The document discusses macroeconomics topics including GDP, inflation, unemployment, and economic models. It provides explanations of: 1) How GDP is measured using different approaches and the relationship between real and nominal GDP. Inflation is also defined and the different inflation indicators of CPI, WPI, and GDP deflator are explained. 2) Major causes of unemployment including frictional, cyclical, and structural unemployment. Different schools of economic thought are outlined including classical economics, Keynesian economics, monetarism, and supply-side economics. 3) The AS-AD model is described showing how equilibrium price and output are determined by the intersection of the aggregate supply and demand curves. Types

1. Macro-Economics?
Micro economicsindicateseconomyworkingatindividualmarketandbusinesslevel (atconsumer,
investorandworker).
Macro-economicindicateshownational economyperformson2 fronts:-
Sustainedgrowthrate andstabilityingeneral price level.
It isimportantto understandmacroeconomicsasitimpactseveryindividual life.Betterunderstanding
of macroeconomicscanhave significantimpactonthe wayof our thinkingandtake dayto day personal
and businessdecisions inbetterway.
Interestrate,consumerconfidence, unemploymentrate, exchange rate,inflation,currencyfluctuation
insome part of the worldcan have potential impactonourlife.
Businessisnolongerregional focus,we all are partof the worldeconomicsandeverychange inanypart
of the worldcan have impactinsome way.
So to understandmacroeconomics, cangive potentialknowledge tomake betterdecisionsineveryday
life.
Major Macroeconomics Problem/key challengeareas?
1.) Rate of economicgrowth
a. Rate of economicgrowthof the country istypicallymeasured/indicatedbyGDP(Gross
DomesticProduct).
b. GDP can be definedastotal marketvalue of all final goodsandservicesproducedinthe
economyina giventime period.
c. GDP can be measuredin multipleways:
i. Flowof cost/income approach
1. All income receivedbypeopleinthe country
a. Wages(Salary),Rentamount,Interestearned,Profit/benefits
earnedinany otherformby everyone inthe country( wages+
rent+ interestearned+profits/benefits)
ii. Flowof product/expenditure approach
1. GDP = Consumption+Investment+GovernmentSpending+NetExport
a. GDP = C + I + G + (X-M)
d. Real vs Nominal GDP
i. Real GDP is the nominal GDPvalue adjustedforinflation.Real GDPshouldbe
watchedcloselythanNominal GDPforgettingtrue picture of the current
economystatus.
ii. Real/Nominal GDPcalculation:-
1. Real GDP is calculatedagainstbase year – CurrentyearQuantity*Price
of base year.
2. Nominal GDPisprice of currentyear * current yearquantity.

2. 1. Real GDP = Nominal GDP – inflation
a. If Year X, Nominal GDPis8 and inflation
is6
i. Real GDP = 2
b. If year X,Nominal GDPis 7 andinflation
is3
i. Real GDP = 4
ii. The GDP forecastedinbudgetgenerallyare Real GDP(
inflationadjusted)
e. GDP EquationInterpretations
i. GDP(Y) = C+I+G+(X-M)
ii. (Y-C) – G – (X-M) = I
1. Savings= Investment
a. Level of savinginthe economyisequal toinvestmentsmade in
the country.
b. Highsavingwill give optionforgovernmentandprivate
institutestohave more moneyforinvestment.
iii. (Y-C-G)-I= (X-M)
1. Savings– Investment=CA Deficit
a. (Y-C-G)-I=CA
b. More investmentthansavingindicatesthatcountryisspending
more than itshouldbe doing – higherimportsthanexports.
f. IndiaGDP

3. 2.) Inflation
a. What isInflation
i. Upward movementof pricesfromone yeartonextyear(change inprice index).
[Prince (2016)-Price (2015)/Prince (2015)] %
ii. There are 3 Inflationindicatorsgenerallyused,all needtobe usedtoknow
abouteconomytrend:-
1. CPI
a. Consumerprice index indicatesthe change inthe price level on
consumerfront.All consumptionof goodsandservicesatretail
price level includingimportsisconsidered.
b. Major itemsinthe buckethavinghighestweightage are food
groups,housing,servicesandmisc.consumptionitems.
c. Takingbase year as reference andcalculatingthe fixedquantity
weights,CPIiscalculatedtoindicate the price increase for
consumer.
d. CPI= (CurrentPrice * Base year quantity) /(Base yearPrice *
Base year quantity)
2. WPI
a. Wholesale Price index indicatesthe change inthe price level on
the largerbasketof goods includingintermediategoods ( butno
service) atwholesale price.
b. Major itemsinthe buckethavigthe highestweightageare
manufacturedgoods,fuelsetc.
c. Takingbase year as reference andcalculating the fixedquantity
weights,WPI iscalculatedtoindicate the price increase for
consumer.
d. WPI = (CurrentPrice * Base yearquantity) /(Base yearPrice *
Base year quantity)
3. GDP Deflator(Nominal GDP /(Nominal GDP – Inflation))
a. GDP deflatorindicatesthe change inthe price level forall
domesticallyproducedfinal goodsandservices(noimport
items).
b. Economicmetric,whichshowshow economyGDPis growingby
removingthe effectof inflation(risingprices) - indicates
changesinconsumptionof goodsandservicescurrently
present.Itisnot basedonthe anyfixedbasketof goodslike CPI.
Anynew additionof goodsandservicesinthe economyalso
getsaddedand thusprovidesmuchbettermetricframework
for economicgrowthindicator.
c. As quantityof goodsandservicesproducedisknownatthe end
of the year,GDP deflatorvalue has1 yearlag.

4. India’sCPI
iii. Whichone to refer:-
1. CPIand WPI are mostlyusedasthe inflationindicatorinthe economy.
2. As bothhave differentbucketandweightageof itemsinthe bucket,
theyprovide datapointsuseful tounderstandeconomyatdifferent
level.

5. a. CPIwill mostlikelytell aboutprice change (demandgrowth)
facedby the commonpeople whobuyfooditems,andavail
services.
b. WPI will mostlikelytellaboutthe price change (demand
growth) facedbythe manufacturers (producers).
iv. Inflationeatsintothe moneyvalue,impactsavingsvalueinfuture.Interestrate
isinfluencedbythe currentinflationandexpectedinflation.
v. Due to inflation,borrowerscanbenefitandlenderscansuffer –As inflationrises
value of moneyreturnedbyborrowerunderfixedinterestlendingdecreasesfor
lender.
3.) Unemployment
a. There are differentkindsof unemploymentthatcanoccur inthe economy.
i. Frictional
1. Jobswitchingcancreate unemployment.
ii. Cyclical
1. Economy dipsintorecession,whichiscyclical asindicatedinthe past
century.Whenevereconomyentersintorecession,itleadsto
unemployment.
iii. Structural
1. These byfar are toughestandhas seenrisinginthe pastfew decades.
Technological revolutionresultsinmakingmanycurrentjobsirrelevant
and leadstounemployment.
b. Unemploymentindictorisquarterlydata.GDPoutputandunemploymentare closely
related– GDP outputincrease leadstodecrease inunemploymentandvice-versa.
c. IndiaUnemploymentdata

