Eeim Unit 2 notes

Topics
2.1 function of central and commercial banks
2.2 inflation, deflation, stagflation
2.3 direct and indirect taxes
2.4 new economic policy
2.5 liberalization, globalization, privatization
2.6 monetary and fiscal policies
2.7 meaning and phases of business cycle
2.1

Commercial bank A commercial bank is a financial institution which performs the functions of accepting chequable
deposits from the public and making loans and investments with the object of securing profits.

Functions of Commercial Banks:-

1. Accepting deposits- A commercial bank accepts deposits from individuals, business firms and other institutions.
These deposits are mainly of three types-
i. Demand Deposits (current Account Deposits) - The bank does not pay any interest on demand deposits but, in fact
makes a small charge on the customers with a current account.
ii. Saving Deposits - Deposits on which the bank pays a certain percentage of interest to the depositors but places
certain restrictions on their withdrawals.
iii. Fixed Deposits/Term Deposits/Time Deposits - The deposits which are kept for a specified time – periods are
called time deposits. A higher rate of interest is paid on such deposits.

2. Advancing of Loans- Commercial banks give loans and pay advances out of their deposits. Loans and advances
are given to all types of persons such as businessmen, farmers, consumers, and employers, etc. against securities.
Prominent ways of providing loans and advances are as follows-
i. Cash Credit - A borrower first sanctions a credit limit upto which he may borrow from the
bank. The borrower has to pay interest on the ‘drawn’ or ‘utilized’ portion of the credit limit only.
ii. Money at call or Demand loans- It refers to loans given for a very short period. Security brokers and Others whose
credit needs to fluctuate on a day to day basis usually take these loans.
iii. Short-term loans- These loans may be given as personal loans to finance working capital or as priority sector
advances. Short-term loans are made against some security.
iv. Other Facilities-
a. Overdraft- An overdraft is an advance given by allowing customers to overdraw his current
account upto an agreed limit. Under overdraft arrangements, people can get more than they
have deposited but they have to pay interest on the extra amount which has to be paid within a
short period. Overdraft facility generally granted to businessmen.
b. Discounting of bills of exchange- A bill of exchange is a written promise by a debtor to a
creditor to pay a sum of money usually after three months. Banks discount the bills after
charging the interest for the period and the cost of collection.

3. Investment of funds- The banks invest their surplus funds in two types of securities:
i. Government Securities- Like treasury bills, National Saving Certificates etc.
ii. Other approved securities- Other approved securities are securities approved under the provisions of Banking
Regulation Act, 1949. For example securities of electricity boards, units of UTI, shares of Regional Rural Banks, etc.

4. Agency Functions- Banks also act as financial agents of their customers.

i. Remittance of funds- remit (send) funds on behalf of their clients, by mail transfer or demand drafts.
ii. Collection and payment of funds- Banks also collect and pay the cheque, bills, rents, income tax,
insurance premium and other receipts and payments on behalf of their clients.
iii. Sale and purchase of securities- Banks also sell and purchase share, stocks debentures, and bonds,
etc. on behalf of their customers.
iv. Representation and correspondence- Many a time, banks procure passports, tickets for their
customers and act as their representatives.
v. Trusteeship- Banks also appoint income tax experts to prepare and finalize the income tax returns of their clients.

5. General Utility Functions-

i. Issuing letters of credit and other credit instruments to their customers.
ii. Receiving the valuables, ornaments, jewels, documents and deeds of their customers for keeping in lockers.
iii. Acting as a referee. Banks collect information about trade, industry and finance, and also advise customers on
financial matters.
iv. Issuing bank drafts and traveler’s cheques in order to facilitate the transfer of funds from one part of the country to
the other.

6. Credit Creation- Commercial banks expand their deposits by giving loans and advances. They create claims
against themselves and create deposits in favor of borrowers.

