TUTORS CIRCLE - Cpt Super Circle Summary Economics december 2013

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Chapter 1
Economics is the study of how society allocates scarce resources and
goods. Resources are the inputs that society uses to produce output, called goods.
Resources include inputs such as labor, capital, and land.
Goods include products such as food, clothing, and housing as well as services such as
those provided by barbers, doctors, and police officers.
These resources and goods are considered scarce because of society's tendency to
demand more resources and goods than are available.
Scarcity: Resources are finite, so decisions must be made as to how to allocate those
resources in the most efficient manner possible. Oil and petrol have rather become
scarce and hence the prices of such commodities continuously rise. In 1995 you could
get a liter of petrol of 20 Rs but the same today costs almost 80 Rs. So let’s assume,
today if you have Rs 1000 would you want to go on a drive with your friends or use the
money to go to a close by restaurant.
The two fundamental facts of Economics is
(i) Human beings have unlimited wants; and
(ii) The means of satisfying these wants are relatively scarce form the subject matter of
Economics.
Adam Smith, the father of Economics, published “The Nature and Causes of Wealth of
Nations “in 1776. He defined Economics as “An inquiry into the nature and causes of the
wealth of the nations.”
J B Say defined economics as “Science which deals with wealth”
Alfred Marshal’s definition of economics: “Economics is a study of mankind in the
ordinary business of life. It examines that part of individual and social action which is
most closely connected with the attainment and with the use of the material requisites
of well-being. Thus, it is on the one side a study of wealth and on the other and more
important side a part of the study of the man.”
A C Pigou – “The range of our inquiry becomes restricted to that part of social welfare
that can be brought directly or indirectly into relation with the measuring rod of money”
Prof. Lionel Robbins - book “Nature and significance of Economics” 1931 “Economics is
the science which studies human behavior as a relationship between ends and scarce
means which have alternative uses”.





Classical Economics- was the first modern style of how people perceived economics. It
flourished in the 18th and 19th century.
Some famous Classical economists were Adam Smith, Jean-Baptiste Say, David
Ricardo, Thomas Malthus and John Stuart Mill.
Neo-classical Economics -Flourished during the late 19th century where economists
related supply and demand to an individual's rationality and his or her ability to
maximize utility or profit.

Paul A. Samuelson defined economics as “Economics is the study of how men and society choose, with or without the use of
money, to employ scarce productive resources which could have alternative uses, to
produce various commodities over time and distribute them for consumption now and
in the future amongst various people and groups of society”.

Prof Henry Smith - Economics, is the “the study of how in a civilized society one obtains
the share of what other people have produced and of how the total product of society
changes and is determined”.

Jacob Viner According to him, “Economics is what Economists do”
Keynesian Economics J.M. Keynes
An economic theory stating that active government intervention in the marketplace
and monetary policy is the best method of ensuring economic growth and stability.
Keynesian economists believed that the government should actively participate to
smoothen out the bumps in a business cycle.

'Laissez Faire' An economic theory from the 18th century that opposes governmental
regulation of or interference in commerce beyond the minimum necessary for a freeenterprise system to operate according to its own economic laws. The transactions
between private parties should be free from taxes, tariffs, and government subsidies.
The phrase laissez-faire is French and literally means "let them do as they will," It has a
few other assumptions:
(i)
(ii)

The economic market rises or falls based upon its own fluctuations with no
government input to stabilize it.
Literally to let things take their own course without interfering.





Microeconomics- micro means small, it studies the markets on a small scale. It focuses on
how a market is impacted by decisions and choices made by small economic units such as
individual consumers, individual firms, or individual government agencies. It includes
(I) Product pricing
(II) Consumer behavior
(III) Factor pricing

(IV) Economic conditions of a section of the people
(v) Study of firms
(VI) Location of an industry

Macro Economics– Is a term derived from the Greek work Makros – meaning large.
Macroeconomics considers the aggregate performance of all markets in the market system
and is concerned with the choices made by the larger subsectors of the economy—the
household sector or consumers; the business sector, or firms; and the government sector or all
government
agencies.
It includes:
(I) National income and output
(ii) General Price level
(iii) Balance of trade and payments

(IV) External value of money
(v) saving and investment
(VI) employment and economic growth

An economic policy is a course of action taken with an intention to influence or control
the behavior of the economy. Economic policies and decisions taken by the
government affect a nation's gross domestic product (GDP), the unemployment rate,
its trade with other nations.
Economic policies are generally implemented and administered by the government.
Examples would be
 How much money to spend on making roads
 How much tax to impose on BMW’s and Audi’s
 How to redistribute Income from rich to the poor.
 How to control the supply of money in an economy.
The effectiveness of economic policies can be assessed in one of two ways, known
as Positive and Normative economics.
Positive Economics – Economics as positive since analyses cause & effect relationship.
It states facts and uses empirical evidence.
Normative Economics- Economics as normative science involves judgments. It analyses
the values and then prescribes the action to be taken.
Deductive Method (Abstract, analytical and priori method) –It involves deducing of
laws logically. Some fundamental assumptions are made & conclusions are drawn
accordingly.





Inductive Method –Facts are collected & analyzed & then conclusions are drawn
based on them.

The Four basic economic problems are





What to produce and how much to produce?
How to produce?
For whom to produce?
How to accelerate economic growth?

Production Possibilities Curve (PPC)A PPF

curve shows and determines all
maximum output possibilities of two goods that can be produced simultaneously given
a set of inputs (resources, labor, etc.) during a given period of time. The PPF assumes
that all inputs are used efficiently.

Points A, B and C represent the points at which production of Good A and Good B is
most efficient. Point X demonstrates the point at which resources are not being used
efficiently in the production of both goods; point Y demonstrates an output that is not
attainable with the given inputs.
TYPES OF ECONOMIES

- Capitalist Economy – Means of production are in private hands
Characteristics
 Private ownership of productive factors
 Freedom of enterprise
 Freedom to choice by consumers
 Work on profit motive
 Competition among sellers & buyers
 Income inequalities



Merits











Initiative to innovate by producers
High standard of living
Works through price mechanism
Productive efficiency
Liberty & freedom to act
Maximum satisfaction to consumers
Preserves fundamental rights
Rewards initiatives
Growth of business talent, research & development etc.

De-merits
 Income inequalities
 Welfare is not protected
 Economic instability
 Huge amount spent on product promotion
 Class conflict between employers & employees
 Misuse of resources
 Formation of monopolies
 Insecure employment

- Socialist Economy – Controlled, managed & regulated by the Government
Characteristics –
 Collective ownership of resources
 Central planning authority
 No choice for consumers
 Less income inequalities
 Absence of price mechanism
Merits Less income inequalities
 Better utilization of resources
 Strict economic planning
 Economic stability
 Better employment conditions
 No class war
 Ensures right to work
 Protection from exploitation & monopoly





De-merits
 Predominance of bureaucracy
 No freedom
 No right of private property
 No incentive to work hard
 Improper cost calculation
 Extreme form not practicable

- Mixed Economy – Public sector & private sector co-exist. It has the best
features of market economy & controlled economy
Characteristics –
 Co-existence of public & private sector
 Better economic planning
 Balanced regional development
 Dual system of pricing
Merits –
 Merits of both capitalism & socialism
 Protects individual freedom
 Price mechanism operates
 Reduced income inequalities
 Stable economy
 Balanced economic development for developing countries
De-merits –
 Difficult to operate
 Excessive controls and heavy taxes
 Red-tapism, nepotism, favoritism, officialdom exist
 According to Schumpeter, advantages offered are temporary

A question from the TutorsCircle Test Bank
Suppose we have a production possibility frontier (PPF) that is a straight line. On the y-axis,
we have coconuts and on the x-axis, we have pineapples. Which of the following statements
best describe this PPF?
A. The opportunity costs of producing an additional pineapple is the same at every point
B. The opportunity cost of producing an additional pineapple increases as the amount of coconuts
produced increases
C. The opportunity cost of producing an additional pineapple decreases as the amount of

coconuts produced decreases
D. The opportunity cost of producing an additional pineapple is zero at every point
Correct Answer is A. The PPC represents what the economy could produce if there is full
employment (i.e., if all resources are being used efficiently and to their full extent).If the
shape of the PPF curve is straight-line, the opportunity cost is constant as production of
different goods is changing.





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CHAPTER 2
Demand: Willingness & ability of consumers to purchase at various prices for a given
period of time.

Demand is effected by
1) Desire
2) Means to purchase
3) Willingness to purchase

Quantity demanded:
1) Always expressed for a given price
2) It is a flow

Definition of Demand: “By demand, we mean the various quantities of a given
commodity or service which consumers would buy in one market in a given period of time, at
various prices, or at various incomes, or at various prices of related goods”.

Determinants of demand:
1)
2)
3)
4)
5)

Price of the good
Price of related goods
Level of household income
Tastes & preferences of consumers
Other factors- Population size
- Composition of population
- Income distribution

Relation between determinants of demand & demand:
1) Price of good: Other things remaining constant, there is an inverse relation
between price of good and its quantity demanded.
2) Price of related goods:
- Complementary goods: Inverse relation between price & demand of
complementary goods. For e.g. pen & ink. Price of pen, price of pen
increases, demand for ink decreases
- Substitute goods: Direct relation between price & demand of substitute
goods. For e.g. tea & coffee. Price for tea increases, demand for coffee
increases.
3) Level of income:
- Normal goods: Direct relation between income & demand. Income
increases, demand increases.
- Inferior goods: Inverse relation between income & demand. Income
increases, demand decreases.





