Unit-1

1. Distinguish between stock variables and flow variables.

2.Mention two macroeconomic variables.
3) Difference between micro & macroeconomics.
4) Categories the following into stocks and flows: (i) Capital (ii) Saving
(iii) Gross Domestic Product (iv) Wealth (v) Losses.
5) Distinguish between open economy and closed economy.
1. Distinguish between the concepts of 'stock' and 'flow' in macroeconomic
theory.
(a) Stock: The stock refers to the level of a variable (at a particular point of
time). For example, the number of vehicles in a city, the amount of money in
the saving account (with any commercial bank) of a person, etc.
According to Richard G. Lipsey, a stock variable has no time dimension. That is
the stock variable is not expressed in terms of per hour or per day or per week
or per month, etc.
(b) Flows: A flow variable represents its quantitative changes per time period.
Hence, a flow variable must have a time dimension.
If it is stated that the income of a person is Rs. 5,000, then this is an
incomplete statement. The correct statement would be 'an income of Rs.5000
per week (or per month)
Difference between Stock and flows:
Stock Flow
A stock has no time dimension. A flow has a time dimension.
A stock is measured at a point of time A flow is measured per time period
(say, as on 31st , March, 2010) (say, per month, per week etc.)
A stock indicates the static aspects of A flow variable indicates the dynamic
an economy. aspects of an economy.
A stock often influence a flow, e.g. A flow variable also influence a stock
higher stock of capital would lead to e.g. greater flow of saving per year
higher flow of goods & services in an would result in higher investment
economy. and greater capital stock in a
country.
2. What do you mean by macroeconomics variables?
Macroeconomic variables are indicators or main signposts signaling the current
trends in the economy.
Like all experts, the government, in order to do a good job of macro-managing
the economy, must study, analyze, and understand the major variables that
determine the current behavior of the macro-economy.
There are 5 main macroeconomic variables:
(a) National Income
(b) Employment
(c) (Economic) Growth

1
 (d) Balance of Payments
(e) Inflation

3. Difference between micro & macroeconomics.

Microeconomics Macroeconomics
1. It is that branch of economics 1. It is that branch of economics
which deals with the economic which deals with aggregates and
decision making of individual averages of the economy, e.g.
economic agents such as the aggregate output, national income,
producer, the consumer, etc. aggregate savings and
investment, etc.
2. In microeconomics, the economic 2. In macroeconomics, the decision
decision making units (or the making units (or the player) are the
economics agents) are individual Central Planning Authority, the
consumers, individual producers etc. Central Bank (e.g. the Reserve Bank
of India) etc.
3. It takes into account small 3. It takes into consideration the
components of the whole economic. economy of any county as a whole.
4. It deals with the process of price 4. It deals with the general price level
determination in case of individual in any economy.
products and factors of production.

4. Categories the following into stocks and flows (with brief justification):
(i) Capital (ii) Saving (iii) Gross domestic Product (iv) Wealth (v) Losses
(i) Capital: Capital is a stock variable because it is a quantity measured at a
particular period of time.
(ii) Saving: Saving is a flow variable because it is a quantity measured over a
specified period of time (If it is given as savings, then it will be considered a
stock concept which accumulates money at a particular point of time).
(iii) Gross domestic product: Gross domestic product is a flow variable
because it is a quantity measured over a specified period of time.
(iv) Wealth: Wealth is a stock variable because it is a quantity measured at a
particular period of time. It includes accumulated past savings and income not
spent.
(v) Losses: Losses is a flow because losses are always with reference to a time.

5. Distinguish between open economy and closed economy.

An economy that does not involve in overseas trade is known as the
closed economy and an economy having
participation in the international integration in the form of trade and flow of
capital as well as other resources is known as an open economy. The major
differences between a closed economy and an open economy are shown

2
below.
Basis Closed economy Open economy
Socio- A closed economy has no An open economy has a socio-
economic socio-economic relation with economic relationship with the
relationships the world economy. rest of the world sector.
Economic The closed economy follows The open economy follows the
Guidance the guidelines of the plans of principles and guidelines of
the central government. the market economic system
Trade scope Only domestic output is It keeps trade association with
traded inside the country and many countries of the world
there is the complete absence economy.
of international trade.
Borrowing This economy neither This economy borrows and
and lending borrows nor lends. lends
Flexibility A closed economy is rigid. An open economy gives & take
foreign aids & loans.

Unit-2
1. What do you mean by GDP deflator?
2) What do you mean by Real GDP & Nominal GDP? Difference?
3) What is meant by circular flow of income in two sector and three Sector
economy?
4)Expenditure method of a calculation GDP.
1. What do you mean by GDP deflator?
GDP Deflator:-
𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
Real GPP =
𝑃𝑟𝑖𝑐𝑒 𝐼𝑛𝑑𝑒𝑥
 100

𝑃𝑟𝑖𝑐𝑒 𝐼𝑛𝑑𝑒𝑥 ×𝑅𝑒𝑎𝑙 𝐺𝐷𝑃

Or, Nominal GDP =
100

𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃
Or, GDP Deflator (Price Index) =
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
 100

Example:-
Nominal GDP (2023-CY) = 250 (₹)
Real GDP (Base year - 2015) = 200 (₹)
250
= × 100 = 125
200
↓
Price Index
125-100 = 25%
↓
Inflation
(It is a ratio of GDP at current price & GDP at constant price,

3
GDP deflator is measured of the level of prices of all new final goods & services
in an economy.
The deflator measures the change in prices that has occurred between
the base year and the current year. Since, GDP deflator is based on a
calculation involving all the goods produced in an economy, it is a widely based
Price index that is frequently used to measure Inflation.

