank will also register MFIs and be responsible for ● Tarun : This last and final category will provide
accreditation and rating of MFI. It will also lay down loans for upto R 10 lakh.
policies for proper last mile practices to be followed by
MFI to prevent indebtedness and provide proper client RBI Issues Charter of Customer Rights
protection. The Reserve Bank of India (RBI) has issued a
Achievements under Pradhan Mantri MUDRA Yojana charter comprising five basic customer rights. These
2015-16 2016-17 2017-18 2018-19 cover a right to fair treatment, transparency, suitability,
1. No. of 34880924 39701047 48130593 59870318 privacy, grievance redress and compensation.
PMMY
loans The Charter of Customer Rights to deal with entities
sanctioned regulated by RBI, has been framed based on global best
2. Amount 137449·27 180528·54 253677·10 321722·79 practices of consumer protection as also discussions and
sanctioned
( R crore) interaction with various stakeholders. The Charter spells
3. Amount 132954·73 175312·13 246437·40 311811·38 out the rights of the customer and also the responsibilities
Disburseme
nt (R crore) of the financial service provider.
The Charter spells out the rights of the customer and
Important features of MUDRA Bank can be summed also the responsibilities of the financial service provider
up as follows :
(FSP) which are as follows :
● MUDRA Bank stands for Micro Units Development
● Right to Fair Treatment : No discrimination on
Refinance Agency (MUDRA). Also, Mudra, in
basis of gender, age, religion, caste and physical
Hindi, means currency.
ability.
● MUDRA Bank is being set up through a statutory
● Right to Transparency, Fair and Honest Dealing
enactment and will be responsible for developing
: Contracts or agreements between financial service
and refinancing through a Pradhan Mantri MUDRA
provider and customer should be transparent and
Yojana.
easy to understand.
● Since small entrepreneurs are businesses are often ● Right to Suitability : Products offered should be
cut off from banking system because of limited appropriate to the needs of the customer.
branch presence, MUDRA Bank will partner with
● Right to Privacy : Customers' personal information
local coordinators and provide finance to ‘Last Mile
Financiers’ of small/micro businesses. to be kept confidential. No unwarranted communi-
cation, electronic or otherwise, to be sent.
● MUDRA has been targeted towards mainstreaming
● Right to Grievance Redress and Compensation :
young, educated or skilled workers and entre-
preneurs including women entrepreneurs. Financial services provider accountable for products
offered (including third party products). Provider to
● The bank will cater to 5·77 crore small business facilitate easy grievance redressal.
units that are spread all across India who currently
find it difficult to access credit from the regular Non-Banking Financial Intitutions Regulated by
the Reserve Bank of India
banking system. (End-Sept. 2018)
● MUDRA Bank will ensure clients are properly Non-Banking Financial Institutions
protected and will lay down principles and methods
of loan recovery in case of a default. The Bank will Non-Banking All India Financial
also rigidly follow ‘responsible financing practices’ Institutions Primary Dealers
Financial Companies
(4) (21)
so deter borrowers from indebtedness. (10,190)
● The Bank will be set up with a corpus of R 20,000
NBFCs-D NBFCs-ND Bank PDs Standalone PDs
crore and a credit guarantee fund of R 2,000 crore.
(108) (10,082) (14) (7)
● The Bank will nurture small businesses through
different stages of growth and development of Systemically Important Other NBFCs-ND
businesses termed as Shishu, Kishor and Tarun. NBFCs-ND (NBFCs-ND)
(NBFCs-ND-SI) (276) (9,806)
● Shishu : This is the first step when the business is
just starting up. The loan cover in this stage will be Note : Figures in parentheses are the number of institutions
upto R 50,000. Source : RBI
620U | Economics (NET)
Gross NPAs of Public Sector Banks March 2019 Structure of Co-operative Credit
Indian Overseas Bank 21·97 Institutions in India position
IDBI Bank 27·47 (As on March 31, 2018)
Central Bank of India 19·28
UCO Bank 25·00
Bank of Maharashtra 16·40
United Bank of India 16·48
Oriental Bank of Commerce 12·66
Bank of India 15·84
Allahabad Bank 17·55
Punjab National Bank 15·50
Andhra Bank 16·21
Corporation Bank 15·35
Union Bank of India 14·98
Bank of Baroda 9·61
Punjab and Sindh Bank 11·83
Canara Bank 8·33
Syndicate Bank 11·37
State Bank of India 7·53
Foreign Bank’s Operation in India
As at end-December 2015, there were 46 foreign
banks operating in India with 325 branches. Another 46 DCCBs : District Central Co-operative Banks : PACS :
Primary Agricultural Credit Societies : SCARDBs : State co-
foreign banks have their representative offices in India. operative Agriculure and Rural Development Banks :
Among foreign banks, Standard Chartered has the PCARDBs : Primary Co-operative Agriculture and Rural
maximum spread of banks branches in India (102 Development Banks.
branches) followed by HSBC (50 branches), Citi Bank Notes : (1) Figures in parentheses indicate the number of
NA (45 branches) and Royal Bank of Scotland NV (10 institutions at end-March 2018 for UCBs and at end-March
branches). 2018 for rural co-operatives.
Indian Banks Abroad (2) For rural co-operatives, the number of co-operatives
refers to reporting co-operatives.
As on December 31, 2015, 183 Offices of Indian
Banks were being operated in foreign countries. Out of Debt Recovery Tribunals
these 163 Offices were of Public Sector Banks and 20 The Government has established Debt Recovery
Offices were of 3 Private Sector Banks.
Tribunals in six cities (Kolkata, Delhi, Jaipur,
Regional Rural Banks Ahmedabad, Bangalore and Chennai) to speed up
Regional Rural Banks (RRBs) were established recovery of loans disbursed by banks and other financial
since 1975 under the provisions of the RRB Act 1976 institutions. An Appellate Tribunal is also working at
with a view to developing the rural economy as well as Mumbai. The first Debt Recovery Tribunal was
to creating an alternative channel to ‘Cooperative Credit established in June 1994 at Kolkata. These tribunals have
Structure’ in order to ensure sufficient institutional been established under ‘Recovery of Debts due to Banks
credit for rural and agricultural sector. In other words, and Financial Institution Act, 1993’.
Regional Rural Banks (RRBs) were established to take Banking Ombudsman Scheme
the banking services to the door steps of rural masses, RBI introduced a Banking Ombudsman Scheme in the
especially in remote rural areas with no access to country on June 14, 1995, for giving a solution for
banking services. These banks provide institutional customer’s complaints. 15 Ombudsmen have already been
credit to the weaker sections of the society at appointed for different regions. These regions are—New
Delhi, Bhopal, Bangalore, Chandigarh, Hyderabad,
concessional rate of interest. These banks were also Mumbai, Patna, Jaipur, Kanpur, Guwahati and
intended to mobilise rural savings and channelise for Bhubaneshwar. Bank customers can send their complaints
supporting the productive activities in the rural area. On to these Ombudsman if concerned banks fail to satisfy them.
October 2, 1975, initially 5 RRBs were established at These Ombudsman take necessary action and will ensure a
Moradabad (U.P.) and Gorakhpur (U.P.), Bhiwani relief to customers.
According to a circular issued by the RBI, all scheduled
(Haryana), Jaipur (Rajasthan) and Malda (West Bengal). primary co-operative banks a n d commercial banks have
Later on RRBs were extended to other districts of the been brought under purview of this banking Ombudsman
country. scheme. Regional Rural Banks (RRBs) have not been
As on March 31, 2018; 56 RRBs with 21667 included under the scheme.
branches are working in India. The matter should be reported by grieved customer t o
Ombudsman within the period of one month after getting
Though, RRBs were initially intended to support final reply from concerned bank. Ombudsman will not act
productive activities in the rural areas. With effect from upon the complaints having received after this time limit.
April 1997 the concept of priority sector lending was The Banking Ombudsman Scheme 2006 has been
made applicable to RRBs. Similarly, the interest rates on amended by RBI on February 3, 2009. The coverage of the
term deposits offered and interest rates on loans charged scheme has been widened and included new grounds of
by RRBs have also been freed. complaint.
Economics (NET) | 621U
As on December 31, 2017; 5 Debt Recovery Main Share Price Index in Famous Share Market
Applate Tribunals and 39 Debt Recovery Tribunals are of the World
working in India. Mumbai DOLEX
SENSEX
RBI fixed following mentioned Capital Adequacy S & PCNX
ratios for banking institutions— NIFTY FIFTY
NewYork DOW JONES
1. All Foreign Banks 8% Capital Adequacy Ratio (till Tokyo NIKKEI
working in India March 1993) Frankfurt (Germany) MID DAX
2. All Indian Banks 4% Capital Adequacy Ratio (till Hong Kong HANG SENG
March 1993) Singapore SIMEX
STRAITS TIMES
3. All Indian Banks 8% Capital Adequacy Ratio (till
having branches in March 1995) Commodity Futures Market
foreign countries Commodities traded on the commodity futures
4. All other Indian 9% Capital Adequacy Ratio (till market during 2009 included a variety of agricultural
Banks March 2000) commodities, bullion, crude oil, energy and metal
products. Several new commodities were permitted for
trading in 2009, such as aviation turbine fuel, carbon
Capital Market credit, carbon financial instrument, red arecanut,
Progress on developing India’s capital market, coriander seeds, garlic, steel long (ingots/billets) and
which is already more competitive, deep and developed thermal coal.
by international markets standards, continued. Business
in the country’s oldest stock exchange, namely the
Commodity Exchanges of India
Bombay Stock Exchange (BSE) dating back to 1875, 1. National Multi Commodity Exchange–NMCE
which is also one of the oldest stock exchanges in the 2. MCX Estd. November 2003; H. Q. Mumbai
world, continued to thrive. The National Stock Chairman : Thomas Mathew
Exchange (NSE), which emerged in the mid-1990s and 3. National Commodity and Derivatives Exchange
catalysed improvements in trading systems to provide Limited (NCDEX)
the necessary depth and choice to investors, made 4. ACE Commodity Exchange
sustained progress. With the BSE and NSE emerging as
the two apex institutions of the country’s capital market,
Securities and Exchange Board of
restructuring of other stock exchanges went apace. India (SEBI)
Overseen by Securities and Exchange Board of India SEBI (Securities and Exchange Board of India) was
(SEBI), an independent statutory regulatory authority, initially constituted on April 12, 1988 as a non-statutory
the country’s capital market dealt in scrips of a large body through a resolution of the Government for dealing
number of listed companies with a wide geographical with all matters relating to development and regulation
outreach, providing a world class trading and settlement of securities market and investor protection and to
system, a wide range of product availability with a fast advise the Government on all these matters. SEBI was
growing derivatives market, and well laid down given statutory status and powers through an ordinance
corporate governance and investor protection measures. promulgated on January 30, 1992.
SEBI is managed by six members—one chairman
MIBOR AND MIBID (nominated by Central Government), two members
Two New Reference Rates of National Stock (officers of central ministries), one member (from RBI)
Exchange and remaining two members are nominated by Central
On June 15, 1998 National Stock Exchange has Government. The office of SEBI is situated at Mumbai
launched two new Reference Rates for the loans of Inter- with its regional offices at Kolkata, Delhi and Chennai.
Bank Call Money Market. These rates are—M I B O R In 1988 the initial capital of SEBI was R 7·5 crore which
(Mumbai Inter-Bank Offer Rate) and MIBID (Mumbai was provided by its promoters (IDBI, ICICI, IFCI). This
Inter-Bank Bid Rate). amount was invested and with its interest amount day-
MIBOR will be the indicator of Lending Rate for loans to-day expenses of SEBI are met.
while MIBID will be the lending rate for receipts.
Recognised Exchanges
Names of Share Price Indices Changed (Stock & Commodity)
On July 28, 1998, main Share price indices have been 1. Ace Derivatives and Commodity Exchange Limited,
renamed as follows : Mumbai
Old Name New Name 2. Ahmedabad Stock Exchange Ltd.
3. Bombay Stock Exchange Ltd.
NSE—50 S & PCNX Nifty 4. Bombay Commodity Exchange Ltd., Vashi
Crisil 500 S & PCNX—500 5. Calcutta Stock Exchange Ltd.
622U | Economics (NET)
6. Chamber of Commerce, Hapur Depository System in India
7. Cotton Association of India, Mumbai
Depository system, based on non-physical transfer
8. Delhi Stock Exchange Ltd.
of share certificates, was introduced in the country on
9. India Pepper & Spice Trade Association, Kochi
the recommendations of a technical committee. On
10. Indian Commodity Exchange Limited, New Delhi
September 21, 1995 the President of India gave his
11. Magadh Stock Exchange Ltd.
acceptance to Depository Ordinance 1995. This
12. Metropolitan Stock Exchange of India Ltd.
ordinance was passed in Lok Sabha but it could not
13. Multi Commodity Exchange of India Ltd., Mumbai
obtain the acceptance of Rajya Sabha. Again on January
14. National Commodity & Derivatives Exchange Ltd.,
Mumbai 7, 1996, Ordinance was released for second time which
15. National Multi Commodity Exchange of India Limited., cleared all obstacles of establishing depository in India.
Ahmedabad The objective of the depository services is to improve
16. National Stock Exchange of India Ltd. and modernise the market and to enhance the level of
investor protection through eliminating bad deliveries,
17. Rajkot Commodity Exchange Ltd., Rajkot
forgery of shares and expediting the transfer of shares.
18. Spices and Oilseeds Exchange Ltd., Sangli
This is being done through electronic book entry form
19. Universal Commodity Exchange Ltd., Navi Mumbai and scripless trading in stock exchanges thereby
Notes : The Hyderabad Securities and Enterprises Ltd. reducing settlement risk. The salient features of the
(erstwhile Hyderabad Stock Exchange), Coimbatore Stock system are as follows—
Exchange Ltd., Saurashtra Kutch Stock Exchange Ltd. 1. Legal provisions have been made for entry of
Mangalore Stock Exchange, Inter-Connected Stock account details relating to security ownership.
Exchange of India Ltd. Cochin Stock Exchange Ltd.,
Bangalore Stock Exchance Ltd., Ludhiana Stock Exchange 2. Investor can either continue with the existing
Ltd., Gauhati Stock Exchange Ltd., Bhubaneswar Stock share certificate system or opt for depository mode. The
Exchange Ltd., Jaipur Stock Exchange Ltd., OTC Exchange investors opting for depository system will have to get
of India, Pune Stock Exchange Ltd., Madras Stock their registration with any participant in depository.
Exchange Ltd., U.P. Stock Exchange Ltd., Madhya Pradesh These participants will be registered with SEBI.
Stock Exchange Ltd. and Vadodara Stock Exchange Ltd. Generally commercial banks, financial institutions,
have been granted exit by SEBI vide orders dated January custodians of securities and share brokers will work as
25, 2013, April 3, 2013, April 5, 2013, March 3, 2014, participants in depository.
December 08, 2014, December 23, 2014, December 26,
2014, December 30, 2014, January 27, 2015, February 09, 3. Every depository will be registered with SEBI
2015, March 23, 2015, March 31, 2015, April 13, 2015, and will work only after securing certificate to this effect
May 14, 2015, June 09, 2015 and November 09, 2015 from SEBI.
respectively. 4. All payments, transactions and transfer under
depository system will be free from stamp duty.
All statutory powers for regulating Indian capital Similarly, no stamp duty is payable at the time of joining
market are vested with SEBI itself. or leaving depository system.
Functions of SEBI 5. Companies issuing new shares will provide
1. To safeguard the interests of investors and to options to investors for obtaining securities or adopting
regulate capital market with suitable measures. depository system.
2. To regulate the business of stock exchanges and 6. Under depository system, change of ownership
other securities market. will become as electronic book entry transfer.
3. To regulate the working of Stock Brokers, Sub- First & Second Share Depository in the
brokers, Share Transfer Agents, Trustees, Merchant Country
Bankers, Underwriters, Portfolio Managers etc. and
also to make their registration. On November 8, 1996, the first share depository in the
country was established in Mumbai, named as National
4. To register and regulate collective investment plans Securities Depository Limited (NSDL). This depository has
of mutual funds. been established by 3 main financial institutions in the
5. To encourage self-regulatory organisations. country, i.e., UTI, IDBI and National Stock Exchange
(NSE).
6. To eliminate malpractices of security markets. This depository has opened a new chapter of ‘Paperless
7. To train the persons associated with security Trading’ of securities in the country. Under this system the
markets and also to encourage investors’ education. delivery of securities will not be necessary between buyers
8. To check insider trading of securities. and sellers of securities but mechanised system in depository
will insure the change in the name of security holder.
9. To supervise the working of various organisations In February 1998, the second depository named
trading in security market and also to ensure ‘Central Depository Services India Ltd. (CDSL)’ has started
systematic dealings. its functioning. CDSL has been sponsored by BSE, Bank of
10. To promote research and investigations for ensuring India, Bank of Baroda, S B I and HDFC Bank. CDSL got
the attainment of above objectives. registered with SEBI on August 19, 1998.
Economics (NET) | 623U
Financial Assistance Sanctioned and Disbursed by Financial Institutions
Institutions 2016-17 2017-18 2018-19 (April-
Sept.)
S D S D S D
A. All India Financial Institutions (1 to 4) 3,895 3,137 4,314 3,928 2,759 2,137
1. NABARD 2,401 1,977 2,184 2,227 1,885 1,150
2. SIDBI@ 406 395 595 591 523 563
3. EXIM Bank 709 531 1,086 826 243 368
4. NHB** 379 234 449 285 108 56
B. Specialised Financial Institutions (5, 6 and 7) 14 9 15 9 6 2
5. IVCF 3 2 1 1 0 0
6. ICICI venture — — — — — —
7. TFCI 12 7 15 9 6 2
C. Investment Institutions (8 and 9) 687 337 862 638 147 127
8. LIC 687 337 862 638 147 127
9. GIC 0 0 0 0 0 0
D. Financial Institutions (A + B + C) 4,597 3,483 5,191 4,575 2,913 2,265
E. Total Assistance by All Financial Institutions (D + E) 4,597 3,483 5,191 4,575 2,913 2,265
S : Sanctions, D : Disbursements
Reforms in Insurance Sector
Insurance Sector constitutes an important segment of financial market in India and plays a predominant role in the
formation of capital in the country. The reforms in the insurance sector started with the enactment of Insurance Regulatory and
Development Authority Act, 1999. The Act paved the way for the entry of private insurance companies into the insurance
market and also constitution of Insurance Regulatory and Development Authority (IRDA).
Insurance Regulatory and Development Authority
The Insurance Regulatory and Development Authority (IRDA) was constituted on April 19, 2000 to protect the interest of
the holders of insurance policies and to regulate, promote and ensure orderly growth of the insurance industry. The authority
consists of a Chairperson, three whole-time Members and four part-time Members.
For regulating the insurance sector, the Authority has been issuing regulations covering almost the entire segment of
insurance industry, namely, regulation on insurance agents, solvency margin, re-insurance, registration of insurers, obligation
of insurers to rural and social sector, accounting procedure, etc.
Insurance (Amendment) Act, 2002—The Government, functioning of the opened up insurance sector, has enacted
Insurance (Amendment) Act, 2002. The Act relates to introduction of brokers as intermediaries, allowing more flexibility in the
eligibility qualifications for corporate agents, allowing more flexible mode of payment of premium through credit cards, smart
cards, over internet, etc., change in the allocation of surplus between shareholders and policy holders, direct entry of co-
operatives in the insurance sector and some other consequential amendments which are of a technical nature for the smooth
functioning of the opened up sector.
General Insurance Business (Nationalisation) Amendment Act, 2002—With the enactment of IRDA Act, 1999 it was
necessary to nominate Indian Re-insurer under Insurance Act, 1938. The Government decided that General Insurance
Corporation (GIC) which was a holding company of four public sector insurance companies, should be declared as Indian Re-
insurer. Since under the Act, a Re-insurer cannot underwrite general insurance business, it has been decided to re-transfer the
holding of GIC to the Government. To achieve these objectives, the Government has enacted General Insurance Business
(Nationalisation) Amendment Act, 2002.
Insurance Penetration
Insurance Penetration and Insurance Density are two important indicators of the potential and performance of the
insurance sector. Insurance penetration is defined as the ratio of premium underwritten in a given year to the gross domestic
product (GDP), while insurance density is measured as the ratio of premium underwritten in a given year to the total
population. The insurance penetration in India in 2000 was 2·32 which has increased to 4·60. The life insurance penetration in
India increased from 1·77 per cent in 2000 to 5·1 (life 4·4 and non-life 0·7) in 2010.
624U | Economics (NET)
Introduction of New Series of CPI (R + U)
The Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation has introduced a
new CPI series on base 2010 = 100 for All-India and States/ Union Territories (UTs) separately for rural, urban and
combined with effect from January 2011. CPI (Urban) covers 310 towns while CPI (Rural) covers 1,181 villages
\
across the country. The weighting diagrams for the new CPI series have been derived on the basis of average
monthly consumer expenditure of an urban/rural household obtained from the NSS 61st round Consumer Ex-
penditure Survey Data (2004-05). The year-on-year inflation for CPI-CSO (Urban), CPI-CSO (Rural) and CPI-CSO
(Combined) was 8·25 per cent, 7·38 per cent and 7·65 per cent respectively in January 2012. While a strict
comparison is not possible and the new series is yet to be tested over time, the inflation rate for January 2012 with
CPI-CSO (Rural) (7·38 per cent) is reported to be higher than with CPI-Labour Bureau (Rural Labour) (5·27 per
cent)—due to differences in coverage and weighting (consumption) patterns. The weighting pattern for CPI-Labour
Bureau (Rural Labour) is based on 1983 NSS consumer expenditure survey as compared to the use of 2004-05
consumer expenditure survey for CPI-CSO (Rural).
Comparison of weighing diagrams of old and revised series of Consumer Price Index
Old series of CPI Revised Series of CPI
(Base CES 2004-05) (Base CES 2011-12)
Groups
Rural Urban Combined Rural Urban Combined
Food and Beverages 56.59 35.81 47.58 54.18 36.29 45.86
Pan, Tobacco and Intoxicants 2.72 1.34 2.13 3.26 1.36 2.38
Clothing and Foot-wear 5.36 3.91 4.73 7.36 5.57 6.53
Housing — 22.54 9.77 — 21.67 10.07
Fuel and Light 10.42 8.40 9.49 7.94 5.58 6.84
Miscellaneous 24.91 28.00 26.31 27.26 29.53 28.32
Total 100.00 100.00 100.00 100.00 100.00 100.00
Base Year of Wholesale Price Index Changed to 2011-12
The new series of Wholesale Price Index (WPI) with 2011-12 as its base year has replaced the series with base year 2004-
05 with effect from 12 May, 2017. The number of commodities included in the new series stands at 697 while it was only 676 in
old series with base year 2004-05. In total included 697 commodities, the members of primary articles, fuel and power and
manufactured products stand at 117, 16 and 564 respectively.
Base Year ♦1970-71 1981-82 1993-94 2004-05 2011-12
Number of Commodities
Primary Articles 80 93 98 102 117
Fuel and Power 10 20 19 19 16
Manufactured Products 270 334 318 555 564
All Commodities 360 447 435 676 697
Number of Price Quotations
Primary Articles 411 519 455 579 983
Fuel and Power 30 73 72 72 442
Manufactured Products 854 1779 1391 4831 6906
All Commodities 1295 2371 1918 5482 8331
Relative Weight in WPI
Primary Articles 41·667 32·295 22·025 20·118 22·62
Fuel and Power 8·459 10·663 14·226 14·910 13·15
Manufactured Products 49·874 57·042 63·749 64·972 64·23
All Commodities 100 100 100 100 100·00
O/o Economic Adviser, Deptt. of Ind. Policy and Promotion. PTI Graphics
Economics (NET) | 625U
CPI Basket Weights Revised, Base based on goods and services may be compiled and
released once the coverage of service sector indices
Year Changed from 2010 to 2012 is adequate and the sector-wise indices are robust
The government of India has revised the base year and stable.
of the All India Consumer Price, Index series from (ii) Two separate sets of input PPIs may be compiled -
2010:100 to 2012:100 starting with the January 2015 one including services and the other excluding
reading. The first date based on the revised series was services.
released on February 12, 2015. The weights of the sub-
components within the new CPI basket are based on the (iii) An additional set of output PPI based on Final
Consumer Expenditure Survey (CES) of 2011-12, Demand and Intermediate Demand framework may
against the old/current basket individual weights based also be compiled for the benefit of the users.
on CES of 2004-05. (iv) The PPIs may be initially compiled on an
These changes reflect the falling share of household experimental basis and switching over from WPI to
expenditure on food and the rising share of the non-food PPI should be under-taken after the PPI series
items. In addition, the number of items has also been stabilizes and due consultation with the stake-
increase from 437 to 448 in the rural basket and from holders is done.
450 to 460 in the urban basket. (v) For compilation of experimental PPI, price
Compared with the old basket, the weights of the quotations collected for current series of WPI may
food and fuel groups have been reduced in the new be used.
basket. Meanwhile, the weights of the miscellaneous and (vi) The experimental PPI will be released on monthly
clothing, bedding and footwear groups have been basis. Initially, the base year of the experimental
increased. With these changes, the weight of the Core PPI would be 2011-12.
group (CPI ex-food and fuel) will rise to 47.3% from (vii) The Working Group recommended inclusion of 15
42.9% earlier. services in the PPI basket to begin with. The
coverage of service sector may be extended to all
Producer Price Index key sectors on an urgent basis during the
The Government had set up a Working Group under experimental phases of PPI.
the Chairmanship of Professor B. N. Goldar o n 21st The Producer Price Index (PPI) measures the
August, 2014 to suggest the methodology for average change in the prices of goods and services,
introducing Producer Price Index (PPI) in India. The either as they leave the place of production called
Working Group submitted its report on 31.08.2017. The Output PPI or as they enter the production process called
major recommendations of the Working Group on Input PPI. Thus, the output indices measure the average
Producer Price Index are as follows : change in prices that producers receive for their outputs
(i) PPI in India may be compiled based on Supply Use while the input indices measure the average change in
Table 2011-12 using Total Final Use values for prices that producers pay for their inputs. PPI contrasts
higher level weights. Initially indices based on with other measures such as the Consumer Price Index
Total Final Use weights should be compiled (CPI) which measures changes in prices from buyers or
separately for goods and services. Aggregate index consumers perspective.
WPI Vs. CPI
Composition of the Indicators
Title CPI-IW CPI-AL CPI-RL WPI CPI*
Base 2001 1986-87 1986-87 2011-12 2012
Lag** 1 month 18 days 18 days 14 days 18 days
Elementary items 320 260 260 697 200 weighted
items#
Weight of food products (%) 48·47 69·15 66·77 22·62 45·86
(Primary articles)
Weight of energy products (%) 7·43 8·35 7·9 13·15 6·84
Weight of miscellaneous items, which 23·26 11·73 11·87 Services not included 28·32
primarily include services (%)
No. of collection centres 78 Urban 600 Rural 600Rural Centralised collection 1181 Villages and
310 Towns
Note : Weights do not include all categories.
* The new CPI comprises Consumer Price Index for urban areas, rural areas and a combination of both. It has Pan, Tobacco
& Intoxicants (2·38%) and Clothing (6·53%) and Housing (10·07)
** Days since the end of the reference month.
# Weighted items have various varieties within each item depending on usage in a particular state.
626U | Economics (NET)
Money Stock Measures in India by providing them incomegenerating assets through a
mix of bank credit and government subsidy. The SGSY
During planning era, money supply has been now restructured as the NRLM has been renamed
increasing continuously with the rise in prices, though Aajeevika and implemented in mission mode across the
the increase rate in money supply has varied from year countr since 2011. The main features of Aajeevika are :
to year. (a) One woman member from each identified rural poor
On the recommendations of the second working household to be brought under the S H G network, (b)
group on money supply, RBI introduced a series of Ensuring 50 per cent of the beneficiaries from SC/STs,
money stock measures in India since 1970-71 which are 15 per cent from minorities, and 3 per cent persons with
as follows— disability while keeping in view the ultimate target of
(1) M1 ♦ Money with the Public (currency notes 100 per cent coverage of BPL families, (c) Training for
and coins) + Demand deposits of banks (on current capacity building and skill development, (d) Ensuring
and saving bank accounts) + Other demand deposits revolving fund and capital subsidy, (e) Financial
with RBI. inclusion, (f) Provision of interest subsidy, (g) Backward
(2) M 2 ♦ M1 + Saving bank deposits with Post- and forward linkages, and (h) Promoting innovations.
offices. In November 2015, the programme was renamed as
(3) M 3 ♦ M1 + Term deposits with the bank. Deendayal Antyodaya Yojana—NRLM. For diversifying
(4) M 4 ♦ M3 + All deposits of Post-offices. livelihoods the Deendayal Antyodaya Yojna-National
Rural Livelihood Mission has successfully brought more
M1 measure represents the most liquid form of than 4.5 crore women into the fold of SHGs. Through
money among four money stock measures adopted by capacity development and skill training, the Bank linka-
RBI. As we proceed from M1 to M 4 the liquidity gets ges for economic activities have expanded considerably
reduced. In other words, M 4 possesses the lowest in the last few years. From Bank linkages of R 23,953
liquidity among all these measures. The decline in crore in 2014-15 the current outstanding loans stands at
liquidity indicates the shifting from ‘medium of nearly R 60,000 crores. Women SHGs in Northern,
exchange’ to ‘store of value’. All these four money stock Eastern and North-Eastern States are also diversifying
measures are not of equal importance. Their relative livelihoods like the SHGs in Southern States did over
importance varies from the point of view of monetary the last few decades. This facilitates poor households
policy. Generally, in developed countries, the bank coming out of poverty by increasing productivity assets
deposits are the most important component in money and incomes. Work with over 32 lakh women farmers is
supply, while due to less banking habits in under- also going on for sustainable agriculture moving towards
developed countries people want to keep their money in development of 1000 organic clusters. DAY-NRLM and
the most liquid form, i.e., currency. MGNREGS along with Ministry of Agriculture will
M3 is the most important component among all provide support for developing market infrastructure for
money stock measures which is generally termed as these women SHGs, Producer Groups and Producer
‘Broad money’. Companies.
Development, Poverty Alleviation and Mahatma Gandhi National Rural
Employment Guarantee Scheme
Employment Generation (MGNREGS)
Programmes in India After the notification of the National Rural
Deendayal Antyodaya Yojana—NRLM Employment Guarantee Act on September 7, 2005, a
Union government has launched ‘National Rural new scheme named 'National Rural Employment
Livelihood Mission’ with the aim to eliminate poverty Guarantee Scheme (NREGS)' (which later on the Act
in rural areas. Mrs. Sonia Gandhi on June 3, 2011 changed with the name Mahatma Gandhi National
launched this Mission from Banswada District of Rural Employment Guarantee Act) has been launched
Rajasthan. Under this mission, Self-help Groups (SHGs) on February 2, 2006. The ongoing programmes of
at the village level is constituted in the form of Sampoorna Grameen Rozgar Yojana (SGRY) and
federation and these SHGs provide beneficial self- National Food for Work Programme (NFFWP) were
employment opportunities to the rural people for subsumed within the NREGS in the 200 districts
ensuring better and stable livelihood. The new mission identified in the initial stage. Implemented by the
gives focus on women, scheduled caste/scheduled tribes, Ministry of Rural Development, National Rural
minorities and disabled people. The mission proposes to Employment Guarantee Act (NREGA) is a flagship
include atleast one woman member of the identified programme of the government that directly touches lives
poor family in Self-help Group. of the poor and promotes inclusive growth.
Swarnjayanti Gram Swarozgar Yojana (SGSY) was The salient features of MGNREGA are as follows :
the precursor of NRLM a self-employment programme ● Right based Framework : For adult members of a
implemented since April 1999 aims at lifting the assisted rural house-hold willing to do unskilled manual
rural poor families (swarozgaris) above the poverty line work.
Economics (NET) | 627U
● Time bound Guarantee : 15 days for provision of release for the programme from R 32,977 crore in
employment, else unemployment allowance. financial year 2014-15 to R 55,167 crore in the
● Guaranteed Employment : Upto 100 days of financial year 2017-18. This is a clear evidence of
guaranteed wage employment in a financial year per the increasing faith of the people in the programme.
household, depending on the actual demand. The MGNREGS witnessed a record expenditure of
● Labour Intensive Works : 60 : 40 wage and R 63,644 crore in 2017-18 including state share, the
highest since the programme was launched. This
material ratio for permissible works at the Gram year is going to be even higher.
Panchayat, no contractors/machinery.
● The issue of creation of durable assets was very
● Decentralized Planning
important. The 60 : 40 ratio was mandated at Gram
* Gram Sabhas to recommend works. Panchayat level often leading to non-productive
* At least 50% of works by Gram Panchayats for asset being created simply because 60% had to be
execution. spent on unskilled wage labour in that Gram
* Principal role of PRIs in planning, monitoring Panchayat.
and implementation. ● On account of reforms, it was possible to take up
● Work site facilities : Creche, drinking water, first pro-poor public infrastructure like Aanganwadi
aid and shade provided at worksites. Buildings under the MGNREGS. The linkage of
● Women empowerment : Priority shall be given to MGNREGS with women SHGs, infrastructure for
women in such a way that at least one third of the Deen Dayal Antyodaya Yojana-National Rural
beneficiaries shall be women who have registered Livelihood Mission (DAYNRLM) activities has
and requested for work under this Act. also supplemented incomes of very poor
● Transparency & Accountability : Proactive dis- households. The skill development opportunities for
closure through Social Audit Grievance Redressal MGNREGS workers to become certified rural
Mechanism. masons, barefoot technicians or in other skill
programme of Deen Dayal Upadhyaya Grameen
● Funding : 90% borne by Central Government and
Kaushalya Yojana (DDUGKY) and Rural Self
10% by State Government.
Employment Training Institutes (RSETIs) makes a
The Act came into force on February 2, 2006 and difference to poverty in the long run.
was implemented in a phased manner. In Phase one it
was introduced in 200 of the most backward districts of ● In its provision for work for the disabled and for
the country. The MGNREGS is in operation in all 682 women, MGNREGS has only improved further in
districts 6861 Blocks and 262273 Gram Panchayats o f the recent years where more than half the workforce
the country as on January 16, 2019. 12·94 crore job is women and over 4 lakh disabled persons get work
cards have been issued till Jan. 16, 2019. 2730 crore every year.
workers have been benefited with a cumulative ● The generation of payment within 15 days has
expenditure of R 500616 crore under this programme moved up from 26 per cent in 2014-15 to 91 per
since its inception. cent in 2018-19.
The Government of India has allocated an
additional R 6,084 crore at RE stage to MGNREGA. Pradhan Mantri Gram Sadak Yojana
This brings the total allocation to the scheme to R 61,084 (PMGSY)
crore in 2018-19, making it the highest ever allocation. Pradhan Mantri Gram Sadak Yojana (PMGSY), a
Governance reforms and thrust on sustainable 100 per cent centrally sponsored scheme was launched
livelihoods through durable assets has ensured better on December 25, 2000. The prime objective of the
lives for the poor through wages, incomes and durable PMGSY was, to provide connectivity to all Unconnected
assets. habitations in the rural areas having population of more
● The first and foremost requirement was to ensure than 500 persons, through goods all-weather roads. In
full transparency in wage payments, asset creation, respect of the Hill States (North-East, Sikkim, Himachal
and payment for materials. It is for this reason that Pradesh, Jammu and Kashmir and Uttarakhand), Desert
efforts were started for a 100% of geotagging of Areas and Tribal (Schedule-V) Areas, the objective is to
assets. AADHAAR linking of Bank Accounts, connect habitations with a population of 250 persons and
IT/DBT transfers for all wages, and material above.
payments and Geographic Information System The PMGSY set out to provide all weather road
(GIS) based planning of works. As on 08.01.19, connectivity to 1,78,184 habitations of 500 population in
GeoMGNREGA is implemented in 31 States/UTs plain areas and 250 population in hilly areas. As of
and 3·40 crore works out of 4·08 crore completed March, 2014, 97838 habitations (55%) were connected.
works since inception of the programme, are already As on January1, 2018, 1,30,947 habitations stand
geotagged and are in public domain. connected under PMGSY and another 14,620 through
● There has been a remarkable increasing trend in the State Governments’ programmes bringing the total
budget allocation of the Central Government and habitations connected to 82%. In 2016-17, a total of
628U | Economics (NET)
47,447 kms roads were constructed at a speed of 130 governments must also put in place an internal
kms per day. Efforts are being made to take this to grievance redressal mechanism which may include
51,000 kms at a speed of 140 kms per day in 2017-18. call centres, help lines, etc.
This will enable achievement of completed all weather ● Mandatory transparency provisions include : (1)
road connectivity to all the eligible habitations by placing all PDS-related records in the public
March, 2019. This will further strengthen Phase-II domain; (2) conducting periodic social audits of the
which is already under implementation. 1,10,000 PDS and other welfare schemes; (3) using
kilometers of upgradation is proposed as PMGSY-III. information and communication technology ‘to
To do so, annual funding support of R 19,000 crore will ensure transparent recording of transactions at all
be maintained, from the Central Government upto 2022. levels’; (4) setting up vigilance committees at all
levels to supervise all schemes under the Act.
National Food Security Scheme-2013
● The Food Commissions have powers to impose
The National Food Security Scheme has finally penalties. If an order of the DGRO is not complied
launched on August 2013, the birth anniversary of late with, the concerned authority or officer can be fined
Prime Minister Rajiv Gandhi, in NCR Delhi, Haryana up to R 5,000.
and Uttarakhand. The scheme has been launched through
The National Food Security Ordinance, 2013 ● The main obligation of the Central Government is to
promulgated by the President of India on July 3, 2013. provide foodgrains (or, failing that, funds) to state
This is a step towards the goal of ‘Food for All’. The governments, at prices specified in Schedule I, to
Lok Sabha and Rajya Sabha passed the bill on August implement the main entitlements. The Central
28 and September 3, 2013 respectively. The salient Government has wide-ranging powers to make
features of the NFS Act are the following— Rules ‘in consultation with the state government’.
● The Act extends to the whole of India and ‘shall be ● The main obligation of state governments is to
deemed to have come into force on the 5th day o f implement the relevant schemes, in accordance with
July 2013’. [NB : This is the date when the National the Central Government guidelines. State govern-
Food Security Ordinance 2013 came into force.] ments also have wide-ranging powers to make Rules.
They are free to extend benefits and entitlements
● Priority households are entitled to 5 kgs of beyond what is prescribed in the Bill, from their
foodgrains per person per month, and Antyodaya own resources.
households to 35 kgs per household per month. The
● Local Authorities and Panchayati Raj Institutions
combined coverage of Priority and Antyodaya
households (called ‘eligible households’) shall are responsible for proper implementation of the
extend ‘up to 75% of the rural population and up to Bill in their respective areas, and may be given
50% of the urban population’. The PDS issue prices additional responsibilities by notification.
will be 3/kg for rice, 2/kg for wheat and 1/kg for Deen Dayal Antyodaya : National
coarse cereals. These may be revised after three
years. Urban Livelihoods Mission (DAY-
● For children in the age group of 6 months to 6 years NULM)
: an ageappropriate meal, free of charge, through the Ministry of Housing and Urban Poverty Alleviation,
local anganwadi. For children aged 6-14 years, one restructured the Swarna Jayanti Shahari Rojgar Yojana
free Mid-Day Meal every day (except on school (SJSRY), which was in operation since December 1,
holidays) in all government and government-aided 1997 in all urban and semi-urban towns of the country,
shools, up to Class VIII. For children below six and launched the National Urban Livelihoods Mission
months, 'exclusive breastfeeding shall be promoted'. (NULM) in 2013. NULM has been under implementa-
For children who suffer from malnutrition, meals tion w.e.f. September 24, 2013 in all district headquarters
will be provided to them free of charge ‘through the and all the cities with population of one lakh or more.
local anganwadi’. SJSRY was allowed to continue till March 31, 2014.
● Every pregnant and lactating mother is entitled to a Self-Employment Programme (SEP) is one of the
components of NULM which focuses on providing
free meal at the local anganwadi (during pregnancy
financial assistance through a provision of interest
and six months after child birth) as well as
subsidy on loans to support establishment of individual
maternity benefits of 6,000, in installments.
and Group Enterprises and self-help groups of urban
● The NFS Act provides for the creation of State Food poor. Components of NULM are following—
Commissions. The main function of the State ● Social mobilisation and institutions development.
Commission is to monitor the implementation of the
● Capacity Building and Training.
Act, give advice to the states governments and their
agencies, and inquire into violations of entitlements. ● Employment Through Skills Training and
● The Act provides for a two-tier grievance redressal Placement.
structure, involving the District Grievance Redressal ● Self-Employment Programme.
Officer (DGRO) and State Food Commission. State ● Support to Street Vendors.
Economics (NET) | 629U
Various Women-oriented Schemes of highly subsidised rates of R 1/2/3 per kg for coarse
grains/wheat/rice respectively.
State Governments
1. Panchdhara Yojana—Madhya Pradesh Govern- National Rural Health Mission
ment's Scheme was launched on November 1, 1991 for rural (NRHM)
and tribal women which includes following five Schemes —
(i) Vatsalya Yojana—For health care and The National Rural Health Mission (NRHM) was
facilities at the time of delivery of a child. launched on 12th April, 2005, to provide accessible,
(ii) Gramya Yojana—For providing working affordable and accountable quality health services even
capital to rural women for small trade. to the poorest households in the remote rural regions.
(iii) Aayushmati Yojana—Govt. subsidy is The difficult areas with unsatisfactory health indicators
provided for medical treatment to the poorest women. were classified as special focus States to ensure greatest
(iv) Social Security Pension Scheme—For orphan attention where needed. The thrust of the Mission was
widows. on establishing a fully functional, community owned,
decentralized health delivery system with inter-sectoral
(v) Kalpavraksha (d`Yio~ ” ‚ Scheme—For providing
convergence at all levels, to ensure simultaneous action
employment to SC/ST women in tribal areas.
on a wide range of determinants of health like water,
2. Apni Beti Apna Dhan Yojana (viuh csVh viuk |u sanitation, education, nutrition, social and gender
;kstuk)—Haryana Government's Scheme was launched equality. Institutional integration within the fragmented
on October 2, 1994 under which an investment of R 2,500 is health sector was expected to provide a focus on
made by the Government in Indira Vikas Patra for newly outcomes, measured against Indian Public Health
born female child in SC/ST families which becomes Standards for all health facilities. From narrowly defined
R 25,000 after 18 years and given to the concerned girl. schemes, the NRHM shifted focus to a functional health
3. Kunwar Bainu Mamerun (dq∑`oj ckbuqa ekesÔ∑‚ system at all levels, from the village to the district.
Scheme—Gujarat Govt.'s Scheme was launched in 1995 in NRHM is being operationalized throughout the
which an assistance of R 5,000 is provided to families country with special focus on 18 states which includes 8
having annual income of less than R 7,500 at the time of
Empowered Action Group States (Bihar, Jharkhand,
their daughter’s marriage.
Madhya Pradesh, Chhattisgarh, Uttar Pradesh,
4. Kamdhenu Yojana—Maharashtra Govern-ment's
Uttarakhand, Odisha and Rajasthan), 8 NE states,
Scheme provides the financial opportunities of self-
employment to disabled, divorced women. Himachal Pradesh, Jammu & Kashmir.
5. Girl Child Protection Scheme—Andhra Pradesh Among major innovations of the NRHM are
Government's Scheme aims at protecting the interest of girl creation of a cadre of Accredited Social Health Activists
child in the society. (ASHA) and improved hospital care, decentralisation at
district level to improve intra and intersectoral
GoI, on February 20, 2016 renamed NULM as Deen
convergence and effective utilisation of resources
Dayal Antyodaya Yojana—NULM and extended its
through NGOs and community in general.
coverage to all 4041 statutory urban local bodies in the
Under NRHM, over 1·4 lakh health human
country. The scheme is also known as, ¸nhun;k¥ vUR;ksn; resources have been added to the health system across
;kstuk%jkÆV_h; ægjh vkthfod`k feæu\π the country (upto September 2012). Accredited Social
Health Activists (ASHAs) have been engaged in each
Antyodaya Anna Yojana (AAY) village in the ratio one per 1000 population.
