1. Which are the different Market Structure? Describe Each in brief.2. What is Demand Elasticity ? Explain different types of Demand Elasticity.3. What is price determination? Which are the different elements of price

determination?4. Discuss different types of demand forecasting methods.5. Justify the role of Managerial economics & also discuss the factors

influencing managerial decisions.6. How to evaluate the production function? Identify and discuss various

determinants which are useful to decide the level of production.7. Discuss different cost concepts required for production. Also, Explain

various determinate of cost. 8. Q) Explain National Income concepts and its methods.

OrQ) Can national income help the government in planning, policy marketing and forecasting the economic activities? Provide your views.

OrQ) Exemplify the method for measuring the national income of country.

9. Specify money and monetary policy. Give its common instrument in brief. 10. What is International Trade? What are the methods of balance of

payments?11. Identify and discuss the various functions of commercial banks.12. What is inflation give its causes, consequences and remedies with an

example?

QUESTION

Which are the different Market Structure? Describe Each in brief.ANSWER:

There are basically 4 types of market structure 1. Perfect Competition.2. Imperfect or Monopolistic Competition.3. Monopoly.4. Oligopoly.

1. Perfect Competition Use of resources are efficient due to the high degree of competition. Price is usually marginal cost. Consumer benefit. Normal profit is made in long term. Firms operate at maximum efficiency. No barrier of moving out or coming into the market. There can be many firms.

Suppose in agriculture market there are several farmers selling similar products into the market and have many buyers. Here the prices can be easily compared with the sellers. So this often gets closer to the perfect competition market. The above are the advantages of perfect competition.Disadvantages:

With the introduction of a new idea firm can make abnormal profit on a short term period.2. Imperfect Competition or Monopolistic Competition:

Type of imperfect competition where many sells the products that are different from one another.

Advantages

The promotion of competition. Differentiation bring greater choice and variety. Product and services quality. Consumer becomes more knowledgeable of products.

Disadvantages:

They can be wasteful. Allocative inefficient.

Higher prices. Advertising.

Examples:- The restaurants business, hotels and pubs. 3. Monopoly:

A situation in which a single company or group owns all or nearly all of the market for a given type of product or service.Advantages:

Stability of prices. Source of revenue for the government. Massive profits. Monopoly firms offer some services efficiently.

Disadvantages:

Exploitation of consumers. Dissatisfied consumer. Price discrimination. Inferior goods and services.

4. Oligopoly:

A state of limited competition, in which a market is shared by a small number of producers or sellers.Advantages:

High profits. Simple choices. Competitive prices. Better information and goods.

Disadvantages:

Difficult for consumers due to fix prices. No fear of competition. Fewer choices.

What is Demand Elasticity ? Explain different types of Demand Elasticity.

Demand elasticity refers to how sensitive the demand for a good is to changes in other economic variables, such as the prices and consumer income. Demand elasticity is calculated by taking the percent change in quantity of a good demanded and dividing it by a percent change in another economic variable. A higher demand elasticity for a particular economic variable means that consumers are more responsive to changes in this variable, such as price or incomeThere are 6 different types of elasticity.They are :

- Price Elasticity of Demand

- Point Elasticity of Demand

- Arc Elasticity of Demand

- Income Elasticity of Demand

- Cross Elasticity of Demand

- Promotional Elasticity of Demand

(1) Price Elasticity of Demand

Price elasticity of demand is a measure of the relationship between a change in the quantity demanded of a particular good and a change in its price. Price elasticity of demand is a term in economics often used when discussing price sensitivity.

The formula for calculating price elasticity of demand is:

Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price

If a small change in price is accompanied by a large change in quantity demanded, the product is said to be elastic (or responsive to price changes). Conversely, a product is inelastic if a large change in price is accompanied by a small amount of change in quantity demanded.

(2) Point Elasticity of Demand

Point elasticity is the price elasticity of demand at a specific point on the demand curve instead of over a range of it.

The measure of the change in quantity demanded to a very small change in price.

(3) Arc Elasticity of Demand

;Arc elasticity is the elasticity of one variable with respect to another between two given points. It is used when there is no general function to define the relationship of the two variables.

Arc elasticity is also defined as the elasticity between two points on a curve.

(4) Income Elasticity of Demand

Income elasticity of demand refers to the sensitivity of the quantity demanded for a certain good to a change in real income of consumers who buy this good, keeping all other things constant.

The formula for calculating income elasticity of demand is the percent change in quantity demanded divided by the percent change in income.

With income elasticity of demand, you can tell if a particular good represents a necessity or a luxury.

(5) Cross Elasticity of Demand

Cross elasticity of demand is an economic concept that measures the responsiveness in the quantity demand of one good when a change in price takes place in another good.

It is also called cross price elasticity of demand, this measurement is calculated by taking the percentage change in the quantity demanded of one good and dividing it by the percentage change in price of the other good.

(6)Promotional Elasticity of Demand

A measure of a market's sensitivity to increases or decreases in advertising saturation. Advertising elasticity is a measure of an advertising campaign's effectiveness in generating new sales.

It is calculated by dividing the percentage change in the quantity demanded by the

percentage change in advertising expenditures.

A positive advertising elasticity indicates that an increase in advertising leads to an increase in demand for the advertised good or service.

What is price determination? Which are the different elements of price determination?

Determination of prices is an important managerial function in all enterprises. Price affects profit through its effect both on total revenue and total cost. The total revenue or sale proceeds equals price per unit multiplied by the quantity sold. The quantity sold varies with variations in the price, and the total cost as well as the average cost depend on the volume of output. Thus, pricing plays an important role in profit planning. Every management attempts to find that combination of price, volume and cost which will be most advantageous to it. If the price is set too high, the seller may not find enough consumers to buy his product. If the price is too low, the seller may not be able to cover his costs. Furthermore, since what is a good price today need not be a good price tomorrow, the pricing decision needs to be reviewed and reformulated from time to time.Both demand and supply are as important in price determination as the blades of a pair of scissors in cutting cloth. The greater the demand and/or smaller the supply, the greater will be the price and vice versa. Direct price controls take the form of fixation of maximum or minimum price for all output and fixation of the price either for all output(price freeze) or for a part of the output(dual pricing).

There are five basic determinants:1. The demand for it2. Its cost of production3. Objective of its producers4. Nature of the competition in its market 5. Government policy pertaining to it.

Price determination:Let the demand facing a firm for its product be expressed as following:Q=25-0.5P(Q=quantity demanded, P=price) And the supply of this firm, which is obtained from its cost function and its objective as explained Q=10+1.0P

In the absence of any influence from the government, the price for this commodity will be obtained by equating demand and supply:25-0.5P ≠10+1.0Pi.e. P=10

Q=20

If the government imposes a specific sales tax at the rate of say Rs. 3 per unit the new supply function would be Q=10+1.0(P-3)

Discuss different types of demand forecasting methods.Survey method:

Survey method is one of the most common and direct methods of forecasting demand in the short term.

