Macroeconomics

KEY CONCEPTS
• Macro Economics: Its meaning
• Consumption goods, capital goods, final goods,
intermediate goods, stock and flow, gross
investment and depreciation.
• Circular flow of income
• Methods of calculation of national income
• Value added method (product method)
• Expenditure method
• Income method
• Concepts and aggregates related to national
income

KEY CONCEPTS
• Net National product
• Gross national product
• Gross and Net domestic product at
market price and at factor cost.
• National disposable income (Gross and
net)
• Private income
• Personal income
• Personal disposable income
• Real and Nominal GDP
• GDP and welfare

Macro Economics
• Macroeconomics is the study of
aggregate economic variables of an
economy.

Circular Flow of Income
• It refers to the cycle of generation of
income in the production process, its
distribution among the factors of
production and finally, its circulation
from households to the production units
in the form of consumption expenditure on
goods and services produced by this units.

Three phases of circular flow of income
Generation
Phase
Disposition
phase
Distribution
Phase

Real Flow
• It refers to flow of factor services from
households to firms and the
corresponding flow of goods and
services from firms to households.
Factor Services
Firms
Goods and
Services
Households

Money Flow
• It refers to flow of factor payments from firms
to households for their factor services and
corresponding flow of consumption
expenditure from households to firms for
purchase of goods and services produced by
the firms.
Consumption Expenditure
Firms
Factor Payments
Households

Circular flow in a two sector economy
• Producers (firms) and households are the constituents in
a two sectors economy.
• Households give factors of production to firm and firms
in turn supply goods and services to households.

Concept of domestic (economic)
territory
• Domestic territory is a geographical
territory administered by a government
within which persons, goods and capital
circulate freely. (Areas of operation
generating domestic income, freedom of
circulation of persons, goods and capital)

Normal resident
• It refers to an individual or an
institution who ordinarily resides
in the country for a period more
than one year and whose centre of
interest also lies in that country.

Citizenship
It is basically a legal concept based on the place of
birth of the person or some legal provisions allowing
a person to become a citizen. It means, Indian
citizenship can arise in two ways:
When a person is born in India, he acquires
automatic citizenship of India.
A person born outside India applies for citizenship
and Indian Law allows him to become Indian
Citizen.

Residentship
• It is an economic concept based on the
basic economic activities performed by a
person.
• An Individual is a normal resident of a
country if he ordinarily resides in the
country for a period more than one year
and his centre of economic interest also
lies in that country.

Factor Income
• It is the income received by
the factors of production for
rendering factor services in
the process of production.

Transfer Income
• It refers to the income received
without rendering any
productive service in return.

Final Goods
• Are those goods, which are used either for
final consumption or for investment.
• It includes final consumer goods and final
production goods. They are not meant for
resale.
• So, no value is added to these goods. Their
value is included in the national income.

Intermediate goods
• Intermediate goods are those goods,
which are used either for resale or
• for further production. Example for
intermediate good is- milk used by a
tea shop for selling tea.

Stock
• Quantity of an economic variable
which is measured at a particular
point of time.
• Stock has no time dimension. Stock is
static concept.
• Eg: wealth, water in a tank.

Flow
• Flow is that quantity of an economic
variable, which is measured during the
period of time.
• Flow has time dimension- like per hr, per
day etc.
• Flow is a dynamic concept.
• Eg: Investment, water in a stream.

Investment
• Investment is the net
addition made to the existing
stock of capital.
• Net Investment = Gross
investment – depreciation

Depreciation
• depreciation refers to fall in the value
of fixed assets due to normal wear
and tear, passage of time and
expected obsolescence.

Consumption goods
• Are those which are bought by consumers
as final or ultimate goods to satisfy their
wants.
• Eg: Durable goods car, television, radio
etc.
• Non-durable goods and services like fruit,
oil, milk, vegetable etc.
• Semi durable goods such as crockery etc.

Capital goods
• Capital goods are those final
goods, which are used and help
in the process of production of
other goods and services. E.g.:
plant, machinery etc.

Gross Domestic product at market
price
• It is the money value of all final
goods and services produced during
an accounting year with in the
domestic territory of a country.

Gross National product at market
price
• It is a money value of all final goods
and services produced by a country
during an accounting year including
net factor income from abroad.

Net factor income from abroad
• Difference between the factor incomes
earned by our residents from abroad
and factor income earned by non-
residents with in our country.