In order to make TPDS more focused and targeted
towards the poorest section of population, the
National Urban Health Mission
‘Antyodaya Anna Yojana’ (AAY) was launched in (NUHM)
December 2000 for one crore poor families. Initially The Union Cabinet on May 1, 2013 approved the
AAY contemplated identification of one crore poorest of 22,507 crore National Urban Health Mission (NUHM)
the poor families from amongst the BPL families that seeks to address healthcare challenges in towns and
covered under TPDS within the States and providing cities with focus on urban poor. The scheme will now be
them foodgrains at a highly subsidised rate of 2 per kg introduced as a submission under the National Health
for wheat and 3 per kg for rice. The States/UTs are Mission (NHM). The mission will be implemented in
required to bear the distribution, cost, including margin 779 cities and towns, each with a population of more
to dealers and retailers as well as the transportation cost. than 50,000 and cover over 7·75 crore people.
Thus the entire food subsidy is being passed on to the The Objectives of NUHM—
consumers under the scheme. (i) To improve the health status of the urban population
The scale of issue that was initially 25 kg per family in general, and the poor and other dis-advantaged
per month has been increased to 35 kg per family per sections in particular, by facilitating equitable
month with effect from 1st April, 2002. AAY is now a access to quality healthcare through a revamped
component of National Food Security Act, 2013 (NFSA), primary public healthcare system.
which provides for coverage of 75% of the rural and (ii) Targeted outreach services and involvement of the
50% of the urban population for receiving foodgrains at community and urban local bodies.
630U | Economics (NET)
(iii) Reduction in the Infant Mortality Rate (IMR) and to NSAP schemes, which is 38% more than the budget
the Maternal Mortality Ratio (MMR). allocation of 2014-15 which stood at R 7241 crore. An
(iv) Universal access to reproductive health care, and amount of R 8696 crore has been released to States/UTs
under NSAP during 2017-18, which is 23% more than
(v) The convergence of all health-related interventions.
the releases of 2014-15.
The key highlights of NUHM are the following :
At present, NSAP comprises the following schemes :
● The NUHM will be on the lines of the Health and
1. Indira Gandhi National Old Age Pension Scheme
Family Welfare Ministry’s flagship National Rural
(IGNOAPS) : Under the scheme, BPL, pensions in
Health Mission (NRHM) launched in 2005 to
the age group of 60-79 years are entitled to a monthly
address the health challenges of rural India.
pension of R 400 and BPL persons of age of 80 years
● One Urban Primary Health Centre for a population and above are entitled to a monthly pension of R 500.
of 50,000-60,000, one Urban Community Health
2. Indira Gandhi National Widows Pension Scheme
Centre for five to six urban Primary Health Centres
(IGNWPS) : BPL widows aged 40–59 years are
will be set up in big cities.
entitled to a monthly pension of R 300.
● An Auxiliary Nursing Midwives (ANM) for a
3. Indira Gandhi National Disability Pension
population o f 10,000 and an Accredited Social
Scheme (IGNDPS) : BPL pensions aged 18-59 years
Health Activist (ASHA) (community link worker)
with severe and multiple disabilities are entitled to a
for 200 to 500 households.
monthly pension of R 300.
● The Central government is to provide a share of
4. National Family Benefit Scheme (NFBS) : Under
R 16,955 crore toward the estimated cost of NUHM the scheme a BPL household is entitled to lump sum
for five years R 22,507 crore.
amount of money on the death of the primary
● While the Centre will fund 75 per cent of the breadwinner aged between 18 and 64 years. The
mission and the State 25 per cent, the funding ratio amount of assistance is R 20,000.
for North Eastern States and special category States
5. Annapurna : Under the scheme, 10 kg of foodgrains
of Jammu and Kashmir, Himachal Pradesh and
per month are provided free of cost to those senior
Uttarakhand will be 90 : 10.
citizens who, though eligible, are not receiving old
National Social Assistance age pension.
Programme Programmes for Agriculture and Rural
The National Social Assistance Programme (NSAP) Development
which came into effect from 15th August, 1995 1. Community Development Programme 1952
represents a significant step towards the fulfilment of the (CDP)
Directive Principles in Article 41 of the Constitution. 2. Intensive Agriculture Development 1960-61
The programme introduced a National Policy for Social Programme (IADP)
Assistance for the poor and aims at ensuring minimum 3. Intensive Agriculture Area Programme 1964-65
national standard for social assistance in addition to the (IAAP)
benefits that states are currently providing or might 4. Green Revolution (High Yielding Variety 1966-67
provide in future. NSAP at present, comprises of Indira Programme) (HYVP)
Gandhi National Old Age Pension Scheme (IGNOAPS), 5. Rural Electrification Programme (REP) 1969
Indira Gandhi National Widow Pension Scheme 6. Scheme of Discriminatory Interest Rate 1972
(IGNWPS), Indira Gandhi National Disability Pension
Scheme (IGNDPS), National Family Benefit Scheme 7. Accelerated Rural Water Supply Programme 1972-73
(ARWSP)
(NFBS) and Annapurna.
8. Prime Minister’s Twenty Point Programme 1975
Under the National Social Assistance Programme
Government is committed towards extending direct 9. Desert Development Programme (DDP) 1977-78
transfers to over 30 million old age, widow and 10. National Fund for Rural Development 1984
differently abled beneficiaries belonging to below (NFRD)
poverty line families. The cash transfers being facilitated 11. National Drinking Water Mission (NDWM) 1986
under the National Social Assistance Programme are an 12. Agriculture and Rural Debt Relief Scheme 1990
important subset of overall social security net including (ARDRS)
food security and health insurance extended by the 13. Rajeev Gandhi Grameen Vidyutikaran 2005
Government to families facing deprivation. Yojana (RGGVY)
Ever since the strategic decision to bring the NSAP 14. National Horticulture Mission 2005-06
scheme within the umbrella of ‘Core and Core’ scheme 15. Bharat Nirman 2005-06
in 2016, the financial commitment towards meeting the 16. National Food Security Mission 2007-08
100% requirement of the scheme by the Central
17. Rashtriya Krishi Vikas Yojana 2007-08
Government is continuously increasing. For the year
2018-19, an amount of R 9975 crore has been allocated 18. National Mission for Sustainable Agriculture XII Plan
Economics (NET) | 631U
Rural Wage Employment Programmes Programme for Poverty Alleviation and
1. Rural Manpower Programme (RMP) 1960-61 Employment Generation in Urban Areas
2. Crash Scheme for Rural Employment 1971-72 1. Self Employment Programme for the Urban 1986
(CRSE) (Prime Minister’s Crash Programme) Poor (SEPUP)
3. Food for Work Programme (FWP) 1977-78 2. Nehru Rojgar Yojana (NRY) 1989
4. National Rural Employment Programme October 3. Scheme for Urban Micro Enterprises 1990
(NREP) 2, 1980 (SUME)
5. Rural Landless Employment Gurantee Aug. 15, 4. Scheme for Urban Wage Employment 1990
Programme (RLEGP) 1983 (SUWE)
6. Employment Assurance Scheme (EASY) October 5. Scheme for Housing and Shelter Upgrada- 1990
2, 1993 tion
7. Jawahar Rojgar Yojana April 1, 6. Scheme for Infrastructural Development of 1994
1989 Mega Cities (SIDMC)
8. Jawahar Gram Samridhi Yojana (JGSY) 1999- 7. Prime Minister’s Integrated Urban Poverty 1995
2000 Eradication Programme (PMIUPEP)
9. Sampoorna Grameen Rojgar Yojana (SGRY) 2001-02 8. Swarn Jayanti Shahari Rojgar Yojana 1997
(SJSRY)
10. Pradhan Mantri Gramodaya Yojana (PMGY) 2000
9. Valmiki Ambedkar Awas Yojana Decem-
11. National Food For Work Programme 2005 (VAMBAY) ber 2001
(NFFWP) 10. Rajeev Awas Yojana (RAY) 2009
12. Mahatma Gandhi National Rural Employ- 2005-06 11. National Urban Livelihood Mission 2013-14
ment Gurantee Scheme (MNREGA)
Rural Poverty Alleviation Programme
Latest Schemes/Programmes of
Central Government
1. Marginal Farmers and Agricultural 1969
Labourers Scheme (MFAL) Schemes / Programmes Related with
2. Small Farmers Development Agency 1971 Banking and Insurance
(SFDA)
3. Training of Rural Youth for Self Employ- 1979-80
Pradhan Mantri Jan Dhan Yojana
ment (TRYSEM) (Aug. 15,
(PMJDY)
1979) Launched : August 28, 2014.
4. Integrated Rural Development Programme 1980-81 Main Objective : Financial inclusion and access to
(IRDP) (Oct. 2, financial services for all households in the country.
1980) Pradhan Mantri Jan Dhan Yojana (PMJDY), one of
5. Development of Women and Children in 1982 the biggest initiative of financial inclusion in the world,
Rural Arears (DWCRA) is a national mission to bring comprehensive financial
6. National Social Assistance Programme inclusion of all the households in the country. Under the
(i) Indira Gandhi National Old Age PMJDY, any individual above the age of 10 years and
Pension Scheme (NGOAPS) 1995 does not have a bank account can open a bank account
(ii) Indira Gandhi National Widow Pension without depositing any money.
Scheme (IGNWPS) 1995 The scheme was to ensure the access to financial
(iii) Indira Gandhi National Disability services such as banking/savings & deposit Accounts,
Pension Scheme (IGNDPS) 1995 remittance, credit, debit cards, insurance and pension in
(iv) National Family Benefit Scheme affordable manner. The scheme was mostly targeted to
(NFBS) 1995 the people belonging to the Below Poverty Line but is
7. Ganga Kalyan Yojana 1997-98 beneficial to everyone who does not have a bank account.
8. Supply of Improved Toolkits to Rural 1998-99 The government on September 5, 2018 decided to
Artisans (SITRA) make the Pradhan Mantri Jan Dhan Yojana (PMJDY) an
9. Bhagyashree Bal Kalyan Yojana (BBKY) 1998 open-ended scheme and added more incentives to
10. Annapurna Yojana March encourage people to open bank accounts.
1999 ● Jah Dhan Yojana is now an open ended scheme.
11. Swarn Jayanti Gram Swarojgar Yojana April ● The over-draft limit for account holders has now
been doubled to R 10,000. There will be no
1999
12. Antyodaya Anna Yojana (AAY) Dec. 25, conditions attached for overdraft of up to R 2,000.
2000
● The free accident insurance cover for those opening
13. Janani Suraksha Yojana (JSY) 2005 Jan Dhan accounts after August 28, 2018 too has
14. Aam Admi Bima Yojana (AABY) 2007 been doubled to R 2 lakh. Also, the upper age limit
15. National Rural Livelihood Mission June for availing the facility has been hiked to 65 from
2011 the earlier 60 years.
632U | Economics (NET)
● As on August 29, 2018, there are approximately The small businesses/startups or entrepreneurs can
32·54 crore Jan Dhan accounts having a total avail loans from R 50 thousand to 10 Lakh to start/ grow
deposit balance of R 82,039·5 crore. their business under the three.
● About 30 lakh people have so far availed the (i) Shishu : Covering loans upto R 50,000.
overdraft facility. (ii) Kishor : Covering loans above R 50,000 and
● The pipeline of Jan Dhan-Aadhaar-Mobile (JAM) up to R 5 lakh.
will continue to provide the necessary backbone for (iii) Tarun : Covering loans above R 5 lakh and up
coverage of these activities and thereby accelerating to R 10 lakh.
the pace of digitised financially included and
insured society.
R 3·48 crore Mudra loans were sanctioned during
2015-16, which increased to 3·97 crore in 2016-17, 4·81
● 53 per cent of the PMJDY account holders are crore in 2017-18 and 3·16 crore in 2018-19 (till January
women. 11, 2019). R 1·33 lakh crore loan distributed in 2015-16,
● 83 per cent of the total accounts are seeded with R 1·75 lakh crore in 2016-17, R 2·46 lakh crore in 2017-
Aadhaar. 18 and R 1·63 lakh crore in 2018-19 (till January 11,
● As on January 9, 2019 total number of beneficiaries 2019) worth of loans were distributed under this scheme.
of PMJDY was 33·82 crore with a deposits of The products under the scheme are :
R 87551 crore. ● Sector/activity specific schemes such as schemes for
● 26·88 crore account holders have been given Rupay business activities in land, transport, community
Debit Card. social and personal services, food products and
Pradhan Mantri Sukanya Samriddhi textile product sector.
Yojana (PMSSY) ● Micro Credit scheme.
Launched : January 22, 2015. ● Refinance scheme for Regional Rural Banks/
Main Objective : Secure the future of girl child. Scheduled cooperative Banks.
Sukanya Samriddhi Scheme is a phenomenal step ● Mahila Udyami Scheme.
by the GoI and it was launched on 22nd January, 2015. ● Business loan for traders and shopkeepers.
It is a part of GoI’s ‘Beti Bachao-Beti Padhao’ initiative. ● Missing Middle Credit schemes-Equipment Finance
It is an ambitious small deposit savings scheme for a for Micro-Units.
girl child. Under the scheme, a saving account can be
opened in the name of girl child and deposits can be Pradhan Mantri Jeevan Jyoti Bima
made for 14 years. After the girl reach 18 years of age, Yojana (PMJJBY)
she can withdraw 50% of the amount for marriage or Launched : May 9, 2015.
higher study purposes.
Main Objective : Provide life insurance cover to all
After the girl completes 21 years of age, the Indian citizens.
maturity amount can be withdrawn including the interest
at rates decided by Government every year. Pradhan Mantri Jeevan Jyoti Bima Yojana is a
government backed life insurance scheme in India aimed
The investments and returns are exempted under at increasing the penetration of life insurance cover in
section 80C of Indian income tax act. The maximum India. The scheme is open and available to all Indian
investment of R 1.5 lakh per year can be made while citizens between the age of 18 to 50 years.
minimum deposit is R 1000 per year.
Under the scheme, the policy holder can get a life
In case of more than one girl child, parents can open
another account on the different name but only for 2 girl insurance cover of R 2 lakh with an annual premium of
child. Only exception is that the parents have twins and just R 330 excluding service tax. All the Indian citizens
another girl child. between 18-50 years of age with a saving bank account
are eligible to avail the scheme.
Pradhan Mantri MUDRA Yojana As on December 31, 2018, nearly 5·67 crore people
(PMMY) had enrolled under PMJJBY and the total number of
Launched : April 8, 2015. claims settled till December 31, 2018 were nearly 1·10
Main Objective : Financial support for growth of lakh involving an amount of R 2,488·44 crore settled so
micro enterprises sector. far.
Pradhan Mantri MUDRA (Micro Units Develop- Pradhan Mantri Suraksha Bima Yojana
ment and Refinance Agency) Yojana was launched with
the purpose of funding to the non-corporate small
(PMSBY)
business sector. Pradhan Mantri Mudra Yojana (PMMY) Launched : May 9, 2015.
is open and is available from all Bank branches across Main Objective : Provide accidental insurance
the country. cover to all Indian citizens.
Economics (NET) | 633U
Pradhan Mantri Suraksha Bima Yojana is also a workers, street vendors, mid-day meal workers,
government backed accident insurance scheme in India head loaders, brick kiln workers, cobblers, rag
aimed at increasing the penetration of accidental pickers, domestic workers, washermen, rickshaw-
insurance cover in India. The scheme is open and pullers, landless labourers, own account workers,
available to all Indian citizens between the age of 18 to agricultural workers, construction workers, beedi
70 years. workers, handloom workers, leather workers, audio-
Under the scheme, the policy holder can get a visual workers and similar other occupations.
insurance cover for a sum of R 2 lakh in case of ● To join the mega pension scheme, the monthly
accidental death or permanent full disability or a sum of income of unorganized worker should not exceed
R 1 lakh in case of partial but permanent disability. R 15,000.
Annual premium i s just R 12 per person per year ● The eligible person should have a savings bank
excluding service tax. All the Indian citizens between account and Aadhaar number.
18-70 years of age with a saving bank account are
eligible to avail the scheme. The scheme is valid for one ● The age of worker should not be less than 18 years
year and it can be renewed every year. and not more than 40 years of age.
As on Oct. 31, 2018, nearly 14·27 crore people had ● A worker will not be eligible if he/she is already a
enrolled under PMSBY, with almost 1·5 lakh joining it member of other pension schemes—National
on a weekly basis. Pension Scheme (NPS) where contribution is also
made by the Central Government of Employee State
Atal Pension Yojana (APY) Insurance Corporation Scheme or Employee
Launched : May 9, 2015. Provident Fund or he is an income tax assessee.
Main Objective : Increase the number of people ● In case of default on payment contributions, the
covered under any kind of pension scheme. eligible subscriber will be allowed to regularise
Atal Pension Yojana is one of the three Jan Suraksha his/her contributions by paying the outstanding dues
schemes launched by PM Narendra Modi. APY is aimed along with interest. The interest will be determined
at increasing the number of pension scheme by the Government of India.
beneficiaries across t h e country. The scheme is
especially targeted to the private unorganized sector and ● If the subscriber wishes to exit the scheme, within
is open to all Indian citizens between the age of 18 to 40 ten years of date of joining, then only his share of
years. contribution will be returned to him along with
Under the scheme, the beneficiary have to make savings bank interest rate.
contribution for at least 20 years before he/she can get ● If the eligible subscriber dies due to any cause, then
pension after attaining age of 60 years. The scheme the spouse shall have an option to continue the
provides a monthly pension of R 1000 to R 5000 per scheme by making regular contribution or exit the
month based on the contribution amount. scheme by receiving share of contribution paid by
Atal Pension Yojana has added over 1·1 crore the subscriber along with accumulated interest or
subscribers since it launch in May 2015. Upto May 15, savings bank interest rate, whichever is higher.
2018, the APY has collected R 3950 crore of contribu- ● Post the death of subscriber and the spouse, the
tion from subscribers. The scheme has generated around corpus will be credited back to the fund.
9·10% Compounded Annual Growth Rate (CAGR) since
● In case the subscriber becomes permanently
inception till March 2018.
disabled before the age of sixty and is unable to
Pradhan Mantri Shram Yogi Maandhan contribute to the scheme, then he has the option to
Finance Minister Piyush Goyal announced, in his exit the scheme by receiving his share of
maiden budget speech 2019-20, a mega pension scheme contribution along with interest actually earned by
for the workers of unorganized sector. The mega the pension scheme for savings bank interest rate,
pension scheme is known as Pradhan Mantri Shram whichever is higher. Another option i s that spouse
Yogi Maandhan. This scheme is meant for workers in will be allowed to continue to contribute to the
unorganized sector such as maids, drivers and so on scheme subsequently by payment of regular
whose monthly income does not exceed R 15,000. Under contribution.
the scheme, pension of R 3,000 per month will be given ● During the years when pension is received by
to eligible subscribers. Both subscriber and government subscriber, if he/she dies, then spouse shall be
will contribute equal amounts to the pension corpus eligible to receive 50 per cent of the pension
during the years of accumulation. Here are the eligibility received by the subscriber. Children of the
criteria. Read on to find out who can get it. subscriber will not be allowed to receive any
● The scheme will come into force from February 15, pension benefit after his/her death.
2019. ● The minimum monthly pension assured in the
● This scheme shall apply to the unorganized workers scheme is R 3,000 which will be paid to the
who are working or engaged as home-based subscriber after attaining the age of 60 years.
634U | Economics (NET)
● Subscribing member’s contribution ranges from Major Benefits Under the Pradhan
R 55 per month (Entry age 18 years) to R 200 per Mantri Vaya Vandana Yojana (PMVVY)
month (entry age 40 years). Central government will ● Scheme provides an assured return of 8% p.a.
contribute the same amount every month.
payable monthly (equivalent to 8.30% p.a. effective)
Pradhan Mantri Kisan Maandhan for 10 years.
Yojana ● Pension is payable at the end of each period, during
The Union Cabinet approved a farmers pension the policy term of 10 years, as per the frequency of
scheme on May 31, 2019, which is available only to monthly/quarterly / half-yearly/yearly as chosen by
small and marginal farmers. the pensioner at the time of purchase.
Key features of the scheme are following : ● The Union Cabinet on May 2, 2018 approved
● A voluntary and contributory pension scheme for all extending the investment limit from R 7·5 lakh to
Small and Marginal Farmers (SMF) across the R 15 lakh.
country. ● Last for subscription to scheme is March 31, 2020.
● Entry age of 18 to 40 years with a provision of ● The scheme is being implemented through LIC.
minimum fixed pension of R 3,000 on attaining the ● On survival of the pensioner to the end of the policy
age of 60 years. term of 10 years, Purchase price along with final
● For example, a beneficiary farmer is required to pension instalment shall be payable.
contribute R 100 per month at median entry age of ● Loan upto 75% of Purchase Price shall be allowed
29 years. The Central Government shall also after 3 policy years (to meet the liquidity needs).
contribute to the Pension Fund an equal amount as Loan interest shall be recovered from the pension
contributed by the eligible farmer. instalments and loan to be recovered from claim
● After the subscriber’s death, while receiving proceeds.
pension, the spouse of the SMF beneficiary shall be ● The scheme also allows for premature exit for the
entitled to receive 50% of the pension received by treatment of any critical/ terminal illness of self or
the beneficiary as family pension, provided he/she is spouse. On such premature exit, 98% of the
not already an SMF beneficiary of the Scheme. If, Purchase Price shall be refunded.
the death of the subscriber happens during the ● On death of the pensioner during the policy term of
period of contribution, the spouse shall have the 10 years, the Purchase Price shall be paid to the
option of continuing the Scheme by paying regular beneficiary.
contribution. ● Minimum / Maximum Purchase Price and Pension
● An interesting feature of the Scheme is that the Amount :
farmers can opt to allow their monthly contribution
to the Scheme to be made from the benefits drawn Mode of Minimum Maximum Minimum Maximum
Pension Purchase Purchase Pension Pension
from the Pradhan Mantri Kisan SAmman Nidhi Price Price amount amount
(PMKISAN) Scheme directly. Alternatively, a Yearly R 1,44,578 R 14,45,783 R 12,000 R 1,20,000
farmer can pay his monthly contribution by
Half- R 1,47,601 R 14,76,015 R 6,000 R 60,000
registering through Common Service Centres yearly
(CSCs) under MeitY. Quarterly R 1,49,068 R 14,90,683 R 3,000 R 30,000
It is estimated that 5 crore small and marginal Monthly R 1,50,000 R 15,00,000 R 1,000 R 10,000
farmers will benefit in the first three years itself. The
Central Government would spend R 10774·50 crore for a ● The ceiling of maximum pension is for a family as a
period of 3 years towards its contribution (matching whole, the family will comprise the pensioner,
share) for providing social security cover as envisaged his/her spouse aand dependants.
under the scheme. ● The shortfall owing to the difference between the
interest guaranteed and the actual interest earned
Pradhan Mantri Vaya Vandana Yojana and the expenses relating to administration shall be
(PMVYY) Launched on July 21, 2017 subsidized by the Government of India and
The Union Minister for Finance, Defence and reimbursed to the Corporation.
Corporate Affairs formally launched the Pradhan Mantri
Vaya Vandana Yojana (PMVVY) on July 21, 2017 in
Pradhan Mantri Laghu Vyapari
New Delhi. PMVVY is a Pension Scheme announced by Maandhan Yojana
the Government of India exclusively for the senior In a decision that will benefit the trading
citizens aged 60 years and above which is available from community, the Union Cabinet, chaired by Prime
4th May, 2017 to 3rd May, 2018. The Scheme can be Minister Shri Narendra Modi has approved a new
purchased offline as well as online through Life scheme on May 31, 2019 that offers pension coverage to
Insurance Corporation (LIC) of India which has been the trading community. This is a part of the Prime
given the sole privilege to operate this Scheme. Minister’s vision to provide a robust architecture of
Economics (NET) | 635U
universal social security.Key points of the scheme are former/present members of Lok Sabha/Rajya
following : Sabha/state legislative assemblies/state legislative
● Under this scheme all shopkeepers, retail traders councils, former and present mayors of municipal
and self-employed persons are assured a minimum corporations and former and present chairpersons of
monthly pension of R 3,000 month after attaining district panchayats.
the age of 60 years. ● The exclusion list includes families of all serving or
● All small shopkeepers and self-employed persons as retired officers and employees of Central/State
well as the retail traders with GST turnover below government ministries/offices/departments and its
R 1·5 crore and age between 18-40 years, can enrol field units central or state public sector enterprises
for this scheme. The scheme would benefit more (PSEs) and attached offices/autonomous institutions
than 3 crore small shopkeepers and traders. under government as well as regular employees of
● The scheme is based on self-declaration as no the local bodies (excluding multi tasking staff/class
documents are required except Aadhaar and bank IV/Group D employees).
account. Interested persons can enrol themselves ● All superannuated/retired pensioners whose monthly
through more than 3,25,000 Common Service pension is R 10,000/or more (excluding multi-
Centres spread across the country. tasking staff / Class IV / Group D employees) of
● The Government of India will make matching above category will also be excluded.
contribution in the subscribers’ account. For ● The benefit of the scheme would not be available to
example if a person with age of 29 years contributes “all persons who paid income tax in last assessment
R 100 per month, then the Central Government also year.”
contributes the equal amount as subsidy into
subscriber’s pension account every month. ● Families having one or more members as
professionals like doctors, engineers, lawyers,
By imitating a pension architecture for the trading
chartered accountants, and architects registered with
community, the Prime Minister and his team have
professional bodies and carrying out profession by
fulfilled a major promise made to the people of India.
undertaking practices would also be excluded from
Shri M o d i had spoken about the need of providing
the beneficiary list.
pension for traders, that would assure them a life of
dignity and financial security especially during their old ● “For the purpose of exclusion State/UT Government
age.This decision can also be seen in the light of several can certify the eligibility of the beneficiary based on
other steps taken for the welfare of traders, small and self declaration by the beneficiaries.”
medium business. The GST underwent significant ● “In case of incorrect self declaration, beneficiary
simplification after taking feed-back of the trading shall be liable for recovery of transferred financial
community. In the same way, Mudra loans gave wings benefit and other penal actions as per law.”
to the entrepreneurial zeal of young India. Loans upto
R 1 crore are now easily available. ● PM-Kisan, is being implemented from December 1,
2018 and the first instalment will be transferred by
Schemes / Programmes Related with March 2019.
Agriculture and Rural Development ● The cut-off date for ownership of cultivable land is
‘Pradhan Mantri Kisan Samman Nidhi’ February 1, 2019.
(PM-Kisan) ● As per a decision of Union Cabinet on May 31,
In the interim Union Budget 2019-20, Finance 2019 PM-KISAN has been extended to all farmers
Minister Piyush Goyal announced direct income support irrespective of land owned by them, keeping other
of R 6,000 per year to 12 crore small and marginal conditions at the same level.
farmers holding cultivable land up to 2 hectare. Key Pradhan Mantri Annadata Aay
features of the scheme are following—
Sanrakshan Yojana (PM-AASHA)
● A family comprising of husband, wife and minor
Centre launched a new scheme, Pradhan Mantri
children who collectively own cultivable land up to
Annadata Aay Sanrakshan Abhiyan, intended to shore
2 hectare as per land records of the concerned State/
up the prices that farmers get for their produce. The
UT is eligible.
move follows increasing farmer unrest across the
● The Government intends to release the first country as prices of many key agricultural commodities
instalment before March 31, but will make Aadhaar have fallen below their MSP (minimum support price).
mandatory for availing the second instalment in the The three different components of the scheme, it is said,
next fiscal. will cover gaps in the procurement and compensation
● Farmer families are excluded if one or more mechanism for crops and help boost farmers’ income.
members belong to following categories—(a) The AASHA scheme has three components, and
former and present holders of constitutional posts these will complement the existing schemes of the
(b) former and present ministers/state ministers and Department of Food and Public Distribution for
636U | Economics (NET)
procurement of paddy, wheat and other cereals and 5. 25 per cent of the likely claim will be settled directly
coarse grains where procurement is at MSP now. on farmers account.
● The first part is the Price Support Scheme (PSS). 6. There will be one insurance company for the entire
Here, physical procurement of pulses, oilseeds and state.
copra will be done by Central Nodal Agencies.
7. The scheme also provides for coverage of post-
Besides NAFED, Food Cooperation of India will
harvest losses.
also take up procurement of crops under PSS. The
expenditure and losses due to procurement will be 8. Covers localised crop losses like hailstones.
borne by the Centre. Crop Insurance Schemes
● The second leg is the Price Deficiency Payment ● Comprehensive Crop Insurance Scheme : 1985
Scheme (PDPS). Under this, the Centre proposes to ● National Agricultural Insurance Scheme : 1999
cover all oilseeds and pay the farmer directly into
● Weather based Crop Insurance Scheme : 2007
his bank account the difference between the MSP
and his actual selling/modal price. Farmers who sell ● Modified National Agricultural Scheme : 2010
their crops in recognised mandis within the notified ● Pradhan Mantri Fasal Bima Yojana : 2014
period can benefit from it. 9. The scheme is implemented through Ministry of
● The third part is the pilot of Private Procurement & Agriculture and farmers welfare designated/
Stockist Scheme (PPSS). In the case of oilseeds, empanelled Agriculture Insurance company of India
States will have the option to roll out PPSSs in and same private insurance companies.
select districts where a private player can procure 10. Comprehensive risk insurance is provided to cover
crops at MSP when market prices drop below MSP. yield losses due t o non-preventable risks such as
The private player will then be compensated Natural fire and lightning, storm, hailstorm,
through a service charge that will be up to a cyclone, Ty-phoon, Hurricane, Tornado, Flood,
maximum of 15 per cent of the MSP of the crop. Inundation and Land-slide, Drought, Dry spells,
● The AASHA scheme tries to address the gaps in the Perts/ Diseases etc.
MSP system and give better returns to farmers.
● It also promises to plug the holes in the procurement
Pradhan Mantri Krishi Sinchai
system through PDP. If effectively implemented, Yojana (PMKSY)
the scheme will result in savings for the centre. Launched : July 1, 2015.
● In the current physical procurement, government Main Objective : Irrigating the field of every
agencies end up stock-piling foodgrains, incurring farmer and improving water use efficiency to provide
storage costs and significant wastage and leakages ‘Per Drop More Crop’.
as well. Pradhan Mantri Krishi Sinchai Yojana (PMKSY)
Pradhan Mantri Fasal Bima Yojana has been formulated with the vision of extending the
coverage of irrigation ‘Har Khet Ko Pani’ and
(PMFBY) improving water use efficiency ‘More Crop Per Drop’ in
Launched : October 11, 2014. a focused manner with end to end solution on source
Main Objective : Provide insurance cover to rabi creation, distribution, management, field application and
and kharif crops and financial support to farmers in case extension activities.
of damage of crops. The government has approved R 50,000 crore for the
In order to make crop insurance simpler and cheaper implementation of Pradhan Mantri Krishi Sinchai
for the farmers and to provide them with better Yojana for next 5 years, i.e., up to 2020.
insurance services, a Central Sector Scheme of Pradhan 3·58 lakh Ha area has been covered under drip
Mantri Fasal Bima Yojana (PMFSY) was launched by irrigation, and 3·36 lakh Ha under sprinkler irrigation
the Government of India replacing NAIS and MNAIS. during 2018-19. Potential created for protective
Key features of the PMFBY are following : irrigation during 2018-19 was 0·15 lakh Ha.
1. Maximum Insurance charges payable by farmer is
2% of sum insured or Actuarial rate (which ever is Jal Shakti Abhiyan for Water Conser-
less) for Kharif crops, 1·5% for Rabi crops and 5% vation Launched
for commercial horticultural crops. Union Jal Shakti Minister, Shri Gajendra Singh
2. Insuring income of the farmer and not crop per se. Shekhawat, on July 1, 2019 announced the commence-
3. In PMFBY, there will not be a cap on the premium ment of the Jal Shakti Abhiyan—a campaign for water
and reduction of the sum insured. conservation and water security. The campaign will run
4. Promises to provide prompt and easy settlement through citizens participation during the monsoon
of claims through the use of technology like GPS, season, from 1st July, 2019 to 15th September, 2019. An
smart phones, remote sensing and drones to access additional Phase 2 will be run from 1st October, 2019 to
actual crop damage. 30th November, 2019 for States receiving the North East
Economics (NET) | 637U
retreating monsoons. The focus of the campaign will be Deen Dayal Upadhyaya Gram Jyoti
on water stressed districts and blocks. Yojana (DDUGJY)
The Prime Minister, Shri Narendra Modi, in his Launched : July 25, 2015.
Mann Ki Baat address June 30, 2019 had given a clarion
Main Objective : Electric supply feeder separation
call to citizens to join hands for water conservation and
(rural households and agricultural) and strengthening of
create a jan-andolan along the lines of the Swachh
subtransmission and distribution infrastructure including
Bharat Mission, to save water and secure the future. The
metering at all levels in rural areas.
Prime Minister invited ideas, traditional knowledge,
initiatives undertaken, success stories, and films made DDUGJY helped in providing round the clock
on water conservation from common citizens, celebrities power to rural house-holds and adequate power to agri-
and NGOs alike. cultural consumers. The earlier scheme for rural
electrification viz. Rajiv Gandhi Grameen Vidyutikaran
The government aims at providing drinking water Yojana (RGGVY) has been subsumed in the new scheme
to every household on priority and in a sustainable as its rural electrification component.
manner. The Jal Shakti Abhiyan should bring positive
The progress of DDUGKY is exemplary as 100 per
change in people for water conservation. It will help
cent villages of the country have been electrified as on
people to work for rain water harvesting, maintenance
April 28, 2018; 2,58,870 km HT and LT lines have been
and upkeep of ponds and village tanks and conservation
eracted.
of water.
Action Plan Pradhan Mantri Kisan SAMPADA
(Scheme for Agro-Marine Processing and
● The Jal Shakti Abhiyan is a collaborative effort
of various Ministries of the Government of India
Development of Agra-Processing
and State Governments, being coordinated by the Clusters) Yojana
DDWS. Prime Minister Narendra Modi has launched the
● Teams of officers from the central government will agro-marine processing scheme SAMPADA to promote
visit and work with district administration in 1592 food processing and promised to make the North-East
water stressed blocks in 256 districts, to ensure five the economic hub of ‘new India’. 'There are immense
important water conservation interventions. possibilities for agro-product valuation and the R 6,000
crore SAMPADA (Scheme for Agro- Marine Processing
● These will be water conservation and rainwater and Development of Agro-Processing) will go a long
harvesting, renovation of traditional and other water way in developing the food processing industry and
bodies/tanks, reuse, bore well recharge structures, creating employment opportunities for the youth', he
watershed development and intensive afforestation. said after laying the foundation stone of the Indian
● These water conservation efforts will also be Agriculture Research Institute in the Dhemaji district.
supplemented with special interventions including SAMPADA is an umbrella programme for food
the development of Block and District Water Con- processing sector with 6,000 crore outlay to integrate
servation Plans, promotion of efficient water use current and new schemes aimed at reducing food
for irrigation and better choice of crops through wastage and doubling farmers’ income.It is a scheme for
Krishi Vigyan Kendras. Agro-Marine Produce Processing and Development of
● A large-scale communications campaign has also Agro-Processing Cluster. SAMPADA will include
been planned alongside the JSA involving mass ongoing schemes like mega food parks and cold chain
mobilisation of different groups including school projects as well as three new schemes that the
students, college students, swachhagrahis, Self Help government will launch shortly. To create infrastructure
Groups, Panchayati Raj Institution members, youth for improving the entire food supply chain, three
groups (NSS/NYKS/NCC), defence personnel, ex- schemes—‘Creation / Expansion of Food Processing and
servicemen and pensioners, among various others. Preservation Capacities’, ‘New Agro-Processing
Clusters’ and ‘Backward and Forward Linkages’ are on
Soil Health Card Scheme anvil.
Launched : February 17, 2015. The Centre has so far sanctioned 42 mega food
parks and 234 cold chain projects with 139 lakh tonnes
Main Objective : To help farmers to improve of preserving and processing capacity of agro-produce
productivity from their farms by letting them know worth R 35,000 crore.
about nutrient/fertilizer requirements for their farms.
The soil health card studies and reviews the health of
Rashtriya Gokul Mission
soil or rather a complete evaluation of the quality of soil Launched : December 16, 2014.
right from its functional characteristics, to water and Main Objective : To conserve and develop
nutrients content and other biological properties. It will indigenous bovine breeds.
also contain corrective measures that a farmer should Rashtriya Gokul Mission aims to conserve and
adopt to obtain a better yield. develop indigenous breeds in a focused and scientific
638U | Economics (NET)
manner. It is a focussed project under National Pro- The programme so far has been implemented on
gramme for Bovine Breeding and Dairy Development, cost sharing basis between the Central and State
with an outlay of R 500 crore during the 12th Five Year Governments in the ratio of 60:40. In a rare instance of
Plan. departure, the Central Government has decided to
Key features of Rashtriya Gokul Mission are now bear the entire cost of the programme to ensure
following : complete eradication of these diseases and better
● The Mission will be implemented with the livelihood opportunities for all the livestock rearing
objectives to : farmers in the country.
● development and conservation of indigenous Van Dhan Scheme
breeds.
The Prime Minister of India Shri Narendra Modi
● undertake breed improvement programme for
launched the Van Dhan Scheme of Ministry of Tribal
indigenous cattle breeds so as to improve the Affairs and TRIFED on 14th April, 2018 at Bijapur,
genetic make up and increase the stock. Chhattisgarh.
● enhance milk production and productivity.
Key features of the scheme are following :
● upgrade nondescript cattle using elite indigenous
breeds like Gir, Sahiwal, Rathi, Deoni, ● The establishment of ‘Van Dhan Vikas Kendra’ is
Tharparkar, Red Sindhi. for providing skill upgradation and capacity
● Distribute disease free high genetic merit bulls building training and setting up of primary
for natural service. processing and value addition facility.
● Funds under the scheme will be allocated for : ● Under Van Dhan, 10 Self Help Groups of 30 Tribal
(a) Establishment of Integrated Indigenous Cattle gatherers is constituted. they are then trained and
Centres viz. ‘Gokul Gram’; provided with working capital to add value to the
(b) Strengthening of bull mother farms to conserve products, which they collect from the jungle.
high genetic merit Indigenous Breeds; Working under the leadership of Collector these
(c) Establishment of Field Performance Recording groups can then market their products not only
(FPR) in the breeding tract within the States but also outside the States.
Training and technical support is provided by
(d) Assistance to Institutions/ Institutes which are
repositories of best germplasm; TRIFED. It is proposed to develop 30,000 such
centres in the country.
(e) Implementation of Pedigree Selection
Programme for the Indigenous Breeds with ● Value addition assumes that critical importance in
large population; ensuring remunerative prices to the tribals in this
(f) Establishment of Breeder’s Societies : Gopalan approach. Three stage value addition would be the
Sangh corner stone for enhancing incomes of the tribals
under the scheme.
(g) Distribution of disease free high genetic merit
bulls for natural service ● The grass root level procurement is proposed to be
(h) Incentive to farmers maintaining elite animals undertaken through Self Help Groups associated
of indigenous breeds; with implementing agencies. Convergence and
Networking with other Govt. departments/scheme
(i) Heifer rearing programme; award to Farmers
shall be undertaken to utilise the services of existing
(‘Gopal Ratna’) and Breeders’ Societies
SHGs like Ajeevika, etc.
(‘Kamadhenu’ );
● These SHGs shall be appropriately trained on
(j) Organization of Milk Yield Competitions for
indigenous breeds and sustainable harvesting/collectiion, primary process-
(k) Organization of Training Programme for ing & value addition and be formed into clusters so
technical and non-technical personnel working as to aggregate their stock in tradable quantity and
at the Institute/Institutions engaged in indige- linking them with facility of primary processing in a
nous cattle development. Van Dhan Vikas Kendra.
● The stock after primary processing shall be supplied
Livestock Vaccination Programme by these SHGs to the State Implementing Agencies
for Foot and Mouth Disease or direct tie up for supply to corporate secondary
processor.
The Centre decided to bear the expenses of
vaccinating livestock against foot and mouth disease and Schemes / Programmes Related with
brucellosis disease. In case of FMD, the scheme Housing and Urban Development
envisages vaccination coverage to 30 crore bovines
(cows-bulls and buffaloes) and 20 crore sheep/goat and Pradhan Mantri Awas Yojana (PMAY)
1 crore pigs at six months’ interval along with primary Launched : June 25, 2015.
vaccination in bovine calves, while the Brucellosis Main Objective : Achieve housing for all by the
control programme shall extend to cover 100% year 2022, 2 crore in Urban and 3 crore homes in Rural
vaccination coverage of 3·6 crore female calves. areas.
Economics (NET) | 639U
Pradhan Mantri Awas Yojana is an ambitious Atal Mission for Rejuvenation and
scheme of Narendra Modi Government. Under the Urban Transformation (AMRUT)
PMAY, the government aims to provide about 5 crore
affordable homes to the people belonging to EWS and Launched : June 24, 2015.
LIG categories by the year 2022. There is a target of Main Objective : Providing basic services (e.g.,
building 2 crore homes in urban area and 3 crore in rural water supply, sewerage, urban transport) to house-holds
areas across the country. and build amenities in cities which will improve the
Under the scheme, the government will provide quality of life for all, especially the poor and the
financial assistance to the poor home buyers, interest disadvantaged.
subsidy on home loan and direct subsidy on homes The purpose of Atal Mission for Rejuvenation and
bought under the scheme. Urban Transformation (AMRUT) is to (i) ensure that
every household has access to a tap with assured supply
Pradhan Mantri Awas Yojana–Gramin of water and a sewerage connection; (ii) increase the
Government to construct 1 crore pucca (permanent) amenity value of cities by developing greenery and well
houses for the rural poor in the next three years. A total maintained open spaces (e.g., parks); and (iii) reduce
of 4 crore homes would be constructed under PMAY-G pollution by switching to public transport or constructing
in rural areas across the country by the year 2022. facilities for non-motorized transport (e.g., walking and
The scheme is expected to boost job creation in rural cycling).
areas. National Heritage City Development and
The project will be implemented in a span of three Augmentation Yojana (HRIDAY)
years from 2016-17 to 2018-19 with a budget of Launched : January 21, 2015.
R 81,975 crore. Main Objective : Bringing together urban planning,
Of the total estimated expenditure, R 60,000 crore economic growth and heritage conservation in an
will come from budgetary allocations and the remaining inclusive manner to preserve the heritage character of
through NABARD. each Heritage City.
● The cost of unit (house) assistance is to be shared With a duration of 27 months (completing in March
between central and state governments in the ratio 2017) and a total outlay of INR 500 Crores, the Scheme
60 : 40 in plain areas and 90:10 for north-eastern is being implemented in 12 identified Cities namely,
and hilly states. Ajmer, Amaravati, Amritsar, Badami, Dwarka, Gaya,
Kanchipuram, Mathura, Puri, Varanasi, Velankanni and
● Beneficiaries of the rural houses would be chosen
Warangal. The scheme is implemented in a mission
according to data taken from the Socio-Economic mode.
Caste Census of 2011.
● An allowance of R 120,000 in plain areas and Smart City Mission
R 130,000 in hilly areas will be provided for Launched : June 25, 2015.
construction of homes. Main Objective : To develop 100 cities all over the
● The unit size will be enhanced from the existing 20 country making them citizen friendly and sustainable.
sq.mt. to up to 25 sq.mt. including a dedicated area Under the mission, the NDA Government aims to
for hygienic cooking. develop smart cities equipped with basic infrastructure
and offer a good quality of life through smart solutions.
● Provision of toilets at R 12000 and 90/95 days o f
Assured water and power supply, sanitation and solid
unskilled wage labour under MGNREGA over and waste management, efficient urban mobility and public
above the unit cost. transport, robust IT connectivity, e-governance and
● Funds will be transferred electronically directly to citizen participation along with safety of its citizens are
the account of the beneficiary. some of the likely attributes of these smart cities.