This method encompasses the future purchase plans of consumers and their intentions.

In this method, an organization conducts surveys with consumers to determine the demand for their existing products and services and anticipate the future demand accordingly.

I. Expert’s opinion Method o Refers to a method in which experts are requested to provide

their opinion about the product.o Sales representatives are in close touch with consumers;

therefore, they are well aware of the consumers’ future purchase plans, their reactions to market change, and their perceptions for other competing products.

o They provide an approximate estimate of the demand for the organization’s products.

o This method is quite simple and less expensive.

II. Consumer’s Interview method Under this method, efforts are made to collect the relevant information

directly from the consumers with regard to their future purchase plans. In order to gather information from consumers, a number of alternative

techniques are developed from time to time. Among them, the following are some of the important ones.

a) Complete enumeration method: Under this method, all potential customers are interviewed in a particular city or a region.

b) Sample survey method o Under this method, different cross sections of customers

that make up the bulk of the market are carefully chosen.o Only such consumers selected from the relevant market

through some sampling method are interviewed or surveyed.

c) End Use Method

o Under this method, the sale of the product under consideration is projected on the basis of demand surveys of the industries using the given product as an intermediate product.

Statistical Method

Statistical methods are complex set of methods of demand forecasting in the long term.

In this method, demand is forecasted on the basis of historical data and cross-sectional data.

Historical data refers to the past data obtained from various sources, such as previous years’ balance sheets and market survey reports.

On the other hand, cross-sectional data is collected by conducting interviews with individuals and performing market surveys.

Unlike survey methods, statistical methods are cost effective and reliable as the element of subjectivity is minimum in these methods.

I. Trend Projection Method -Trend projection or least square method is the classical method of business forecasting.

-In this method, a large amount of reliable data is required for forecasting demand.

-In addition, this method assumes that the factors, such as sales and demand, responsible for past trends would remain the same in future.

-This method uses time-series data on sales for forecasting the demand of a product.

-The advantage in this method is that it does not require the formal knowledge of economic theory and the market, it only needs the time series data.

-The only limitation in this method is that it assumes that the past is repeated in future.

- Also, it is an appropriate method for long-run forecasts, but inappropriate for short-run forecasts.

II. Regression Method Regression is a generic term for all methods attempting to fit a model to

observed data in order to quantify the relationship between two groups of variables. The fitted model may then be used either to merely describe the relationship between the two groups of variables, or to predict new values.

III. Leading indicator method Under this method, a few economic indicators become the basis for forecasting the sales of a company. An economic indicator indicates change in the magnitude of an economic variable. It gives the signal about the direction of change in an economic variable. This helps in decision making process of a company.

IV. Simultaneous equation method It is also known as the ‘complete system approach’ or ‘econometric

model building’. Moreover, this method is normally used in macro-level forecasting for

the economy as a whole. The method is indeed very complicated. The principle advantage in this method is that the forecaster needs to

estimate the future values of only the exogenous variables unlike the regression method where he has to predict the future values of all, endogenous and exogenous variables affecting the variable under forecast.

The values of exogenous variables are easier to predict than those of the endogenous variables. However, such econometric models have limitations, similar to that of regression method.

Q. Justify the role of Managerial economics & also discuss the factors influencing managerial decisions.

A. Managerial economics may be viewed as economics applied to problem solving at the level of the firm. The Problems maybe related to choices and allocation of resources which hare economic in nature and are faced by managers all the time.

The focus of managerial economics is focused on the subject of identifying & solving the decision problems faced by the manager in the enterprise. Managerial economics interacts with other related disciplines.

Factors influencing managerial decisions1. Human and Behavioral considerations2. Technological Forces 3. Environmental Factors

Human and Behavioral considerations Managers may take into account factors such as the impact of a

decision on employee morale or motivation. It is not uncommon to come across small entrepreneurs who refuse to

expand or diversify even though analysis provide clear signals of opportunities ahead of them.

Many of them decide to remain small since they feel that such expansion will tend to strain their life style or threaten their control over management.

In other words their final decision takes into account economic logic as well as human and personal considerations.

Technological Forces The influence of technology on business decisions is too pervasive to be

ignored. An assessment of technological alternatives, the technological moves of

competitors and emerging new technologies and processes are among the most critical factors that mangers consider in their planning and resource allocation within the enterprise.

Any manager worth his salt knows that technological compulsions alone cannot provide a basis for taking major business decisions.

So an interplay of technological and economic considerations takes place before the manager arrives at a final decision.

Environmental Factors Environmental considerations are growing day by day for two reasons.

Public awareness of the impact of the firm-level decisions on society is growing and consumer groups and other organizations are increasingly concerned about the nature and consequences of these decisions.

The soundness of managers decisions are being increasingly challenged on the grounds that they don’t take into account the social costs involved and the decisions might sound profitable to manager.

So , State intervention increases and forces enterprise manages to take into account these matters into their decision making.

Q- How to evaluate the production function? Identify and discuss various determinants which are useful to decide the level of production.

Production Function: A production function is a mathematical and graphical way to measure the efficiency of production by considering the relationships between two or more variables, meaning two or more factors that are relevant when producing a good or a service sale or raw material and labour.

Only a business has determined the factor for production, it can begin building the production function.

Features of Production Function: - Ability to Substitute: The factors of production or inputs are substitutes of one

another which make it possible to vary the total output by changing the quantity of one or a few inputs while quantities at all other inputs.

Complementarity: The factor of production is also to one another, i.e. the two or more inputs are to be used together as nothing will be produced if the quantity at either of the inputs used in the production process is zero.

Specificity: It reveals that the inputs are specific to the production of a particular product machines and is specialize more and raw materials are. For example, specificity of factor of production.

Determinants of Production: -

Output Price: An increase in the price of the product, say the value of the marginal product of labour and therefore increase the demand for labours.

Technology Change: Technological advance raises the marginal product of labour which in turn raises the value of the marginal product of labour.e.g. Introduction of word processor reduced the demand for typist and increased the demand for computer literate office assistants.

The supply of other factories: The quantity available of one factory can affect the marginal product of another.Therefore, any change in the availability at another factory will likely affect the demand for labour.

Q- Discuss different cost concepts required for production. Also, Explain various determinate of cost.

The analysis of cost is important in the study of managerial economics because it provides a basis for two important decisions made by managers: 

(a) whether to produce or not and (b) how much to produce when a decision is taken to produce. 

