economics notes

ECONOMICS NOTES

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WHAT IS ECONOMICS?

Economics is the study of how we the people engage ourselves in production, distribution and Consumption of goods and services in a society.

Law of Demand

Other things remaining the same when price of a good increase its demand Decreases and

vice-versa. Other factors are income, population, tastes, prices of all other goods etc.

Price

Demand

10

20

12

18

14

16

Demand curve:

A demand curve is a graph that obtains when price (one of the determinants of demand) is

plotted against quantity demanded.

Price (P)

14

12

10

Demand Curve (inverse Relation with Demand and Price)

16 18 20 Quantity Demanded (Q)


Law of Supply

When Price of a good increases its supply also increase and vice versa..

Price

Supply

10

50

12

55

14

60

Supply curve:

A supply schedule is a table which shows various combinations of quantity supplied and

price.

Graphical illustration of this table gives us the supply curve.

Price (P) 14

12

Supply Curve

10

50 55 60 Supply


Other Things also Called Assumption.

Assumption Demand

(I) No Change in income

(II) No Change in people or population

(III) No change in season / Weather

(IV) No change in Prices of selected goods

Assumption of Supply

(I) No change in technology

(II) No Change in Supply related Goods

(III) No change in Season/weather

Related Goods

(I) Substitute (Exp Pepsi & Cock)

(II)

Compliment

(These are Also Called Jointly Use)


Market Equilibrium

Its a Point where Quantities, Demand and Supply are equal at one price or point called Equilibrium.

Price

Demand

Supply

10

10

20

12

80

40

14

60

60

16

40

80

18

20

100

Choose in Demand Supply

1 Extension and Contraction / Movement along the Curve ( Due to change in price)

2 Rise and Fall / Shifts in Curve (Due to Change in Other Factors)

Price (P)

P2

b

Edition

a P1 Contraction

Qs1 Qs2 QS


S

S1

Price (P)

Fall

Rise

QS

Price (P)

Fall Rise

D1

D

Qd

Extension means: When increase due to change in price.

Rise: when increase due to changes in other Factors

ELASTICITY

It is responsiveness of one variable to changes in another. In proper words, it is the relative

response of one variable to changes in another variable.

The price elasticity of Demand is measure of degree of Responsiveness of changes in

quantity of demand to change in price of product in other word it is the Ratio of

Proportionate or percentage change in quantity of Demand to proportionate or percentage

change in the price of the product.

Ep= Proportionate / Percentage changes in Demand

Proportionate / Percentage changes in price

A B

Price Qd Price Qd

2 10 20 5 2 10 20 2

12 15 12 18

Product A has High Elasticity of Demand as compared to the product B

A B

Price Qd Price Qd

3 10 60 17 2 15 78 26

13 43 17 52

Ep = 1 Where Price and Quantity percentage are change equal.

Ep

Ep

=

=

> 1

< 1

Where Price increase and quantity Decrease.

Where price decrease and Quantity increase.


Method of Measurement

1- Total Revenue / Total Expenditure

2- Formula / Mathematical

3- Geometrical

Total Revenue / Total Expenditure

According to this method the price Elasticity of Demand is observed by changes in price &

total Expenditure according to this method there three categories of Elasticity.

(I) Price Elasticity Demand = 1

(ii) Price Elasticity Demand > 1

(iii) Price Elasticity Demand < 1


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THREE CORE RULES OF ELASTICTY

RULE #Ol

Less than gieater than

Price elasticity Inerastic 1 Elastic

RULE #02

Income elasticity

RULE #03

onnal good

Inferior good

+

Cross elasticity

Substih1tes

Cornpletnents

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Price Elasticity Demand = > 1

If Price and Total Expenditure/ Revenue make in Opposite Direction.

Price Elasticity Demand = 1

If due to change in price total expenditure remain the same.

For Exp.

Price Qd TR/TE = P x Qd

10 20 200

20 10 200

For Exp.

Price Qd TR/TE = PxQd

10 20 200

20 8 160

Price Elasticity Demand = < 1

If Price and Total Expenditure make in same direction.

For Exp.

P Qd TR/TE = PxQd

10 20 200

20 12 240


Formula / Mathematical Method

(I) Point Elasticity

(II) Arc Elasticity

Point Elasticity

Point elasticity is used when the change in price is very small, i.e. the two points between

which Elasticity is being measured essentially collapse on each other.

