Economics tuition partner

What is Economics?
Economics is the social science that studies the production,
distribution, and consumption of goods and services.
Economics is the study of how people allocate scarce
resources for production, distribution, and consumption, both
individually and collectively.

Types of Economics
Microeconomics focuses on how individual consumers and
firm make decisions; these individuals can be a single person,
a household, a business/organization or a government
agency.
Macroeconomics studies an overall economy on both a
national and international level. Its focus can include a distinct
geographical region, a country, a continent, or even the whole
world.

Types of Economics
Microeconomics focuses on how individual consumers and
firms make decisions; these individuals can be a single
person, a household, a business/organization or a government
agency.
Macroeconomics studies an overall economy on both a
national and international level. Its focus can include a distinct
geographical region, a country, a continent, or even the whole
world.

Opportunity Cost
Opportunity costs represent the benefits an individual,
investor or business misses out on when choosing one
alternative over another.
Example 1: You bought a tshirt for Nrs. 3000.
Opportunity cost: You could have bought a pair of shoes with that money.
Example 2: You are watching this course now.
Opportunity cost: You could have watched tiktok videos.

Demand
the consumer's desire and ability to
purchase a good or service.

Law of Demand
Other things being constant, as the price of a
good increases (↑), quantity demanded
decreases (↓);
Similarly, as the price of a good decreases (↓),
quantity demanded increases (↑)

Demand Curve
A demand curve is a
graph that shows the
quantity demanded at
each price.
The demand curve is
downward sloping to
the right.

Why is the demand curve downward sloping?
Why does the demand decrease when
price increase and why demand increase
when price decrease?

There are two reasons that cause price to behave
like that
1. Income Effect
1. Substitution Effect

Income Effect
The income effect suggests that, as the price of a
good falls, real income (that is, what consumers
can buy with their money income ) rises and
consumers increase their demand. Similarly, If
price of good increase they can buy less of that
thus decreasing the demand.

Substitution Effect
as the price of one good (Suppose Product XYZ) falls, it
becomes relatively less expensive than the other similar
products whose price stays the same. So people buying that
another products will also start buying product XYZ thus
increasing the demand. Similarly if the price of XYZ increases,
people will buy other alternatives which will decrease the
demand of product XYZ

Expansion and Contraction in Demand
Expansion of demand: when quantity
demanded increases because of the
fall in price.
Contraction of demand: when the
quantity demanded is less due to
rise in the price.

Shift in demand curve
A shift (Downward or Upward) in
the demand curve occurs when the
demand of the product changes for
the same price.
In expansion or contraction of
demand, the demand changes due
to change in price but in shift of
demand curve, the price remains
same but the demand changes.

Supply
the willingness and ability of producers
to create goods and services to take
them to market.

Supply Curve
Supply Curve is the
graphic representation
that shows the relation
between product price
and quantity of product
that a seller is willing
and able to supply.

Equilibrium
Equilibrium is the state
in which market supply
and demand balance
each other, and as a
result, prices become
stable.

When there is
increase in price
than the
equilibrium
price, there is
EXCESS SUPPLY

When there is
decrease in price
than the
equilibrium
price, there is
SHORTAGE

Factors that affect demand (other than price of the
good)
Income
Tastes
Price of other goods
Population
Consumers' Expectations with Regard to Future Prices

Income
When consumer’s income increases, she usually buys more
goods which increases the demand or people who couldn’t
afford the goods previously might afford it now thus increasing
demand of the product.
For eg: When income of a city increase, people will do more
shopping and buy more things.
However, for inferior goods, demand will decrease when income
increases because people will buy more quality alternatives.

Prices of other goods (Substitutes goods)
Let's take two substitute goods; Parachute coconut oil and Dabur
coconut oil. If price of Parachute oil increases, more people will give up
buying Parachute oil and buy dabur oil instead. The demand of dabur oil
will increase.
Parachute Oil Dabur Oil
Price Increase so, More people will now buy dabur oil. so,
Demand Decrease Demand INCREASES

Prices of other goods (Complementary goods)
Let's take two complementary goods; Meat and Meat Masala (Spices). If
price of Meat increase more people will buy/consume less meat so buy
less Masala as well.. The demand of Meat Masala decrease.
MEAT MEAT MASALA
Price INCREASE so, People will buy less Masala so,
Demand Decrease Demand DECREASES

Population
If population of the place
increase, then for the
same price more people
will buy the products
which increases the
demand similarly if
population decreases,
demand decreases.