6. Different school of economics and evolution of economics study groups in
World
1.) Classical economics
Classical economicsplayedcentral role andprovidedguidingprinciplewhichworkedformostof
the 18th
centurytill early19th
century – Adam SmithandRiccardo were the socalledclassical
economicsdefiningfathers.Theirbelief andprincipal were:-
a. Economy is self-correcting,noneedforgovernmentorexternal agencytoparticipate (
PopularlynamesasLaissezFair)
b. Unemploymentispartof businesscycle,asbusinesscycle iscyclicthere are phase when
unemploymenthappensbuteconomyself-correctingmechanismaddressesthe
unemploymentissue.Thisishow itmaywork:-
c. Whenbusinessstartswithsome resources,due toeconomy of scale andwagesincrease
overtime leadstobusinessnotbeingsoprofitable.Thuswagesneedtoagaingo back to
the correct level.Unemploymenthappens,more peopleavailabletotake job,wages
decrease,expenseof runningbusinessdecreasesandthus businessstartmakingprofit
againwithmore jobsbeingcreated.Classical economicsbasedon2 basicprinciples:
d. SaysLaw - Supplycreatesitsowndemand.Supplyof goodsandservicesinthe economy
producedwill have itscorrespondingdemand.
e. MV=PQ
f. Thisequationindicatesthatkeepingvelocityof moneysupplyconstantandquantity
stable,increase inMoneysupplywill resultinincrease inPrice.
g. What happenedduringGreatDepression
h. Stock marketcrash in1929
i. GDP fell one thirdbetween1929 and 1933
j. 25% unemployment
k. Businessinvestmentfell from16Mto 1 M in1933
l. Great depressionwascauseddue toclassical economicsview thateconomyself corrects
withoutthe involvementof governmentinstitute.
m. But thisdidnot happen,andwhensentimentswentdowneconomymovedintodeeper
recession.
2.) KeynesianEconomics
a. It rejectedthe classical economicsviewof economyself-correctingitself.
b. Wheneconomygoesintorecessionandsentimentsare down,economicpumpbythe
governmentisnecessarytorevive the economy,
c. Before price adjustmenttakesplace,itisprecededbythe income adjustmentbehavior –
Duringgreat depressionpeople andbusinessbehaviorchangedquicklyonthe basisof
recessionandreducinglevel of income.Thuslarge expenditure bythe government is
important.
d. Thus Role of Fiscal policyisimportantforthe economy.
e. Fiscal Policyfocusistowardstax policyandgovernmentspending.

7. f. Philosophywasbasedon –wheneconomyisinrecessionitcauseshighunemployment
and people donotspend(demand goesdown).Wheneconomyisboomingitcauses
highemploymentandpeople spendmore causinginflation.
g. Unemploymentandinflationisinverselyrelated.Bothcannotcoexistatthe same time.
h. What happenedduring1970’s
i. Justlike duringclassical economics,ledtogreatdepressionwhichforcedeconomistto
lookforother options,Keynesianusage wasfollowedwithanothereconomicproblem –
Stagflation.
j. Stagflationis – highunemploymentwithhighinflation.Thiswasunknownscenario
before 1970’s.
k. It was causedprimarilybecause of:-
l. Huge Tax cuts by the governmentaspart of fiscal policyatthe start of 1970’s.
m. VietnamWarat the same time – whichincreasedthe spendingtosupportwar.
n. As moneysupplyinthe economyincreased,causeddemandpull inflation inthe
economy.
o. As warended,witheconomy/businesscycle goingdown,unreasonablemoneysupply
and shortspike inbusinessduringsmall phaseledtoincrease of unemploymentwith
highinflationinthe economyatthe same time – causingstagflation.
3.) MonetaristSchool of economics
a. Believe thatmacro-economicproblemsof inflationandunemployment/Recession
happensinthe economydue to
b. Rate of growthof moneysupply
c. Inflationhappenswhengovernmentprintsexcessive money
d. Recessionhappenswhengovernment printslessmoney
e. Keynesianpolicytodrive the unemploymentbelow the lowestsustainable
unemploymentrate,whichusedtomove economyintouncertaintyzone,causing
inflation.
f. Natural rate of unemploymentisanimportantconceptbroughtbythe Monetarist
economist
g. Alsocalledaslowestsustainable unemploymentrate ( LSUR)
h. Lowestlevel of unemploymentwithoutputtingupwardpressure of inflation
i. GoingbelowLSUR,can leadtoshort termgrowth inthe economy.Butin longtermit
leadstothe prices/wages increase thuscausingthe inflation.
j. To bringdownthe inflation,thenneedtoincrease the level of unemployment(inducing
recession) inthe economy.Inducingrecessionbringsinincrease ininterestrate tovery
highlevel.

8. 4.) Supplyside economics
a. Governmentfocusonaddressingsupplyside basedonthe followingphilosophywithout
inducinginflation:-
b. Increase governmentexpenditure –governmentpumpintoexpandingproductionand
supportinbuildinginfrastructuretohelpinproductionandaccelerate economic
growth.
c. Cut taxes
d. Tax cut thoughwill cause inflationinshortterm.Butlongterm, people getincentive to
earnmore andwork more,whichleadstoincreasedproductivityandemployment.
Businessincentiveandpeople incentivetosupplymore increases;ASCurve shiftsright
thusreducingthe inflationinlongterm.
e. But there ispotential riskof increasingthe budget/fiscal deficit,whichmayleadto
graduallybuilduptrade deficit(twindeficit).
AS-AD Model (Supply and DemandMarket Model tounderstandand analyze
the state of economy)
1.) How prices and GDP output works in the economy.
 AS – Supplycurve
 Supplyof goods/service inthe economyiscapturedusingAScurve
 WithPrice on Y-AxisandGDP output(efficiency) onX –Axis
 AS curve- AsPrice of goodsincreases,givesbusinessincentivetogrow;
supplierswill be able tocreate more goods/serviceswhichwillincrease
the GDP output.
 AS – Shiftof AS Curve
 Determinantsof AScurve dependson factors:-
P
r
i
c
e
GDP Output
AS