Let us see how money flows from firms to households and from
households to firms. This can be show with the help of flow chart. There are
four factors that are required for productions i.e. land, labour, capital &
organization. The firms get these inputs from the members of households. For
example, owner of land gets rent in exchange from the firms. Supplier of labour
gets wage from the firm. Owner of capital gets interest & the organizer (owner)
of the firm gets profit. Thus, a flow of factors of production from households to
firm continues and in return a flow of money from firms to households
continues.
Again, firms produce commodities and sell them in the market and
households spend their money to purchase it. The expenditure of the
households is the income of the firms. There are flows from firms to household
& households to firm and it is called circular flow. This can be explained by
following flow chart:
How money flows in this circle is clear from above figure. Since the
starting point and the final point are the same, this is called a circular flow.
Households' expenditure on goods & services

2.What do you mean by Real GDP & Nominal GDP? Difference?

Real GDP Nominal GDP

1) It refers to market value of final
goods & services produced in a
country during on year measured at
price of base year.
2) It is a better tool for measuring the
economic growth of a country.
3) It can increase only when output of
goods & services rise in current year.
4) It is also called National Income
constant price.
1) It refers to market value of final
goods & services produced in a
country during an year, measured at
price of current year.
2) It is not a good tool for measuring
the economic growth of a country.
3) It can rise either when output of
goods & services rise or when current
price rise .
4) It is called National Income at
current price,

4
 Comparison between Nominal and Real GDP
Basis Nominal GDP Real GDP
Meaning Value of all the goods and Value of all the goods and
services produced by an services produced by an
economy at current market economy, its investments,
prices. government spendings and
exports.
GDP Data The value of the total product The value of the total product
is seen to be higher because it appears low because inflation
does not reduce inflation. is reduced in it.
Reliability Less reliable in comparison to More reliable in comparison to
Real GDP. Nominal GDP.
Worth High Low
Uses Compares different quarters of Compares two or more FY.
an FY
Financial Analyzing is difficult Analyzing is easy
Growth
Size of 2.93 trillion dollars (2019) Rs.1,40,77,586 Lakh Crores
India's (2018-19)
economy
India's Fifth-largest in the world. Data Unavailable
position in
the world

5
3) What is meant by circular flow of income in two sector and three Sector
economy?
It refers to cycle of generation of Income in the production process. It's
distribution among the factors of production and finally, it's circulation from
households to firms in the form of consumption expenditure on goods and
services produced by them:
1

Factor of production

Land, Labour', capital,

entrepreneur Rent: wages,
interest, profit

2 Firm
Households

3
Flow of goods & Services

Household expenditure
on goods & services

A circular flow of Income is observed between household holds and firms

in the economic activities of a count circular flow is called the circular flow of
income. In order to understand the mutual relationship between the different
basic units, we make the following assumption..
i) Decisions of economic activities in the society are taken by two closes:
households & firms.
ii) Production takes place only in firms. The goods produced by firms are sold
to the members of households.
iii) Members of household supply different factors & receive income in lieu of it.
iv) Members of household purchase goods / services from firms / Govt, who in
this activity earns money.

6
THE THREE SECTOR MODEL: Introducing the Government Sector
In the two sector model, we have illustrated how goods, services, and
factors of production move between households and firms. Let us now
introduce the government sector into this flow. The government spends on the
purchase of goods and services and also provides subsidies, grants, and aids.
The government also employs factor services from the households and
makes payment for them. The salaries received by government servants are
part of it. In this model, the entire earning of the firms is not coming from the
sales in the household sector. A part of it is coming from the government as
payments from goods and services or subsidies or grants. Similarly for
households, the entire income earned by the sector does not come from the
firms as part of it is obtained from the government sector. Thus, the
expenditure made by the government sector can be seen as injection in the
circular flow as it is not coming from either the household sector or the firm
sector.
The government makes the expenditure from the revenue it earns from
taxes and other sources. It collects taxes from both firms and households.
Thus part of the income of the households is flowing to the government sector
instead of going to the firms as payments for goods and services. Similarly, a
part of the earnings of the firms is going to the government as taxes and not to
the households. Thus, this can be viewed as leakage from the system.

Goods and services

Payments for goods and services

Tax payment Tax payment

Firms Government Households

Govt. expenditure Govt. expenditure

Payments for factor services

Factor services

4)Expenditure method of a calculation GDP.

Expenditure Method:-
The expenditure method of measuring national income is also called
income disposal Method or final expenditure method of consumption and
investment Method. According to this method national income is measured in

7
terms of expenditure on purchase of final goods and services produced in the
economy during an accounting year.
Step 1:- Identification of Economic units which incur final Expenditure":""
- household sector.
- Firm Sector
- Govt. Sector
- Rest of the world
Step 2 :-
ii) classification of final expenses
a) Private final consumption Exp. (C)
↳ Food, Education, Health, cloth.
+
Non-profit organization.

(b) Govt. final consumption Exp. (G)

Law & order, Health & education, defense

(c) gross domestic. capital Formation (Investment). I

Gross Domestic Fixed capital Inventory Investment

Formation or
change in stock.
(Closing Stock - Opening Stock)
d) Net export = (Export - Import) = (X – M)
Step 3
Calculation of 𝑮𝑫𝑷𝑴𝑷 = = C + G + I + (X-M)

Step4
Calculation of National Income.
𝑁𝑁𝑃𝐹𝐶 = 𝐺𝐷𝑃𝑀𝑃 -NIT – NFIA - Depreciation

Precautions involved in this Method

i) Transfer payment like scholarship, old age pension etc. > Not included.
ii) Final expenditure → Included.
iii) Intermediate Expenditure → Not included.
iv) Expenditure on purchase of second hand goods → Not included.
v) Expenditure on shares & Bonds = Not Included.
vi) Imputed value of owner self-occupied house → Included.
vii) goods purchased produced for self-consumption = Included.

8
viii) service produced for self-consumption = Not included.

i) Identification of Economic units which incurs final expenditure.

- Household Sector
- Firm Sector
- Govt. Sector
- Rest Of World
ii) Classification of Final Expenses.
a) Private final consumption Exp. (C)
↳ Food, Education, Health, cloth.
+
Non-profit organization.

(b) Govt. final consumption Exp. (G)

Law & order, Health & education, defense

(c) gross domestic. capital Formation (Investment). I

Gross Domestic Fixed capital Inventory Investment

Formation or
change in stock.
(Closing Stock - Opening Stock)
d) Net export = (Export - Import) = (X – M)
iii) Calculation of 𝑮𝑫𝑷𝑴𝑷 = = C + G + I + (X-M)
↳ Food, Education, Health, Cloth.
+
Non- Profit Organization.