● The beneficiary would be facilitated to avail loan of Implementation of Pradhan Mantri Awas Yojana—
up to R 70000 for construction of the house which is Gramin has been approved by the Narendra Modi
optional. Government on 23rd March in a cabinet meeting. The
● Special Projects to be sanctioned to states based on rural housing scheme will help achieve housing for all
by 2022 in Rural areas across the country.
situational exigencies and special needs.
Latest Update : Number of homes to be
New Update : Home loans up to R 2 lakh taken in constructed under PMAY-G has been increased by 33%
2017 for maintenance or upgradation of homes under PM from 3 crore to 4 crore by the year 2022.
Awas Yojana—Gramin will receive interest subvention To address the gap in rural housing and in view of
of 3%. The scheme is also expected to generate Government’s commitment to provide ‘Housing for All’
employment in the rural areas, especially in the by 2022, the scheme of IAY has been restructured into
construction sector which is currently the 2nd largest Pradhan Mantri Awas Yojana—Gramin (PMAY-G)
employers in India. w.e.f. 1st April, 2016.
640U | Economics (NET)
Smart Ganga City Scheme of four hours every day, which would be telecast six
times a day allowing the student to choose the time of
Launched : August 13, 2016. his/her convenience.
Union Minister for Water Resources, River The main features of SWAYAM Prabha would be
Development and Ganga Rejuvenation Sushri Uma as under : (i) Curriculum based course contents covering
Bharti and Union Urban Development Minister Shri M. diverse disciplines such as arts, science, commerce,
Venkaiah Naidu on August 13, 2016 launched Smart performing arts, social sciences and humanities subjects,
Ganga City Scheme in ten important cities. engineering, technology, law, medicine, agriculture etc.
Key Facts : (ii) Covers all level of education: School education,
● These cities are—Haridwar, Rishikesh, Mathura- undergraduate, postgraduate, engineering, out of school
Vrindavan, Varanasi, Kanpur, Allahabad, Lucknow, children, vocational courses and teacher training.
Patna, Sahibgunj and Barrackpore. Initially the programmes will be in English but with
● National Mission for Clean Ganga (NMCG) has the passage of time the programmes will be launched in
chosen these cities in the first phase for regional languages also.
infrastructure development for sewage treatment.
● This will be on hybrid annuity mode based on PPP RISE Scheme
model. A new initiative known as ‘RISE’ was announced by
● Learning from the past experience of Ganga action the Finance Minister on February 1, 2018. RISE stands
plan her Ministry this time has gone for hybrid for ‘Revitalising of Infrastructure and Systems in
annuity mode based on PPP model. Education'. While talking about the same, FM Jaitley
● Though in the first phase only ten cities have been said the scheme known as RISE will be launched in the
taken up but gradually more and more cities will be country with a total investment of R 1 lakh crore in the
taken up. next four years.
'The government proposed to revitalise infrastruc-
Pradhan Mantri Kaushal Vikas Yojana ture, opening schools for Scheduled Tribe population as
(PMKVY) well as promoting programmes for teachers, in order to
Prime Minister Narendra Modi on January 8, 2017 improve quality education for students,' said FM Arun
announced that the government is planning to launch Jaitley. The government has allotted a total expenditure
Pravasi Kaushal Vikas Yojana to train Indian youth for of 1.35 lakh crore for health, education and social
overseas employment. welfare.
● The announcement was made at the inauguration of
the 14th Pravasi Bhartiya Divas Convention in Pradhan Mantri Yuva Yojana
Bengaluru, Karnataka. The Union Ministry of Skill Development and
● Pradhan Mantri Kaushal Vikas Yojana (PMKVY) is Entrepreneurship has launched of Pradhan Mantri Yuva
the flagship scheme of the Ministry of Skill Yojana (PMYY) to scale up an ecosystem o f entre-
Development & Entrepreneurship (MSDE). preneurship for youngsters. The scheme was launched by
● The programme seeks to train and certify Indians Union Minister of State(I/C) for Skill Development and
who are seeking overseas employment. Entrepreneurship Rajiv Pratap Rudy to mark 2 n d
● The objective of this Skill Certification Scheme is to Foundation Day of Ministry of Skill Development and
enable a large number of Indian youth to take up Entrepreneurship (MSDE).
industry-relevant skill training that will help them in
securing a better livelihood. Individuals with prior Key Facts
learning experience or skills will also be assessed ● PMYY is MSDE’s flagship scheme on entrepre-
and certified under Recognition of Prior Learning neurship education and training.
(RPL). ● The scheme spans over five years (2016-17 to 2020-
● Under this Scheme, Training and Assessment fees 21) with a project cost of R 499.94 crore.
are completely paid by the Government. ● It will provide entrepreneurship education and
● The scheme will be implemented through the training to over 7 lakh students in 5 years through
National Skill Development Corporation (NSDC). 3,050 institutes.
SWAYAM Prabha ● It will provide easy access to information and
Launched : July 18, 2016. mentor network, incubator, credit and accelerator
Government has approved a project to launch the and advocacy to create a pathway for the youth.
‘SWAYAM Prabha’-a project for operationalising 32 ● The institutes under the PMYY include 2,200
Direct to Home (DTH) Television Channels for institutes of higher learning (colleges, universities,
providing high quality educational content to all and premier institutes), 500 ITIs, 300 schools and
teachers, students and citizens across the country 50 entrepreneurship development centres through
interested in lifelong learning. There will be new content Massive Open Online Courses (MOOCs).
Economics (NET) | 641U
Initiatives to Improve Teaching continuum from pre-school, primary, upper primary,
secondary to senior secondary levels. The Scheme would
Quality in Higher Education lead to an optimal utilization of budgetary allocations
Government is serious about improving the quality and effective use of human resources and institutional
in teaching in higher education. In this regard, University structures created for the erstwhile Schemes.
Grants Commission (UGC) and All India Council for An allocation of R 75,000 crore over the period 1st
Technical Education (AICTE) have taken various initia- April, 2018 to 31st March, 2020 has been approved for
tives. Some of these initiatives are as under : the Scheme which is a 20% increase over the current
1. Diksha : It is a platform for teachers which enables allocations. Its main features, inter alia, are as follows :
capacity building of all categories of teachers. It 1. Annual Grant of R 5,000 to R 20,000 per school for
helps over 50 lakh teachers in improving the quality streng-thening of Libraries.
of education. Teachers upload their own material on 2. Composite school grant increased from R 14,500-
the portal, which also offer online courses, allow 50,000 to R 25,000-1 lakh and to be allocated on the
sharing of best content, monitor progress and basis of school enrolment.
introduce energized text books with QR Code.
3. Annual Grant for sports equipments at the cost of
2. Technical Education Quality Improvement
Programme (TEQUIP) : This is a quality
R 5,000 for primary Schools, R 10,000 for upper
primary schools and up to R 25,000 for secondary
improvement program in technical education. 1200 and senior secondary schools.
IIT and NIT graduates have opted for 3 years
teaching in educationally backward regions. They 4. Allocation for children with Special Needs (CwSN)
have resumed their duties in 53 government increased from R 3,000 to R 3,500 per child per
engineering colleges where faculty vacancies were annum including a stipend of R 200 per month for
large. Thus 1,00,000 students get quality education CWSN girls to be provided from Classes I to XII.—
which they were deprived off till recently. earlier it was only for classes IX to XII.
3. Global Initiative of Academic Networks (GIAN) : 5. Allocation for uniforms enhanced from R 400 to
Under GIAN, 700 professors from 58 countries R 600 per child per annum.
have so far conducted about 1 1 2 0 courses in 6. Allocation for textbooks enhanced from R 150/250
specialized topics for students in Indian Higher to R 250/ 400 per child per annum.
Educational institutions. More than 40,000 students 7. Upgradation of existing schools.
and associated Indian Faculty has benefited from 8. Upgradation of Kasturba Gandhi Balika Vidyalayas
this international teaching exposure. (KGBVs) from Class 6-8 to Class 6-12.
4. Pandit Madan Mohan Malaviya National 9. Strengthening Teacher Education Institutions like
Mission for Teachers Training (PMMMNM-TT): SCERTs and DIETs to improve the quality of
Under this scheme in-service training programs for teachers with SCERT as the nodal institution for in-
more than 1,00,000 college and university teachers service and pre-service teacher training.
have been organized. Newly appointed teachers
undergo six months pedagogical training, so they 10. Enhanced use of digital technology in education
can make good rapport with students and the quality through smart classrooms, digital boards and DTH
improves. channels.
5. Inter University Centres (IUCS) : To improve the As the Scheme expands support for school
standards of higher education and research, the education at pre-school and senior secondary levels, it
UGC establishes Inter-University Centres for provides for additional job opportunities for teachers,
Teachers Education within the university system part-time teachers, support staff in schools, resource
under Clause 12(ccc) of the UGC Act. persons for academic support to teachers, teacher
educators and administrative personnel. Further, the
Samagra Shiksha Abhiyan matters related to requirement of manpower to
The Department of School Education and Literacy administer the Schemes, recruitment and the terms and
of Ministry of HRD, GoI, has launched the Samagra conditions of service fall within the purview of the
Shiksha—an Integrated Scheme for School Education as States and Union Territories.
a Centrally Sponsored Scheme with effect from the year
2018-19. This programme subsumes the three erstwhile Leadership for Academicians
Centrally Sponsored Schmes of Sarva Shiksha Abhiyan Programme (LEAP) and Annual
(SSA), Rashtriya Madhyamik Shiksha Abhiyan (RMSA) Refresher Programme in Teaching
and Teacher Education (TE). (ARPIT) for Higher Education
Samagra Shiksha is, therefore, an overarching
programme for the school education sector extending
Faculty Launched
from pre-school to class XII and aims to ensure Dr. Satya Pal Singh, Minister of State, Ministry
inclusive and equitable quality education at all level s of of Human Resource Development, launched two new
school education. It envisages the ‘school’ as a initiatives : Leadership for Academicians Programme
642U | Economics (NET)
(LEAP) and Annual Refresher Programme In ● NRCs are located in a mixed range of institutions.
Teaching (ARPIT) on November 13, 2018. ● ARPIT will be an ongoing exercise so that every
Leadership for Academicians Programme year NRCs will continuously develop new refresher
(LEAP) : It is a three weeks Flagship leadership module in their ear-marked discipline each year.
development training programme (2 weeks within India
and one week foreign training) for second level acade- Schemes / Programmes Related with
mic functionaries in public funded higher education Health and Sanitation
institutions. Key features of the programme are the
following : Ayushman Bharat Programme
● The main objective of LEAP is to prepare second Finance Minister Arun Jaitley in his budget speech
tier academic heads that are potentially likely to 2018-19 announced two major initiatives in health
assume leadership roles in the future. sector, as part of Ayushman Bharat programme. This
● The programme would provide senior faculty, with was aimed at making path breaking interventions to
high academic credentials, the required leadership address health holistically, in primary, secondary and
and managerial skills including skills of problem- tertiary care systems, covering both prevention and
solving, handling stress, team building work, con- health promotion. The initiatives are as follows :
flict management, developing communication skills,
(i) Health and Wellness Centre : The National Health
understanding and coping with the complexity and
challenges of governance in HEIs, financial and Policy, 2017 has envisioned Health and Wellness
general administration. Centres as the foundation of India’s health system.
● The implementation of LEAP Programme will be Under this 1.5 lakh centres will bring health care
through 15 National Institutional Ranking Frame- system closer to the homes of people. These centres
work (NIRF) top ranked Indian Institutions. will provide comprehensive health care, including
● The foreign universities identified for the training for non-communicable diseases and maternal and
are also within the top 100 in the world global child health services. These centres will also
rankings. provide free essential drugs and diagnostic services.
The Budget 2018-19 has allocated R 1200 crore for
Annual Refresher Programme in this flagship programme. Contribution of private
Teaching (ARPIT) sector through Corporate Social Responsibility and
Key Features of ARPIT are the following : philanthropic institutions in adopting these centres
● It is a major and unique initiative of online is also envisaged.
professional development of 15 lakh higher (ii) Pradhan Mantri Jan Aarogya Yojana : Prime
education faculty using the massive open online Minister Narendra Modi on September 23, 2018
courses (MOOCs) platform Study Webs of Active– launched the Pradhan Mantri Jan Aarogya Abhiyan
Learning for Young Aspiring Minds (SWAYAM). (Ayushman Bharat-National Health Protection
Mission : AB-NHPM) in the capital city Ranchi in
● For implementing ARPIT, 75 discipline-specific Jharkhand. The Scheme is under the larger
institutions have been identified and notified as Ayushman Bharat Programme. It is a health
National Resource Centres (NRCs) in the first insurance scheme that assures a cover of R 5 lakh
phase, which are tasked to prepare online training per year to India’s poorest families. It plans to cover
material with focus on latest developments in the more than 1,300 medical treatments and procedures.
discipline, new and emerging trends, pedagogical It is touted as the 'World’s largest government
improvements and methodologies for transacting funded healthcare program.' It is a big step towards
revised curriculum. providing good quality and easily accessible health
● In 2018, the inaugural year itself, the NRCs are care to the poor people.
expected to cater to around 13 lakh faculty of the Around 10·74 crore entitled families (approximately
total 15 lakh faculty in higher education. 50 crore beneficiaries) are eligible for benefits
● Currently, registrations are open for the online under the scheme. Eligible people can avail benefits
refresher courses on SWAYAM platform, https:// in government and listed private hospitals. The
swayam.gov.in/course/public. beneficiaries are identified based on four 'depri-
● The course is a 40 hour module with 20 hours of vation categories'. There is no cap on family size or
age under this scheme. The scheme will become
video content and 20 hours of non-video content.
operational from September 25 on the birth
● At the end of the course, there will be a terminal anniversary of Pandit Deendayal Upadhyay.
assessment which can be either online or a written Billed as the world’s largest government healthcare
examination. programme, it is being funded with 60 per cent
● The courses will remain open from 1st November, contribution coming from the Centre and remaining
2018 to 28th February, 2019. from the states.
Economics (NET) | 643U
The scheme targets poor, deprived rural families ● The scheme aims at boosting the health care
and identified occupational category of urban facilities for the pregnant women, especially the
workers’ families, 8·03 crore in rural and 2·33 crore poor.
in urban areas, as per the latest Socio-Economic ● It also seeks to protect pregnant women from
Caste Census (SECC) data. It will cover around 50 infectious diseases.
crore people and there is no cap on family size and ● Under the scheme, the pregnant women are being
age in the scheme ensuring that nobody is left out. given free health check-up and required treatment
Over 16,112 hospitals, both public and private, have for free on 9th of every month.
been empanelled for the scheme, and as many as 31 ● The scheme is applicable for pregnant women to
states and union territories have signed MoUs with avail in every government hospitals across India.
the Centre and will implement the programme,
● The national programme provides speical free
Telangana, Odisha, Delhi, Kerala and Punjab are
antenatal care to about 3 crore pregnant women
not among the states which have opted for the
across the country in order to detect and prevent
scheme.
high risk pregnancies.
The scheme is cashless and paperless at public
● At the function J. P. Nadda also launched the
hospitals and empanelled private hospitals. The
PMSMA Web Portal and a Mobile Application
scheme is targeted at poor, deprived rural families
along with the 360 degree communication package
and identified occupational categories of urban
to raise awareness about the campaign.
workers’ families.
The Union Cabinet chaired by the Prime Minister
Ayushman Bharat may cost the exchequer around
Shri Narendra Modi has given ex-post facto approval to
R 5,000 crore during 2018-19 because of the time Pan-India implementation of Maternity Benefit
taken to rollout the scheme. The scheme will cost
Programme which now has been extended to all districts
R 10,000 crore when its rolled out across India in of the country w.e.f. 01.01.2017.
2019-20. While in 2018-19 there are likely to be 8
crore beneficiaries, the target is to cover 10 crore by The Maternity Benefit Programme is providing
2019-20. compensation for the wage loss in terms of cash
incentives so that the women can take adequate rest
The Ayushman Bharat-PMJAY has been acclaimed
before and after delivery and not be deprived of proper
worldwide. Co-founder of Microsoft Bill Gates has
nutrition. The total cost of the proposal for the period
congratulated the Indian Government for the
from 01.01.2017 to 31.03. 2020 including Central and
successful completion of the first 100 days of the
State Government share is R 12,661 crore. Government
scheme. Similarly, World Health Organisation
of India’s share during the period 01.01.2017 to
Director-General Tedros Adhanom Ghebreyesus on
31.03.2020 comes to around R 7932 crore.
January 3, 2019 praised PM Modi and Health
Minister Nadda for their visionary leadership which Objective of the Scheme
helped around seven lakh people avail benefits of
(i) To provide partial compensation for the wage loss in
the healthcare scheme.
terms of cash incentives so that the woman can take
Ironically West Bengal Chief Minister Mamta adequate rest before and after delivery of the first
Benerji has announced that West Bengal government living child.
would not participated in PMJAY.
(ii) The cash incentives provided would lead to
Mission Indradhanush improved health seeking behaviour amongst the
Pregnant Women and Lactating Mother (PW&LM)
Launched : December 25, 2014. to reduce the effects of under-nutrition namely
Main Objective : To immunize all children as well stunting, wasting and other related problems.
as pregnant women against seven vaccine preventable
diseases namely diphtheria, whooping cough (Pertussis), Target Group
tetanus, polio, tuberculosis, measles and hepatitis B by All eligible Pregnant Women and Lactating Mothers
2020.
(PW&LM), excluding the Pregnant Women and
The aim of Mission Indradhanush is t o achieve full Lactating Mothers who are in regular employment with
immunization in 352 districts which includes 279 mid
the Central Government or State Government or Public
priority districts, 33 districts from the North East states
and 40 districts from phase one where huge number of Sector Undertakings or those who are in receipt of
missed out children were detected. similar benefits under any law for the time being. It has
been decided to give the benefit of R 5000 to PW&LM
Pradhan Mantri Surakshit Matritva in three installment for the birth of the first live child by
Abhiyan MWCD and the remaining cash incentive as per
Pradhan Mantri Surakshit Matritva Abhiyan approved norms towards Maternity Benefit under
(PMSMA), an initiative of the Narendra Modi existing programmes after institutional delivery so that
Government, was launched in June 2016. on an average, a woman will get R 6000.
644U | Economics (NET)
Conditions and installments ● Camps will be organised in villages for spot
registration of beneficiaries.
Pregnant Women and Lactating Mothers who are
eligible to receive a cash benefit of R 5,000 in three ● The Gram Panchayat/Public institutions in the rural
installment at the following stages as specified in the areas may be authorised to collect application forms
table given below : along with complete documentation, distribute bills
and collect revenue in consultation with the
Cash Transfer Conditions Amount Panchayat Raj Institutions and Urban Local Bodies.
(in R)
● The Rural Electrification Corporation Limited
First ● Early Registration of 1,000 (REC) will remain the nodal agency for the
installment Pregnancy.
operationalisation of the scheme.
Second install- ● Received at least one 2,000
ment antenatal Check-up (after 6 According to government data, among 17·92 crore
months of pregnancy) households in rural areas, 13·87 crore families have got
electricity connections. As many as 4·05 crore families
Third install- ● Child birth is registered. 2,000
ment are yet to be provided electricity connections. The
● Child has received first cycle
of BCG, OPV, DPT and
government is looking to provide electricity to all
Hepatitis-B or its equivalent/ villages of the country by the end of the year.
substitute. 9 States have achieved 100% saturation in house-
hold electrification under Saubhagya Yojana namely—
The eligible beneficiaries would continue to receive M.P., Tripura, Bihar, J&K, Uttarakhand, Mizoram,
the remaining cash incentive as per approved norms
Sikkim, Telangana and West Bengal. Thus, total 16
towards Maternity Benefit under existing programmes
after institutional delivery so that on an average, a states in the country now have 100% household
woman will get R 6000. electrification. Nation was expected to achieve 100%
Mode of cash transfer to the Beneficiaries : The household electrification by December 31, 2018.
conditional cash transfer scheme would be in DBT Maharashtra, Manipur, Arunachal Pradesh, Chhattisgarh
mode. were lagging in 100% household electrification.
Schemes / Programmes Related with Pradhan Mantri Ujjwala Yojana
Electrification Launched : May 1, 2016.
Main Objective : To distribute free LPG
Saubhagya Yojana connections to the women belonging to 5 crore BPL
Prime Minister Narendra Modi on September 25, families across the country.
2017 launched the Pradhan Mantri Sahaj Bijli Har Salient Features of Ujjwala scheme are following :
Ghar Yojana ‘Saubhagya’. The ambitious scheme
● Cabinet Committee on Economic Affairs (CCEA)
plans to give electricity to all the households in India by
approved R 8000 crore for the next 3 years.
December 2018. Some of the salient features of the
scheme as under : ● Pradhan Mantri Ujjwala Yojana will provide 5 crore
LPG connections to BPL families, with the financial
● Aims to provide electric connection to 4 crore
support of R 1600.
families in rural and urban India by December 2018.
● Connections have been issued on the name of
● The scheme will cost R 16,320 crore while the
women beneficiaries.
Gross Budgetary Support (GBS) is R 12,320 crore.
● EMI facility provided for stove and refill cost.
● The outlay for the rural house-holds is R 14,025
● Vice President M. Venkaiah Naidu handed over 6
crore while the GBS is R 10,587·50 crore. For the
croreth LPG connection under PMUY to Smt.
urban households the outlay is R 2,295 crore while
Jasmina Khatoon from Shivpark, Khanpur, Delhi.
GBS is R 1,732·50 crore.
● Coverage of LPG connections has jumped from
● The Centre will be providing funds to the states and
55% in 2014 to 90% at the end of 2018.
union territories.
● Universal PMUY now covers release of LPG
● Families eligible for free electricity connection connections under PMUY to all poor on account of
would be identified using Socio Economic and their names not been covered in earlier identified
Caste Census (SECC) 2011 data. categories like identified through socio-economic
● Rest can avail the scheme on payment of R 500 caste census list and in case the names are not
which shall be recovered by DISCOMs in 10 appearing in the SELC list, beneficiaries are
instalments through electricity bill. identified from categories, i.e., SC/STs house-holds,
● The solar power packs of 200 to 300 Watt with beneficiaries of Pradhanmantri Awas Yojana
battery bank for un-electrified households located in (Gramin), Antyodaya Anna Yojana, Forest dwellers,
remote and inaccessible areas, comprises of Five Most Backward Classes, Tea and Ex. 7 Tea Garden,
LED lights, One DC fan, One DC power plug. Tribes and people residing in Islands/river islands.
Economics (NET) | 645U
● Poor families who could not get LPG connection The 60% subsidy on the solar pumps provided to
under PMUY in any of the above categories are farmers will be shared between the Centre and the States
now eligible to get a connection subject to fulfilling while 30% would be provided through bank loans. The
the eligibility norms and furnishing required balance cost has to be borne by the farmers.
documents. Gobar-Dhan Scheme
● WHO hailed PMUY as decisive intervention to In an effort to make the villages open defecation
facilitate the switch to clean household energy use, free and improving the lives of villagers, the Finance
thereby addressing the problems associated with Minister in his budget speech February 1, 2018
Indoor Household pollution. announced the launch of Galvanizing Organic Bio-
Kisan Urja Suraksha evam Utthaan Agro Resources Dhan (GOBAR-DHAN). The
Mahabhiyan – Kusum Scheme Minister added that this will manage and convert cattle
dung and solid waste in farms to compost, bio-gas and
Prime Minister Narendra Modi has announced bio-CNG.
Kisan Urja Suraksha evam Utthaan Mahabhiyan –
Kusum Scheme for farmers. Subsequently, govt. will NABH Nirman
provide subsidy on setting up of solar power plants on The Finance Minister is seeking to provide a big
their barren land. Accordingly, Kusum Scheme will push to the country's civil aviation sector, aiming at five-
solarize agricultural pump sets to double the income of fold growth in passenger traffic to a billion trips a year.
farmers by 2022. Central govt. has allocated R 48,000 The Minister said the Airport Authority of India (AAI)
crore in Union Budget 2018-19 for upcoming 5 years for has 124 airports and it is proposed to expand by more
successful implementation of this scheme. than five times the airport capacity to handle a billion
Farmers can set up solar power projects on their trips a year under a new initiative- NextGen Airports for
barren land and use the generated energy. Moreover, Bharat (NABH) Nirman.
farmers can also sell the excess energy to DISCOMS He said, 'In the last three years, domestic air
through grid setups to generate additional income. passenger traffic grew at 18 per cent per annum and the
Ministry of New and Renewable Energy will start airline companies have placed orders for more than 900
implementing this scheme from the next fiscal year to aircraft.'
promote solar farming among farmers. 'The regional connectivity scheme of UDAN (Ude
The Centre has announced a R 1.4 lakh-crore scheme Desh ka Aam Nagrik) initiated by the Government last
for promoting decentralised solar power production of year should connect 56 unserved airports and 31
up to 28,250 MW to help farmers, according to R. K. unserved helipads across the country. Operations have
Singh, Minister of State for Power and New and already started at 16 such airports,' he said. It is
Renewable Energy. proposed to leverage the balance sheet of AAI to raise
The Centre will spend R 48,000 crore on the ten- more resources to fund this expansion.
year scheme which was announced in the Union Budget Schemes / Programmes Related with
2018-19. Kisan Urja Suraksha evam Utthaan
Mahaabhiyan or KUSUM scheme would provide extra Pilgrimage and Tourism
income to farmers, by giving them an option to sell PRASAD (Pilgrimage Rejuvenation and
additional power to the grid through solar power projects Spiritual Augmentation Drive)
set up on their barren lands, the Minister said. Launched : March 9, 2015.
It would help in dedieselising the sector as also the Main Objective : Develop world class tourism
DISCOMS. infrastructure in Amritsar, Ajmer, Amaravati, Dwaraka,
India had about 30 million farm pumps that include Gaya, Kanchipuram, Kedarnath, Kamakhya, Mathura,
10 million pumps running on diesel. Puri, Varanasi and Vellankani.
The Minister said the positive outcomes that are PRASAD scheme aims to create spiritual centres for
expected when the scheme is fully implemented across tourism development within the nation. As part of
the country include promotion of decentralised solar mission strategy, religious destinaions that have potential
power production, reduction of transmission losses as to be showcased as world class tourism products are
well as providing support to the financial health of identified and infrastructure is developed on a priority
DISCOMs by reducing the subsidy burden to the basis.
agriculture sector. The scheme would also promote
energy efficiency and water conservation and provide Other Schemes/Programmes
water security to farmers. Launched by Central Government
The components of the scheme include building PAHAL-Direct Benefits Transfer for
10,000 MW solar plants on barren lands and providing
sops to DISCOMS to purchase the electricity produced,
LPG (DBTL) Consumers Scheme
‘solarising’ existing pumps of 7250 MW as well as Launched : January 1, 2015.
government tube wells with a capacity of 8250 MW and Main Objective : To send the subsidy money of
distributing 17.5 lakh solar pumps. LPG cylinders directly into the bank accounts of the
646U | Economics (NET)
consumers and increase efficiency & transparency in the high quality and conforming to the standards laid down
whole system. by the Bureau of Indian Standards, wherever applicable.
Under the scheme, the LPG consumer can now This is a Central Sector Scheme, fully funded by the
receive subsidy in his bank account by two methods. Central Government. The expenditure for implementa-
Such a consumer will be called CTC (Cash Transfer tion of the scheme will be met from the ‘Senior Citizens’
Compliant) once he joins the scheme and is ready to Welfare Fund’. Under the Scheme, the following Aids
receive subsidy in the bank account. and Assisted-Living Devices will be provided to eligible
Setu Bharatam Project elderly beneficiary senior citizens, depending upon their
Launched : March 3, 2016. physical impairment :
Main Objective : To free all national highways 1. Walking sticks, 2. Elbow crutches, 3. Walkers/
from railway level crossings and renovate the old bridges Crutches, 4. Tripods/Quadpods, 5. Hearing Aids, 6.
on national highways by 2019. Wheelchair, 7. Artificial Dentures, 8. Spectacles.
Setu Bharatam is an ambitious programme with an Salient features of the Scheme are as under :
investment of R 50,000 crore to build bridges for safe ● Free of cost distribution of the devices, commen-
and seamless travel on National Highways. surate with the extent of disability/infirmity that is
208 new 'road over bridges / road under bridges' are manifested among the eligible senior citizens.
envisaged for construction, while 1500 bridges will be ● In case of multiple disabilities/ infirmities mani-
widened, rehabilitated or replaced. fested in the same person, the assistive devices will
be given in respect of each disability/impairment.
Rashtriya Vayoshri Yojana ● The devices will help the Senior Citizens to
‘Rashtriya Vayoshri Yojana’, a ‘Scheme for overcome their age related physical impairment and
providing Physical Aids and Assisted-living Devices for to lead a dignified and productive life with minimal
Senior citizens belonging to BPL category’ has been dependence on care givers or other members of the
launched in District Nellore, Andhra Pradesh on April 1, family.
2017. The Physical Aids and Assisted-living Devices for ● The Scheme will be implemented through the sole
Senior citizens will be distributed in Camp mode and the implementing agency, ‘Artificial Limbs Manu-
Scheme will be implemented through the sole facturing Corporation (ALIMCO)’, (a PSU under
implementing agency, ‘Artificial Limbs Manufacturing the Ministry of Social Justice and Empowerment).
Corporation (ALIMCO)’, (a PSU under M/o SJ&E),
which will undertake one year free maintenance of the ● ALIMCO will undertake one year free maintenance
aids and assisted living devices. The devices will help of the aids and assisted living devices.
the Senior Citizens to overcome their age related ● Beneficiaries in each district will be identified by the
physical impairment and to lead a dignified and State Governments/UT Administrations through a
productive life with minimal dependence on care givers Committee chaired by the Deputy Commissioner/
or other members of the family. The ambitious Scheme, District Collector.
first of its kind in the country is expected to benefit ● As far as possible, 30% of the beneficiaries in each
5,20,000 Senior Citizens over a period of the 3 years, he district shall be women.
added. ● The State Government / UT Administration /
As per the Census figures of 2011, the population of District Level Committee can also utilize the data of
senior citizens in India is 10·38 crore. More than 70% of BPL beneficiaries receiving Old Age Pension under
the population of senior citizens live in rural areas of the the NSAP or any other Scheme of the state/UT for
country. A sizeable percentage (5·2%) of the senior identification of senior citizens belonging to BPL
citizens suffers from some part of disabilities related to category.
old age. Projections indicate that the number of elderly ● The devices will be distributed in Camp mode.
population will increase to around 173 million by 2026.
● The expected financial outlay over the next three
The proposal for formulation of a Scheme for
providing Physical Aids and Assisted-Living Devices years (i.e., upto 2019-20) is R 483·6 crores.
for Senior Citizens belonging to BPL Category was The ambitious Scheme, first of its kind in the
announced in the Budget 2015-16. Pursuant to this, the country is expected to benefit 5,20,000 Senior Citizens
‘Rashtriya Vayoshri Yojana’ has been formulated. The over a period of the 3 years.
Scheme aims at providing Senior Citizens, belonging to
BPL category and suffering from any of the age related Atal Bimit Vyakti Kalyan Yojana
disability/infirmity viz. Low vision, Hearing impairment, The Employees’ State Insurance Corporation (ESIC)
Loss of teeth and Locomotor disability, with such has approved a scheme for providing unemployment
assisted-living devices which can restore near normalcy allowance to workers rendered jobless due to the
in their bodily functions, overcoming the disability/ 'changing employment pattern', acknowledging the fact
infirmity manifested. The assistive devices shall be of that permanent jobs are on a decline in the country.
Economics (NET) | 647U
● The scheme, named Atal Bimit Vyakti Kalyan The proposal to extend the scheme to students
Yojana, will be applicable for employees covered opting to graduate before marriage was sent to the
under the Employees’ State Insurance (ESI) Act, Minister of Minority Affairs Mukhtar Abbas Naqvi in
1948, It will benefit over 1 million workers across July.
the country. The Foundation is now preparing a web portal
● Workers who are left unemployed for whatsoever detailing the criterion of the scheme, which is called
reasons will be paid money, from their own contri- ‘Shaadi Shagun', and will be presented at the general
bution towards the ESI scheme, in cash through body meeting next month to the minister. Shaadi Shagun
bank account transfer. is an addition made in the existing Begum Hazrat Mahal
Scholarship that is given to meritorious girl students
● Workers who are ‘insured persons’ under the ESI
belonging to six notified minority communities—
Act for a period of two years continuously will be Muslims, Christians, Sikhs, Buddhists, Jains and Parsis.
eligible to be a part of it.
However, students whose parents earn more than
● Workers will be able to draw 47 per cent of their R 2 lakh per annum cannot avail the scholarships. The
total contributions towards ESIC after remaining objective of the scholarship that ties marriage with
unemployed for at least three months from the date education is to help parents prioritise expenditure on
of leaving their previous jobs. education over marriage.
● The person can choose to receive the cash at one go ‘Seva Bhoj Yojana’
or in installments.
The Ministry of Culture, Government of India has
Nearly 4·75 per cent of a worker’s monthly salary introduced a new scheme namely, ‘Seva Bhoj Yojana’
goes towards ESI as the employer’s contribution, 1·75 with a total outlay of R 325 crores for Financial Years
per cent of the income is the employee’s share. The 2018-19 and 2019-20. The scheme envisages to
employees’ insurance scheme applies to all factories and reimburse the Central Government share of Central
establishments employing at least 10 workers. Workers Goods and Services Tax (CGST) and Integrated Goods
drawing salary up to R 15,000 per month are entitled to and Services Tax (IGST) so as to lessen the financial
medical benefits for treatment during incidences of burden of such Charitable Religious Institutions who
sickness, maternity, disability and death due to injury provide Food/Prasad/Langar/(Community Kitchen)/
during work. The ESI Act applies to factories with 10 or Bhandara free of cost without any discrimination to
more workers and it is also applicable to shops, hotels, Public/Devotees.
restaurants, cinemas and road transport undertakings. The Charitable Religious Institutions such as
The new scheme is in addition to the Rajiv Gandhi Temples, Gurudwara, Mosque, Church, Dharmik
Shramik Kalyan Yojana (RGSKY) under which ESIC Ashram, Dargah, Matth, Monasteries etc. which have
subscribers are provided unemployment allowance. been in existence for at least five years before applying
However, persons who have become unemployed after for financial assitance/grant and who serve free food to
being insured for at least three years, only for three at least 5000 people in a month and such institutions
reasons closure of factory, retrenchment or permanent covered under Section 10(23BBA) of the Income Tax
invalidity are entitled to be a part of the RGSKY Act or Institutions registered as Society under Societies
scheme. Unemployment allowance equal to 50 per cent Registration Act (XXI of 1860) or as a Public Trust
of wage for a maximum period of two years is provided, under any law for the time being in force of statuary
along with medical care for the worker and her family religious bodies constituted under any Act or institutions
during the period of unemployment. registered under Section 12AA of Income Tax Act shall
be eligible for grant under the scheme.
Shaadi Shagun Scheme
Meritorious Muslim girls who go on to complete Krishak Bandhu Scheme
graduation before marriage will get a special gift of West Bengal Chief Minister Mamata Banerjee
R 51,000 from the Central government. This proposal by announced Krishak Bandhu Scheme on December 31,
the Maulana Azad Education Foundation has now been 2018 for farm sector. Dubbed as ‘Krishak Bandhu’, the
cleared by the Ministry of Minority Affairs.The Shaadi scheme bears similarity to the Telangana government’s
Shagun—as the scheme is called—is aimed at incenti- flagship ‘Rythu Bandhu’ in terms of providing financial
vising higher education among minority groups. assistance to farmers and landless labourers. The scheme
has the following features :
All students availing Begum Hazrat Mahal scholar-
ships funded by the Maulana Azad Foundation are ● The Krishak Bandhu Scheme is similar to Telan-
eligible to apply for this top-up provision being gana Governments ‘Rythu Bandhu Scheme.
introduced in the scheme. The minority scholarships ● Against the Telagana government’s promised
for weaker sections in the minority communities were R 8,000 an acre, the West Bengal government will
initiated during Atal Bihari Vajpayee regime in 2003. give an annual financial assistance (cash dole) of
In its earlier avatar, meritorious girls from the minority R 5,000 per acre in two instalments one during kharif
community were given monthly stipends only till and another during rabi for a single crop. Farmers
Class 12. can take the financial assistance at one go too.
648U | Economics (NET)
● A life insurance cover of R 2,00,000 in case of One Nation-One Ration Card Scheme
death, irrespective of the cause, of an earning family To sustain the reforms brought in by scheme on
member (farmer) aged between 18 and 60 years. ‘End to End Computerization of Targeted Public
Farmers need not pay any premium for availing this Distribution System (TPDS) Operations’ the Department
life insurance cover. of Food & Public Distribution has launched a new
● The average land holding per cultivator in Bengal is scheme namely “Integrated Management of Public
pegged at around 0·5 hectares (or 1·2 acres). Now Distribution System (IM-PDS)” for implementation
the farmer gets an assistance of R 5,000 per acre. So during 2018-19 and 2019-20. The main objective of the
the payout is pegged at around R 6,000. At this rate, scheme is to introduce nationwide portability of ration
a payout to even 50 lakh farmers means an annual card holders under National Food Security Act, 2013
burden of R 3,000 crore on the exchequer. (NFSA), to lift their entitlement foodgrains from any FPS
in the country without the need to obtain a new ration
KALIA (Krashak Assistance for Liveli- card, by integrating the existing PDS system/portals of
hoods & Income Augmentation) Scheme States/UTs with the Central systems/portals, etc. The
Among a number of farmer-specific schemes, national portability under ‘One Nation One Ration Card’
announced or planed, across the country ahead of the system shall be applicable only to the ration card holders
Lok Sabha elections, the Odisha government has come under NFSA.
up with a support scheme whose primary targets are ● Under IM-PDS scheme, there is no requirement to
small farmers, cultivators and landless agricultural change the functioning of existing PDS systems/
labourers. Called KALIA, the scheme involves operations of the States/UTs.
payments to encourage cultivation and associated ● So far, 20 States/UTs have completed the installa-
activities. tion of electronic Point of Sale (ePoS) devices in all
● Under the scheme, R 10,180 crore will be spent over FPSs. This scheme is planned to commence in
three years until 2020-21 in providing financial phased manner in States/UTs preferably in States/
assistance to cultivators and landless agricultural UTs having ePoS devices functioning properly in
labourers. FPSs.
● The scheme will benefit 92% of the cultivators in ● ‘One Nation One Ration Card’ scheme, which will
the state and include every category from big allow portability of food security benefits, will be
farmers to landless cultivators. available across the country from July 1, 2020.
● All farmers will be provided R 10,000 per family as ● This means poor migrant workers will be able to
assistance for cultivation. Each family will get buy subsidised rice and wheat from any ration shop
R 5,000 separately in the kharif and rabi seasons, in the country, so long as their ration cards are
for five cropping seasons between 2018-19 and linked to Aadhaar.
2021-22. ● Ten States—Andhra Pradesh, Gujarat, Haryana,
● The scheme is not linked to the area of land owned, Jharkhand, Karnataka, Kerala, Maharashtra, Rajas-
than, Telangana and Tripura—already offer this
it will ‘greatly benefit’ share croppers and culti-
portability.
vators, most of whom own little or no land.
● In a bid to reduce nutrition deficiencies among
● This targets 10 lakh landless households, and
beneficiaries, the Centre would roll out a pilot
specifically SC and ST families. They will be project in 15 districts to fortify rice grains with iron,
supported with a unit cost of R 12,500 for activities folic acid, Vitamin A and Vitamin B12 . The first
like goat rearing, mushroom cultivation, beekeep-
ing, poultry farming and fishery. fortified grains would be available in ration shops
from this November 2019.
● This is also going to be an area-specific scheme in
the sense that an input support for a particular trade, Compaign Angikaar Launched
say mushroom cultivation, will be provided if it is Shri Hardeep S. Puri, Minister of State (I/C) for
prevalent throughout that locality so that there is Housing and Urban Affairs on August 29, 2019 launched
aggregation of produce. ‘Angikaar’ a campaign for change management and
● One of the interventions will assist the elderly, sick e-Course on Vulnerability Atlas of India.
and differently-abled population who are unable to In line with the vision of Prime Minister, Angikaar
take up cultivation, by providing R 10,000 per has been launched for social behaviour change, focusing
house-hold per year. This is meant to be used for on issues such as water & energy conservation, waste
sustenance. management, health, tree plantation, sanitation and
● The KALIA scheme includes a life insurance cover hygiene for beneficiaries of completed houses under
of R 2 lakh and additional personal accident PMAY (U), through community mobilisation and IEC
coverage of the same amount for 57 lakh activities. For this purpose, the campaign will converge
households. Crop loans up to R 50,000 are interest- with schemes and Missions of other Ministries dealing
free. with these subjects. The convergence would especially
Economics (NET) | 649U
focus on Ujjwala for gas connection and Ayushman (g) Indigenizing of Second Generation Biomass to
Bharat for health insurance to the beneficiaries of Ethanol technologies.
PMAY (U). ● The ethanol produced by the scheme beneficiaries
Under PMAY (U) about 88 lakh houses has been will be mandatorily supplied to Oil Marketing
approved till now as against demand of 1·12 crore. The Companies (OMCs) to further enhance the blending
angikaar aims at reaching out all the beneficiaries of the percentage under EBP Programme.
Mission in phased manner. The campaign will be ● Ministry of Petroleum & Natural Gas has targeted to
initiated in all target cities on 2nd October, 2019 achieve 10% blending percentage of Ethanol in
commemorating 150th Gandhi Jayanti after preparatory petrol by 2022. Despite efforts of the Government
phase and culminate on the occasion of Human Rights such as higher ethanol prices and simplification of
Day, 10th December, 2019. The campaign will include ethanol purchase system, the highest ever ethanol
door to door activities, ward and city level events. procurement stands around 150 crore litres during
Ethanol supply year 2017-18 which is sufficient for
Pradhan Mantri JI-VAN Yojana around 4·22% blending on Pan India basis.
The Cabinet Committee on Economic Affairs on Therefore, an alternate route viz. Second Genera-
February 28, 2019, chaired by Hon’ble Prime Minister tion (2G) Ethanol from biomass and other wastes
Shri Narendra Modi approved the “Pradhan Mantri is being explored by Ministry of Petroleum &
JI-VAN (Jaiv Indhan-Vatavaran Anukool Fasal Natural Gas to bridge the supply gap for EBP
Awashesh Nivaran) Yojana” for providing financial programme. In this direction, “Pradhan Mantri JI-
support to Integrated Bio-ethanol Projects using ligno- VAN Yojana” is being launched as a tool to create
cellulosic biomass and other renewable feedstock. Key 2G Ethanol capacity in the country and attract
features of the scheme are the following : investments in this new sector.
● Total financial outlay of the scheme is R 1969·50
crore for the period from 2018-19 to 2023-24. Out Bangla Shashya Bima (BSB) Yojana
of it R 1800 crore has been allocated for supporting West Bengal government has announced a crop
12 Commercial projects, R 150 crore has been insurance scheme in collaboration with the Agriculture
allocated for supporting 10 demonstration Projects Insurance Company of India (AIC), for the 2019 kharif
and remaining R 9·50 crore will be provided to season. The scheme called Bangla Shashya Bima (BSB)
Centre for High Technology (CHT) as adminis- is applicable for farmers in 15 districts—Darjeeling,
trative charges. Kalimpong, Purba Bardhaman, Paschim Bardhaman,
● Under this Yojana, 12 Commercial Scale and 10 Purba Medinipur, Malda, Hooghly, Nadia, Murshida-
demonstration scale Second Generation (2G) ethanol bad, Cooch Behar, Birbhum, Purulia, Dakshin Dinajpur,
Projects will be provided a Viability Gap Funding North 24 Parganas and South 24 Parganas.
(VGF) support in two phases. The crop insurance scheme would be free of cost for
● The scheme focuses to incentivise 2G Ethanol the farmers since the government will pay the full
sector and support this nascent industry by creating premium. The crops that will come under insurance are
a suitable ecosystem for setting up commercial aman paddy, aus paddy, jute and maize.
projects and increasing Research & Development in All farmers taking loans (granted or applied for)
this area. and even those not taking loans can avail of the
● Apart from supplementing the targets envisaged by insurance. The insurance will be paid in four stages for
the Government under EBP programme, the scheme any losses suffered during planting, during cultivation,
will also have the following benefits : during the period post-cutting when crops are lying in
(a) Meeting Government of India vision of reducing the field, and for adverse weather situations. The
import dependence of crude oil by way of sub- amount will be decided by the state government and will
stituting fossil fuels with Bio-fuels. be calculated per hectare.