Process of Credit Creation (Money Creation) by Commercial Banks:-

When the persons are granted loans by the banks they do not get cash money from the banks. Banks open accounts
of the borrowers and the loan money is deposited in their accounts. In this process, new deposits or (secondary
deposits) are created by the banks, thus banks create credit by advancing loans. eg-
Factors Affecting Credit Creation:-
1.Primary Cash Deposits- Larger the availability of cash, the larger will be the amount of credit
creation.
2.Cash Reserve Ratio (CRR) - There is an inverse relationship between cash reserve ratio and credit creation.
3.Banking Habits of the people- In the countries where people prefer to deal through banks, credit creation capacity
will be more and vice-versa.
4.Policy of the central bank- Central bank can control credit. If its policy is to encourage credit
creation, it will adopt a cheap money policy. On the contrary, if its policy is to discourage credit
creation, it adopts dear money policy.

Central bank is an apex institution which acts as the leader of the money market. It supervises, regulates and controls
the activities of commercial banks and other financial institutions. In India, rbi is the central bank of the country.

Functions of Central Bank or RBI

1. Bank of Issue- RBI has been given the sole right of issue of currency notes (except one rupee notes and coins
which are issued by the ministry of finance).
2. Banker, Agent and Advisor to the Government - As banker to the govt, The central bank makes and receives
payment on behalf of the govt. It helps the govt. with short term loans and advances in times of difficulty. As govt.
agent, the central bank conducts sale and purchase of govt. securities and also manages the national debt as well as
foreign debt. The central bank also acts as an advisor to the govt., especially on monetary, banking and financial
matters.
3. Custodian of the cash reserves of the commercial banks- All commercial banks keep part of their cash balances as
deposits with the central bank of the country. It is because of this function that the central bank is called a banker’s
bank.
4. Lender of last resort- A commercial bank lend to the individuals, the central bank lends to the
commercial banks in times of unanticipated emergencies. Thus, the central bank assumes the
responsibility of meeting, directly or indirectly, all the reasonable demands for funds.
5. Custodian of foreign exchange reserves- All receipts and payments in foreign exchange are made by the central
bank. Through this function, the central bank maintains the rate of exchange and manages exchange control.
6. Controller of Money Supply and credit- Central bank can control inflationary and deflationary
situations in the economy through various credit control measures like CRR, SLR. Bank Rate, OMO, etc.
7. Bank of central clearance- A central bank keeps the cash balances of all commercial banks, it is easier for member
banks to adjust their claims against each other in the books of the central bank.

Instruments of Monetary policy or Credit Control Measures:-

1. Quantitative Credit Control Measures (or General Control measures) - These measures control the total
volume of bank credit.
i. Bank Rate (Repo Rate) policy- The rate at which central bank advances loans to the commercial banks or
rediscounts first class bills of exchange and govt. securities held by them are known as bank rate or discount rate or
Repo Rate.
On the other hand, the rate at which commercial banks advance loans to their customers is called the interest rate.
Reverse Repo Rate is the rate at which the RBI borrows money from commercial banks. If RBI
increase this Reverse Repo Rate, it means RBI wants contraction of credit and vice-versa.
ii. Open Market Operations (OMO) – Open Market Operations refers to the policy of sale and
purchase of securities in the open market by the RBI. Credit expands with the purchase of
securities and contracts with their sales.
iii. Variable Reserve Requirements- Commercial banks are required to maintain two types of
reserves with the central bank: Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio
(SLR). These two are the components of Legal Reserve Ratio (LRR).
CRR- Every commercial bank is required to keep a minimum percentage of its total deposits
with the central bank, is termed as Cash Reserve Ratio. An increases in CRR reduces the cash
reserves of the commercial banks, in turn, reduces credit creation capacity of the banks and vice- versa.
SLR- The commercial banks are also required to maintain a minimum amount of their total
liabilities in the form of liquid assets, is termed as Statutory Liquidity Ratio. Increase in SLR
reduces credit creation capacity and decrease in SLR increase the credit creation capacity of
banks.