Unit-5
1. What is inflationary gap? Diagrammatically explain the concept of inflationary
gap.

9
2.What do mean by natural rate of unemployment? Do you think that full
employment means zero unemployment? Explain the concept of frictional
unemployment.
3. Distinguished between Deemed – Pull and Cost – Push inflation. Briefly explain
the theory of Cost – Push inflation.
4. Explain the concept of High – Powered Money. Derive the money multiplier in
this context.
5. Distinguish between narrow money and board money.
6. (a) Explain the different concepts of inflation.
(b) Discuss the Different measures of controlling inflation.
7) Examine how far fiscal policy is more effective than monetary policy in
combatting a recessionary situation.
8) What do you mean by voluntary and involuntary unemployment?
9)Explain the concept of Frictional Unemployment.

1. What is inflationary gap? Diagrammatically explain the concept of inflationary

gap.
(Concept Note)
Excess Demand: - If refers to a situation when aggregate Demand is more than
the aggregate supply (AS) correspond to full employment level of output in the
economy. Excess Demand = AD>AS (at equilibrium level)

Y Inflationary gap AS (Y)

AD1 (Actual 12000 cr.)

E AD (Planned 10000 cr.)

O Q X Income/output/employment

Equilibrium level of output = Q.

Inflationary gap:-
Inflationary gap refers to a gap by which actual aggregate demand
exceeds the aggregate Demand required to be establish at full employment
equilibrium.
In the above diagram Income /output/ Employment measured at X axis
and AD is on y axis. Both AD & AS curve are intersect to each other at point E,
which indicates full.. employment equilibrium due to increase in Investment ∆I

10
AD rises AD to AD1 it denotes the situation of excess demand and the gap
between them is terms as inflationary gap.
What is Inflationary Gap?
According to Prof. Keynes, at full employment level of income, if the total demand for
commodity is greater than the total supply of commodity then that excess demand for
commodity is called inflationary gap i.e. inflationary gap is the difference between total demand
for commodity and total supply of commodity at full employment level of income.
According to Prof. Keynes equilibrium level of income is determined where total demand
in the country is equal to total supply of that country. Total supply of commodity of a country
is the total national income or total income (Y) of the country due to equality of national income
and national product. To determine the total demand of the country three sectors economic
system is considered. These three sectors are households who incur consumption expenditure
(C) i.e. make demand for consumption goods, firms or production units who make investment
(I) i.e. make demand for capital goods and the government sector which incur government
expenditure (G) i.e. make demand for consumption goods and capital goods. So here total
demand of the society or country is C+I+G. So it can be said that equilibrium level of income is
determined where
Total Supply = Total Demand
i.e. Y = C + I + G.
With the help of Figure inflationary gap is analyzed.

E
Consumption
Expenditure (C),
Investment
Expenditure (I), C+I+G
Government H C+I
Expenditure (G) A
C

45° Total Income (Y)

D F
In Figure total income (Y) is measured on the horizontal axis. On the other hand, consumption
expenditure (C), investment expenditure (1) and government expenditure (G) are measured on
the vertical axis. In the diagram OE is the 45° line. This OE line (45° line) is the total income (Y)
line i.e. total commodity supply curve of the economy or country. In the diagram C is the
consumption expenditure curve, C+ I curve is the consumption expenditure + investment
expenditure curve and C+I+G curve is the consumption expenditure + investment expenditure
+ government expenditure curve. Thus C +I+G curve is the total expenditure curve of the
society i.e. C+I+G curve is the total demand curve of the society. So curve OE is the total
supply curve of the society and curve C+I+G is the total demand curve of the society.
From Figure, it is seen that C+I+G curve cuts the OE line at point H i.e. point H is the
equilibrium point because at point H equilibrium condition is fulfilled. From the diagram it is
seen that amount of total supply and the amount of total demand of the society both are equal

11
to FH. So it is necessary that the equilibrium level of income should be OF amount. Here it is
assumed that maximum amount of income at full employment level of income is OD. This
means that in the society it is not possible to increase the total level of income more than the
amount OD i.e. even though total demand of the society is C+I+G but it is not possible to
increase the total level of income of the amount OF. Here OD is the full employment level of
income. At this OD level of income total demand of the society is DB and the total supply of the
society is DA. So here the amount of excess demand is (DB-DA) AB. This AB is called
inflationary gap.
Price level of the country increases continuously or inflation occurs due to this
inflationary gap of the amount AB. So long as this inflationary gap exist up to that, total
demand of the society is greater than total supply of the society and due to the effect of this
excess demand price level continue to increase or inflation continues i.e. inflation in the
country continue so long as this inflationary gap exist.
Inflationary gap will be removed and inflation will stop if C + I + G curve shifts in the
downward direction and passes through the point A.
2.What do mean by natural rate of unemployment? Do you think that full
employment means zero unemployment? Explain the concept of frictional
unemployment.
Natural rate of unemployment?
The natural rate of unemployment, or NAIRU, represents the level of
unemployment inherent in a healthy, functioning economy. It includes
structural and frictional unemployment, reflecting the time It takes for people
to find suitable jobs and adjustments in the economy. When the actual
unemployment rate aligns with the natural rate, the economy is considered at
full employment. Policymakers use this concept to understand the normal state
of the labour market and to avoid the Inflationary consequences associated
with pushing unemployment below the natural rate. The natural rate serves as
a crucial benchmark for economic analysis and policy formulation.
Full employment means zero unemployment?
No, full employment does not necessarily mean zero unemployment. Instead,
full employment is a state where the economy is operating at Its potential
output, and the unemployment rate is at its natural or equilibrium level. This
level of unemployment includes frictional and structural unemployment, which
are considered normal in a dynamic economy.
Frictional unemployment occurs as individuals transition between jobs or
enter the workforce, while structural unemployment arises due to shifts in the
economy's structure, rendering some skills obsolete. These types of
unemployment are generally unavoidable and do not imply economic
Inefficiency.
Therefore, full employment acknowledges the existence of some level of
unemployment that is consistent with a well-functioning, dynamic labour
market. It provides room for job turnover, voluntary transitions, and
adjustments within the economy while maintaining stable inflation and

12
overall economic health.