4) Taste & preferences: Taste changes in favour of good, demand increases & vice
versa.
5) Other factors:
- Population: Population increases, demand increases
- Composition of population: Effected by the age group of people
- Income distribution: Less rich people & more of poor people – Less demand
Law of demand:

Prof. Alfred Marshall - “The greater the amount to be sold, the smaller must be the
price at which it is offered in order that it may find purchasers or in other words the
amount demanded increases with a fall in price and diminishes with a rise in price”.

Law of demand states that, ceteris paribus, or other things remaining constant, people
will buy more at lower price and will buy less at higher price.

Demand schedule: Data stating different quantity of goods demanded by consumers
at different prices
- Individual schedule: Shows the demand pattern of an individual consumer
- Market schedule: Shows the demand pattern for entire market. It is
constructed by aggregating the demand schedules of many individual
consumers.

Demand curve: Horizontal axis – Price
Vertical axis – Quantity
Curve – Negatively sloping i.e. slopes downwards to the right.





Rationale for law of demand:
(Reason for the negative slope)
1) Law of diminishing marginal utility: As more of a good is consumed, the
satisfaction derived decreases. So consumer will only buy till the price it equalizes
their satisfaction.
2) Substitution effect: As the price of good increases, consumers replace the goods
with the substitutes.
3) Income effect: As price increases, the real income of the consumer decreases
and therefore quantity demanded falls & vice versa.
4) Arrival of new consumers: As price for a good fall, new consumers also move in
to buy them. This increases the demand at lower price.
5) Different uses: If price for commodities with multiple uses rises, consumer will limit
their use and this will decrease demand and vice versa.

Exceptions of Law of Demand:
1) Conspicuous goods: These are also called article of distinction or Veblen goods.
These goods act as a status symbol and there is direct relation between their
price and quantity demanded. For e.g. Diamonds, jewellery & gems.
2)
3)
4)

5)
6)
7)

Giffen goods: These are the goods whose demand falls even if price falls. For
e.g. coarse grains like bajra, low quality rice etc.
Conspicuous necessities: These goods have become necessities due to their
constant usage. For e.g. television, coolers etc.
Future expectations about prices: If price of good increases and is expected to
increase even more in futures then consumers will buy them in present despite of
a price increase.
Ignorance: Due to poor knowledge and ignorance of consumers, impulsive
purchases are made without appropriate calculations.
Demand for necessities: The demand for necessities is not affected much by
price change.
Speculative goods: Speculative goods like stocks and shares, demand increases
with price.





Expansion & Contraction of Demand
Expansion: When price falls and quantity demanded increases. There is a downward
movement along the demand curve.
Contraction: When price rises and quantity demanded decreases. There is an upward
movement along the demand curve.

Increase & Decrease in Demand
Increase: Price of the commodity remains the same but there is an increase in demand
due to change in other factors. There is a rightward shift in the demand curve.
Decrease: Price of the commodity remains the same but there is a decrease in
demand due to change in other factors. There is leftward shift in the demand curve.





Movement along demand curve vs. Shift in curve
Movement along curve
1. Indicate change in quantity
demanded due to change in price.

Shift in curve
1. Indicate change in demand due to
change in factors other than price.

2. There is a movement along the
same curve.

2. There is a shift in whole curve and a
new curve is formed.

3. It is termed as change in “quantity
demanded”.

3. It is termed as change in “demand”

Elasticity of Demand

Definition: Elasticity of demand is defined as the responsiveness of the quantity
demanded of a good to changes in one of the variables on which demand depends
or we can say that it is the percentage change in quantity demanded divided by the
percentage in one of the variables on which demand depends.

 Price elasticity: It measures responsiveness of quantity demanded to the
change in price when other things remain constant.
Ep = % change in quantity demanded ÷ % change in price
(Change in quantity/ Original quantity) x (Original price/ Change in price)
Price elasticity is negative because of the inverse relationship between price and
quantity demanded.





Degrees of price elasticity:
Perfectly elastic

Perfectly inelastic

Unit elastic

Elastic

Inelastic

E=∞
A little change in price causes infinite
change in quantity demanded.
E=0
Quantity demanded doesn’t change with
price.
E=1
Change in quantity demanded is equal to
the change in price
∞> E > 1
Proportionate
change
in
quantity
demanded is more than change in price
0<E<1
Proportionate
change
in
quantity
demanded is less than change in price

 Point elasticity: It measures elasticity at a given point on demand curve.
Point elasticity = Lower segment ÷ Upper segment
It is zero at the midpoint and increase as we move from bottom to top i.e. from
quantity axis to price axis.





 Arc elasticity: It is used when change is price is larger. It measures price
elasticity between two prices or two points in demand curve.
Elasticity by Arc method = [(q 1-q2)/ (q1+q2)] x [(p1+p2)/ (p1-p 2)]
 Total outlay method of calculating Price Elasticity: This method measure the
price elasticity of demand by analysing the changes in total expenditure or
outlay. It only states whether the good is elastic or inelastic.

Total outlay method
ELASTICITY

PRICE

TOTAL EXPENDITURE

E > 1, Elastic demand

Increases

Decreases

Decreases

Increases

E = 1, Unitary elastic

100% increase

Unchanged

E < 1, Inelastic demand

Increases

Increases

Decreases

Decreases

Determinants of price elasticity:




Availability of substitutes: Goods with close or perfect substitutes have highly
elastic demand & vice versa. For e.g. tea & coffee. Change in price of tea will
affect the demand for coffee.
Position of commodity in consumer’s budget: If greater proportion of income is
spent on a commodity then its elasticity of demand will also be high & vice












versa. For e.g. needle. It has a very small proportion in consumer’s budget & any
price change will not affect the demand for it.
Nature of need that a commodity satisfies: Luxury goods- elastic demand
Necessities- inelastic demand
Number of uses to which a commodity can be put: The more the possible uses of
a commodity the greater will be its price elasticity and vice versa. For e.g.
electricity. If the price of electricity increases, its use will be restricted to important
things & demand will be elastic.
The period: Longer the period, for which elasticity is measured, more elastic will
be the demand & vice versa.
Consumer habits: If consumer is habitual to the commodity then its demand will
be inelastic. For e.g. tobacco.
Tied demand: If demand for a good is tied to demand for another good then it
will have inelastic demand.
Price range: High or low price range- inelastic demand
Middle price range- elastic demand

 Income elasticity of demand:
It measures responsiveness of quantity demanded of goods to the change in the
income of the consumer.

Ey = % change in the quantity demanded ÷ % change in the income
Income elasticity = 1

Proportion of income spent on a goods
remains the same as income increases

Income elasticity > 1

increases as income increases
decreases as income rises

Income elasticity < 1

Positive income elasticity: With increase in income, demand for goods increases &
vice versa. It happened for normal goods.

Negative income elasticity: With increase in income, demand for good falls & vice
versa. It happens for inferior goods, also known as Giffen goods.

Zero income elasticity: There is no change in the demand with the change in income.
It happens for necessities like salt etc.

 Cross Elasticity of Demand:
It measures the responsiveness of change in demand of a good to the change in
price of other good.
Ec = % change in demand of good A ÷ % change in price of good B





Positive cross elasticity: Substitute goods have positive cross elasticity. Their curve
slopes upwards from left to right.
Negative cross elasticity: Complementary goods have negative cross elasticity.
Their curve slopes downwards from left to right.
Zero cross elasticity: Goods are unrelated.

Demand distinctions:
1. Producer goods- Intermediate goods used for further production.
Consumer goods- Used for final consumption
2. Durable goods- Consumer goods which can be used more than once over a
period of time
Non-durable goods- Consumer goods which can be used just once.
3. Derived demand- Demand of these goods is consequence of purchasing
another good.
Autonomous demand- Demand of these goods is independent.
4. Industry demand- Total demand of a particular industry
Company demand- Demand by a particular individual company
5. Short run demand- Demand with its immediate reaction to changes in the
factors affecting demand
Long run demand- Demand with changes after allowing enough time to react.
Wants: Tastes, desires & motives of human beings.
Classification of wants:
1. Necessaries: Goods essential for living
2. Comforts: Not essential for living but are required for happy living
3. Luxury: Expensive goods which adds consumers’ efficiency.
Utility:
Satisfaction derived from the consumption of a commodity.

Total utility (Full Satiety): Sum of utility derived from consumption of different units of
commodity. It is sum total of marginal utilities.

Marginal utility (Marginal Satiety): Additional utility derived from the consumption of
one additional unit of a commodity.

MU = TUn– TUn-1





Assumptions of Marginal Utility Analysis:
1. The Cardinal Measurability of Utility- It states that utility is measurable.
2. Constancy of the Marginal Utility of Money- While consumer is spending money
on commodity, the marginal utility of money remains the same.
3. The Hypothesis of Independent Utility- It states that the total utility is just the sum
total of different utilities of goods.

The Law of Diminishing Marginal Utility

“The additional benefit which a person derives from a given increase in stock of a thing
diminishes with every increase in the stock that he already has.” – Marshall

In simple words it states that as the more of a thing is consumed, the lesser marginal
utility it has. As the consumption of a good is increased the marginal utility starts falling
and after the point of saturation it becomes negative. Due to this the total utility also
falls

Relationship between Total Utility& Marginal
utility:
1. When the total utility rises the marginal utility
diminishes.
2. When the total utility is at maximum then the
marginal utility is zero.
3. When the total utility is diminishing then the
marginal utility is negative.