In this answer, we shall discuss some important cost concepts that are relevant for managerial decisions. We analysis the basic differences between these cost concepts and also, examine how accountants and economists differ on treating different cost concepts. We will continue the discussion on cost concepts and analysis.1. ACTUAL COSTS and OPPORTUNITY COSTS

2. EXPLICIT and IMPLICIT COSTS

3. ACCOUNTING COSTS and ECONOMIC COSTS

4. Controllable and Non-Controllable costs

5. Historical and Replacement costs

6. Private Costs and Social Costs

7. Relevant Costs and Irrelevant Costs

8. Sunk Costs and Incremental Costs

9. DIRECT COSTS and INDIRECT COSTS

10.Separable Costs and Common Costs

11.TOTAL COST and AVERAGE COST and MARGINAL COST12.FIXED and VARIABLE COSTS

13.SHORT-RUN and LONG-RUN COSTS

ACTUAL COSTS AND OPPORTUNITY COSTS

Actual costs are those costs, which a firm incurs while producing or acquiring a good or service like raw materials, labour, rent, etc. Suppose, we pay Rs. 150 per day to a worker whom we employ for 10 days, then the cost of labour is Rs. 1500. The economists called this cost as accounting costs because traditionally accountants have been primarily connected with collection of historical data (that is the costs actually incurred) in reporting a firm’s financial position and in calculating its taxes. Sometimes the actual costs are also called acquisition costs or outlay costs. On the other hand, opportunity cost is defined as the value of a resource in its next best use.

For example, Mr. Ram is currently working with a firm and earning Rs. 5 lakhs per year. He decides to quit his job and start his own small business. Although, the accounting cost of Mr. Ram’s labour to his own business is 0, the opportunity cost is Rs. 5 lakhs per year. Therefore, the opportunity cost is the earnings he foregoes by working for his own firm. One may ask you that whether this opportunity cost is really meaningful in the decision-making process. As we see that the opportunity cost is important simply because, if Mr. Ram cannot recover this cost from his new business, then he will probably return to his old job. Opportunity cost can be similarly defined for other factors of production. For example, consider a firm that owns a building and therefore do not pay rent for office space. If the building was rented to others, the firm could have earned rent. The foregone rent is an opportunity cost of utilizing the office space and should be included as part of the cost of doing business. Sometimes these opportunity costs are called as alternative costs.

EXPLICIT AND IMPLICIT COSTS

Explicit costs are those costs that involve an actual payment to other parties. Therefore, an explicit cost is the monitory payment made by a firm for use of an input owned or controlled by others. Explicit costs are also referred to as accounting costs. For example, a firm pays Rs. 100 per day to a worker and engages 15 workers for 10 days, the explicit cost will be Rs. 15,000 incurred by the firm. Other types of explicit costs include purchase of raw materials, renting a building, amount spent on advertising etc. On the other hand, implicit costs represent the value of foregone opportunities but do not involve an actual cash payment. Implicit costs are just as important as explicit costs but are sometimes neglected because they are not as obvious.For example, a manager who runs his own business fore goes the salary that could have been earned working for someone else as we have seen in our earlier example. This implicit cost generally is not reflected in accounting statements, but rational decision-making requires that it be considered. Therefore, an implicit cost is the opportunity cost of using resources that are owned or controlled by the owners of the firm. The implicit cost is the foregone return, the owner of the firm could have received had they used their own resources in their best alternative use rather than using the resources for their own firm’s production.

ACCOUNTING COSTS AND ECONOMIC COSTS

For a long time, there has been a considerable disagreement among economists and accountants on how costs should be treated. The reason for the difference of opinion is that the two groups want to use the cost data for dissimilar purposes. Accountants always

have been concerned with firms’ financial statements. Accountants tend to take a retrospective look at firms finances because they keep trace of assets and liabilities and evaluate past performance. The accounting costs are useful for managing taxation needs as well as to calculate profit or loss of the firm. On the other hand, economists take forward-looking view of the firm. They are concerned with what cost is expected to be in the future and how the firm might be able to rearrange its resources to lower its costs and improve its profitability. They must therefore be concerned with opportunity cost. Since the only cost that matters for business decisions are the future costs, it is the economic costs that are used for decision-making. Accountants and economists both include explicit costs in their calculations. For accountants, explicit costs are important because they involve direct payments made by a firm. These explicit costs are also important for economists as well because the cost of wages and materials represent money that could be useful elsewhere. We have already seen, while discussing actual costs and opportunity costs, how economic cost can differ from accounting cost. In that example we have seen how a person who owns business chooses not to consider his/her own salary. Although, no monitory transaction has occurred (and thus would not appear as an accounting cost), the business nonetheless incurs an opportunity cost because the owner could have earned a competitive salary by working elsewhere. Accountants and economists use the term ‘profits’ differently. Accounting profits are the firm’s total revenue less its explicit costs. But economists define profits differently. Economic profits are total revenue less all costs (explicit and implicit costs). The economist takes into account the implicit costs (including a normal profit) in addition to explicit costs in order to retain resources in a given line of production. Therefore, when an economist says that a firm is just covering its costs, it is meant that all explicit and implicit costs are being met, and that, the entrepreneur is receiving a return just large enough to retain his/her talents in the present line of production. If a firm’s total receipts exceed all its economic costs, the residual accruing to the entrepreneur is called an economic profit, or pure profit. Example of Economic Profit and Accounting Profit Mr. Raj is a small store owner. He has invested Rs. 2 lakhs as equity in the store and inventory. His annual turnover is Rs. 8 lakhs, from which he must deduct the cost of goods sold, salaries of hired staff, and depreciation of equipment and building to arrive at annual profit of the store. He asked help of a friend who is an accountant by profession to prepare annual income statement. The accountant reported the profit to be Rs. 1.5 lakhs. Mr. Raj could not believe this and asked the help of another friend who is an economist by profession. The economist told him that the actual profit was only Rs. 75,000 and not Rs. 1.5 lakhs. The economist found that the accountant had underestimated the costs by not including the implicit costs of time spent as Manager by Mr. Raj in the business and interest on owner’s equity. The two income statements are shown below:

Controllable and Non-Controllable costs

Controllable costs are those which are capable of being controlled or regulated by executive vigilance and, therefore, can be used for assessing executive efficiency. Non-controllable costs are those, which cannot be subjected to administrative control and supervision. Most of the costs are controllable, except, of course, those due to obsolescence and depreciation. The level at which such control can be exercised, however, differs: some costs (like, capital costs) are not controllable at factory’s shop level, but inventory costs can be controlled at the shop level. Out-of-pocket costs and Book costs Out of pocket costs are those costs that improve current cash payments to outsiders. For example, wages and salaries paid to the employees are out of pocket costs. Other examples of out-of-pocket costs are payment of rent, interest, transport charges, etc. On the other hand, book costs are those business costs, which do not involve any cash payments but for them a provision is made in the books of account to include them in profit and loss accounts and take tax advantages.