3. Distinguished between Demand – Pull and Cost – Push inflation. Briefly

explain the theory of Cost – Push inflation.
From theoretical point of view differences between demand-pull inflation and cost-push
inflation are stated below-
DEMAND PULL INFLATION DEMAND-PUSH INFLATION
(a) Considering aggregate supply of the (a) Increasing tendency in general price level
commodities in the economy unchanged. due to increase in cost of production
Increase in aggregate demand in the (especially wage cost) of the firms as a whole
economy creates excess demand that leads to results in cost-push inflation.
a rising price tendency generally called
demand-pull inflation.
(b) In case of demand-pull inflation (b) But due to increase in cost of production.
producers are encouraged to increase their producers are highly discouraged to conduct
production. In such a situation demand for their production process as usually due to
the factors are increased which leads to low profitability. It leads to a reduction in
increase in factor total production and hence total supply of
prices. commodities also reduced.
(c) Under demand-pull inflation existence of (c) But in case of cost-push inflation
full employment of resources is an important existence of full employment is not an
Criterion. important condition.
(d) Under demand-pull inflation, it is (d) On the other hand, cost-push inflation
assumed that On the other hand, under cost- aggregate demand for the commodities in the
push inflation. cost of production remained economy assumed to be fixed.
unchanged.
(e) Diagrammatically demand-pull inflation, (e) On the other hand, in case of cost-push
can be explained with the help of rightward inflation can be explained with the help of
shit in the aggregate demand curve keeping leftward shift in aggregate supply curve with
aggregate supply curve unchanged. unchanged aggregate demand schedule.
(f) Under demand-pull inflation excess (f) On the other hand, in case of cost-push
demand for commodities pulls up the price inflation higher cost of production pushes
level from above. Due to this it is termed as the general price level up. Due to this such
demand-pull inflation an inflationary situation is termed as the
cost-push inflation.
(g) Demand-pull inflation may lead to (g) On the other hand, cost-push inflation
galloping inflationary situation if not checked may lead to economic stagflation in the
at the initial stage. economy if not properly controlled.
(h) In case of demand-pull inflation both (h) But, in case of cost-push inflation neither
fiscal and monetary measures are effective to fiscal nor monetary measures but the other
check inflationary pressure. measures are effective to check inflationary
pressure.

 Cost Push Theory of Inflation: If the price level of the country rises continuously as a result
of increase in cost of production due to increase in the prices of the factors of production then
that situation is called cost push inflation. Though cost of production increases due to increase
in the prices of factors of production but according to the modern economist price of labour i.e.
wage rate is most important among the prices of factors at production. According to them,
nowadays trade unions are so strong that they can increase the wage rate by giving pressure
upon the owner. If the wage rate increases at a greater rate due to trade unions pressure than
the rate of increase in productivity of labour then cost of production increases as a result of

13
increase in that wage rate. If price level rises continuously as a result of increase in cost of
production due to that wage increase then it is called cost push inflation. Fig. 5.4. is used to
explain cost inflation. །
In Fig. 5.4. amount of commodity is measured on the horizontal axis and price le is
measured on the vertical axis In the diagram OS is the amount of production at full
employment level. Here S1AS0 is the primary supply curve. The portion S1A of this supply
curve is upward rising, this is because before full employment supply of commodity increases
as price level increases. Further the portion AS0 of the supply curve S1AS0 is parallel to price
level axis, this is because at full employment level amount of production and supply of
commodity remain fixed (OS). As a result amount of production and supply of commodity
remain constant even though the price level increases after full employment. In the diagram
DD1 is the total demand curve of the society. From the diagram it is seen that total demand
curve of the society DD1, and total supply curve S1AS0 intersect each other at point E1. Here
the point E1 is the equilibrium point. Here the equilibrium price is OP 1 and the equilibrium
amount of commodity is OM1 which is less than the amount of commodity (OS) at full
employment level.
Price Level S0

A
D

E2
P2
P1 E1 D1
S2

S1
O M 2 M1 S Amount of Commodity

Fig. 5.4.
If the wage rate increases due to trade union pressure but the productivity of labourer
remain the same, then cost of production rises and the production unit claim higher price than
before for the same amount of commodity. As a result supply curve shifts to the left. From the
diagram it is seen that as a result of increase in cost of production due to trade union pressure
total supply curve shift to the left from S1AS0 to S2BS0. From the diagram it is seen that new
supply curve S2BS0 intersect the fixed demand curve DD1 at point E2. Here E2 is the new
equilibrium point and the equilibrium price level is OP 2 and the equilibrium amount of
commodity is OM2. So here equilibrium price level increases from OP1 to OP2 and the
equilibrium amount of supply decreases from OM21 to OM2. Cost of production trend to
increase as the wage rate increases due to trade union pressure. As a result total supply curve
continuously shift to the left. But due to unchanged total demand curve price level increases
continuously. This increase in price level is called cost push inflation. So it is seen that before

14
full employment level, demand remain constant, due to wage increases, cost of production rises
and as a result price level increases which is the cost push inflation.
Here it may be mentioned that trade unions and the production units enjoy high power
to control market. For this they directed the wage rate and price level for their own interest. For
this cost inflation is called administered price inflation.
According to Prof. Samuelson, cost push inflation occurs by the admixture of price
increase. According to him at first price of the commodity increases, as a result trade unions
give pressure for wage increase. Ultimately cost inflation occurs as a result of increase in cost
of production due to wage increase.