Assumptions of Law:
1. Units consumed should be homogeneous in nature
2. Units consumed should be measured in standard units.
3. Consumption should be continuous i.e. without any time gap.
4. Prestigious goods like gold, cash etc. are exemptions.
5. Presence of related goods affects the shape of utility curve.





Consumer Surplus
Consumer surplus as per Marshall-“Excess of the price which a consumer would be
willing to pay rather than go without a thing over that which he actually does pay”.

Consumer surplus is the difference between what a consumer is willing to pay for one
unit of a commodity and what he actually pays for it.
Consumer surplus = Value of the product for consumer – price paid by consumer for it
Consumer surplus declines as more of a commodity is consumed. This is because of
the law of diminishing marginal utility, which suggests that the first unit of a good or
service consumed generates much greater utility than the second, which generates
greater utility than subsequent units.

Consumer Equilibrium: Price = Marginal utility
Graphical representation of consumer surplus:
The demand curve shows the amount that consumers are willing and able to pay for a
good or service.
The actual amount paid by them is the market price.
As consumer surplus = Amount consumer is willing to pay – Price
And demand curve shows the maximum amount consumer will pay for the good.
Therefore, it is the area below the demand curve and above the price line.





Limitations:
1. Cannot be measured precisely
2. In case of necessities, marginal utility varies infinitely for different units
3. It is affected by availability of substitutes.
4. Utility of prestigious goods like diamonds cannot be measured appropriately.
5. Consumer surplus assumes that marginal utility of money remains constant, which
is unrealistic.
6. It assumes utility is measurable in monetary terms.





Indifference Curve
The indifference curve represents a set of possible consumption bundles between
which the individual is indifferent i.e. the consumer derives equal satisfaction for each
bundle.

It is also called Iso- utility curve.

Assumptions:
1. Consumer is rationale
2. Consumer has complete knowledge
3. Consumer can rank combination of goods according to the satisfaction derived
from them.
4. Consumer has consistent consumption pattern.
5. More is preferred to the less of any commodity.
In the figure below, consumer is indifferent at point A & B i.e. the combination of goods
at point A & point B gives consumer equal satisfaction.





Indifference map:
It is a collection of many indifference curves.

Marginal Rate of Substitution (MRS)
The rate at which an individual must give up "good A" in order to obtain one more unit
of "good B", while keeping their overall utility (satisfaction) constant is the Marginal rate
of Substitution. It is calculated between two goods placed on an indifference curve.
As such, the marginal rate of substitution is always changing for a given point on the
indifference curve, and mathematically represents the slope of the curve at that point.

Properties of Indifference curve
1. It slopes downwards to the right.
2. They are convex to the origin
3. Two indifference curves can never intersect each other.
4. Higher indifference curve represents higher level of satisfaction as compared to a lower
indifference curve.
5. It will not touch the axis.





Budget Line
Budget line characterizes on a graph the maximum amounts of goods that the
consumer can afford with the given income and prices.

Consumer Equilibrium
Consumer is at equilibrium at the point where the budget line touches the highest
indifference curve on an indifference map.

The budget line touches indifference curve L2,
which is the highest one it touches. Therefore
we can say that the optimum consumption
point for these two goods would be X1 of
good X and Y1 of good Y. Slope of the budget
line is Px / Py and the indifference curve slope
at any point is MUx / MUy.
Therefore, the consumer equilibrium point is
the point where (Px / Py) = (MUx / MUy).





SUPPLY:
Supply is willingness and ability to offer to the market at various
prices during a period of time.
-It is the quantity that is offered for sale and not what is successfully sold.
- It is a flow
Determinants of supply
1. Price of good- Direct relation between price & supply. Price of the good
increases, quantity supplied increases & vice versa.
2. Price of related goods- If price for other goods increases then supply is shifted to
other goods.
3. Price of factors of production-Inverse relation between price of factors of
production & supply. Price of factors increases, supply decreases.
4. State of technology- If technology improves, supply increases
5. Government policy- Imposition of taxes – supply decreases
Subsidies- supply increases
6. Other factors like government’s industrial and foreign policies, goals of the firm,
infrastructural facilities, market structure, natural factors etc. also affects supply.

Law of Supply
Law of supply states that other things being constant equal, higher the price, the
greater is the quantity supplied & vice versa.

Law of supply is based on 2 factors:
1. When price rises, firm substitutes the production of goods from one to other
2. Assuming other things remain same, higher prices implies higher profits.
Behaviour of supply depends on:
1. Phenomenon considered
2. Degree of possible adjustment in supply
3. Time





Shifts in supply curve- Increase or Decrease in Supply
Increase in supply- Quantity supplied increases due to change in factors other than
price. This shifts the supply curve rightwards.
Decrease in supply- Quantity supplied decreases due to change in factors other than
price. This shifts the supply curve leftwards.

Movements on the Supply Curve- Increase or Decrease in the Quantity Supplied
Expansion-Increase in quantity supplied due to increase in price. This leads to an
upward movement along the supply curve.

Contractions-Decrease in quantity supplied due to fall in price. This leads to a
downward movement along the supply curve.





Elasticity of Supply
Elasticity of supply measures responsiveness of the quantity supplied to the changes in
the price.

Es = % change in quantity supplied / % change in price
= (Change in quantity/ Original quantity) x (Original price/ Change in price)

Degrees of price elasticity:
Perfectly elastic

Perfectly inelastic

Unit elastic

E=∞
A little change in price causes infinite change in quantity
supplied.
E=0
Quantity supplied doesn’t change with price.
E=1
Change in quantity supplied is equal to the change in price

∞>E>1
Elastic

Inelastic


Proportionate change in quantity supplied is more than
change in price
0<E<1
Proportionate change in quantity supplied is less than
change in price




Measurement of Elasticity of Supply:
1. Point elasticity:
It measures the elasticity at a particular point on the supply curve.

Es = (dq/dp) x (p/q)
2. Arc elasticity:
It is used to find elasticity between two points.

Elasticity by Arc method = [(q1-q2)/(q1+q2)] x [(p1+p2)/(p1-p2)]





Equilibrium price:
Price at which Quantity Demanded = Quantity Supplied
It is also called market clearing price.





CHAPTER 3

Production
Production is the act of creating output, a good or service which has value and
contributes to the utility of individuals. It means creation or addition of utility.
“Production is the organized activity of transforming resources into finished products in
the form of goods and services; and the objective of production is to satisfy the
demand of such transformed resources”. - James Bates and J.R. Parkinson

Production process:
1. Change the form of natural resources – Form utility
2. Change the place of the resources to a place where they have greater utility –
Place utility
3. Making materials available when they are required – Time utility
4. Using personal skills

Factors of Production
1. LAND
Economic definition - All free gifts of nature which would include besides the
land, in common parlance, natural resources, fertility of soil, water, air, natural
vegetation etc.
Characteristics:
 Free gift of nature
 Supply of land is fixed i.e. it is strictly limited in quantity
 Land is fixed and cannot be shifted from one place to another
 Properties of land cannot be destroyed
 Land yields results only after human efforts

2. LABOUR
In economics labour means expenditure of physical or mental efforts for
production of goods & services.
Anything done out of love & affection or for pleasure is not a part of economic
activity.
Characteristics:
 Connected with human efforts
 It is highly perishable
 Labour cannot be separated from the labourer
 Labour power & skills differ from labourer to labourer
 All labours are not productive
 Labour has poor bargaining power
 Labourer has to choose between hours of leisure & hours of labour
 Labour is a mobile factor





3. CAPITAL
It is a part of wealth which is used for further production of wealth. It is also termed
as produced means of production as they are already produced goods which are
used in production of goods & services.
Types of capital:
 Fixed capital – Exists in a durable shape and is available for a long period
 Circulating capital – Available for a single use
 Real capital – physical goods
 Human capital – human ability & skills
 Tangible capital – can be touched
 Individual capital – personal property
 Social capital – belongs to society

Capital formation:
It is a term used to describe net capital accumulation during an accounting period.
Capital formation refers to net additions of capital stock such as equipment, buildings
and other intermediate goods. It is also known as investment.
Stages of capital formation Savings – The ability and willingness to save forms the base of the capital
formation. It is more for the higher income group or richer country.
 Mobilization of savings – It involves circulating the saved money to facilitate the
process of capital formation. It is done through banks & financial institutions.
 Investment – It involves converting the real savings into the real capital assets.
This is the final stage of capital formation.

4. ENTREPRENEUR
Entrepreneur mobilizes all the factors of production, combines them in right
proportion, initiates the process of production & bears the risk involved in it. They
are also called organiser, manager or risk taker.
Functions:
 Initiating a business enterprise and resource co-ordination
 Risk bearing or uncertainty bearing
 Introduce innovations





Production Function
“The term production function is applied to the physical relationship between a firm’s
input of resources and its output of goods or services per unit of time leaving prices
aside” -Richard H. Leftwich

Production function states the relationship between inputs and output i.e., the
maximum amount of output that can be produced with given quantities of inputs
under a given state of technical knowledge.
Equation of production function: q = f (a, b, c, d …….n)
‘Q’ = rate of output of given commodity
a,b,c,d…….n, are different factors (inputs) and services used per unit of time.
Short run production function: Capital remains constant where as other factors vary
during short run. It applies law of variable proportion.
Q = T (K, L)
Long run production function: All factors of production can be varied. It applies law of
returns to scale.
Assumptions:
 It is related to a particular unit of time.
 The technical knowledge during that period of time remains constant.
 The factors of production are divisible into most viable units.
 Best available technique is used.