Consumers´ Tastes (Preferences)
When a consumer likes (prefers) the good more she buys it
more and the demand increases.
If a celebrity endorses a new product, this may increase the demand for
a product.
Similarly, if a new health study comes out saying Potato Chips can cause
serious health conditions, this may decrease the demand for Potato
Chips.
Tastes of consumers change time and again creating more or less
demand of products.

Future expectations (Expectations effect)
When consumers expect higher prices in the future, or scarcity in future,
they buy more goods now which causes the increase in demand.
Similarly, if they expect the price decrease in future, they will buy less
now decreasing the demand.
For eg: In the early days of COVID19 pandemic, there was a massive
increase in demand of salt and grocery items. This was due to
consumer’s expectation that there will be scarcity or prices will increase.

REMEMBER
If there is change in price of a
product, there will be a
movement along the demand
curve.
If there is change in conditions ,
the demand curve shifts from its
place.

Elasticity
Elasticity is a measure of a variable's sensitivity to a change
in another variable
Elasticity is an economic measure of how sensitive an
economic factor is to another, for example changes in
demand to change in price, or changes in demand to
changes in income.

Price elasticity of demand
Price elasticity of demand measures the responsiveness of
demand after a change in a product's own price.
This means PED measures how much change in demand happens
when the prices changes.
It is measured as : Percentage change in quantity demanded
divided by the percentage change in price

PED...
If Ped = 0 , demand is perfectly inelastic
If Ped is between 0 and 1 then demand is
inelastic.
If Ped = 1, then demand is unit elastic.
If Ped > 1, then demand demand is elastic.

Cross-Price Elasticity of Demand (XED)
Cross-price elasticity of demand is the percentage
change in the quantity demanded of a good as a
result of a percentage change in the price of another
good.

XED...
For eg: Let’s say the price of Papaya increases by 10% which results in the
increase of demand of Watermelon by 3%.
Hence, XED of watermelon = 3% / 10% = 0.3
For Substitute goods, XED is POSITIVE
For Complements, XED is NEGATIVE
For Unrelated goods, XED is ZERO.

Total Revenue and PED
Total revenue= Quantity demanded * Price
So, Let’s say a price of a smartwatch increases by 10%. After calculation, we
found the TOTAL REVENUE (that is the total amount collected by selling
smartwatches) also increases.
Is the demand of smartwatch elastic?

Factors that influence PED
Availability of substitutes
Proportion of income spent on that product
Necessity
Habit of purchasing that product
Time

Factors that influence PED...Availability of substitutes
If close substitutes for a particular good are available in the
market, then the demand for the good would be relatively more
elastic.
For ex: There are various brands of ballpoint pen available in market.
If one brand(say Cello) increases price, people might simply buy
another brand. So, the % of decrease in demand of Cello will be more
than the % increment in price. Hence the product is MORE ELASTIC.
Again, if there is no close substitute people will continue demanding
the product amid of price increase making it INELASTIC.

Factors that influence PED… Proportion of income spent on
that product
If the buyers spend a small proportion of their income, then they would
not considerably decrease their purchase of the good as its price
increases.
On the other hand, if they spend a large proportion of their income on a
good, then its elasticity of demand would be relatively high.
For eg: If a person earn Rs. 20,000. Her purchasing decisions won’t be much
impacted by increase in price of a product costing Rs. 200(1% of income).
However, if he has to spend Rs 2000 (10% of income) on a product, the increase
in price of the product will make her buy less.

Factors that influence PED...Necessity and Luxury
The elasticity of demand for a necessary good is relatively small. For
example, if the price of such a good rises, its buyers generally are not
able to reduce its demand.
If the price of a necessary good diminishes, the buyers cannot
considerably increase their purchase of the good, since the good is a
necessity, they had been purchasing the required quantities at the
previous price.