There are some criticisms against this cost push theory of inflation. Main criticisms are:
(1) In this theory it is assumed that trade unions can increase wage rate i.e. in the labour
market perfect competition does not exist. But if perfect competition exist in the labour market
then wage rate can increase only when excess labour demand exist in the labour market. So
trade unions cannot increase wage rate if there is no excess demand in the labour market. So if
perfect competition exist in the labour market then only one inflation can exist, that is the
demand pull inflation and not cost push inflation.
(2) If the amount of money supply and government expenditure remain constant the price of
the commodity which is increased as a result of increase in cost of production due to wage
increase through trade unions pressure cannot be continued for a long time. If the amount of
money supply and government expenditure remain constant, the demand for commodity
decreases along with the increase in price level. As a result amount of production and supply
trend to reduce and the number of unemployment in the economy trend to increase. Increase
in wage rate and increase in price level will stop as a result of increase in number of
unemployment. So as a result of wage increase price level cannot increase without any
obstacles if the amount of money supply and government expenditure do not increase along
with the increase in wage rate. For this it is said that cost inflation cannot occur without the
support of the government.
4. Explain the concept of High – Powered Money. Derive the money multiplier in
this context.
High Powered Money - explanation.
Ans. There is two factors in the determination of money supply in the economy.
1) High Powered Money (H) → Denoted by H.
It consists →
• Cash reserves with the Commercial Banks.
• Currency held by the public.
• Required Reserves of the commercial Banks to be maintained with the
RBI.
H = C + RR + ER

when, H = The amount of High Powered Money,

C = Currency held by the public.
RR = Cash Reserves of currency with the Banks.
ER = Important Reserves & other Reserves.

15
Derivation of Money Multiplier
A degree by which total quantity of money supply is changed as a result of
change in High Powered Money is called Money Multiplier.
𝑀
m=
𝐻
M = m. H

Economist Prof. Milton Friedman & S. Sober → Money Supply → equation:-

M = C + D ……….. (i)
H = C + R ........... (ii)

M = Total quantity of Money supply.

H = High Powered Money;
C = Currency held by the public.
D = Demand Deposit of people with commercial Banks.
R = Cash Reserve of currency with the Banks, Important Reserve.

(i) ÷ (ii)
𝑀 𝐶+𝐷
= …………… (iii)
𝐻 𝐶+𝑅
𝐶+𝐷 𝐶
𝑀 𝐷 +1
= 𝐶+𝑅 = 𝐷
𝐶 𝑅 ….…..(iv)
𝐻 +
𝐷 𝐷
𝐷

𝐶
= cash deposit Ratio [K]
𝐷
𝑅
𝐷
= Reserve Deposit Ratio [r]

𝑀 𝑘+1
=
𝐻 𝑘+𝑟
𝑘+1
M = H.
𝑘+𝑟
M = H. m
m = Money Multiplier
1+𝑘
= 𝑟+𝑘

5. Distinguish between narrow money and board money.

What is Narrow Money
Narrow money is a category of money supply that includes all physical money such as coins
and currency, demand deposit and other liquid assets held by Central Bank. M1 or m0 are
used to describe narrow money. Narrow money is a subset of broad money. This category of
money is considered to be the most readily available for transaction and commerce. "the

16
narrow money definition of money supply is a measure of valuable coin and notes in circulation
and other Mani equivalent that are easily. convertible into cash such a short term deposit in
the banking system".

What is Broad Money

Broad money is a measure of total amount of money held by household and company in the
economy. Broad money is made up of commercial Bank deposit. The sum of M1 and time.
deposit is called broad money. In other words, M2, M3, M4 qualify as broad money and M4
represent the largest concept of money supply. These are often referred to as long term time
deposit because their activity is restricted by specific time requirement. "In economics, broad
money is a measure of the amount of money, or money supply, in a national economy
including both highly liquid "narrow money" and less liquid forms.

Narrow Money Broad Money

1. It is denoted by 𝑀1 1. It is denoted by 𝑀3
2. It is the aggregate of malefic coin, 2. It is the aggregate of 𝑀1 and term
paper note, current deposit or deposits of or fixed deposits (TD)
demand deposit with bank and other So, 𝑀3 = 𝑀1 + T.D..
deposits with the central bank. Or,
So, 𝑀1 = C + DD + OD 𝑀3 = C + DD +0D+TD.
3. It's volume is lower. 3. It's volume is comparatively larger.

6. (a) Explain the different concepts of inflation.

(b) Discuss the Different measures of controlling inflation.
■ Concept of Inflation:
Economists are divided regarding the concept of inflation. Different economist give
different definition or concepts of inflation at different times. Classical economist Hautrey gives
the definition of inflation on the basis of quantity of money. According to Prof. Hautrey
inflationary situation is that economic situation in which supply of money is greater than the
supply of commodities. Prof. Pigou gives the definition of inflation on the basis of income-
expenditure. According to Prof. Pigou inflation is that economic situation in which money
income increases at a greater rate than the production of commodities. According to Prof.
Koolburn, inflation is that economic situation in which too much money chasing on too few
goods. According to Prof. Crowther inflation is that economic situation in which price level
increases continuously. According to Prof. Keynes inflation is that economic system where
effective demand of the society is greater than the supply of commodities of the society.
According to Prof. Samuelson tendency to increase price level is noticed when total
expenditure of the society or total purchasing power of the society is greater than the total
production of commodities of the society or total supply of commodities of the society.
On the basis of the definition of inflation given by different economist it can be said that
price of majority commodities of any country when increases continuously then that situation
is called inflation i.e. when general price level rises continuously then the situation which is
created is called inflation.

■ Different Types of Inflation: Price of majority commodities of any country when increases
continuously then that situation is called inflation i.e. when general price level rises
continuously than the situation which is created is called inflation.

17
Inflation is of different types. Here we discuss important types of inflation:

(1) Classification of Inflation according to cause

Inflation can be divided into different groups according to the causes of inflation.
(a) Currency Inflation
If the price level of the country rises continuously as a result of increase in circulated
paper currency of the economy then that situation is called currency inflation.
(b) Credit Inflation
If the price level of the country rises continuously as a result of excess quantity of bank
credit or bank deposit then that situation is called credit inflation.