9. o Inputprices
o Technology
o Productivity
o Legal institutionlike tax
 If cost of importresource like oil rises,productioncostincreases –shift
AS curve on the left - pricesincreasesandoutputdecreases –thisis
calledCostpushinflation.
 If productivityincreases due totechnological shift,averageproduction
cost will fall,AScurve shiftrightwards –Pricesfall andoutputalso
increases.
 If salestax/excise tax falls –decrease productioncost,AScurve shifts
rightwards – priceswill fall andGDPoutputwill increase.
 AD – DemandCurve
 Demandof goodsand servicesinthe economyiscapturedas ADcurve
 WithPrice on Y-AxisandGDP output(efficiency) onX-Axis
 AD curve- as pricesgoesdown purchasingpowerof people increases,
thusdemandof the goodsor service will goup.Tomeetincreased
demandoutputneedstogrow thus GDP outputrises thusincreasingthe
GDP outputnegatively.
 Also,aspricesgoesdowninterestrate reduces,thus
investment/spendingincreasesinthe economywhichleadstothe
increase of the GDP output.
 Shiftof AD curve
o Determinantsof ADcurve dependson4 factors:-
 Consumption
 Govt. Spending
 Investment
 NetExport
o Demandincrease movesthe curve tothe right,and decrease in
demandmovesthe curve tothe left.
P
r
i
c
e
GDP Output
AD

10.  Suppose Stockmarketdips2000 pointsina week,how
will itimpactAD curve
 Consumerwealthgoesdown,ADshifts
leftwards
 Newsof possible recessionwillimpact
 Consumerexpectationwill fall,lessconsumptionand
curve shiftsleftwards
 Duringgovernmentexpansionarypolicy,spending
increaseswithrise inthe paysof the government
employeesandothers.Increase inmoneysupplyinthe
marketwill leadtoincrease inthe demand.ADcurve
shiftstothe right.
 AS-ADcurve
 Supplyanddemandcurve intersection providesthe macro-economic
equilibriumof price andGDP of the economy.
 Intersectpointof ASand AD curve–P1, is the Price equilibrium, andQ1
isthe GDP equilibriumof the economy.
2.) Types ofInflation and how Inflationbuildsup in the economy
 2 typesof inflationarisesinthe economy
 DemandPull inflation
o Too much moneychasingtoofew goods
o More moneyinthe economy- purchasingpowerof people
increasesormore numberof people have money.Thisleadsto
people demandingmore goodsandservicesinthe economy –
AD curve shiftstothe right.If economyisnot inpositionto
supplythe demand,itleadstoinflation.
P1
Q1
P
r
i
c
e
GDP Output
AD
AS

11.  Supplyside Inflation
o Cost of doingbusiness/productcostincreases
 Rapidincrease inthe productioncost/wages/raw
material costpushes the productcost
 Anyothersupplyside shocklike drought/warcanalso
pushthe cost
o As costof doingbusinessincreases,supplygoesdown –AS
curve shiftsleftwards.
 Price increasesbutGDP outputdecreases.
 EconomyfacesInflationalongwithrecession
(Stagflation)
P1
Q1
P
r
i
c
e
GDP Output
AD
AS
AD1
P1
Q1
P
r
i
c
e
GDP Output
AD
AS
AS1

12.  If expansionarypolicyisused,unemploymentwill
decrease,moneysupplyincreases;ADcurve shifts
rightwards.GDPincreasesbutitleadsto more price
increases(more inflation).
 If Contractionarypolicyisused,moneysupply
decreases,inflationcomesdown;ADcurve shifts
leftwards,Pricescome downbutGDP outputalso
decreases.
 Supplyside economicsischallengingasitisdifficultto
correct pricesandoutput.Needtobringback AS1 to AS,
factors whichmoves ASneedtobe closelymonitored.
Businesscosttobe controlledsothatAS curve doesnot
shiftdrasticallytoleftwardtocause supplyside
inflation.
P1
Q1
P
r
i
c
e
GDP Output
AD
AS
AS1
AD1
P1
Q1
P
r
i
c
e
GDP Output
AD
AS
AS1
AD1

13.  AS curve shiftrightwardisthe mostideal situation –in
thiscase pricesfall andGDP outputincreases.
Macro-Economic Policy tools
There are primarilytwogoverningbodiesinmostof the economiccountryworldwide –
Democraticgovernmentandcentral bank.
Both playa veryimportantrole indefiningthe guidelines,rulesandpolicyrequiredforthe
economy tofunctionproperlyandefficiently.
1.) Fiscal Policy
Governmentlaysdownthe fiscal policyof the country,whichprimarilyfocusesonthe
governmentspendingandtax relatedpolicies.
2.) MonetaryPolicy
Central bankof the countrylaysdownthe monetarypolicyof the country,whichprimarily
focusesonthe moneysupplycontrol inthe economy.
Both policyhave tobe in syncto make economystable andcontrol the growthof the economy.
Understanding of some key macroeconomics terminology influencing fiscal
policies
1.) Autonomousconsumption
a. Evenif income is0, consumptionthatisstill requirediscalledasAutonomous
consumption.
b. It helpstogetan ideaaboutdiscretionaryincome (moneyleftafterautonomous
consumption).Growthof discretionaryincomeindicatesgrowingeconomy.
2.) 4 majorcomponents thatdefine the GDPof the economy:-
a. Consumption (C)
b. Govt. expenditure(G)
c. Investment(I)
d. Netexport( X-M)
3.) Consumption –It isone of the majorcontributorsof the GDP growthcomponent.
a. One majorfactor that derives the consumptionlevel inthe economyisPropensityof the
people tosave or spend.Thismicroeconomicsindicatoriscritical toformulate the
consumptionestimateandfuture GDPgrowth.It alsohelpstoformulate fiscal policy
withnumbers – to helpinknowinghow muchgovt.hasto spend/tax cut/printmoney
i. MPC – Marginal Propensityof consumption
ii. Marginal PropensitytoSave(MPS) =1- MPC

14. iii. Consumptionforecast=Currentconsumption+MPC * Disposable income
1. For India,Marginal propensitytoconsume is consideredtobe 0.6.
2. If MPC of economyis0.6, currentconsumptionis Re 8 and disposal
income increasesbyRe 10.
a. MPS = 1-0.6 = 0.4
b. ForecastConsumption=8 + 0.6*10 = 14
3. Future expectationof the Level of consumptioncangive indicationof an
average home expenditure.
4.) Investment
a. It comprisesof eventslike:- Buyingreal estate/goods +Industryspendingonplantsand
infrastructure
b. It dependsonthe interestrate andexpectations/businesssentiments
5.) Netexport
a. Export– Import
b. More importwill leadto:-
i. Increase indollardemandwhichwill have multi foldimpact:-
1. ReductioninGDP growth
2. Trade deficit
3. WeakCurrency
6.) Governmentexpenditure
a. Definedinthe fiscal policy –where agentslike tax rates,governmentspending,
subsidiesetc.formulatesgovernmentexpenditure plan.
i. Governmenttotal expenditure = Revenue Expenditure(Consumption+Interest
payments+Transferpayments) +Capital Expenditure(Infrastructure
expenditure like onroads)
ii. GovernmentOwnReceipts= Revenue Receipts( Direct and indirectTax + non-
tax revenue) + Capital receipts( Recovery of loan + Public sector
disinvestment)
iii. Fiscal deficit= GovernmentReceipts - Governmentexpenditure
7.) Fiscal or Expenditure Multiplier–Whengovernmenttriestobringupextramoneyineconomy
circle by meansof tax cuts or governmentspending,the actual moneyflow inthe economy
growsby level of multiplier.
a. Multiplier=1/MPS = 1/(1-MPC)
i. Govt. spends100b$ ondefense projects,whatisthe impacton the GDP?
1. MPC = 2/3(0.6), thenmultiplierwill be =1/(1-2/3) = 3
2. Increase the economyby3*100 = 300Billion
ii. Recessionarygapof 100b$, how much tax cut required?
1. MPC= 0.8, multiplier=5 ( =1/(1-0.8))
2. Governmentspending–100/5 = 20 B$
3. For tax multiplier- (astax cutsis notspendall)
a. MPC*expenditure multiplier=0.8*5 = 4