For example, salary of owner manager, if not paid, is a book cost. The interest cost of owner’s own fund and depreciation cost are other examples of book cost. The out-of-pocket costs are also called explicit costs and correspondingly book costs are called implicit or imputed costs. Book costs can be converted into out-of-pocket costs by selling assets and leasing them back from buyer. Thus, the difference between these two categories of cost is in terms of whether the company owns it or not. If a factor of production is owned, its cost is a book cost while if it is hired it is an out-of-pocket cost. Past and Future Costs Past costs are actual costs incurred in the past and they are always contained in the income statements. Their measurement is essentially a record keeping activity. These costs can only be observed and evaluated in retrospect. If they are regarded as excessive, management can indulge in post-mortem checks just to find out the factors responsible for the excessive costs, if any, without being able to do anything about reducing them. Future costs are those costs that are likely to be incurred in future periods. Since the future is uncertain, these costs have to be estimated and cannot be expected to be absolutely correct figures. Past costs serve as the basis for projecting future costs. In periods of inflation and deflation, the two cost concepts

differ significantly. Managerial decisions are always forward looking and therefore they require estimates of future costs and not past costs. Unlike past costs, future costs are subject to management control and they can be planned or avoided. If the future costs are considered too high, management can either plan to reduce them or find out ways and means to meet them. Management needs to estimate future costs for a variety of reasons such as expense control pricing, projecting future profits and capital budgeting decisions. When historical costs are used instead of explicit projections, the assumption is made that future costs will be the same as past costs. In periods of significant price variations, such an assumption may lead to wrong managerial decisions.

Historical and Replacement costs

The historical cost of an asset is the actual cost incurred at the time, the asset was originally acquired. In contrast to this, replacement cost is the cost, which will have to be incurred if that asset is purchased now. The difference between the historical and replacement costs results from price changes over time. Suppose a machine was acquired for Rs. 50,000 in the year 1995 and the same machine can be acquired for Rs. 1,20,000 in the year 2001. Here Rs. 50,000 is the historical or original cost of the machine and Rs. 1,20,000 is its replacement cost. The difference of Rs. 70,000 between the two costs has resulted because of the price change of the machine during the period. In the conventional financial accounts the value of assets is shown at their historical costs. But for decision-making, firms should try to adjust historical costs to reflect price level changes. If the price of the asset does not change over time, the historical cost will be the same as the replacement cost. If the price rises the replacement cost will exceed historical cost and vice versa. During periods of substantial price variations, historical costs are poor indicators of actual costs Historical costs and replacement costs represent two ways of reflecting the costs of assets in the balance sheet and establishing the costs that are used to determine net income. The assets are usually shown in the conventional accounts at their historical costs. These must be adjusted for price changes for a correct estimate of costs and profits. Managerial decisions must be based on replacement cost rather than historical costs. The historical cost of an asset is known, for it is actually incurred while acquiring that asset. Replacement cost relates to the current price of that asset and it will be known only if an enquiry is made in the market.

Private Costs and Social Costs

A further distinction that is useful to make - especially in the public sector - is between private and social costs. Private costs are those that accrue directly to the individuals or firms engaged in relevant activity. Social costs, on the\ other hand, are passed on to persons not involved in the activity in any direct way (i.e., they are passed on to society at large). Consider the case of a manufacturer located on the bank of a river who dumps the waste into water rather than disposing it of in some other manner. While the private

cost to the firm of dumping is zero, it is definitely harmful to the society. It affects adversely the people located down current and incur higher costs in terms of treating the water for their use, or having to travel a great deal to fetch potable water. If these external costs were included in the production costs of a producing firm, a true picture of real, or social costs of the output would be obtained. Ignoring external costs may lead to an inefficient and undesirable allocation of resources in society.

Relevant Costs and Irrelevant Costs

The relevant costs for decision-making purposes are those costs, which are incurred as a result of the decision under consideration. The relevant costs are also referred to as the incremental costs. Costs that have been incurred already and costs that will be incurred in the future, regardless of the present decision are irrelevant costs as far as the current decision problem is concerned.There are three main categories of relevant or incremental costs. These are the present-period explicit costs, the opportunity costs implicitly involved in the decision, and the future cost implications that flow from the decision.

For example, direct labour and material costs, and changes in the variable overhead costs are the natural consequences of a decision to increase the output level. Also, if there is any expenditure on capital equipment’s incurred as a result of such a decision, it should be included in full, notwithstanding that the equipment may have a useful life remaining after the present decision has been carried out. Thus, the incremental costs of a decision to increase output level will include all present-period explicit costs, which will be incurred as a consequence of this decision. It will exclude any present-period explicit cost that will be incurred regardless of the present decision. The opportunity cost of a resource under use, as discussed earlier, becomes a relevant cost while arriving at the economic profit of the firm. Many decisions will have implications for future costs, both explicit and implicit. If a firm expects to incur some costs in future as a consequence of the present analysis, suchfuture costs should be included in the present value terms if known for certain.

Sunk Costs and Incremental Costs

Sunk costs are expenditures that have been made in the past or must be paid in the future as part of contractual agreement or previous decision.

For example, the money already paid for machinery, equipment, inventory and future rental payments on a warehouse that must be paid as part of a long-term lease agreement are sunk costs. In general, sunk costs are not relevant to economic decisions.

For example, the purchase of specialized equipment designed to order for a plant. We assume that the equipment can be used to do only what it was originally designed for and cannot be converted for alternative use. The expenditure on this equipment is a sunk cost. Also, because this equipment has no alternative use its opportunity cost is zero and, hence, sunk costs are not relevant to economic decisions. Sometimes the sunk costs are also called as non-avoidable or non-escapable costs.On the other hand, incremental cost refers to total additional cost of implementing a managerial decision. Change in product line, change in output level, adding or replacing a machine, changing distribution channels etc. are examples of incremental costs. Sometimes incremental costs are also called as avoidable or escapable costs. Moreover, since incremental costs may also be regarded as the difference in total costs resulting from a contemplated change, they are also called differential costs. As stated earlier sunk costs are irrelevant for decision making, as they do not vary with the changes contemplated for future by the management.