2. Qualitative Credit Control Measures (or Specific Control Measures) – These measures control certain types of
credits and allocate credit between alternative uses.
i. Change in the Margin Requirements- The difference between the value of security and the
amount of the loan is known as margin requirement. By varying margin requirement, the central
banks can expand or contract the credit creating capacity of commercial banks.
ii. Moral Suasion- Moral Suasion implies persuasion, request, informal suggestion, advice and
appeal by the central bank to commercial banks to cooperate with the general monetary policy
of the central bank.
iii. Credit Rationing- The central bank can give direction to the commercial banks to give credit
for certain purposes or to give more credit for particular purposes or to the priority sectors.
 2.2
What is Inflation or What is the meaning of Inflation?
In economics inflation means a rise in the general level of prices of goods and services in an economy over a period
of time. When the general price level rises, each unit of currency buys fewer goods and services. Thus, inflation
results in loss of value of money. Another popular way of looking at inflation is "too much money chasing too few
goods". The last definition attributes the cause of inflation to monetary growth relative to the output / availability of
goods and services in the economy.
In case the price of say only one commodity rise sharply but prices of other commodities fall, it
will not be termed as inflation. Similarly, in case due to rumors if the price of a commodity rise
during the day itself, it will not be termed as inflation.

What are different types of inflation?

Broadly speaking inflation is divided into two categories i.e.
(a) Demand-Pull inflation- In this type of inflation prices increase results from an
excess of demand over supply for the economy as a whole. Demand inflation occurs when supply cannot expand any
more to meet demand; that is, when critical production factors are being fully utilized, also called Demand inflation.
Causes of Demand-Pull Inflation:
Due to fiscal stimulus.
Increased borrowing.
Depreciation of rupee.
Low unemployment rate.

(b) Cost-Push inflation- This type of inflation occurs when general price levels rise
owing to rising input costs. In general, there are three factors that could contribute to Cost-Push
inflation: rising wages, increases in corporate taxes, and imported inflation. [imported raw or
partly-finished goods may become expensive due to rise in international costs or as a result
of depreciation of local currency]
This type of inflation is caused due to various reasons such as:
Increase in price of inputs
Defective Supply chain
Increase in indirect taxes
Depreciation of Currency

(c) Built-in Inflation- This type of inflation involves a high demand for wages by the workers which the firms address
by increasing the cost of goods and services for the customers.

Remedies to Inflation
The different remedies to solve issues related to inflation can be stated as:
Monetary Policy (Contractionary policy)
The monetary policy of the Reserve Bank of India is aimed at managing the quantity of money in order to meet the
requirements of different sectors of the economy and to boost economic growth.
This contractionary policy is manifested by decreasing bond prices and increasing interest rates. This helps in
reducing expenses during inflation which ultimately helps halt economic growth and, in turn, the rate of inflation.

Fiscal Policy
Monetary policy is often seen separate from fiscal policy which deals with taxation, spending
by government and borrowing. Monetary policy is either contractionary or expansionary.
When the total money supply is increased rapidly than normal, it is called an expansionary
policy while a slower increase or even a decrease of the same refers to a contractionary policy.
It deals with the Revenue and Expenditure policy of the government.
Tools of fiscal policy
1. Direct Taxes and Indirect taxes – Direct taxes should be increased and indirect taxes should be reduced.
2. Public Expenditure should be decreased (should borrow less from RBI and more from other financial
institutions)

Supply Management measures

1. Import commodities that are in short supply
2. Decrease exports
3. Govt may put a check on hoarding and speculation
4. Distribution through Public Distribution System (PDS).

Measurement of Inflation
1. Wholesale Price Index (WPI) – It is estimated by the Ministry of Commerce & Industry and measured on a monthly
basis.
2. Consumer Price Index (CPI) – It is calculated by taking price changes for each item in the
predetermined lot of goods and averaging them.
3. Producer Price Index – It is a measure of the average change in the selling prices over time received by domestic
producers for their output.
4. Commodity Price Indices – It is a fixed-weight index or (weighted) average of selected commodity prices, which
may be based on spot or futures price
5. Core Price Index – It measures the prices paid by consumers for goods and services without the volatility caused
by movements in food and energy prices. It is a way to measure the underlying inflation trends.
6. GDP deflator – It is a measure of general price inflation.

Effect of Inflation on the Economy

The effect of inflation on the economy can be stated as:
1. The effect of inflation is not distributed evenly in the economy. There are chances of hidden costs for
different goods and services in the economy.
2. Sudden or unpredictable inflation rates are harmful to an overall economy. They lead to market
instability and thereby make it difficult for companies to plan a budget for the long-term.
3. Inflation can act as a drag on productivity as companies are forced to mobilize resources away from
products and services to handle the situations of profit and losses from inflation.
4. Moderate inflation enables labor markets to reach equilibrium at a faster pace.