(c) Deficit Induced Inflation

The process of meet up excess expenditure of the government through printing new
through bank loan when total government expenditure is greater than total government income
is called deficit financing. If the price level of the country rises continuously as a result of
excess deficit financing then that situation is called deficit induced inflation.
(d) Wage Induced Inflation
If the price level of the country rises continuously as a result of increase in rate in
comparison to marginal productivity of the labourer due to trade union pressure or due to
other causes then that situation is called wage induced inflation. Prof. Pigou is the pioneer of
wage induced inflation.
(e) Demand Inflation
If the price level of the country rises continuously as a result of increase in demand for
commodities but supply remain constant then that situation is called demand inflation.

(f) Cost Inflation or Sellers' Inflation

If the price level of the country rises continuously as a result of increase in cost of
production due to increase in the prices of the factors of production (land, labour etc.) then
that situation is called cost inflation or sellers' inflation.
Prof. A. P. Lerner and Prof. Samuelson give advanced explanation of cost inflation.
According to them price of the commodity first increases and as a result of this trade unions
give pressure for wage increase and ultimately cost inflation occurs due to increase in cost of
production.

(2) Classification of Inflation according to Speed

Inflation can be divided into different groups according to the speed of increase in price
level.
(a) Mild or Creeping Inflation
If the price level of the country rises at a very slow rate then that situation is called mild or
creeping inflation. But there is no hard and fast rule regarding the annual rate of rise in price
level to become treated it as mild inflation or creeping inflation.
(b) Walking Inflation or Trotting Inflation
If the price level of the country rises continuously and that become acute then that
situation is called walking inflation or trotting inflation. But there is no hard and fast rule
regarding the annual rate of rise in price level to become treated it as walking inflation or
trotting inflation.
(c) Galloping Inflation or Hyper Inflation

18
If the price level of the country rises continuously at a rapid rate then that situation is called
galloping inflation or hyperinflation. But there is no hard and fast rule regarding the annual
rate of rise in price level to become treated it as galloping inflation or hipper inflation.

(3) Classification according to possibility of Inflation or classification according

to Control of Inflation
Inflation can be divided into different groups according to possibility of inflation
or according to control of inflation.
(a) Disguised Inflation or Latent Inflation
The economic situation created due to scarcity of commodity or due to different restrictions of
the government, the people of the country cannot collect commodity in spite of the saving of
large amount of liquid cash at their hands is called disguised inflation or latent inflation. This
is called disguised inflation because the purchasing power of the people exist in disguised
condition even though the saving of large amount of liquid cash at their hands i.e. inflation will
self-revelation as soon as getting chance through the expenditure of that money.
(b) Open Inflation
When the price level of the country rises continuously and the government of the
country or monetary authority (Central Bank) does not take any measures to control the rise of
that price level then the price level of the country rises freely. The situation which is created
due to this is called open inflation.
(c) Suppressed or Repressed Inflation
When the price level of the country rises continuously and the government of the
country or monetary authority takes necessary action (e.g. price control and rationing) then the
price level of the country cannot freely rise. The situation which is created due to this is called
suppressed or repressed inflation.
(4) Classification of Inflation According to Prof. Keynes
Prof. Keynes divides inflation into two groups.
(a) True Inflation or Full Inflation or Pure Inflation
Supply of commodity remain fixed when the country is in full employment situation. In
this situation price level of the country rises continuously as the demand for commodity
increases. The situation which is created due to this is called true inflation or full inflation or
pure inflation.
(b) Partial Inflation or Falls Inflation or Semi Inflation
When the country is in underemployment situation then due to scarcity of any ation
factors of production, the price level of country rises in the short run. The situation which is
created due to this is called partial inflation or falls inflation or semi inflation.

 Stagflation: According to prevailing theory pure inflation occurs at full employment

situation. But at present, price level of the country rises regularly in most of the country before
the arrival of full employment level (i.e. the factors of production of the country unemployed)
i.e. inflation and stagnation co-exist. According to the word of Prof. Samuelson, stagflation of
economic growth and employment, at the same time the prices are rising is called stagflation
i.e. in this situation national income of the country does not rise-economic system become
confined, employment of the Country does not increase yet price level rises regularly.

Main causes of stagflation are:

(1) Insufficient and slow rate of economic growth due to deficit or irregular supply of important
factors, lack of sufficient amount of demand in the market etc.

19
(2) Cost of production rises as a result of sellers' inflation due to increase in price of other
inputs along with wage rate. But necessary amount of employment and production do not rise
due to slow rate of economic growth.
Due to these reasons unemployment in factor of production, commodity deficit etc.
are seen in one side and on the other side price level rises regularly. This is the stagflation
which in now converted into malediction of the world. In India along with other countries of the
world this problem is acute.
(b)The different measures used for controlling inflation are explained below.
A: Monetary measures:
If the supply of money in the economy can be decreased, prices are expected to fall. The
quantity of money and the price level change in the same direction. Hence, if the quantity of
money decreases, the price level will fall. If we can reduce the rate of lending by banks, then we
can reduce the total supply of money significantly. The Central Bank of a country can reduce
the lending of commercial banks in different ways.
Quantitative credit control:
(a) Bank rate: The bank rate is that discount rate at which the Central Bank of any country
rediscounts any bill of exchange submitted by any commercial bank to take loans from
the Central Bank.
(b) Open market operations: This indicates the purchase and sale of Government securities
or treasury bills by the Central Bank At the time of inflation, the Central Bank sells
Government securities in the open market to pump out some amount of money from
circulation However, the open market sale has been pursued by the RBI to check
continuous expansion of liquidity with the banking sector. The success of this policy
instrument depends on an organized bill/security market.
(c) Cash reserve requirements: Every commercial bank has to keep a certain minimum
cash reserve with the Central Bank. The RBI increases this cash reserve requirement
during inflation With a rise in the cash reserve requirements, the amount of loanable
funds with the commercial banks declines. Thus, the process of credit creation by the
commercial banks is checked.
(d) Statutory Liquidity Ratio (SLR): In addition to the CRR, the commercial banks are often
required to maintain a given portion of their total liquid assets with the Central Bank. This is
known as SLR. The SLR is raised for combating the inflationary pressure.