DIRECT COSTS AND INDIRECT COSTS

There are some costs, which can be directly attributed to production of a given product. The use of raw material, labour input, and machine time involved in the production of each unit can usually be determined. On the other hand, there are certain costs like stationery and other office and administrative expenses, electricity charges, depreciation of plant and buildings, and other such expenses that cannot easily and accurately be separated and attributed to individual units of production, except on arbitrary basis. When referring to the separable costs of first category accountants call them the direct, or prime costs per unit. The accountants refer to the joint costs of the second category as indirect or overhead costs. Direct and indirect costs are not exactly synonymous to what economists refer to as variable costs and fixed costs. The criterion used by the economist to divide cost into either fixed or variable is whether or not the cost varies with the level of output, whereas the accountant divides the cost on the basis of whether or not the cost is separable with respect to the production of individual output units. The accounting statements often divide overhead expenses into ‘variable overhead’ and ‘fixed overhead’ categories. If the variable overhead expenses per unit are added to the direct cost per unit, we arrive at what economists call as average variable cost.

Separable Costs and Common Costs

Costs can also be classified on the basis of their traceability. The costs that can be easily attributed to a product, a division, or a process are called separable costs. On the other hand, common costs are those, which cannot be traced to any one unit of operation. For example, in a multiple product firm the cost of raw material may be separable (traceable) product-wise but electricity charges may not be separable product-wise. In a university, the salary of a Vice-Chancellor is not separable department-wise but the salary

of teachers can be separable department-wise. The separable and common costs are also referred to as direct and indirect costs respectively. The distinction between direct and indirect costs is of particular significance in a multi-product firm for setting up economic prices for different products.

TOTAL COST, AVERAGE COST AND MARGINAL COST

Total cost (TC) of a firm is the sum-total of all the explicit and implicit expenditures incurred for producing a given level of output. It represents the money value of the total resources required for production of goods and services.

For example, a shoe-maker’s total cost will include the amount she/ he spends on leather, thread, rent for his/her workshop, interest on borrowed capital, wages and salaries of employees, etc., and the amount she/he charges for his/her services and funds invested in the business. Average cost (AC) is the cost per unit of output. That is, average cost equals the total cost divided by the number of units produced (N). If TC = Rs. 500 and N = 50 then AC = Rs. 10. Marginal cost (MC) is the extra cost of producing one additional unit. At a given level of output, one examines the additional costs being incurred in producing one extra unit and this yields the marginal cost.

For example, if TC of producing 100 units is Rs. 10,000 and the TC of producing 101 units is Rs. 10,050, then MC at N = 101 equalsRs.50. Marginal cost refers to the change in total cost associated with a one-unit change in output. This cost concept is significant to short-term decisions about profit maximizing rates of output.

For example, in an automobile manufacturing plant, the marginal cost of making one additional car per production period would be the labour, material, and energy costs directly associated with that extra car. Marginal cost is that sub category of incremental cost in the sense that incremental cost may include both fixed costs and marginal costs However, when production is not conceived in small units, management will be interested in incremental cost instead of marginal cost.

For example, if a firm produces 5000 units of TV sets, it may not be possible to determine the change in cost involved in producing 5001 units of TV sets. This difficulty can be resolved by taking units to significant size.

For example, if the TV sets produced is measured to hundreds of units and total cost (TC) of producing the current level of three hundred TV sets is Rs. 15,00,000 and the firm decides to increase the production to four hundred TV sets and estimates the TC as Rs. 18,00,000, then the incremental cost of producing one hundred TV sets (above the present production level of three hundred units) is Rs. 3,00,000. The total cost concept is

useful in break-even analysis and finding out whether a firm is making profit or not. The average cost concept is significant for calculating the per unit profit. The marginal and incremental cost concepts are needed in deciding whether a firm needs to expand its production or not. In fact, the relevant costs to be considered will depend upon the situation or production problem faced by the manager.

FIXED AND VARIABLE COSTS

Fixed costs are that part of the total cost of the firm which does not change with output. Expenditures on depreciation, rent of land and buildings, property taxes, and interest payment on bonds are examples of fixed costs. Given a capacity, fixed costs remain the same irrespective of actual output. Variable costs, on the other hand, change with changes in output.

Examples of variable costs are wages and expenses on raw material. However, it is not very easy to classify all costs into fixed and variable. There are some costs, which fall between these extremes. They are called semi variable costs. They are neither perfectly variable nor absolutely fixed in relation to changes in output.

For example, part of the depreciation charges is fixed, and part variable. However, it is very difficult to determine how much of depreciation cost is due to the technical obsolescence of assets and hence fixed cost, and how much is due to the use of equipment’s and hence variable cost. Nevertheless, it does not mean that it is not useful to classify costs into fixed and variable. This distinction is of great value in break-even analysis and pricing decisions. For decision-making purposes, in general, it is the variable cost, which is relevant and not the fixed cost. To an economist the fixed costs are overhead costs and to an accountant these are indirect costs. When the output goes up, the fixed cost per unit of output comes down, as the total fixed cost is divided between larger units of output.

SHORT-RUN AND LONG-RUN COSTS

The short run is defined as a period in which the supply of at least one element of the inputs cannot be changed. To illustrate, certain inputs like machinery, buildings, etc., cannot be changed by the firm whenever it so desires. It takes time to replace, add or dismantle them. Long run, on the other hand, is defined as a period in which all inputs are changed with changes in output. In other words, it is that time-span in which all adjustments and changes are possible to realize. Thus, in the short run, some inputs are fixed (like installed capacity) while others are variable (like the level of capacity utilization); but in the long run all inputs, including the size of the plant, are variable. Short-run costs are the costs that can vary with the degree of utilization

of plant and other fixed factors. In other words, these costs relate to the variation in output, given plant capacity. Short-run costs are, therefore, of two types: fixed costs and variable costs. In the short-run, fixed costs remain unchanged while variable costs fluctuate with output. Long-run costs, in contrast, are costs that can vary with the size of plant and with other facilities normally regarded as fixed in the short-run. In fact, in the long-run there are no fixed inputs and therefore no fixed costs, i.e. all costs are variable. Both short-run and long-run costs are useful in decision-making. Short-run cost is relevant when a firm has to decide whether or not to produce and if a decision is taken to produce then how much more or less to produce with a given plant size. If the firm is considering an increase in plant size, it must examine the long-run cost of expansion. Long-run cost analysis is useful in investment decisions.

Determinants of CostThe general determinants of cost are as follows

Output level Prices of factors of production Productivities of factors of production Technology

1.Level of output:

The cost of production varies according to the quantum of output. If the size of production is large, then the cost of production will also be more.

2. Prices of factors of production:A rise in the cost of input factors will increase the total cost of production

3.Productivities of factors of production:

When the productivity of the input factors is high then the cost of production will fall.4.Technology:

When the organization follows advanced technology in their process then the cost of production will be low.

Q) Explain National Income concepts and its methods.

OrQ) Can national income help the government in planning, policy marketing and forecasting the economic activities? Provide your views.

Or

Q) Exemplify the method for measuring the national income of country.