Why is inflation bad for the economy?

Inflation erodes purchasing power of the people due to sustained increase in prices of goods and services within a
period.

Who decides the inflation rate in India?

The amended RBI Act also provides for the inflation target to be set by the Government of India,
in consultation with the Reserve Bank, once every five years. However, the Reserve Bank of
India is the authority to control inflation through monetary policies which it does by increasing
bank rates, repo rates, cash reserve ratio, buying dollars, regulating money supply and availability of credit.

What is Deflation ?
Deflation is the opposite of inflation. Deflation refers to situation, where there is decline in
general price levels. Thus, deflation occurs when the inflation rate falls below 0% (or it is negative inflation rate).
Deflation increases the real value of money and allows one to buy more goods with the same amount of money over
time. Deflation can occur due to reduction in the supply of money or credit. Deflation can also occur due to direct
decline in spending, either in the form of a reduction in government spending, personal spending or investment
spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often
leads to a lower level of demand in the economy.

What is Stagflation ?
Stagflation refers to economic condition where economic growth is very slow or stagnant and
prices are rising. The side effects of stagflation are increase in unemployment- accompanied by a rise in prices, or
inflation. Stagflation occurs when the economy isn't growing but prices are going up.

2.3
Taxation in India: Direct Taxes and Indirect Taxes
Tax is a payment transfer collected from individuals or any taxable entity by government of the
country for the development and security of the nation. They are generally an involuntary fee or
penalty or charges levied on individuals and corporations in order to finance government
activities.
India has a well-developed tax structure. The tax structure in India is classified as direct and
indirect taxes. In India, the authority to levy taxes is divided between the central government and the state
governments. The central government levies direct taxes and indirect taxes. Whereas the states have the
constitutional power to levy sales tax apart from various other local taxes like entry tax, etc.

Classification of Taxes
Direct Tax:
1. The tax that is levied by the government directly on the individuals or corporations
is called Direct Taxes.
2. The incidence of the tax and its impact will fall on the same person.
3. They are progressive in nature.
4. They are Not at all Inflationary.
5. They are levied to meet both social and economic objectives.
6. Its Social objective is the distribution of income mentioned under article 39(a) of
the DPSP. If a person earns more than he should contribute more for public service
by paying more tax.
Examples- Property tax, Income Tax, Corporation Tax and Wealth Tax.

Types of direct tax

Income Tax:
It is levied on the income earned by the individuals, Hindu undivided families or
other legal people.
In India, it is a progressive tax.
To calculate it, we add income from all sources and taxed as per the income tax
slabs which are mentioned as below:
if the total income exceeds Rs 50 lakh and it is below Rs 1 Crore then a
Surcharge of 10% of income tax will be levied additionally.
if the total income exceeds Rs 1 Crore then a Surcharge of 15% of income
tax will be levied additionally.

Corporation Tax
They are levied on the income of corporate firms or industries.
For taxation purpose, a company is considered as a separate entity, therefore, they
have to pay a separate tax apart from the personal income tax of its owner.
All Companies registered in India under the companies act 1956 are liable to pay
corporate tax.
Tax on Wealth and Capital
Wealth Tax: It was first levied in 1957. It was made on the excess of net wealth
(over 30 lakhs rs) of individuals and companies. It was abolished in 2015.
Gift Tax: it was introduced in 1958. It was levied on all donations except the one
given by the charitable institution. It was abolished in 1998.

Capital Gain Tax: Capital gain is any profit that arises from the sale of the capital
asset. The profit from the sale of any capital is taxed by the government. Capital
Asset includes both moveable as well as immovable properties like land, building,
house, jewelry, patents, copyrights, shares etc.
they are of 2 type -
Short-term capital asset– they are those assets which are held for not more than 36 months or less.
Long-term capital asset– they are those assets that are held for more than
36 months.