Necessity and Luxury...
Example of Necessary goods: Rice, Sugar, electricity, telephone, medicine
People simply don’t buy less rice if the price is reduced or buy more rice
because price decreases. They have been buying the needed amount and
shall continue buying that amount so price change won’t impact much. If
this happens it will be less than the % change in price.
For luxury goods, people can reduce the demand if the price increases or
buy more of that luxury if the price reduces. So such goods are ELASTIC.
Eg of luxury goods: Branded clothes, Camera, Premium movie theaters

Factors that influence PED...HABITS
Habits like alcohol consumption, cigarette, tea etc. Habits
might change over time resulting in change in demand.
Also, if buying certain things might be habit of consumers
like buying newspaper daily, eating PAAN after dinner
etc.
Such products are relatively Inelastic in nature because
they continue buying those products even if the price
changes.

Factors that influence PED...TIME
With time, relatively inelastic goods become elastic.
Why this happen?
When the price of a product changes, consumers consumers
continue buying to consume the product. So the the good is
relatively inelastic in the beginning. As the time passes, people
buy less or more of the product so the good becomes relatively
elastic over time.

Factors that influence PED...TIME...
With time passing, the customers get more information from the market
about other similar goods or even start looking for alternative products
or even start consuming the product less even if alternative is not
available. So, with time, the consumers start buying the product lesser
than immediately after the price increase.
Also, when price decreases, initially the consumers buy the goods in
similar amounts as before. However, with time they may give up
alternative products and start buying more of the goods thus making it
elastic over time.

Income Elasticity of Demand
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.
IED= % change in demand
% change in real income

Giffen Goods
Quite Unusual Concept.
A basic good ( low income, non-luxury products) where demand
increases when the price increases (reversing the usual law of demand).
The idea is that if you are very poor and the price of your basic foodstuff (e.g.
vegetables) increases, then you can’t afford the more expensive alternative food
(meat) therefore, you end up buying more vegetables because it is the only thing
you can afford. If you used to eat meat twice a week, you spend so much money
on buying the vegetables in the other 5 days that you can’t afford meat so you
buy vegetables again in those two days or 1 more day which increases the
demand of vegetables.

Veblen /Snob goods
A veblen good is a good for which demand increases as the
price increases, because of its exclusive nature and appeal
as a status symbol.
These goods are usually considered to be status symbols –
a symbol of wealth, affluence and success.
Eg: Art, Antique items, Diamonds

Shift in suppy curve
A shift (Downward or Upward) in
the supply curve occurs when the
supply of the product changes for
the same price.
In expansion or contraction of
supply, the supply changes due to
change in price but in shift of
supply curve, the price remains
same but the supply changes.

Different type of Goods
Normal (demand increase when income increase, IED 0-
1)
Inferior (demand decrease when income increase, IED <
0)
Luxury (demand decrease when income increase, IED >
1)

An upward shift in supply
At existing price, less quantity will be
supplied.
Reasons:
- Higher production costs (may happen due to
increase in factors of productions like raw
materials, wages, bank interest etc)
- Indirect taxes (rise in indirect taxes like VAT
makes supply at existing price less profitable)

An downward shift in supply
At existing price, more quantity will be
supplied.
Reasons:
- Technical innovation
- more efficient production process
- lower input prices
-reduction in indirect taxes

Minimum and Maximum Prices
The basic assumption in economics is market force maintains its
equilibrium. ("Invisible Hand", Adam Smith)
However, in some cases, this equilibrium price may not be most
desirable for general public.
In such cases, government might intervene and set prices above or
below the market equilibrium price.