Ans:

- There are various concepts of National Income.- he main concepts of NI are: GDP, GNP, NNP, NI, PI, DI, and PCI.- These different concepts explain about the phenomenon of economic activities of

the various sectors of the various sectors of the economy.Gross Domestic Product (GDP)- The most important concept of national income is Gross Domestic Product. Gross

domestic product is the money value of all final goods and services produced within the domestic territory of a country during a year.

- Algebraic expression under product method is,GDP=(P*Q)where,GDP=Gross Domestic ProductP=Price of goods and serviceQ=Quantity of goods and servicedenotes the summation of all values.

- According to expenditure approach, GDP is the sum of consumption, investment, government expenditure, net foreign exports of a country during a year.

- Algebraic expression under expenditure approach is,GDP=C+I+G+(X-M)Where,C=ConsumptionI=InvestmentG=Government expenditure(X-M) =Export minus import

- GDP includes the following types of final goods and services. They are:1. Consumer goods and services.2. Gross private domestic investment in capital goods.3. Government expenditure.4. Exports and imports.

Gross National Product (GNP)

- Gross National Product is the total market value of all final goods and services produced annually in a country plus net factor income from abroad. Thus, GNP is the total measure of the flow of goods and services at market value resulting from current production during a year in a country including net factor income from abroad. The GNP can be expressed as the following equation:

GNP=GDP+NFIA (Net Factor Income from Abroad) or, GNP= C + I + G + (X-M) + NFIA

Hence, GNP includes the following:1. Consumer goods and services.2. Gross private domestic investment in capital goods.3. Government expenditure.4. Net exports (exports-imports).5. Net factor income from abroad.

Net National Product (NNP)

- Net National Product is the market value of all final goods and services after allowing for depreciation. It is also called National Income at market price. When charges for depreciation are deducted from the gross national product, we get it. Thus,

NNP=GNP-Depreciationor, NNP=C+I+G+(X-M)+NFIA-Depreciation

National Income (NI)

- National Income is also known as National Income at factor cost. National income at factor cost means the sum of all incomes earned by resources suppliers for their contribution of land, labor, capital and organizational ability which go into the years net production. Hence, the sum of the income received by factors of production in the form of rent, wages, interest and profit is called National Income. Symbolically,

NI= NNP + Subsidies - Interest Taxesor, GNP – Depreciation + Subsidies-Indirect Taxesor, NI= C + G + I + (X-M) + NFIA – Depreciation - Indirect Taxes + Subsidies

Personal Income (PI)

- Personal Income is the total money income received by individuals and households of a country from all possible sources before direct taxes. Therefore, personal income can be expressed as follows:

PI=NI-Corporate Income Taxes - Undistributed Corporate Profits - Social Security Contribution + Transfer Payments

Disposable Income (DI)

- The income left after the payment of direct taxes from personal income is called Disposable Income. Disposable income means actual income which can be spent on consumption by individuals and families. Thus, it can be expressed as:

DI=PI-Direct Taxes

From consumption approach,DI=Consumption Expenditure + Savings

Per Capita Income (PCI)

- Per Capita Income of a country is derived by dividing the national income of the country by the total population of a country. Thus,

PCI=Total National Income/Total National Population

Q. Specify money and monetary policy. Give its common instrument in brief. ANSWER: Definition of money: Money is an officially-issued legal tender generally consisting of notes and coin, and is the circulating medium of exchange as defined by a government. Money is often synonymous with cash and includes various negotiable instruments such as checks. Each country has its own money that is used as a medium of exchange within that country. Definition of monetary policy: Monetary policy is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity. Common instruments of money monetary system: The instrument of monetary policy is tools or devise which are used by the monetary authority in order to attain some predetermined objectives. There are two types of instruments of the monetary policy as shown below. (A) Quantitative Instruments or General Tools 1. Bank Rate Policy (BRP) 2. Open Market Operation (OMO) 3. Variation in the Reserve Ratios (VRR)

(B) Qualitative Instruments or Selective Tools 1. Fixing Margin Requirements 2. Consumer Credit Regulation 3. Publicity 4. Credit Rationing 5. Moral Suasion 6. Control Through Directives 7. Direct Action

(A) Quantitative Instruments or General Tools

The Quantitative Instruments are also known as the General Tools of monetary policy. These tools are related to the Quantity or Volume of the money. These tools are indirect in nature and are employed for influencing the quantity of credit in the country. 1. Bank Rate Policy (BRP)

The Bank Rate Policy (BRP) is a very important technique used in the monetary policy for influencing the volume or the quantity of the credit in a country. The bank rate refers to rate at which the central bank (i.e. RBI) rediscounts bills and prepares of commercial banks or provides advance to commercial banks against approved securities. It is "the standard rate at which the bank is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchase under the RBI Act". The Bank Rate affects the actual availability and the cost of the credit. Any change in the bank rate necessarily brings out a resultant change in the cost of credit available to commercial banks. 2. Open Market Operation (OMO)

The open market operation refers to the purchase and/or sale of short term and long term securities by the RBI in the open market. This is very effective and popular instrument of the monetary policy. The OMO is used to wipe out shortage of money in the money market, to influence the term and structure of the interest rate and to stabilize the market for government securities, etc. It is important to understand the working of the OMO. If the RBI sells securities in an open market, commercial banks and private individuals buy it. This reduces the existing money supply as money gets transferred from commercial banks to the RBI. 3. Variation in the Reserve Ratios (VRR)

The Commercial Banks have to keep a certain proportion of their total assets in the form of Cash Reserves. Some part of these cash reserves are their total assets in the form of cash. Apart of these cash reserves are also to be kept with the RBI for the purpose of maintaining liquidity and controlling credit in an economy. These reserve ratios are named as Cash Reserve Ratio (CRR) and a Statutory Liquidity Ratio (SLR). The CRR refers to some percentage of commercial bank's net demand and time liabilities which commercial banks have to maintain with the central bank and SLR refers to some percent of reserves to be maintained in the form of gold or foreign securities. In India, the CRR by law remains in between 3-15 percent while the SLR remains in between 25-40 percent of bank reserves. Any change in the VRR (i.e. CRR + SLR) brings out a change in commercial banks reserves positions. Thus, by varying VRR commercial banks lending capacity can be affected.