(b) Achieving the GHG emissions reduction targets
through progressive blending/ substitution of fossil PM Scientific Advisory Council
fuels. 9 Missions
(c) Addressing environment concerns caused due to PMSTIAC, constituted in October 2018, headed by
burning of biomass / crop residues and improve Vijay Raghavan, has NITI Aayog member V.K.
health of citizens. Saraswat, former ISRO Chairman A.S. Kiran Kumar,
(d) Improving farmers’ income by providing them Field Medal-winning mathematician Manjul Bhargava
remunerative income for their otherwise waste and Indian National Science Academy President Ajay
agriculture residues. Kumar Sood among others, as members. The Prime
(e) Creating rural & urban employment opportunities in Minister’s Science, Technology and Innovation
2G Ethanol projects and Biomass supply chain. Advisory Council (PMSTIAC) has launched Nine
(f) Contributing to Swacch Bharat Mission by Missions of national importance, including those on
supporting the aggregation of nonfood bio-fuel artificial intelligence, quantum computing, electric
feed-stocks such as waste biomass and urban waste. vehicles and deep ocean exploration.
650U | Economics (NET)
The missions that would be led by a nodal ministry Policy Initiatives
with collaborations from other ministries, research
institutions and industry partners are expected to focus National Mineral Exploration Policy 2016
on complex problems faced in each of these chosen The Government of India has, in the recent past,
fields within a stipulated time-frame. taken a series of measures for the growth of the mineral
The missions are aimed at understanding and sector, including allowing 100% FDI. However, these
conserving biodiversity, developing sustainable agri- initiatives have fetched only limited success. Further,
cultural processes, leveraging precision health for over the years the dynamics of the mineral sector have
personal well-being, recovering wealth from waste, undergone sea change thereby creating new demands and
developing and using artificial intelligence, quantum imperatives. There is a compelling need to provide an
computing, connected mobility solutions and other impetus to exploration activity in the country.
technologies to address frontier scientific questions and This has prompted the Government to carry out a
the challenges that the country in particular and the comprehensive review of its exploration policy and
planet in general face. strategy. The amendments brought in to the Mines and
Minerals (Development and Regulation). Amend-
● The Quantum Frontier mission will focus on
ment Act, 2015 is a step in this direction. The most
quantum technologies such as quantum computing, important feature of this amendment is that mining
quantum cryptology and quantum communication. leases (ML) and prospecting license-cummining lease
The Department of Science and Technology (DST) (PL-cum-ML) will be granted only through an auction
would be the lead agency for quantum mission process. This is expected to bring in transparency,
● The mission on artificial intelligence (AI) is expeditiousness and simplification in procedures in grant
expected to witness close academia-industry of mineral concessions. Against this background, the
collaboration at national as well as international National Mineral Exploration Policy has been framed so
levels in creating new knowledge as well as in as to provide a new set of objectives, sense of purpose
developing and deploying applications. NITI Aayog and direction to exploration within the amended legal
is expected to spearhead the AI mission. framework. The Union Cabinet chaired by the Prime
● The Department of Biotechnology and Department Minister Shri Narendra Modi has approved the National
of Health Research will lead a mission on har- Mineral Exploration Policy (NMEP) on June 29, 2016.
nessing bioscience for improving health of Indians. Objectives of NMEP
● One of the major tasks cut out for those involved in The NMEP primarily aims at accelerating the
electric vehicles is to make them energy-efficient exploration activity in the country through enhanced
and economically viable. Those working on mission participation of the private sector. There is a need for
on Electric Vehicles will have to develop light comprehensive mineral exploration of the country to
and efficient batteries, vehicle sub-systems and uncover its full mineral potential so as to put the nation’s
components suitable for Indian conditions, including mineral resources (non-fuel and non-coal) to best use
rare-earth based electric motors. and thereby maximize sectoral contribution to the Indian
● The Ministry of Earth Sciences will spearhead a economy.
mission on Deep Ocean Exploration that intends to The policy emphasizes on making available baseline
scour the deep ocean. geoscientific data of world standards in the public
● Other missions would include the one for creating domain, quality research in a publicprivate partnership,
wealth from waste, conserving biodiversity, build- special initiatives for search of deepseated and concealed
ing an innovation eco-system for start-ups and using deposits, quick aero-geo-physical surveys of the country,
a combination of machine and human translation and creation of a dedicated geo-science database etc.
techniques to help Indian students who are not well- Main Features of NMEP
versed in English language access scientific
knowledge. NMEP has the following main features for
facilitating exploration in the country :
The New Missions 1. The Ministry of Mines will carry out auctioning of
1. National Language Translation identified exploration blocks for exploration by
2. Quantum Frontier private sector on revenue sharing basis in case their
3. Artificial Intelligence
exploration leads to auctionable resources. The
revenue will be borne by the successful bidder of
4. National Biodiversity
those auctionable blocks.
5. Electric Vehicles
2. If the explorer agencies do not discover any
6. Bioscience for Human Health
auctionable resources, their exploration expenditure
7. Waste to Wealth will be reimbursed on normative cost basis.
8. Deep Ocean Exploration
3. Creation of baseline geo-scientific data as a public
9. Accelerating Growth for New India’s Innovation good for open dissemination free of charge.
Economics (NET) | 651U
4. Government will carry out a National Aero-geo- 3. Government will launch a special initiative to probe
physical Programme for acquiring state-of-the-art deepseated / concealed mineral deposits in the
baseline data for targeting concealed mineral country. Characterizing India’s geological cover,
deposits. investigating India’s lithospheric architecture,
5. A National Geo-scientific Data Repository is resolving 4D geo-dynamic and metallogenic
proposed to be set up to collate all baseline and evolution, and detecting and characterizing the
mineral exploration information generated by distal footprints of ore deposits, would be the main
various Central & State government agencies and components of this initiative.
also mineral concession holders and to maintain 4. A National Aero-geophysical Mapping programme
these on geo-spatial database. will be launched to map the entire country with low
6. Government proposes to establish a not-for-profit altitude and close space flight to delineate the deep-
autonomous institution that will be known as the seated and concealed mineral deposits.
National Centre for Mineral Targeting (NCMT) in 5. Government will engage private agencies for
collaboration with scientific and research bodies, carrying out exploration in identified blocks / areas
universities and industry for scientific and with the right to certain share in the revenue
technological research to address the mineral accruing to the State government through auction.
exploration challenges in the country. 6. Public expenditure on regional and detailed explora-
7. Provisions for inviting private investment in explo- tion will be prioritized and subject to periodical
ration through attractive revenue sharing models. review based on assessment of criticality and
strategic interests.
8. On the lines of UNCOVER project of Australia, the
government intends to launch a special initiative to New Mining Policy, 2016
probe deep seated/concealed minerals deposits in
the country in collaboration with National Geo- The Union Cabinet has over-hauled India’s mineral
physical Research Institute and the proposed NCMT exploration policy to accelerate the development of the
and Geo-science Australia. country’s untapped reserves of iron ore, gold, diamonds,
limestone, tungsten and other minerals by luring private
‘Uncover’ Project of Geological Survey of participation with attractive terms for sharing revenue.
India The Union Cabinet has approved a National Mineral
Exploration Policy (NMEP) which allows auction of 100
State-of-the-art project to be implemented in 2 selected
areas in the country is focused on probing for deep seated/ prospective mineral blocks. The government now
concealed mineral deposits. expects to attract the private sector in exploration,
This programme is also one of the important action
besides strengthening state-run Geological Survey of
points of the National Mineral Exploration Policy (NMEP) India (GSI), Mineral Exploration Corporation (MECL)
and other notified agencies. According to the official
Main Components of the Project :
sources, India has got 800,000 sq km of area, which has
● Characterising India’s geological cover obvious geological potential for mining. Of this, only 10
● Investigating lithosperic architecture per cent has been explored till date. Government insti-
● Resolving 4D geodynamic and metallogenic evolution tutions like GSI and MECL have limited capabilities.
● Detecting and characterizing the distal footprints of ore Therefore, this step has been taken to invite private
deposits. exploration.
The newly approved policy says selection of private
In order to implement the recommendations of the explorers would be through a transparent process of
NMEP, initially an amount of about 2116 crore over 5 competitive bidding via e-auction. Mineral blocks for
years would be required over and above the annual plan regional exploration will be identified by state govern-
budget of the Geological Survey of India under the ments, for auctioning. Once the explorer gives data after
Ministry of Mines. The NMEP will benefit the entire exploration, the state government will auction the mining
mineral sector across the country. lease for that block. The mining lease owner will then
Major Impact of NMEP pay a royalty to the state. Additionally, an amount
equivalent to a certain percentage of this royalty would
The major impactss of NMEP are : be paid to the private explorer by the mining lease
1. The pre-competitive baseline geo-scientific data will owner. The revenue sharing could be in the form of a
b e created as a public good and will be fully lump sum or an annuity to be paid through the period of
available for open dissemination free of charge. This mining lease, with transferable rights. If explorer
is expected to benefit public and private exploration agencies do not discover any auctionable resources, their
agencies. exploration expenditure will be reimbursed.
2. The collaboration with scientific and research As per the official estimate, for implementing the
bodies, universities and industry for the scientific NMEP recommendations, R 2,116 crore over five years
and technological development necessary for would be required, over and above the annual plan
exploration in public-private partnership. budget of the GSI.
652U | Economics (NET)
National Capital Goods Policy 2016 ● Export obligation would be reduced by 25 per cent
Union Cabinet approved the country’s first ‘National and incentives available under the MEIS and SEIS
Capital Goods Policy’, 2016 on 25th May, 2016. Salient would be extend to the units in the SEZs to make
features of the policy are the following : them more attractive for investors. SEZs have lost
their sheen after imposition of the minimum
● It seeks to treble the production of capital goods in
alternate tax (MAT) and dividend distribution tax
10 years to R 7,50,000 crore. (DDT) in 2012.
● It will provide direct & indirect employment to 30
● Debits against scrips would be eligible for
million people from the current 8·4 million.
CENVAT credit or drawback.
● It will help in promoting growth and capacity
building of Micro Small and Medium Enterprises ● Further business services, hotel and restaurants
(MSME) are also on the agenda. would get rewards scrips under SEIS at the rate of 3
per cent and other specified services at the rate of 5
● It aims to strengthening the existing scheme of the
per cent.
Department of Heavy Industry to enhance the
competitiveness of the capital goods sector by ● SEIS would be applied to ‘Service Providers located
increasing its budgetary allocation. in India’ instead of ‘Indian Service Providers’.
● The policy also aims to increase exports from the ● Served from India Scheme (SFIS) replaced with
current 27 per cent of production to 40 per cent. SEIS.
● It will increase the share of domestic production in ● Under MEIS, the main sectors to be provided
India’s demand from 60 per cent to 80 per cent, support includes processed, packaged agricultural
making India a net exporter of capital goods. and food items, agricultural and village industry
● The policy addresses key issues such as availability goods.
of finance, raw materials, innovation and techno- ● These schemes (MEIS and SEIS) replace multiple
logy, and productivity, among other things. schemes earlier in place, each with different
● It also proposes devising a long-term, stable and conditions for eligibility and usage. Benefits from
rationalised tax and duty structure to create an both these schemes will be extended to units located
ecosystem for a globally competitive capital goods in SEZs.
sector. ● Nomenclature of Export House, Star Export House,
India’s Foreign Trade Policy 2015–20 Trading House, Premier Trading House certificate
changed to 1, 2, 3, 4, 5 Star Export House.
India aims to increase India’s exports of merchan-
dise and services from US $ 465·9 billion in 2013-14 to ● Higher level of rewards under MEIS for export
approximately US $ 900 billion by 2019-20 and to raise items with high domestic content and value
India’s share in world exports from 2 per cent to 3·5 per addition.
cent. Unveiling the first trade policy of the National ● Chapter-3 incentives extended to units located in
Democratic Alliance (NDA) government, Commerce SEZs.
Minister Nirmala Sitharaman said the FTP (2015-20) ● Export obligation under EPCG scheme reduced to
will introduce Merchandise Exports from India Scheme 75% to promote domestic capital goods
(MEIS) and Services Exports from India Scheme (SEIS) manufacturing.
to boost outward shipments. Besides, higher level of ● FTP to be aligned to ‘Make in India’, ‘Digital India’
incentives will be provided for export of agriculture
and ‘Skills India’ initiatives.
products under the Foreign Trade Policy (FTP), which
seeks to integrate with Make in India and Digital India ● Duty credit scrips made freely transferable and
initiatives of the government. The FTP also seeks to usable for payment of custom duty, excise duty and
establish an Export Promotion Mission to provide an service tax.
institutional framework to work with State Governments ● Export promotion mission to take on board state
to boost India’s exports. governments.
The salient features of the new Foreign Trade Policy ● Unlike annual reviews, FTP will be reviewed after
2015-20 are the following : two-and-half years. Higher level of support for
● Merchandise Export from India Scheme (MEIS) export of defence, farm produce and eco-friendly
and Service Exports from India Scheme (SEIS) products.
launched. The ‘Services Exports from India ● Agricultural and village industry products to be
Scheme’ (SEIS) is for increasing exports of notified supported across the globe at rates of 3% and 5%
services. These schemes (MEIS and SEIS) replace under MEIS.
multiple schemes earlier in place, each with different
conditions for eligibility and usage. Incentives ● Industrial products to be supported in major markets
(MEIS & SEIS) to be available for SEZs also. at rates ranging from 2% to 3%.
e-Commerce of handicrafts, handlooms, books etc., ● Branding campaigns planned to promote exports in
eligible for benefits of MEIS. sectors where India has traditional strength.
Economics (NET) | 653U
FTP to promote e-Commerce companies international trade, but also to enable developing
focusing on job creation : countries to articulate their views and concerns from
● Under the new five-year Foreign Trade Policy a well-informed position of strength.
(FTP), the government will provide incentives to e- ● Two institutional mechanisms are being put in place
Commerce companies exporting products from for regular communication with stakeholders the
sectors that create jobs. Board of Trade and the Council for Trade Develop-
● Firms that export goods through courier or foreign ment (CTD) and Promotion. While the Board of
post office using e-commerce of FOB (Freight on Trade will have an advisory role, the CTD would
Board) value up to R 25,000 per consignment will have representation from State and UT governments.
be entitled for rewards under MEIS. The CTD will be an institution between the Centre
and the States with the objective of internalising the
● The objective of MEIS is to offset infra inefficiencies thinking and the processes and the participation of
and associated costs involved in export of goods, State government into central government policy
which are manufactured in India and especially those making, implementation and monitoring.
having high export intensity, employment potential
and can enhance India’s export competitiveness. Mid-Term Review of Foreign Trade
● If the value of exports using e-commerce platform is Policy 2015–20
more than R 25,000 per consignment then MEIS Union Commerce and Industry Minister Suresh
reward would be limited to FOB value of R 25,000 Prabhu on December 5, 2017 unveiled Mid-Term
only. Review of Foreign Trade Policy 2015-20 by
● The goods entitled for benefit under the scheme are announcing a slew of incentives to boost country’s
handloom, books & periodicals, leather footwear, exports. Mid-term review of FTP will leverage the long
toys and customised fashion garments. term advantages of GST in terms of reduced compliance
● Export of such goods under courier regulations shall and logistics costs.
be allowed manually on pilot basis through airports Following are the highlights of the Mid-Term
at New Delhi, Mumbai and Chennai Department of Review of the Foreign Trade Policy (FTP) 2015-20 :
Revenue shall fast track the implementation of EDI ● Scope of Merchandise Exports from India Scheme
mode at courier terminals. (MEIS) and Service Exports from India Scheme
FTP proposes new institutions to boost global (SEIS) enhanced.
trade : ● MEIS incentive raised for readymade garments and
● The new Foreign Trade Policy proposed setting up made-ups by 2% (additional annual outgo R 2,743
of the following (i) Trade Council and (ii) National crore).
Committee on Trade Facilitation, to improve ● Across-the-board increase of 2 per cent in existing
India’s share in global trade and implement of WTO MEIS for exports b y MSMEs/labour incentive
obligations. industries (R 4,567 crore).
● A National Committee on Trade Facilitation is being ● Annual incentive increased by 34 per cent to
constituted for domestic coordination and imple- R 8,450 crore.
mentation of the TFA. ● SEIS incentives raised by 2 per cent with a view to
● Several initiatives are under way for the simpli- boosting services sector exports (R 1,140 crore).
fication of procedures and digitization of various ● Validity of Duty Credit Scrips increased from 18
processes involved in trade transactions. months to 24 months to enhance their utility in GST
● Steps are being taken by various ministries and framework.
departments to simplify administrative procedures ● To focus on improving ease of trading across
and reduce transaction costs based on the borders for exporters and importers.
recommendations of two task forces constituted by ● Professional team to handhold, assist and support
the Directorate General of Foreign Trade. exporters in accessing markets, meeting regulatory
● Specific measures will be taken to facilitate the norms.
entry of new entrepreneurs and manufacturers in ● New Logistics Division to promote integrated
global trade through extensive training programmes. development of the logistics sector.
● “The Niryat Bandhu” scheme will be revamped to ● State-of-the-art trade analytics division in DGFT for
achieve these objectives and also further dovetailed data-based policy actions.
with the ongoing outreach programmes. ● New agricultural exports policy to focus on
● Capacity development efforts will focus on export increasing exports of value-added agri products.
promotion councils and commercial missions. ● New Services Division in DGFT to examine Exim
● A new institution Centre for Research in Inter- policies and procedures to push services exports.
national Trade is being established not only to ● Supplies of goods and services to SEZs to be treated
strengthen India’s research capabilities in the area of as zero rated under GST.
654U | Economics (NET)
● Import of second hand goods for repair / refurbi- 4. Regional Connectivity Scheme (RCS) to revive
shing / re-conditioning / re-engineering made free. unserved airports and routes in Tier II/III cities.
● Increase focus on exploring new markets and 5. Regional connectivity, Cargo, MRO and Skill deve-
products, raising share in traditional markets and lopment to be focus areas.
products. 6. Four heli-hubs to be developed. Helicopter
● Promotion of exports by MSMEs and labour Emergency Medical Services to be facilitated.
intensive sectors to increase employment opportuni- 7. Development of greenfield and brownfield airports
ties for youth. by State government, private sector or in PPP mode
● To enhance participation of Indian industry in to be encouraged.
global value chains. 8. Open skies on reciprocal basis for SAARC nations
● The FTP would focus on micro, small and medium and countries beyond 5000 km.
enterprises, labour-intensive segments and agricul- 9. Domestic Airlines will not require prior approval
ture sector. before entering into international code share
● Self-certification scheme for duty-free imports. agreements.
● Trade accounts for 45% of the country’s GDP. FTP 10. 50 to 100 no frills airport to be set up.
incentives now cover 8,000 of the total 12,000 lines
of items. National Intellectual Property Rights
● Of these incentives, R 749 crore for leather and Policy, 2016
footwear, R 1354 crore for agriculture and related The National Intellectual Property Rights (IPR)
items, R 759 crore for marine exports, R 369 crore Policy as approved by Union Cabinet on May 13, 2016
for telecom and electronic items, R 921 crore for will endeavour for a ‘Creative India; Innovative India
handmade carpets, R 193 crore for medial and jpukRed` Hkjr] vfHuo Hkjr’¸.
surgical equipments, R 1140 crore for textiles and
ready made garments. The National IPR Policy is a vision document that
aims to create and exploit synergies between all forms of
● The department has also abolished the GST for
Intellectual Property (IP), concerned statutes and
transfer and sale of these scrips to zero from 12 per
agencies. It sets in place an institutional mechanism for
cent, increased the validity period for these
implementation, monitoring and review. It aims to
tradeable papers to 24 months from 18 months.
incorporate and adapt global best practices to the Indian
● The round-the-clock customs clearance facility has scenario. This policy shall weave in the strengths of the
been extended at 19 sea ports and 17 air cargo Government, research and development organizations,
complexes. Through export promotion of capital educational institutions, corporate entities including
goods and the 100 per cent EoU scheme, exporters MSMEs, start-ups and other stakeholders in the creation
have been extended the benefit of sourcing inputs of an innovation-conducive environment, which
and capital goods from abroad, as well as domestic stimulates creativity and innovation across sectors, as
suppliers for exports without upfront payment of the also facilitates a stable, transparent and service-oriented
GST. IPR administration in the country.
● Merchant exporters have been allowed to pay The Policy recognizes that India has a well-
nominal GST of 0·1 per cent for procuring goods established Trade Related Intellectual Property Rights-
from domestic suppliers for exports. compliant legislative, administrative and judicial frame-
● A new trade data analytics division under the work to safeguard IPRs, which meets its international
Directorate General of Foreign Trade will analyse obligations while utilizing the flexibilities provided in
real time data to help fine tune policy. the international regime to address its developmental
concerns. It reiterates India’s commitment to the Doha
New National Aviation Policy 2016 Development Agenda and the TRIPS agreement.
Union Cabinet on June 15, 2016 approved the The broad contours of the National IPR Policy are
much-awaited national civil aviation policy. Dubbing it as follows :
as a game changer, Civil Aviation Minister Ashok Vision Statement : An India where creativity and
Gajapathi Raju said the country’s aviation sector is innovation are stimulated by Intellectual Property for the
poised to become the world’s third largest by 2022. benefit of all; an India where intellectual property
1. Govt. scraps 5/20 norms to allow Indian carriers to promotes advancement in science and technology, arts
fly abroad. Any domestic airline can start inter- and culture, traditional knowledge and biodiversity
national operations if it has 20 aircraft fleet. Airlines resources; an India where knowledge is the main driver
no longer need to wait for 5 years before starting of development, and knowledge owned is transformed
international operations. into knowledge shared.
2. Refund of cancelled tickets to be paid in 15 days.
3. Fares on Regional Connectivity Scheme (RCS) Mission Statement
routes to be R 2500 inclusive of taxes for an hour Stimulate a dynamic, vibrant and balanced
flight and R 1,200 for 30 minutes flight. intellectual property rights system in India to :
Economics (NET) | 655U
● foster creativity and innovation and thereby, promote GDP. India has also crossed 100 MT mark for
entrepreneurship and enhance socio-economic and production for sale in 2016-17. Overtaking Japan, India
cultural development, and emerged as the second largest stainless steel producer in
● focus on enhancing access to healthcare, food the world after China. India’s stainless production rose
security and environmental protection, among other to 3·32 million tonnes for 2016.
sectors of vital social, economic and technological With the roll out of the National Steel Policy-2017,
importance. it is envisaged that the industry will be steered in creat-
ing an environment for promoting domestic steel and
Objectives thereby ensuring a scenario where production meets the
The Policy lays down the following seven anticipated pace of growth in consumption, through a
objectives : technologically advanced and globally competitive steel
● IPR Awareness : Outreach and Promotion—To industry. This will be facilitated by Ministry of Steel, in
create public awareness about the economic, social coordination with relevant Ministries, as may be
and cultural benefits of IPRs among all sections of required.
society. Key highlighting features of the NSP 2017 are :
● Generation of IPRs—To stimulate the generation 1. Create self-sufficiency in steel production by
of IPRs. providing policy support & guidance to private
● Legal and Legislative Framework— T o have manufacturers, MSME steel producers, CPSEs
strong and effective IPR laws, which balance the 2. Encourage adequate capacity additions,
interests of rights owners with larger public interest. 3. Development of globally competitive steel manu-
● Administration and Management—To modernize facturing capabilities,
and strengthen service-oriented IPR administration. 4. Cost-efficient production
● Commercialization of IPRs—Get value for IPRs 5. Domestic availability of iron ore, coking coal &
through commercialization. natural gas,
● Enforcement and Adjudication—To strengthen 6. Facilitating foreign investment
the enforcement and adjudicatory mechanisms for 7. Asset acquisitions of raw materials
combating IPR infringements.
8. Enhancing the domestic steel demand.
● Human Capital Development—To strengthen and
expand human resources, institutions and capacities New Metro Rail Policy, 2017
for teaching, training, research and skill building in The Union Cabinet has approved a new Metro Rail
IPRs. Policy that seeks to enable realization of growing metro
These objectives are sought to be achieved through rail aspirations of a large number of cities but in a
detailed action points. The action by different responsible manner. The policy opens a big window for
Ministries/Departments shall be monitored by DIPP private investments across a range of metro operations
which shall be the nodal department to coordinate, making PPP component mandatory for availing central
guide and oversee implementation and future assistance for new metro projects. Private investment
development of IPRs in India. and other innovative forms of financing of metro
New National Steel Policy 2017 projects have been made compulsory to meet the huge
resource demand for capital intensive high capacity
The Union Cabinet has given its approval for New metro projects.
National Steel Policy (NSP) 2017. The new Steel Policy In view of inadequate availability and even absence
enshrines the long term vision of the Government to of last mile connectivity at present, the new policy seeks
give impetus to the steel sector. It seeks to enhance to ensure it focusing on a catchment area of five kms on
domestic steel consumption and ensure high quality steel either side of metro stations requiring States to commit
production and create a technologically advanced and in project reports to provide necessary last mile
globally competitive steel industry. connectivity through feeder services, Non-Motorised
The policy projects crude steel capacity of 300 Transport infrastructure like walking and cycling
million tonnes (MT), production of 255 MT and a robust pathways and introduction of para-transport facilities.
finished steel per capita consumption of 158 Kgs by States, proposing new metro projects will be required to
2030-31, as against the current consumption of 61 kgs. indicate in project report the proposals and investments
The policy also envisages to domestically meet the that would be made for such services.
entire demand of high grade automotive steel, electrical The new Metro Rail Policy provides for rigorous
steel, special steels and alloys for strategic applications assessment of new metro proposals and proposes an
and increase domestic availability of washed coking coal independent third party assessment by agencies to be
so as to reduce import dependence on coking coal from identified by the Government like the Institute of Urban
about 85% to around 65% by 2030-31. Transport and other such Centres of Excellence whose
Indian steel sector has grown rapidly over the past capacities would be augmented, as required in this
few years contributing to about 2% of the country’s regard.
656U | Economics (NET)
Taking note of substantial social, economic and facilitate local manufacturing and boost domestic
environmental gains of metro projects, the Policy demand for locally manufactured products.
stipulated a shift from the present ‘Financial Internal ● The preference to the domestic manufactured goods
Rate of Return of 8%’ to ‘Economic Internal Rate of would be given under the ‘Government Procure-
Return of 14%’ for approving metro projects, in line ment Preference to Make in India order 2017.’
with global practices. ● Eligibility norms/conditions would be made non-
The new policy empowers States to make rules and restrictive and avoided in tenders.
regulations and set up permanent Fare Fixation Authority ● Standing committee would over-see implementation
for timely revision of fares. States can take up metro of Make in India preference in public procurement.
projects exercising any of the three options for availing ● There would be a transparent mechanism of self-
central assistance. These include PPP with central
certification and a third party certification to verify
assistance under the Viability Gap Funding scheme of
local content.
the Ministry of Finance, Grant by Government of India
under which 10% of the project cost will be given as ● There would also be an annual review to increase
lump sum central assistance and 50:50 Equity sharing local content requirements in public procurement,
model between central and state governments. Under all which would be subject to local competition and
these options, private participation, however, is quality.
mandatory. ● Preference in government procurement will be
given to local suppliers whose goods or services
Strategic Partnership Model, 2017 meet prescribed minimum thresholds (ordinarily 50
The Union Cabinet has approved the much-awaited per cent) for local content.
strategic partnership model which will allow local ● In procurement of goods for R 50 lakh and less, and
private sector companies to form manufacturing joint where the nodal ministry determines that there is
ventures with foreign defence equipment makers—a sufficient local capacity and local competition, only
shot in the arm for the government’s ‘Make in India’ local suppliers will be eligible.
programme as well as efforts by the Indian private sector ● For procurements valued at more than R 50 lakh (or
to make inroads into the lucrative defence equipment where there is insufficient local capacity or
business. competition) if the lowest bid is not from a non-
● Indian firms Larsen and Toubro Ltd., Ashok local supplier, the lowest-cost local supplier who is
Leyland Ltd., Mahindra and Mahindra Ltd., within a margin of 20 per cent of the lowest bid,
Reliance Infrastructure Ltd., Tata Group, Punj will be given an opportunity to match the lowest bid.
Lloyd, Adani Group and Bharat Forge Ltd., which ● If the procurement is of a type that the order can be
have existing defence businesses, are likely to divided and given to more than one supplier, the
benefit the most from the decision. non-local supplier, who is the lowest bidder will get
● A February 2015 report by lobby group FICCI and half of the order and the local supplier will get the
Centrum Capital estimated that by 2022, the annual other half, if it agrees to match the price of the
opportunity for Indian companies, both state-owned lowest bid. If the procurement cannot be divided,
and private, would be around $ 41 billion. That then the lowest cost local supplier will be given the
number could increase further because of the new order if it agrees to match the lowest bid.
policy. ● Small purchases of less than R 5 lakh are exempted
● The Indian defence industry is currently dominated from the policy. The order also covers autonomous
by state-owned manufacturers, including HAL. bodies, government companies and entities under
the government’s control.
● Under the ‘strategic partnership’ model, the govern-
ment will shortlist and then pick Indian companies As per an estimate, the combined value of annual
to join forces with foreign firms to make fighter jets, procurement by central and state governments work out
helicopters, armoured vehicles and submarines. to R 5-7 lakh crore. The policy lays down a procedure
for verification of local content relying primarily on self-
● Lockheed Martin, Boeing, BAE Systems, Airbus certification. There will be penal consequences for false
and Saab are among the key foreign companies declarations. In some cases, verification by statutory and
looking at the India market. Many like Boeing and cost auditors will be required. A standing committee in
Airbus already source products worth $ 500 million the department of industrial policy and promotion
annually from India. (Dipp) will supervise implementation of this order and
Public Procurement Policy, 2017 for issues arising there from, and make recommendations to
nodal ministries and procuring entities. Meanwhile, the
Local Goods cabinet committee on economic affairs (CCEA) decided
The Union Cabinet on May 24, 2017 approved a to increase fair and remunerative price (FRP) of
public procurement policy to give preference to sugarcane by R 25 per quintal to R 255 for 2017-18
domestically manufactured goods with a view to season beginning October. The FRP is the minimum
promoting ‘Make in India’ initiative. The move would price that sugarcane farmers are legally guaranteed.
Economics (NET) | 657U
Major Policy Initiatives for able housing, direct relationship ownership housing
and direct relationship rental housing.
Increasing Share of Renewable
● Under these six government land-based PPP
Energy in Total Installed Capacity models, beneficiaries can avail Central assistance of
Government of India has taken following initiatives R 1-2.50 lakh per house as provisioned under
to increase the share of renewable energy in total different components of Pradhan Mantri Aawas
installed capacity. Yojana-PMAY (Urban).
1. Announced a cumulative target of 175 GW
● Beneficiaries will be identified as per the norms of
renewable energy based electric installed capacity
of 100 GW solar power installed capacity; PMAY (Urban).
2. Issued guidelines for procurement of solar and wind National Policy on Biofuels-2018
power through tariff based competitive bidding
The Union Cabinet, chaired by the Prime Minister
process;
Shri Narendra Modi has approved National Policy on
3. Declared Renewable Purchase Obligation (RPO) up Biofuels-2018.
to the year 2018-19;
4. Declared Renewable Generation Obligation on new Salient Features
coal/lignite based thermal plants; ● The Policy categorises biofuels as ‘Basic Biofuels’
5. Notified National Offshore Wind Energy Policy; viz. First Generation (1G) bioethanol bio-diesel and
6. Notified policy for Repowering of Wind Power ‘Advanced Biofuels’ Second Generation (2G)
Projects; ethanol, Municipal Solid Waste (MSW) to drop-in
7. Notified standards for deployment of solar fuels, Third Generation (3G) biofuels, bio-CNG etc.
photovoltaic systems/devices; to enbale extension of appropriate financial and
8. Issued order for waiving the Inter State Trans- fiscal incentives under each category.
mission System charges and losses for interstate ● The Policy expands the scope of raw material for
sale of solar and wind power for projects to be ethanol production by allowing use of Sugarcane
commissioned by March 2019; Juice, Sugar containing materials like Sugar Beet,
9. Launched Atal Jyoti Yojana for Solar LED Street Sweet Sorghum, Starch containing materials like
Lights in five States; and Corn, Cassava, Damaged foodgrains like wheat,
10. Launched Surya Mitra programme for developing a broken rice, Rotten Potatoes, unfit for human
cadre of trained manpower for deployment of solar consumption for ethanol production.
energy projects. ● Farmers are at a risk of not getting appropriate price
The above initiatives resulted in significant increase for their produce during the surplus production
in renewable energy deployment. In October 2017 the phase. Taking this into account, the Policy allows
cumulative renewable power installed capacity was use of surplus foodgrains for production of ethanol
60·98 GW. Of this, 26 GW renewable power installed for blending with petrol with the approval of
capacity was added from April 2014 to October 2017, National Biofuel Coordination Committee.
the Minister added. ● With a thrust on Advanced Bio-fuels, the Policy
indicates a viability gap funding scheme for 2G
New Public-Private Partnership ethanol Bio refineries of R 5000 crore in 6 years in
Policy for Affordable Housing 2017 addition to additional tax incentives, higher
Central Government on September 21, 2017 purchase price as compared to 1G biofuels.
announced a new public-private partnership policy for ● The Policy encourages setting up of supply chain
affordable housing. The main features of the policy are mechanisms for biodiesel production from non-
ahead : edible oilseeds, Used Cooking Oil, short gestation
● It allows assistance of up to R 2.5 lakh per house to crops.
be built by private builders even on private land. ● Roles and responsibilities of all the concerned
● It aims to boost private investments in affordable Ministries/Departments with respect to biofuels has
housing projects on government land in urban areas. been captured in the Policy document to synergise
● The policy gives eight PPP options for the private efforts.
sector to invest in the affordable housing segment.
● Six out of the eight options had been evolved after
National Mineral Policy, 2019
extensive consultations with States, promoter bodies The Union Cabinet on February 28, 2019, chaired
and other stakeholders. by the Prime Minister Narendra Modi has approved
● The six options include the DBT (Design, Build, National Mineral Policy 2019. Key features of the NMP,
Transfer) model, mixed development cross- 2019 are the following :
subsidised housing, annuity-based subsidised ● To ensure more effective regulation it will lead to
housing, annuity-cum-capital grant-based afford- sustainable mining sector development in future
658U | Economics (NET)
while addressing the issues of project affected ● NMP 2019 proposes a long term export import
persons especially those residing in tribal areas. policy for the mineral sector to provide stability
● The aim of NMP, 2019 is to have a more effective, and as an incentive for investing in large scale
meaningful and implementable policy that brings in commercial mining activity.
further transparency, better regulation and enforce-
ment, balanced social and economic growth as well New National Rubber Policy 2019
as sustainable mining practices. The Department of Commerce brought out the
● The National Mineral Policy 2019 includes provi- National Rubber Policy in March 2019. The National
sions which will give boost to mining sector such Rubber Policy includes several provisions to support the
as : Natural Rubber (NR) production sector and the entire
* Introduction of Right of First Refusal for RP/PL rubber industry value chain. The Policy covers new
holders. planting and replanting of rubber, support for growers,
* Encouraging the private sector to take up explo- processing and marketing of natural rubber, labour
ration. shortage, grower forums, external trade, Centre-State
* Auctioning in virgin areas for composite RP cum integrated strategies, research, training, rubber product
PL cum ML on revenue sharing basis. manufacturing and export, climate change concerns and
* Encouragement of merger and acquisition of carbon market.
mining entities.
National Rubber Policy is based on the short term
* Transfer of mining leases and creation of dedi-
cated mineral corridors to boost private sector and long term strategies identified by the Task Force
mining areas. constituted on the rubber sector for mitigating problems
* The NMP 2019 proposes to grant status of faced by rubber growers in the country. The Task Force
industry to mining activity to boost financing held extensive consultations with various stakeholders of
of mining for private sector and for acquisitions rubber sector. Prior to the notification of the National
of mineral assets in other countries by private Rubber Policy, stakeholders’ views were obtained. The
sector. policy is expected to benefit natural rubber growers and
* It also mentions that Long term import export promote the natural rubber production sector.
policy for mineral will help private sector in Developmental and research activities for supporting
better planning and stability in business. NR sector for the welfare of growers are carried out
* The Policy also mentions rationalizing reserved through Rubber Board by implementing the scheme
areas given to PSUs which have not been used
Sustainable and Inclusive Development of Natural
and to put these areas to auction, which will give
more opportunity to private sector for partici- Rubber Sector in the Medium Term Framework (MTF)
pation. (2017-18 to 2019-20). The developmental activities
* The Policy also mentions to make efforts to include financial and technical assistance for planting,
harmonize taxes, levies and royalty with world supply of quality planting materials, support for grower
benchmarks to help private sector forums, training and skill development programme.
● Among the changes introduced in the National
Mineral Policy, 2019 is included the focus on make Foreign Trade and Balance of
in India initiative and Gender sensitivity in terms of Payments
the vision. Volume of India’s Foreign Trade
● In so far as the regulation in Minerals is concerned, After independence, Indian foreign trade has made
E-Governance, IT enabled systems, awareness and cumulative progress both qualitatively and quantitatively.
Information campaigns have been incorporated. Though the size of foreign trade and its value both have
● Regarding the role of state in mineral development increased during post-independence era, this increase in
online public portal with provision for generating foreign trade cannot be said satisfactory because Indian
triggers at higher level in the event of delay of share in total foreign trade of the world has remained
clearances has been put in place. remarkable low. In 1950, the Indian share in the total
● NMP 2019 aims to attract private investment world trade was 1·78%, which came down to 0·6% in
through incentives while the efforts would be made 1995. India’s merchandise trade has been growing in
to maintain a database of mineral resources and importance over the years with the share in world
tenements under mining tenement systems. exports and imports increasing, though gradually, from
● NMP 2019 focusses on the use of coastal waterways 0·7 per cent and 0·8 per cent respectively in 2000 to 1·68
and inland shipping for evacuation and transporta- per cent and 2·48 per cent respectively in 2017. India’s
tion of minerals and encourages dedicated mineral ranking in the top merchandise exporters and importers
corridors to facilitate the transportation of minerals. in the world has also improved from 30th in 2000 to
● The utilization of the district mineral fund for 20th in 2017 in exports and from 23rd to 11th for
equitable development of project affected persons imports in the same years, as per the World Trade
and areas. Organization (WTO). There has also been marked
Economics (NET) | 659U
improvement in India’s total merchandise trade to GDP Performance of India’s Foreign
ratio from 21·8 per cent in 2000-01 to 29·55 per cent in
2017-18. Trade
In the context of global slowdown of output and
Indian Share in World Trade trade, growing trade protectionism and unilateralism
(in %) across the world, India’s external sector has shown a
Year Export Import Trade rather satisfactory performance in 2018-19. India’s
1950 1·85 1·71 1·78 macroeconomic situation on the external side continues
1960 1·03 1·69 1·36 to be stable. Though the current account deficit increases
1970 0·64 0·65 0·65 to 2·1 per cent of GDP in 2018-19 (US $ 57·2 billion),
up from 1·8 per cent in 2017-18, this is within
1980 0·42 0·72 0·57
reasonable levels. The widening of the current account
1990 0·52 0·66 0·59
deficit has been driven by a deterioration of trade deficit
1991 0·50 0·56 0·53
from 6.0 per cent of GDP to 6·7 per cent across the two
1992 0·53 0·61 0·57 years. India’s merchandise exports increased to US $
1997 0·60 0·60 0·60 330·07 billion in 2018-19, registering a growth rate of
1998 0·60 0·60 0·60 8·75 per cent over 2017-18 (US $ 303·53 billion).
1999 0·60 0·80 0·70 Imports grew more faster at 10·41 per cent in 2018-19
2000 0·70 0·80 0·70 over 2017-18 and reached at US $ 514·03 billion in
2010 1·5 2·0 — 2018-19 from US $ 465·58 billion in 2017-18. As a
2011 1·7 2·5 — result Trade deficit widened to US $ 183·96 billion in
2012 1·6 2·63 — 2018-19 from US $ 162·06 billion in 2017-18.
2013 1·7 2·5 — So far as services trade is concerned, the perfor-
2014 1·7 2·43 — mance of services exports as well as services imports
2015 1·62 2·34 — has decelerated during 2018-19 as compared to 2017-18.
2016 1·65 2·21 — Services exports grew by only 5·49 per cent in 2018-19
2017 1·68 2·48 — as compared to a high growth rate of 18·81 per cent in
India's trade links with all the regions of the world 2017-18. Likewise , services imports registered a modest
have increased over the years. In view of the current growth rate of 6·75 per cent in 2018-19 as compared to
wave of worldwide globalisation, India has taken major 22·61 per cent growth rate registered in 2017-18. It is
initiatives to diversify its exports as also their des- to be worth mentioning here that Net of Services trade is
tinations. Indian exports cover over 7500 commodities to financing 43·67 per cent of the merchandise trade deficit
about 190 countries while imports from about 140 in 2018-19.
countries account for over 6000 commodities.
It is a remarkable fact that during whole planning I. Merchandise Trade
period our balance of trade has remained unfavourable. The broad trends in Merchanise Exports, Imports
Our imports have exceeded exports, showing a trade and Trade Balance in the last ten years are indicated in
deficit. the table 1 & 2.
Only two financial years i.e., 1972-73 and 1976-
77 were exceptional in showing favourable balance of Table 1. Merchandise Trade
trade worth 104 crore and 68 crore respectively. (Values in US $ billion)
The deficit in balance of trade in our country has been Year Exports Growth Imports Growth Trade
generally increasing, even though our foreign trade has (%) (%) Balance
been getting much more broad based. The Government
has introduced a number of measures for reducing 2009-10 178·75 – 3·53 288·37 – 5·05 – 109·62
deficit in the balance of trade. The main objective was to 2010-11 249·82 39·76 369·77 28·23 – 119·95
control imports on the one hand and to promote exports 2011-12 305·96 22·48 489·32 32·33 – 183·36
on the other. The basic reason of increasing deficit in
balance of trade in India has been the high import bill of 2012-13 300·40 – 1·82 490·74 0·29 – 190·34
petroleum products. Since July 1991, the government 2013-14 314·41 4·66 450·20 – 8·26 – 135·80
adopted the policy of economic liberalisation and a series
2014-15 310·34 – 1·29 448·03 – 0·48 – 137·70
of economic reforms were adopted in the country.
Devaluation of rupee in 1991, and the convertibility 2015-16 262·29 – 15·48 381·01 – 14·96 – 118·72
of Indian rupee in trade account and current account 2016-17 275·85 5·17 384·36 0·88 – 108·51
during 1993-94 and 1994-95 respectively improved the 2017-18 303·53 10·03 465·58 21·13 – 162·06
balance of trade position in 1993-94. But the deficit
again increased during the subsequent years. 2018-19 330·07 8·75 514·03 10·41 – 183·96
660U | Economics (NET)
II. India’s Services Trade continue to have the largest share in India’s export
basket at 14·1 per cent in 2018-19.
Table 2. Services Trade The growth in merchandise imports from 0·9 per
(Values in US $ billion) cent in 2016-17 to 10·4 per cent in 2018-19 can also be
Year Exports Growth Imports Growth Net of attributed to a sharp rise in growth rate of POL imports
(%) (%) Services from 4·8 per cent in 2016-17 to 29·7 per cent in 2018-19.