Maximum Price (Price Ceiling)
A maximum price occurs when a
government sets a legal maximum
limit on the price of a good or service –
with the aim of reducing prices below
the market equilibrium price.
Examples: Bus fare, Rent, Meat prices

Maximum Price (Price Ceiling) | WHY? |
-to benefit consumers on low incomes so that
every citizen can afford and consume essential
goods.
- to control inflation (limit price hikes)
- to limit monopoly pricing (so that some major
producers can't make their products too
expensive)

Maximum Price (Price Ceiling) | CAN CAUSE |
- Shortage in supply
- Dissatisfaction of consumers (due to shortage)
- Arbitrary (unfaithful) ways of allocating/distributing products
-Misallocation of resources (suppliers might use resources to
produce other ; less useful goods)
- emergence of black markets
-Reduction of quality

Minimum Price (Price Floor)
A price floor is the lowest legal price
that can be charged for goods and
services, labor, or financial capital.
Examples: Minimum wage, Coffee,
Agro products

Minimum Price (Price Floor) | WHY? |
-to ensure that the market price of a commodity
does not fall below a level that would threaten the
financial existence of producers of the commodity.
- to ensure service providers, workers can provide
service and labor in sustainable manner.

Minimum Price (Price Floor) | CAN CAUSE |
- Excess supply
- Dissatisfaction of consumers ( goods become expensive for
customers)
- Misallocation of resources (sellers may use less resources to
produce other goods)
- Waste of resources ( resource can be used to produce goods
with no demand)
-Unemployment

The economic behaviour of cost
i.e how costs tend to vary over time
- Short term cost behaviour
- Long term cost behaviour

Short term cost behaviour
In short term, micro economists believe that costs follow the law of
diminishing returns.
Law of diminishing (marginal ) returns:
At beginning, with every extra input added (all other factors being fixed),
output increases and average cost per unit fall in a great proportion.
However a point will eventually be reached at which additions of the
input yield progressively smaller, or diminishing, increases in output.

Let's consider a fish tank. There are 34 fish which
share the fixed resource ; the water, tank.
If farmer add one more fish, the output will
increase and average cost per kg of fish will
decrease. After a certain point, there will be too
many fishes who will compete each other for
oxygen, swimming space and this might result in
fishes not developing at full potential causing loss
in weight. Hence adding more fishes will not
increase the output as much as earlier.

Let's consider a factory.
Suppose we increase number of workers with machines, space being same.
Initially with every added number of worker, the cost to produce will reduce
progressively. (machine, factory space could be used in full capacity)
However, soon the workers will have to wait for resources (eg, machine,
space to work) and will start getting at each other's way hence adding very
less benefit. The average cost will start increasing again.

The short-run average total
cost curve (SRATC) tends to
be "U" shaped, following the
law of diminishing returns.

Long term cost behaviour
In short term,all costs tend to be variable in nature.
As business expands, it becomes difficult to control costs and maintain
efficiency of operations.
At first, the total cost decreases with addition of factors of production.
However, after some expansion, there may be difficulty in getting
regular supplies, managing workers, controlling operations hence
increasing the average costs again. (diseconomies of scale)

In long run, the space /pond is variable factor.
Farmer can simply add extra pond if number of
fishes increase. It becomes more difficult for the
farmer to take care of all ponds. Even if he
employs some other people, that may not be as
efficient as managing small pond. Also, as the
fish ponds become scarce, it will cost the farmer
more to get extra pits.
Hence in long run, initially the average cost per
unit decrease but start increase in long run.

The short-run average total
cost curve (LRATC) tends to
be "U" shaped.

Types of Markets
1. Perfect Markets
2. Imperfect Markets
- Monopoly
- Monopolistic Competition
- Oligipolies

Types of Markets : Perfect Markets
A perfect market exists when all the following criteria are met:
- Large number of customers and suppliers (none can dominate the market)
- Identical products by all sellers (homogenous products)
- All consumers and suppliers have complete information on the prices of
goods/services sold elsewhere in market
- no barrier to entry or exit from market. (any competitor can come and go from
market)
IDEAL MARKET, Not quite seen in real world, Equilibrium happens in
Perfect markets

Types of Markets : Imperfect Markets
If any of the previously mentioned criteria not met, the market becomes
imperfect market. Almost all markets in the world are imperfect markets.

Imperfect Markets : Monopoly
A market where one company is the sole supplier.
Key features:
- one major supplier
- No close substitute products available
- Supplier is free to set any price
Eg: luxottica, de beers
Causes: Economics of scale, government regulation, ownership of key
resource

Imperfect Markets : Monopoly
Can be caused by:
- Economics of scale
- Government regulation
- Ownership of key resource
- Patients
The government may wish to regulate monopolies to protect the
interests of consumers. For example, monopolies have the market
power to set prices higher than in competitive markets.