Total product - Total quantity of output produced with the given quantity on inputs. If
one factor is kept constant then total product will vary with the quantity of variable
factor.

Average product -Output of each unit of variable input employed

AP = Total product / Units of variable input
Marginal product- Change in total output due to a one unit change in the variable
input.

MP = TPn – TPn-1





Relationship between Average Product & Marginal Product
1. Both are derived from total Product
2. When AP rises with the increase in quantity of variable input
then MP>AP
3. When AP is maximum the AP and MP curve intersect AP curve
at its maximum
4. When AP falls with decrease in quantity of variable input then
MP<AP

Law of variable proportions or Law of diminishing returns
“The law of diminishing return is the marginal product of each unit of input will decline
as the amount of that output increases, holding all other inputs constant”- Samuelson

If the variable factor of production is increased, there will come a point where extra unit
of input become less productive than previous ones. Therefore, these extra inputs will
have a lower marginal product.
Assumptions:
 Technology remains same
 One input is variable and others are fixed
 Factors of production can be used in different proportions
 Only physical inputs & outputs are considered





STAGES

TOTAL PRODUCT

MARGINAL
PRODUCT
Initially reaches the
maximum point &
then starts falling.

AVERAGE PRODUCT

1ST stage
(MP > AP)
Law of increasing
returns

Initially increases at
an increasing rate.
Later at diminishing
rate

2nd stage
(MP < AP)
Law of diminishing
returns

Increases at a
diminishing rate &
reaches its
maximum point

Decreases &
become zero at
point M

After reaching its
maximum point,
begins to fall

3rd stage
(Beyond H)
Law of negative
returns

Begins to fall

Becomes negative

Continues to fall but
remains positive

Increases & reaches
its maximum point.
Here, AP = MP

Stage of operation:
Inappropriate stages of production1. Stage 1 – As MP is negative
2. Stage 2 – Resources are underutilized and AP can be increased by increasing
variable factor





Efficient stage of productionA rationale produced will produce in Stage 2 where MP & AP are falling. Resources
are efficiently utilized.

Returns to Scale
It studies the production in long run where all factors are variable. It studies the change
in output with the change in scale i.e. all the factors are increased (decreased) in same
proportion.
1. Constant Returns to Scale – It states that with increase in the scale in some
proportion, output increases in same proportion. It is also called “Linear
Homogenous Production Function”.
2. Increasing Returns to Scale – It states that with increase in the scale in some
proportion, output increases in higher proportion.
3. Decreasing Returns to Scale – It states that with increase in the scale in some
proportion, output increases in lower proportion.

Economies & Diseconomies of Scale
The Scale of Production
Economies of scale are the advantages arising because of large scale production.
Economies of scale are experienced till a point after that diseconomies follow i.e. there
are increasing returns to scale initially till a point and after that limit firm experiences
decreasing returns to scale.

1. Internal economies & diseconomies –
These economies or diseconomies are related to a single firm due to its individual
operations.
TYPES
Technical

Managerial


ECONOMIES
(Reduces cost)
As production in increased
better utilization of capital
& machinery is possible.
Also there is greater degree
of division of labour or
specialisation

DISECONOMIES
(Increases cost)
After the maximum point of
efficient
utilization
of
resources further increase
will
make
things
unmanageable

With increase in scale,
application of division of
labour to management
enables managers to look
after their own sections
more efficiently

Increase in scale beyond a
limit lead
to improper
coordination & complex
structure




Commercial

Requirement
of
large After the optimum scale
amount
of
materials economies converts into
enables to place bulk diseconomies
orders & enjoy discounts.
Sales can be increased
with little extra cost

Financial

Finance can be raised
easily for large firms as it
provides
security
to
financers.

Risk bearing

Large
business
with After a point diversification
diversified
&
multi- can increase exposure to
production
capabilities economic disturbances
have better risk bearing

Financial cost increases
after optimum scale due to
over
dependence
on
external finance

2. External economies & diseconomies
These accrue to firms as a result of expansion in the output of whole industry and
not just one firm.
External economies Cheaper raw materials & capital equipment – Expansion helps in exploring
new & cheaper sources of raw material, machinery & other capital
equipment.
 Technological external economies – New technical knowledge can be
discovered which will improve overall productivity of the industry.
 Development of skilled labour – Labour becomes for skilled & specialized
in their areas of production.
 Growth of ancillary industries – Ancillary industries become more
specialised & developed and provide raw material, tools & machinery at
lower prices.
 Better transportation & marketing facilities - Marketing & transportation
networks develops with industry expansion & reduces costs.

External diseconomies –




Some factor prices may rise due to increased demand
High pollution cost
Government policies may restrict expansion in particular area





Cost Analysis
It is the study of the behaviour of in relation to or more production criteria like size of
output scale of operations, price of production factors.

1. Accounting costs – Payments made to suppliers of various productive factors.
For e.g. wages paid to the workers. These are also called explicit costs & are
recorded in the books of accounts.
2. Economic costs– Economic costs = Accounting costs + Implicit costs.
It includes
- Implicit cost i.e. the normal return on money capital invested by the
entrepreneur himself in his own business.
- The wages or salary not paid to the entrepreneur but could have been
earned if the services had been sold somewhere else.
Abnormal profits = Revenues – Explicit costs – implicit costs
3. Outlay costs– Includes actual expenditure of funds. For e.g. wages, rent, interest
etc. it involves financial expenditure & is recorded in books of accounts.
4. Opportunity cost - Opportunity cost is the sacrifice related to the second best
choice available to someone who has picked among several choices. These are
not recorded in books of accounts.
5. Direct or traceable cost– These costs can be directly traced to a cost object
such as a product or a department. For e.g. cost of woods for a furniture
manufacturing firm.

6. Indirect or non-traceable cost - These costs cannot be traced to a specific
product or department. For e.g. Rent for the building that houses production
unit, warehouse & office.

7. Fixed costs– Fixed costs do not vary with output and remains the same
irrespective of the level of output. These cannot be avoided. They are also
called inescapable or uncontrollable costs.

8. Variable costs - These costs vary with the level of output. These are a function of
output in the production period.





Cost Function
It is the mathematical relationship between cost of a product and factors affecting the
cost.
C= f(Q, T, Pf, K)
C = total cost
Q = Output
T = Technology
Pf = factor price
K = Capital

Short Run Total Cost
Fixed Costs – These costs do not vary with output.
Variable Costs – These costs vary with the level of output
Semi-variable costs – These costs are neither completely variable nor completely fixed.
For e.g. electricity charges.
Stair-step variable cost – Remains fixed till a level of output and suddenly increases
majorly beyond that limit of output.
Fixed factors – Factors of production which cannot be easily varied like building
Variable Factors – Factors which can be easily adjusted like workers
Short run - Period of time in which output can be increased or decreased by changing
only the amount of variable factors. This period is too short to vary fixed factors.
Long run – This is the period in which all factors are variable
Total costs – it is the sum total of variable cost & fixed costs.

TC = TVC + TFC





Short run average cost
Average Fixed costs – Fixed cost per unit of output
AFC = TFC / Output
It decreases as the output increases but is never zero and is therefore negatively
sloping.
Average Variable Costs – Variable costs per unit of output
AVC = TVC / Output
It normally falls as output increases from zero to normal capacity. Beyond normal
capacity it increases due to diminishing returns. Therefore, it first falls and reaches its
minimum and then starts rising.
Average Total Cost – Total cost per unit of output
ATC = AFC + AVC or TC / Output

In beginning AFC & AVC falls, so ATC falls
When AVC rises but AFC falls, ATC continues to fall as AFC > AVC
After a point AVC begin to increase and becomes more than AFC & hence ATC rises.
Due to this ATC is “U” shaped.

Marginal cost – Increase in total cost when one additional unit of output is produced.
MC = TCn – TCn-1
It first declines, reaches its minimum & then begins to increase.





Relation between MC & AC
1. Average costs falls with increase in output, MC
< AC
2. AC rises with increase in output, MC > AC
3. AC minimum, MC = AC i.e. MC curve cuts AC
curve at its minimum point.

Long Run Average Cost Curve
In long run firm can vary plant size and move to bigger plant to increase output & vice
versa. During long run the cost of production is least possible cost at which a given level
of output can be produced when all factors are variable.
Long run cost curve shows the relation between output & long run cost of production.
The minimum point on this curve is called “Minimum Efficient Scale”.





In order to derive a long run average cost curve short run average cost curves for
different periods are considered and then long run cost curve is drawn as tangent to all
these short run average cost curves. It is NOT tangent to them at their minimum points.
Long run cost curve is “Planning curve” as firm produces any output in long run by
choosing a plant on the long run average cost curve corresponding to the given
output.
It is also called “Envelope curve” because it envelopes short run average cost curves
from below.

Reason for “U” shape
Initially when firm expands there are economies of scale (increasing returns to scale) &
cost falls.
Then after the minimum point further expansion leads to diseconomies of scale
(decreasing returns to scale) & cost increases.