Formula point Elasticity

Ep = Qd x P1

P Qd1

Arc Elasticity

Arc elasticity measures the average elasticity between two points on the demand curve.

Formula of Arc Elasticity

Ep = Qd x P2 + P1

P Qd2 + Qd1

Where

Qd1 = Initial Quantity of Demand

Qd2 = New Quantity of Demand

P1 = initial Period

P2 = New Period

Qd = Qd2 Qd1

P = P2 P1


Example: Calculate Ep by Point and Arc Formula to Following Data.

Price Qd

20 40

23 32

3 -8

Point Formula

Ep = Qd x P1

P Qd1

= -8 x 20

3 40

= -8

6

Ep = -1.33

Arc Formula

Ep = Qd x P

P2 + P1

Qd2 + Qd1

= -8 x

3

23+20

32+40

= -8 x 43

3 72

Ep = -1.59

Relationship between Price & Demand is Always Negative. Due to Negative Relationship

between Price & Quantity of Demand


Example No 2

Price Qd

23 32

20 40

-3 8

Point Formula

Ep = Qd x P1 P Qd1

= 8 x 23

- 3 32

= 23

-12

Ep = -1.92

Arc Formula

Ep = Qd x P2 + P1

P Qd2 + Qd1

= 8 x 20 + 23 - 3 40 + 32

=

8

x

43 - 3 72

= 43 -27

Ep

=

-1.59

The Point Formula is preferable when changes price and Demand are minor otherwise Arc

Formula give better result. Moreover Arc formula in general preferable because it gives

constant result if the value are inverse.


Geometrical Method

According to this method price Elasticity of Demand is calculated in two cases.

(I) When Demand Curve is Linear

(II) When Demand Curve is Non Linear

When Demand Curve is Linear

In this case price Elasticity of Demand on the certain point of the linear Demand curve is

calculated by lower distance of Demand curve with upper distance of Demand curve.

P A Ep = infinity

Ep = >1

C Ep = 1

Ep = < 1

B Ep = 0

Qd

Example AB = 8 cm

AC

cb

=

=

4cm

4cm

When Demand Curve is Non Linear.

In this Price Elasticity of Demand on a certainty point of Non Linear Demand curve is

calculated by 1st making a tangent point and the dividing the lower distance of tangent with

upper distance.

BC +?

P B

F

A Ep = AC

BA

E Ep = AC

FE

c G

Qd

Kind / Types of Elasticity of Demand

1 Price Elasticity of Demand (Ep)

2 Income Elasticity of Demand (Ei)

3 Cross Elasticity of Demand (Ec)

Income Elasticity of Demand

Price Elasticity is a measure of Degree of Responsiveness of change in quantity of demand

to change in income of consumer in other words it is a ratio of proportionate of of

percentage change in Demand in income.

Ey = Proportionate / Percentage change in Demand

Proportionate / Percentage change in Income



Measurement

Point Formula

Ey = Qd2 qd1

y2 y1 = Qd x y1

y1 y Qd1

Arc Formula

Ey = Qd2 Qd1

Qd2 + Qd1 = Qd x y2 + y1

y2 - y1 y Qd2 + Qd1

y2 + y1

Where

Qd1 = Initial Demand

Qd2 = New Demand

P1 = initial Income

P2 = New Income

Qd = Qd2 Qd1

P = Y2 Y1


Y Qd

5000 10

55000 12

5000 2

Point Formula

Ey = Qd x Y1 y Qd1

= 2 x

50,000 5000

10

= 100,000

50000

Ey = 2

Arc Formula

Ey = Qd x y2 + y1 y Qd2 + Qd1

= 2 x

50

55000 + 50000

12 10

=

2

x 105,000 5000 22

Ey

=

1.91

For normal goods income Elasticity of demand is positive where as for inferior goods

income elasticity of Demand is negative.


3- Cross Elasticity of Demand (Ec)

Cross Elasticity of Demand is a measure of Degree of Responsiveness of Change in

quantity of Demand of one goods to change in price of an other goods. In other word its is a

ration of to proportionate / percentage change in demand one goods to proportionate /

percentage change price another goods.