Imperfect Markets : Monopolistic competition
There are many competitors but they provide differentiated products
(not perfect substitutes)
Features:
- business can make independent decisions about its product and price.
However, does not have as much power as monopolies.
- no major barrier to entry and exit in market
- Heavy advertising and marketing is common
example: restaurants, bakeries, designer clothes

Imperfect Markets : Oligopolies
Market is controlled by a small number of businesses. (generally 2-6)
Example: Nepali Airlines, Payment Gateways (khalti, esewa, IMEpay)
Can cause:
- Difficulties to new firms to enter market
- Give them power to influence the price of goods and services
DUOPOLY: If two firms dominate the market eg: Ncell and NTC

Macroeconomics
Macroeconomics (from the Greek prefix makro- meaning "large" +
economics) is a branch of economics dealing with the performance,
structure, behavior, and decision-making of an economy as a whole
including:
- overall (aggregate) demand for goods and services
- Total output of goods and services (national output)
- Supply of resources (capital, labour, land etc)

Macroeconomic Policy
Many economists advocate free market (one without government
interferences)
However, in reality governments intervene through various
macroeconomic policies to improve the performance of the
economy.

Macroeconomic Policy
Their main objectives are typically:
- Economic Growth (Increasing the productive capacity of the economy)
- Low inflation (limiting price hikes)
- High employment (providing jobs to maximum people)
- Sustainable balance of payment (maintaining healthy trade with other
countries)

Aggregate demand
The total demand for a country's output.
AD= C + I + G + (X- M)
Where, C= Consumer spending
I= Investment by businesses
G= Government spending (on the economy)
X= Exports (demand from other countries)
M= Imports (demand of other country's goods and services)

Consumer spending
With higher consumer confidence, consumer spending increases which
increase the aggregate demand of the economy.
Consumer confidence: degree of optimism that consumers feel about
the economy (market) and their own personal finances.

Investment by businesses
With higher business confidence, businesses put more money in the
market through investment (new factory, machines, technology etc)
which increase the aggregate demand of the economy.
Investment of businesses can be increased by: Greater availability of
finance, lower interest rate (businesses can take more loan to invest)
Business confidence: degree of optimism that businesses feel about the
economy (market).
Confidence can be reduced by factors like: high unemployment, high
inflation etc

Examples
- a consumer is has a stable monthly income and feels his job is secure for
foreseeable future. This will increase his confidence and hence increase
spending. AD increase.
-Government increases Income Tax. People will spend less so AD decreases.
- The demand of local product increases in foreign country. AD increases
- The currency of a country becomes strong (strengthening currency), exports
become expensive and imports become cheaper. So Lower (X-M) With lower
export demand and greater spending on imports, we would expect fall in
domestic aggregate demand (AD), causing lower economic growth.

Strengthening currency and Aggregate demand
Also called currency appreciation.
Let's say, Rs. 1 = 1 Yen (2018)
Rs. 1 = 2 Yen (2021) (NPR becomes strong in relation to JPY)
For the same thing worth Rs. 5000, Japanese companies would pay 5000 Yen
on 2018 but have to pay 10000 Yen on 2021. So, demand for Nepalese product
in Japan decreases.
Similarly, to buy anything worth 1000 Yen from Japan, in 2018 it cost Rs. 1000
while in 2021 it costs Rs. 500. So, more Nepalese may demand Japanese
products hence increasing imports.
So, Aggregate demand falls. Remember: AD = C+I+G+(X-M)

Recession is a slowdown or a massive contraction in economic activities.
A significant fall in spending generally leads to a recession
A trough is the stage of the economy's business cycle that marks the
end of a period of declining business activity and the transition to
expansion.
Expansion is the phase of the business cycle when the economy moves
from a trough to a peak
A peak is realized when the economy is producing at its maximum
allowable output, full employment.

BOOM and BUST
During the boom the
economy grows, jobs
are plentiful and the
market brings high
returns to investors.
In the bust the economy
shrinks, people lose
their jobs and investors
lose money.