15. 4. 100/5 times= 25b$
5. 25b$ of tax cut requiredtoclose recessionaryeconomicgap of 100b in
the economy.
iii. Inflationarygap – 60b$
1. MPC = 0.75
2. Multiplier=1/1-0.75 = 4
3. Needtopull out15b$ moneyfromthe economyeitherby
a. Reduce Governmentspending by15 b$ Or
b. Raise tax collection by20b$
8.) Fiscal/BudgetDeficit
a. Fiscal deficit= GovernmentReceipts - Governmentexpenditure
b. Fiscal deficitcanbe brokeninto2 sub-components:-
i. Structural deficit
1. Due to existingtax structure andpayingschemes.
ii. Cyclical deficit
1. Causeddue to recessionasautomaticstabilizerspolicy –fiscal policy
like subsidies,compensationsetc.
2. Automaticstabilizers
a. Unemploymentrate increases - spendingmore andtax is also
less
b. Inflationalsoimpactsgovernmentspending.
c. Deficitcanbe financedbygovernmentinfollowingways:-
i. Raise taxes
1. Unpopularstep
ii. Borrowmoney
1. From central bankthuspullingoutmoneyfromthe system
a. T-Bonds, G-Securities(sellinggovernmentsecuritiestocentral
bank)
i. Can leadto Crowdingoutcan be problem
ii. Crowdingoutwill nothave impactduringrecessionor
cyclical deficits.
iii. Raise Interestrates
iv. Borrowfrom internationalmarket –importof goodsandservices fromabroad
1. Import> export,thustrade deficitstartsincreasingcanleadtotwin
deficit( trade deficitandfiscal deficit)
2. But if importitemsare usedfor productive use,andable togenerate
GDP growthit will helpeconomyrevive.
3. Borrowingfromabroad,can leadto fluctuationof the currencyinthe
international market.Investmentandtradingcanget affecteddue to
currencyfluctuation.

16. v. Printmoney
1. Central buysGovernmentBondsandprintsnew money
a. Can cause of inflation
d. BudgetDeficitprosandCons
i. Cons
1. Highdeficit,highinterestrate,crowdingout,higherinterestrate foreign
investmentpoursin,Mustexchange currencywithdollars,dollarvalue
increasesdue tohighdemand,strongerUSdollarimpactsexportswhile
importsstill highthusleadingtotrade deficit.
2. For trade deficit– needtosell assetstoforeigninvestors,thismaylead
to reduce countrygrowthand real income forcitizens.
3. Debtto external hasincreased.
4. Payinginterestonexternaldebtimpactsmoneysupply
5. Foreigndebtexposespolitical issues.
6. Internal debtisalsonotgood
7. Paymentof interest,interestof paymentmeanstax payersmoneygoing
to wealthypeoplewhobuysgovernmentbonds,moneyotherwise could
have beenspendonothergovernmentimprovementschemeslike
education,accumulationof large debtputspressure onfuture
generations
ii. Pros
1. Most of debtininternal debt,borrowedfromcitizens
2. Debttoday isusedforinvestmentwhichwill benefitfuturegenerations.
3. Private investmentdependsonthe countryinfrastructure andhuman
resource capability.
4. Govt. spendingonToomanywasteful programsshouldbe controlled –
like war,subsidies,welfareprogramsetc..
5. Publicinvestmentislessproductivethanprivate investment
Problemwith Economy followingonlyFiscal policy (i.e.Governmentpolicytopush spendingin the
economyto fuel growth)
1.) Crowdingoutof the private marketplayers.
a. As Keynesianprimarytool isfiscal policy,governmentspendingcanleadtocrowdingout
– whichmeansgovernmentwill pickmoneyfromthe marketandthusmoneyforprivate
playerswill notbe available.
2.) GovernmentspendingcanpotentiallyleadtoFiscal deficitinlongrun.Large Fiscal deficitwill
leadto increase inthe interestrate.
3.) It ignoresmonetarypolicyandinflation.
4.) Also,doesnot account forAS-ADmodel whichdependsonGDPand Price.

17. Central Bank and MonetaryPolicy
1.) Type of Money
a. Commoditymoney
i. Bank money
ii. Papermoney
2.) Feature of money
a. Mediumof exchange
i. It indicatesthe goodsandservicesthatare exchangedinthe economy
b. Unit of account – rate at whichgoodsare exchanged
c. Store value ( holdmoneyfora year and spendnextyear)
3.) How money gotcreated:-
a. Startedwithgoldstandardcouple of centuryago.
i. Askedgoldsmithtostore gold andinissue receipttothe people.Forany
transactionneedtogo to goldsmith,getgoldfortransaction.
ii. But it leadto3 basicconceptswhichledto the formulationof basisof money
market:-
1. Paperreceiptcan be used directlyfortransaction
2. Goldsmithcompetitioncanleadtoadditional benefitstodepositors –
interestrate ongoldstorage.
3. Fractional reserves –Goldsmithcanissue multiple goldreceiptstothe
people basedonthe assumptionthatall peoplewillnotcome backfor
theirgoldat the same time – thusexpandingthe moneysupply.
iii. Above 3 pointsformthe basisof today’sbankingsystemalso.
a. Currencynotesare useddirectlyfortransaction
b. Banksprovide variousinterestratesasbenefittocustomersfor
keepingmoneywithbanks
c. Fractional reserve,banksissuecurrencyinthe marketbasedon
the below ratioguidelines:-
i. Cash Reserve ratio (CRR) - The amountof moneyBank
needtoholdto at any given pointof time for
safeguardingliquidity.
ii. Money Multiplier=1/RR
iii. Thus Re 100 depositinthe bank,withRRof 0.1 will
increase the moneysupplyby100*10= 1000.
1. Moneysupplyismultiple of moneymultiplier.
iv. Central banksprovidesthe moneytothe bankingsystems.
4.) InterestRate
a. It isdefine asthe Price of the money.
b. Value of money,whichis consideredascommodity, followsthe same AS-ADrules.
c. Demandand supplyof moneydriversthe interestrate.More moneysupplyinthe
marketcan push interestrate downandvice versa.