Components of Net factor income
from abroad
• Net compensation of employees
• Net income from property and
entrepreneurship (other than retained
earnings of resident companies of abroad)
• Net retained earnings of resident
companies abroad

Formulas
• NNP Mp = GNP mp - depreciation
• NDP Mp = GDPmp – depreciation
• NDP Fc = NDP mp – Net indirect taxes (indirect tax –
subsidies)
• GDP Fc = NDP fc + depreciation
• NNP Fc = GDP mp - depreciation + Net factor income
from abroad – Net indirect taxes
• (NNP FC is the sum total of factor income earned by
normal residents of a country during the accounting
year)
• NNP fc = NDP fc + Net factor income from abroad.

CALCULATION OF NATIONAL DISPOSABLE INCOME
• National Disposable income
It is the income from all the sources (Earned
Income as well as transfer payment from
abroad) available to resident of a country for
consumption expenditure or saving during a
year. NNPFC + Net Indirect tax + Net current
transfer from abroad=Net National
disposable income.(Gross National
Disposable Income includes depreciation)

CALCULATION OF PRIVATE INCOME
• Private Income includes factor income as well as
Transfer income (Earned income +Unearned
income)
Factor income from net domestic product accruing
to private sector includes income from enterprises
owned and controlled by the private individual.
Excludes:-1. Property and entrepreneurial income
of the Gov. departmentalenterprise2. Savings of the
Non-department a Enterprise. Factor Income from
NDP Accruing to private sector = NDPFC (-) income
from properly entrepreneurship accruing to the
govt departmental Enterprises(-) savings of Non
departmental enterprises.

CALCULATION OF PRIVATE
INCOME
• Private Income Includes
Factor income from net domestic
product accruing to private
sector.+ Net factor income from
abroad+ Interest on National Debt+
Current transfer from Govt.+
Current transfer from rest of the
world.

Calculation of Personal income
• Personal Income
PI is the income Actually received by the
individuals and households from all
sources in the form of factor income and
current transfers. Personal income =
Private Income (-) corporation tax.(-)
Corporate Savings OR Undistributed
profits.

Calculation of personal disposable
income
• Personal disposable income
Personal income (-) Direct Personal tax (-
)Miscellaneous Receipts of the govt.
Administrative department(fees and fines
paid by house hold.)

Relation between national product
and Domestic product
• Domestic product concept is based on the
production units located within domestic
(economic) territory, operated both by residents
and non-residents. National product concept
based on resident and includes their contribution
to production both within and outside the
economic territory.
• National product = Domestic product + Residents
contribution to production outside the economic
territory (Factor income from abroad) - Non-
resident contribution to production inside the
economic territory (Factor income to abroad)

Methods of calculation of National
Income
I - PRODUCT METHOD (Value added method):
• Sales + change in stock = value of output
• Change in stock = closing stock – opening stock
• Value of output - Intermediate consumption =
Gross value added (GDPMp)
• NNP Fc (N.I) = GDPMp (-) consumption of fixed
capital (depreciation)
• (+) Net factor income from abroad
• ( -) Net indirect tax.

Income method
• Compensation of employees
• Operating surplus

Income method
• National Income=NDPfc + Net factor income from
abroad
• NDPfc =Compensation of Employees+ Rent and
Royalty+ Interest +Profit + Mixed Income
• NDPfc=Compensation of Employees + Operating
Surplus + Mixed Income
• Compensation of Employees=Wages and salaries in
cash + Wages and salaries in kind+ Employer’s
Contribution t social security schemes
• Operating Surplus=Rent + Royalty + Interest +
Profit

Mixed income of self-employed
• NDP fc = (1) + (2) + (3)
• NNP fc = NDP fc (+) Net factor income
from abroad
• GNP mp = NDP fc + consumption of fixed
capital + Net indirect tax
• (Indirect tax – subsidy)

Expenditure method
• Government final consumption
expenditure.
• Private final consumption expenditure.
• Net Export.
• Gross domestic capital formation.

Expenditure method
• National Income=GDPmp – Depreciation – Net
Indirect Tax + Net factor income from abroad
• GDPmp = Private final Consumption
Expenditure + Government Final Consumption
Expenditure + Gross Domestic Capital
Formation + Net Exports
• Gross Domestic Capital Formation= Gross
Fixed Capital Formation + Change in Stock
• Net Exports = Exports – Imports

Nominal GDP & Real GDP
• Nominal GDP- It refers to production of
goods and services valued at current
prices.
• Real GDP- It refers to production of
goods & services valued at constant price.
It is better than Nominal GDP as it truly
reflects the growth of an economy.