B: Fiscal Measures:
An inflationary gap arises when aggregate demand exceeds the maximum potential supply in
an economy. To overcome this situation, the following types of fiscal measures can be
undertaken:
(a) A decrease in the Government expenditure, or.
(b) A decrease in the Government transfer and subsidy payments.
(c) An increase in taxes imposed by the Government, or
(d) A combination of all these measures.
These are regarded as contractionary fiscal policies. These contractionary fiscal policies reduce
the employment and income opportunities within the economy. For instance an increase in the
tax rate reduces the disposable income of the consumers. Hence, these policies restrict the
growing demand for goods and services within the economy, and help in contracting the
inflationary pressure.
7) Examine how far fiscal policy is more effective than monetary policy in

20
combatting a recessionary situation.

Ans:- The effectiveness of fiscal policy versus monetary policy In combating a

recessionary situation depends on various factors and the specific
circumstances of the economy. Here are some considerations:
1. Fiscal Policy:-
Direct Impact on Demand: Fiscal policy involves government spending
and taxation. During a recession, increased government spending (stimulus
packages) or tax cuts can directly boost aggregate demand, as consumers and
businesses benefit from increased disposable income.
Targeted Measures: Fiscal policy allows for targeted interventions, such
as infrastructure projects or social programs, which can have a more
Immediate Impact on employment and income distribution.
Crowding Out: Critics argue that Increased government spending might
lead to higher interest rates and crowd out private Investment, potentially
limiting the overall effectiveness of fiscal measures.
2. Monetary Policy:
Interest Rate Adjustments: Central banks use monetary policy to
influence interest rates. Lowering interest rates encourages borrowing and
spending by making credit more affordable. This can stimulate investment and
consumption.
Flexible and Quick Implementation: Monetary policy adjustments can
be implemented relatively quickly compared to fiscal measures, allowing for
rapid responses to changing economic conditions.
Limits in the Zero Lower Bound: In situations where interest rates are
already very low (near zero), the effectiveness of further rate cuts may be
limited, leading to the need for unconventional measures like quantitative
easing.
3. Coordination: In some cases, a combination of fiscal and monetary policies
might be more effective. When both policies work in tandem, they can reinforce
each other's impact on the economy.
4. Expectations and Confidence: Both fiscal and monetary policies can
Influence expectations and confidence in the economy. If businesses and
consumers believe that policies will be effective, it can positively impact their
behavior.
In summary, the effectiveness of fiscal policy versus monetary policy in
combating a recession depends on factors like the severity of the recession, the
flexibility of the policies, and the existing economic conditions. In practice, a
combination of well-coordinated fiscal and monetary measures is often
considered a comprehensive approach to address recessionary challenges.

21
8) What do you mean by voluntary and involuntary unemployment?
Voluntary Unemployment and Involuntary Unemployment : Generally there are two types
of unemployment in every economy. One is voluntary unemployment and the other is
involuntary unemployment. A person is said to be voluntarily unemployed if he is not willing to
work at the existing wage rate even if he gets the job. On the other hand, a person is said to be
involuntarily unemployed if he fails to get a job at the prevailing wage rates. The main
problems of unemployment in an economy is the problem of involuntary unemployment.

Following are the differences between voluntary and involuntary unemployment.

Voluntary unemployment Involuntary unemployment.

Voluntary unemployment refers to a
situation where a person who is able to work
remains unemployed due to his/her own
willingness,, perhaps just for a short period
of time
Under this situation, the person remains
unemployed despite jobs being available in
the market
Willful unemployment
Laziness, obsession with wealth
No serious Economic Problem
Involuntary unemployment refers to a
situation where a person who is willing and
is able to work does not get work at the
existing wage rate.
Under this situation, the person remains is
unemployed due to non-availability of jobs in
the market.
Forced Unemployment
Willing for fork, looking for job but does not
find the Job
Caused by economic issues.

Concept Note

Measures to correct Excess Demand

Fiscal Policy Monetary Policy

↓ ↓
These policy is framed These policy is framed
by central govt. by central Bank
i) Decrease in govt spending.
ii) Increase in taxes.

quantitative Method qualitative Method

i) Increase in i) Increase in
Bank Rate. Margin Requirement
ii) Increase in Repo rate ii) Advice to discourage
lending.
iii) sale of securities. iii) credit rationing
iv) Increase in LRR iv) under SCC.

22
1) Fiscal Policy:-
Those policies & roles which is made by govt. is called Fiscal Policy.
i) Decrease in gout spending : Govt. spends huge amount on its
infrastructural and administrative activities to control the situation of excess
demand.
Govt. should reduce its expenditure on maximum possible, extent which would
result reduce the level of AD in the com economy and help to correct
inflationary pressures in the economy,

Reduce the amt. spending infrastructural Activities

↓
circulation of money reduce
↓
Reduce the income level
↓
Excess of Aggregate demand controlled.

ii) Increase in Taxes:- During excess Demand, Govt. increases the rate of
Taxes and even imposes some new taxes. It leads to decrease in the level
of Aggregate expenditure in the economy and helps to control the situation of
excess demand.
Before After
Tax Rale = 10%. Tax Rate = 20%
Income =10,000 Income = 10,000

Income = 10,000 Income = 10,000

(-) Tax = 1,000 (-) Tax = 2,000
Disposal Income- 9,000 Disposal Income- 8,000

2) Monetary Policy:
The RBI is empowered to regulate the money supply in the economy
through Monetary Policy.
i) qualitative Instrument:- These instruments aim to influence the
total volume of credit in circulation.

open market Legal Reserve

Bank Rate
Ratio CRR/SLR.
& Repo operations
Rate
23
Bank Rate:- It is the rate at which the central bank of a Country (RBI) lends
money to the commercial Bank for short term credit.

₹ ₹

Commercial
X Bank
Bank
Int. @10% Int. 18%

Short Bank Rate Long Repo Rate

Open Market operations: It refers to sale and purchase of securities in the open
market by central Bank.
During excess demand, central Bank offers securities for Sale of
securities reduce the reserve of Commercial Bank. It adversely affects the
Bankers ability to create credit & decrease the level of AD.