The non-POL imports also increased from – 0·2 per cent
2009-10 96·04 – 9·36 60·03 15·34 36·02 in 2016-17 to 4·5 per cent in 2018-19, possibly depicting
2010-11 124·64 29·77 80·55 34·19 44·08 a downturn in the economy. This appears to be all the
2011-12 142·32 14·19 78·23 – 2·89 64·10 more so as in Q4 of 2018-19 both POL and Non-POL
imports registered negative growth rate. Even then,
2012-13 145·68 2·36 80·76 3·24 64·91
Crude petroleum continues to be the largest imported
2013-14 151·81 4·21 78·75 – 2·50 73·07 commodity in 2018-19 with a share of 22·2 per cent,
2014-15 158·11 4·15 81·58 3·59 76·53 followed by Gold/Silver; Pearl, Precious, Semi-Precious
2015-16 154·31 – 2·40 84·63 3·75 69·68 Stones; and Petroleum Products; having share of 6·4 per
cent, 5·3 per cent and 5·2 per cent respectively, in the
2016-17 164·20 6·41 95·85 13·25 68·34
import basket.
2017-18 195·09 18·81 117·53 22·61 77·56 The acceleration in growth of POL imports from
2018-19(P) 205·79 5·49 125·46 6·75 80·33 2016-17 to 2018-19 was on account of both price
increase in the international market and volume con-
sumed by India. However, growth of POL exports was
only driven by price rise as volume exported by India
actually contracted from 2016-17 to 2018-19. This
reflects that India is more dependent on POL imports
than the world is on India’s POL exports.
The growth in merchandise exports increased
from 5·2 per cent in 2016-17 to 8·8 per cent in 2018-19.
It has mainly resulted from high growth in Petroleum,
Oil & Lubricants (POL) exports, which increased from
3·1 per cent in 2016-17 to 24·2 per cent in 2018-19,
while non-POL exports grew modestly from 5·4 per cent
to 7·0 per cent between 2017-18 and 2018-19. However, Within Non-POL imports, sharp movements can be
from Q1 of 2018-19, the growth rate of POL exports has seen with respect to annual growth rates of gold and
been declining continuously and turned negative in Q4 silver imports, which increased from – 17·3 per cent in
of 2018-19. Be that as it may, petroleum products 2016-17 to 25·6 per cent in 2017-18, and then reduced to
Economics (NET) | 661U
-0·6 per cent in 2018-19. Non-POL, Non-Gold and besides drug formulations, biologicals (Figure 1). How-
Silver Imports witnessed the same trend with increase in ever; it was exports of organic chemicals which grew the
growth rate from 2·1 per cent in 2016-17 to 19·4 per highest at 30·6 per cent in 2018-19.
cent in 2017-18, and then a deceleration to 5·1 per cent
In the import basket of 2018-19, petroleum: crude,
in 2018-19, unlike Gold and Silver Imports, whose
at 22·2 per cent had the largest share followed by gold
growth again turned negative in 2018-19, although not
and other precious metal Jewelry at 6·4 per cent and
to the same extent as in 2016-17. A positive Q4 of 2018-
pearls precious/ semi-precious stones at 5·3 per cent
19 growth of gold and silver imports did not allow its
(Figure 2). Growth rates of gold and pearls (including
growth to fall as much for the full year whereas the
precious and semi-precious stones) however declined in
negative growth rate of Non-POL, Non-Gold & Silver
2018-19. Electronics components grew the fastest at
Imports in Q4 significantly pulled down its full year
54·6 per cent in 2018-19, followed by petroleum: crude
growth rate.
and iron and steel. The exports/ imports of top ten
Table 3. Exports of Top Ten Commodities in commodities, their growth rates and percentage shares in
2018-19 2017- 18 and 2018-19 are indicated in table – 2 & 3.
(Values in US $ billion) Direction of Trade
Rank Commodity 2017- 2018- % %
18 19 Growth Share United States of America (USA) continues to be the
1 Petroleum Products 37·47 46·54 24·23 14·10 biggest trade partner of India in the matter of exports. It
2 Pearl, Precious, Semi- 25·87 25·98 0·43 7·87 accounted for 16 per cent of India’s exports (in value
Precious Stones terms) in 2018-19, followed by United Arab Emirates
3 Drug Formulations, 12·91 14·39 11·46 4·36 (UAE), China and Hong Kong (Figure 3). However, in
Biological 2018-19, growth of India’s exports to the Netherlands
4 Gold and other 12·81 12·94 1·02 3·92
Precious Metal was the highest (40·7 per cent), followed by China (25·6
Jewellery per cent) and Nepal (17·4 per cent).
5 Iron and Steel 11·24 9·74 – 13·36 2·95
Table 5. Top Ten Export Destinations of India in
6 Organic Chemicals 7·14 9·33 30·58 2·83
2018-19
7 RMG Cotton incl. 8·51 8·69 2·16 2·63
Accessories (Values in US $ billion)
8 Motor Vehicle/Cars 8·47 8·50 0·32 2·58 Rank Country 2017-18 2018-19 % % Share
9 Electric Machinery and 6·71 8·42 25·58 2·55 Growth
Equipments 1 USA 47·88 52·43 9·49 15·88
10 Products of Iron and 6·77 7·26 7·22 2·2 2 United Arab 28·15 30·13 7·04 9·13
Steel Emirates
3 China PRP 13·33 16·75 25·62 5·07
Source : DGCI&S, Kolkata
4 Hong Kong 14·69 13·00 – 11·49 3·94
Table 4. Imports of Top Ten Commodities in 5 Singapore 10·20 11·57 13·41 3·51
2018-19 6 UK 9·71 9·33 – 3·94 2·83
(Values in US $ billion) 7 Bangladesh PR 8·61 9·21 6·96 2·79
Rank Commodity 2017- 2018- % % 8 Germany 8·69 8·90 2·48 2·70
18 19 Growth Share 9 Netherland 6·26 8·81 40·73 2·67
1 Petroleum : Crude 87·37 114·04 30·52 22·19 10 Nepal 6·61 7·76 17·40 2·3
2 Gold 33·66 32·90 – 2·26 6·40
Source : DGCI&S, Kolkata
3 Pearl, Precious, Semi- 34·28 27·08 – 21·01 5·27
Precious Stones
4 Petroleum Products 21·29 26·88 21·26 5·23 Table 6. Top Ten Import Sources of India in
5 Coal, Coke and 22·90 26·17 14·28 5·09 2018-19
Briquittes etc. (Values in US $ billion)
6 Telecom Instruments 21·85 17·92 – 17·99 3·49 Rank Country 2017-18 2018-19 % Growth % Share
7 Electronics Components 10·18 15·75 54·63 3·06 1 China PRP 76·38 70·32 – 7·94 13·68
8 Organic Chemicals 12·43 14·25 14·66 2·77 2 USA 26·61 35·55 33·59 6·92
9 Iron and Steel 10·43 12·58 20·60 2·45
3 United Arab 21·74 29·78 37·01 5·79
10 Industrial, Machinery 10·48 12·47 18·97 2·43 Emirates
for Dairy etc.
4 Saudi Arab 22·07 28·48 29·04 5·54
Source : DGCI&S, Kolkata
5 Iraq 17·62 22·37 27·00 4·35
Composition of Trade 6 Switzerland 18·92 18·08 – 4·47 3·52
7 Hong Kong 10·68 17·99 68·48 3·50
In 2018-19, petroleum products continued to be the 8 Korea RP 16·36 16·76 2·43 3·26
largest exported commodity, in value terms, with a share 9 Singapore 7·47 16·28 118·05 3·17
of 14·1 per cent in the country’s export basket. Other 10 Indonesia 16·44 15·85 – 3·59 3·08
major exports included pearls, precious, semi-precious
stones as also gold and other precious metal jewelry Source : DGCI&S, Kolkata
662U | Economics (NET)
China continues to be the largest source of imports 3. Removing 20% exposure limit of FPI’s corporate bond
of India accounting for 13·7 per cent of the total portfolio to a single corporate group, and 50% of any
imported value in 2018-19. USA with a share of 6·92 issue of corporate bonds will be reviewed.
per cent is at the second place followed by UAE (5·79%) 4. Exception to masala bonds from withholding tax for
issuances up to March 31, 2019.
and Saudi Arab (5·54%) (Figure 4). In terms of growth
5. Removing restriction on Indian banks’ market-making in
rates, imports from Singapore grew the highest at 118·1 masala bonds, including underwriting of masala bonds.
per cent in 2018-19, followed by Hong-Kong (68·5 per
cent) and UAE (37·0 per cent). Further, though China Meaning of Convertibility of Money
continues to be the largest exporter to India, India’s Prior to First World War, the whole world was having
imports from China fell from US $ 76·4 billion in 2017- gold standard under which the currency in circulation was
18 to US $ 70·3 billion in 2018-19, registering a allowed to get converted either in gold or in other
negative growth. The top ten export destinations and currencies based on gold standard. Such currency was
called convertible money. But after First World War all the
import sources of India in 2017-18 and 2018-19 are indi- countries dropped gold standard and paper currency was
cated in table 5 & 6. used which was non-convertible.
In existing money standards convertibility of money has
India’s BoP Declined to 0·7 per cent different meaning. Presently, convertibility of money implies
in Q4 of 2018-19 but Increased to 2·1 such a system in which country’s currency becomes conver-
tible in foreign exchange and vice-versa.
per cent for the Fiscal 2018-19 Since August 19, 1994 Indian rupee has been made fully
● The CAD increased to 2·1 per cent of GDP in 2018-19 convertible in current account transactions related to goods
and services.
from 1·8 per cent in 2017-18 on the back of widening of
the trade deficit. Special Economic Zone Act, 2005
● India’s trade deficit increased to US $ 180·3 billion in
2018-19 from US$ 160·0 billion in 2017-18. As a major step forward meant to instil confidence in
investors and signal the government’s commitment to a
● Net invisible receipts were higher in 2018-19 mainly stable SEZ policy regime, a comprehensive Special
due to increase in net services earnings and private Economic Zones Act, 2005 was passed by the Parliament in
transfer receipts. May 2005. It received Presidential assent on the 23rd of
● Net FDI inflows at US $ 30·7 billion in 2018-19 were June 2005. This Act came into force w.e.f. February 10,
marginally higher than US $ 30·3 billion in 2017-18. 2006.
● Portfolio investment recorded a net outflow of US $ 2·4 The main objectives of the SEZ Act are :
billion in 2018-19 as against an inflow of US $ 22·1 (a) Generation of additional economic activity.
billion a year ago. (b) Promotion of exports of goods & services.
● In 2018-19, there was a depletion of US $ 3·3 billion of (c) Promotion of investment from domestic and foreign
the foreign exchange reserves (on a BoP basis). sources.
(d) Creation of employment opportunities.
Five Point Plan to Control Current (e) Development of infrastructure facilities.
The salient features of SEZs Act are :
Account Deficit ● Exemption from customs duty, excise duty etc. on import/
India’s CAD rose to 2·4 per cent of Gross Domestic domestic procurement of goods for the development,
Product (GDP) in the Q1 of 2018-19 from 1·9 per cent in operation and maintenance of SEZs and the units
therein.
the Q4 of 2017-18. The trade deficit, which is the biggest
● 100% income tax exemption for 5 years, 50% for the next
part of the CAD, reduced to $ 17·4 billion in August 5 years and 50% of ploughed back export profits for 5
2018, lower than the $ 18·2 billion in July 2018. So, in years thereafter for SEZs units.
July and August the trade deficit has risen to $ 35·6 ● Exemption from capital gains on transfer of an
billion after it stood at almost $ 45 billion in Q1 of 2018- undertaking from an urban area to SEZs.
● 100% income tax exemption to SEZ developers for a
19. As such, the CAD will come under pressure now, block of 10 years in 15 years.
with economists forecasting it at 3 per cent of GDP in ● Exemption from dividend distribution tax to SEZ
the current fiscal year. developers.
In the backdrop of rising CAD, decreasing foreign ● 100% income tax exemption for 5 years and 50% for next
exchange reserves, and sharp depreciation of Indian five years for off shore Banking units located in SEZ.
rupee, the Government decided to curb non-essential ● Exemption to SEZ developer and units from Minimum
Alternate Tax.
imports and increase exports, besides announcing five- ● CST exemption to SEZ developer and units on interstate
pronged measures to increase dollar inflows into the purchase of goods.
country to fund and reduce the Current Account Deficit ● Constitution of an authority for each SEZ with a view to
(CAD). providing greater administrative, financial and
Five-pronged measures to increase dollar inflows into functional autonomy to these zones.
● Establishment of designated courts and a single
the country : enforcement agency to ensure speedy trial and
1. Mandatory ECB hedging conditions for infra-structure investigation of offences committed in SEZs.
loans will be reviewed. ● Encouragement to State Governments to liberalise State
2. To permit manufacturing companies to avail of ECBs up laws and delegate their powers to the Development
to $50 million with a minimum maturity period of one Commissioners to the SEZs to facilitate single window
year. clearance.
Economics (NET) | 663U
SEZ Norms Liberalised (2013-14)
Amid dwindling interest in SEZs, the government announced a ‘package of reforms’ on 18th April, 2013, including easing
of land requirement norms and an exit policy, to rekindle investor interest in Special Economic Zones. SEZ, once a major
attraction for investors, lost the sheen following imposition of MAT and DDT, certain provisions in the proposed direct tax
regime (DTC) besides the global slowdown. Announcing the supplementary foreign trade policy (FTP), Union Minister of
Commerce Anand Sharma said the government has taken note ‘of the fact’ that there are acute difficulties in aggregating large
tracts of uncultivable land which is vacant to set up SEZ.
1. The Minimum Land Area Requirement for SEZ has been reduced by half for different categories of SEZs.
2. For multi-product SEZ, minimum land requirement has been brought down from 1000 hectares to 500 hectares and for
Sector-Specific SEZs, it has been brought down to 50 hectares.
3. Also, there would be no minimum land requirement for setting up IT/ITES SEZs, besides easing of minimum built up area
criteria.
4. The Government has decided to allow transfer of ownership of SEZ units including sale.
5. The 170 functional SEZs-export oriented-enclaves have attracted investment over 2·36 lakh crore and exports from them
totalled 4·76 lakh crore in 2012-13, a growth of over 2,000 per cent over the 7 year period.
Fact Sheet on Special Economic Zones
Number of Formal approvals (As on 15.05.2 019) 416
Number of notified SEZs (As on 15.05.2 019) 351 + (7 Central Govt. + 12 State/Pvt. SEZs)
Number of In-Principle Approvals (As on 15.05.2 019) 32
Operational SEZs (As on 31st March, 2019) 232 (Break up : 25 are multi product SEZs, remaining are
sector specific SEZs)
Units Approved in SEZs (As on 31st March, 2019) 5,109
Land for SEZs 7 Central Govt. + 11 Notified SEZs under Total Notified Formally Approved Total Area
State/Pvt. SEZs notified the SEZ Act, 2005 SEZs Area (1 + 2) SEZs (420-355)
(As on 15.05.2019) before SEZ Act, 2005 (3 + 4)
(1) (2) (3) (4) (5)
2244·95 Ha 40178·32 Ha 42423·27 Ha 5450·81 Ha 47874·08 Ha
Land is a State subject. Land for SEZs is procured as per the policy and procedures of the respective
State Governments.
Investment Total Investment
Investment Incremental Investment
(As on February, 2006) (As on 31st March, 2019)
Central Government SEZs R 2,279·20 cr. R 16,397·80 cr. R 18,677 cr.
State/Pvt. SEZs set up before 2006 R 1,756·31 cr. R 11,517·69 cr. R 13,274 cr.
SEZs Notified under the Act — R 4,75,693 cr. R 4,75,693 cr.
Total R 4,035·51 cr. R 5,03,608·49 cr. R 5,07,644 cr.
Employment Total Employment
Employment Incremental Employment
(As on February, 2006) (As on 31st March, 2019)
Central Government SEZs 1,22,236 persons 1,05,801 persons 2,28,037 persons
State/Pvt. SEZs set up before 2006 12,468 persons 90,584 persons 1,03,052 persons
SEZs Notified under the Act 0 persons 17,29,966 persons 17,29,966 persons
Total 1,34,704 persons 19,26,351 persons 20,61,055 persons
Exports in 2016-17 R 5,23,637 crore (Growth of 12·05% over FY 2015-16)
DTA Sale (Deemed exports) R 19,886 crore (3% of total production)
DTA Sale (Not counted for + ve NFE) R 40,633 crore (7% of total production)
Exports in 2017-18 R 5,81,033 crore (Growth of 11% over FY 2016-17)
DTA Sale (Deemed exports) R 19,125 crore (3% of total production)
DTA Sale (Not counted for + ve NFE) R 1,04,097 crore (15% of total production)
Exports in 2018-19 R 7,01,179 crore (Growth of 21% over the exports of the corresponding
(As on 31st March, 2019) period of FY 2017-18)
DTA Sale (Deemed exports) R 19,908 crore (2% of total production)
DTA Sale (Not counted for + ve NFE) R 1,01,866 crore (12% of total production)
664U | Economics (NET)
Export Development Centres NRIs are Indian citizens; the other two are not. The
The Government has made a plan to invest about decision that NRI includes OCI cardholders as well as
PIO cardholders is meant to align the Foreign Direct
50,000 crore for developing infrastructure in 23 Export
Investment (FDI) policy with the government’s stated
Development Centres identified by Union Commerce
policy to provide PIOs and OCIs parity with NRIs in
Ministry in 1995-96. The major portion of this
(the) economic, financial and educational fields, was the
investment will be made by the Private Sector.
official statement after the meeting, chaired by Prime
Export Development Centres Minister Narendra Modi.
1. Tirupur—Hosiery and Weaving Industry.
2. Moradabad—Brass Ware Handicraft. New Norms Regarding Investments by PIOs
3. Ludhiana—Heavy Machinery and Hosiery. and OCIs
4. Surat—Gem and Jewellery. ● Now, NRI investments would be deemed to be domestic
investment made by residents.
5. Panipat—Handloom textiles.
● This will increase investments across sectors and lead to
6. Alleppi—Coconut and coir. greater inflow of forex remittance.
7. Jalandhar—Sport goods. ● Currently, investments b y NRIs are made on a non-
8. Ranipat (Amboor)—Leather. repatriation basis; it has not been provided that these
9. Nagpur—Hand-made equipments. are domestic investments.
10. Vishakhapatnam—Fish and Fish products. ● The proposal to tap NRIs for investments came from the
11. Meerut—Sport goods. Department of Industrial Policy and Promotion.
12. Aligarh—Brass locks. ● Last year, govt. had set up a panel to consider treating
13. Agra—Leather shoes. non-repatriable NRI funds as domestic investment.
14. Khurja—Clay pots. The government also approved an amendment to
15. Kanchipuram—Silk. Schedule 4 of the Foreign Exchange Management Act
16. Selam—Hand-made items. (FEMA) Regulations, that NRI investments would be
17. Sivakashi—Match boxes. ‘deemed to be domestic investment made by residents’.
18. Ambala—Scientific equipments.
19. Rajkot—Engine pump. Foreign Direct Investment Inflow (Million US
20. Wapi (Ankleshshwar)–Chemicals Dollar)
21. Jamnagar—Brass spare parts. Cumulative
22. Batala—Machine equipment. Item 2018-19 (April 2000-
23. Bhagalpur—Weaving. March 2019)
FIPB Abolished FDI INFLOWS (Equity inflows + 64,375 6,09,838
‘Re-invested earnings’ + ‘Other
The Union Cabinet on May 24, 2017 approved capital’)
winding up of the 25-year-old Foreign Investment
FDI EQUITY INFLOWS (exclud- 44,366 4,22,900
Promotion Board (FIPB), which has been vetting FDI ing, amount remitted through
proposals requiring government approval. The RBI’s NRI Schemes)
ministerial body, which comes under the ministry’s
Department of Economic Affairs. The government will Share of Top Investing Countries FDI Equity Inflows
soon come out with a notification that will lay down 1. Mauritius 8,084 1,34,469
which ministry or departmen is responsible for clearing 2. Singapore 18,228 82,998
proposals in the 11 sectors where approvals for FDI are 3. Japan 2,965 30,274
not through the automatic route. 4. Netherlands 3,870 27,352
The last three years, 91-95 per cent of FDI came Sectors Attracting Highest FDI Equity Inflows
into the country through the automatic route. The
balance 5-9 per cent that needed approval are restricted 1. Services Sector 9,158 74,149
to just 11 sectors and they will continue to need 2. Computer Software & 6,415 37,238
approval. These 11 sectors include defence, retail and Hardware
telecom. In sectors where there are concerns related to 3. Telecommunications 2,668 32,826
security, FDI proposals will also need Home Ministry 4. Trading 4,462 23,021
approval, Jaitley said.
RBI’s Regional Offices (with state covered) Received FDI
Government Relaxes FDI Norms for Equity Inflows 1
NRIs, PIOs, OCIs 1. Maharashtra, Dadra & Nagar 11,383 1,27,089
The Union Cabinet on May 21, 2015 approved a Haveli, Daman & Diu
relaxation of policy on investment proposals from 2. Delhi, Part of Uttar Pradesh 10,142 84,642
Persons of Indian Origin (PIOs) and Overseas Citizens and Haryana
of India (OCIs), treating them at par with Non-Resident
Indians (NRIs) in this regard. 3. Karnataka 6,721 37,670
Economics (NET) | 665U
The government has tried to liberalise the FDI India’s exports of agri and allied products declined by
regime. In its year in power, the FDI limit in the defence 25 per cent to $ 24·7 billion for 2016-17, as against
sector has been raised to 49 per cent, up to 100 per cent nearly $ 33 billion in 2013-14. In contrast, import of agri
has been permitted in railways and norms pertaining to and allied products jumped in the same period to $ 23·2
FDI in construction development were liberalised. That billion, from $ 13·5 billion.
in medical devices were exempted from the sectoral A report by the Center for Environment and Agri-
restrictions for pharmaceuticals. And, FDI in the culture, in association with Tata Strategic Management
insurance and pension sectors have been permitted up to Group, emphasises the need to quadruple India’s agri
49 per cent. and allied exports by 2022.
APEDA to Focus on Fruits and India’s Agri Trade Balance
Vegetables ($ million)
With export earnings from basmati and bovine Financial Plantations Agri & Allied Products
meat—the flagship agricultural and processed export Year Import Export Import Export
sectors—hitting a plateau, the Agricultural and Processed
Food Products Export Development Authority (APEDA) 2010 458·3 1,106·0 10,696·0 12,971·3
is exploring newer avenues. According to data available 2011 749·9 1,521·1 10,755·9 17,762·5
with APEDA, export earnings from agricultural and 2012 1,028·4 1,894·6 14,062·5 27,881·1
processed food products have drastically dropped from 2013 1,038·4 1,840·7 16,774·5 32,655·6
$ 21·5 billion in 2014-15 to $ 16·25 billion in 2016-17,
2014 1,075·1 1,625·1 13,492·3 32,953·6
due to declining basmati rice and bovine meat exports.
2015 1,034·1 1,502·9 19,004·1 30,147·3
While the export value of bovine meat dwindled from a
high of $ 4·78 billion to $ 4·07 billion in 2015-16 and 2016 895·8 1,562·6 20,673·6 24,521·9
$ 3·93 billion in 2016-17, basmati exports plummeted 2017 841·2 1,619·3 23,208·5 24,698·5
from $ 4·52 billion in 2014-15 to $ 3·23 billion in 2016- Source : Directorate General of Commercial Intelligence and
17. Increasing revenues further from these areas is next Statistics.
to impossible because of stringent conditions imposed
by importing countries on these products. Foreign Exchange Reserves in India
Foreign exchange reserves are an important
List of Clusters for Development for Phase-I component of the BoP and an essential element in the
Product State Districts analysis of an economy’s external position. The foreign
Banana Andhra Kurnool, Kadapa and Anan- exchange reserves of the country include three important
Pradesh thapuramu components—
Pomegranate Kurnool, Kadapa and Anan- 1. Foreign Exchange Assets of RBI.
thapuramu 2. Gold Stock of RBI.
Nendran Kerala Thrissur 3. SDR holdings of the Government.
Banana The foreign exchange reserves of India consist of
Pineapple
foreign currency assets held by the RBI, gold holding of
Pineapple Meghalaya Ribhoi district the RBI and SDRs.
Banana Gujarat Bharuch to Narmada India’s Foreign Exchange Reserves, as on May 17,
Mango
2019 are as under :
Vegetables West Bengal Murshidabad, Nadia,
Midnapur North and South 24 Foreign Exchange Reserves in India
Parganas (As on August 23, 2019)
Rose Onion, Karnataka Bengaluru Rural, Belagavi, Item US $ billion
Mango Dharwad, Bagal-kot, Kolar, 1. Total Reserves 429·051
Chikkaballapur, Ramnagar
1.1 Foreign Currency Assets 397·129
Mango Telangana Rangareddy, Karim Nagar,
Mehboob Nagar, Khammam, 1.2 Gold 26·867
Warangal 1.3 SDRs 1·433
1.4 Reserve Position in the IMF 3·621
International Trade in Agriculture
and Allied Services Foreign Exchange Management Act
From a 150 per cent surplus of export over import,
(FEMA)
India’s trade balance in agricultural and allied products In the budget of 1997-98, the Government had
has slipped in four years to near-equality. Data showed proposed to replace FERA-1973 by FEMA (Foreign
666U | Economics (NET)
Exchange Management Act). FEMA (Foreign Exchange India’s External Debt end March 2019
Management Act) 1999 was approved by both the
External debt indicator Amount in % to total
houses of Parliament in December 1999. After the US$ billion external
approval of the President FEMA-1999 has come into Debt
force w.e.f. June 1, 2000. Under FEMA-1999 provisions Total External Debt 543·0 100·00
related to foreign exchange have been modified and Long-term debt 434·6 80·0
liberalised so as to simplify foreign trade and payments. Short term debt 108·4 20·0
FEMA-1999 will make favourable development in Sovereign (government) debt 103·8
Foreign Money market. Govt· debt as % of GDP 3·8
Non-Govt. External debt 439·2
Non-Govt· debt as % of GDP 16·6
The Prevention of Money- Multilateral debt 57·4 10·57
Laundering (Amendment) Act, 2012 Bi-lateral debt 25·7 4·73
Notified IMF 5·5 1·01
Trade Credit 7·9 1·45
The Prevention of Money-Laundering (Amendment) Commercial Borrowings 206·4 37·98
Act, 2012 has got President’s assent on January 3, 2013 NRI Deposits 130·4 24·01
Debt Service Ratio (September 6·4
and the same was notified on January 4, 2013 in the 2018)
official Gazette. Ratio of Foreign Exchange 76·0
Reserves to Total Debt
The PMLA was enacted in 2002, but was amended
Ratio of Concessional Debt to 8·7
thrice, first in 2005, then in 2009 and then 2012. The Total Debt
2012 version of the amendment received president’s Ratio of Short-term Debt to 26·3
assent on January 3, 2013 and the law became opera- Foreign Exchange Reserves
tional from February 15, 2013, when the finance US dollar denominated debt 50·5
ministry notified it. PMLA (Amendment) Act, 2012 has Indian Rupee debt 35·7
enlarged the definition of money laundering by SDR 5·6
Japanese Yen 4·9
including activities such as concealment, acquisition,
Euro debt 3·0
possession and use of proceeds of crime as criminal
activities. Some other features are as follows : External Sector Vulnerability Indicators of
● The amendment has introduced the concept of India
(Per cent, unless indicated otherwise)
Corresponding law to link the provisions of Indian
law with the laws of foreign countries and to Indicator End.-Mar. End-Mar.
2018 2019
provide for transfer of the proceeds of foreign
1. External Debt to GDP ratio 20·5 19·7
predicate offence committed in any manner in India.
2. Ratio of Short-term Debt to 19·3 20·0
● It also adds the concept of ‘reporting entity’ which Total Debt (original maturity)
would include a banking company, financial 3. Ratio of Short-term Debt to 42·0 43·4
institution, intermediary or a person carrying on a Total Debt (residual maturity)
designated business or profession. 4. Ratio of Concessional Debt 9·1 8·7
to Total Debt
● The Prevention of Money Laundering Act, 2002 5. Ratio of Reserves to Total 80·2 76·0
levied a fine up to R 5 lakh. The amendment act has Debt
removed this upper limit. 6. Ratio of Short-term Debt to 24·1 26·3
Reserves
● The act has provided for provisional attachment and 7. Ratio of Short-term Debt (re- 52·3 57·0
confiscation of property of any person (for a period sidual maturity) to Reserves
not exceeding 180 days). This power may be 8. Reserves Cover of Imports 10·9 9·98
(in months)
exercised by the authority if it has reason to believe 9. Debt Service Ratio (Debt 7·5 6·4
that t h e offence of money laundering has taken Service Payments to Current
place. Receipts)
10. External Debt (US $ billion) 529·7 543·0
● The act has conferred the powers upon the Director 11. Net International Investment – 438·4 – 426·6
to call for records of transactions or any additional Position (NIIP) (US $ billion) (2017)
information that may be required for the purposes of 12. NIIP/GDP ratio – 16·0 – 16·5
investigation. The Director may also make inquiries (2017)
for non-compliance of the obligations of the 13. CAD/GDP ratio 1·9 2·1
reporting entities. Source : RBI
Economics (NET) | 667U
International Comparison of Top Twenty Developing Debtor Countries, 2017
S. No. Country Total Ratio of total Ratio of Ratio of Ratio of
external Short term
external total foreign short term
debt to debt to
debt (US$ external exchange debt to total
exports of foreign
million) debt to GNI reserves/total debt (%)
goods and exchange
(%) debt (%)
service (%) reserves (%)
1 2 3 4 5 6 7 8
1. China 17,10,235 63·8 14·0 184·7 60·3 32·6
2. Brazil 5,42,980 205·9 27·0 68·4 9·7 14·1
3. India 5,13,209 101·0 19·8 75·9 19·0 25·1
4. Russian Federation 4,92,763 107·6 32·0 72·3 10·4 14·3
5. Mexico 4,55,058 101·6 40·5 37·5 11·7 31·2
6. Turkey 4,54,725 211·4 54·1 18·5 25·9 140·0
7. Indonesia 3,54,352 177·0 36·0 35·8 13·8 38·6
8. South Africa 1,76,335 160·4 52·0 25·8 18·7 72·3
9. Kazakhstan 1,67,485 287·1 118·4 10·9 4·6 41·9
10. Thailand 1,29,765 40·6 29·8 151·1 45·0 29·8
11. Colombia 1,24,364 232·7 41·3 37·6 10·5 28·1
12. Ukraine 1,13,281 179·3 98·4 15·7 19·6 125·4
13. Romania 1,09,354 119·4 53·1 36·7 13·5 36·8
14. Vietnam 1,04,079 45·7 48·8 47·2 21·0 44·6
15. Pakistan 84,523 286·0 26·3 18·7 10·2 54·5
16. Egypt 82,886 190·3 35·9 40·1 13·4 33·5
17. Philippines 73,080 74·4 19·4 100·2 19·5 19·5
18. Peru 68,083 127·3 33·6 91·6 12·8 13·9
19. Sri Lanka 50,142 260·1 59·1 14·0 15·0 107·0
20. Bangladesh 47,155 120·1 18·1 69·7 22·8 32·8
Note : The order of the countries are the ranking of total external debt stock appearing in column No. 3.
Source : International Debt Statistics, 2019 World Bank.
Transport and Communications nearly 84% of revenue-earning freight traffic (in physical
terms), of which about 44% is coal.
Railways
The first train in India was started on a small rail Different Zones of Indian Railway
route of 34 kilometres between Bombay and Thane on Zone Headquarters Date of Starting
April 16, 1853. At present, the Indian Broad Gauge is Working
the most widely used rail gauge in India with 149490 km 1. C.R. Mumbai V.T. Nov. 5, 1951
of track length and about 68442 km of route length in 2. E.R. Kolkata Aug. 1, 1955
March 2018. Out of which Broad gauge consists of 3. N.R. New Delhi April 4, 1952
63491 km, Meter gauge consists o f 3200 km of route 4. N.E.R. Gorakhpur April 4, 1952
5. N.E.F.R. Maligaon- Jan. 15, 1958
length. Narrow gauge covers less than 1751 km route Guwahati
length in March 2018. With such a large rail route, the 6. S.R. Chennai April 14, 1951
Indian Railways network has become the biggest (Madras)
railway of Asia and the third in the world. About 42·92% 7. S.C.R. Secunderabad Oct. 2, 1966
of the route kilometres, 41% of running track kilometre 8. S.E.R. Kolkata Aug. 1, 1955
and 43% of total track kilometre has been electrified. On 9. W.R. Mumbai- Nov. 5, 1951
this electrified, route, 64·50% of freight traffic and Churchgate
56·5% of passenger traffic is houled with fuel cost on 10. E.C.R. Hazipur Oct. 1, 2002
electric transaction being merely 36·39% of the total 11. N.W.R. Jaipur Oct. 1, 2002
transaction fuel cost on Indian Railway. Railways absorb 12. E.C. (coast) R. Bhubaneshwar April 1, 2003
about 41% of the total central government employees. 13. N.C.R. Allahabad April 1, 2003
Indian railways has been contributing to the industrial 14. W.C.R. Jabalpur April 1, 2003
and economic landscape for over 150 years. Of the two 15. S.W.R. Hubli April 1, 2003
main segments—freight and passenger of the Indian 16. S.E.C.R. Bilaspur April 5, 2003
railways, the freight segment accounts for roughly two 17. Kolkata Kolkata Dec. 30, 2010
thirds of revenues. Metro Rail
Out of the freight & passenger traffic, the freight Zone
segment accounts for about 70 per cent of revenue 18. South Vishakhapatnam Announced 2019
within the freight segment, bulk traffic accounts for Coast Railway
668U | Economics (NET)
Indian Transport Sector : An Overview
Railways and roads are the dominant means of transport carrying more than 95 per cent of the total traffic generated in
the country. The transport sector has expanded manifolds since the beginning of planning era in the country, both in terms of
spread and capacity.
Railways—The Railways in India provide the principal mode of transportation for freight and passengers. It brings
together people from the farthest corners of the country and makes possible the conduct of business, sight seeing, pilgrimage
and education. The Indian Railways have been a great integrating force during the last more than 155 years. It has bound the
economic life of the country and helped in accelerating the development of industry and agriculture. From a very modest
beginning in 1853, when the first train steamed off from Mumbai to Thane, a distance of 34 km, Indian Railways have grown
into a vast network of 7,318 stations spread over a route length of about 68,442 km.
Roads—India has one of the largest road networks in the world, aggregating to about 58·98 lakh kilometres as on
September 2017. The country’s road network consists of National Highways (NHs) (1,32,499 km), State Highways (1,75,036
kms), and 56,08,477 km other roads. National Highways is the responsibility of the Central Government, has about 1,32,499
km length and comprises only 2·08 of the total length of roads, it carries over 40% of the total traffic across the length and
breadth of the country. The government has embarked upon a massive National Highways Development Project (NHDP) in the
country. The NHDP is the largest highway project ever taken in the country. The NHDP is being implemented mainly by NHAI
in phases I to VII.
Inland Water Transport (IWT)—India has over 14,500 km of navigable waterways. Considering the inherent advantages
of Inland Water Transport (IWT) mode namely; fuel efficiency, environment friendlines, cost effectiveness and decongestion of
road and rail networks, particularly for movement to bulk goods, hazardous good and over dimensional approach. Inland
Waterways Authority of India (IWAI) was set up in 1986 for regulation and development of inland waterways for the purpose of
shipping and navigation. IWAI is primarily responsible for development, maintenance and regulation of national waterways.
Following five waterways have so far been declared as national waterways :
● Allahabad-Haldia stretch (1620 km) of the Ganga-Bhagirathi-Hooghly river system (NW-1) in 1986.
● Sadiya-Dhubri stretch (891 km) of Brahmaputra river (NW-2) in 1988.
● Kottapuram-Kollam stretch of West Coast Canal along with Champakara Canal and Udyogmandal Canal (205 km) (NW-
3) in 1993.
● Kakinada-Puducherry stretch of Canal and Kalurelly Tank, stretches of river Godavari and Krishna (1028 km) in 2008.
(NW-4)
● Talcher-Dhamra stretch of river Brahmani, Geonkhali Charbatia stretch of East Coast Canel, Charbatia-Dhamra stretch
of Matai river along with Mahanadi delta river system (585 km) in 2008. (NW-5)
● Lakhipur to Bhanga of River Barak, NW-6, proposed in 2013, total length 121 km.
Civil Aviation—Civil Aviation, the fastest mode of transport for movement of passenger and cargo traffic, is broadly
structured into three distinct functional entities, viz., regulatory, cum-development, operational and infrastructure. The main
objective of the Civil Aviation development is to provide world class infrastructure facilities and efficient, safe and reliable air
services to meet domestic and international travel needs of trade and tourism.
The Public Sector Undertakings of the Railways
There are 13 undertakings under the administrative control of the Ministry of Railways viz., (i) Rail India Technical and
Economic Services. Limited (RITES); (ii) Indian Railway Construction (IRCON) International Limited; (iii) Indian Railway
Finance Corporation Limited (IRFC); (iv) Container Corporation of India Limited (CONCOR); (v) Konkan Railway
Corporation Limited (KRCL). (vi) Indian Railway Catering and Tourism Corporation Ltd. (IRCTC), (vii) Railtel Corporation
of India Ltd. (Rail Tel), (viii) Mumbai Rail Vikas Nigam Ltd. (MRVNL), (ix) Rail Vikas Nigam Ltd. (RVNL). Centre for Railway
Information System (CRIS) and (x) Dedicated Freight Corridor Corporation of India Ltd. (DFCCIL) and (xi) Bharat Wagon &
Engg. Co. Ltd. (BWFL). (xii) Burn Standard Co. Ltd. (BSCL) and (xiii) Braithwaite & Company Ltd. (BCL).
Rail Tourism
At present 5 luxury tourist train ‘Palace on Wheels’, ‘Deccan Ody-ssey’, ‘Golden Chariot’, ‘Royal Raj asthan
on Wheels’ and ‘Maharajas Express’ are run by Indian Railway.
Luxury Tourist Trains on IR-At a Glance
Name of Train Intro- Joint Period of No. of Days
duced in Venture No. of Coaches Operation
Palace on Wheels 1982 IR & RTDC 22 (including 14 saloons, 2 Sept. to April 7 nights-
dining cars a spa car and a 8 days
lounge car)
Deccan Odyssey 2007 IR & Govt. of — April to Sept. 10 Itineraries
Maharashtra
Golden Chariot 2008 IR & KSTDC 18 thematically designed Sept. to March 7 days Karnataka Goa and
coaches Karnataka-Tamil Nadu and
Kerala
Royal Rajasthan 2009 IR & RTDC 22 (including 14 passenger car, Oct. to April 7 nights- 8 days
on Wheels one bar car one gym cum spa
car)
Maharaja Express 2010 IR & IRCTC 23-including 15 passenger Sept. to April Pan India Itinerary of 7
coaches nights/ 8 days and 3 nights/
4 days
Economics (NET) | 669U
Rail Development Authority A series of initiatives have been undertaken in recent
years, to set the stage for a quantum leap in India’s road
Government has approved formation of a Rail system. These initiatives combine new institutional
Development Authority (RDA) comprising Chairman arrangements, highway engineering of international
and three Members. The objective underlying RDA is to standards, founded on a self-financing revenue model
get expert advice/ make informed decision on : comprising tolls and a cess on fuel. Three initiatives in
1. Pricing of services commensurate with costs. the road sector were begun in recent years : The
2. Suggest measures for enhancement of Non Fare National Highway Development Project (NHDP),
Revenue. Pradhan Mantri Bharat Jodo Pariyojana (PMBJP) and
3. Protection of consumer interests, by ensuring Pradhan Mantri Gram Sadak Yojana (PMGSY). NHDP
quality of service and cost optimization. dealt with building high quality highways. The PMBJP
4. Promoting competition, efficiency and economy. dealt with linking up major cities to the NHDP
Highways. The PMGSY addressed rural roads.
5. Encouraging market development and participation
of stakeholders in the rail sector and for ensuring a While the Central Sector Programme pertains mainly
fair deal to the stakeholders and customers. to National Highways the responsibility for development
6. Creating positive environment for investment. of other categories of roads vests with the State/Union
territories.
7. Promoting efficient allocation of resources in the
Sector. The Indian road network, the largest in the world
8. Benchmarking of service standards against inter- aggregating 58,97,671 km consists of 1,32,499 km of
national norms and specify and enforce standards National Highways, 1,75,036 km of State Highways and
with respect to the quality, continuity and reliability about 56,08,477 km of Other District and Rural Roads.
of services provided by them. The National Highways account for about 2·08% of the
9. Providing framework for non-discriminatory open total road network but carry as much as 40% of the total
access to the Dedicated Freight Corridor (DFC) road traffic in the country. Out of the total length of
infrastructure and others in future. National Highways, 24% is single lane/intermediate
10. Suggesting measures to absorb new technologies for lane, 52% is 2-lane standard and balance of 24% is four-
achieving desired efficiency and performance lane standard or more.
standards.
11. Suggesting measures for human resource develop- National Highway Development
ment to achieve any of its stated objectives. Project (NHDP)
Road Transport The largest highway project ever undertaken in the
India has one of the largest road networks in the country is being implemented by the National Highway
world aggregating to about 5·897 million km at present. Authority of India (NHAI).
NHDP & Other NHAI Projects (March 31, 2019)
Total Length Already 4/6 Under Contracts Under Balance length
(km) Laned (km) Implementation Implementation for award (km)
(km) (No.)
GQ 5,846 5,846 0 0 —
(100%)
NS-EW Ph. I & II 7,142 6,568 30 20 274
Port Connectivity 435 383 52 7 —
NHDP NHDP Phase III 11,809 7,621 2,161 71 2,027
NHDP Phase IV 13,203 4,058 6,050 105 3,095
NHDP Phase V 6,500 2,564 1,428 33 2,508
NHDP Phase VI 1,000 — 184 9 816
NHDP Phase VII 700 22 94 4 584
NHDP Total 46,635 27,062 10,269 257 9,304
Others (Ph.-I, Ph.-II & Misc.) 2,048 1,743 305 18 —
SARDP-NE 110 105 5 1 —
Total by NHAI 48,793 28,915 1,057 276 9,304
Total 20,000 km was approved under NHDP Phase IV. Out of which 13,203 km as assigned to NHAI remaining km with
MORTH.
670U | Economics (NET)
A part of the fuel cess imposed on petrol and diesel for financing projects under the NHDP from the World
is allocated to the National Highways Authority of India Bank (US $ 1965 million), Asian Development Bank
(NHAI) for funding the NHDP. The NHAI leverages the (ADB) (US $ 1605 million), and Japan Bank for
cess resources to borrow additional funds from the debt International Cooperation (32,060 million yen) which
market. Till date, such borrowings have been limited to are passed on to the NHAI partly in the form of grants
funds raised through 54 EC (capital gains tax and partly as loan. The NHAI has also taken a direct
exemption) bonds, taxfree bonds, and short-term loan of US $ 149·78 million from the ADB for the
overdraft facility. The government has also taken loans Manor Expressway Project.
Central Road Fund Changed as Central Road and Infrastructure Fund
Government of India has decided to recast seventeen years old Central Road Fund as Central Road and Infrastructure
Fund . Central Road Fund was created through an Act of Parliament (Central Road Fund Act, 2000). The Union government
had introduced road cess in 1998-99 as a non-lapsable, dedicated fund to make roads. It was collected from users of diesel and
petrol by levying an extra cess on the amount of fuel they bought. The non-lapsable pool of funds was subsequently adopted as
a law called the Central Road Fund (CRF) Act 2000, with a levy of just one rupee a litre each on diesel and petrol. The fund
was envisaged to be used for various kinds of road construction including national highways, rural roads, inter-State
connectivities and road over-and under-bridges at the unmanned level crossings of rail tracks. Rate of road cess was increased
to R 6 per litre) to part fund construction of national highways, rural roads, state highways, railway over bridges/under
bridges, erection of safety works at unmanned rail-road crossings, new lines, conversion of existing standard lines into gauge
lines and electrification of rail lines. In 2017, the government amended the CRF Act to allocate 2.5 per cent of the proceeds of
CRF for development and maintenance of national waterways (NWs) through a reduction in the share provided for
development of national highways. The fund collected under CRF — a non-lapsable fund — was R 80,800 crore in 2016 -17,
R 69,540 crore in 2015-16 and R 25,122 crore in 2014-15.