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CHAPTER 4
Elements of Market
(i) Buyers and sellers;
(ii) A product or service;
(iii) Bargaining for a price;
(iv) Knowledge about market conditions; and
(v) One price for a product or service at a given time.

Classification of Market
On basis of area
1. Local markets – perishable goods are traded
2. Regional markets –semi-durable goods are traded
3. National markets –durable goods & industrial items are traded
4. International markets –precious goods are traded
On basis of time
1. Very short period market – perishable goods, fixed supply
2. Short period market – supply can be increased by increasing variable factors
3. Long- period market – supply can be increased by changing fixed factors
4. Very long period or secular period – very long period in which there is
movement in factors like population size, supply of capital & raw material etc.
On basis of nature of transactions
1. Spot market – goods are physically transacted on the spot
2. Future market – involves future contracts
On basis of regulation
1. Regulated market - transactions are statutorily regulated
2. Unregulated market – no restrictions
On basis of volume of business
1. Wholesale market – commodities are bought & sold in bulk
2. Retail market – commodities are sold in small quantities
On basis of competitions
1. Perfectly competitive market
2. Imperfect competition





Types of Market Structure
Criteria

Perfect Comp.

Monopolistic

Oligopoly

Monopoly

No. of sellers

Many

Many

A few

One

Nature
product

of Homogeneous

Differentiated

Differentiated

Unique

Freedom
entry & exit

of Complete
freedom

Complete
freedom

Barriers to entry

Barriers to entry

Price elasticity Infinite
of demand

Large

Small

Small

Degree of price None
control

Some

Some

Very
considerable

Total revenue, Average revenue & Marginal revenue
Total revenueMoney realised by the sale of commodity
TR = P x Q
P = Price
Q = Quantity of the commodity

Average revenue –
Revenue per unit & is equal to price of the commodity
AR = TR / Q
TR = Total revenue
Q = Quantity sold

Marginal revenue –
Increase in revenue due to sale of an extra unit
MR = TRn – TRn-1
AR, MR, TR & Elasticity of demand
MR = AR [(e – 1) / e]
Where, e = elasticity of demand
MR = 0, e = 1
MR > 0, e > 1
MR < 0, e < 1





Behavioural Principles
1. Firm should produce till TR = TC or TR > TC
2. Production should be expanded if MR > MC till MR = MC

Determination of Prices
Price is fixed at the point where demand = supply
I.e. demand curve intersects supply curve

Changes in Demand
1. Increase in demandDemand increases – demand curve shift rightwards – price & quantity increases

2. Decrease in demandDemand decreases – demand curve shift leftwards – price & quantity falls





3. Increase in supply
Supply increases – supply curve shift rightwards – quantity increases, price
decreases

4. Decrease in supply
Supply decreases – supply curve shift leftwards – quantity falls, price rises

Simultaneous changes in demand & supply
1. Equal increase in demand & supply – quantity increases,
price remain same
2. Increase in demand > increase in supply – quantity
increases, price increases
3. Increase in demand < increase in supply – quantity
increases, price decreases
4. Equal decrease in demand & supply – quantity falls, price
remains same
5. Decrease in demand > decrease in supply – quantity
decreases, price decreases
6. Decrease in demand < decrease in supply – quantity
decreases, price increases





Perfect competition
Also called pure competition
1.
2.
3.
4.
5.
6.

Large no. of buyers & sellers
Homogenous commodity
Free entry & exit
Perfect market knowledge
Buyers & sellers are indifferent
Firms are price takers & there is a uniform price

Industry equilibrium: Total output = Total demand
Firm equilibrium:
Price line is the demand curve.
Produces where profit is maximum i.e.
- MC = MR
- MC curve cuts MR curve from below

Supply curve:
MC curve above AVC depicts firm’s supply curve
AVC > Price – firm’s supply is zero
AVC > Price – firm’s supply at point where MC = Price
Breakeven: AVC = Price
Normal profits: AR = ATC
Super normal profits: AR > ATC
Losses: In case of losses firm will try to produce where loss is minimized i.e. where it
covers its variable cost & a part of fixed cost.

Long run equilibrium of firm:
Where, long run marginal cost = Long run average cost = Price
At this point
Short run average costs = Long run average costs





Short run marginal costs = Long run marginal costs

Long run equilibrium of industry:
1. All firms are in equilibrium, &
2. There is no further entry or exit from market
At long run equilibrium industry satisfies following conditions:
1. Output is produced at least possible cost
2. MC = AR = Price
3. MC = AC i.e. there is no wastage
4. AC = AR, firms earn normal profits
5. MC = MR i.e. profits are maximised but are normal.

Monopoly
Features:
1.
2.
3.
4.
5.

Single seller
Strong barriers to entry
No close substitutes for the products sold
Price discrimination can be adopted
Firms are price maker & not price taker

As there is only one seller, the firm’s supply curve is also the market’s supply curve &
firm’s demand curve is also the market demand curve.

Revenue curves:
1. AR & MR are negatively sloped
2. MR curve lies half-way between the AR curve and the Y axis
3. AR can never be zero but MR can be zero or even negative

Profit maximization or Equilibrium
Short run equilibrium:
1. MC = MR, &
2. MC curve cuts MR curve from below





Profit: When firm charges price which is more than the equilibrium price of the firm.
Losses: Firm will suffer losses if ATC > AR. However, production is continued if firm can
cover AVC & a part of fixed cost.

Shutdown: Price < AVC
Long run equilibrium:
Produces at any point where profits are maximum. It need not be the minimum point on
LAC curve.

Price discrimination
Price discrimination occurs when same commodity is sold at different prices to different
buyers by the same producer.
It is possible only if following conditions are satisfied1. Seller should have some control over supply
2. Market should be divisible into two or more sub markets
3. Price elasticity should be different in different markets –
Price elasticity < 1, charge higher price
4. Buyers should not be able to resell the product at higher price.

Objectives of price discrimination1. To earn maximum profit
2. To dispose of surplus stock
3. To enjoy the economies of scale
4. To capture foreign markets
5. To secure equity through pricing





Degrees of price control1. 1st degree – when the fixed price eliminates the entire consumer surplus
2. 2nd degree – price takes away a part of consumer surplus
3. 3rd degree – price vary according to location or customer segment

Equilibrium under price discrimination –
-

-

The discriminating monopolist will maximize his profits by producing the level
of output at which marginal cost curve MC intersects the aggregate
marginal revenue curve AMR.
This output will be divided between the sub markets in such a way that the
marginal revenues of the markets are equal.
The MC of the markets should also be equal
Prices will be decided according to the quantity that can be sold in the
different markets.

Imperfect competition – Monopolistic market
Features:
1.
2.
3.
4.

There is a large no. of sellers
Products are differentiated on the basis of brands
Firms are free to enter or exit
Non- price competition exist i.e. seller compete on basis of factors other than
price.
5. Demand is not perfectly elastic
6. Firms are price makers

Equilibrium of firm
Conditions to be satisfied
1. MC = MR
2. MC cuts MR curve from below
Firms earn super normal profits during short run.
During long run, due to entry of new firms, firm earns only normal profits.





Loss: If AC > Price then firm suffer loss.
Firms which suffer losses during short run will exit till the remaining firms earn just normal
profits.
During long run, firms have excess capacity at equilibrium but the output will not be
increased as it will reduce the AR more than it will reduce the AC.

Oligopoly
Features:
1. Few sellers
2. Homogeneous or differentiated products

Types:
1. Open oligopoly – free entry in market
2. Closed oligopoly – entry is restricted
3. Collusive oligopoly – firms act in collusion with each other i.e. on basis of
understanding
4. Competitive oligopoly – there is no understanding & firms compete with each
other
5. Partial oligopoly - one large firm dominate the market
6. Full oligopoly – there is no leadership
7. Syndicated oligopoly – products are sold through centralised syndicate
8. Organized oligopoly – firms organise themselves into central association

Characteristics:
1.
2.
3.
4.

Firms’ policies are interdependent on each other
Major advertising & selling cost exist
As firms are interdependent there exist group behaviour i.e. firms act as a group
They compete on terms other than price i.e. there is a non- price competition





Price & output decisions:
Change in price by any firm will result in reaction by other firms by changing prices.
Due to this the demand curve keep shifting & there is no specific demand curve, price
or output

Kinked demand curve
It is known as “Sweezy’s model” as it is proposed by economist Paul M. Sweezy.
Kinked demand curve explains the price stickiness or rigidity in an oligopoly market.
According to the kinked-demand theory, each firm will face two market demand
curves for its product. At high prices, the firm faces the relatively elastic market demand
curve. At low prices, the firm faces the relatively inelastic market demand curve.





