Economics basics

1. Economics is the science of the optimum or
best utilization of economic resources

2. Microeconomics Basics

3. Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good

4. Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good

5. 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.

6. Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good

7. Some definitions
• Supply
Supply is the total quantity of an economic good
that is available for purchase at a given price

8. Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good

9. 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

10. Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good

11. 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

12. Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good

13. Some definitions
• Complementary good
An economic good which is usually used along
with another good
Examples
1. Tea: milk, sugar
2. Pen: ink, paper

14. Some definitions
• Demand
• Supply
• Consumer
• Customer
• Complementary Good
• Substitute Good

15. 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

16. 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
∆

17. 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

18. 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)

19. 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

20. Price Elasticity of Demand
• Change in demand /unit change in price
• Price Elasticity = ∆D/∆P
• High elasticity
• Non essential goods
• Goods without close substitutes
• Low elasticity
• Essentials, without close substitutes
• Price is set largely by supply

21. 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

22. Law of supply
The 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

23. 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)

24. Equilibrium
Surplus
Shortage
Equilibrium price and Equilibrium quantity

25. 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

26. Macroeconomics Basics

27. 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

28. 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

29. 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

30. 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

31. 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

32. 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.

33. 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

34. 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.

35. 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

36. Fiscal Policy
The government’s policy of achieving
economic objectives (employment, per
capita income…) through government
earning and spending.

37. Govt Sources and Uses of Funds
• Taxes and duties
• Dividends from PSU, Disinvestment
• Fines and other charges
• Public & private borrowing
• External borrowing
• Printing Money
• Employee salaries
• Consumables
• Infrastructure

38. Monetary Policy
The 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

39. 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.

40. MONETARY POLICY
Regulates the money supply in the economy
1. Bank Rate - official rate of interest charged
by RBI as the lender of last resort. Current
rate – 6%
2. Open market operations - RBI buying and
selling securities to regulate money supply.
Repo rate – 6% . Reverse Repo – 7.25%

41. MONETARY POLICY
3. A) CRR - every commercial bank to keep a certain
percent of it’s demand and time deposits with the
RBI ( 5.5% ).
B) SLR - commercial banks keep a fixed
percentage of their demand and time deposits in
liquid assets ( cash, securities, gold ) currently at
25%.
4. Priority sector lending
5. Differential Interest Rates ( PLRs )

42. 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

43. ROLE OF THE RBI
• Issue of bank notes of all denominations
• Regulates money supply
• Lender of last resort to banks
• Controls FOREX operations.

44. 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.

45. 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…

46. Taxes as fiscal tool
• Government uses Taxes
• Revenues
• Price Control
• Stimulate investment
• Suppress sale of Negative goods

47. 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.

48. 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.

49. EXPENDITURE SIDE
1. Plan expenditure
incurred in central development schemes. Costs around
25% of total expenditure.
- Revenue and Capital
2. Non-plan expenditure
Interest payments, defense, subsidies, salary of govt.
employees.
Accounts for approx. 75% of total expenditure.

50. 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