GDP Deflator
• It measures the average level of
prices of all the goods & services
that make up GDP.
• GDP Deflator = Nominal GDP *100
/Real GDP

Limitations Of GDP and Welfare
• Distribution of GDP
• Change in prices
• Non Monetary exchanges
• Externalities
• Rate of Population Growth

Problem of Double Counting
• In measuring the National Income, the
value of only final goods & services is to
be included.
• It refers to counting of an output more
than once while passing through various
stages of production.

Money
• Money is anything that is
generally acceptable as a means of
exchange and at the same time, act
as a store of value.

Money
Legal Definition :- Money is anything
declared by law as money
Functional Definition :- Money is
anything that acts as a medium of
exchange, measure of value, store of
value and standard for deferred
payments

Classification Of Money
 Full bodied money
 Representative full bodied
money
Credit money

Barter System
• Barter System means the direct
exchange of one commodity to
another.

Barter Economy
• Barter economy can be termed as
C-C economy i.e., Commodity for
Commodity economy.

Difficulties of Barter System
• Lack of Double Coincidence
• Lack of divisibility
• Lack of Common measure
• Difficulty of Storage and Transfer of
Wealth
• Difficulty in deferred payment
• Difficulty in the exchange of services

Why we need money?
• Robinson-Crusoe Economy: autarky, do
not need money
• Robinson + Friday: need exchange, barter
economy
• Barter economy has a drawback: “double
coincidence of wants”

Why we need money?
• Introduce money  greases the wheel of
exchange and make the whole economy
more productive
• With money, market does not need to be
“personal,” the extent of exchange is
greatly increased

The Functions of Money
• Money
– Medium of exchange
• Standard object - exchange goods
& services
– Unit of account
• Standard unit – quoting prices
– Store of value
• Store wealth

What serves as money?
• For a money, we need it
– Divisible
– Identical (uniform)
– Storable and durable
– Compact (easy to carry): high value
per unit of volume or weight
– Candidate: gold, silver, copper, …

• Chinese coin

• Paper is even better…
• First paper money, 11th century
in China
• Bank notes carried a guarantee that
it could be traded at any time
for coin age

– Decreed as money by government
– Little value as commodity
– Maintains value - medium of exchange
because people have faith that the issuer will
stand behind it

Fiat Money
It refers to money by order
/authority of the government. It
includes Notes And Coins.

Fiduciary Money
• It refers to money backed
up by trust between the
payer and payee.

Money Supplier
• In the Modern times the
source of supply of money are
government, central bank of
the country and commercial
bank.

High Powered Money
• It Includes currency (R) with
the public and cash(c)
reserves with bank. High
Powered money=R+C.

How Quantity of Money is
Measured
• Asset’s liquidity
– Ease – convert into cash
• Credit cards
– Not included in money supply
• Convention: Money only includes
– Coins
– Paper money
– Checkable deposits

Banking
• Banking implies accepting
deposits of money from the
public for the purpose of lending
or investment which is repayable
on demand and can be
withdrawn by means of cheques,
draft order etc.

Commercial Bank
• A Commercial Bank is a financial
institution engaged in the business of
accepting deposits and making loans to
the people.

Central Bank
• A Central Bank is an apex institution of
a country that controls and regulates
the monetary and financial system of
the country.

Functions of Commercial
bank
 Acceptance of deposits from the public
 Advancing of loans
 Investment Of Funds
 Agency Function
Remittance of funds
 Collection and payment of fund
Sale and purchase of security
 Representation and correspondence
 Trusteeship
 General utility functions
 Credit creation

Factors affecting Credit Creation
Primary cash deposits
Cash reserve ratio
Banking habits of the people
Policy of the Central

Functions Of Central banks(RBI)
Bank Of issue
Banker, agent and advisor to the
government
Custodian of nation’s reserves of
international currency
Lender of the last resort
Bank of central clearance
Controller of money supply and credit

Instruments of Monetary
Policy or Credit Control
Measures
Quantitative Instruments
Bank rate
Open market operation
Cash Reserve Ratio (CRR)
Statutory Liquidity Ratio (SLR)

Instruments of Monetary
Policy or Credit Control
Measures
Qualitative Instruments
Margin requirements
Rationing of credit
Direct action
Moral suasion

Cash Reserve Ratio(CRR)
• It refers to the minimum percentage
of a bank’s total deposits required
to be kept with the Central Bank.