Indirect Tax:
1. The tax which is levied by the government on any entity (Manufacturer of goods),
but later is passed on to the final consumer by the manufacturer.
2. The incidence of this indirect tax and its impact falls on different persons.
3. They are regressive in nature.
4. The objective of this tax is Only Economical. As when an indirect tax is levied on
a product, both rich and poor pay taxes at the same rate. So they share the same
burden despite being an income difference.
5. They are inflationary.
Examples- VAT, Service tax, GST, Excise duty,
entertainment tax and Customs Duty.

Types of indirect taxes

Custom Duty- Customs duty refers to the tax imposed on goods when they are transported across international
borders. In simple terms, it is the tax that is levied on import and export of goods. The government uses this duty to
raise its revenues, safeguard domestic industries, and regulate movement of goods.

Excise Duty- Excise duty is a form of tax imposed on goods for their production, licensing and sale. An indirect tax
paid to the Government of India by producers of goods, excise duty is the opposite of Customs duty in that it applies
to goods manufactured domestically in the country, while Customs is levied on those coming from outside of the
country.

Service Tax- Service tax was an indirect tax levied by the government on services offered by service providers.
Introduced under Section 65 of the Finance Act, 1994, service tax was in July 2017 replaced by Goods and Services
Tax (GST), Service tax was paid to the government in exchange for different services received from service
providers. Though the tax was paid by service providers, it was recovered from customers who bought or availed of
the taxable services.

Value Added Tax- It is a type of indirect tax levied on goods and services for value added at every point of production
or distribution cycle, starting from raw materials and going all the way to the final retail purchase.

GST (Goods and Services Tax)- The goods and services tax (GST) is a tax on goods and services sold domestically
for consumption.
The tax is included in the final price and paid by consumers at point of sale and passed to the government by the
seller.
The GST is a common tax used by the majority of countries globally.
The GST is usually taxed at a single rate across a nation.

Diff bet direct and indirect tax

2.4
New Economic Policy of India was launched in the year 1991 under the leadership of P. V. Narasimha Rao.
This policy opened the door of the India Economy to global exposure for the first time.
In this New Economic Policy P. V. Narasimha Rao government reduced the import duties, opened reserved sectors
for the private players, devalued the Indian currency to increase the export.

Objectives of New Economic Policy 1991

1. Enter into the field of ‘globalization’ and make the economy more market-oriented.
2. Reduce the inflation rate and rectify imbalances in payment.
3. Increase the growth rate of the economy and create enough foreign exchange reserves.
4. Stabilize the economy and convert the economy into a market economy by the removal of unwanted
restrictions.
5. Allow the international flow of goods, capital, services, technology, human resources, etc. without too many
restrictions.
6. Enhance the participation of private players in all sectors of the economy. For this, the reserved sectors for
the government were reduced to just 3.

2.5
Liberalization

1. All commercial banks were now free to fix their interest rates. This was previously done by the RBI.
2. Investment limit for small-scale industries was increased to Rs. 1 Crore.
3. Indian industries were given the freedom to import capital goods.
4. Companies were given the freedom to expand and diversify their production capacities based on market
requirements. Previously, the government used to fix the maximum limit of production capacity.
5. Restrictive trade practices were abolished. Licensing was removed in the private sector and only a few
industries were required to obtain licenses, namely, liquor, cigarette, industrial explosives, defense
equipment, hazardous chemicals and drugs.
Privatization:

Simply speaking, privatization means permitting the private sector to set up industries which were previously reserved
for the public sector. Under this policy many PSUs were sold to the private sector. Literally speaking, privatization is
the process of involving the private sector-in the ownership of Public Sector Units (PSU’s).

1. Under this, many public sector undertakings (PSUs) were sold to private players.
2. PSU shares were sold to private players.
3. PSUs were disinvested.
4. The number of industries reserved for the public sector was reduced to 3 (mining of atomic minerals, railway
transport, and atomic energy).

Globalization

Globalization means to make Global or worldwide, otherwise taking into consideration the whole world. Broadly
speaking, Globalization means the interaction of the domestic economy with the rest of the world with regard to
foreign investment, trade, production and financial matters.

1. Tax were reduced – reduction of customs duties in import and export to attract global investors.
2. Foreign trade policy was for the long-term – Liberal and open policy was enforced.
3. The Indian currency was made partially convertible.
4. The equity limit of foreign investment was increased.