(B) Qualitative Instruments or Selective Tools

The Qualitative Instruments are also known as the Selective Tools of monetary policy. These tools are not directed towards the quality of credit or the use of the credit. They are used for discriminating between different uses of credit. This method can have influence over the lender and borrower of the credit. The Selective Tools of credit control comprises of following instruments. 1. Fixing Margin Requirements

The margin refers to the "proportion of the loan amount which is not financed by the bank". Or in other words, it is that part of a loan which a borrower has to raise in order to get finance for his purpose. A change in a margin implies a change in the loan size. This method is used to encourage credit supply for the needy sector and discourage it for other non-necessary sectors. This can be done by increasing margin for the non-necessary sectors and by reducing it for other needy sectors. 2. Consumer Credit Regulation

Under this method, consumer credit supply is regulated through hire-purchase and installment sale of consumer goods. Under this method the down payment, installment amount, loan duration, etc. is fixed in advance. This can help in checking the credit use and then inflation in a country. 3. Publicity

This is yet another method of selective credit control. Through it Central Bank (RBI) publishes various reports stating what is good and what is bad in the system. This published information can help commercial banks to direct credit supply in the desired sectors. Through its weekly and monthly bulletins, the information is made public and banks can use it for attaining goals of monetary policy. 4. Credit Rationing

Central Bank fixes credit amount to be granted. Credit is rationed by limiting the amount available for each commercial bank. This method controls even bill rediscounting. For certain purpose, upper limit of credit can be fixed and banks are told to stick to this limit. This can help in lowering banks credit exposure to unwanted sectors.

5. Moral Suasion

It implies to pressure exerted by the RBI on the Indian banking system without any strict action for compliance of the rules. It is a suggestion to banks. It helps in restraining credit during inflationary periods. Commercial banks are informed about the expectations of the central bank through a monetary policy. Under moral suasion central banks can issue directives, guidelines and suggestions for commercial banks regarding reducing credit supply for speculative purposes. 6. Control Through Directives

Under this method the central bank issue frequent directives to commercial banks. These directives guide commercial banks in framing their lending policy. Through a directive the central bank can influence credit structures, supply of credit to certain limit for a specific purpose. The RBI issues directives to commercial banks for not lending loans to speculative sector such as securities, etc. beyond a certain limit 7. Direct Action

Under this method the RBI can impose an action against a bank. If certain banks are not adhering to the RBI's directives, the RBI may refuse to rediscount their bills and securities. Secondly, RBI may refuse credit supply to those banks whose borrowings are in excess to their capital. Central bank can penalize a bank by changing some rates. At last it can even put a ban on a particular bank if it does not follow its directives and work against the objectives of the monetary policy. COCLUSION: These are various selective instruments of the monetary policy. However, the success of these tools is limited by the availability of alternative sources of credit in economy, working of the Non-Banking Financial Institutions (NBFIs), profit motive of commercial banks and undemocratic nature off these tools. But a right mix of both the general and selective tools of monetary policy can give the desired results.

Question: What is International Trade? What are the methods of balance of payments?

Answer: International trade is the exchange of capital, goods, and services across international borders or territories. This type of trade allows for a greater competitive pricing in the market. The competition results in more affordable products for the consumer. To get more clear this concept visit this link & see the small video (http://www.investopedia.com/articles/03/112503.asp)

Methods of Balance of Payments: -

1) Cash-in-Advance2) Letters of Credit3) Documentary Collections4) Open Account

1) Cash-in-Advance: - With cash-in-advance payment terms, the exporter can avoid credit risk because payment is received before the ownership of the goods is transferred. Wire transfers and credit cards are the most commonly used cash-in-advance options available to exporters. However, requiring payment in advance is the least attractive option for the buyer, because it creates cash-flow problems. Foreign buyers are also concerned that the goods may not be sent if payment is made in advance. Thus, exporters who insist on this payment method as their sole manner of doing business may lose to competitors who offer more attractive payment terms.

2) Letters of Credit: -

Letters of credit (LCs) are one of the most secure instruments available to international traders. An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter, provided that the terms and conditions stated in the LC have been met, as verified through the presentation of all required documents. The buyer pays his or her bank to render this service. An LC is useful when reliable credit information about a foreign buyer is difficult to obtain, but the exporter is satisfied with the creditworthiness of the buyer’s foreign bank. An LC also protects the buyer because no payment obligation arises until the goods have been shipped or delivered as promised.

3) Documentary Collections A documentarycollection (D/C) is a transaction whereby the exporter entrusts the collection of a payment to the remitting bank (exporter’s bank), which sends documents to a collecting bank (importer’s bank), along with instructions for payment. Funds are received from the importer and remitted to the exporter through

the banks involved in the collection in exchange for those documents. D/Cs involve using a draft that requires the importer to pay the face amount either at sight (document against payment) or on a specified date (document against acceptance). The draft gives instructions that specify the documents required for the transfer of title to the goods. Although banks do act as facilitators for their clients, D/Cs offer no verification process and limited recourse in the event of non-payment. Drafts are generally less expensive than LCs.

4) Open Account

An open account transaction is a sale where the goods are shipped and delivered before payment is due, which is usually in 30 to 90 days. Obviously, this option is the most advantageous option to the importer in terms of cash flow and cost, but it is consequently the highest risk option for an exporter. Because of intense competition in export markets, foreign buyers often press exporters for open account terms since the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may lose a sale to their competitors. However, the exporter can offer competitive open account terms while substantially mitigating the risk of non-payment by using of one or more of the appropriate trade finance techniques, such as export credit insurance.

Question: Identify and discuss the various functions of commercial banks.

Solution :

Functions of Commercial Banks

The functions of commercial banks are explained below:

Primary functions

Collection of deposits Making loans and advances

Collection of deposits: The primary function of commercial banks is to collect deposits from the public. Such deposits are of three main types: current, saving and fixed.

A current account is used to make payments. A customer can deposit and withdraw money from the current account subject to a minimum required balance. If the customer overdraws the account, he may be required to pay interest to the bank. Cash credit facility is allowed in the current account.

Savings account is an interest yielding account. Deposits in savings account are used for saving money. Savings bank account-holder is required to maintain a minimum balance in his account to avail of cheque facilities.

Fixed or term deposits are used by the customers to save money for a specific period of time, ranging from 7 days to 3 years or more. The rate of interest is related to the period of deposit. For example, a fixed deposit with a maturity period of 3 years will give a higher rate of return than a deposit with a maturity period of 1 year. But money cannot be usually withdrawn before the due date. Some banks also impose penalty if the fixed deposits are withdrawn before the due date. However, the customer can obtain a loan from the bank against the fixed deposit receipt.

Loans and advances: Commercial banks have to keep a certain portion of their deposits as legal reserves. The balance is used to make loans and advances to the borrowers. Individuals and firms can borrow this money and banks make profits by charging interest on these loans. Commercial banks make various types of loans such as:

1. Loan to a person or to a firm against some collateral security;2. Cash credit (loan in installments against certain security);3. Overdraft facilities (i.e. allowing the customers to withdraw more money than what

their deposits permit); and

4. Loan by discounting bills of exchange..

Secondary functions

Agency services General utility services

Agency Services: The customers may give standing instruction to the banks to accept or make payments on their behalf. The relationship between the banker and customer is that of Principal and Agent. The following agency services are provided by the bankers:

1. Payment of rent, insurance premium, telephone bills, installments on hire purchase, etc. The payments are obviously made from the customer’s account. The banks may also collect such receipts on behalf of the customer.