Statutory Liquidity
Ratio(SLR)
• Every Bank is required to maintain
a fixed percentage of its assets in
the form of cash Or Other Liquid
assets.

Aggregate Demand and
Related Concepts

Aggregate Demand
• It refers to the total value of final
goods and services which all the
sectors of an economy are planning to
buy at a given level of income during
a period of year accounting.

Components of aggregate
demand
• Private Consumption Expenditure-It refers to the total
expenditure incurred by households on purchase of goods
and services during an accounting year.
• Investment Expenditure-It refers to the total expenditure
incurred by all private firms on capital goods.
• Government Expenditure-It refers to the total
expenditure incurred by government on consumer goods
and capital goods to satisfy the common needs of the
economy.
• Net Exports-The difference between exports and imports
is termed as net exports.

Components of aggregate
demand

Aggregate Supply
• Aggregate Supply refers to money value of
final goods and services that all the
producers are willing to supply in an
economy in a given time period.

Aggregate Supply=National
Income
• The sum Total of these factor
incomes(i.e.
rent+wages+interest+profit) at
domestic and National level is
termed as National Income. So, we
can say that aggregate supply(AS)
and national income(Y), are one
and the same thing.

Components of Aggregate Supply(AS)
or National Income(Y)
• National Income(Y)=Consumption(C)+Saving(S)
OR
Y=AS+C+S

Consumption Function
(Propensity to Consume)
• Consumption function refers to functional
relationship between consumption and
national income.
C=F(Y)

Types of Propensities to
consume
• Average Propensity to Consume(APC)
• Marginal Propensity to Consume(MPC)

Average Propensity to Consume
• It refers to the ratio of consumption expenditure
to the corresponding level of income.
APC = C/Y
Where , APC=Average propensity to consume;
C=Consumption; Y=Income

Marginal Propensity to
consume
• It refers to the ratio of change in consumption
expenditure to change in total income
• MPC= C /Y

Difference Between APC and MPC
• It is the ratio of consumption expenditure
(C) to the corresponding level of income(Y)
at a point of time.
• APC can be more than one as long as
consumption is more than national
income, i.e. till the break even point.
• When Income increases , APC falls but a
rate less than that of MPC.
• APC=C/Y
• APC • MPC
• It is the ratio of change in
consumption expenditure to
change in income over a
period of time.
• MPC cannot be more than
one as change in
consumption cannot be
more than change in
income.
• When Income increases ,
MPC also falls but a rate
more than that of APC.
• MPC= C /Y

Saving Function (Propensity to
save)
• Saving functions refers to the functional relationship
between saving and national income.
S=f(Y)
Where, S=Saving; Y=National Income; f=Functional
relationship

Average Propensity to Save
• Average propensity to save refers to the
ratio of saving to the corresponding level
of income.
APS=Saving/Income

Marginal Propensity to
consume
• Marginal propensity to save refers to the
ratio of change in saving to change in
total income.
MPS=Change in Saving
Change in Income

Investment function
• Investment refers to the expenditure incurred
on creation of new capital assets.
• It includes the expenditure incurred on assets
like
machinery,building,equipment,rawmaterial,e
tc.

Investment function
• The Investment expenditure is classified
under two heads-
Induced Investment
Autonomous investment

Induced Investment
• It is directly influenced by the income level. It
is made when marginal efficiency of
investment is more than the rate of interest.

Autonomous investment
• It refers to the investment which is
not affected by changes in the level
of income and is not induced solely
by profit motive.

Ex-Ante Saving & Investment
• Ex-Ante Saving-It refers to the amount which
savers plan to save at different levels of
income in an economy.
• Ex-Ante Investment-It refers to the amount
which investors plan to invest at different
levels of income in an economy.

Ex-post Saving & Ex-post Investment
• Ex-post Saving-It refers to the actual saving in
an economy during a year.
• Ex-post Investment-It refers to the actual
investment in an economy during a year.

Full Employment
• It refers to a situation in which all
those people, who are willing and
able to work at the existing wage
rate, get work without any undue
difficulty.

Involuntary Employment
• It refers to a situation in which all those
people, who are willing and able to work
at the existing wage rate, do not get work.

Income Determination and
Multiplier

The components of aggregate
demand are :
• Demand for goods and services for
private consumption also called
private final
• consumption expenditure.
• Demand for private investment
• Demand for goods and services by
the government
• Net exports.