Do you think outsourcing is good for india? Why are developed countries opposing it?

Outsourcing is one of the important results of globalization. In outsourcing, a company hires regular service from
external sources, mostly from other countries. Many of the services such as accountancy, music recording, film
editing, book transcription, clinical advice, etc are being outsourced by companies in developed countries to India.
Therefore, outsourcing has proved to be good for India in the following manner

(i) Employment Generation Outsourcing from developed nations has helped in creating more employment
opportunities in India. It has resulted in generation of higher paying jobs which utilize the skills of educated youth of
India.

(ii) Increased Foreign Investment Successful execution of processes outsourced to India has increased India's
international credibility and hence the inflow of foreign capital to India.

(iii) Promotes Other Sectors Outsourcing creates various backward and forward linkages which make it beneficial for
other related sectors like industrial and agricultural sector too.

(iv) Human Resource Development Outsourcing has helped in developing human resources by draining the youth
and imparting skills required for specific jobs which have high remuneration.

(v) Rise in Standard of Living Outsourcing has improved the standard of living of the people in India by generating
more and better employment with rise in average salaries.

Outsourcing is beneficial for India but developed countries oppose this because outsourcing leads to the outflow of
capital from the developed countries to the developing countries further, outsourcing leads to a reduction in
employment in the developed countries as the same jobs are outsourced to the developing countries where these are
done at relatively cheap wage rates.
 2.6

What is Monetary Policy?

Monetary policy is the procedure by which the monetary authority of a nation, normally the central bank or currency
board, controls either the expense of short-term borrowing or the cash supply, focusing on inflation or the loan fee to
guarantee value strength and general trust in the currency.

Further goals of monetary policy are-

to contribute to the stability of the gross domestic product

to achieve and maintain low unemployment

to maintain predictable exchange rates with other currencies

Types of monetary policy

Contractionary
This policy increases interest rates and limits the outstanding money supply to slow growth and decrease inflation,
where the prices of goods and services in an economy rise and reduce the purchasing power of money.

Expansionary
During times of slowdown or a recession, an expansionary policy grows economic activity. By lowering interest rates,
saving becomes less attractive, and consumer and borrowing increase.

Monetary Policy of RBI | Monetary Policy in India

Developing the Monetary Policy in India is a privilege of the Reserve Bank of India. Hence, it is also called the
Monetary Policy of RBI. The RBI is vested with this responsibility under the RBI Act, 1934.
The Monetary policy of RBI regulates the money supply, availability of credit and interest rates, also rbi uses it to
regulate the money supply to achieve the objectives of the economic plan.

Main Goal of Monetary Policy of RBI

The primary goal of monetary policy of RBI is to maintain price stability keeping in mind the objectives of the
economic plan. Price stability is extremely important for attaining sustainable growth. To maintain price stability,
inflation must be kept in check. RBI uses various monetary policy instruments to ensure that inflation is controlled.

Monetary Policy Instruments | Monetary Policy of RBI

These are monetary policy instruments that help in implementing the monetary policy in India.
1. Repo Rate: Repo rate is the rate at which RBI lends short term loans (less than 90 days) to commercial banks.
2. Reverse Repo Rate: Reverse repo is the rate at which the RBI keeps the extra deposit of all banks within itself.
3. Marginal Standing Facility (MSF): It is the rate at which banks borrow overnight loans from RBI..
4. Bank Rate: It is the rate at which RBI offers long term loans (more than 90 days) to commercial banks.
5. Cash Reserve Ratio (CRR): It is the ratio of the bank’s total deposit that every bank has to keep with the RBI. It
has to be in cash form only.
6. Statutory Liquidity Ratio (SLR): It is the ratio of the bank’s total deposit that a bank has to maintain with itself. It can
either be in cash or in liquid assets including Gold, Foreign Currency, Government Bonds, etc.
7. Open Market Operations(OMO):It refers to the buying and selling of government securities between the RBI &
banks.
Fiscal policy in India: Fiscal policy in India is the guiding force that helps the government decide how much money it
should spend to support the economic activity, and how much revenue it must earn from the system, to keep the
wheels of the economy running smoothly.
In recent times, the importance of fiscal policy has been increasing to achieve economic growth swiftly, both in India
and across the world. Attaining rapid economic growth is one of the key goals of fiscal policy formulated by the
Government of India.