CHAPTER 5
Features of Underdeveloped economy
1. Agriculture is the main occupation
2. Wide spread poverty
3. High rate of population growth
4. Low standard of living
5. Low productivity of labour
6. Backward production techniques
7. High unemployment & underemployment
8. Low level of human well being
9. Widespread income inequalities
10. Low rate of capital formation
11. Low participation in foreign trade
12. Traditional social life
13. Weak infrastructure

India’s case:
1. Agriculture main occupation- population involved at the time of independence
72% and currently nearly 50%
2. 1/3rd of world’s poor live in India. Population in India below poverty line –
1993-94 – 36%
1999-2000 – 26%
2004-05 – 22%
3. High population growth rate of 2%
4. The dependency rate i.e. percentage of people in non-working age group is
nearly 40%
5. Low per capita income - $1410 (2011)
6. Low gross capital formation –
Gross domestic savings:
- 1990-91 – 23%
- 2010-11 – 32.3%
Domestic capital formation:
- 1990-91 – 26%
- 2010-11 – 35.1%
7. Backward techniques of production
8. High unemployment& underemployment – Currently 6.6%
- 1999-2000: 7.31%
- 2004-05: 8.2%





9. Low level of human well-being –
Measured by Human Development Index (HDI) on the basis of longevity,
knowledge and standard of living.
2000 – 0.44
2010 – 0.519
2011 – 0.547
Relative global ranking (2010) – 119 among 169 countries
Ranking in 2011 – 134 out of 187 countries
10. Highly unequal income distribution –
Income inequalities are measured by GINI index:
- Zero index – perfect equality
- One index – perfect inequality
As per HDI, India’s GINI index
1994 – 0.297
2000-10 – 0.368

India – A developing country
1. National income (NNP at factor cost) has increased fromRs.2,20,000 crore (195051) Rs.42,60,000crore (2010-11).
2. Per capita income has increased 5 times from Rs.6,122 (1950-51) to Rs.35,917
(2010-11)
3. There are significant changes in the occupational distribution of people
Occupation
1951 (%)
2009-10 (%)
Primary sector
72.1
49.3
Secondary sector
10.6
21.9
Tertiary sector
17.3
28.8
Total
100
100

4. Sectoral distribution of domestic product has changed i.e. the share of
agricultural sector in GDP has reduced.

Agriculture
Industry
Service

1950-51 (%)
53.1
16.6
30.3

2011-12 (%)
13.9
27.0
59.0

5. There is a growth in the capital base of the economy
6. Social overhead capital has improved i.e. transport facilities, irrigation facilities,
energy, education system, health and medical facilities.
- Asia’s largest & world’s second largest rail network
- World’s 2nd largest road network





Increase in installed capacity
Increase in area under irrigation from 22.6 million hectares (1950-51) to 87.2
million-hectares (2007-08)
- Increase in literacy rate from 18.33% (1951) to 74% (2011).
- Improvement in medical field. No. of doctors has increased by more than 12
times & bed population ratio has increased to 1.03 per 1000
7. Development in banking & financial sector
-

India – A Mixed Economy
1.
2.
3.
4.
5.

Private ownership of most of the sectors
Market forces freely determine prices. Government regulations have reduced.
Growth of monopoly houses
Development of public sector
Economic planning is an integrated part of Indian economy

Agriculture
Contribution
1. Provide employment
2. Share in National Income

Detail
50% of population (2010-11) is engaged in
agriculture sector
It contributes 12.3% of GDP (2010-11) &
13.9% of national income (2011-12)

3. Support industries

4.

5.
6.
7.
8.

Provide inputs for many industries.
Demand of industrial products depends
on income of farmers.
Share in foreign trade
Agricultural exports forms 10% of national
exports (2010-11)
Agricultural imports constitute 3% of
national imports (2010-11)
Supplier of food & fodder
It meets food needs of people & fodder
needs of livestock.
Savings of capital
It requires lesser capital per unit of output
produced compared with the industries.
Contribution
to
government’s Indirectly influences revenues of state &
revenue
central government.
Solving
problems
of
urban Progress in agricultural sector helps in
congestion and brain drain
solving the problem of migration from rural
areas to urban areas

Growth of agriculture sector:
1. Increase in production –
- Agricultural production has increased by more than 3 times in last 6 decades.
- Food grains production increased from 51 million tonnes (1950-51) to 245
million tonnes (2010-11)
- Green revolution –










Also called wheat revolution or High Yielding Varieties Programmes
(HYVP)
Programme started in 1966
Significant breakthrough in production of food grains from 81 million
tonnes to 245 million tonnes in 2010-11
Restricted to 5 crops i.e. wheat, bajra, jowar, maize & rice
Wheat production increased from 827kg per hectares (1965-67) to
2938kg per hectare in 2010-11.

2. Increase in productivity –
- Productivity increased at a rate of around 2.06% per annum during 1967-2003
- Productivity of food grains increased from 2.74% (1980-1990) to 2.91% (200012)
3. Diversified agriculture –
- Share of non-crop sectors in agricultural output is increasing.
- Area under commercial crops & superior cereals is increasing
4. Modern agriculture –
- Increased use of high yielding varieties of seeds, fertilizers, pesticides etc.
- Use of intensive cultivation, multiple cropping, scientific water management is
increasing
- Adoption of modern techniques by farmers which is resulting in improved
agricultural capacity.
- Better marketing of agricultural products
5. Improved agrarian system –
- Abolition of zamindari system, the ryotwari system and the mahalwari system
& of exploitation of cultivators
- Introduction of tenancy reforms –
 Rents were fixed between 25-50% for different states
 Legislations disallowing the ejectments of tenants were passed
 Ceilings were imposed on agricultural holdings
 2.18 million hectares of land has been distributed as surplus area
- Land holdings were reorganised
6. Other developments –
- Inputs are provided at subsidised rates
- Provision of credit at low interest rate
- Minimum wage level is fixed
- Government’s support in marketing & selling
- Special programmes to provide employment to rural people
- Special schemes passed to support production of various product





Problems of agriculture sector
Problems

Details
1.
2.
3.
4.

Slow & uneven growth

1. Only 44% of the gross cropped area is covered by
HYVP
2. Old methods are used
3. 60% of net sown area in rain fed
4. 40 per cent of the gross cropped area has irrigation
facilities

Backward techniques

1. All states are not covered
2. There are snags in legislation

Flaws in land reforms

Finance related
problems

Warehousing &
marketing problems

Targeted growth rate is not met
Certain crops have higher growth rate than others
Low yield per unit area
Regional imbalances

Steps:
1. 14 banks were nationalised in 1969 & 6 in 1980
2. Regional Rural Banks (RRBs) were set up in 1975
3. National Bank for Agriculture and Rural Development
(NABARD) was set up in 1982 as apex bank
4. Kisan Credit Card scheme was started in 1998
5. Agricultural Debt Waiver and Debt Relief Scheme in
2008
6. Rehabilitation package was initiated
Problems:
1. Loans concentrated to limited regions
2. Nearly 40% of amount financed does not come back
to the society
3. Large & medium farmers enjoyed major benefits
4. Lack of proper staff in financial institutions
1. Improper storage facilities
2. Lack of organization among farmers
3. Existence of agents between farmers & buyers who
charge heave fees
4. Produces have to be sold in nearby markets at low
prices due to improper transport facilities
5. Existence of several malpractices
6. Improper knowledge of market
7. Low level grading & standardization




Warehousing &
marketing problems

Steps for improvement:
1. Agricultural Produce Market Committee (APMC) Act
has been amended
2. Initiatives have been taken to transfer agricultural
technologies and information to the farming sector
3. National Policy for Farmers, 2007 is being adopted
providing many facilities to farmers
4. Schemes insuring the farmers against crop loss are
introduced

Agriculture under XI Plan
Targeted growth – 4% (double of X year plan’s growth rate)
Urgent requirement of 2nd Green Revolution

Industry
Role of Industry
1. Modernises & improves agricultural productivity
2. Generate employment opportunities. Currently employs 22% of labour force
(2009-10)
3. Share in GDP increased from 12% (1950-51) to 27% (2011-12)
4. Contributes to more than 2/3rd of export earnings.
5. Industrial development increases GNP per capita
6. Industrialization enhances self-sustaining economic growth
7. Industries helps in meeting high-income demands
8. It strengthens the economy
- Produce capital goods at low cost
- Helps in production of economic infrastructure
- Supports agricultural sector
- Makes country self-reliant in defence materials

Growth of Industrial Sector in India
1. Industries on basis of size:
- Large industries
- Medium industries
- Small industries
2. On basis of end use:
- Basic good industries
- Capital goods industries
- Intermediates goods
- Consumer goods
Annual average rate - 6.9 % per annum





Pattern of Industrial Development
1.
2.
3.
4.
5.
6.
7.
8.