Equilibrium by AD and AS
Approach

Equilibrium by AD and AS
Approach
• In the AD or(C+I) curve shows the desired level of expenditure by
consumers and firms corresponding to each level of income. The
economy is in equilibrium at point 'E' where (C+I) curve intersects
the 45^ line.
• 'E' is the equilibrium point because at this point, the level of
desired spending on consumption and investment exactly equals
the level of total output.
• OY is the equilibrium level of output corresponding to point E.
• The Equilibrium level of income is Rs400 crores, when AD (or
C+I)=AS =Rs400 crores.
• It is a situation of 'Effective Demand'. Effective demand refers to
that level of AD which becomes 'Effective' because it is equal to
AS.

When AD is more than AS
• When planned spending (AD) is more than
planned output (AS), then (C+I) curve lies
above the 45^ line . It means that consumer
and firms together would be buying more
goods than firms are willing to produce. As a
result, the planned inventory would fall below
the desired level.

When AD is less than AS
• When AD<AS, then (C+I) curve lies below the
45^ line. It means that consumers and firms
together would be buying less goods than
firms are willing to produce AS a result, the
planned inventory would rise.
• Saving and Investment Approach
• Equilibrium level of income is determined at
the level where planned saving is equal to
planned investment, i.e., when S=I.

Saving–Investment Approach (S-I
Approach)

Saving–Investment Approach (S-I
Approach)
• In Fig , Investment curve is parallel to the X-Axis
because of the autonomous character of investments.
The Saving curve (S) Slopes upwards showing that as
income rises, saving also rises.
• The economy is in equilibrium at a point 'E' where
saving and investment curves intersect each other.
• At point 'E', ex-ante saving is equal to ex-ante
investment.
• OY is the equilibrium level of output corresponding to
point E.
• the equilibrium level of income is Rs400 crores, when
planned saving=planned investment=RS40 crores.

When Saving is more than Investment
• If planned saving is more than planned
investment after point 'E', it means that
households are not consuming as much as
the firms expected them to. As a result, the
inventory rises above the desired level.

When Saving is less than Investment
• If planned saving is less than planned
investment before point 'E' , it means that
households are consuming more and saving
less than what the firms expected them to. As
a result, planned inventory would fall below
the desired level.

Full Employment Equilibrium
• It refers to a situation when aggregate
demand is equal to the aggregate supply at
full employment level.

Underemployment Equilibrium
• It refers to a situation when aggregate
demand is equal to the aggregate supply at a
level where the resources are not fully
employed.

Over Full Employment Equilibrium
• It refers to a situation when AD is Equal to AS
beyond the full employment level.

Multiplier
• It refers to the ratio of change in income( Y),
to a change in investment (^I).K=^Y/^I. The
minimum value of multiplier can be one and
the maximum value can be infinity.
• Multiplier is directly related with the MPC,
i.e., K=1/1-MPC.
• Multiplier is inversity related with the MPS,
i.e., K=1/MPS.

Working of Multiplier
• It is based on the fact "One person's
expenditure is another person's income". So ,
multiplier expresses the relationship between
an initial increment in investment and the
resulting increase in aggregate income

Excess Demand And
Deficient Demand

Excess of Demand
• It refers to a situation when AD>AS
corresponding to the full employment level of
output in the economy.

Inflationary Gap
• It shows the gap by which actual AD exceeds
the Ad required to establish full employment
equilibrium.

Reasons for Excess Demand
• Rise in the propensity to consume
• Reduction in taxes
• Increase in Government Expenditure
• Increase in Investment
• Fall in Imports
• Rise in Exports
• Deficit Financing

Impact of Excess Demand
• Excess demand leads to inflation without any
increase in output and employment as the
economy is already operating at the full
employment level.

Deficient Demand
• It refers to a situation when Ad<AS
corresponding to the full employment level of
output in the economy.

Deflationary Gap
• It shows the gap by which actual AD falls
short of the AD required to establish full
employment equilibrium.

Reasons for Deficient Demand
• Decrease in this propensity to consume
• Increase in taxes
• Decrease in Government Expenditure
• Fall in Investment Expenditure
• Rise in Imports
• Fall in Exports

Impact of Deficient Demand
• Deficient demand leads to fall in prices
which, in turn, leads to fall in the output and
employment level.