Ec = Proportionate\ Percentage change in Demand of X

Proportionate \ Percentage change in Price of Y

Measurement

(i) Point Formula

Ey = Qdx2 Qdx1

Qdx1

Py2 Py1 = Qdx x Py1

Py1 Py Qdx1

(ii) Arc Formula

Ey = Qdx2 Qdx1

Qdx2 + Qdx1 = Qdx x Py2 + Py1

Py2 - Py1 P y Qdx2 + Qdx1

Py2 + Py1

Where

Qdx1 = Initial Demand of Goods x

Qdx2 = New Demand of Goods x

Py1 = initial Price of Goods y

Py2 = New Income price of goods y

Qdx= Qdx2 Qdx1

Py = Py2 Py1


Example No 1

Py Qdx

15 20

17 25

2 5

Point Formula

Ey = Qdx x Py1

Py Qdx1

= 5 x 15 2 20

= 15

8

Ey = 1.87

Arc Formula

Ey = Qdx x Py2 + Py1

Py Qdx2 + Qdx1

= 5 x 15 + 17

2 25 + 20

= 5 x 32

2 45

= 160

90

Ey = 1.77

The cross Elasticity between substitute is positive where as cross Elasticity between

compliment is negative.


Example.

Y = Petrol

x = KM driven

Factor or Determinant of Elasticity of Demand.

(I) Nature of Goods

(II) Availability of Substitute

(III) No of uses of a product

(IV) Time period

(V) level of income

(VI) Level of Price

Example

Example of Nature of Goods (Necessity, comfort, luxury)

In case of Availability Substitute Elasticity Demand is high

In case of Non Availability Substitute Elasticity Demand is Low

In Case of level of income Low + High (Elasticity Low) in case of Middle Elasticity High

In short time period Elasticity Demand is (Inelastic)

In long time period Elasticity Demand is (Elastic)

Elasticity of Supply:

Price Elasticity of Supply is a measure of Degree of Responsiveness of change in quantity

of supply to change in price of a product in other word it is a ratio of proportionate/

percentage change in supply to proportionate / percentage change in price.

Es = Proportionate/ percentage change in supply

Proportionate/ percentage change in price


Measurement

(i) Point Formula

Es = Qs2 Qs1

Qs1

P2 P1 = Qs x P1

P1 P Ps1

(ii) Arc Formula

Ey = Qs2 Qs1

Qs2 + Qs1 = Qs x P2 + P1

P2 - P1 Py Qs2 + Qs1

P2 + P1

Where

Qs1

Qs2

=

=

Initial Supply of Goods

New Supply of Goods

P1

P2

=

=

Initial Price of Goods

New price of goods

Qs

=

Qs2 Qs1

P

=

P2 P1

Example No 1

P Qs

55 100

60 120

5 20

Elasticity of Supply is + ve


D (Ep = 0)

D

P S S(Es = 0)

S

Demand Qd Supply Qs

P S

Qd Qs


Determinants / Factors of Elasticity of Supply

1 Level of Technology (Advance technology High Elasticity)

2 Nature of goods (Agricultural Low Elasticity + Industrial High Elasticity)

3 Productive Capacity of Firms

4 Mean of Transportation and Communication

5 Time Period (Short time period low and long high elasticity)

Market Equilibrium and Govt Policy

1- Price Floors and Price Ceilings

2- Taxes and Subsidies

P s

S1

S Excess

Pc

Pc E

Pe E pe

pf Shortage

D

Qe Qe1 Q Q

S S

E

E

D

D


Incidents of a Tax

Incident of tax denote the incident of a tax of producer & consumers its depend upon

relative Elasticity of Demand and Supply. Incident of tax is more on consumer if Demand is

less elastic than supply where as its more on producer if supply is less elastic than Demand.

Analysis of Cost

1- In Short Run

2- In Long Run

Deference in Short Run and Long Run

The Distinguish between short run and long run is that in the short run atleast one factor of

production is constant where as in long run all the four factor of production become

variable.