Finance Minister has changed the structure of duties on petrol and diesel in budget 2018-19 . However Finance Minister
assured that it would not change consumer prices, but would give the government a dedicated source of income for its massive
road building programme. The government has proposed an R 8-per-litre levy of road and infrastructure cess on petrol and
diesel, which will get offset by the abolition of the R 6 per litre additional excise duty and R 2 per litre basic excise duty on the
fuels. The Centre has to share its collection of excise duties with states, but does not have to do so in the case of a cess.
However, Ethanol-blended petrol and biodiesel-mixed diesel will attract no road and Infra cess. The cess will be R 4
per litre on petrol and diesel manufactured at four specified refineries in the Northeast.
The proceeds from new Cess will go to rechristened Central Road and Infrastructure Fund Act. ‘The new cess would help
expand the scope of utilisation of the proceeds to the entire infrastructure sector and not just roads, highways and waterways.
Following categories of the projects of infrastructure can be financed from this fund :
● Port projects, including channel-deepening works or capital dredging and shipyards.
● Post-harvest storage infrastructure for agriculture and horticulture produce, including cold storage and cold chain
(including cold room facility for farm level pre-cooling, for preservation or storage of agriculture and allied produce,
marine products and meat).
● Airports,
● Urban public transport (except rolling stock in case of urban road transport),
● Solid waste management, water supply pipelines, water treatment plants, sewage collection, treatment and disposal
system,
● Irrigation (dams, channels, embankments), storm water drainage system, slurry pipelines,
● Telecommunication (fixed network, including optical fibre/wire/cable networks which provide broadband/internet),
telecommunication towers, telecommunications and telecom services,
● Educational institutions (capital stock),
● Sports and infrastructure (including provision of sports stadia and infrastructure for academies for training/research in
sports and sports-related activities),
● Hospitals (capital stock including medical colleges, para medical training institutes and diagnostic centres),
● Tourism infrastructure- three-star or higher category classified hotels located outside cities with population of more than
one million, ropeways and cable cars.
● Common infrastructure for industrial parks and other parks with industrial activity such as food parks, textile parks,
● Special economic zones,
● Tourism facilities
● Agriculture markets, terminal markets,
● Soil-testing laboratories
● Affordable housing (including a housing project using at least 50 per cent of the Floor Area Ratio (FAR)/Floor Space
Index (FSI) for dwelling units with carpet area of not more than 60 square meters can also avail themselves of the fund.
Economics (NET) | 671U
‘Bharatmala’ : A Mega Project of Setu Bharatam Programme
Highways Development Prime Minister Shri Narendra Modi launched the
Setu Bharatam programme for building bridges for safe
The Union Cabinet on October 24, 2017 cleared the
and seamless travel on National Highways, on March 4,
Bharatmala project to construct 20,000 km of highways
2016. The Setu Bharatam programme aims to make all
connecting western and eastern parts of the country at an
National Highways free of railway level crossings by
estimated investment of R 7 lakh crore. In the first phase
2019. This is being done to prevent the frequent
to be undertaken over three-five years, the project would
accidents and loss of lives at level crossings. 208
cost R 5·5 lakh crore. The project would be funded
Railway Over Bridges (ROB) / Railway Under Bridges
through various sources, including R 2·09 lakh crore
(RUB) will be built at the level crossings at a cost of
from the market, R 1·06 lakh crore through private
R 20,800 crore as part of the programme. The details of
investment and R 2·19 lakh crore from the central road
208 ROBs are as follows :
fund or toll collection.
Andhra Pradesh – 33, Assam – 12, Bihar – 20,
In the first phase of the Bharatmala project, the
Chhattisgarh – 5, Gujarat – 8, Haryana – 10, Himachal
central government plans to construct R 5·5 lakh crore
worth of projects in the next three-five years. The Pradesh – 5, Jharkhand – 11, Karnataka – 17, Kerala – 4,
average cost of constructing 1 km of road is R 13 crore. Madhya Pradesh -6, Maharashtra – 12, Odisha – 4 ,
The roads that would be built under Bharatmala will Punjab – 10, Rajasthan – 9, Tamil Nadu – 9, Uttarakhand
include state highways, national highways and some – 2, Uttar Pradesh – 9, West Bengal – 22.
state roads across the country. Every state will get Detailed Project Reports have already been received
proportional projects under the scheme. for 73 ROBs and of these 64 ROBs are likely to be
Bharatmala is the largest highways project after the sanctioned with an estimated cost of R 5600 crore by
National Highway Development Programme (NHDP) this financial year i.e. 2015-16.
which saw the development of about 50,000 km, and In addition to this, about 1500 old and worn down
aims at improving connectivity in border and other bridges will also be improved by replacement/widening/
areas. The project that was first mooted in April 2015 strengthening in a phased manner at a cost of about
aims to connect Gujarat and Rajasthan, then move to R 30,000 crore. The Ministry of Road Transport &
Punjab and cover Jammu & Kashmir, Himachal Highways has also established an Indian Bridge
Pradesh, Uttarakhand followed by Uttar Pradesh and Management System (IBMS) at the Indian Academy for
Bihar and further to Sikkim, Assam, Arunachal Pradesh Highway Engineer in Noida, U.P. The aim is to carry out
and right up to the Indo-Myanmar border in Manipur conditions survey and inventorization of all bridges on
and Mizoram. National Highways in India by using Mobile Inspection
The aim is to improve the speed of traffic flow on Units. 11 consultancy firms have been appointed for this
key corridors by providing uniform fourlane roads purpose. Till now inventorization of 50,000 bridges has
between two identified points. These corridors will been done. The first cycle of the survey is expected to be
permit faster movement of cargo vehicles. Construction completed by June 2016. This data base will be the
of 10,000 km of highways annually has the potential of largest of its kind and will also help in smoothening the
generating 40 million mandays of employment. movement of Over-Dimension and Over-Weight con-
The Bharatmala programme would not only cover signments on National Highways.
the economic corridors and provide last mile Water Transport
connectivity to the ports, it is also expected to give a Under Water Transport, Coastal Transport and
huge impetus to the development of rural roads. Asset Overseas Transport have their own importance. In the
recycling of the toll assets of NHAI was being coastal areas of the sea, navigation is comparatively
undertaken for the first time. cheaper. On the 7517 km of main coastline of India
This initiative is expected to fast track the spread over 13 states/uts there are 13 major and 200
development of the roads and highways and provide minor and intermediary operable ports providing
opportunities to the private sector. The implementation congenial and favourable conditions for the development
of this programme could get India the much needed cost of domestic transport infrastructure. Of the non-major
competitiveness in the manufacturing sector by bringing ports about 66 ports are handling traffic. The develop-
down the logistics cost which is currently one of the ment and the management of major ports rests with
highest amongst the emerging markets and way above respective Port Trusts under the central government, the
that prevalent in the developed economies. The state governments administer the minor ports. Among
government would seek assistance of the Border Roads the major ports, Kandala, Mumbai, Majhgaon, New
Organisation in tough terrain. Mangalore, Cochin and JNPT (Jawahar Lal Nehru Port,
Bharatmala was proposed on the lines of Sagarmala Mumbai) are situated on the Western Coast and
in which a string of ports will be built in the Indian Tuticorin, Chennai, Vishakhapatnam, Paradeep, Kolkata
Ocean to protect maritime interests. The government and Haldia ports are situated on the Eastern coast.
plans to improve road connectivity, not just to coastal Jawahar Lal Nehru port is the latest big port equipped
and border areas but also backward areas. with most modern facilities. The ports of Mumbai and
672U | Economics (NET)
Cochin are natural sea-ports whereas the Kandala sea- (iii) Port Led Industrialisation 29
port is used in tides. Vishakhapatnam is the deepest port (iv) Coastal Community Development 8
of India among the sea-ports of the eastern coast.
Chennai is the oldest sea-port. Kolkata port is situated ‘Smart Port Cities’ : An Ambitious
on the river bank. The major ports in India carry Plan of GoI
about three-fourths of the total traffic with The ambitious plan of Nitin Gadkari, Union
Vishakhapatnam as the top traffic handler in each of Minister for Road Transport, Highways & Shipping, to
the last seven years. develop a smart city around major ports is likely to start
Following are the major Ports in India : with Kandla port, where a smart city will come up in a
Western Coast Eastern Coast few years time.
Kandla (child of partition) Kolkata-Haldia (riverine port) There are 12 major ports in India - Kandla, Mumbai,
Mumbai (busiest and biggest) Paradip (exports raw iron to Jawaharlal Nehru Port Trust, Mormugao, Visakhapat-
Japan) nam, Cochin, Chennai, New Mangalore, Ennore,
Jawahar Lal Nehru (fastest Vishakhapatnam (deepest port) Tuticorin, Paradip and Kolkata - having 260,000 acres of
growing) land between them.
Marmugao (naval base also) Chennai (oldest and artificial) Each major port will construct one smart city with
Mangalore (exports Kudre- Ennore (most modern-in pri- an expenditure of R 3,000-4,000 crore. These will be
mukh iron-ore) vate hands) green smart cities with green energy generation
Cochin (natural Harbour) Tuticorin (southernmost) facilities.
Among major ports, Mumbai is the biggest. Kandla Port water to be recycled, and vehicles to be
is a tidal port. Marmugao enjoys the second position by incentivized to use biogas, which will be produced from
value of the tonnage of the bulk of which is export of waste at the ports.
Iron core. Vishakhapatnam is the deepest land-locked The smart port industrial cities will be built in line
and protected port. Chennai has an artificial harbour, with international standards and will have wide roads,
Kolkata is a riverine port, Haldia has a fully equipped advanced townships, special economic zones, greenery,
containerised berth. etc. The ports will also have international bench-
Besides there are about 2 0 0 minor & intermediate marking, ship-breaking and ship-building centres,
ports. The minor ports are located in Gujarat, besides other ancillary things, the official added.
Maharashtra, Goa, Daman and Div, Karnataka, Kerala,
Lakshadweep, Tamil Nadu, Puducherry, Andhra Air Transport
Pradesh, Odisha, West Bengal and Andman & Nicobar. The civil aviation sector in India has resumed a
Sagarmala Project higher trajectory of growth after emerging from adverse
Sagarmala Project is a multi- dimensional project to impact of global financial crisis. India’s air traffic has
infuse a new life into some o f the neglected sectors of grown by about 18 per cent per year since 2004. The
water transport such as inland waterways and coastal potential for higher levels of growth in the future is also
shipping as well as making the large ports of world class very high. Industry forecasts suggest that India will be
order so a s t o make Indian shipping industry most the fastest growing civil aviation market in the world by
competetive in the world. R 1,00,000 crore project 2020 with about 420 million passengers being handled
encompasses all the facets of the maritime sector, by the Indian airport system as against 140 million in
including ports, shipping, shipbuilding, inland water- 2010. Such growth prospects pose a number of
ways as well as maritime education and training. challenges on many fronts.
It aims to fully realise the potential of the sector, Subsequent t o amalgamation of Air India and
which will play a major role in the accelerated India Airlines with National Aviation Company Ltd.,
development of our country and its economy. The the brand name ‘Air India’ has been retained with
project’s main thrust is on encouraging private and ‘Maharaja’ as its mascot.
foreign investment, and privatising port facilities, under
the landlord model, to keep pace with the expected Airport Authority of India
growth in India’s sea-borne traffic in the coming years. Airports Authority of India (AAI) is a leader PSU under
Sagarmala a golden sea chain of transport along the the Ministry of Civil Aviation engaged in development,
coastline is an ambitions project covering all facets of building airport infrastructure & managing airports across
the length and breadth of the country including remote and
maritime transport, including ports, shipping and far flung areas. AAI came into existence on 01.04.1995 with
landline waterways and even cruise tourism. the merger of the then two authorities (National Airports
The National Perspective Plan for the Sagarmala Authority & International Airports Authority of India). AAI
programme was put in place in 2016. In all 173 projects manages 115 airports including 23 civil enclave and also
provides CNS-ATM facilities at 11 other air-ports. AAI has
have been initially identified under four projects been bestowed with the responsibility to manage the entire
archetypes of Sagarmala. Indian airspace measuring around 2·8 million nautical
The identified projects and their number are : square mile area covering the Bay of Bengal and the
(i) Port Modernisation 53 Arabian Sea, as designated by ICAO for provisioning of Air
(ii) Port Connectivity 83 Traffic Services in the said air space.
Economics (NET) | 673U
Airport Infrastructure ● The decision to award routes to the airlines was
taken only after the airlines gave bank guarantees
The Airports Authority of India (AAI) is a major
for the routes.
airport operator managing 115 airports across the
country and also entrused with the sovereign function of ● In the first round of RCS, Alliance Air has got 1 5
providing air traffic services in India. To enhance airport routes, which will see it touch five unserved and
infrastructure in India, modernization of existing airport two under-served airports. Air Deccan has been
infrastructure in metro and non-metro cities and awarded 34 routes (10 unserved and five under-
construction of greenfield aiports were contemplated. served). Air Odisha has won 50 routes.
The major initiatives to augment better airport ● An unserved airport is one to which there is no daily
infrastructure across the country are : (a) implementation service, while an under-served airport is one which
of PPP projects at four airports of the AAI, namely has not seen a flight for two consecutive flight
Chennai, Kolkata, Ahmedabad, and Jaipur, (b) setting up schedules.
of greenfield airports, namely, Mopa in Goa; Navi ● Globally, airlines follow two schedules—a winter
Mumbai, Shirdi and Sindhudurg i n Maharashtra; schedule from the last Sunday of October to the last
Shimoga, Gulbarga, Hassan and Bijapur in Karnataka; Saturday of March of the following year and a
Kannur and Arnamula in Kerala; Durgapur in West summer schedule that runs from the last Sunday of
Bengal; Pakyong in Sikkim; Datia/Gwalior (cargo) in March till the last Saturday of October.
Madhya Pradesh; Kushinagar in Uttar Pradesh and ● Flights under the RCS scheme could take off as
Karaikal in Puducherry, and (c) development of small early as April with both Alliance Air and Air
airports in Tier II and Tier III cities, namely Hubli and Deccan indicating that they plan to launch services
Belgaum in Karnataka, Kishangarh in Rajasthan, between Shimla and Delhi in April.
Jharsuguda in Odisha and Tezu in Arunachal Pradesh. ● Air Deccan plans to operate Durgapur-Kolkata and
GAGAN Project Rourkela-Kolkata flights from July 2017 and launch
flights linking Kullu to Delhi and Pant Nagar to
Implementation of the GPS-aided GEO-augmented Dehradun in August 2017. Air Odisha plans to link
Navigation (GAGAN) project over Indian Air-space for Bhavnagar to Ahmedabad and Diu to Ahmedabad in
seamless navigation of civil aircraft is in progress. The August 2017 followed by flights between Kadapa
total cost of the project is R 774 crore, out of which
and Bengaluru, Kadapa and Chennai, Rourkela and
R 148 crore has been spent on the GAGAN-Technology Bhubaneswar and Puducherry and Chennai among
Demonstration System (TDS) Phase with the AAI’s
others.
contributing R 108 crore and the Indian Space Research
Organisation (ISRO) R 40 crore. An amount of R 626 ● Spicejet’s plans include Puducherry-Hyderabad,
crore has been earmarked for GAGAN-Final Operational Porbandar-Mumbai, Adampur-Delhi and Kandla-
Phase (FOP) out of which the AAI is required to Mumbai services from August.
contribute R 496 crore and ISRO the balance. Public Finance
Regional Air Connectivity Scheme Financial Relations
(RCS) between Centre and States
The Government of India kick-started its Regional India possesses a federal structure in which a clear
Air Connectivity Scheme (RCS) on March 30, 2017. distinction is made between the union and the state
The RCS has the following salient features— functions and sources of revenue. Our Constitution
● GoI awarded 128 regional routes to five airlines— provides residual powers to the Centre. Article 264 and
Alliance Air, Spicejet, Turbo Megha, Air Odisha 293 explain the financial relations between the Union
and Air Deccan. and State Government.
● As a result, there will soon be Salem - Chennai, Although the states have been assigned certain taxes
Kadapa-Chennai, Nanded-Hyderabad and which are levied and collected by them, they also share
Puducherry-Salem flights on which at least half the in the revenue of certain union taxes and there are
passengers will be able to fly at fares of under certain other taxes which are levied and collected by the
R 2,500. Central Government but whole proceeds are transferred
to the states.
● The Government has proposed at least half the seats The Constitution provides residuary powers to the
on every flight be available under a fare cap of Centre. The Indian Constitution makes a clear division
R 2,500 per seat per hour of flying. of fiscal powers between the Centre and the State
● Interestingly, at least two of the airlines that have Governments.
been awarded routes—Air Odisha and Air Deccan— (A) The List I of Seventh schedule of Indian
had been in the news earlier. Air Odisha’s Chairman Constitution enlists the union taxes which are as
and Managing Director was arrested in June 2016 follows :
on charges of cheating while Air Deccan was (1) Taxes on income other than agriculture income.
acquired by Kingfisher Air-lines. (2) Corporation tax.
674U | Economics (NET)
(3) Custom duties. (iii) Taxes on railway freight and fares.
(4) Excise duties except on alcoholic liquors and (iv) Taxes on transactions in stock exchanges and
narcotics not contained in medical or toilet preparation. future markets.
(5) Estate and succession duties other than on (v) Taxes on sale and purchase of newspapers and
agricultural land. advertisements therein.
(6) Taxes on the capital value of assets except (3) Taxes levied and distributed between the
agricultural land of individuals and companies. Union and the States—As per the provisions of the
(7) Rates of stamp duties on financial documents. Article(1) all taxes and duties referred to in the Union
(8) Taxes other than stamp duties on transactions in List, except the duties and taxes referred to in Articles
stock exchanges and future markets. 268 and 269, respectively, surcharge on taxes and duties
(9) Taxes on sales or purchases of newspapers and referred to in Article 271 and any cess levied for specific
on advertisements therein. purposes under any law made by Parliament shall be
(10) Taxes on railway freight and fares. levied and collected by the Government of India and
(11) Terminal taxes on goods or passengers carried shall be distributed between the Union and the States in
by railways, sea or air. the manner provided in clause (2).
(12) Taxes on the sale or purchase of goods in the (2) Such percentage, as may be prescribed, of the
course of interstate trade. net proceeds of any such tax or duty in any financial
(B) List II of Seventh schedule enlists the taxes year shall not form part of the Consolidated Fund of
which are within the jurisdiction of the states : India, but shall be assigned to the States within which
(1) Land revenue. that tax or duty is leviable in that year, and shall be
(2) Taxes on the sale and purchase of goods, except distributed among those States in such manner and from
newspapers. such time as may be prescribed in the manner provided
(3) Taxes on agricultural income. in clause (3).
(4) Taxes on land and buildings. (3) In this Article, ‘prescribed’ means—
(5) Succession and estate duties on agricultural land. (i) until a Finance Commission has been constitu-
(6) Excise on alcoholic liquors and narcotics. ted, prescribed by the President by order, and
(7) Taxes on the entry of goods into a local area. (ii) after a Finance Commission has been constitu-
(8) Taxes on the consumption and sale of electricity. ted, prescribed by the President by order after consider-
(9) Taxes on mineral rights (subject to any ing the recommendations of the Finance Commission.
limitations imposed by the Parliament). At present the net tax revenue from (i) Central
(10) Taxes on vehicles, animals and boats. Excise Duties, (ii) Custom Duties, (iii) Taxes on income
(11) Stamp duties except those on financial other than agricultural income, (iv) Corporation tax, (v)
documents. Wealth Tax (vi) Gift tax, (vii) Expenditure tax and (viii)
(12) Taxes on goods and passengers carried by Interest tax is formed the divisible pool of central taxes
board or inland waterways. and this revenue is shared between the central govern-
(13) Taxes on luxuries including entertainments, ment and the state government in the ratio prescribed by
betting and gambling. the Finance Commission (88th Amendment of Indian
(14) Tolls. Constitution in 2003).
(15) T a x e s o n professions, trades, callings and
According to the recommendation of the Thirteenth
employment.
Finance Commission 32 per cent of net proceeds of
(16) Capitation taxation.
divisible central taxes are distributed among the states.
(17) Taxes on advertisements other than those
However, the proceeds from cesses and surcharges,
contained in newspapers.
levied by the central government is not distributed
(C) Apart from taxes levied and collected by the
among the states.
states, the constitution has provided for the revenues
for certain taxes on the union list to be allotted, (4) Proceeds of additional excise duty on mill made
partly or wholly to the states. These provisions fall textiles, sugar and tobacco which are levied by the union
into various categories : since 1957 in replacement of state sales taxes on these
(1) Duties which are levied by the union govern- commodities, are wholly distributed among the states in
ment but are collected and appropriated by the states. a manner as to guarantee their former incomes from the
These include stamp duties, excise duties on medical displaced sales taxes.
preparations containing alcohol or narcotics.
(2) Taxes which are levied and collected by the Finance Commission
union, but the entire proceeds of which are assigned to Finance Commission is constituted to define
the states, in proportion determined by the Parliament. financial relations between the Centre and the States.
These taxes include : Under the provision of Article 280 of the constitution,
(i) Succession and Estate duty. the President appoints a Finance Commission for the
(ii) Terminal taxes on goods and passengers. specific purpose of devolution of non-plan revenue
Economics (NET) | 675U
Finance Year of Establish- Operational Year of Submitting Report
Commission ment Chairman
Duration
I 1951 K.C. Niyogi 1952–57 1952
II 1956 K. Santhanam 1957–62 1956* and 1957
III 1960 A.K. Chanda 1962–66 1961
IV 1964 P.V. Rajamannar 1966–69 1965
V 1968 Mahaveer Tyagi 1969–74 1968* and 1969
VI 1972 Brahma Nand Reddy 1974–79 1973
VII 1977 J.M. Shellet 1979–84 1978
VIII 1983 Y.B. Chawan 1984–89 1983* and 1984
IX 1987 N.K.P. Salve 1989–95 1989
X 1992 K.C. Pant 1995–2000 Nov. 26, 1994
XI 1998 A. M. Khusro 2000–2005 Jan. 15, 2000* & July 7, 2000 & Aug. 31, 2000.
XII 2003 C. Rangarajan 2005–10 Report submitted on Nov. 30, 2004.
XIII 2007 Vijai L. Kelkar 2010–15 Submitted Report on December 30, 2009
XIV 2012 Y. B. Reddy 2015–20 Submitted Report on December 15, 2014
XV 2018 N. K. Singh 2020-25 Constituted
* Interim Report.
resources. The functions of the Commission are to make shall be credited to the public account of India or the
recommendations to the President in respect of : public account of the State, as the case may be.
(1) The distribution of net proceeds of taxes to be
shared between the union and the states and the Contingency Fund
allocation of share of such proceeds among the states.
As per the provisions Article 267 of the Indian
(2) The principles which should govern the payment
Constitution Parliament may by law establish a
of grants-in-aid by the Centre to the States.
Contingency Fund in the nature of an imprest to be
(3) Any other matter concerning financial relations entitled ‘the Contingency Fund of India’ into which shall
between the Centre and the States. be paid from time to time such sums as may be
determined by such law, and the said Fund shall be
Consolidated Funds of India and of placed at the disposal of the President to enable
the States advances to be made by him out of such Fund for the
As per the provisions of Article 266, subject to the purposes of meeting unforeseen expenditure pending
provisions of Article 267 and to the provisions of authorisation of such expenditure by Parliament by law
Chapter XIII with respect to the assignment of the whole under Article 115 or Article 116.
or part of the net proceeds of certain taxes and duties to
States, all revenues received by the Government of Fourteenth Finance Commission
India, all loans raised by that Government by the issue Recommendations
of treasury bills, loans or ways and means advances and
all moneys received by that Government in repayment of Article 280 of the Constitution of India requires the
loans shall form one consolidated fund to be entitled ‘the constitution of a Finance Commission every five years,
Consolidated Fund of India’, and all revenues received or earlier. For the period 1st April, 2015 to 31st March,
by the Government of a State, all loans raised by 2020 the 14th Finance Commission (FFC) was
treasury bills, loans or ways and means advances and all constituted by the orders of President on 2nd January,
moneys received by that Government in repayment of 2013 and submitted its report on 15-12-2014. The FFC
loans shall form one consolidated fund to be entitled ‘the was constituted under the chairmanship of Dr. Y.V.
Consolidated Fund of the State’. Reddy, former Governor of RBI. Ms. Sushma Nath, Dr.
No moneys out of the Consolidated Fund of India or M. Govinda Rao, Dr. Sudipto Mundle and Prof. Abhijit
the Consolidated Fund of a State shall be appropriated
Sen (Past time) were the other members of the
except in accordance with law and for the purposes and
in the manner provided in this Constitution. commission.
In earlier context so far 13 Finance Commissions The Finance Commission was required to
have been appointed which are as follows : recommend the distribution of the net proceeds of taxes
of the Union between the Union and the States
Public Accounts of India and of the (commonly referred to as vertical devolution); and the
States allocation between the States of the respective shares of
All other public moneys received by or on behalf of such proceeds (commonly known as horizontal
the Government of India or the Government of a State devolution).
676U | Economics (NET)
Table 1 : Fourteenth Finance Commission’s Devolution
of Union Revenue to States (2015–20)
State Inter-se Share Share of Grants to PRIs (R crore) Grants to Urban Local Bodies Grants-in-aid
of net States other ( R crore) for Revenue
proceeds of than J&K in Deficit
Union Tax Service Tax Basic Grant Performance Basic Grant Performance ( R crore)
Revenue (%) (%) Grant Grant
Andhra Pradesh 4·305 4·398 7788·68 865·41 2908·34 727·16 22113
Arunachal 1·37 1·431 737·93 81·99 195·22 48·81 0
Pradesh
Assam 3·111 3·371 4874·92 541·66 776·43 194·11 3379
Bihar 9·665 9·787 1896·05 2101·78 2140·99 535·25 0
Chhattisgarh 3·08 3·166 4719·72 524·41 1270·33 317·58 0
Goa 0·378 0·379 120·39 13·38 175·88 43·97 0
Gujarat 3·084 3·172 7771·26 863·47 5125·91 1281·48 0
Haryana 1·084 1·091 3495·17 388·35 1663·95 415·99 0
Himachal Pradesh 0·713 0·722 1628·82 180·98 161·42 40·35 40625
Jammu & 1·854 0 3117·36 346·37 1044·51 261·13 59666
Kashmir
Jharkhand 3·139 3·198 5442·07 604·67 1531·64 382·91 0
Karnataka 4·713 4·822 8359·79 928·87 4685·5 1171·38 0
Kerala 2·5 2·526 3615·85 401·76 2931·48 732·87 9519
Madhya Pradesh 7·548 7·727 12200·72 1355·64 4141·27 1035·32 0
Maharashtra 5·521 5·674 13532·11 1503·57 9930·29 2482·57 0
Manipur 0·617 0·623 185·44 20·6 138·16 34·54 10227
Meghalaya 0·642 0·65 0 0 25·22 6·3 1770
Mizoram 0·46 0·464 0 0 96·17 24·04 12183
Nagaland 0·498 0·503 0 0 101·98 25·5 18475
Odisha 4·642 4·744 7965·28 885·03 1417·98 354·5 0
Punjab 1·577 1·589 3682·02 409·11 1962·25 490·59 0
Rajasthan 5·495 5·647 12270·27 1363·36 3610·5 902·62 0
Sikkim 0·367 0·369 133·64 14·85 39·92 9·98 0
Tamil Nadu 4·023 4·104 7899·69 877·74 6585·85 1646·46 0
Telangana 2·437 2·499 4837·75 537·53 2711·12 677·78 0
Tripura 0·642 0·648 302·11 33·57 178·48 44·62 5103
Uttar Pradesh 17·959 18·205 32198·9 3577·66 8199·37 2049·84 0
Uttarakhand 1·052 1·068 1694·42 188·27 652·66 163·17 0
West Bengal 7·324 7·423 12772·6 1419·18 5311·81 1327·95 11760
All States 100 100 180262·96 20029·22 69715·04 17428·76 194821
Note : Service Tax is not applicable in Jammu & Kashmir.
With regard to vertical distribution, FFC has In recommending horizontal distribution, the FFC
recommended that the States’ share in the net proceeds has used broad parameters of population (1971) and
of the Union tax revenues be 42%. The recommendation changes of population since, income distance, forest
of tax devolution at 42% is a huge jump from the 32% cover and area.
recommended by the 13th Finance Commission. As
compared to the total devolutions in 2014-15 the total Criteria and Weights for Horizontal Distribution
devolution of the States in 2015-16 will increase by over Criteria Weight (per cent)
45%. Population 17·5
FFC has taken the view that tax devolution should Demographic Change 10
be primary route of transfer of resources to States. It Income Distance 50
may be noted that in reckoning the requirements of the Area 15
States, the FFC has ignored the Plan and Non-Plan Forest Cover 7·5
distinction; it sees the enhanced devolution of the
divisible pool of taxes as a ‘compositional shift in Where :
transfers from grants to tax devolution’. (a) Population is the population of the State as per the
1971 census.
Keeping in mind the spirit of cooperative federalism
that has underpinned the creation of National Institution (b) Demographic change are changes in population
for Transforming India (NITI), the Government has since 1971.
accepted the recommendation of the FFC to keep the (c) Income Distance is computed by calculating the
States’ share of Union Tax proceeds (net) at 42%. difference between 3 years average (2010-11 to
Economics (NET) | 677U
2012-13) GSDP for each State with respect to the Fifteenth Finance Commission
State with highest per capita GSDP.
Constituted
(d) Forest Cover has been used as there is an
opportunity cost in terms of area not available for The Government of India, with the approval
other economic activities. President of India, has constituted Fifteenth Finance
Commission in pursuance of clause (1) of article 280 of
(e) Area has a floor limit at 2% for smaller States in
the Constitution, read with the provisions of the Finance
deciding the horizontal devolution.
Commission (Miscellaneous Provisions) Act, 1951
The Statewise share of the divisible pool of Central w.e.f. 27th November, 2017. The Commission will make
taxes, in percentage terms, is given in table-1. As service recommendations for the five years commencing on
tax is not levied in J&K, the share of the States, in April 1, 2020.
percentage terms has been calculated separately by FFC.
This Commission will be headed by Shri. N.K.
These are given in Table.
Singh, former Member of Parliament and former
FFC has recommended distribution of grants to Secretary to the Government of India. Shri Shaktikanta
States for local bodies using 2011 population data with Das, former Secretary to the Government of India and
weight of 90% and area with weight of 10%. The grants Dr. Anoop Singh, Adjunct Professor, Georgetown
to States will be divided into two, a grant to duly University shall be the members of the Commission.
constituted G r a m Panchayats and a grant to duly Dr. Ashok Lahiri, Chairman (Non-executive, part
constituted Municipal bodies, o n the basis of rural and time), Bandhan Bank and Dr. Ramesh Chand, Member,
urban population. FFC has recommended grants in two NITI Aayog shall be the Part time members of the
parts; a basic grant, and a performance grant, for duly Commission. Shri Arvind Mehta shall be the Secretary
constituted Gram Panchayats and municipalities. The to the Commission.
ratio of basic to performance grant is 90 : 10 with
1. The Commission shall make recommendations
respect to Panchayats and 80 : 20 with respect to
as to the following matters, namely :
Municipalities.
FFC has recommended out a total grant of (i) The distribution between the Union and the States
R 2,87,436 crore for five year period from 1-4-2015 to of the net proceeds of taxes which are to be, or may
31-3-2020. Of this the grant recommended to Panchaya- be, divided between them under Chapter I, Part XII
tas is R 2,00,292·20 crores and that to municipalities is of the Constitution and the allocation between the
R 87,143·80 crores. The transfers in the year 2015-16 States of the respective shares of such proceeds;
will be R 29,988 crores. Inter-se share of each state in (ii) The principles which should govern the grants-in-
respect of local bodies grant is at Table. aid of the revenues of the States out of the
FFC has recommended that up to 10 per cent of the Consolidated Fund of India and the sums to be paid
funds available under the SDRF can be used by a State to the States by way of grants-in-aid of their
for occurrences which State considers to be ‘disasters’ revenues under Article 275 of the Constitution for
within its local context and which are not in the notified purposes other than those specified in the provisos
list of disasters of the Ministry of Home Affairs. to clause (1) of that article; and
Taking thus into account the expenditure (iii) The measures needed to augment the Consolidated
requirements of the States, the tax devolution to them, Fund of a State to supplement the resources of the
and the revenue mobilization capacity of the States, The Panchayats and Municipalities in the State on the
FFC have recommended ‘Post-Devolution Revenue basis of the recommendations made by the Finance
Deficit Grants’ of a total of R 1,94,821 crores, for the Commission of the State.
five year period. The States of Andhra Pradesh, Assam, The Commission shall review the current status of
J&K, Himachal Pradesh, Kerala, Manipur, Meghalaya, the finance, deficit, debt levels, cash balances and fiscal
Mizoram, Nagaland, Tripura and West Bengal (a total of discipline efforts of the Union and the States, and
11 States) have been identified for receiving these recommend a fiscal consolidation roadmap for sound
revenue deficit grants. The details are given in Table. fiscal management, taking into account the responsibility
The government has accepted the recommendation in of the Central Government and State Governments t o
principle. adhere to appropriate levels of general and consolidated
The Grants-in-Aid to the States total to 5·37 lac government debt and deficit levels, while fostering
crores is given in the Table given below : higher inclusive growth in the country, guided by the
principles of equity.
Grants-in-Aid to States
2. The Commission shall use the population data of
(R crore) 2011 while making its recommendations.
1. Local Government (all States) 287436 3. The Commission may review the present arrange-
2. Disaster Management (all States) 55097 ments on financing Disaster Management initiatives,
3. Post-devolution Revenue Deficit (11 194821 with reference to the funds constituted under the
States) Disaster Management Act, 2005 (53 of 2005), and make
Total 537354 appropriate recommendations thereon.
678U | Economics (NET)
4. The Commission shall indicate the basis on which (vi) Progress made in promoting ease of doing business
it has arrived at its findings and make available the State by effecting related policy and regulatory changes
wise estimates of receipts and expenditure and promoting labour intensive growth;
5. While making its recommendations, the Commi- (vii) Provision of grants in aid to local bodies for basic
ssion shall have regard, among other considerations, to : services, including quality human resources, and
(i) The resources of the Central Government and the implementation of performance grant system in
State Governments for the five years commencing improving delivery of services;
on 1st April, 2020 on the basis of the levels of tax (viii) Control or lack of it in incurring expenditure on
and the non-tax revenues likely to be reached by populist measures; and
2024-25. In the context of both tax and non-tax
revenues, the Commission will also take into (ix) Progress made in sanitation, solid waste manage-
consideration their potential and fiscal capacity; ment and bringing in behavioural change to end
open defecation.
(ii) The demand on the resources of the Central
Government particularly on account of defence, GST Rolled Out Finally
internal security, infrastructure, railways, climate
change, commitments towards administration of After 17 arduous years of negotiations by
UTs without legislature, and other committed successive governments at the Centre and in the States,
expenditure and liabilities; the Narendra Modi government has finally introduced a
uniform Goods and Services Tax (GST) regime that
(iii) The demand on the resources of the State
converts the country into a single market. The biggest
Governments, particularly on account of financing
tax reform in Independent India, the Goods and Services
socioeconomic development and critical infrastru-
Tax (GST), finally rolled out at the midnight hour on
cture, assets maintenance expenditure, balanced
June 30, 2017, with President Pranab Mukherjee and
regional development and impact of the debt and
Prime Minister Narendra Modi pressing a button to mark
liabilities of their public utilities;
the occasion in the historic central hall of Parliament.
(iv) The impact on the fiscal situation of the Union Calling the GST ‘a good and simple tax’, Modi said the
Government of substantially enhanced tax devolu- country was moving towards a modern taxation system,
tion to States following recommendations of the much simpler and more transparent than the existing
14th Finance Commission, coupled with the one. ‘From Gandhinagar to Itanagar, from Leh to
continuing imperative of the national development Lakshadweep, the dream of one nation, one tax will
programme including New India – 2022; come true,’ he added.
(v) The impact of the GST, including payment of com-
pensation for possible loss of revenues for 5 years, The GST replaces 17 central and state taxes,
and abolition of a number of cesses, earmarking including services tax, value-added tax, octroi, duties
thereof for compensation and other structural and other charges, except Customs levy, across the
reforms programme, on the finances of Centre and country except in Jammu and Kashmir. The tax will
States; and create a common market in the $ 2-trillion economy
(vi) The conditions that GoI may impose on the States with 1.3 billion people. It is expected to curb ‘tax
while providing consent under Article 293(3) of terrorism and inspector raj’.
the Constitution. National Anti-Profiteering Authority
6. The Commission may consider proposing
measurable performance-based incentives for States, at Set-up
the appropriate level of government, in following areas: The government of India has set up, on November
(i) Efforts made by the States in expansion and 28, 2017, the National Anti-Profiteering Authority,
deepening of tax net under GST; under the Chairmanship of B. N. Sharma, additional
(ii) Efforts and Progress made in moving towards secretary in the department of revenue, amid reports that
replacement rate of population growth; some companies, particularly restaurants, are not passing
(iii) Achievements in implementation of flagship on the benefit of the goods and services tax (GST) rate
schemes of Government of India, disaster resilient cuts to consumers. Key features of the NAPA are
infrastructure, sustainable development goals, and following :
quality of expenditure; ● The authority will exist for a period of two years
(iv) Progress made in increasing capital expenditure, from the date B.N. Sharma assumes charge.
eliminating losses of power sector, and improving
● The authority is mandated to ensure that the benefits
the quality of such expenditure in generating future
income streams; of input credit and the reduction in GST rates on
(v) Progress made in increasing tax/non-tax revenues, specified goods or services are passed on to the
promoting savings by adoption of Direct Benefit consumers by way of a commensurate reduction in
Transfers and Public Finance Management System, prices.
promoting digital economy and removing layers ● The government also named four senior officials as
between the government and the beneficiaries; technical members of the authority.
Economics (NET) | 679U
List of Taxes Included in GST & Benefits of GST consists of a standing committee, state-level
(List of Indirect Taxes) screening committees and the Directorate General
of Safe-guards in the Central Board of Excise &
Indirect Taxes Included Under GST Customs (CBEC).
(A) State taxes subsumed in SGST :
● Consumers who are aggrieved that there has been
● VAT/Sales tax/Trade Tax
no commensurate reduction in prices may apply for
● Entertainment tax (unless it is levied by local bodies)
relief to the screening committee in the state
● Luxury tax concerned. After forming a prima facie view on the
● Taxes on lottery, betting and gambling substance of the application, the matter would be
● State cess and surcharges to the extent related to supply referred to a standing committee at the Centre. The
of goods and services. standing committee will, in turn, ask the Director
● Entry tax not on in lieu of octroi General of Safe-guards to carry out a detailed
● Electricity Duty investigation which will give its findings to the
(B) Central taxes subsumed in CGST : authority.
● Central Excise duty ● The screening committee is expected to look into
● Special Additional Duty of Custom (SAD) complaints of local nature while the standing
● Additional Custom Duty (CVD) committee would ordinarily enquire into cases o f
● Additional excise duty mass impact with all-India ramifications.
● The excise duty levied under The Medical and ● Most complaints on profiteering with screening
Toiletries Preparation Act committees and the standing committee relate to
● Service tax restaurants and the real estate sector.
● Additional customs duty, commonly known as ● Once the authority confirms there is justification to
countervailing duty (CVD)
apply anti-profiteering measures, it has the authority
● Special additional duty of customs (SAD)
to order the business concerned to reduce its prices
● Education cess or return the undue bene-fit availed, along with
● Surcharges interest at the rate of 18 per cent, to the consumers
● Tax on advertisement other than in Press/ TV/ Radio of the goods or services. If the undue benefit cannot
● Taxes on lottery, betting and gambling be passed on to the consumers, it can be ordered to
Benefits of GST be deposited in the Consumer Welfare Fund.
GST has been envisaged as a more efficient tax system, ● The authority also has the power to impose penalty
neutral in its application and attractive in distribution. The on the defaulting business or even order the
advantages of GST are : cancellation of its registration under the GST.
● Wider tax base, necessary for lowering the tax rates and
eliminating classification disputes The Present GST Rate Structure
● Elimination of multiplicity of taxes and their cascading (January 1, 2019)
effects GST Number Category of Goods & Services
● Rationalization of tax structure and simplification of Rate of Items
compliance procedures 0% 183 Mostly Agricultural produce
● Harmonization of center and State tax administrations, 5% 308 Branded cereals, Edible oils, Pizza
which would reduce duplication and compliance costs bread, snacks, insulin, footwears of upto
● Automation of compliance procedures to reduce errors R 1000, parts of wheelchairs
and increase efficiency 12% 178 Butter & other Fats, pasta, branded
● Reduces transaction costs and unnecessary wastages snacks, diabetic foods, drinking water
● Eliminates the multiplicity of taxation packed in 200 litre bottles, feeding
● One point single tax bottles, surgical rubber gloves, carpets,
● Reduces average tax burdens mobile phones, bicycles.
● Reduces the corruption 18% 517 Vinegar, Marbles, paints, varnishes,
fibre board, plywood
● In addition to the authority, the institutional 28% 28 Cement, Auto parts, air conditioners,
mechanism for effective implementation of the anti- dish washers, tobacco, cigarettes,
profiteering measures enshrined in the GST rules aerated drinks
680U | Economics (NET)
Objective Questions
1. Which of the following statements is not valid in the 4. Consider the following statements and choose the
case of an economy suffering from deflation ? correct code given below
(A) Companies tend to spend less on new capital I. The capital adequacy ratio denotes how much
stock capital a bank has against its loans and
(B) Floating –rate savers are adversely affected advances.
(C) Fixed rate borrowers are benefited II. Under Basel III norms, the minimum required
(D) Bonds enjoy a bull market capital adequacy ratio is 10.5 per cent
[Other thing remaining the same , borrowers benefit (A) Only I is correct
from inflation as each installment repaid by them is (B) Only II is correct
less valuable to the lender, owing to the falling (C) I&II both are correct
purchasing power of money. However, this is (D) Neither I nor II is correct
inverted in a deflationary situation, as the purchasing
power of money increases, thereby benefiting the 5. ……………… is the first Indian who has been
lender] declared fugitive economic offender by a court.
2. Chinese tech company Huawei and ZTE were (A) Vijay Mallya (B) Nirav Modi
banned in many countries from providing— (C) Mehul Chokse (D) Lalit Modi
(A) 5G technology equipment
[Former liquor baron Vijay Mallya, accused of
(B) Mobile phones defaulting on loans of over Rs 9,000 crore, received
(C) High tech toys another blow as a Mumbai court on Saturday
(D) Data cables declared him a “fugitive economic offender” (FEO).
[Huawei is the second-largest seller of mobile Mallya became the first businessman to be declared
phones worldwide, behind South Korea’s Samsung an FEO under the Fugitive Economic Offenders
and ahead of the US’ Apple. While ZTE is a major Act, which came into existence in August 2018.]
global provider of telecommunications equipment 6. Which of the following instruments of banking
and network solutions based in China’s Shenzhen. sector celebrated its Golden Anniversary in 2017?
The new 5G technology promises data transmission (A) ATM (B) Cheque Book
speeds 100 times faster than the current generation (C) Credit card (D) Debit card
of mobile networks, allowing users to enjoy faster
downloads and video streaming on their smart- [The first ATM was installed by Barclays bank in at
phones. But perhaps the most important applications its Enfield Branch in London in 1967.]
for 5G will be in self-driving cars, the internet of 7. Reserve Bank of India has constituted an expert
things and other emerging technologies for which committee under the chairmanship of ……………
ultra high-speed communication is crucial. It is on Economic Capital Framework.
being alleged that Huawei and ZTE devices may (A) Dr. Y.V.Reddy
pose an unacceptable risk to (military) personnel, (B) Dr. Vimal Jalan
information and mission,] (C) Dr. Rakesh Mohan
3. Government of India fixes Minimum Support prices (D) Dr. Raghuram G. Rajan
(MSPs) for ………… mandated agricultural crops.
8. Union Government has signed on January
(A) 19 (B) 20
11, 2019an MoU with six Chief Ministers for the
(C) 21 (D) 22 construction of Renukaji multipurpose dam project.