Measures to correct Excess Demand
• Decrease in Government Spending: In this
Fiscal measure, central government needs to
reduce its expenditure in order to decrease
level of aggregate demand.
• Decrease in Availability of Credit: Central
Bank aims to reduce availability of credit
through 'Monetary Policy' . It includes :

Quantitative Instrument:
• Increase In Bank rate
• Open Market Operation(Sale of securities)
• Increase in legal reserve requirements

Qualitative Instrument:
• Increase in margin requirements
• Moral Suasion (Advise to discourage Lending)
• Selective Credit Controls(Introduce Credit
Rationing)

Measures to correct Deficient
Demand
• Increase in Government Spending: In this
Fiscal measure, central government needs to
increase its expenditure in order to raise the
level of aggregate demand.
• Increase in Availability of Credit : Central
Bank aims to reduce availability of credit
through 'Monetary Policy' . It includes :

Quantitative Instrument:
• Decrease In Bank rate
• Open Market Operation(Purchase of
securities)
• Decrease in legal reserve requirements

Qualitative Instrument:
• Decrease in margin requirements
• Moral Suasion (Advise to encourage Lending)
• Selective Credit Controls(Withdraw Credit
Rationing)

Contents Government Budget –
Meaning, Objective
• Components of Government Budget.
• Classification of receipts – Capital and
revenue .
• Classification of expenditure - Capital and
revenue .
• Balanced budget surplus budget, deficit
budget - meaning and implication .
• Revenue deficit, Fiscal deficit, primary
deficit - Meaning and implication

Meaning of Government Budget
• A government budget is an annual
statement of the estimated receipts and
estimated expenditure of the government
during a fiscal year .
• Fiscal year is taken from 1st April to 31st
March.

Objective of the Government
Budget
• It means managed and proper distribution of resources. As
private sector can not provide all the goods and services the
government has to provide these goods.
• Through budget government tries to reduce the gap between
Rich and poor. This is achieved through taxing the rich and
subsidizing the needs of poor people.
• There may be inflation or depression in the economy.
Inflation is the situation of rise in price level whereas
depression is lack of demand. Both the situations are
undesirable. During depression government reduces rate of
tax and borrowing and increases public expenditure. During
inflation government increases the rate of tax and borrowing
and decreases public expenditure. Reallocation of resources -:
To reduce inequalities in income and wealth-: . To achieve
economic stability -:

Objective of the Government
Budget
• IV. Large no: of Public Enterprises which are
established and managed for social welfare of the
public. V. depends upon rate of saving and
investment.
• Through taxation and expenditure policy.
Management of Public Enterprises . To achieve
economic growth Reducing regional disparities.

Components of Government
Budget:
Components of budget refer to structure of
the budget. Two main components are:
• Revenue Budget
• Capital Budget

Components of budget can also be
categorized according to receipts
and expenditures
• Budget Receipts
• Budget Expenditure

Budget Receipts
• Budget receipts refer to the estimated money
receipts of the government from all sources
during a given fiscal year. Budget Receipts
Revenue receipts Capital receipts Tax revenue
Non-tax revenue Recovery of loans Borrowing
Other receipts

Capital Receipts: -
• Capital Receipts refer to those receipts of the government
which i) tend to create a liability or ii) Causes reduction in
its assets. All the Capital receipts are broadly classified into
three categories.
• Recovery of loans :- These are Capital receipts because they
reduce financial assets of the government .
• Borrowings: - Funds raised by the government form the
borrowing are treated as capital receipts such receipts creates
liability.
• Other Receipts: - Funds raised through disinvestment are
included in this category. By this government assets are
reduced.

Revenue Receipts
• Any receipts which do not either create a
liability or lead to reduction in assets is
called revenue receipts. Two sources of
revenue receipts Tax Revenue Non-Tax
Revenue. Revenue receipts Tax revenue
Non-tax revenue Direct Tax Indirect Tax.
Interest Profit and dividend Fees and fines
Gifts and grants .

How to classify a tax as
Direct Tax or Indirect Tax
• A tax is a direct tax, if its burden cannot
be shifted. For example, income tax is a
burden tax as its impact and incidence is
on the same person.
• A tax is a indirect tax, if its burden can be
shifted. For example, sales tax is an
indirect tax as its impact and incidence is
on different persons.

• Corporation tax
• Value added tax
• Service tax
• Excise duty
• Wealth tax
• Sales tax

How to classify a receipt as Revenue
Receipt or Capital Receipt?
• A receipt is a capital receipt, if it creates a
liability or reduces an asset.
• A receipt is a revenue receipt, if it neither
creates a liability nor reduces any asset.

Budget Expenditure
• Budget expenditure refers to the
estimated expenditure of the government
during a given fiscal year.