It is lopsided i.e. dominated by large or small industries
Low capital employed per worker
More focus on consumer goods
Steady growth of 8% during 1951-65
Growth fell down to 4.1% during 1965-80
Growth rate was 7.8% during 1980-91
Annual growth rate of production 1990-91 to 1999-2000: 5.7%
X Plan (2002-2007) –
- Aim- 10% growth rate
- Actual- Average growth rate of 8.7% p.a.
9. The Eleventh Plan aims at 8.5 per cent per annum growth in the GDP

Important points
1. Based on Mahalanobis model, during 2nd plan, focus was shifted on
basic & capital goods & Three Steel Plants were set up in the public
sector at Bhilai, Rourkela and Durgapur. 1st 5 year plan in India started
in 1951.
2. Industrial sector has become broad-based and modernised
3. Massive increase in the size and diversification of public sector from 5
units (1951) to 242 units (2008)
4. Emergence of many big industries in Private Sector from 2 units (1951)
to 80 in present
5. Major expansion of infrastructural facilities
- Emergence of public financial institutions
- Improvement power generation, railway transport facilities,
telecommunications etc.
6. India ranks high in the world in respect of technological talent and
manpower and in development of information and communication
etc.
7. Since 1951 there has been the mammoth growth of small-scale
industrial units. They employ nearly 312 lakh people.
8. Classification of industries as per Micro, Small and Medium Enterprises
Development (MSMED) Act, 2006
In Manufacturing Sector- Investment up to Rs.25 lakh - micro enterprises
- Investment between Rs.25 lakh and Rs.5 crore – small enterprises
- Investment between Rs.5 crore and Rs.10 crore – medium
enterprises
In Service Sector
- Investment up to Rs.10 lakh - micro units
- Investment between Rs.10 lakh and Rs. 2 crore - small enterprises
- Investment between Rs. 2 crore and Rs.5 crore - medium
enterprises





Reasons behind deceleration and retrogression during 1965-80
(a) Unsatisfactory performance of agriculture.
(b) Slackening of real investment especially in public sector.
(c) Slow-down in import substitution.
(d) Regulation and control over private sector
(e) Narrow market for industrial goods

Problems of Industrial Development in India
1. Failure to achieve targets
2. Underutilization of capacity
3. Absence of world class infrastructure
4. Increase in capital – output ratio
5. Cost of production in India is higher as compared to international market
6. Inadequate employment generation in relation to investment made
7. Performance of public sector is quite poor
8. Sectoral imbalances
9. Regional imbalances
10. Industrial sickness – Around 96% of sick units are small units and 4% are big units.





Services
Service sector includes:
1. Business & professional services
2. Communication services
3. Real estate & related services
4. Distributive services
5. Education services
6. Energy & environmental services
7. Financial services
8. Health services
9. Tourism
10. Transport

Role of Service Sector in India
1. Increase in GDP –
1950-51 – 1/3rd of GDP
2011-12 – 59% of GDP
2. Provide employment –
1951 – 17.3% of work force
2009-10 – 29%
3. Providing support to other sectors – Support agriculture & industries
4. Contribution to exports –
- Services accounted for about one third of total exports in India (2010-11)
- In 2006, India's share in world's total commercial services export was 2.7%
- There is a growth of 20% in India’s service exports (2004-11)

Growth of service sector during planning period
1.
2.
3.
4.
5.
6.
7.
8.
9.

7.54% per annum in the Eighth Plan
8.1 per cent per annum in the Ninth Plan
9% p.a. during Tenth plan
Eleventh plan – Aim: 9.4% - Actual growth till now: 10%
Transport, storage and communication are fastest growing – Avg. growth 15.3%
per annum during the Tenth plans.
Tourism – 6.7% p.a. during 2009-10
Financial – 9.2% during 2009-10
Community & social services – 12% during 2009-10
Third largest scientific and technical manpower in the world

Reasons for service sector growth
1. Income elasticity of demand for services is greater than one
2. Outsourcing has become more efficient
3. It has become possible to deliver services over long distances at a reasonable
cost
4. Economic reforms worked in favour of service sector





Problems of service sector
1.
2.
3.
4.
5.

Inadequate infrastructure facilities
High contribution in GDP but low in providing employment
Inadequate financial structure
Inappropriate behaviour
Inappropriate maintenance

NATIONAL INCOME
National income is the money value of all the final goods and services produced by a
country during a period of one year.

Basic Concepts
1. Gross Domestic Product (GDP):Goods & services produced within the
domestic territory of a country during an accounting year

2. GDP at Constant Prices & Current Prices :
- Current prices - estimated on the basis of the prevailing prices
- Constant prices - measured on the basis of some fixed prices i.e. some base
year prices
3. GDP at Factor Cost & at Market Price:
- At factor cost - estimated as the sum of net value added by the different
producing units and the consumption of fixed capital.
- At market price – at price paid by consumers.
- GDPF.C = GDPM.P - IT + S.
IT = Indirect Tax
S = Subsidies
4. Net Domestic Product: GDP – depreciation
5. Gross National Product (GNP):GDP + Net Factor Income from Abroad (NFIA)
NFIA = Difference between income received from abroad & income paid to
non-residents within domestic territory.
6. Net National Product (NNP):GNP – Depreciation
NNP = NDP + NFIA
7. NNP at Factor Cost or National Income: Volume of commodities and services
produced during an accounting year, counted without duplication.
NNP at FC = National Income = FID + NFIA
FID = factor income earned in the domestic territory of a country





8. Personal Income: Sum of all incomes actually received by individuals during a
given year
PI = National income - social security contribution - corporate income taxes undistributed corporate profits + personal payments
9. Personal Disposable Income: Personal income – personal taxes
Or
Consumption + Saving

Methods of measuring National Income
1. Value Added Method or Product Method:
GDP at market price = value of output in an economy in the particular year intermediate consumption
NNP at factor cost = GDP at market price - depreciation + NFIA - net indirect
taxes

Care to be taken –
- Sale of second hand items is to be excluded
- Non-monetary activities excluded
- Production for self-consumption included
- Commission of dealer of 2nd hand goods included

2. Income Method:
Factor income of all the factors of production is added.
NI = Compensation of employees + Net interest + Rental & royalty income + Profit
Care to be taken –
- Income of primary factors only is to be included
- Transfer incomes excluded
- Labour income included
- Non-labour income excluded
- Illegal incomes, windfall incomes, death duties etc. excluded
- Sale proceeds of 2nd hand goods excluded
- Income of self-employed included
Note:
- If NI is calculated from data regarding incomes paid out by producers then
add NFIA
- If NI is calculated from incomes received by people then NFIA is not added

3. Expenditure Method:





It focuses on finding the total output of a nation by finding the total amount of
money spent.
NI = Expenditure on final goods & services + Net foreign investment

Items Included

Items Excluded

1. Fees paid to educational institutions 1. Expenditure on the repair of fixed capital asset
by students (payment for a service (intermediate consumption)
received)
2. Expenditure on electricity by
household (final consumption).

a 2. Expenditure on electricity by some enterprise
(intermediate expenditure).

3. Expenditure on final goods and 3. Expenditure on
services.
scholarship, etc.

transfer

payments

like

4. Expenses of foreign visitors in India (it 4. Expenditure on a purchase of an old house.
is a part of net exports).
5. Expenditure on street lighting (it is 5. Expenditure incurred by way of grants during
final consumption expenditure by natural calamities, e.g. earthquake, floods,
the government).
etc. (it is a transfer payment).

Gross national expenditure = Consumption expenditure + net domestic investment +
net foreign investment + replacement expenditure (i.e., expenditure on replacement
investment).

Net national expenditure= Consumption expenditure + net domestic investment + net
foreign investment.

Net domestic expenditure= Consumption expenditure + net domestic investment.
Important Points:
1. All measures of NI should give same result
2. Methods used by different sectors:
- Agricultural sector – Net value added
- Small scale sector & service sector – Income method
- Construction sector – Expenditure method
3. Developed economies – use income method

Problems in calculation NI
(1) Presence of a large non-monetized sector
(2) Lack of appropriate and reliable data
(3) Problem of double counting
(4) Problem of transfer payments
(5) Difficulties in classification of working population
(6) Unreported illegal income





Trend in India’s National Income Growth & Structure
1. Trends in NNP:
1950-51 to 1980-81 - growth in GDP was 3.2%
1980-81 to 2009-10 - growth in GDP was 6.6%
2009-10 to 2010-11 – growth in GDP was 8.4%
Growth rate on real NI – 4.9% (1950-51 to 2009-10)
Per capita income growth rate – 3% p.a. in last 60 years

TAX SYSTEM IN INDIA
-

Direct tax: Taxes which are not shifted. Income tax & Wealth tax are

-

examples of Direct taxes
Indirect tax: The burden is shifted through a change in price. For e.g. sales
tax, custom duty, excise duty etc.

Merits of Direct Taxes:
Imposed according to person’s ability to pay
Revenue is income elastic
Create better civic consciousness
Helps in transferring the income from rich to poor

Merits of Indirect Taxes:
Convenient to assess
Consumer doesn’t feel much burdened
Difficult to evade
May not be regressive if levied on ad
valorem basis
Indirect taxes on drinks, narcotics and
tobacco discourage their consumption

Demerits of Direct Taxes:
Ability to pay cannot be determined
appropriately
Actual payment depends on honesty of tax
payer
Require proper maintenance of accounts
Cumbersome assessment procedure

Demerits of Indirect taxes:
Criticised regressive character
May not create social consciousness
Government is uncertain about proceeds of
these taxes
Burden can be shifted forward or backward
Can be evaded by methods like smuggling,
falsification of accounts etc.

Direct taxes in India
1. Income tax –
-

Introduced in 1860, discontinued in 1873, reintroduced in 1886.
Important types - Personal income tax and Corporate income tax
Personal income tax - levied on individuals, Hindu Undivided Families,
unregistered firms and other association of people
Corporate tax – Charged on registered companies & corporations



-


Income tax is Progressive in nature i.e. tax rate increases with income
Corporates are taxed at flat rate

2. Taxes on Wealth and Capital-

Estate duty, annual tax on wealth and gift tax
Estate duty was first introduced in 1953
Wealth tax was introduced in 1957
Gift tax was first introduced in 1958 & was abolished in 1998 & was
reintroduced in April 2005
Tax on agricultural land and funds in Provident Account were exempt

Indirect Taxes in India
1. Custom Duties-

Levied on exports and imports
Before tax reform periods, India has highest custom duties tariffs
Custom duty on non-agricultural products – 10% (2007-08)

2. Excise Duties-

Levied on production
No connection with actual sale
Modified Value Added Tax (MODVAT) introduced in 1986-87 to remove
cascading problem
Under MODVAT a manufacturer got full reimbursement of excise duty paid on
the raw materials or components
Central Value-Added Tax (CENVAT) was introduced in 2000-01 which
consisted of only one basic excise duty.