[Government of India fixes Minimum Support Renukaji dam will be in the state of …………..
prices (MSPs) for 22 mandated agricultural crops (A) Jammu & Kashmir (B) Punjab
viz. Paddy, Jowar, Bajra, Maize, Ragi, Arhar, (C) Himachal Pradesh (D) Uttarakhand
Moong, Urad, Groundnut-in-shell, Soyabean, Sun-
flower, Sesamum, Nigerseed, Cotton, Wheat, [The Agreement for the construction of Renukaji
Barley, Gram, Masur (Lentil), Rapeseed / Mustard, Dam Multi-Purpose Project was signed by six
Safflower, Jute and Copra and Fair & Remunerative states, Haryana, Himachal Pradesh, Uttarakhand,
Price (FRP) for Sugarcane on the basis of the Delhi, Rajasthan and Uttar Pradesh. Renukaji Dam
recommendations of the Commission for Agri- Multi-Purpose Project is a storage project on the
cultural Costs and Prices (CACP), considering the Giri river which is tributary of the Yamuna at
views of the State Governments and Central Mini- Sirmour district of Himachal Pradesh].
stries/Departments and other relevant factors. In 9. ‘Ama Ghare LED scheme has been launched in the
addition, MSP for Toria and De-Husked coconut is state of …………
also fixed on the basis of MSPs of Rapeseed / (A) Andhra Pradesh (B) West Bengal
Mustard and Copra respectively] (C) Jharkhand (D) Odisha
Economics (NET) | 681U
[Odisha Chief Minister Naveen Patnaik on (C) To increase the export of organic products
January 11, 2019 launched the ‘Ama Ghare LED’ (D) To create export hubs for the export of horti-
Scheme, under which about 95 lakh families in cultural products
Odisha will each get four LED bulbs free of cost.9 14. An online portal “ENSURE” has been launched
watt LED bulbs will be distributed to the benefi- by……….
ciaries registered under the National Food Security
Act and the State Food Security Scheme] (A) Department of Higher Education (Ministry of
HRD)
10. Which of the following statement is/are correct
about wealth inequalities in India ( based on Oxfam (B) Department of Animal Husbandry, Dairying
report 2018) and Fisheries
I. Total wealth of Indian billionaires is higher (C) Department of Science and Technology
than the total Budget of Central government for (D) Ministry of AYUSH
the year 2018-19: Rs. 24,42,200 crore) [Union Minister of Agriculture and Farmers’
II. Top 10% of the population holds 77.4% of total Welfare on December 11, 2018 launched a portal
national wealth. ENSURE-National Livestock Mission-EDGE deve-
III. Top 1% holds 51.53% of the country’s national loped by NABARD]
wealth 15. Which country of the world is the largest exporter
IV. India is a ‘Billionaires Boys Club” of Liquefied Natural Gas?
Correct code is— (A) USA (B) Russia
(A) I, II, III & IV are correct (C) Saudi Arab (D) Qatar
(B) Only II & IV are correct
16. As per NITI Aayog’s SDG India Index 2018 which
(C) Only III & IV are correct of the following state is in the Achiever category?
(D) I, II & III are correct (A) Kerala (B) Tamil Nadu
[The widening economic disparity between the rich (C) Himachal Pradesh (D) No state/UT of India
and the poor in India has been highlighted in an
annual report –‘Public Good or Private Wealth’ by 17. As per NITI Aayog’s SDG India Index 2018 Delhi
Oxfam, an international charity organization .] and Puducherry are in Achievers category in respect
11. “SDG India Index 2018” has been released by of ………….
………. (A) SDG 6 ( Clean Water and sanitation)
(A) United nation Development Programme (B) SDG 9 (Industry, Innovation and Infrastructure
(UNDP) (C) SDG 10 ( Reducing inequality)
(B) National Institution for Transforming India (D) SDG 13 (Climate Action)
(NITI Aayog)
(C) United Nations Environment Programme 18. Which of the following is an objective of “ Ideate
(UNEP) for India-Creative Solutions Using Technology”?
(D) Ministry of Environment, Forest and Climate (A) To promote innovation in Central government
Change funded research laboratories
12. Which of the following pairs is/are correctly (B) To select cities for funding for smart city
matched? mission
I. SEZ policy Review Committee- Baba Kalyani (C) To give engineering colleges a platform and
II. Review of RBI’s Economic Capital Frame- opportunities to become solution creators for
work- Bimal Jalan the problems they see around them
III. Logistic Development Committee-Bibek (D) To give school students a platform and oppor-
Debroy tunities to become solution creators for the
Correct code is— problems they see around them
(A) Only III is correct 19. Which of the following Schemes/programmes is/are
(B) Only II & III are correct related to the development of higher education
(C) I, II & III are correct system of India?
(D) Only I & II are correct I. TEAM II. ARPIT
13. Which of the following is an objective of Agricul- III. SWAYAM IV. RUSA
ture Export Policy, 2018? Correct code is—
(A) To double agricultural exports from present
(A) Only IV is correct
US$ 30 + billion to US $ 60 + billion by 2022
(B) To strive to triple India’s share in world (B) Only I & IV are correct
exports by integrating with global value chain (C) Only I, II & III are correct
at the earliest (D) I, II, III & IV are correct
682U | Economics (NET)
20. A holistic approach for the development of pre- 24. Consider the following facts about Intellectual
school education upto the senior secondary educa- Property Index , and choose the correct code given
tion is in the core of …………. below
(A) Sarva Shiksha Abhiyan I. This Index has been developed by the US
(B) Rashtriya Madhyamik Shiksha Abhiyan Chamber of Commerce’s Global Innovation
(C) Samagra Shiksha Abhiyan Policy Center’s (GIPC’s)
(D) Operation Black Board II. India’s rank in Intellectual Property Index 2019
21. Finance Minister announced many benefits to tax is 36
payers in interim budget 2019-20. Which of the III. United State of America is at the top in
following provisions is/are correct ? Intellectual Property Index 2019
I. Person with net taxable income R 5.00 lakh IV. Pakistan’s rank in Intellectual Property Index
need not to pay any income tax in financial 2019 is 47th
year 2019-20 Correct code is—
II. Income tax rate in the income slab R 0 to (A) Only II is correct
R 5.00 lakh reduced to zero per cent. (B) Only I& II are correct
III. Standard deductions for salaried class has
(C) I, II, III & IV are correct
increased to R 50000
IV. No TDS on interest income up to R 40000 from (D) Only III is correct
interest earned bank/post office deposits 25. e-Marketplace (GeM) has been created by the central
Government. It has transformed ………by making
Correct code is—
it fully transparent, inclusive and efficient.
(A) Only I is correct
(A) Public procurement
(B) Only I, III & IV are correct
(B) Procurement of perishable dairy products
(C) Only II is correct
(C) Procurement of perishable dairy products
(D) Only III & IV are correct
(D) Procurement of handicraft products
22. Which of the following statement is correct about 26. Consider the Assertion (A) and Reason (R) given
Department for Promotion of Industry and Internal below and choose the correct code
Trade (DPIIT)? Assertion (A) : Bad loans of public sector banks
(A) It is a new department under the Ministry of declined by more than R 31,000 crore to R 8,64,433
Commerce and Industry crore in the first nine months of 2018-19 as
(B) DIPP has been renamed as the DPIIT compared to end of March 2018
(C) The issues concerning promotion of internal Reason ( R) : The government’s 4Rs strategy of
trade, including retail trade; welfare of traders recognition, resolution, recapitalisation and reforms
and their employees; matters relating to in respect of public sector banks gave better results
facilitating ease of doing business; and startups in the year 2018-19
will dealt by the DPIIT Correct code is—
(D) All of the above (A) Assertion (A) and Reason (R) both are correct
23. The Industry 4.0 fuses various technologies such and Reason (R) is the correct explanation of
as............ Assertion (A)
(B) Assertion (A) and Reason ( R) both are correct
I. Artificial intelligence (AI) & The internet of
but Reason (R) is not the correct explanation of
things (IoT)
Assertion (A)
II. 5G telephony & Nanotechnology (C) Assertion (A) is correct but Reason (R) is
III. Biotechnology incorrect
IV. Robotics & quantum computing and the like. (D) Assertion (A) is incorrect but Reason (R) is
Correct code is— correct
(A) Only I (B) Only I & II 27. Which of the following statement is/are correct
(C) I, II, III & IV (D) Only IV about Annadatha Sukhibhava scheme
[The world is at the cusp of the Industry 4.0. (A) It is a Direct Benefit Transfer scheme of finan-
Industry 1.0 used water and steam to mechanise cial assistance to the farmers in the state of
production; Industry 2.0 used electric power; Andhra Pradesh.
Industry 3.0 used electronics and IT. Industry 4.0 (B) This scheme has been merged with Central
fuses various technologies such as artificial Government’s PM-KISAN
intelligence (AI), the internet of things (IoT), (C) Each and every farmer, including the tenant
autonomous vehicles, 5G telephony, nanotech- farmers, will get R 10000 per year in two
nology, biotech, robotics, quantum computing and instalments of R 5000 each
the like.] (D) All of the above
Economics (NET) | 683U
28. Which of the following pairs is/are matched [In such cases the investor purchases the bonds
correctly ? above the face value ( say Rs. 100) and the same
I. Lactalis – Prabhat Dairy bond is sold at the maturity at face value. It resulted
II. Danone - Epigamia into a capital loss]
III. GSMMF- AMUL 34. The government expects India’s merchandise
exports to grow 7.3% year on year to $325 billion in
IV. Madhya Pradesh Sate Cooperative Dairy 2018-19. The growth rate would be lower than 9.8%
Federation Limited –SANCHI clocked in 2017-18 due to factors including
Correct code is— (A) Muted growth of traditional exports such as
(A) Only III is correct gems and jewellery, farm and engineering
(B) Only II & IV are correct (B) A liquidity crunch
(C) I, III & III are Correct (C) Global factors
(D) I, II, III & IV are correct (D) All of the above
29. 59-minute Loan portal is related to ………… 35. The term ‘Henry Hub’ is the colloquial for the price
(A) Foreign Investors in priority sectors benchmark for…………….
(B) Micro, Small and Medium Enterprises (A) Crude oil
(MSME) sector (B) Refined edible oil
(C) Marginal and Small farmers (C) Liquefied Natural Gas
(D) Weaker Sections (D) Liquefied Petroleum Gas
30. As on January 31, 2019 which State/Union Territory 36. Which of the following country topped The
has fixed highest minimum wages per worker per Economist’s Glass Ceiling Index, 2019?
month in India?
(A) Canada (B) Sweden
(A) Punjab
(C) Norway (D) Finland
(B) Kerala
[The Glass Ceiling Index shows the state of women
(C) Delhi employment worldwide. Sweden retained its top
(D) Andaman and Nicobar Islands position this year too followed by Norway.]
31. Adani Group won the bids to develop and operate 37. Which of the following is India’s only ‘defined
certain Airports in Indi (A) These Airports are— Benefit +defined contribution scheme’?
I. Ahmadabad II. Jaipur (A) Public Provident Fund
III. Lucknow IV. Mangalore (B) National Pension Scheme
V. Trivandrum. (C) Equity-linked savings scheme
Correct code is— (D) Employee Provident Fund
(A) I, IV & V only [Each employee contributes a fixed percentage of
(B) II & III only his salary ( currently 12%) to the fund and receives
(C) I Only a quisi-fixed return (Which is set every year) on this
(D) I, II, III, IV & V contribution]
32. Solow’s paradox deals with the relationship 38. Which is the India’s first bank to link its savings
between………….and…………. bank interest rate to the RBI repo rate?
(A) Technology and labour (A) HDFC Bank
(B) Labour and capital (B) State Bank of India
(C) Technology and productivity (C) Punjab National Bank
(D) Capital and productivity (D) Bank of Baroda
[It is also known as Solow’s computer paradox. It is 39. M0 , M 1 , M 2 , M 3 and M4 are the measures of
the peculiar observation made in business analysis …………
that as more investment is made in information
technology a workers productivity may go down (A) Public debt
instead of up] (B) Money Supply
33. Bond holder always suffer a capital loss when they (C) Buffer stock of foodgrains
purchase bonds at a …………….and ………….. (D) Movement of stock prices
(A) Discount, hold to maturity 40. India’s rank in United Nations’ World Happiness
(B) Discount, sell before maturity Index 2019 is……..
(C) Premium, hold to maturity (A) 133rd (B) 135th
(D) Premium, sell before maturity (C) 140th (D) 142nd
684U | Economics (NET)
41. United Nations’ World Happiness Index,2019 is 46. Women’s Livelihood Bonds (WLBs) are being
based on an average of threes of surveys taken by launched in close collaboration with………….
Gallop between 2016 and 2018 and includes factors I. World Bank
such as ……… II. UN Women
I. Gross Domestic Product per capita III. Small Industries Development Bank of India
II. Social Support from Friends and Family Correct code is—
III. Healthy Life Expectancy and recent emotions (A) Only by I (B) Only II
IV. Freedom to make Choices (C) Only By III (D) I, II & III
V. Perceived corruption
[World bank, UN Women and SIDBI have joined
Correct code is— hands to launch a new social impact bonds exclu-
(A) Only I, II & III (B) Only II, III & IV sively for women, called Women’s Livelihood
(C) Only III, IV & V (D) I, II, III, IV & V Bonds (WLBs), with an initial corpus of Rs. 300
42. SWAYATT is an initiative to………………. crore]
(A) Promote Start-ups 47. ……………is the first state in India to set up a price
monitoring and research unit (PMRU) to track
(B) Creating facilities for women and youth
violation of prices of essential drugs and medical
advantage through e-transaction on government
devices.
e- marketplace
(A) Uttar Pradesh (B) Haryana
(C) A & B both
(C) Kerala (D) Rajasthan
(D) Neither A nor B
48. Who, among the following is not a member of NITI
43. Which of the following statement is correct about Aayog (As on June 10, 2019)?
International Intellectual Property Index 2019?
(A) Dr. Bibek Debroy
I. India’s rank in IP index 2019 is 36th
(B) Dr. V.K.Saraswat
II. It has been released by US Chamber of
Commerce’s global centre (C) Prof. Ramesh CHand
III. It ranks only 50 countries only (D) Dr. V.K.Paul
(A) Only I is correct 49. Which of the following statement is correct about
(B) Only I&II are correct monetary policy in India?
(C) Only II&III are correct I. Benchmark policy rate (Repo Rate) is deter-
(D) I, II & III are correct mined by high powered monetary policy
committee (MPC)
44. Which of the following statement is correct about II. MPC has six members including the RBI
vote-on-account? Governor
I. Vote on account is the permission of the III. Three members of MPC are appointed by the
legislature to withdraw money from the Central Government with a fixed tenure of four
Consolidated Fund of India in that period, years
usually two months. IV. Monetary Policy is reviewed bi-monthly
II. Vote on account is a formality and requires no Correct code is—
debate. (A) Only I, II, & III are correct
III. When elections are scheduled a few months (B) I, II, III & IV are correct
into the new financial year, the government (C) Only IV is correct
seeks vote on account for four months.
(D) None is correct
IV. Vote on account is the interim permission of
the parliament to the government to spend 50. Minimum Support Price is determined by the
money. Government of India on the recommendations of
Correct code is …………
(A) Only IV is correct (A) Commission for Agricultural Costs & Prices
(B) Only I is correct (B) NITI Aayog
(C) NABARD
(C) Only II & IV are correct
(D) NABARD & NAFED
(D) All are correct
51. Which of the following has suggested bringing a
45. India ranks ………… on World Economic Forum’s legislation conferring on Farmers’ ‘Right to Sell at
Global Energy Transition Index, 2019 MSP’(Minimum Support Price)
(A) 76th (B) 77th (A) The National Commission on Farmers, chaired
(C) 78th (D) 79th by Prof. M. S. Swaminathan
Economics (NET) | 685U
(B) Commission for Agricultural Costs and Correct code is—
Prices (CACP) in its Price Policy report for (A) Only I & II (B) Only II & III
Kharif Crops for 2018-19 season (C) Only I & III (D) I, II & III
(C) Standing Committee on Agriculture
57. Which of the following is a Central sector scheme ?
(D) Fourteenth Finance Commission
(A) National Women Fund
52. Which of the following statement is correct in (B) Pradhan Mantri Kisan Samman Nidhi (PM-
respect of Indian agriculture? KISAN)
(A) Foodgrain production in 2018-19 is expected to (C) Alternative Investment Funds (AIFs)
be higher as compared to horticulture pro-
duction (D) India Aspiration Fund
(B) Horticulture production in 2018-19 is 58. Which of the following scheme is not related to the
expected to be higher as compared to empowerment and development of women
foodgrain production (A) Arundhati Scheme
(C) Government of India announces Minimum (B) MAMTA scheme
support price for each agricultural produce (C) KUSUM scheme
(D) Fair and Remunerative price (FRP) is (D) RUPASHREE PRAKALPA
announced in respect of all commercial crops [KUSUM—‘Kisan Urja Suraksha evam Utthaan
[As per First Advance estimates for 2018-19 Mahabhiyan scheme is related to promotion of use
horticulture production is estimated to be 314.67 of solar power for irrigation]
million tones, while the foodgrain production has
been estimated at 281.37 million tones in Second 59. Consider the establishment of the following institu-
Advance estimates for 2018-19] tions and choose the correct chronological order in
ascending order
53. Which of the following statement is correct about
poverty rates’ estimation in India I. University Grant Commission
(A) State wise poverty rates are estimated by the II. NABARD
NITI Aayog III. SEBI
(B) State wise poverty rates are determined by the IV. National Testing Agency
Ministry of Rural Development (A) I-II-III-IV (B) II-III-IV-I
(C) Last poverty rates and state wise poverty lines (C) I-III-II-IV (D) IV-III-II-I
were determined by the Expert Group to
60. Which of the following BSE Sensex stocks is not a
Review the Methodology for Estimation of
part of $100 billion club?
Poverty (Rangarajan Committee )
(D) The current methodology for poverty estima- (A) Reliance Industries
tion is based on the recommendations of an (B) ITC
Expert Group to Review the Methodology for (C) TCS
Estimation of Poverty (Tendulkar Committee) (D) HDFC Bank
54. India’s rank in Global Passport Index 2019 is ……..
61. Consider the following statements regarding india’s
(A) 35th (B) 49th Agricultural exports.
(C) 52nd (D) 67th I. Agricultural Export Policy ,2018 aims to
55. ‘SHREYAS’ is related with……….. double agricultural exports to $60 billion by
(A) Providing Industrial Apprenticeship and Skills 2022.
to graduates II. Transport and marketing Assistance scheme is
(B) Promoting Value education to under graduates one of the key initiatives to increase the
(C) Development of Traditional culture in North agricultural exports
East region (A) Only I is correct
(D) Providing training facilities to young aspirants (B) Only II is correct
of sports
(C) I&II both are correct
56. Which of the following statement is correct about
(D) Neither I nor II is correct
“Operation Digital Board”?
I. It is for the students of class IX and above 62. Consider the Assertion (A) and Reason (R) given
II. The scheme will be implemented from educa- below and choose the correct code :
tional session 2019-20 Assertion (A ) : According to WTO’s report 2019,
III. At least one digital and interactive board per growth in global trade volumes is likely to slow
class will be established in government and down to 2.6 per cent in 2019 compared to 3 per cent
government added schools in 2018.
686U | Economics (NET)
Reason ( R ) : World witnessed rising trade tensions II. It has powers similar to civil courts
between major economic powers and increased III. It can levy penalties against auditing firms
economic uncertainty during 2018 and 2019. IV. It can black list auditing firms and auditing
Correct code is— professionals
(A) Assertion (A) and Reason (R) both are correct Correct code is—
and R is the correct explanation of Assertion (A) Only I & II (B) Only II & III
(A)
(C) Only I, II & III (D) I, II, III & IV
(B) Assertion (A) and Reason (R) both are correct
and R is not the correct explanation of 67. Inflation rate is highest in the world in 2019 in
Assertion (A) which country ?
(C) Assertion (A) is correct but Reason (R) is (A) Venezuela (B) Russian Federation
incorrect (C) South Africa (D) Argentina
(D) Assertion (A) is incorrect and Reason (R) is 68. After Pulwama terrorist attack in February 2019,
correct Government of India took following decisions
63. Which of the following statement is incorrect about against Pakistan.
India’s external sector’s performance in 2018-19? I. GoI withdrew Most Favoured Nation status
I. India was the net importer of steel during 2018- granted to Pakistan
19 , the first time in the last three years II. Government of India has suspended the trade
II. India’s trade deficit against China declined by across the Line of Control (LoC) with Pakistan
US$ 10 billion in 2018-19 from April 19, 2019
III. India’ finished steel exports fell by 34 per cent Correct code is—
in 2018-19 to 6.36 million tones (A) Only I (B) Only II
IV. India’s Finished steel imports increased by 4.7 (C) Only I & II (D) Neither I nor II
per cent to 7.84 million tones in 2018-19
Correct code is— 69. California almonds were in the news in March-
April 2019 because of following reasons.
(A) Only II (B) Only I
I. California almonds are known worldwide for
(C) I, II, III & IV all (D) Only I, III & IV their high nutritional value.
64. Consider the following statements and choose the II. The almonds produced in California (US) have
correct code given below. been regularly finding their way through LOC
I. The Minimum Support Price (MSP) for Minor trade.
Forest Produce (MFP) scheme was started by III. These were being used in cross-Line of control
the central government in 2013 to ensure fair trade between India and Pakistan as a mode to
and remunerative prices to MFP gatherers earn profit through under-invoicing.
II. Ministry of Tribal Affairs is the final authority IV. Profit earned in the trade of California almonds
over the list of MFPs covered under the scheme was funneled to terrorists and separatists in
III. As on April 1,2019, 49 MFPs are under the Jammu and Kashmir.
MSP scheme Correct code is—
Correct code is— (A) Only I (B) Only II & IV
(A) Only I is correct (C) Only I, II & III (D) I, II, III & IV
(B) I&III are correct only
70. Commission for Agricultural Costs and Prices is
(C) Only II&III are correct
mandated to advice on the price policy for certain
(D) I, II & III all are correct crops. These include……….
65. Which of the following statement is correct about I. Seven cereal crops
National Rural Economic Transformation Project II. Five pulse crops
(NRETP) ? III. Seven oilseeds crops
(A) It is IBRD (World Bank) funded project IV. Copra, cotton, raw jute, and sugarcane
(B) It is being implemented under Deendayal Correct code is—
Antyodaya Yojana-National Rural Livelihood
(A) Only I (B) Only I & II
Mission (DAY-NRLM)
(C) Only I, II & III (D) I, II, III & IV
(C) It is a sub component of MGNREGA
(D) A & B both [MSPs are announced by the GoI, on the
recommendations of CACP, for seven cereals
66. Which of the following statement is correct about (Paddy , Wheat, Jwar, Bajra, maize , ragi & barley);
National Financial Reporting Authority (NFRA). five pulse crops (gram, tur, urad, moong and lentil);
I. NFRA can make auditors accountable seven oilseeds (groundnut, sunflower seed, soya-
Economics (NET) | 687U
bean, rapeseed/mustard, safflower, nigerseed and (C) Rotterdam Convention- Prior informed consent
seasmum); Copra, cotton, raw jute. Fair and procedure for certain Hazardous Chemicals and
Remunerated Price is announced for sugarcane] Pesticides in International Trade
71. Consider the list I (Innovative ideas of public (D) Stockholm Convention - Persistent Organic
participation in Mid-Day meal programme) and List Pollutant
II (State) and choose the correct code given below. [Minimata Convention is on the development of a
List I List II global legally binding instrument on Mercury]
(a) Tithi Bhojan 1. Rajasthan 75. If the Purchasing Managers’ Index number is below
(b) Samarpit Bhojan 2. Himachal Pradesh 50, it indicates…………
(c) Utsav Bhoj 3. Gujarat (A) Inflation is on downward trend
(d) Dham 4. Assam (B) Inflation is on upward trend
(C) Growing optimism
Correct code is—
(D) Deteriorating Economic Conditions
(a) (b) (c) (d)
[PMI is economic indicator derived from the
(A) 3 4 1 2 monthly surveys of private companies. ]
(B) 4 3 1 2
76. It is estimated that the commercial banks, especially
(C) 1 2 3 4 the Public Sector Banks, have written off R 7 trillion
(D) 4 3 2 1 worth of bad loans during the last ten years. What is
[Tithi Bhojan (Gujarat) is an innovative concept the implication of this exercise?
under Mid-Day-Meal programme to ensure greater I. Liabilities of the bank becomes higher than its
public participation. It is known by Samarpit assets.
Bhojan in Assam, Dham in Himachal Pradesh, Sneh II. After a write off, the bank can continue with its
Bhojan in Maharashtra, Shaegagi Naavu Neevu in recovery efforts.
Karnataka, Anna Dhanam in Puducherry, Priti Bhoj III. Since the balance sheet is cleaned up , there is
in Punjab and Utsav Bhoj in Rajasthan] very little incentive for the bank to pursue the
72. Which of the following is odd one out ? defaulter.
(A) SAKSHAM (B) PAHAL IV. Identities of the beneficiaries of the write –offs
(C) PRAGATI (D) ISHAN-UDAy are not disclosed.
[PAHAL (Pratyaksh Hanstantrit Labh) is a scheme Correct code is—
of Direct Benefit transfer of LPG (DBTL) subsidy, (A) Only I & II (B) Only III & IV
while SAKSHAM is a scholarship scheme for (C) Only I, II & III (D) I, II, III & IV
differently–abled children; PRAGATI is scholarship
77. At the end of March 2019, India’s total external debt
scheme for girls students; and Ishan Uday is a
stood at—
special scholarship scheme for students of North
East region] (A) $ 516 billion (B) $ 543 billion
73. Which of the following schemes /programmes are (C) $ 562 billion (D) $ 580 billion
of energy sector ? 78. Which of the following companies/start-ups is/are
I. DDUGJY the examples of ‘gig economy’ ?
II. SAUBHAGYA I. Ola II. Uber
III. Zomato IV. Swiggy
III. UDAY
Correct code is—
IV. PMUY
(A) Only I & II (B) Only III & IV
Correct code is— (C) I, II, III & IV all (D) None of the above
(A) I, II, III & IV (B) Only II & IV
79. Consider the following statements about the Pradhan
(C) Only II (D) Only I, III & IV
Mantri Jan Dhan Yojana and choose correct code
[DDUGJY – Deendayal Upadhyaya Gram Jyoti given below—
Yojana; SAUGHAGYA- Sahaj Bijali Har Ghar I. The focus of the scheme is on accounts from
Yojana; UDAY – Ujwal DISCOM Assurance ‘every household’ to ‘every un-banke (D)
Yojana; PMUY – Pradhan Mantri Ujjwala Yojana]
II. The PMJDY envisages channelling all govern-
74. Which of the following pair is not matched ment benefits to the beneficiary accounts and
correctly ? pushing the Direct Benefit Transfer (DBT)
(A) Basel Convention – The control of Trans scheme of the central government.
boundary Movements of Hazardous Waste and (A) Only I is correct
their disposal (B) Only II is correct
(B) Minimata Convention – Safe disposal of (C) I&II both are correct
Lead and its compounds (D) Neither I nor II is correct
688U | Economics (NET)
80. Consider the List I (Committee) and List II (Chair (C) Assertion (A) is correct and Reason (R) is
person/Head) and choose the correct code given wrong
below— (D) Assertion (A) is wrong and Reason (R) is
List I correct
(A) Digital Payments and Financial inclusion 84. Assertion (A) : India’s economy appears to have
through Fintech slowed down slightly in 2018-19.
(B) Transformative Mobility Reason (R) : Declining growth of private consump-
(C) Offshore rupee Market tion, tepid increase in fixed investment, and muted
(D) Mediation panel on Ram Janm Bhumi Babri- exports during 2018-19.
Masjid case Choose the correct answer on the basis of Assertion
List II (A) and Reason (R).
1. Amitabh Kant (A) Assertion (A) and Reason (R) both are correct
2. Nandan Nilekani and R is the correct explanation of A
3. Justice Kalifullah (B) Assertion (A) and Reason (R) both are correct
4. Usha Thorat and R is not the correct explanation of A
Correct code is— (C) Assertion (A) is correct and Reason (R) is
(a) (b) (c) (d) wrong
(A) 2 1 4 3 (D) Assertion (A) is wrong and Reason (R) is
(B) 4 3 2 1 correct
(C) 1 2 3 4 85. Which of the following states/UTs have been placed
(D) 1 2 4 3 in ‘Grade I’ category of Ministry of HRD’s per-
formance of states/UTs in PGI on school education
81. As per World Trade Organisation’s ‘Agreement on 2017-18
Agriculture which type of subsidy has no mention I. Union Territory Delhi
in this agreement?
II. Union Territory Chandigarh
(A) Green Subsidies (B) Yellow subsidies
III. Gujarat
(C) Red Subsidies (D) Amber subsidies
IV. Kerala
[Subsidies have been classified under three cate-
(A) Only IV (B) Only III & IV
gories : 1. Red subsidies- Subsidies with high trade–
distorting effects, such as export subsidies, and (C) Only I, II & III (D) I, II, III & IV
those which favour the use of domestic goods over 86. A/An ………………monetary policy is usually
imported goods; Green Subsidies- Subsidies that are ineffective when interest rates are extremely low.
not specific to an enterprise of industry or a group
(A) Concretionary (B) Expansionary
of industries or industries are not actionable; Amber
subsidies- Subsidies that are neither red nor green (C) Stagflationary (D) Inflationary
belong to Amber category] [An expansionary monetary policy involves lower-
82. Smishing and vishing are types of …………….. ing interest rates to increase the supply of money in
(A) Advertising campaigns the economy. However, the effectiveness of this
policy steadily reduces as interest rates settle down
(B) Frauds at relatively abnormally low levels. Hence, it may
(C) Employe Stock options have to be supplemented by other monetary tools]
(D) Profit Sharing Structure
87. Friends of Fish is an informal coalition of WTO
[Smishing is relates fraud through SMS and vishing members seeking to significantly reduce fisheries
through fraudulent phone calles] subsidies given to developing countries. Which of
83. Assertion (A) : Banks in India have witnessed spurt the following countries are members of this
in CASA (current account and savings banks coalition ?
accounts) during 2018-19. I. Argentina
Reason (R) : Total balance in Pradhan Mantri Jan II. New Zealand
Dhan Yojana accounts is about R 99752 crore in III. Norway
end March 2019.
IV. Australia
Choose the correct answer on the basis of Assertion
(A) and Reason (R). V. Pakistan
(A) Assertion (A) and Reason (R) both are correct (A) I, II, III, IV & V
and R is the correct explanation of A (B) Only I, II, III & IV
(B) Assertion (A) and Reason (R) both are correct (C) Only II, III, IV & V
and R is not the correct explanation of A (D) Only I, III & V
Economics (NET) | 689U
88. Financial institutions play a crucial role in enhancing IV. When limit of WMA is crossed the overdraft is
the financial inclusion. Which of the following provided to the government for period not
institution’s role is minimal in this regard? exceeding ten consecutive working days
(A) Commercial Bank V. Interest rate on WMA is equal to Repo Rate,
(B) Reserve Bank of India while on overdraft it is two percent above repo
(C) Export Import Bank of India rate
(D) Cooperative banks (A) Only I is correct
(B) Only II is correct
89. Which of the following is a development bank?
(C) Only I, III & V are correct
I. NABARD
(D) I, II, III, IV & V are correct
II. SIDBI
III. EXIM Bank 93. Find out the correct chronological order of the
following institutes—
IV. National Housing Bank
I. Indian Council of Social Sciences Research
(A) Only I & II
(B) Only I, II & IV II. Indian Council of Medical Research
(C) Only I III. Indian Council of Agricultural Research
(D) I, II, III & IV IV. Council for Scientific and Industrial Research
90. Which of the following banks is not in operation as (A) II-III-IV-I
on March 31, 2019 ? (B) III-II-I-IV
I. New Bank of India (C) I-II-III-IV
II. Dena Bank (D) IV-III-II-I
III. Vijaya Bank [Indian Council of Medical Research(1911), Indian
IV. Rashtriya Mahila Bank Council of Agricultural Research (July 16, 1929),
(A) Only I Council for Scientific and Industrial Research
(September 1942), Indian Council of Social Sciences
(B) Only II & III
Research (1969)]
(C) Only II, III & IV
(D) I, II, III & IV 94. A new social impact bonds exclusively for women,
called Women’s Livelihood Bonds have been
[New Bank of India, one of the nationalized bank,
was acquired by PNB in 1993, while other three launched jointly by………..
have been merged with SBI in 2019] I. World Bank
91. Which of the following institution is not in II. UN Women
operation, as on January 1, 2019 ? III. Small Scale Development Bank of India
(A) Forward Market Commission (A) Only I & II
(B) Rashtriya Mahila Kosh (B) Only II&III
(C) Infrastructure Leasing & Financial Services (C) Only I & III
Lt(D)
(D) I, II & III
(D) None of the above
[Forward Market Commission, established in 1953, 95. Solar Charkha Mission is implemented by ………
merged with SEBI on September 28, 2015] (A) Khadi & Village Industries Commission
92. Which of the following statement is correct about (B) Ministry of Textiles
Ways and Means Advances? (C) Ministry of Micro, Small and Medium
I. The WMA scheme for the Central Government Enterprises
was introduced on April 1, 1997, after putting (D) Government of Gujarat
an end to the four-decade old system of adhoc
(temporary) Treasury Bills to finance the 96. Energy Transmission Index, 2019 has been
Central Government deficit. developed by………….
II. WMA limit for the first half of 2019-20 has (A) World Economic Forum
been fixed at R 75000 crore by the RBI
(B) United Nations Environment Programme
III. When government runs short of cash, the
WMA is provided by the RBI for a period of (C) United Nations Development Programme
90 days (D) World Bank
690U | Economics (NET)
97. ‘Green-Ag’ project has been launched by Govern- Answers
ment of India in collaboration with 1. (C) 2. (A) 3. (D) 4. (C) 5. (A)
I. Food and Agriculture organization 6. (A) 7. (B) 8. (C) 9. (D) 10. (A)
II. Global Environment Facility 11. (B) 12. (C) 13. (A) 14. (B) 15. (D)
III. United Nations Environment Programme 16. (D) 17. (B) 18. (D) 19. (D) 20. (C)
(A) Only I & II (B) Only II & III 21. (B) 22. (D) 23. (C) 24. (C) 25. (A)
(C) Only I & III (D) I, II & III 26. (A) 27. (D) 28. (D) 29. (B) 30. (C)
31. (D) 32. (C) 33. (C) 34. (D) 35. (C)
98. Which of the following countries tops the list of
World Competitiveness Index 2018 ? 36. (B) 37. (D) 38. (B) 39. (B) 40. (C)
(A) Hong Kong (B) USA 41. (D) 42. (C) 43. (D) 44. (D) 45. (A)
46. (D) 47. (C) 48. (A) 49. (B) 50. (A)
(C) Singapore (D) Switzerland
51. (B) 52. (B) 53. (C) 54. (D) 55. (A)
99. India ranks…………on Global Peace Index 2018 56. (D) 57. (B) 58. (C) 59. (A) 60. (B)
among 163 countries.
61. (C) 62. (A) 63. (C) 64. (D) 65. (D)
(A) 130th (B) 136th 66. (D) 67. (A) 68. (C) 69. (D) 70. (D)
(C) 137th (D) 139th 71. (A) 72. (B) 73. (A) 74. (B) 75. (D)
100. As per the III advance estimates of Horticulture 76. (D) 77. (B) 78. (C) 79. (C) 80. (A)
crops for 2018-19, the total horticulture crop 81. (B) 82. (B) 83. (A) 84. (A) 85. (C)
production has estimated at— 86. (B) 87. (A) 88. (C) 89. (D) 90. (D)
(A) 302·7 MT (B) 313·85 MT 91. (A) 92. (D) 93. (A) 94. (D) 95. (C)
(C) 312·2 MT (D) 316 MT 96. (A) 97. (D) 98. (B) 99. (C) 100. (B)
Economics (NET) | 691U
Miscellaneous Questions
1. As per IV Estimates of Food-grains for the year 7. As per revised estimates for the year 2018-19, the
2018-19, the total foodgrain production has been fiscal deficit stood at……per cent of GDP.
estimated at— (A) 3·0 (B) 3·1
(A) 256·32 MT (B) 284·95 MT (C) 3·4 (D) 3·3
(C) 251·86 MT (D) 250·22 MT 8. Foreign Trade Policy 2015–20 has set the target of
exports at $ ……billion by 2020.
2. Which of the following community has sex-ratio in
favour of women as per the Religion-based data of (A) 850 (B) 875
census 2011 ? (C) 900 (D) 925
(A) Sikh (B) Christian 9. Kisan Sampada Yojana is being implemented by the
(C) Jain (D) Buddhist Ministry /Department of—
(A) Agriculture, Cooperation and Farmers’ welfare
3. Fourteenth Finance Commission has recommended (B) Micro, Small & Medium enterprises
………per cent share of states in the net proceeds of
(C) Food Processing Industries
the Union Tax Revenues.
(D) Commerce and Industries
(A) 40 (B) 42
10. As per Central Public Sector Enterprise Survey
(C) 45 (D) 48 2017-18, total investment in all 339 CPSEs stood
4. Fifteenth Finance Commission has been constituted at—
under the chairmanship of— (A) R 11,61,019 crore (B) R 13,73,412 crore
(A) Dr. Arvind Pangarhia (C) R 13,61,052 crore (D) R 14,52,326 crore
(B) Dr. Arvind Subramanian 11. Government of India constituted a high power
(C) Dr. Subir Gokaran committee under the chairmanship of Justice
(D) N. K. Singh Srikrishna, former judge of the Supreme Court. The
committee is related—
5. Finance Minister announced many benefits to tax (A) To recommend a framework for securing
payers in interim budget 2019-20. Which of the personal data in the increasingly digitised
following provisions is/are correct ? economy as also address privacy concerns and
1. Person with net taxable income R 5 lakh need build safeguards against data breaches
not to pay any income tax in financial year (B) To recommend the ways and means to control
2019-20. mob killing
2. Income tax rate in the income slab R 0 to R 5 (C) To suggest measures to recover the loans of
lakh reduced to zero per cent. commercial banks
3. Standard deductions for salaried class has (D) To suggest measures to expand the coverage of
increased to R 50000. ‘Visa-on-Arrival’ scheme
4. No TDS on interest income up to R 40000 from 12. Which of the following facts is incorrect about
interest earned bank/post office deposits. Agri-Udaan ?
Correct code is— (A) It is managed by ICAR-NAARM’s technology
incubator, a-IDEA along with IIM Ahmeda-
(A) Only 1 is correct bad’s Centre for Innovation.
(B) Only 1, 3 and 4 are correct (B) Anybody from an innovative farmer to
(C) Only 2 is correct agricultural graduate to a person with minimal
(D) Only 3 and 4 are correct educational qualification can apply for the
scheme
6. Which o f the following statement is correct about (C) The accelerator programme is funded mainly
Department for Promotion of Industry and Internal through the Department of Science and
Trade (DPIIT) ? Technology
(A) It is a new department under the Ministry of (D) It is a scheme, recently launched by Department
Commerce and Industry of Agriculture, Cooperation and Farmers’
(B) DIPP has been renamed as the DPIIT welfare
(C) The issues concerning promotion of internal 13. What is ‘NIKKEI’ ?
trade, including retail trade; welfare of traders (A) Share Price Index of Tokyo Share Market
and their employees; matters relating to (B) Name of Japanese Central Bank
facilitating ease of doing business; and startsups (C) Japanese name of Country’s Planning
will dealt by the DPIIT Commission
(D) All of the above (D) Foreign Exchange Market of Japan
692U | Economics (NET)
14. Committee on decontrolling the prices of petrol and 23. Which state contributes maximum in the direct
diesel was headed by— taxes of Central government in 2016-17 ?
(A) Kelkar Vijai (B) Kirit S. Parekh (A) Gujarat (B) Maharashtra
(C) Abhijit Sen (D) C. Rangarajan (C) Tamil Nadu (D) Punjab
15. Asian Infrastructure Investment Bank (AIIB) has 24. India’s rank in Global Innovation Index 2018
officially been established on December 25, 2015. (Estimated by World Intellectual Property
Which of the following nation has the maximum Organisation) stood at—
share-holding in the Bank ?
(A) 57th (B) 75th
(A) China (B) India
(C) Russia (D) Australia (C) 80th (D) 84th
16. Kutir Jyoti scheme is associated with— 25. Which statement of the following is true for IMF ?
(A) Promoting cottage industry in villages (A) It is not an agency of UNO
(B) Promoting employment among rural unemplo- (B) It can grant loan to any country of the world
yed youth (C) It can grant loan to state Govt. of a country
(C) Providing electricity to rural families living (D) It grants loan only to member nations
below the poverty line
(D) All of the above 26. In census data 2011, which of the following state
holds the maximum rural population in the
17. The financial year for banks is April-March but country ?
what is the financial year for RBI ?
(A) Uttar Pradesh (B) Bihar
(A) January-December
(C) Madhya Pradesh (D) Andhra Pradesh
(B) April-March
(C) October-September 27. According to 2011 census urban-rural population
(D) July-June ratio was about%
18. Consider the following statements and choose the (A) 35 : 65 (B) 32 : 68
correct code given below : (C) 28 : 72 (D) 31 : 69
I. The current account deficit has widened to 2·1 28. Central Issue price of foodgrains under TPDS
per cent of GDP in 2018-19 from 1·8 per cent includes price for BPL and APL (below poverty line
in 2017-18. and above poverty line). What is the difference
II. Foreign exchange reserves hit a record high of between the two ?
$ 429·05 billion as of August 23, 2019. (A) Price for APL is double of BPL price
The correct code is —
(B) Price for BPL is one-third of APL price
(A) Only I is correct
(C) Difference of 500 per Qt.
(B) Only II is correct
(D) Difference of 250 per Qt.
(C) I and II both are correct
(D) Neither I nor II is correct 29. In Indian economy, which of the following sectors
is ‘Saving Surplus’ sector ?
19. SEBI is a—
(A) Statutory body (A) Agriculture Sector (B) Industrial Sector
(B) Advisory body (C) Domestic Sector (D) None of the above
(C) Constitutional body 30. Which of the following state has the maximum
(D) Non-statutory body urban population as per the final data of Census
2011 ?
20. Note issuing deptt. of RBI should always possess
the minimum gold stock of worth— (A) Gujarat (B) Maharashtra
(A) 85 crore (B) 115 crore (C) Punjab (D) Rajasthan
(C) 200 crore (D) None of the above 31. Which of the following taxes has not been merged
in newly proposed GST (Goods and Service Tax) ?
21. The share of direct taxes in the total taxes was
estimated at ………for 2018-19. (A) Custom Duty (B) Corporate Tax
(A) 50·67 per cent (B) 55·4 per cent (C) Excise Duty (D) Service Tax
(C) 39·6 per cent (D) 57·2 per cent 32. Government of India has launched ‘Samagra
22. The ‘Ad hoc Treasury Bill System’ of meeting Shiksha Abhiyan w.e.f. April 1, 2018. Which of the
budget deficit in India was replaced by ‘Ways and ongoing schemes have been subsumed in it ?