In Short Run

1- Fixed Cost (FC)

2-

Variable Cost

(VC)

3-

Total Cost

(TC)

=

FC + VC

4-

Average Fixed Cost

(AFC)

=

FC/Q

5-

Average Variable Cost

(AVC)

=

VC/Q

6-

Average Fixed Total Cost

(ATC)

=

TC/Q

=

AFC + AVC

7-

Marginal Cost

(MC)

=

TC/ Q


Fixed Cost

Fixed Cost is that cost which Does not change with change in level of output. Fixed

cost consists of expenditure on Rent infrastructure supply of Administrative staff etc.

Variable Cost

Variable Cost is that cost which change with the level of output it consist of

expenditure on raw material Wages of Direct Labor Fuel and Electricity Maintenance etc.

Analysis of Cost

Q FC VC TC AFC AVC ATC MC

0 300 0 300 0 0 0 0

1 300 300 600 300 300 600 300

2 300 400 700 150 200 350 100

3 300 440 740 100 146.67 246.67 40

4 300 450 750 75 112.50 187.50 10

5 300 500 800 60 100 160 50

6 300 600 900 50 100 150 100

7 300 780 1080 42.86 111.43 154.29 180

8 300 990 1290 37.50 123.75 161.25 210

9 300 1300 1600 33.33 144.44 177.78 310

10 300 1700 2000 30 170 200 400


-Q

- Fe

- vc

-TC

1 2 3 4 5 6 7 8 9 10 11

700

600

500

400

300

200

100

0

1 2 3 4 5 6 7 8 9 10

- AFC

- AVC

- ATC

-MC

The three curves AVC, AVC & MC are U shave meaning that initially they fall and after

reacting a minimum point they rise again. The margin cost curve fall speedily and also rise

speedily and while rising it intersect the minimum point of AVC & ATC AFC curve is not

U shade but is L shave meaning that it fall continuously will rise in level of output.

In Long Run

Cost

LMC

LAC

Q

TC

LTC

Q



Maximize

Profit = TR TC Loss = TC TR

Main Object of Firm maximizes profit and minimize loss

A Revenue under Perfect competition

B Revenue under Imperfect competition

Market Structure

Perfect competition Imperfect competition

Imperfect Competition

1- Monopoly

2- Duopoly

3- Oligopoly

4- Monopolistic competition


Under perfect Competition

Q p TR AR MR

1 10 10 10 10

2 10 20 10 10

3 10 30 10 10

4 10 40 10 10

5 10 50 10 10

Revenue

50 TR

40

30

20

10 AR =MR=P

0

1 2 3 4 5

Revenue


Under imperfect competition

Q

P

TR

AR

MR

1

10

10

10

10

2

9

18

9

8

3

8

24

8

6

4

7

28

7

4

5

6

30

6

2

6

5

30

5

0

7

4

28

4

-2


Relationship Note

Where the total revenue is maximum minor revenue will be zero when total revenue start

falling margin revenue will become negative.

The MR Curve fall at the double speed than average revenue curve.

Speed Point

AR

MR

Perfect Competition

Perfect Competition is a market structure in which there is large number of firms

producing a homogenous product and there are no barriers in the market.

Characteristics / Futures

Many sellers and Buyers

Homogenous products

Free entry to exit of firms

Complete knowledge market condition

Free mobility of factor of production

Equilibrium of firm under perfect competition

A- In short Run B- In Long Run

In Short Run

1- Firm Earning Abnormal Profit

2- Firm Earning Normal Profit

3- Firm Facing Normal Loss

4- Firm Facing Abnormal Loss



Revenue cost MC

ATC

Pe E AR=MR

A

B

0 Qe Q

Firm as in Equilibrium at point E, Where MR= MC

So firm will produce OQe Units and Sell at OPe Price.

Profit= TR TC

= AR x Q AC x Q

= OPe x OQe OA x OQe

= OQeEPe

= OQeEPe OQeBA

= ABEPe (Abnormal Profit)

(AR=MR=P)


2- Firm Earning normal Profit

Revenue cost MC

ATC

Pe E AR=MR

0 Qe Q



Profit = TR TC

= AR x Q AC x Q

= OPe x OQe OPe x OQe

= OQeEPe

= OQeEPe OQeEPe

= 0

TC= (Rent + Wages + Interest + Normal Profit)

Firm earns normal profit which is including in its cost.



