Economics 101
Micro & Macro
EconomicsRahul Reddy
Economics is the science of the optimum or best utilization of economic resources
Microeconomics Basics
Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good
Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good
Some definitions
• Demand
Demand is the want or desire to possess an economic good, backed by the necessary financial capability to buy that good, at a given price.
Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good
Some definitions
• Supply
Supply is the total quantity of an economic good that is available for purchase at a given price
Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good
Some definitions
• Consumer
An individual who acquires an economic good for direct use or ownership and not for resale or use in production of some other economic good
Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good
Some definitions
Customer
An individual who purchases an economic good for self or on behalf of the consumer.
A customer may be different from the consumer, eg:
1. Government purchasing oil from the OPEC for consumption by the population
2. Parents purchasing baby food for consumption by the infant
Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good
Some definitions• Complementary good
An economic good which is usually used along with another good
Examples
1. Tea: milk, sugar
2. Pen: ink, paper
Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good
Some definitions• Substitute good
An economic good which is usually used in place of another good
Examples
1. Tea: coffee, cold drinks
2. Pen: pencil, crayon, brush
Marginal Utility
Marginal utility of water
The utility, and therefore demand, of every incremental unit of water diminishes
⇒ Price equals marginal utility⇒ If price reduces, demand
increases
∆
Law of demand
The higher the price of an economic good, the lower is its quantity demanded, ceterus paribus.
Demand Curve of a normal economic good is downward sloping
Factors affecting demand• Income
• Tastes and Preferences
• Price of complement goods
• Price of substitute goods
• Price expectations of the customer
• Number of customers (at a macro level)
Exceptions to law of demand
• Veblen Good
• demand increased with price
• Luxury products (snob value)
• Price is only indicator of quality
• Giffen Goods
• demand rises as price rises
• Inferior cereals, essentials
Price Elasticity of Demand• Change in demand /unit change in price
• Price Elasticity = ∆D/∆P
• High elasticity
• Non essential goods
• Goods with close substitutes
• Low elasticity
• Essentials, without close substitutes
• Price is set largely by supply
Income elasticity of demand
• Unit change in demand per unit change in income of people demanding the good.
• eI > 1 for luxury goods
• e.g. 10% Higher income --> 20% Higher Demand
• Higher disposable income
• eI < 1 for goods of necessity: Engel’s law
• Consumption of essentials does not rise
• eI < 0 for inferior goods
• As income rises consumption --> substitute goods
Law of supplyThe higher the price of an economic good, the higher
is its quantity supplied, ceterus paribus.
Supply Curve of a normal economic good is upward sloping
Factors affecting supply• Price and availability of resources
• Price of complement goods
• Price of substitute goods
• Technological changes
• Price expectations of the seller
• Taxes and subsidies
• Number of sellers (at a macro level)
Equilibrium
Surplus
Shortage
Equilibrium price and Equilibrium quantity
Market : self balancing tool • If Demand is high, price goes up
• Consumers curtail demand
• Higher profits invite fresh suppliers
• If Supply is high, price goes down
• some suppliers go out of business
• Low price increases demand
• Market promotes efficiency
• Inefficient suppliers are weeded out
• Allocation of resources based on demand
Macroeconomics Basics
Gross Domestic Product, GDP
Total market value of all final goods and
services manufactured within the country in a financial year
=
Household Consumption + Investment + Government Expenditure + Net Exports
(Consumption approach)
=
Wages + Interest + Rent + Profit + Indirect Tax + Depreciation
(Income approach)
Gross National Product, GNP
Total market value of all final goods and
services manufactured within the country in a financial year plus net
factor income from abroad
=
GDP + Income earned by Indians from foreign investments – Income earned by foreigners from domestic investments
Consumer Price Index, CPI
CPI is a measure of the level of inflation.
CPI measures how much the price of a basket of consumer goods has changed
over a given time period.
In India CPI is computed weekly and is measured YoY and WoW
Wholesale Price Index, WPI
WPI is a measure of the level of inflation from an industrial point of view.
WPI measures how much the price of a basket of wholesale goods has changed
over a given time period.
Generally WPI leads the CPI by 60 – 90 days
Current Account Convertibility
Freedom to exchange the Rupee into other currencies
In connection with Foreign trade and other normal business functions.
Payments due - as interest on loans and as net income from other investments
Individual remittances for family living expenses
Business travel, participation in overseas conferences, studies abroad, training or medical treatment
Capital Account Convertibility
Home currency can be freely converted into foreign currencies for
acquisition of capital assets abroad or for any purpose.
The rupee is currently not freely convertible on the capital account.
Purchasing Power Parity, PPP
• A method of measuring the relative purchasing power of different countries’ currencies over the same types of goods and services.