Main objectives of Fiscal Policy in India:

Economic growth: Fiscal policy helps maintain the economy’s growth rate so that certain economic goals can be
achieved.
Price stability: It controls the price level of the country so that when the inflation is too high prices can be regulated.
Full employment: It aims to achieve full employment, or near full employment, as a tool to recover from low
economic activity.

Importance of Fiscal Policy in India:

1. In a country like India, fiscal policy plays a key role in elevating the rate of capital formation both in the public and
private sectors.
2.Through taxation, the fiscal policy helps prepare a considerable amount of resources for financing its numerous
projects.
3. Fiscal policy also helps in providing a boost to elevate the savings rate.
4. The fiscal policy gives enough motivation to the private sector to expand its activities.
5. Fiscal policy aims to minimize the imbalance in the distribution of income and wealth.

What is meant by Fiscal Policy in India? Example of Fiscal Policy in India:

Through the fiscal policy, the government of a country controls the flow of tax revenues and public expenditure to
navigate the economy. If the government receives more revenue than it spends, it runs a surplus, while if it spends
more than the tax and non-tax receipts, it runs a deficit. To meet additional expenditures, the government needs to
borrow domestically or from overseas.Alternatively, the government may also choose to draw upon its foreign
exchange reserves or print additional money.
Eg- during an economic decline, the government may decide to open up its cash box (aka coffers) to spend more on
building projects, welfare schemes, providing business incentives, etc. The aim is to help make more productive
money available to the people, free up some cash with the people so that they can spend it elsewhere, and
encourage businesses to make investments. At the same time, the government may also decide to tax businesses
and people a little less, thereby earning lesser revenue itself.
Diff bet monetary & fiscal policy?
 2.7

Business cycles are characterized by boom in one period and collapse in the subsequent period in the economic
activities of a country. These fluctuations in the economic activities are termed as phases of business cycles.The
upward and downward fluctuations in the cumulative economic magnitudes of a country show variations in different
economic activities in terms of production, investment, employment, credits, prices, and wages. Such changes
represent different phases of business cycles.

1. Expansion:
The line of cycle that moves above the steady growth line represents the expansion phase of a business cycle. In the
expansion phase, there is an increase in various economic factors, such as production, employment, output, wages,
profits, demand and supply of products, and sales.

2. Peak:
The growth in the expansion phase eventually slows down and reaches to its peak. This phase is known as the peak
phase. In other words, peak phase refers to the phase in which the increase in growth rate of the business cycle
achieves its maximum limit. In the peak phase, the economic factors, such as production, profit, sales, and
employment, are higher, but do not increase further.here is a gradual decrease in the demand of various products
due to increase in the prices of input.

3. Recession:
As discussed earlier, in peak phase, there is a gradual decrease in the demand of various products due to increase in
the prices of input. When the decline in the demand of products becomes rapid and steady, the recession phase
takes place.
In the recession phase, all the economic factors, such as production, prices, saving and investment, start decreasing.
Generally, producers are unaware of the decrease in the demand of products and they continue to produce goods
and services. In such a case, the supply of products exceeds the demand.

4. Trough:
During the trough phase, the economic activities of a country decline below the normal level. In this phase, the growth
rate of an economy becomes negative. In addition, in the trough phase, there is a rapid decline in national income
and expenditure.In this phase, it becomes difficult for debtors to pay off their debts. As a result, the rate of interest
decreases; therefore, banks do not prefer to lend money.Thus, banks face the situation of an increase in their cash
balances.

5. Recovery:
As discussed above, in the trough phase, an economy reaches to the lowest level of shrinking. This lowest level is
the limit to which an economy shrinks. Once the economy touches the lowest level, it happens to be the end of
negativity and beginning of positivity
This leads to reversal of the process of business cycle. As a result, individuals and organizations start developing a
positive attitude toward the various economic factors, such as investment, employment, and production. This process
of reversal starts from the labor market.
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