18. d. Inflationandinterestrate canbe consideredasthe 2 sidesof the coin.
e. Real interestrate = nominal interestrate – inflation
i. There are variousinterestratesterms:-
1. PolicyRepoRate : 6.50%
a. Rate at whichcommercial bankcanborrow moneyfromRBI
2. Reverse RepoRate : 6.00%
a. Rate at whichRBI can borrow moneyfromcommercial bank
3. Marginal StandingFacilityRate : 7.00%
a. Rate at whichbankscan borrow moneyfromRBI
4. Bank Rate : 7.00%
a. Rate at whichcommercial bankloanmoneyfromthe RBIon
short term.It isdifferentfromreporate.
5. Base Rate : 9.30% - 9.70%
a. Minimumrate setby RBI, below thisrate bankscannotloan
moneytothe consumers.
5.) Central Bankis responsible for:-
a. Issue currency
b. Lenderof last resort
c. Regulate financialinstitutions
d. Provide bankingsystemtothe government
e. Provide financialsystemstothe nationbanks
f. Conductmonetarypolicy
6.) Monetary policy(definedbycentral bank) focuspointscanbe:-
a. Promote economicgrowthin-line withpotential economic
b. Highlevel of employment
c. Insure stable prices ( control inflationlevel)
d. Moderate longterminterestrates
e. Insure exchange rate prices( control currencyvalue inthe global market)
7.) Moneysupplyinthe economyhasimpact on3 majoreconomicfactors:-
a. Interestrates,Assetsprices,Exchangerates.
b. These factorsinfluence consumptionspendingandinvestment,thusimpactingthe GDP
of the economy.
i. For example,more moneysupplyinthe economymayleadtomore investment
inbonds.Bondpricescan go up thus yieldcomesdown –Interestrate comes
down.
8.) Major policyinstrumentswithCentral bank toinfluence the moneysupplyinthe economy:-
a. Settingreserve ratio–Impactsthe moneymultiplier
i. CRR : 4%
1. Bank needtoholdcertain% withRBIfor ensuringliquidityatall times.
2. Use case of CRR – if Rs 100 is injectedinthe economythe impactonthe
moneysupplywill be
a. Moneysupply= 100/0.04 = 2500

19. b. WithRs 100, economymoneysupplybecomesRs2500.
ii. SLR : 21.25%
1. Bank needtoholdcertain% inthe form of governmentsecurity.
b. Discountrate ( Interestrate)
c. Openmarketoperation
i. Buyingandsellinggovernmentsecuritybonds(Treasurybills)
a. Central bank Monetarypolicyuse case (openmarket
operation):-
i. Inflation(demandpull inflation) inthe economy –this
will needsome contractionarypolicytobe inplace - Sell
treasurybills
ii. Openmarketoperationssteps:-
iii. Sell treasurybillstoBrokers/Dealerswhosell to
commercial banks,Bigcorporations,Financial
institutionsandIndividualsperhaps
iv. Buyersbuybondsby writingcheckstothe Feddrawn
fromsome commercial bank
v. Fedpresentsthe checkto the bank,paymenthappens
by reducingthe bankreserve withFed/Central bank
reserves.
vi. Thisreductioninthe reservesleadstoreducingthe
moneysupplyinthe economy.
vii. Reserve isdown,moneysupplycontracts,interestgoes
up,Investment,consumptionandnetexports
decreases,ADdown( real GDP and inflationgoes down)
Where to use Monetary and Fiscal Policy
i. If size of recessionarygapandmultiplierisknownthenbetterfiscal policycan
be laid.
ii. Believe fiscal policyisbettertools,Monetarypolicyisgoodonlyforfine tuning
the economy whennotinrecession orinflationstage
Unemployment
1.) One of the parametersorindicatorof Growth of the economyisthe unemployment.This
indicatorisnot yetpublishedforIndiarecently, the lastdataisfor 2013 whichstandsat
4.9%.Highestbeingin2010 as 9.4% in lastdecade.
2.) Unemployeddataisgatheredusingthe sample data.
3.) It doesnotcontainnon-workinggroup
4.) Workinggroup( Or laborforce) consistsof:-
a. Employed
b. Notemployed
c. Employed/Laborforce
5.) For every2%drop of GDP,unemploymentraisesby1%.

20. 6.) Actual GDP shouldbe close topotential GDPto keepunemploymentrate constant.
7.) UnemploymentandInflation
a. Wagesfall whenunemploymentishighandvice versa
b. Natural rate of unemploymentisthe minimallevel of unemploymentwithoutputting
upwardpressure oninflation
8.) Expansionarypolicytokeepunemploymentbelow the lowest rate will easeinitial
unemploymentlevel butinlongrunwill resultininflationaryspiral.
9.) Shouldcontrol/cutwages andpricestobring downinflation
What is Twin Deficit?
 Fiscal deficitandTrade deficit
o GDP = C+I+G+(X-M)
 GDP – C –G –(X-m) = I,where GDP – Consumptionwill leave Savings+tax.
 Saving+ (Tax – Governmentspending) +(Import - Export) = Investment
o Tax – Government - > IndicatesFiscal Deficit
o Import– Export-> Indicates Trade deficit
o If economyhas burdenof huge fiscal deficit( Governmentspendingismore thanthe
governmentmoneycollection),thenfollowingeventsmayhappen:-
 Savingneedstogo up(citizenstosave more),interestratesneedtogoup.
 Importand exportgapshouldincrease ( more importthanexport)
 Withpossible increaseof interestrates,Investmentwill godown.
o IF fiscal deficitincreases
 It may resultinincrease ininterestrate togive incentive forpeople tosave more. But
increase ininterestrate will hampergrowthasloanwill become expensive.
 To reduce the fiscal deficit,governmentmaydependonborrowingfrominternational
market,
Summary of Leading Economic indicators
 GDP = C+I+G+(X-M)
o GDP – ECRI leadingindex,stockmarket,yieldcurve speed
o C – consumerconfidence,retail/housesales
o I – Manufacturingindex
 CPI/WPI – Inflationindicators( RBImay rate interestrate tocontrol inflation)
o G – TreasuryReport
o (x-m) –Trade report
 ImpactsGDP
 AndimpactsInvestment