2. The bank collects cheques, drafts, and bills on behalf of the customer.3. The banks can exchange domestic currency for foreign currencies as per the

regulations.4. The banks can act as trustees / executors to their customers. For example, banks

can execute the will after the death of their clients, if so instructed by the latter.

General Utility Services: The commercial banks also provide various general utility services to their customers. Some of these services are discussed below:

1. Safeguarding money and valuables: People feel safe and secured by depositing their money and valuables in the safe custody of commercial banks. Many banks look after valuable documents like house deeds and property, and jewellery items.

2. Transferring money: Money can be transferred from one place to another. In the same way, banks collect funds of their customers from other banks and credit the same in the customer’s account.

3. Merchant banking: Many commercial banks provide merchant banking services to the investors and the firms. The merchant banking activity covers project advisory services and loan syndication, corporate advisory services such as advice on mergers and acquisitions, equity valuation, disinvestment, identification of joint venture partners and so on.

4. Automatic Teller Machines (ATM): The ATMs are machines for quick withdrawal of cash. In the last 10 years, most banks have introduced ATM facilities in metropolitan and semi-urban areas. The account holders as well as credit card holders can withdraw cash from ATMs.

5. Traveler’s cheque: A traveler’s cheque is a printed cheque of a specific denomination. The cheque may be purchased by a person from the bank after making the necessary payments. The customer may carry the traveler’s cheque

while travelling. The traveler’s cheques are accepted in banks, hotels and other establishments.

6. Credit Cards: Credit cards are another important means of making payments. The Visa and Master Cards are operated by the commercial banks. A person can use a credit card to withdraw cash from ATMs as well as make payments to trade establishments.

Que. What is inflation give its causes, consequences and remedies with an example?

Ans. Inflation is the rate at which the general level of prices for goods and services is

rising and, consequently, the purchasing power of currency is falling. Central banks attempt to limit inflation, and avoid deflation, in order to keep the economy running smoothly.

OR  Inflation is the percentage change in the value of the Wholesale Price Index

(WPI) on a year-on year basis. It effectively measures the change in the prices of a basket of goods and services in a year. In India, inflation is calculated by taking the WPI as base.

Example of Inflation:Zimbabwe - 2006 to 2008Inflation reached 66,212pc in December 2007, the highest in the world at that time. The highest denomination bank note had a face value of 10 trillion Zimbabwe dollars.

Real Life Example:

Year Commodity Price Quantity (kg) Bill Inflation

20101.     Apple2.    Orange

100100

12

100*1 + 100*2 = 300 No data

20111.   Apple

2.  Oranges11095

12 110*1 + 95*2= 300 300-300/300

Inflation in apples 110-100/100 would be 10%Inflation in oranges 95-100/100 would be -5%

so general inflation would be 10% + (-5%) = 5% 

Types of Inflation

We will discuss the two major types of inflation:

1. Demand Pull Inflation: Inflation arises when there is an increase in the supply of money but there is no corresponding increase in the supply of goods useful to the community.

Accumulation of more money than before raises the purchasing power of people and stimulates the demand for goods but the supply of the latter being limited, the necessary consequence will be the inflation of the price level. Demand Pull Inflation thus means, in plain words, too much money chasing too few goods.2. Cost Push Inflation: When the prices of goods increases because of an increase in the cost of production, it is known as cost push inflation.

Causes of Inflation

Most economists feel there are three main factors which lead to it. These three are usually called demand-pull, cost-push, and money supply expansion.

In the demand-pull scenario, consumer demand for goods and services is greater than the available supply. Thus, the pricing of those items is raised to prevent inventories from being depleted.

Cost-push inflation happens on the supply side. Sellers raise their pricing in order to cover their increased production costs such as labor and components of the items they produce.

Money supply is the third major factor to be considered. It is also a method of the government to help control inflation. As more money is in circulation, consumers will likely use it to purchase additional items they would not have normally bought.

Keeping these factors in mind, it becomes easier to understand both the positive and negative effects of inflation and why its control is important for a growing economy.

Remedies for Inflation

However, the harmful tendencies of inflation should be minimized. In countries where inflation prevails, the Government must take effective steps to keep it under check.

It can be combated by reducing the purchasing power of the people through imposition of additional taxes. A high rate of taxation may, however, prove annoying and take away the initiative for enterprise.

The Government sometimes raises public loans, which also effectively restricts the purchasing power of people.

It may also be necessary to impose a system of control on production and distribution of many goods.

The main measures which are used to control inflation are:

1.     Monitory policy.2.     Fiscal policy.3.     Direct measures and other measures.

1.  Monitory policy:

Monitory policy is a policy that influences, the economy through changes in money supply and available credit. Monitory policy is adopted by central bank of country. The various monitory measures which are used to control inflation are grouped under heads.

a.     Qualitative control.b.     Quantitative control.

There are:1.     Open markeet operations2.     Variation in bank rates3.     Credit rationing4.     Varing reserve requirements.

2. Fiscal policy:

Fiscal policy is the deliberate change in either government pending or taxes to simulate or slow down the economy. It is the budgetary policy of government relating to taxes, public expenses, public borrowing and deficit financing.

Fiscal policy is based upon demand management examples, raising or lowering the level of aggregate demand by controlling various. Expenses, government expenses, consumption expenses.

3.  Direct measures:

It means the step of government like rationing of goods and freezing of prices and wages. The government can also increase voluntary savings of people by giving them various incentives.

Other measure:

a. Increase in output:

The most effective method to control inflation is to increase the supply of goods. For this purchase, industrial and agricultural out put should be increased. However, Pakistan performance in this regard in unsatisfactory.

b. Control of smuggling:

All steps should be adopted to check these evils through publicity as well as punishment. Large quantity of wheat, ghee, and other essential commodities being smuggled to Afghanistan should be control.

c. Industrial peace:

Industrial peace should be control to maintain the supply of goods and avoid the danger of scarcity. The disturbance such as what happened at Karachi during the post years? Should be control.

d. Control of money supply:

Volume of credit and money supply should be control. This can be done if tight monitory policy is followed. Decrease in money supply means less purchasing power with the people.

e. No deficit financing:

Deficit financing should be disco tribute. The development expenses should be meat through taxation, savings. Excessive issue of currency should not be used to meet budget deficit.

f. Population control:

Measure should be adopted to decrees the rate of population growth. The campaign of population planning has already started showing some success.

g. Simple living:

Luxurious life style should be discouraged and simple living should be adopted. The political leaders should themselves adopt simple living and provide an example for others.