Public
Central
Bank

Commercial
Bank

Legal Reserve Ralio:- Each commercial bank Kept a certain amount of money
from the deposit as a Reserve.

24
 Legal Reserve Ratio

CRR SLR
• It refers to the minimum %
of net demand & time
• It is the minimum %
liability which commercial
of net demand & Time
banks are required to
liability, to be kept by
maintain with them- selves.
commercial bank with
the central bank.

Deposit LRR Lending Capacity

Case 1:- 100000 10% 90,000
Case 2:- 100000 20% 80,000

Reduce the purchasing power.


Excess demand are in Controlled.
An increase in LRR reduce the availability of credit which would result decline
in the purchasing power of the People & excess demand is controlled.
To correct the excess demand, the central Bank increases CRR/ SLR. It
reduces the amount of effective cash resources of Commercial banks.

It ultimately helps in reducing Credit availability in the economy.

qualitative Instrument: -
These instruments aim to regulate the direction of credit.

Margin Moral Selective Credit

Requirement Suasion control.
s
margin requirements: refers the difference between the Market value of security
offered and the value of amount lend.

Margin Requirement = Security Amount - Loan Amount.

25
when economy is suffering from excess demand, central Bank increases the
margin which restricts the credit creating power of Banks.
Loan (₹) Security (₹) Margin Requirements (₹)
case 1 1,00,000 1,50,000 50,000
Case 2 1,00,000 3,00,000 2,00,000
Discourage The Loan

Excess Demand are
controlled.
Moral suasion (Advising to discourage lending :-
Moral suasion = (Persuasion + pressure) by the central banks.

Moral Suasion is exercised through discussions, letters, speeches and hint to

bank, during excess demand, the central bank advises Commercial banks not
to advance credit for speculative activities. It help to reduce availability of credit
& AD.
Selective credit Control :-
It refers to a method in which the central bank gives direction to other
banks to give or not to give credit for certain purposes to particular sectors.
During excess demand, the central bank introduces rationing of credit in order
to prevent excessive flow of credit.

Loan

Education House Car

↑ ↑ 
(selective group of people)

Q. Explain how such Policy can control cyclical fluctuations in capitalist

economy.
Ans. It is already discussed earlier that the stage of economy in a capitalist
economy does not remain stable or same for all time. The economy experiences
various stages of cyclical fluctuation. Sometimes there is a boom or sometimes
it passes through the stage of depression. To maintain the stability in the
economy Govt. should take appropriate measures. In fact the government in
capitalist economy or mixed economy take various measures to Check cyclical

26
fluctuation. The measures which a govt usually takes include the monetary
and fiscal measures.
There are some benefits, of monetary measures, but it has certain
limitations also. For this reason modern economists have suggested some fiscal
measures which are fruitful, Prof. Keynes has suggested to apply fiscal policy
extensively to counter cyclical fluctuations. In present days, many more
economist also support such measures. The main reason of cyclical movement
of the economy is that the expenditure for consumer goods is either more or
less than the volume of saleable goods. Therefore cyclical movements of the
economy can be controlled if the deficit or surplus demand for consumer goods
can be checked.
Inflation:- Inflation is defined as a situation where there is a Continuous rise
in general price level of goods & services and I fall in the purchasing power of
money.
For instance, if a product which cost ₹100 costs ₹110 after a certain period of
time, the inflation for that period is 10%.
There are mainly two causes of inflation :-
a) Demand Side Factors (Demand Pull. Inflation)
b) supply side Factors (cost push Inflations)

Demand Pull Inflation :-

Demand Pull Inflation exist when aggregate demand for a good or service is
more than aggregate supply. In such a case consumers demand more goods
but there is no rise in supply of goods. As a result. Price of goods rises., It is
called Demand Pull inflation.
Here, we assume that, there is no change in the level of supply
causes :-
• Rise in foreign exchange rate.
• Increase in Money supply.
• Rise in Population
• Rise in Fiscal Deficit.
• Increase in Public expenditure
• Decrease in taxes.

27
 D2
D1 S’
D
𝑃2 E2
𝑃1 E1
𝑃 E D’2
D’1

Price S D’

0 Q quantity

A co. producing smart phones at ₹5000 whose quantity demand is 200 per day
and production per day is 150 per day at full employment level. Therefore
demand creates inflation in the economy.

S0
Price D’1 D’2
Level
P2 E2

P1 E1 D2

D1

O S Amount of commodity

The amount of commodity is measured on the horizontal axis and Price Level is
measured on the vertical axis. In the diagram 550 is the total supply curve of
commodity at full employment This supply curve is parallel to price level axis
because amount of production and total supply of commodity remain constant

28
(OS) at full employment level. In the diagram it is seen that total demand curve
and total supply curve intersect each other, at point E [E = Equilibrium point].
Here Equilibrium Price level is OP, and the equilibrium amount of commodity
is OS. Total demand curve will move to the right if total demand of economy
increases. From the diagram it is seen that total demand curve shifts to the
right from DD1 to DD2 due to increase in total demand in economy. Demand
Curve DD2 intersect the unchanged supply curve SS0 at point E2. Here, E2 is
the new equilibrium level Point and the new equilibrium price level is OP2. But
at new equilibrium price level, the amount of commodity remain constant at
OS level. Here equilibrium price increase from OP1 to OP2 but production and
supply remain constant due to full employment. This increase in price level is
called demand Pull inflation. Thus it is seen that at full employment level total
supply remain constant, the price level which is increased due to increase in
demand is the demand Pull inflation.

Basis of Demand - Pull - Inflation Cost-Push Inflation

difference
Employment It always occurs in full It always occurs in less than
employment situation. full employment situation.
origin. It arises due to emergence of It arises due to a rise in cost.
excess demand.
Shift Here, we observe a right-ward Here we observe a left-ward
shift of the demand Curve. shift of the supply curve.
Impact on Here, total output remain Here, total output falls.
output Constant.

29