3. Sales tax-

Charged on the sale or purchase of a particular commodity within the
country
It is more in the case of luxury items and less or almost nil in the case of
necessities
Sales tax was in two forms – state sales tax and central sales tax, which is
replaced by Value Added Tax (VAT)

-

4. Value Added Tax (VAT)-

Multistage sales tax with credit for taxes paid on business purchases
Introduced in 1999
Implemented in April 2005 (only in some states)
At present, implemented in all states/ union territories.

5. Service Tax –
-

Imposed on specified services
Introduced in 1994-95
Covers more than 120 services



-


Current rate – 10%

Features of Indian Tax Structure
1. Tax revenues form about 16% (2010-11)of the total national income
2. Tax revenue is more than Rs.11,60,000crore (2010-11)
3. During 2009-10, the share of direct taxes in the gross tax revenue was 41% while
that of indirect taxes was 59%
4. Indian tax structure relies on a very narrow population base.
5. Insufficient tax revenue to meet the requirements of economy
6. Direct taxes are progressive & indirect taxes are differential in nature
7. Agricultural income is tax exempt

Evaluation of Indian Tax System
1.
2.
3.
4.
5.
6.

Current share of direct taxes in GDP/ GNP – 7% (2010-11)
Tax system majorly depends on urban income
Tax structure is modified time to time
Simplification of tax system has been attempted
Cost of tax collection - more than Rs.6,500 crore (2010-11)
High evasion and tax avoidance





CHAPTER 6

Population
All the inhabitants of a particular town, area, or country
Or
Total no. of people residing in a place
Population growth as an asset:
Population growth as a burden:
Provide work force
Lead to increased unemployment
Provides market for produced goods
Pressure on social overheads
Promote innovations
Pressure on means of subsistence
Promote labor specialization
Slow capital formation
Increase dependency

Demographic Trends in India
1. Size of population:
-

In 1901 was 23.84 crores
In 2010 was more than 117crores
In 2011 more than 121.02 crore
In population size, India ranks second in the world after China
Every sixth person in the world is an Indian

2. Rate of growth:
-

1901-11, the population growth rate 5.74% per decade & 0.56% per annum
1991-2001, the growth rate was 1.97% per annum.
2001-2011: 1.64% p.a.
1921 – Year of Great Divide

3. Birth rate & Death rate:
-

-

-

Death rate –
 1951- 27.4
 2010 – 7.2
Birth rate –
 1951- 39.9
 2010- 22.1
Lowest birth rate – Kerala
Highest birth rate – Uttar Pradesh
Lowest death rate – West Bengal
Highest death rate – Orissa





4. Density of Population:
-

Number of persons per square kilometre
In 1951: 117
In 2001: 325
In 2011: 382
It is not same for all states
Most densely populated state: Bihar (1102 )
2nd most densely populated state: West Bengal (880)
Considering all states & union territories:
 Most densely populated – Delhi with density 11297
 2nd – Chandigarh with density 9252

5. Sex Ratio:
-

Number of females per 1000 males
Highly favourable to males than females
Sex ratio in 1991: 927
Sex ratio is favourable to males in all the States except Kerala: 1084 (2001)
Haryana has the lowest female sex ratio of 877 (2011)

6. Life expectancy at birth:
-

Expectation of life at birth
1901-11: 23 years
2011: 63.5 years
Kerala has highest life expectancy: 71.4 years (2006)
Madhya Pradesh has lowest life expectancy: 58 years (2006)

7. Literacy ratio:
-

-

-

Number of literates as a percentage of total population
1951:
 Males: 27.2%
 Females: 8.9%
 Total: 18.3%
2011:
 Males: 82.1%
 Females: 65.5%
 Total: 74%
Highest literacy: Kerala – 92%
Lowest literacy: Bihar –53%

Causes of rapid growth of population





High Birth Rate:
India being agrarian economy considers
children as assets

Fall in Death Rate:

Small urbanization

Control of some diseases

High incidence of poverty

Spread of education

Marriages are almost compulsory

Improved medical facilities

Most Indians want more children

Improved food & water supply etc.

Reduction in famines

Lack of education
Joint family system encourages big families

Growth of population in India & its effects on Economic Development
Theory of Demographic Transition:
3 stages –
1st stage: High birth & death rate & stable population.
2nd stage: Stage of population explosion - Minor fall in birth rate & major fall in death
rate.
3rd stage: Low birth & death rate & moderate population growth
India is passing through 2nd stage i.e. Population explosion

Effects of Growth in Population
1. Growth in national income: Due to high growth rate of population the increase in
per capita income is low as compared to National income
2. Food supply: As compared to increasing demand for food, per capita
availability of food grains is insufficient.
3. Unproductive consumers: High ratio of children and old persons - Higher burden
of unproductive consumers on the total population
4. Problem of unemployment: Increase in labour force is more than the increase in
employment opportunities
5. Capital Formation: Huge capital formation in needed to maintain the standard
of living of this large population.
6. Ecological degradation: Ecological imbalance is caused

Government Measures for Solving Population Problem
1. Increased emphasis on family planning for which Family Planning Department
was established in 1966.
2. Marriageable age was increased under National Population Policy
3. Spread of education



4.
5.
6.
7.


Provision of Old age pension & Social security
Reduction in infant mortality through improved medical facilities
Introduction of incentives for people with small families
Encouragement of urbanization

Tenth Plan Targets
1. Reduction in Infant Mortality Rate to 1 per 1000 live births by 2012
2. Reduction in decadal growth rate of the population between 2001-2011 to 16.2%

Population Census 2011 (Provisional)
1.
2.
3.
4.
5.
6.

India’s population as on March 1st 2011 was 1,210.2 million.
The male population is 623.7 million
Female population is 586.5 million
The density of population is 382 in 2011
Sex ratio now is 940
Literacy rate has increased to 74%

POVERTY
Absolute Poverty:
-

Level of poverty as defined in terms of the minimal requirements necessary to
afford minimal standards of food, clothing, health care and shelter.
More relevant for less developed countries
Measured in terms of income/ consumption expenditure

Relative Poverty:
-

A measure of relative poverty defines "poverty" as being below some relative
poverty threshold.
More relevant of developed countries

Poverty in India
1. Use concept of absolute poverty
2. “Expert Group” poverty lines are used in India which defines separate poverty
line for rural & urban thresholds.
3. Poverty ratio as per URP data 2004-05:
- Rural: 28.3
- Urban: 25.7
- Total: 27.5
4. Poverty ratio as per MRP data 2004-05:
- Rural: 21.8
- Urban: 21.7
- Total: 21.8
5. Per capita consumption expenditure reduced to 60.5 of population in 2004-05.
6. India has a poverty index of 0.296 with a rank of 119 (among 169) countries

Causes of Poverty



Economic causes:
Rapidly growing population
Agriculture is main occupation
Low productivity
Underdeveloped economy
Income inequalities
Large level of unemployment
Inflation

Political & Social causes:
Improper policies
Discrimination on basis of caste
& religion

Other causes:
Large family sizes
Poor education
Bonded labour

Government Measures to Reduce Poverty
1. Pradhan Mantri Gram SadakYojana (PMGSY):
- Launched in December 2000
- Aimed to improve road connectivity
2. Indira AwasYojana (IAY):
- Launched in 1985
- Aimed to provide assistance for construction of houses
3. SwaranJayanti Gram SwarozgarYojana (SGSY):
- Introduced in April,1999
- Self – employment programme for rural poor
4. Sampoorna Grameen Rojgar Yojana (SGRY):
- Launched in 2001
- Aims at
 Providing wage employment in rural areas
 Food security
 Creation of durable community, social and economic assets.
5. The Mahatma Gandhi National Rural Employment Guarantee Scheme
(MGNREGS):
- Notified in 2006 & extended to whole country in 2008
- Aimed at enhancing livelihood security of households in rural areas of the
country by providing at least 100 days of guaranteed wage employment

6. The Swarna Jayanti Shahkari Rozgar Yojana (SJSRY):
- Came into operation from December, 1997
- Aims to provide gainful employment to the urban unemployed or
underemployed

UNEMPLOYMENT





Types of Unemployment:
1. Voluntary: People who are willingly unemployed
2. Frictional: Temporary unemployment due to change of jobs, strikes or lockouts

3. Casual: Occurs due to short term contracts

4. Seasonal: Occurs in seasonal industries as people remain unemployed during offseason

5. Structural: Occurs due to structural changes in the economy

6. Technological: Occurs due to introduction of new machinery

7. Cyclical: Temporary unemployment occurring due to change in the trade cycle

8. Chronic: Long term unemployment

9. Disguised: Underemployment of labour where more than required people are
employed for same job

Nature of Unemployment in India
Indian economy basically suffers from problem of Structural unemployment
Rural unemployment –
- Chronic, Seasonal & Disguised
Urban unemployment –
- Industrial unemployment
- Educated unemployment
- Technological unemployment
Over one-third of India’s work force is disguisedly unemployed.

Causes of Unemployment in India
1. Growth without adequate employment opportunities
2. High population growth rate
3. Inappropriate technology



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