Revenue cost MC

ATC

AVC

A B

Pe E AR=MR

0 Qe Q



Loss = TC TR

= AC x Q - AR x Q

= OA x OQe - OPe x OQe

= OQeBA - OQeEPe

= PeEBA



Revenue cost MC

ATC

AVC

A B

Pe E AR=MR

AFC

0 Qe Q



Loss = TC TR

= AC x Q - AR x Q

= OA x OQe - OPe x OQe

= OQeBA - OQeEPe

= PeEBA = FC

The distance Between ATC & AVC will be Reduce


In Long Run

Revenue cost LMC (Long Run Marginal Cost)

LAC (Long Run Average Cost)

Pe E AR=MR

0 Qe Q



Profit = TR TC

= AR x Q AC x Q


= OQeEPe

= OQeEPe OQeEPe

= 0


Monopoly

Monopoly is a Market Structure in which there is only one firm producing or selling the

product and there are barriers in the market.

Characteristic of Monopoly

1- Only one firm

2- Product may be homogenous or differentiated

3- Barriers in the market

4- Complete information about the market

Equilibrium of firm (In Short Run/ Time of start business)


2- Firm Earning Normal Profit




Firm Earning Abnormal Profit

RC

MC

c AC

Pe

A B

E

MR AR = P

0 Qe Q

Firm is in equilibrium at a point E Where MR = MC

Profit = TR TC

= AR x Q AC x Q


= OQecPe OQeBA

= ABCPe

In Monopoly price and quantity decided according to own wish and take help

equilibrium point.

Under Perfect Competition

Under Perfect competition a firm is called price taker.

Under Monopoly

Under monopoly a firm is called price setter.


Firm Earning Normal Profit

RC

MC

A AC

Pe

E

MR AR = P

0 Qe Q


Profit = TR TC

= AR x Q AC x Q


= OQeAPe OQeAPe

= 0


Firm Facing Normal Loss

RC

MC

B AC

A AVC

Pe C

D F

E

MR AR = P

Q

0 Qe


Loss =

=

=

=

=

TC = OQeBA

= FC + VC

= DFBA + OQeFD

Loss < FC

PeCBA < DFBA


Loss Portion should must be less than F.C.

Firm Facing Abnormal Loss (Shut down position)

RC

MC

A B AC

AVC

Pe C

E

MR AR = P

0 Qe Q


Loss = TC TR

= AC x Q AR x Q

= OA x OQe OPe x OQe

= OQeBA OQeCPe

= PeCBA


Monopolistic Competition

Monopolistic Competition is a market structure in which there are large number of firms

producing or selling differentiated product and there are no barriers in the market.

Characteristic of Monopolistic competition

1- Large number of buyer & seller

2- Differentiated Product

3- Free entry and exit of firms.

4- Complete market information


It is a mixture of Perfect Competition & Monopoly.

Example of monopolistic Competition Curve

Price & Demand Curve also called AR

Pe AR = MR

Monopoly

Perfect Competition

Monopolistic Competition

Oligopoly

Duopoly

In monopolistic all Four cases are same like monopoly just the AR & MR Curve more

flat.

Monopolistic Competition Curve

AR



RC

MC

C AC

Pe

A B

E

MR AR = P

0 Qe Q


Profit = TR TC

= AR x Q AC x Q


= OQecPe OQeBA

= ABCPe

Under Perfect Competition

Under Perfect competition a firm is called price taker.

Under Monopoly

Under monopoly a firm is called price setter.


Firm Earning Normal Profit

RC

MC

A AC

Pe

E

MR AR = P

0 Qe Q


Profit = TR TC

= AR x Q AC x Q


= OQeAPe OQeAPe

= 0


Firm Facing Normal Loss

RC

MC

A B AC

C AVC

Pe

D F

E

MR AR = P

0 Qe Q


Loss = TC TR

= AC x Q AR x Q


= OQeBA OQeCPe

= PeCBA

TC = OQeBA

= FC + VC

= DFBA + OQeFD

Loss < FC

PeCBA < DFBA


Firm Facing Abnormal Loss

RC MC

AC

A B

C AVC

Pe

E

MR AR = P

0 Qe Q

Firm is in equilibrium at point E Where MR = MC

Loss = TC TR

= AC x Q AR x Q


OQeBA OQeCPe

= PeCBA


Monopoly

Equilibrium of Firm in Long Run


RC LMC

LAC

Pe C

A

E

MR AR

0 Qe Q


Profit = TR TC

= AR x Q AC x Q


= OQeCPe OQeBA

= ABCPe


Monopolistic competition

Equilibrium of Firm in Long Run

Firm Earning Normal Profit:

RC LMC

LAC

Pe A

E

MR AR

0 Qe Q


Profit = TR TC

= AR x Q AC x Q



= OQeAPe OQeAPe

= 0

Macro Economics

National Income and Its Concepts

National income is the aggregate of market value of all final goods and services produce

by the country during one year.