BOOM and BUST
-When demand begins to fall, recession starts. Low demand means low
production, low employment, less purchase of raw material and lower overall
economic activity.
-This will decrease people's income which further reduces the aggregate
demand.
- Economy falls quickly, business and consumer confidence becomes low.
- Government may be forced to inject more spending, reduce interest rates, thus
increasing the AD, businesses start gaining some confidence and economic
activities increase and unemployment starts decreasing. Expansion starts.

BOOM and BUST
-The economy expands, pushing upwards into a boom. When demand,
employment reaches full potential (peak), demand become stable for some time.
Reduction of new investment starts and again economy starts slowing down .
The cycle continues.

BOOM
The Goods
- Low unemployment
- High consumer and business
confidence
- Growth in business
The Bads
- Inflation
- People may over-stretch
borrowing

BUST
The Bads
- Job Losses
- No money left to pay mortgages and other bills
- Fall in labor mobility (movement of labour within an economy and between
different economies)
- Bankruptcy
-Low business confidence, Corporate failures, Decline in profits, excess capacity

Key Economic Issues
- Stagnation and economic growth
- Inflation
- Unemployment
- Balance of Payments

Economic Growth
Benefits:
- More demand and supply
- More jobs, increased employment
- More earning so higher living standards

Economic Growth
Problems:
- Unequal distribution of benefits of growth may increase gap between
rich and poor (Economic inequality)
- Overexploitation of environment and poor
- Rising incomes leads to increase in demand of imported goods. This
can lead to decrease Aggregate demand of economy.
- Demand may rise faster than the production capacity. Scarcity of
goods can increase inflation rapidly.

Stagnation
Stagnation is a prolonged period of little or no growth in an economy.
Generally, real economic growth of less than 2% annually is considered
stagnation
Stagnation often involves substantial unemployment and under
employment, as well as an economy that is generally performing below
its potential.

Inflation
Inflation refers to the rise in the prices of most goods and services of
daily or common use, such as food, clothing, housing, recreation,
transport, consumer staples, etc.
Governments want stable prices and low inflation rate. Policymakers/
economists generally believe that an acceptable inflation rate is around
2 percent or a bit below.
Inflation rate of Nepal 2019: 5.6%
(https://data.worldbank.org/indicator/FP.CPI.TOTL.ZG?locations=NP)

Inflation...
Problems that inflation causes:
- Consumers buy less goods due to higher prices
- Employees will demand high salary so businesses will suffer
- Increase in cost makes production expensive
- Businesses lose confidence and reduce investment
- Price hike of domestic products can make imported goods attractive
thus increasing imports and reducing Aggregate demand.

Inflation and saver's behaviour:
Transactions Motive: saving money to spend later.
- These people will save less because they can buy less with the money
saved so instead spend now.
Precautionary Motive: spending less to save for future emergencies.
- These people will save more because more money will be required in
future due to increasing prices.

Stagflation
Stagflation is an economic event in which the inflation rate increases
when the economic growth slows and unemployment increases.
Generally, inflation is high at high growth.
Such an unfavorable combination is feared and can be a dilemma for
governments since most actions designed to lower inflation may raise
unemployment levels, and policies designed to decrease unemployment
may worsen inflation.

Unemployment
Unemployment is a term referring to individuals who are employable
(able to work) and actively seeking a job but are unable to find a job.
Government always try to keep unemployment level reasonably low.
High rates of unemployment are a signal of economic distress, but
extremely low rates of unemployment may signal an overheated
economy.
An overheating economy is an economy that is expanding at an unsustainable
rate. (Signals of overheated economy: High Inflation, extremely low
unemployment)

Unemployment
Problems that unemployment can cause:
- Less income tax, increased unemployment benefits
- Higher income tax for other workers. This will reduce consumer confidence and
spending.
- Reduced standard of living, lower self esteem.
However for Businesses:
- Increased pool of labour to hire, can pay low salary and wages, existing staff
will accept reduced payment as there are not much options left.
But decreased demand in the economy will hurt businesses.

Balance of Payments
The balance of payments (BOP) is a statement of all transactions made between
entities in one country and the rest of the world over a defined period of time,
such as a quarter or a year.
BOP is split into three parts:
- Current account (import and export of goods and services)
- Capital account (monitors the flow of international capital transactions.)
- Financial account (In the financial account, international monetary flows
related to investment in business, real estate, bonds, and stocks are
documented.)