Means Advances System’ which has come into (A) Sarva Shiksha Abhiyan
force on— (B) Rashtriya Madhyamik Shiksha Abhiyan
(A) March 31, 1997 (B) April 1, 1996 (C) Teacher Education
(C) April 1, 1997 (D) None of the above (D) All of the above
Economics (NET) | 693U
33. Van Dhan Yojana launched by P.M. Narendra Modi 43. Major goods/sectors excluded from GST are—
on April 14, 2018, is being implemented by— I. Alcohol II. Petroleum and energy
(A) Ministry of Environment and Forest III. Electricity IV. Land and real estate
(B) Ministry of Agriculture and Farmer’s Welfare V. Education VI. Healthcare
(C) Jointly by Ministry of Tribal Affairs and The correct code is—
TRIFED (A) II, V and VI (B) II, III and IV
(D) Ministry of Food Processing (C) I, II, III and IV (D) All of the above
34. ‘Ayushman Bharat’ scheme has been announced in 44. Devaluation means—
the budget— (A) To reduce the value of home currency in other
(A) 2015-16 (B) 2016-17 currency
(C) 2017-18 (D) 2018-19 (B) To appreciate the value of home currency
35. Which of the following schemes has been (C) To issue new currency in place of old currency
announced in Budget 2018-19 ? (D) None of the above
(A) SANKALP (B) STRIVE 45. Statement I : India has slipped three notches to
(C) MUSK (D) GOBAR DHAN 11th position in the AT Kearney Foreign Direct
36. Which of the following schemes/ missions has/have Investment Confidence Index 2018.
been sub-sumed in newly approved Green Statement II : Overall, India remains among the
Revolution – Krishonnati Yojana— top investment destinations due to its sheer market
I. Mission f o r Integrated Development of size and rapid economic growth.
Horticulture. (A) I and II are correct
II. National Food Security Mission. (B) Only I is correct
III. National Mission for sustainable Agriculture. (C) Only II is correct
The correct code is— (D) Neither I nor II is correct
(A) Only II (B) I and II only 46. Which of the following banks becomes the first
(C) II and III only (D) I, II and III bank in India which started ‘Watch-Banking
Scheme’ ?
37. In Budget Estimates of 2019-20, the fiscal deficit
stands at……of GDP. (A) AXIS Bank (B) SBI
(A) 3·0% (B) 3·4% (C) HDFC Bank (D) ICICI Bank
(C) 3·4% (D) 3·5% 47. Aam Admi Bima Yojana provides social security
to—
38. Indian State having the lowest Infant Mortality Rate
(A) All labours in rural areas
is—
(B) All landless labours living below poverty line
(A) Maharashtra (B) Goa
in rural areas
(C) Gujarat (D) Kerala
(C) All labours in urban areas
39. Insider Trading is related to— (D) All labours in both rural as well as urban areas
(A) Share Market (B) Horse racing
48. Pradhan Mantri Fasal Bima Yojana launched in the
(C) Taxation (D) Public Expenditure
year—
40. The Industry 4·0 fuses various technologies such (A) 2013-14 (B) 2014-15
as— (C) 2015-16 (D) 2016-17
1. Artificial Intelligence (AI) & The internet of
things (IoT). 49. The interest rate on EPF during 2017-18 has been
2. 5G telephony & Nano-technology. fixed at—
3. Biotechnology. (A) 8·75% (B) 8·55%
4. Robotics & quantum computing and the like. (C) 8·25% (D) 8·0%
Correct code is— 50. Which pair is not correct ?
(A) Only 1 (B) Only 1 and 2 (A) Rekhi Committee
(C) 1, 2, 3 and 4 (D) Only 4 —Simplification of Export and Import
41. Which of the following States of India tops the list (B) Nanjundappa Committee —Railway Fare
of ‘Ease of Doing Business’ for the year 2018 ? (C) Rangrajan Committee —Balance of Payment
(A) Karnataka (B) Andhra Pradesh (D) Goiporia Committee
(C) Haryana (D) Maharashtra —Banking Service Improvements
42. The new Share Price Index (in dollar value) of 51. In Indian context which of the following deficit is
Mumbai Share Market is— largest ?
(A) DOLEX (B) UREX (A) Primary Deficit (B) Revenue Deficit
(C) FOREX (D) SENSEX (C) Fiscal Deficit (D) All above are equal
694U | Economics (NET)
52. Reserve Bank of India Act, 1934 has been amended 60. ‘Operation Twist’ is the new name given to
in May 2016. Which of the following provisions has America’s Federal Bank strategy related to—
been made in the amended Act ? (A) Increasing outsourcing activities
I. Inflation target would be set by the Govern- (B) Reducing interest rates to promote long-run
ment, in consultation with the Reserve Bank, loans
once in every five years. (C) Curtailing down assistance to various nations
II. Benchmark interest rate (Repo Rate) will be (D) Selling gold reserves in the market
determined by an empowered monetary policy
committee. 61. As per projection of UNO Report 2015, the world
III. Monetary Policy Committee has three members, population in 2050 will be—
including the RBI Governor, from the RBI and (A) 9·3 billion (B)10·6 billion
three other members are nominated by the GoI. (C) 11·2 billion (D)11·9 billion
(A) I, II and III are correct 62. To boost liquidity in the farming sector, particularly
(B) II and III are correct among small and marginal farmers, the RBI on
(C) I and II are correct February 7, 2019 increased the limit on collateral-
(D) Only III is correct free agriculture loans to……from R 1 lakh.
53. Recently launched 'SAUBHAGYA' scheme is (A) R 1·6 lakh (B) R 1·75 lakh
related to— (C) R 2·0 lakh (D) R 2·50 lakh
(A) Free power for Poor
63. Which of the following company is on the verge of
(B) A lump sum grant for the marriage of girls i n using sound waves as means of payment authenti-
below poverty households cation ?
(C) Economic empowerment of women
(A) Paytm (B) Scripbox
(D) Free education to all girls
(C) Citrus Pay (D) ICICI Direct
54. The process of budget making after re-evaluating [Paytm is testing sound based payments technology
every item of expenditure in every financial year is to make purchase at a store].
known as—
(A) Performance Budgeting 64. Which of the following nations topped the 2018
(B) Deficit Budgeting Global Innovation Index ?
(C) Zero Based Budgeting (A) Ireland (B) Switzerland
(D) Fresh Budgeting (C) Sweden (D) United Kingdom
55. Revenue Deficit for 2019-20 (Budget Estimate) 65. ‘UDAY’ Scheme launched by Union government is
stands at— related with—
(A) 2·0% of GDP (B) 2·2% of GDP (A) Promoting FDI
(C) 1·6% of GDP (D) 1·2% of GDP (B) Promoting Tourism
56. What is the maximum age of a girl eligible for (C) Improving financial status of Power Distribu-
opening account in Sukanya Samriddhi Yojana ? tion Companies
(A) 7 years (B) 8 years (D) Improving financial health of Banks having
(C) 9 years (D) 10 years heavy deficit
57. ‘Focus Product’ and ‘Focus Market’ are the two 66. What is the share of natural gas in the fuel basket of
schemes introduced related to— India ?
(A) Industrial Diversification (A) about 7% (B) about 12%
(B) Technology Upgradation (C) about 15% (D) about 18%
(C) Export Promotion 67. What is ‘Hawala’ ?
(D) Control of Inflation
(A) Full details of a subject
58. UNDP has introduced a new poverty index known (B) Illegal transactions of foreign exchange
as— (C) Illegal trading of shares
(A) Human Poverty Index
(D) Tax evasion
(B) Poorest among Poor Index
(C) Social Poverty Index 68. Which plan was terminated one year before the time
(D) Multi-dimensional Poverty Index schedule ?
59. As per Census 2011, Kerala holds the highest sex- (A) First Plan (1951–56)
ratio among states which stands at— (B) Third Plan (1966–71)
(A) 1046 (B) 1084 (C) Sixth Plan (1980–85)
(C) 1092 (D) 1103 (D) Fifth Plan (1974–79)
Economics (NET) | 695U
69. Consider the following facts about Intellectual (C) Atal Pension Yojana (APY)
Property Index, and choose the correct code given (D) Pradhan Mantri Mudra Yojana.
below :
1. This Index has been developed by the US 77. Scheduled Commercial Banks determine the bench
Chamber of Commerce’s Global Innovation mark interest rate on the basis of—
Policy Center’s (GIPC’s). (A) Base Rate system
2. India’s rank in Intellectual Property Index 2019 (B) Marginal Cost of Funds based lending rate
is 36. (C) Average deposit rate
3. United States of America is at the top in (D) Sovereign Borrowing Rate
Intellectual Property Index 2019. 78. Size of India’s external trade is about….in 2018-19.
4. Pakistan’s rank in Intellectual Property Index (A) US $ 860 billion (B) US $ 802 billion
2019 is 47th.
(C) US $ 852 billion (D) US $ 838 billion
Correct code is—
(A) Only 2 is correct 79. What is the rank of Uttar Pradesh in the list of ‘Ease
(B) Only 1 and 2 are correct of Doing Business’ for the year 2018 ?
(C) 1, 2, 3 and 4 are correct (A) 5th (B) 8th
(D) Only 3 is correct (C) 9th (D) 11th
70. As per UNDP India’s HDI rank in 2017 stands at— 80. Which Indian port handles maximum cargo traffic ?
(A) 129th (B) 130th (A) Kandla
(C) 131st (D) 132nd (B) Paradip
71. The government is preparing Devolution Index (C) Jawahar Lal Nehru Port
which will measure social empowerment of people (D) Mumbai
at the— 81. GST has been implemented from—
(A) Panchayat level (B) Block level (A) January 1, 2017 (B) July 1, 2017
(C) District level (D) State level (C) January 1, 2018 (D) April 1, 2018
72. Which committee was constituted for reforms in 82. As on March 31, 2019 total grid—interactive
tax-structure ? installed capacity in the renewable energy sector
(A) Narsimham Committee was about—
(B) Chelliah Committee (A) 60,000 MW (B) 64,000 MW
(C) Gadgil Committee (C) 65,000 MW (D) 77,641 MW
(D) Kelkar Committee
83. Lahiri Committee was associated with—
73. Narsimham Committee was related to— (A) Industrial Sickness
(A) High Education Reforms (B) Minimum Support Prices of Agriculture
(B) Tax Structure Reforms Products
(C) Banking Structure Reforms (C) Price Structure of Edible Oil
(D) Planning Implementation Reforms (D) Handicraft Exports
74. Trade related transactions of which state in India is
84. National Income in India is estimated by—
not managed by RBI ?
(A) Meghalaya (B) Assam (A) NITI Aayog
(C) Jammu & Kashmir (D) Nagaland (B) Finance Commission
75. Which is true for existing Economic and Industrial (C) Indian Statistical Institute
Policies of Indian Govt. ? (D) National Statistics office
1. FERA was abolished. 85. For how many years, Central government will
2. MRTP was abolished. compensate the loss of State governments due to
3. Cash compensatory support for exports was GST ?
abolished. (A) 3 years (B) 4 years
4. Industrial licensing (except a few goods) was (C) 5 years (D) No compensation
abolished.
86. Consider the following statements regarding
(A) 1, 2, 3 and 4 (B) 1, 3 and 4
‘Pradhan Mantri Kisan Samman Nidhi’ (PM-Kisan),
(C) Only 3 and 4 (D) Only 2 and 3 and choose the correct code given below—
76. Which of the following is the most successful 1. This scheme has been announced in the Union
scheme of financial inclusion in India ? Budget 2019-20.
(A) Pradhan Mantri Jan Dhan Yojana (PMJDY) 2. R 6000 per annum will be transferred in the
(B) Pradhan Mantri Suraksha Bima Yojana beneficiary farmers in the three installments of
(PMSBY) R 2000 each.
696U | Economics (NET)
3. The scheme covers all farmers irrespective of (B) It is total expenditure less total receipts
area of land owned by them excluding borrowings
4. Families with income tax payers, serving or (C) It reflects the decrease in tax collections for the
retired government employees and former or year
present MPs, MLAs and ministers are not (D) It means the lack of liquidity and earnings for
eligible to receive the income support. the economy
5. Professionals like doctors, engineers, lawyers, 93. Which of the following is not a financial regulator
chartered accountants, and architects registered at present (2019) ?
with professional bodies and their immediate (A) IRDA
family members are not eligible to receive the (B) PFRDA
income support ineligible. (C) Forward Market Commission
Correct code is— (D) SEBI
(A) 1, 2, 3, 4 and 5 all are correct
94. Consider the following facts about recently
(B) Only 1 and 2 are correct launched ‘JIGYASA’ initiative :
(C) Only 2, 3 and 4 are correct I. The ‘JIGYASA’ would inculcate the culture of
(D) Only 1, 2, 3 and 4 are correct inquisitiveness and scientific temper, amongst
87. ‘Open market operation’ is a part of— the school students and their teachers.
II. It is a student-scientist connect programme.
(A) Income Policy (B) Fiscal Policy
III. It is a joint initiative of Council of Scientific
(C) Credit Policy (D) Labour Policy and Industrial Research (CSIR), and Kendriya
88. Which of the following pairs is not matched Vidyalaya Sangathan (KVS).
correctly ? IV. The Programme is expected to connect 1151
(A) Ayushman Yojana—Ministry of Health and Kendriya Vidyalayas with 38 National Labo-
Family Welfare ratories of CSIR targeting 100,000 students and
(B) Pradhan Mantri Vay Vandana Yojana—LIC of nearly 1000 teachers annually.
India Which of the above statement(s) is/are correct ?
(C) SAMPADA Yojana—Ministry of Food (A) Only I (B) I and II
Processing (C) I, II and III (D) I, II, III and IV
(D) KUSUM Yojana—Ministry of Agriculture
95. GDP deflator is a type of—
89. Which of the following sequences of states is (A) Volume Index (B) Monetary Policy Tool
correct in relation to marine fish production in
descending order ? (C) Price Index (D) Fiscal Policy Tool
(A) Gujarat - Tamil Nadu - Karnataka - Kerala 96. Which of the following banks has launched ‘Kissan
(B) Tamil Nadu - Kerala - Gujarat - Karnataka Vaani’ ?
(C) Kerala - Tamil Nadu - Karnataka - Gujarat (A) SBI (B) HDFC Bank
(D) Gujarat - Kerala - Tamil Nadu - Gujarat (C) Andhra Bank (D) ICICI Bank
90. What is ‘Mission 41K’ ? 97. Which of the following is not an initiative under e-
(A) It is a mission of Indian Railways to save education ?
electricity consumption charges by betting big (A) Swayam—an indigenously designed massive
on solar energy open online course (MOOC)
(B) To stabilize India’s population by 2041 (B) Swayam Prabha—32 Direct-to-Home channels
(C) To make the country self reliant in crude oil for transmitting high-quality educational
production by 2041 content
(D) None of the above (C) JIGYASA
91. Which of the following is not a sub mission of (D) The National Academic Depository for authen-
National livestock Mission ? ticating all certificates issued by institutions
(A) Sub-Mission on Livestock Development 98. Which of the following statements is correct about
(B) Sub-Mission on Pig Development in southern The Insolvency and Bankruptcy Code ?
Region (A) The Code is implemented by The Insolvency
(C) Sub-Mission on Fodder and Feed Development and Bankruptcy Board of India (IBBI)
(D) Sub-Mission on Skill Development, Techno- (B) The Code is operational since December 2016
logy Transfer and Extension (C) IBBI a n d National Company Law Tribunal
92. High fiscal deficit is cause for concern for any (NCLT) are in hands in gloves to complete the
economy. What does it denote ? proceedings under the code
(A) It is a measure of the borrowings of an economy (D) All of the above
Economics (NET) | 697U
99. Match the following— 2. Prompt repayment incentive of 3% for the entire
Unit–I Unit–II period of reschedulement of their loans.
(a) Aquaculture 1. Silk Correct code is—
(b) Floriculture 2. Grapes (A) Only 1 is correct
(c) Sericulture 3. Flower (B) Only 2 is correct
(d) Viticulture 4. Fisheries (C) 1 and 2 both are correct
(a) (b) (c) (d) (D) Neither 1 nor 2 is correct
(A) 4 3 2 1 107. The official exchange rate of Indian rupee is
(B) 3 4 1 2 associated with—
(C) 3 4 2 1 (A) Pound Sterling
(D) 4 3 1 2 (B) Dollar
100. Which of the following statements is correct about (C) SDR
DIPAM ? (D) A basket of selected countries
(A) It is a separate department under the Ministry 108. Consider the following statements and choose the
of Finance correct code given below—
(B) Its key function is to implement the disinvest- Statements :
ment policy of the Central Government I. India has set an ambitious target to set up
(C) The Department of Disinvestment has been renewable energy capacities to the tune of
renamed as Department of Investment and 175 GW by 2022.
Public Asset Management (DIPAM) from II. At 77·41 GW of installed capacity as on
14th April, 2016 March 31, 2019 renewable energy accounts
(D) All of the above for 20 per cent of the total installed power
101. Which types of tax helps in reducing disparities of capacities in India.
income ? (A) Only I is correct
(A) Proportionate tax (B) Progressive tax (B) Only II is correct
(C) Regressive tax (D) All of the above (C) I and II both are correct
102. Which was the first country in the world to (D) Neither I nor II is correct
introduce Goods and Services Tax (GST) ? 109. Loans provided by banks to farmers small traders
(A) France (B) Italy come under the category of—
(C) U.K. (D) Japan (A) Commercial Loans
103. ‘ABC Index’ announced by the govt. is associated (B) Priority Sector Lending
with— (C) Non-profitable loan
(A) Agriculture (B) Communication (D) Zero interest loan
(C) Health (D) Education 110. Which of the following is not a regional Block the
104. Which of the following committee has proposed to global economic order ?
abolish distinction between Plan and Non-Plan (A) ASEAN (B) SAFTA
Expenditure ? (C) WTO (D) NAFTA
(A) Suresh Tendulkar Committee 111. On which one of the following ‘Head of Expenses’,
(B) Rangrajan Committee the expenses of the Govt. of India are highest ?
(C) Rakesh Mohan Committee (A) Food Subsidy (B) Oil Subsidy
(D) Usha Thorat Committee (C) Fertiliser Subsidy (D) POL Subsidy
105. Which is true for Finance Commission ? 112. Fiscal Deficit means—
(A) It is a statutory body (A) Public Expenditure
(B) It is constituted under article 280 of the Consti- —Debts from sources other than RBI
tution (B) Public Capital Expenditure
(C) N. K. Singh is Chairman of 15th Finance —Surplus of Revenue Account
Commission (C) Govt. Expenditure —Revenue receipts
(D) All of the above (D) Public Expenditure
106. As per an announcement of the Finance Minister in —Tax and non-tax revenue receipts
Interim Union Budget 2019-20 Government has 113. Dunkel Draft was—
now decided that all farmers affected by severe
(A) Associated with Uruguay round
natural calamities, where assistance is provided
from National Disaster Relief Fund (NDRF), will (B) Related to atomic treaty among nations
be provided the benefit of— (C) Related to Super 301
1. Interest subvention of 2%. (D) Related to promoting drugs trade
698U | Economics (NET)
114. India’s longest road bridge—the Dhola-Sadiya 3. The maximum ceiling of the pay has been
bridge in Tinsukia district of Assam over river increased from R 10,000 pm to R 21,000 pm.
Lohit, tributary of river Brahmaputra has been 4. The ceiling of payment of gratuity has been
named after— enhanced from R 10 lakhs to R 20 lakhs.
(A) Shyama Prasad Mukherji Correct code is—
(B) Bhupen Hazarika (A) Only 1 is correct
(C) Atal Bihari Bajpayee (B) Only 2 and 3 are correct
(D) Deen Dayal Upadhyay (C) Only 1, 3 and 4 are correct
115. Consider the following lists and choose the correct (D) 1, 2, 3 and 4 are correct
code given below— 121. What is ‘Zero Base Budgeting’ ?
List-I (A) Infinite deficit financing
(Religion Group) (B) No curtailment in unproductive expenditure
(a) Hindus (b) Muslims (C) No appraisal of new programmes
(c) Sikhs (d) Christians (D) Preparation of new budget every time
List-II
122. In India, equity fund-of-funds are taxed in the same
(Population Growth Rate 2001–11) manner as—
1. 15·5% 2. 16·8% (A) Debt funds
3. 24·6% 4. 8·4% (B) Equity-linked saving schemes
The correct code is—
(C) Real Estate
(a) (b) (c) (d)
(D) Fixed deposits
(A) 2 3 4 1
(B) 2 4 3 1 123. What was the aim of Antyodaya Programme ?
(C) 3 2 1 4 (A) Elimination of Urban Poverty
(D) 1 2 3 4 (B) Improving the standards of scheduled castes
(C) Uplifting minorities
116. Which of the following is known as ‘white coal’ ?
(D) Helping the poorest among poor
(A) Hydro Power (B) Nuclear Power
(C) Thermal Power (D) All types of Power 124. Find the odd one out—
(A) JNNURM (B) Smart Cities Mission
117. What is ‘Green Banking’ ?
(C) PRASAD (D) AMRUT
(A) Bank financing on pro-environment projects
(B) Bank financing to agriculture 125. Half of India’s GDP comes from the sweat and toil
of 42 crore workers engaged in the unorganised
(C) Bank financing to irrigation sector working as—
(D) All Bank financing to farmers (A) Street vendors, rickshaw-pullers, construction
118. The Scheme HIRDAY is associated with— workers, rag pickers
(A) free heart treatment of poor below poverty (B) Agricultural workers
line (C) Beedi workers, handloom weavers, leather
(B) cleaning of Ganga River workers and workers in numerous other
(C) developing heritage cities similar occupations
(D) developing Wi-Fi facility on platforms (D) All of the above
119. ‘DIPAM’ is a new name given to— 126. Choose correct code given below on the basis of
following Assertion (A) and Reason (R). There
(A) Khadi Village Industries
of—
(B) Power Generation
Assertion (A) : Women’s labour force participa-
(C) Disinvestment Deptt. tion in India declined to 27 per cent in 2011-12
(D) Primary Education in HRD Ministry among the lowest in the world from nearly 40 per
120. Which of the following provisions has been made cent in early 2000s.
by the Central Government for the benefit of Reason (R) : Educational opportunities for girls in
labourers ? the age group of 15-24 years have been improved
1. The New Pension Scheme (NPS) has been during the last two decades.
liberalized. Keeping the contribution of the (A) Assertion (A) and Reason (R) both are correct
employee at 10%, Government contribution and (R) is the correct explanation of (A)
has been increased from 10% to 14%. (B) Assertion (A) and Reason (R) both are correct
2. Maximum ceiling of the bonus given to the but (R) is not the correct explanation of (A)
labourers has been increased from R 3,500 pm (C) Only Assertion (A) is correct
to R 7,000 pm (D) Only Reason (R) is correct
Economics (NET) | 699U
127. Mega Food Parks Scheme was initiated by the 132. Which measure comes under quantitative credit
Govt. of India with the objective— controls adopted by Central Bank of the Country ?
(A) To ensure better prices of products to farmers (A) Bank Rate
(B) To increase productivity of agriculture crops (B) Open Market Operations
(C) To control food prices (C) Cash Reserve Ratio
(D) None of the above (D) All of the above
128. Which of the following statements is incorrect 133. An SPV–National High Speed Rail Corporation
about women’s employment in India ? Ltd. has been established to develop Mumbai-
(A) Women’s labour force participation in India Ahmedabad High Speed Rail Corridor Project.
declined to 27 per cent in 2011-12 Which of the following statements is incorrect
(B) Two thirds of decline was because of India’s about it ?
inability to create enough jobs in the I. Indian Railways’ share in this company is
manufacturing and services sectors 50%.
(C) According to the World Bank, nearly two- II. Government of Maharashtra’s share in this
thirds of Indian women with college degrees company is 25%.
are without jobs III. Government of Gujarat’s share in this
(D) The Indian Parliament recently passed a law company is 25%.
that has tripled maternity leave and allowed IV. Government of Japan has agreed to provide a
female employees to work from home long term loan upto the 81% of the project
129. Which of the following statements is correct about cost at 0·1 per cent annual interest rate.
participatory notes (p-notes) ? (A) I, II, III and IV are correct
(A) Participatory notes (p-notes) are an instrument (B) I, III & IV are correct
used by foreign investors to take exposure to (C) I, II and III are correct
the domestic market without registering in
India (D) Only IV is correct
(B) Participatory notes (p-notes) are an instrument 134. Global Hunger Index report is published annually
used by NRI investors to take exposure to the by International Food Policy Research Institute.
domestic market without registering in India. The index is based on—
(C) Participatory notes (p-notes) are an instrument I. Undernourished Children
used by domestic investors to take exposure II. Child wasting
to the domestic market without registering in
III. Child stunting
India
IV. The mortality rate of children
(D) Participatory notes (p-notes) are an instrument
used by Indian investors to take exposure to Correct code is—
the foreign market without registering in such (A) Only I (B) Only II and III
markets (C) I, II, III and IV (D) Only I and IV
130. Which of the following statements is correct about 135. Which of the following scheme has been
participatory notes ? announced in the Interim Union Budget 2019-20 ?
(A) SEBI has proposed to bar p-notes, or offshore (A) ‘Pradhan Mantri Shram-Yogi Maandhan’
derivative instruments (ODIs) from taking (B) Atal Pension Yojana
speculative positions in the futures and (C) Pradhan Mantri Jeevan Jyoti Bima Yojana
options segment
(D) Pradhan Mantri Suraksha Bima Yojana
(B) Participatory note-holders would be allowed
exposure to the derivatives market only for 136. Which of the following is not a feature of Pradhan
hedging and not for naked speculation Mantri Shram-Yogi Maandhan ?
(C) SEBI is trying to curb the volatility in the (A) It is a mega pension scheme for workers of
Futures and Options market that emanates unorganized sector with a monthly income of
through ODIs R 15000
(D) All of the above (B) This pension scheme will provide the workers
an assured pension of R 3000 per month after
131. What does the Global Findex Index measure ? the age of 60 years
(A) Global Indebtedness (C) The eligible worker has to contribute only
(B) Financial Inclusion R 55 per month upto the age of 60 years
(C) Global Remittances (D) R 500 crore has been allotted for this scheme
(D) Financial Literacy in the budget 2019-20
700U | Economics (NET)
137. Which of the following commissions has/have II. The number of returns filed have also
done a commendable job to identify and list increased from 3·79 crore to 6·85 crore
various nomadic, seminomadic and denotified showing 80% growth in tax base.
communities ? Correct code is—
(A) Renke Commission (A) Only I is correct
(B) Idate Commission (B) Only II is correct
(C) Mandal Commission (C) I and II both are correct
(D) (A) and (B) both
(D) Neither I nor II is correct
138. Union government’s ‘PAHAL’ scheme is related
to— 144. HRD Ministry’s survey based report ‘NIRF
(A) LPG subsidy transfer in consumer’s account Ranking 2018’ gives top ranking in the country
(B) Toilets construction in schools to—
(C) Promoting girls education (A) Indian Institute of Science, Bengaluru
(D) Ensuring health facilities to senior citizens (B) Indian Institute of Chemical Technology,
139. National Food Security Act, 2013 ensures the Mumbai
supply of wheat and rice at— (C) JNU Delhi
(A) R 3 and R 2 respectively (D) Hyderabad University
(B) R 2 and R 3 respectively
145. Which of the following statements is/are correct
(C) R 2 and R 4 respectively about income tax department of government of
(D) R 1 and R 2 respectively India ?
140. Government of India has proposed certain steps for (A) Returns, assessments, refunds and queries are
the welfare of nomadic, semi nomadic and all under-taken online
denotified communities. It includes—
(B) For the assessment year 2018-19, 99·54% of
I. A Committee under NITI Aayog will be set the income-tax returns were accepted as they
up to complete the task of identifying were filed
Denotified, Nomadic and Semi-Nomadic
communities not yet formally classified. (C) All returns for the assessment year 2019-20
and onward will be processed in twenty-four
II. Government will set up a Welfare Develop-
hours and refunds issued simultaneously
ment Board under the Ministry of Social
Justice and Empowerment specifically for the (D) All of the above
purpose of implementing welfare and develop- 146. Which of the following is not a body of World
ment programmes for Denotified, Nomadic Bank Group ?
and Semi-Nomadic communities. (A) IBRD (B) IFC
Correct code is— (C) IDA (D) ADB
(A) Only I is correct
(B) Only II is correct 147. Which of the following statements correctly
explains the Statutory Liquidity Ratio ?
(C) I and II both are correct
(D) Neither I nor II is correct (A) Bank has to keep a certain proportion of its
total assets in the form of highly secured
141. The innovative programme ‘Mera Gaon Mera
government securities
Gaurav’ is basically a—
(A) Development Programme (B) Bank has to keep a certain proportion of total
(B) Empowerment Programme deposits in the form of highly secured
government securities
(C) Research Oriented Programme
(D) Environment sustainability programme (C) Bank has to keep a certain proportion of
liquid assets with the RBI
142. What is the ascending order of introducing
(D) Bank has to maintain a daily balance with the
following mentioned programmes ?
RBI as required in SLR provisions
1. DPAP 2. JRY
3. IRDP 4. MNP 148. Poor women of India have been benefited most by
(A) 1, 4, 3, 2 (B) 4, 3, 2, 1 which of the following scheme of Central Govern-
(C) 1, 2, 3, 4 (D) 4, 3, 1, 2 ment ?
(A) Sahaj Bijali Har Ghar Yojana (SAUBHAG-
143. Consider the following statements about India’s
YA)
tax system and choose the correct code given
below : (B) Deendayal Upadhyaya Gram JYOTI Yojana
(DDUGJY)
I. The tax collections increased significantly
from R 6·38 lakh crore in 2013-14 to almost (C) Pradhan Mantri Ujjwala Yojana (PMUY)
R 12 lakh crore in 2018-19. (D) Pradhan Mantri Mudra Yojana (PMMY)
Economics (NET) | 701U
149. Consider the following statements and choose the 154. Shyama Prasad Mukherjee ‘RURBAN’ Mission
correct code given below : was officially launched in the state of—
I. The requirement of sourcing from SMEs by (A) Chhattisgarh (B) Madhya Pradesh
Government enterprises has been increased to (C) Gujarat (D) Uttar Pradesh
25%. 155. Which of the following is not a tool of Monetary
II. Of this, the material to the extent of at least and credit policy ?
3% will be sourced from women owned (A) Repo rate and reverse repo rate
SMEs. (B) Cash reserve ratio
Correct code is— (C) Base rate
(A) Only I is correct (D) Marginal standing facility
(B) Only II is correct 156. What is open sky scheme ?
(C) I and II both are correct (A) Export promotion scheme of Civil Aviation
Ministry
(D) Neither I nor II is correct
(B) Free economy policy
150. e-Marketplace (GeM) has been created by the (C) Tax free policy
Central Government. It has transformed ……… by (D) None of the above
making it fully transparent, inclusive and efficient.
157. Fiscal policy does not deal with—
(A) Public procurement
(A) Taxation
(B) Procurement of perishable dairy products (B) Public Expenditure
(C) Procurement of perishable dairy products (C) Credit expansion and contraction
(D) Procurement of handicraft products (D) Deficit Financing
151. At end-March 2019, India’s external debt stood 158. Which o f the following statement is/are correct
at— about Annadatha Sukhibhava scheme ?
(A) US $ 497·61 bn (B) US $ 543·0 bn (A) It is a Direct Benefit Transfer scheme of
(C) US $ 521·2 bn (D) US $ 569·2 bn financial assistance to the farmers in the state
of Andhra Pradesh
152. Consider the Assertion (A) and Reason (R) given (B) This scheme has been merged with Central
below and choose the correct code : Government’s PM-KISAN
Assertion (A) : Bad loans of public sector banks (C) Each and every farmer, including the tenant
declined by more than R 31,000 crore to R 8,64,433 farmers, will get R 10000 per year in two
crore in the first nine months of 2018-19 as instalments of R 5000 each
compared to end of March 2018. (D) All of the above
Reason (R) : The government’s 4Rs strategy of 159. Which of the following terms is/ are associated
recognition, resolution, recapitalisation and reforms with bad loans of commercial banks ?
in respect of public sector banks gave better results
in the year 2018-19. I. CDR II. SDR
III. S4A IV. SLR
Correct code is :
(A) I, II and III (B) I, II, III and IV
(A) Assertion (A) and Reason (R) both are correct
and Reason (R) is the correct explanation of (C) I, II (D) Only III
Assertion (A) 160. Certain foreign banks, currently operating in India,
(B) Assertion (A) and Reason (R) both are correct have decided either to reduce their business or bind
but Reason (R) is not the correct explanation up their operations. These banks are :
of Assertion (A) I. HSBC
(C) Assertion (A) is correct but Reason (R) is II. First Rand Bank
incorrect III. Citi Bank
(D) Assertion (A) is incorrect but Reason (R) is IV. Commonwealth Bank of Australia
correct V. Royal Bank of Scotland
153. Which of the following programmes is being The correct code is—
redesigned as the umbrella project of the road (A) I, II and III (B) II, III and IV
sector ? (C) III, IV and V (D) I, II, III, IV and V
(A) National Highways Development Programme 161. Which of the following statements is incorrect
(B) Bharatmala about Insolvency and Bankruptcy Code (IBC) ?
(C) Bharat Jodo Yojana (A) National Company Law Tribunal (NCLT) is
(D) Creation of Economic Corridors the adjudicating authority under this Act
702U | Economics (NET)
(B) It specifies a timeframe of 180 days after the 170. ‘Rythu Bandhu’ scheme for the farmers has been
process is initiated and an additional 90-day launched by the state of—
extension for resolving insolvency (A) Andhra Pradesh (B) Telangana
(C) There are five stages in the resolution process (C) Karnataka (D) Tamil Nadu
through IBC
171. RBI has extended the time limit of adopting Basel
(D) None of the above
III norms. Now this time limit expires on—
162. R. N. Malhotra Committee gave recommendations (A) March 31, 2017 (B) March 31, 2018
on the field of—
(C) March 31, 2019 (D) March 31, 2020
(A) Sick industries (B) Tax reforms
(C) Insurance Sector (D) Banking Sector 172. D. Swaroop Committee is associated with—
163. ‘BAFTA’ award is associated with— (A) Financial Products Marketing
(A) Banking sector (B) Cinema (B) Sugar Marketing
(C) Insurance Sector (D) Tourism (C) Capital Marketing
164. Which of the following statements is/are correct (D) Banking
about India’s Agricultural sector ? 173. In which of the following states, is an integrated
(A) India produces more horticulture produces industrial township ‘Vikram Udyogpuri’ being
than the food grain developed ?
(B) As per II Advance Estimates total production (A) Madhya Pradesh (B) Uttar Pradesh
of horticulture crops is estimated at 314·87
million tonnes in 2018-19 (C) Rajasthan (D) Telangana
(C) As per fourth estimates of foodgrain pro- 174. World Bank means—
duction India had produced record 285·01 (A) Only IBRD
million tonnes of foodgrains in 2017-18 (B) Both IBRD & IDA
(D) All of the above
(C) IBRD, IDA, IFC & MIGA
165. ‘EEE Taxation’ stands for— (D) IBRD, IDA, IFC, MIGA, ICSID
(A) Exempt - Exempt - Exempt Taxation
(B) Effective Exempt Exit Taxation 175. The Union government has approved the first-ever
capital good policy with the aim to create over 21
(C) Elaborate Exempt Exit Taxation
million new jobs by the year—
(D) None of the above
(A) 2020 (B) 2022
166. Government has decided to amend EPF Act (Emp-
loyee Provident Fund Act) to make it applicable (C) 2023 (D) 2025
also to those institutions which has minimum 176. ‘UDAY Yojana’ is associated with—
number of ? (A) Panchayati Raj
(A) 5 employees (B) 10 employees (B) Women Empowerment
(C) 12 employees (D) 15 employees (C) Energy Distribution
167. As per the assessment made by DIPP and World (D) Banking Sector
Bank, which of the following states has been
placed at the top for ease of doing business in 177. An Expert Committee under the chairmanship of
India ? V.V. Giri National Labour Institute (VVGNLI)
(A) Telangana (B) Andhra Pradesh Fellow Anoop Satpathy has proposed doubling the
national-level minimum wage for a worker in the
(C) Gujarat (D) Madhya Pradesh
country—
168. Nachiket Mor committee’s recommendations are (A) To R 9,750 a month, up from a floor of
related to— R 4,576 at present
(A) Insider Trading (B) Financial Inclusion (B) To R 10,750 a month, up from a floor of
(C) Micro Financing (D) None of the above R 5,375 at present
169. Consider sthe following facts. Which of these (C) To R 12,660 a month, up from a floor of
is/are part of ‘Industry 4·0’ ? R 6,330 at present
I. Automation and data exchange in manufactur- (D) To R 8,440 a month, up from a floor of
ing technologies. R 4,220 at present
II. Cyber-Physical Systems 178. Maastricht Treaty is related to—
III. Internet of Things (A) Environment Protection
IV. Cloud Computing (B) Europe Unification
(A) Only II (B) II and III (C) Limitation of Atomic Power
(C) III and IV (D) I, II, III and IV (D) Unification of East and West Germany
Economics (NET) | 703U
179. India is not a member of— 188. National Food Security Mission targets to increase
(A) APTA (B) MERCOSUR the production of wheat, rice and pulses in next
(C) BIMSTEC (D) SAFTA four years to—
180. What is India’s rank of International Intellectual (A) 10, 8 and 2 million tonne respectively
Property Index 2019 ? (B) 8, 10 and 2 million tonne respectively
(A) 42nd (B) 43rd (C) 8, 12 and 2 million tonne respectively
(C) 36th (D) 45th (D) 8, 10 and 4 million tonne respectively
181. By the Constitution (101st Amendment) Act 2016 189. NOAPS has been renamed as Indira Gandhi Old
certain new Articles have been inserted in the Age Pension Scheme with its extended scope. Now
Constitution of India this scheme will include all old age persons—
I. Article 246A II. Article 269A (A) Living below poverty line
III. Article 279A (B) Above 60 years age
(A) Only I (B) I and II (C) Above 65 years age
(C) I, II and III (D) Only IV
(D) Both (A) and (C)
182. 'Operation Green' is related to—
190. Crop intensity and productivity are critically
(A) Environment Pollution Control
dependent on—
(B) Green Mannure
(A) Irrigation
(C) Afforestation
(D) Better remunerative price to Tomato, Onion (B) Tenancy reforms
and Potato (C) Crop loans
183. Consider the following statements and choose the (D) Remunerative price for agriculture produces
correct code given below : 191. Project ‘SAKSHAM’ is associated with—
Statements : (A) BPL benefit scheme
I. WPI based inflation rate is determined and (B) Old age pension
released by office of Economic Adviser, (C) Indirect Tax Network
Department of Industrial Policy and Promo-
tion (D) Encouraging rural self-employment
II. CPI (Combined, Rural and Urban) based 192. RBI has issued guidelines to implement BASEL-
inflation rate is determined and released by III norms w.e.f.—
Central Statistics Office. (A) July 1, 2012
Correct code is— (B) October 1, 2012
(A) Only I is correct (C) January 1, 2013
(B) Only II is correct (D) April 1, 2013
(C) I and II both are correct
(D) Neither I nor II is correct 193. Pradhan Mantri Krishi Sinchayee Yojana focuses
on :
184. ‘Pratibha Kiran Yojana’ is a new scheme to
I. Accelerated Irrigation Benefits Programme
promote higher education among girls introduced (AIBP)
by—
II. Har Khet Ko Pani
(A) Karnataka (B) Bihar
(C) Madhya Pradesh (D) Uttar Pradesh III. Per Drop More Crop
IV. Watershed Development
185. Government has extended Mid-Day Meal Scheme
to cover the students upto class— The correct code is—
(A) 6th (B) 7th (A) Only II (B) Only II and III
(C) 8th (D) 10th (C) I, II and III (D) I, II, III and IV
186. Which of the following initiatives has been 194. Consider the following initiatives in agriculture :
announced for developing education in the Budget I. Precision farming
2018-19 ?
(A) RISE (B) HEFA II. Poly house cultivation of fruits and vegetables
(C) RITES (D) SANKALP III. Self-propelled sprayers
187. Operational Clean Money has been started by— IV. Transplanters for rice and vegetable seedlings
(A) NITI Aayog Which of these is most suitable for small and
(B) Income Tax Department marginal farmers ?
(C) Ministry of Finance (A) II and III (B) I, II and IV
(D) Central Board of Direct Taxation (C) II, III and IV (D) I, II, III & IV
704U | Economics (NET)
195. Which form of unemployment in India is the most 26. (A) 27. (D) 28. (A) 29. (C) 30. (B)
serious challenge before the policy planners and 31. (B) 32. (D) 33. (C) 34. (D) 35. (D)
the government ?
36. (D) 37. (B) 38. (D) 39. (A)
(A) Open Unemployment
(B) Under-employment 40. (C) The world is at the cusp of the Industry 4·0.
Industry 1·0 used water and steam to mechanise
(C) Low-wage unemployment
production; Industry 2·0 used electric power;
(D) Structural unemployment Industry 3·0 used electronics and IT. Industry 4·0
196. As per Three Years Action Plan agenda of NITI fuses various technologies such as Artificial
Aayog, till date only four developing countries of Intelligence (AI), the Internet of Things (IoT),
the world have successfully transformed them- autonomous vehicles, 5G telephony, nano-
selves within three decades. Which of the technology, biotech, robotics, quantum computing
following groups represents these countries ? and the like.
(A) China, Singapore, South Korea and Taiwan 41. (B) 42. (A) 43. (D) 44. (A) 45. (A)
(B) China, Indonesia, Malaysia, Singapore 46. (C) 47. (B) 48. (C) 49. (B) 50. (A)
(C) China, Indonesia, Singapore, Thailand 51. (C) 52. (A) 53. (A) 54. (C) 55. (B)
(D) China, Mexico, Brazil, Singapore 56. (D) 57. (C) 58. (D) 59. (B) 60. (B)
197. Creation of Coastal economic Zone in India has 61. (C) 62. (A) 63. (A) 64. (B) 65. (C)
been recommended by— 66. (A) 67. (B) 68. (D) 69. (C) 70. (B)
(A) Dr. Arvind Subramanian, Chief Economic 71. (A) 72. (B) 73. (C) 74. (C) 75. (C)
Advisor , GoI 76. (A) 77. (B) 78. (D) 79. (D) 80. (A)
(B) NITI Aayog in 'Three Years Action Plan' 81. (B) 82. (D) 83. (C) 84. (D) 85. (C)
(C) Dr. Urjit Patel, RBI Governor 86. (A) 87. (C) 88. (D) 89. (A) 90. (A)
(D) Mrs. Nirmala Sitharaman, Minister of State, 91. (B) 92. (B) 93. (C) 94. (D) 95. (C)
GoI
96. (D) 97. (C) 98. (D) 99. (D) 100. (D)
198. Which of the rate is not determined by Reserve 101. (B) 102. (A) 103. (C) 104. (B) 105. (D)
Bank of India ?
106. (C) 107. (D) 108. (C) 109. (B) 110. (C)
(A) Bank Rate (B) CRR
111. (A) 112. (D) 113. (A) 114. (B) 115. (A)
(C) SLR (D) PLR
116. (A) 117. (A) 118. (C) 119. (C) 120. (D)
199. ‘KUSUM’ Scheme launched by Government of
India is associated with— 121. (D) 122. (A) 123. (D) 124. (C) 125. (D)
(A) Female child protection 126. (A) 127. (A) 128. (C) 129. (A) 130. (D)
(B) Solar power plants 131. (B) 132. (D) 133. (A) 134. (C) 135. (A)
(C) Flower production 136. (C) 137. (D) 138. (A) 139. (B) 140. (C)
(D) Promoting plantation 141. (C) 142. (A) 143. (C) 144. (A) 145. (D)
146. (D) 147. (B) 148. (C) 149. (C) 150. (A)
200. In which year MUDRA Micro Units Development
& Refinance Agency was established ? 151. (C) 152. (A) 153. (B) 154. (A) 155. (C)
(A) 1991 (B) 2001 156. (A) 157. (C) 158. (D) 159. (A) 160. (D)
(C) 2012 (D) 2015 161. (D) 162. (C) 163. (B) 164. (D) 165. (A)
166. (B) 167. (A) 168. (B) 169. (D) 170. (B)
Answers with Hints 171. (C) 172. (A) 173. (A) 174. (D) 175. (D)
1. (B) 2. (B) 3. (B) 4. (D) 5. (B) 176. (C) 177. (A) 178. (B) 179. (B) 180. (C)
6. (D) 7. (C) 8. (C) 9. (C) 10. (B) 181. (C) 182. (D) 183. (C) 184. (C) 185. (C)
11. (A) 12. (D) 13. (A) 14. (B) 15. (A) 186. (A) 187. (B) 188. (B) 189. (D) 190. (A)
16. (C) 17. (D) 18. (C) 19. (A) 20. (B) 191. (C) 192. (C) 193. (D) 194. (D) 195. (C)
21. (A) 22. (C) 23. (B) 24. (A) 25. (D) 196. (A) 197. (D) 198. (D) 199. (B) 200. (D)
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