• Allows us to make more accurate comparisons of standards of living across countries.
• Not all items can be matched exactly across countries and time, the estimates are not always "robust”
• India is # 4 in GDP (PPP) terms and # 10 in GDP (nominal) terms worldwide
Foreign Direct Investment, FDI
Foreign Direct Investment (FDI) is investment into physical assets of other countries,
• Through financial collaborations.
• Through joint ventures and technical collaborations.
• Through capital markets via Euro issues.
• Through private placements or preferential allotments.
Areas prohibited under FDI:
• Arms and ammunition.
• Atomic Energy.
• Railway Transport.
• Coal and lignite.
• Mining of iron, manganese, chrome, gypsum, sulphur, gold, diamonds, copper, zinc.
Foreign Institutional Investors, FII
FII means an entity established or incorporated outside India which proposes to
make investment in India. (Shares less than 10% of total voting shares)
In India, the Following entities / funds are eligible to get registered as FII:
• Pension Funds & Mutual Funds
• Insurance Companies
• Banks & Investment Trusts
• University Funds
• Endowments, Charitable Trusts / Charitable Societies, Foundations
Fiscal Policy
The government’s policy of achieving economic objectives (employment, per capita income…) through government earning and spending.
Monetary PolicyThe government’s policy of achieving
economic objectives (employment, per capita income, balance of trade, economic parity…)
through controlling money supply
Decrease in supply: Deflation or decrease in prices
Increase in supply: Inflation or increase in prices
MONEY SUPPLY• M1 = currency in circulation - cash with
banks + demand deposits with banks
( also called narrow money – most liquid )
• M2 = M1+ small saving deposits
• M3 = M1+ time deposits with banks
( also called broad money )
• M3 > GDP → Inflation.
MONETARY POLICY
Regulates the money supply in the economy
1. Repo Rate.
2. Reverse Repo Rate.
2. Open market operations - RBI buying and selling securities to regulate money supply.
MONETARY POLICY3. A) CRR - every commercial bank to keep a
certain percent of it’s demand and time deposits with the RBI.
B) SLR - commercial banks keep a fixed percentage of their demand and time deposits in liquid assets ( cash, securities, gold ).
4. Priority sector lending
5. Differential Interest Rates ( PLRs )
Interest Rates
• Interest rates – Tool of monetary policy
• Low interest rates
• Incentive to borrow: Consume/Invest
• Used with Hi money supply
• High Interest rates
• Incentive to Save
• Used with Low Money supply
• Used to control Inflation
ROLE OF THE RBI
• Issue of bank notes of all denominations
• Regulates money supply
• Lender of last resort to banks
• Controls FOREX operations.
Fiscal Policy
• Fiscal or Budgetary Policy is the policy involving Government revenues and Expenditure
• Objectives:
• Economic Growth
• Inflation control
• Employment generation
• Social sector objectives
TAXES
• DIRECT TAXES
Direct incidence of tax on the person who pays the tax. liability to pay tax is NOT passed on to someone else. e.g. INCOME TAX, CORPORATION TAX, WEALTH TAX, LAND REVENUE, GIFT TAX etc….
• INDIRECT TAXES
Levied on goods and services. traders / producers pay it. Liability passed on to end customer. e.g. VAT, EXCISE TAX, CUSTOMS DUTY, SERVICE TAX…
Taxes as fiscal tool
• Government uses Taxes
• Revenues
• Price Control
• Stimulate investment
• Promote Balanced Economic growth
• Suppress sale of Negative goods
STRUCTURE OF UNION BUDGET
REVENUE SIDE
1. Revenue receipts
A) tax revenue — central excise, customs duty, corporation tax, income tax, service tax, FBT, CTT, STT.
B) non-tax revenue —interest receipts on loans , profits from PSUs.
2. Capital receipts
Dividends from PSUs, principal repayment from debtors, disinvestment proceeds , market borrowings.
Revenue and Capital Expenditure
• Revenue Expenditure: Expenditure which is not directly linked to creation of asset. e.g. Salary payment, Consumable purchases etc
• Capital expenditure: Expenditure that leads to the creation of assets. (Investment). e.g. Purchase of machinery or durable.
DEFICITS
• Revenue deficit
Revenue expenditure ( interest + subsidy + defense + law and order) — revenue receipts
( tax + non tax)
• Budget deficit
Total expenditure - total receipts (incl borrowing)
• Fiscal deficit (Real Deficit)
Budget deficit + borrowings from banks and public
DEFICIT FINANCING AND IMPACT
• Government borrows from RBI by transferring securities. RBI prints new currency and lends to the govt.
• Increases money supply. Adds inflationary pressure in economy.
• Reduces funds available for private borrowers.
• Government ends up paying more interest in future.
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