Balance of Payments
The balance of payments (BOP) is a statement of all transactions made between
entities in one country and the rest of the world over a defined period of time,
such as a quarter or a year.
BOP is split into three parts:
- Current account
- Capital account
- Financial account
The current account should be balanced against the combined-capital and
financial accounts; however, as mentioned above, this rarely happens.

Balance of Payments
CURRENT ACCOUNT: The current account is used to mark the inflow and
outflow of goods and services into a country. Earnings on investments, both
public and private, are also put into the current account.
CAPITAL ACCOUNT: The capital account records all international purchases and
sales of assets such as money, stocks, bonds, etc. It also includes foreign
investments and loans.
FINANCIAL ACCOUNT: international monetary flows related to investment in
business, real estate, bonds, and stocks are documented.

Trade Deficit and Trade Surplus
TRADE SURPLUS: A trade surplus occurs when a country's exports exceed its
imports. Will lead to high economic growth and inflation. Also called Positive
Balance of Trade
TRADE DEFICIT: A trade deficit occurs when a country's imports exceed its
exports during a given time period. Decreases the wealth of county. Also called
Negative Balance of Trade
Balance of trade (BOT) is the difference between the value of a country's
imports and exports for a given period. It is a component of BOP
BOT= Value of exports- Value of imports

Economic Policy Options
Government have two main ways of affecting the economy.
- Fiscal Policy (Government's taxation and spending plans)
- Monetary Policy (Management of the money supply in the economy)

Fiscal Policy
Government Planning of Income (taxes) and expenditures (spending)
Income: Money raised from direct and indirect taxes.
Expenditure: Money spent to provide services to population. Eg;
healthcare, education, transportation etc
Balanced Budget: When government's income and expenditure are
exactly matched.

Budget Deficit
When Government Spending is higher than Government income.
By running budget deficit, the government is injecting more money in
the economy (more govt spending) than it it taking out. This boosts
Aggregate demand and reduce unemployment.
Running a budget deficit is also known as 'expansionary' strategy

Budget Deficit
This is used by Government when there is Deflationary Gap.
Deflationary Gap is a situation where there is insufficient
aggregate demand to get the economy to full employment.

Budget Surplus
When Government Spending is lower than Government income.
By running budget surplus, the government is taking out more money
from the economy (more govt income) than it is spending. This reduces
Aggregate demand.
Running a budget deficit is also known as 'contractionary' strategy

Budget Surplus
Used by Government when there is an Inflationary gap.
Inflationary gap is a situation when aggregate demand in economy is
higher than the country can supply leading to high inflation.

Monetary Policy
Expansionary Monetary policy: A policy to increase money supply in the
economy
Contractionary Monetary policy: A policy to decrease the total money
supply in the economy.
Government can use various policies to control the amount of money
that flows to and from the economy.

Monetary Policy
Tools government use to increase or decrease the money supply in the
economy:
1. Interest Rates
2. Reserve Requirements
3. Open Market Operations

Monetary Policy
1. Interest Rates
Raising interest rate decrease the money supply as people and
businesses will take less loan from banks.
This will generally reduce Aggregate Demand.

Monetary Policy
2. Reserve Requirement
Reserve requirements are the amount of funds that a bank holds in
reserve to ensure that it is able to meet liabilities in case of sudden
withdrawals.
For eq, if bank has 1crore in deposits, 10% of reserve requirement means
bank should keep 10 lakhs in reserve and can lend 90 lakhs.
Increasing Reserve requirement means banks can lend less money so
decreasing money supply.

Monetary Policy
3. Open Market Operations
Government can buy and sell bonds to increase or decrease money
A government bond is a form of security sold by the government. When you buy
a government bond, you lend the government an agreed amount of money for
an agreed period of time. In return, the government will pay you back a set level
of interest at regular periods, known as the coupon. This makes bonds a fixed-
income asset.