Revenue Expenditure
• An expenditure which do not creates assets or
reduces liability is called Revenue Expenditure.
• It is recurring nature.
• It is incurred on normal functioning of the
government and the provisions for various
services.
• • Examples are – Salaries of government
employees, interest payment on loan taken by
the government, pension, subsidies, grants etc.

An expenditure is a revenue expenditure
,if it satisfies the following two essential
condition.:
• The expenditure must not create an asset
of the government. The expenditure must
not cause decrease in any liability.
• Revenue expenditure Neither creates an
Asset Nor reduces any liability

Capital Expenditure:-
• It refers to the expenditure which leads to
creation of assets and reduction in liabilities .
• It is non-recurring in nature
• It adds to capital stock of the economy and
increases its productivity through expenditure
in long period development programmes like
Metro or Flyover.
• eg. Expenditure incurred on construction of
building, roads, bridges etc.

An expenditure is a capital expenditure, if it
satisfies any one of the following two
conditions:
• The expenditure must create an asset for
the government. Eg: construction of metro.
• The expenditure must cause a decrease in
the liabilities. Eg: repayment of
borrowings. Capital expenditure Either
creates an Asset Or reduces a liability

How to classify Expenditure as
Revenue of Capital Expenditure?
• An expenditure is a capital expenditure, if
it creates an asset or reduces a liability.
• An expenditure is revenue expenditure, if
it neither creates any asset nor reduces an
liability.

Plan and Non- plan Expenditure
• Plan expenditure refers to the expenditure
that is incurred on the programmes
detailed in the current five year.
• Non-plan expenditure refers to the
expenditure other than the expenditure
related to the current five-year plan.
Budget expenditure Plan expenditure Non-
expenditure

Plan expenditure vs. non-plan
expenditure Plan expenditure
• Plan expenditure is spent on current
development and investment outlays.
• It arises only when the plans provide for
such expenditure. non-plan expenditure . It
is spent on the routine functioning of the
government.
• It is a must for every economy and the
government cannot escape from it.

How to classify an expenditure as
plan or non- plan expenditure?
• An expenditure is a plan expenditure,
if it arises due to planned proposals.
• An expenditure is a non-plan
expenditure, if it is out of the scope
off government plans.

Developmental and Non- developmental
Expenditure Developmental Expenditure
• It refers to the expenditure which is directly related
to economic and social development of the country.
• It directly contributes to development of the
economy.
 It is productive in nature as it adds to the flow of
goods and services. Non- developmental Expenditure
.
 It refers to the expenditure which is incurred on the
essential general services of the government .
 It does not contribute directly to the development ,
but it lubricates the wheels of economic development.
 It is not concerned with the productivity of working
class.

How to classify an expenditure as
developmental expenditure and non
developmental expenditure
• An expenditure is a developmental
expenditure, if it directly adds to the flow
of goods and services.
• An expenditure is a non-developmental
expenditure, if it indirectly contributes to
economic development.

Measures of government deficit
• Types:- Deficit Budget:- When
government expenditure exceeds
government receipts in the budget
is said to be a deficit budget.
• Government deficit Revenue
Deficit:- Fiscal deficit & Primary
deficit:-

Revenue Deficit
• Revenue deficit refers to the excess of
revenue expenditure of the
government over its revenue receipts.
• Revenue deficit = Total revenue
expenditure – Total revenue receipts.

Fiscal deficit
• Fiscal deficit is defined as excess of
total expenditure over total receipts .
• Fiscal Deficit = Total budget
expenditure - Total budget receipts
net of borrowings.

Primary deficit
• It refers to the difference between
fiscal deficit of the current year and
interest payments on the previous
borrowings.
• Primary deficit= fiscal deficit -
interest payments .

BALANCE OF PAYMENTS
• The balance of payments of a country
is a systematic record of all economic
transactions between residents of a
country and residents of foreign
countries during a given period of
time.

BALANCE OF TRADE AND BALANCE OF PAYMENTS
• Balance of trade: Balance of trade is the
difference between the money value of exports
and imports of material goods (visible item)
• Balance of payments: Balance of payments is a
systematic record of all economic transactions
between residents of a country and the
residents of foreign countries during a given
period of time. It includes both visible and
invisible items. Hence the balance of payments
represents a better picture of a country’s
economic transactions with the rest of the
world than the balance of trade.