Concept of National Income

1- Gross Domestic Product (GDP)

2- Net Domestic Product (NDP)

3- Gross National Product (GNP)

4- Net National Product (NNP)

5- Personal Income (PI)

6- Disposable Personal Income (DPI)


1- Gross Domestic Product (GDP)

Gross domestic Product is the aggregate of market value of all final goods &

Services produce inside the country during one year.

2- Net Domestic Product (NDP)

Net domestic product (NDP) is obtained by subtracting depreciation from GDP.

Depreciation is the reduction in the value of a capital good due to the wear and

tear caused during production. The total market value of all final goods and

services produced within the political boundaries of an economy during a given

period of time, usually a year, after adjusting for the depreciation of capital.

NDP = GDP Depreciation allowance

3- Gross National Product (GNP)

Gross National Product is the Aggregate of Market Value of all Final goods &

Services produced by the Nationals of the country.

4- Net National Product (NNP)

NNP = GNP Depreciation allowance

5- Personal Income (PI)

Personal Income is the aggregate of all incomes actually received by all

individuals of a country during one years

Personal income is equal to = National income social security Contribution

Corporate Taxes Undistributed Corporate Profit + Transfer Payments

(Gifts, Pension, Grants)


6- Disposable Personal Income (DPI)

DPI= Personal Income Direct Tax

Relationship between GDP and GNP

GNP = GDP + Net Foreign Income

Net Foreign Income = Income of Home Factors engaged abroad Income of

Foreign factors engaged at home

Method of Measurement of National Income

1- Product or Output Method

2- Income Method

3- Expenditure Method

1 Product or Output Method

According to Product Method National Income is the aggregate of Market value of

all final goods and services produced in various sector of the economy. The major

sector of the economy includes agriculture, Manufacturing, transport and

communication, services, Mining, Fishery, Forestry etc.


2- Income Method

According to income method national income is the aggregate of the following items.

1- Wages & Salaries

2- Rents of Houses, Land, Buildings

3- Interest on capital

4- Profits of unincorporated enterprises

5- Profits of incorporated enterprises (like dividend)

6- Undistributed corporate profit

7- Corporate Taxes

8- Indirect taxes

9- Depreciation

10- Net income from abroad

3- Expenditure Method

According to expenditure Method National income is the aggregate of following

four items.

(i) Conception Expenditure ( C )

(ii) Investment Expenditure ( I )

(iii) Government Expenditure ( G ) ( Development + Non Development)

(iv) Net Expenditure (X M)(X = Export Earning, M = Import Payment)


Y = National Income

Y = C + I + G + (X M)

Difficulties in Measurement of National Income

1- Barter Transaction

2- Services Without Reward

3- Self Consumed Production

4- Income Earned Through illegal activities

5- Part time Jobs

6- Non Co-Operation of Public

7- Non Maintenance of accounts

8- Price changes

Circular Flow of National Income

The circular flow of National income shows how National income moves between

household sector and Business sector in the economy. This circular flow also includes

some leakages and injections which effect National income in a positive and negative

way.


There are three types of Leakages and Injections.

Leakages Injections

1- Savings Investments

2- Taxes Government Expenditures

3- Imports Exports

Leakages: leakages cause reduction in national income

Injections: injections cause increase in national income

Inflationary and Deflationary Gaps

1- Aggregate Supply Curve

2- Aggregate Demand Curve

Aggregate Supply Curve

Aggregate supply curve shows aggregate of goods and services produced and supplied at

various price levels. Aggregate supply curve can be shown with the following diagram.


Price Level (P) AS

Where Yf National income

At full employment level.