21. RecentWorld Events
 US economygrewby 3.5% average from1947 till 2001. From 2001 till 2011 it grew by 1.6%.
 In 2007, saw massive financialcrisisinUSmarketespeciallyReal estate andBankingsectorwhichled
to Downturn,massive fiscal stimulusandmonetarystimulustilldate.
 To bringup the economyto goodgrowthand increase the GDP,countrieslike USinitiated
expansionarypolicynotseenearlierinthe world –termin economicsknownasQuantitative easing.
 Quantitative easing-
o Central bankbuysmassive amountof bonds – increase bondprice ,lowerbondyieldand
interestrate
o Lowerinterestrate helpsininvestmentasmoneyborrowingrequiredtocreate jobs
o Helpsto devalue the currencyandhelpexportof the country.
 But thishas nothelpedtosolve the groundproblem inmanycountriestill now.Andthe reason
seemstobe tiedwithstructural problemandeffectof worldtrade.
o ChinajoinsWTO 2001, whicheventuallyledtoGDPfall formany countriesaroundthe
globe. Itcan be understoodonthe basisof followingpointsof the change happenedfor
worldeconomies.
 Large trade deficits (X-M) withmanycountriesaroundglobe
 As X-Mincreases,GDPgoesdown( massive importsfromChinatoother
countriesinthe world)
 Massive reductioninthe Investment
 Companiesaroundthe globe startputtingupfactoriesandmanufacturing
unitsinChina,thusInvestmentinrespectivecountrieshasgone down.
 Structural emergence of low growingGDPeconomies
 Increase inthe Governmentexpenditure hasnothelpedeconomyandGDPto grow.
o Evenwithlowinterestrates,economyhasnotpickedupinthe developedcountries.
 Thiscan be attributedtothe followingreasonsastowhyquantitative easingandlow
interestratesnotable topick upeconomygrowth:-
 Agingpopulationinthe developed nation
 Withreal estate and stockcrash in the past few yearsworldwidehasledto
belief thathuge riskisnotadvisable.
 Thus majorpopulationinthe developednationnow have inclinationfor
savinginsteadof consumption.
 Withinclinationtosave more andlow interestrate,itcreatesenvironment
where people intendtosave more andmore to coverup marketrisks,
supportagingneedsandmore moneyrequiredinfuture.
o Thus US/Europe QE didnot affectthe growthas structural issue of chronictrade imbalance
was notaddressed
o Thus RecessioninEurope/US alongwithlessconsumptionneedledto  weakimportfrom
China weakimportforcommoditycountry(Canada/Australia/Russia –provide natural
resourcestochina).Thiscycle has ledto worldgrowthtogo on decline inthe pastfew
years.

22. There are possible three majorproblem statementsthat differentschool of economist consideras the
most challenging:-
 What causesinstabilityin the economy
 Keynesiansview
o Change ininvestmentandconsumptionshiftADcurve
o Adverse supplysideshock (Natural disastercausingsurge inhighoil prices)
shiftAScurve
 Monetarist
o Reliesonthe marketprocessestogauge economy –thus theybelieve
instabilityisdue toBad Governmentpolicy
o Pricesandwage demandin competitive marketcausesfluctuationsin
Demand
 wagescannotadjustbecause of governmentpoliciesandmonopoly
protections
o MV=PQ
 Change inM( Moneysupplyinthe economy) leadstoinflation(
velocitystable andQisnot relatedtoprice)
 Supplyside
o Agree supplyside shocksleadtoinstability
o Agree governmentfailurecanleadtoinstability
o Viewhightax ratesand regulationsthatreduce supplyincentives.
 Is Economy self-correctingandif so how quicklyit corrects
 Monetaristview
o Market adaptsand self-correct
o AD (Demandcurve) shiftsright,Price movesupandGDP output(Q) moves
right.
o Normal wageswill rise,increase supplycost
o AS shiftleft
o Price risesandeconomyreturnto full employmentlevel
o Adaptive expectations –graduallychange expectations.Ittakeslonger.
o Fewbelieverational expectations –changesfaster.
 Keynesians
o Rational expectationisnotcorrect,it takeslongformarketto self-correct.
Thus requiresfiscal andmonetarypolicytointerfere.
o Agree withsupplyside shocksimpact.
Governmentinvolvementinfiscal and monetary policycan lead to:
 InfluencingAggregate demandinthe economy
o Due to moneysupplyperhapsnotinline withoutputincrease ratio
o Due to Rational expectationwhichmayoccurwhenevercentral bank increasesthe
moneysupply,whichcanoffsetthe moneysupplytocontrol prices.

23.  Causinginstabilityinthe economydue to GovernmentFailure
o Governmentinduce huge fiscaldeficit
o Crowdingoutcan happen leadingtonoprivate investmentsinthe country
Understandingthe Factors which influence growthofthe economy of a country (GDPgrowth factors)
1.) Human resources
a. Qualityof laborinputs
i. Improvementineducation,healthetc.
2.) Natural resource
a. Arable land,water,gas,forestetc.
3.) Capital formation
a. Roads,powerplantetc.
4.) Technology
a. ChangesinproductionProcesses
b. Newproductor services
5.) 2 otherfactors influence economygrowth
a. Demandfactor – nationmustemploygrowingsupplyof resourcesforfull utilization,
thusdemandshouldgrow
b. Efficiencyfactor–
i. To reach productionpotential,mustreachproductive efficiency,byusing
existingandnew resourcesinleastcostlyway.
ii. Allocative efficiency –goodsand servicesallocationshouldbe able tomaximize
efficiency.
 Natural and humanresource as suchdoes not seemtocontribute muchineconomicgrowthafter
certainpoint.The reasonforit can be understoodby:
o Law of diminishingreturns
 Marginal product of labor decreasesaspopulationincreasesandlandisarearemains
more or lessconstant.
 Thus populationpressure drivesthe economyoutputslowlyif there isresource
constraint.
 Technological andcapital investmentovercome law of diminishingreturns
o Newindustryandincrease inthe productivityefficiencyhelpeddrive the economy
What shouldbe focusareas to realize economicgrowth?
o Capital investment
 More rail roads and highways
 More computersandinfrastructure
 More farmsmachineryandirrigationfacilities
o Technological andR&Dinvestment
 Newindustrycreationhelpstodrive the economy
 Technological change isrequiredforgoodeconomicgrowth

24.  Processes
 Newproductgoodsand services
o Education/laborquality
 Labor productivityplaysthe mostimportantrole ineconomygrowth.
 Technological advancescontributesmostinimprovingthe labor
productivity.
How governmentcan use public policyto simulate growth
 Demandside policy
oInadequate aggregate demandcanleadtorecessionarygap
 Monetarypolicy – low interestrate
 Fiscal policy – eliminatefiscal deficitcanreinforce easymoneypolicy
 Supplyside policy
oCapital-laborratio
 Productivityincreaseswithcapital tolaborratioincrease
 Investmentinnew plants/machinery
 Lowerbusinesstax rates
 Tax creditsetc.policies
oHuman capital
 Improve laborforce quality
 Tuitiontax credits,student loan,learningprogramsandplatforms
for learningnew skills
oTechnological change
 More goodsand servicesfromgivenamountof resources
 Tax incentives,R&Dbenefits
oRaise level investmentininfrastructure
 Increase indomesticsavingrate,asit provides investmentfinancials.