STRUCTURE OF BALANCE OF
PAYMENT ACCOUNTING
• A balance of payments
statement is a summary of a
Nation’s total economic
transaction undertaken on
international account

Current Account
• a) Visible items of trade: The balance of exports and
imports of goods is called the
• balance of visible trade.
• b) Invisible trade: The balance of exports and imports of
services is called the balance of invisible trade E.g.
Shipping insurance etc.
• c) Unilateral transfers: Unilateral transfers are receipts
which resident of a country receive (or) payments that
the residents of a country make without getting
anything in return e.g. gifts.
• The net value of balances of visible trade and of
invisible trade and of unilateral transfers is the balance
on current account.

CAPITAL ACCOUNT
• It records all international
transactions that involve a
resident of the domestic
country changing his assets
with a foreign resident or his
liabilities to a foreign resident.

VARIOUS FORMS OF CAPITAL
ACCOUNT TRANSACTIONS
1. Private transactions: These are transactions that
are affecting assets (or) liabilities by individuals.
• 2. Official transactions: Transactions affecting
assets and liabilities by the government and its
agencies.
• 3. Direct Investment: It is the act of purchasing an
asset and at the same time acquiring and control
of it.
• 4. Portfolio investment: It is the acquisition of
assets that does not give the particular control
over the asset.
• The net value of balances of direct and portfolio
investment is called the balance on capital
account.

OTHER ITEMS IN THE BALANCE OF
PAYMENT
1) Errors and Omissions: They may arise due to
the presence of sampling and due to his
honesty.
• 2) Official reserve transactions: All
transactions except those in this category may
be termed as autonomous transactions. They
are so called because they were entered into
with some independent motive. Balance of
payments always balance.

AUTONOMOUS ITEMS
• Autonomous items: Autonomous items in the B.O.P
refer to international economic transactions that take
place due to some economic motive such as profit
maximization. These items are often called above the
line items in the B.O.P.
• The balance of payments is in a deficit if the
autonomous receipts are less than autonomous
payments. The monetary authorities may finance a
deficit by depleting their reserves of foreign currencies,
or by borrowing from I.M.F.

ACCOMMODATING ITEMS
• Accommodating items in the B.O.P.
refer to transactions that occur
because of other activity with the
B.O.P such as government financing.
Accommodating items are also
referred to as below the line of items.

DISEQUILIBRIUM THE BALANCE OF
PAYMENTS
• I Economic factors: Large scale development expenditure
that may cause large imports.
• Cyclical fluctuations in general business activities such
as recession or depression.
• High domestic prices may result in imports.
• II Political factors: Political instability may cause large
capital outflows and hamper the inflows of foreign
capital.
• III Social factors: Changes in tastes, preferences and
fashions may affect imports and exports.

Foreign Exchange
• It refers to all currencies
other than the domestic
currency of a given
country.

Foreign exchange rate
• It is the rate at which currency of
one country can be exchanged for
currency of another country.

Foreign Exchange Market
• The Foreign Exchange market is
the market where the national
currencies are traded for one
another.

Functions of Foreign Exchange
Market:
• Transfer function: It transfers the
purchasing power between countries.
• Credit function: It provides credit
channels for foreign trade
• Hedging function: It protects against
foreign exchange risks.

FIXED EXCHANGE RATE
SYSTEM
• Fixed exchange rate is the rate
which is officially fixed by the
government, monetary authority
and not determined by market
forces.

FLEXIBLE EXCHANGE RATE
• Flexible exchange rate is
the rate which is
determined by forces of
supply and demand in the
foreign exchange market.

Demand for foreign exchange
• To purchase goods and services from other
countries
• To send gifts abroad
• To purchase financial assets (shares and bonds)
• To speculate on the value of foreign currencies
• To undertake foreign tours
• To invest directly in shops, factories, buildings
• To make payments of international trade.

Supply of foreign exchange
• When foreigners purchase home countries
goods and services through exports
• When foreigners invest in bonds and
equity shares of the home country.
• Foreign currencies flow into the economy
due to currency dealers and speculators.
• When foreign tourists come to India
• When Indian workers working abroad
send their saving to families in India.

EQUILIBRIUM IN THE FOREIGN
EXCHANGE MARKET
• The equilibrium exchange rate is
determined at a point where demand for
and supply of foreign exchange are equal.
Graphically interaction of demand and
supply curve determines the equilibrium
exchange rate of foreign currency.

Managed Floating
• This is the combination of fixed and
flexible exchange rate. Under this, country
manipulates the exchange rate to adjust
the deficit in the B.O.P by following
certain
guidelines issued by I.M.F.

Dirty floating
• If the countries manipulate the exchange
rate without following the guidelines
issued by the I.M.F is called as dirty
floating.

Macroeconomics

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