0 Yf AS

Aggregate supply curve has + ve relation with price.

Aggregate Demand Curves

Aggregate demand curve shows the aggregate of goods and services consumed or

demand at different price levels. Aggregate Demand shown with following diagram.

Price Level (P) ADC has inverse relation with price.

AD

0 AD


Ideal Situations

Price Level (P) AS

Pi E Means equality of

Pi (ideal price level) ASC &ADC.

AD

0 Yf AS,AD

Note:

In this situation aggregate Demand curve intersects aggregate supply curve at full

employment level and the price level determined by this situation is called ideal price level.

Inflationary Gape

Inflationary gaps occur when aggregate demand curve intersects aggregate supply curve

at a higher point than full employment level of income. It can be shown with following

diagram.


P AS

E

Pe

Inflationary

Gap Pi

AD

0 Yf AS,AD

Note:

In the diagram the difference between equilibrium price and ideal price is inflationary

gap because equilibrium price is higher than ideal price.

Deflationary Gap

Deflationary gap occurs when aggregate demand curve intersects aggregate supply at

less than full employment level of income .It shown with following diagram.


P AS

Deflationary Pi

Gap Pe E

AD

0 Y1 Yf AS, AD

Price are less than received level

In this diagram equilibrium price is less than ideal price and the difference is called

deflationary gap.

Measure to Remove inflationary and Deflationary gaps

There are two methods.

1- Fiscal Policy

2- Monitory Policy


Measure to Remove Inflationary Gap

In case of inflationary gap contractionary Fiscal and monitory policy are

required which means that government expenditure should be reduced and

government earning should be increased through taxes and other measures and

in case of monitory policy the circulation of money and credit should be

reduced to reduced inflation in the economy.

Measure to Remove Deflationary Gap

In case of deflationary gap expansionary Fiscal and monitory policies are

required In Case of Fiscal policy government expenditure should be increased

and taxes should be decreased. In case of monitory policy circulation of money

and credit should be increased in ordered to increase prices and economic

activity in the economy.

Fiscal Policy

Fiscal policy is the policy of regulating and controlling revenue and expenditure of the

government to achieve macro economics objective.

Budget: Budgeting is the picture of Fiscal policy

Budget Deficit : Difference Between Revenue and Expenditures is Called Budget Deficit.


Budget Deficit is also called deficit Financing.

Budget

Revenue Expenditures Deficit Financing

Current Exp. Development Exp.

Tax Revenue Non Tax Revenue Internal External

Direct Taxes Indirect Taxes Bank Borrowing Public Debt / Borrowing

Objectives of Fiscal Policy/ Macro Economics Objectives

1- High growth of national income

2- Fair Distribution of national income

3- High Employment

4- Price Stability

5- Reduction in regional disparities


6- Discouraging Production and Consumption of unnecessary goods

7- Reduction in deficit in balance of payment

Instruments/ Tools of Fiscal Policy

A- Automatic / Built in Stabilizers (Non Discretionary Tools)

B- Discretionary Tools

Automatic /Non Discretionary Tools

1- Progressive taxation

2- Unemployment allowance

3- Support price policy

4- Corporate and Family saving

Discretionary Tools

1- Changes in tax rates

2- Changing public works expenditure

3- Changing in transfer payment

4- Credit aids

Business Cycles

The fluctuation in economic activities comprising National income and employment is

called business cycle or trade cycle.


Phases

1- Recovery

2- Boom / peek

3- Recession

4- Depression

Economic

Activities

Recovery Boom

Recession

Depression

0 Time

Boom

Recovery Recession

Depression


Features

1- One business cycle is said to be completed when it passes through all the four phases.

2- There is no hard and Fast rule regarding time period for the completion of a trade

cycle whoever the research has shown that it takes from two to ten years for its

completion.

3- The recovery phase is said to be longer than the recession phase.

4- Every next Boom or Depression will be at higher level of economic activity than

previous one.

Business Cycle and Fiscal Policy

The role of government in controlling fluctuations comes in the form of changes in

Fiscal policy in the period of boom government operates a contractionary Fiscal policy

in which it increases the tax rates and revenue and decreases its expenditure. Where as in

the time of depression government operate expansionary Fiscal policy in which it

decreases tax rates and its revenue and increases its expenditure to move out the

economy from depression.