25. Trade model - Why do nationstrade and how nations decide what to import/export.
 Absolute advantage
o Countrythat can produce goodsat lowercost thanany othercountry
o Saudi Arabia– oil,US– cheapfood.
 Comparative advantage
o Each country will benefitif itspecializesinthe exportof goodswhichitcanproduce at
relativelylowcost.
o Each country will benefitif itspecializedinthe importof goodswhichitcan produce at
relativelyhighcost.
ItemsCountry(Labor-
hours)
CountryA CountryB Comparative Advantage
1 unitof Food 1 (hrto produce 1 unit) 3 CountryA
1 unitof Clothes 2 4 CountryB
In CountryA:-
1 unitof food= ½ of cost of clothing
1 unitof cloth = 2X costof food
In CountryB:-
1 unitof food=3/4 of cost of clothing
1 unitof cloth = 4/3 of costof food
Example:-
150 unitof foodin countryB can be tradedfor 300 unitof foodfromcountryA. If producedincountry B
only,countryB couldhave producedmaximum200(150*4/3) unitof clothing.Sotrade isbeneficial.
2 countryengage inunrestrictedfree trade,followprinciplesof comparative advantage,bothcangain
fromfree trade.
About Trade deficit
 Trade deficit(Currentaccountdeficit) iscalculatedwithrespecttoparticularcountry.
 Two componentof trade deficitusedforcalculationsare
o Currentaccount
 Merchandise trade balance
 Feesforservices
 Netinvestmentincome
o Capital account
 Foreignpurchasesof assetsincountry
 Countrypurchasesof assetsoutside country
 Reserve changes
 Large currentaccount trade deficitwill getoffsetbysellingcountryassetstoforeign(inflowsof
money).

26.  US chronic Trade Deficit
o Withso large trade deficit,itshouldhave ledtoUS dollarweakeningdemandandthus
devalue of USdollar(depreciate USdollar).Thisshouldhave ledtoUS exportgetting
attractive (lowerprice forexport) andhigherprice of import.Whichshouldhave
encouragedmore exportsandthusbalancingthe trade deficit.
o Large Trade deficitoccurreddue to:-
 Large budgetdeficitsince 1980’s, whichledto increasingthe interestrate(money
supplyineconomyislow soincrease the interestrate hightoindicate scarcityof
dollarmoney).Large interestrate increasedthe dollardemand,ledtodollar
appreciation,whichmade exportsexpensive andimportscheaper.Andthisledto
large trade deficit.
 Decline savingrate,andinvestmentbeingmore orlessstable withlittle increase –and
the moneyforthisflowedintothe countryfromforeigninvestment.Demandof
dollarincreasedthusappreciatingthe dollarvalue again.
 In countryA GDP (A) goesdown,income goesdown,importitemsgoesdown,impactCountryB
export,income goesdownandGDPfallsforcountry B. Cyclicnotionorchain of causality.
 Fiscal policyof one countrycan impact othercountryeconomy.
o CountryB fiscal policycanbe structuredtotake expansionarypolicyroute sothatcountryB
can have importsfromcountry A and country B currencyappreciates.More importsfrom
countryA will helpbalance trade deficitalso.
 Monetarypolicyimpacton exchange rate:-
o US raisesinterestrate,investorssell euroandbuydollars,demandfordollarincreases,
dollarappreciates,andeurodepreciates,itincreaseseuronetexportandraisesnetincome.
o Side-effect,USinterestrate increase tendtoincrease Europeaninterestrate,thus
investmentfallsandincome falls.

About Exchange rate
 One nationcurrencycan be tradedwith the currencyof othercountry.
 Demand-supplyof currencycontrolsthe exchange rate betweencountries.
 Currencythat gainsinvalue inrelative toanothercurrency – appreciates.
o Demandismore for the currency comparedtoother currencyleadstoincrease inthe value.
o 1 dollar== Rs 60 , butlater1 dollar== Rs 65, thismeansdollarappreciates orrupee
depreciates.
o Depreciate means:-
 Export/outsourcing benefits( with1dollarcan buy more rupeesservice)
 Why exchange rate changes:-
o Differingrate of GDPgrowth rate betweencountry
 Example- increase of GDPcan leadtoincrease inthe income – whichcan leadto
perhapsincreasingthe demandof some currency.
o Differingrate of inflationbetweencountry
 Real inflationadjustedpricesshouldbe same,thusimpactingexchange rate –Law of
one Price
o Change inrelative interestratesbetweencountry

27.  Raise of interestrate inone country,will leadtomore investmentinthe country.Thus
value of currencyof some countrywill appreciate comparedtothe othernation.
 If US raisesinterestrate,investorswill pull moneyfromIndiamarketandinvestinUS.
Theywill sell rupees,rupeessupplywillincreaseanddollardemandwill increase.US
dollarwill appreciate comparedtoRupee.
o Change intastes
o Andpurely Speculation
 There are potentially2kindsof exchange rates
o Floating
 Exchange rate changesbasedon demand/supplyof the currency.
o Fixedexchange rate.
 Will pegvalue of itis currencywithothercurrencyor withbasketof currencies
 Countrywill take necessarystepstomaintainthe pegvalue
 How exchange rate evolved fromancient goldstandard
o Currencyissuedbyeachcountryhad to be in goldor redeemableingold
o Currencyon the countrythereafterwould be convertibleintofixedamountof gold
o Fixedexchange rate
 If country has trade deficit,thenithasto use itsgoldreserve tobuycurrency to prevent
value of currencyfalling.Value of currencywillfall due tomore currencyusedtopayoutfor
excessimportleadingto fall inthe currencycirculationin the country.(thatiscountry will
needtolose goldreserves).
 If trade surplus,more exportwill helptoaccumulate more goldreservesandcountrywill
have more currencycirculationinthe economy.
o DuringWW1, manycountriesabandonedgoldstandardtosupportwar.Thisleadto those countries
increasingthe moneysupply inrespective economy whichfinallyledtodifferingrate of inflationin
countries. Postwargoldexchange rate implementationbecameachallenge-
 Countrywhichhad undervaluedcurrency,gained asexportincreasedandthusincreasing
goldreserves.
 Countrywhichhad overvaluedcurrency,hadtodependon import– whichledto gold
reservestogodown.
o Goldstandard got abandonedin1933, withUS and Britaindroppingthe goldstandard.
o Withno standard,countriesstartedtodevalue theircurrencytoable tocreate more jobsandmake
exportscompetitive.
o Thisdevaluationbyall countriestooutpace othercountries ledtodestabilize the economy.
Countriesincreasedmoneysupplywhichtriggeredincrease of inflationinmostof the countries.And
thiseconomicbreakage buildpolitical pressurewhichfinallyhelpedtotriggerWW2. Rise of
inflationin Germanyis consideredtobe the most important reason ofthe rise of Hitler and
causing WW2.
 New international monetarysystem(1944)
o Partiallyfixedoradjustable pegsystem.
o ReplacedgoldstandardwithUSDollarstandard,thus identifiedasglobal currency.