Quantitative Easing
Quantitative easing usually involves a country's central bank purchasing
longer-term government bonds, as well as other types of financial assets
using the money generated electronically.
It is like printing money to buy government bonds so that government
has enough money to circulate in the economy. This can create inflation.

Economies Theories
Classical Theory:
The fundamental principle of the classical theory is that the economy is
self‐regulating. Government should do nothing as economy maintains its
equilibrium by its own.

Economies Theories
The Keynesian View (Demand Side):
Keynesian economics is a theory that says the government should
increase demand to boost growth or decrease aggregate demand
to control inflation.
Keynesian economics focuses on using active government policy
to manage aggregate demand in order to address or prevent
economic recessions.

Economies Theories
The Monetarist View (Supply Side):
Monetarist view focuses on improving the supply of factors of
productions.
The core point of supply-side economics is that production (i.e.
the "supply" of goods and services) is the most important in
determining economic growth.

Achieving Policy Objectives
A government will focus on trying to control growth, inflation,
unemployment and the balance of payments using a variety of
tools.

Growth:
Policies to promote growth:
- Running a budget deficit
- Increasing the availability of production factors
- Reducing interest rates
- Government grants and incentives

Unemployment:
Cyclical Unemployment : (also known as demand deficient, persistent or
Keynesian unemployment)
Caused by Aggregate Demand being too low to create employment
opportunities.
Keynesian solution: boost aggregate demand (by running trade surplus,
budget deficit)
Monetarist solution: remove market imperfections.

Unemployment:
Frictional Unemployment : Short-term unemployment as people
move between jobs.
Solution: increase information unemployed people receive about
job opportunities (supply-side policy)

Unemployment:
Structural or Technological Unemployment : Structural
unemployment refers to a mismatch between the jobs available
and the skill levels of the unemployed.
Mainly caused by technological advancement in industries and
change in the location of economic development.
In such unemployment monetarist policies are likely to be more
effective like govt funded training, support for labor relocation etc

Unemployment:
Seasonal Unemployment : Seasonal unemployment occurs when
people are unemployed at particular times of the year when
demand for labour is lower than usual. For example, in an ice
cream factory ,unemployment is likely to be higher in the winter.

Unemployment:
Real wage Unemployment : Real wage unemployment occurs
when wages are set above the equilibrium level causing the
supply of labour to be greater than demand.
Union negotiations keep wages artificially high which leads
businesses to employ less employees leading unemployment.
Solution: Reduce market imperfections like union power,
minimum wage agreements etc (supply-side)

Inflation:
Inflation is considered to be a complex situation for an economy.
If inflation goes beyond a moderate rate, it can create disastrous
situations for an economy. So governments always try to control
inflation.
Types of inflation:
Demand-pull inflation, Cost-push inflation, Imported Inflation,
Monetary Inflation, Inflation due to expectations effect

Inflation:
Demand-pull inflation: Occurs when demand grows faster than
the supply in economy.
Keynesian solution: reduce aggregate demand through tax rises,
reduce govt spending, increase interest rates.

Inflation:
Cost Push inflation: Occurs when cost of factor of production (raw
material, labour etc) rises.
Monetarist solution: Govt can give tax incentives to businesses so
they can produce more.

Inflation:
Imported inflation: Price increase due to an increase in costs of
imported products. Occurs in countries with significant levels of
imports.
Imported inflation is caused by a decline in the value of a
country's currency. The more the currency depreciates on the
foreign exchange market the higher the price of imports.
Effectively, more money is needed to buy goods and services
outside the country.

Inflation:
Monetary inflation: Inflation caused by the increase of money
Monetarist solution: Reduce the money supply in economy. eg :
by increasing interest rates.

Inflation:
Inflation due to expectations effect: People expect that prices will
increase in future. To protect themselves, they will start
demanding increased wages, buying more goods now which will
actually increase the inflation.

Balance of Payment:
Government tries to reduce the trade deficit by:
- Expenditure-reducing strategies (Government deliberately shrinks the
domestic economy to reduce demand for imports by contractionary
monetary policy or running budget surplus)
- Expenditure- switching strategies (Government tries to encourage
consumers to buy domestically produced goods by for eg: controls in
imports via increased customs duty and quotas for imports, subsidising
exports, currency devaluation)

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