Monitory Policy

Monitory policy is the policy of controlling supply and demand for money and credit in

the economy.

Monitory policy is the policy of central Bank and Fiscal policy is the policy of government.


Features of Monitory Policy

1- Creation and expansion of financial institutions.

2- A suitable interest rate policy.

3- Debt management (Public Debt)

4- Proper adjustment between supply and demand for money.

5- Credit control

(I) Quantitative Measures

(II) Qualitative Measures

Quantitative Measures

1- Open Market operation

2- Bank Rate policy

3- Variable reserve rate

1- Open Market Operation

Open Market operations are the sale and purchase of government securities through

financial institutions in order to increase the money supply. These securities are

purchased back from the public while to decrease money supply more securities are sold

to the public through financial institutions.

2- Bank Rate Policy

The Bank rate is that rate of interest at which central bank provides loan to

reduced. Where as to decreased the supply of credit the bank rate is increased.


3- Variable Reserve Ratio

Commercial Banks are directed to keep a certain portion of their demand and time

deposits to meet their daily cash requirements. If the purpose is to increase credit supply

their reserve ratio is decreased where as to decreased credit supply this reserve ratio is

increased.

Qualitative Measures

1- Selective Credit Control.

1- Selective Credit Control

Selective credit control means different interest rates for different sectors or public

requirements for loans on preference basis. For Example A low rate of interest may be

charged for the a farmers to purchase seeds, Fertilizers, Pesticides machinery etc.

Similarly a low interest rate may be charged for public on loans for Houses, Car

Financing, Foreign Development.

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Unemployment And its kinds

1- Employed

2- Unemployed

3- Not in Labour Forces

4- Labour Force

1- Employed

The employed are those persons who perform any paid work and those who

have jobs but are absent from work due to illness strike or vocations.

2- Unemployed

Unemployed are those persons who are not employed but are actively

looking for work not labour force.

3- Not in Labour Force

The persons who are not in labour force include retired, aged and not looking

for work.

4- Labour Force

The labour force include those persons who are either employed or

unemployed.

Labour Force = Employed + Unemployed

Unemployment Rate

The unemployment rate is equal to the number of unemployed people / labour force

Unemployment Rate = Number of unemployed people

Labour Forces

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Page 67

Okun's Law

For every two persons that GDP falls relative to potential GDP the

unemployment rate rises about one percentage point

For example it mean that if GDP begins at 100% of its potential level and falls to 98%

of its potential the unemployment rate rises by 1% point. For example 6 % to 7 %.

Kind of unemployment

1- Frictional Unemployment

2- Structural Unemployment

3- Cyclical Unemployment

4- Disguised Unemployment

5- Voluntary Unemployment

6- Involuntary Unemployment

1- Frictional Unemployment

Frictional unemployment arises because of movement of people between

regions and jobs. It is possible that in a full employed country there is a

frictional unemployment at a moderate level.

2- Structural Unemployment

Structural unemployment arises due to a mismatch between supply and

demand for workers when structure and technology of the economy changes.


3- Cyclical Unemployment

Cyclical Unemployment arises when demand for labour decreases in recession

due to a fall in aggregate demand.

4- Disguised Unemployment

Disguised unemployment arises when people seem to work but their work do not

contribute to the productivity.

For example: In rural area if five worker are needed but that works is done by ten

workers then five workers are called disguised unemployed.

5- Voluntary Unemployment

Voluntary unemployment arises when people do not want to work at existing

wage rates and they considered that the wage rate is lower than their education

skill or experience.

6- Involuntary Unemployment

Involuntary unemployment arises when people are willing to work at existing

wage rates but they do not find work due to low demand for labour. In this

situation markets existing rate is higher than market clearing wage rate due to

minimum wage laws or labour unions.


Voluntary Unemployment

Wage Rate SL

Equilibrium Wage Rate

E

We --------------------- ------------ Voluntary Unemployment

DL

LT Labour Force

Involuntary Unemployment

Wage Rate SL

Involuntary

Unemployment

Minimum Wage Rate

Wm

We ---------------------

DL

LT Labour Force


economics notes

Documents

price supply

price demand supply

price increase

price elasticity of

price of product

price decrease

b price qd price qd

quantity of demand