28. o All currencieswere valuedagainstGoldanddollar – andexchange rate betweencurrencies
was defined.
o It was partial fixedexchange rate –periodicallycurrencywillbe adjustedtoreflectthe
currentcurrency values.
o Stabilityof goldsystemfixedrate withbenefitsof adaptabilityof exchangerate overtime.
o US economyboomedin1950’s, dollarlendtoEurope andUS industrybeingsetupfor
Europe to importUS goods.Overtime,USexportsfell,withstillstrongeconomy,global
investorswere pushingmoneyinUS,US dollarwasovervaluedandimpactedexportsector.
Thisledto increase inTrade deficitandwithVietnamwarcurrentdeficitalsoincreased.
o US dollarsurplusincreasedoutsideUS,andUS plan to devalue dollarprice,whichledto
sellingof USdollarsandget gold.Withso muchdollarsinthe marketnow,and no demand
dollarvalue plungedandUSgoldreservesalsowentdown.
o US droppeddollarstandardand1970’s dollarvalue fell.
 Today’sHybridsystem
o Flowmanagedbased(demand/supplybased).Differentcountriesthoughtool various
optionstowork intoday’sworld.
 Fewcountrieshave floatingexchange rate.Marketdecide the valueandno
intervention.
 Othercountries(like CanadaandJapan) – flexibleexchange rate.Countrybuys/sells
currencyto maintainthe volatile fluctuations, Systematicintervention.
 Small currencies –Pegwithothercurrency (SwissFranc).
 Currencybloc– Euro – flexiblecurrencymodel.
o Governmentintervention isminimal intoday’ssystem.Central bankplaysmore important
role inmaintainingstable exchange rate.
 Central Bank Buys rupeeswithDollars.Appreciate the rupeecomparedtothe dollar.
 Indiadollarreserve inthe past5 years hasgrown primarilydue todeclining
oil marketand oil importcost.

29.  If trade deficitislarger(importmore thanexport),thencurrencydemandwill fall and
thusdepreciate.Once depreciate,exportwill becomecheaperandtrade balance
will tryto getrestoredwithincreasingexport.
 G-7 nationsboughtlargeramountof US dollarsin1980’s, to helpUS dollarfromfalling
furtheras thiscouldhave ledtoUS exportgettingattractive andthusimpactingthe
trade exportforall othercountries.Thusbybuyingmore dollars,G-7nation
increasedthe dollardemandandthusappreciate the dollarvalue incomparisonto
their.
Some Country/Zone economicknowhow
 Euro monetarysystem
o 1970’s, EU countrieswentforfixedexchange rate pegagainstGermancurrencysothat
deliberatedevaluationof currencybyindividual countrydoesnothappen.
o 1990, westandeast Germanyreunification –leadtolarge budgetdeficitaseastGermany
industrieswere subsidizedtosupportupliftingthe industryin-line withrest.
o More subsidiesleadtomore moneysupplyinthe economy,whichbuildpressure forthe
inflation.Totargetanticipatoryinflation,Germanyraisedinterestrates.
o As Germanraises interestrate,thiscouldhave ledtoGermancurrencyin demand
comparedto otherneighboringcountriesandothercurrencycouldhave depreciated
againstGermancurrency.
o Euro systemcrashedas interestrate were highandunrealisticexchangerate value.
o Countrycannot have fixedexchange rate,opencapital marketsandindependentmonetary
system.
o Andit gave wayfor the birth of commoncurrency – EURO.
o Global cooperationisimportant:-
 Loweringtrade barriers
 Jointmonetarypolicyexpansion
 Tighteningfiscal policytoincrease savingsandinvestment

30. Definitionofdevelopingcountry
 Low percapital income
o Poorhealth,lowliteracy,shortlife expectancyandsufferfrommalnutrition.
o Factors of developmentgrowth
 Human resources
 Quality
o Populationgrowsfasterindevelopingcountries,soasGDP mayrise so does
population.
o Needtocontrol populationgrowth –but before control itisimportantto
reach a stage of highincome andgoodeducationsysteminplace.Thiswill
leadto increase expensesformore childrenandpeople wouldhave
receivedoldage safetynetfromsaving/governmentschemes –whichwill
make ideaof more childrenforsupportgo away.
 Quality
o Education,training,improve publicsafetyandhealth
o Workersneedtouse technology,lesssick leaves,use capital more
effectively.
 Natural resources
 Arable lab
o Much of the populationof the developingnationisemployedinfarming –
thusgood use of land withrighttechnology,fertilizerswill helpnation
output.
o Some countrieslike UShave beenable touse the natural resourcestobuild
industrial revolutionandexpandthe economy.
o Othercountrieshave notbeenable tomake use of resourcesefficientlydue
to lack of political willandcorruption –NigeriaandZaire are good
examples.
o Land ownershipwithfarmerscreate betterecosystemforfarmerstohave
strongincentive toincrease the landyield.Indevelopingcountry,small
percentage of people holdmajorportionof landwhichdoesnothelpthe
agriculture growth.
o
 Capital resources
 TO buildnationcapital resource reservesisimportant,countriesshouldtrytoavoid
use of currentcapital reservestoaccumulate capital.
 Whennationispoor, itis difficulttoabstainfromnotusingthe current resources.
 Growth countriesinvestaround20% of nationoutputincapital formation,whereas
developingnationsave around5% ,most of the savingisspendinprovidinghousing
and otherbenefitsforthe poorpeople.
 Technology
 Developingcountriescanbenefitfromthe technological inventiondone inother
countries – adaptationof foreigntechnologycanbenefitdevelopingnation.

31. o But withoutqualityhumanresources,capital andentrepreneursitwill not
resultinany benefit.
 Some developingnationprosperwhile manyotherdonot
o Cycle of poverty
 Rapidpopulationgrowth  Low percapital income  low level of savingandlow level of
demand lowlevel of investmentinphysical andhumancapital  low level of
productivity  Lowpercapital income.
 Povertyisaccompaniedbylow level of education,skillsandliteracy.
 Thisin turnleadsto low adoptionof new technology.
o Needmultiple stepstobe takenatthe same time to breakthe virtuouscycle of poverty:-
 Investmore
 Educationand healthimprovement
 Developskills
 Curb populationgrowth
o Policies thatcanhelpbreakthe cycle:-
 IndustrializationvsAgriculture
 Industrializationif capital intensive,leadstocrowdedcities,andhighlevel of
unemployment
 Raisingproductivityinfarmsmayrequire lesscapital,while providingproductive
employmentforlaborsurplus.
 State vs Market economy
 Market orientedeconomy
o Outwardorientationintrade policy,low tariffsandfew quantitative trade
restrictions,promotionof small businessandfosteringcompetition.
o Markets workwell instable macro-economiccondition,taxesare stable and
inflationislow.
 Growth andopenness
 Importvs domesticproduction,improvingefficiencyandcompetitivenessandlow
trade barriers.
o Policiessummary:-
 EstablishingRule of Law
 Opennesstointernational trade
 Controllingpopulationgrowth
 EncouragingFDI
 Buildinghumancapital
 Making peace withneighbors
 Independentcentral banks
 Realisticexchangerate policy
 Privatizingstate industries