Unit 1 | unit 1 introduction

BECO3

Unit 1

Introduction

Q1) explain scope of macro economics? 8 marks

A1)

The term "macro" was first used in economics by Ragnar Frisch in 1933. However, it originated in the 16th and 17th century mercantilists as a methodological approach to economic problems. They were interested in the entire economic system. In the 18th century, Physiocrats adopted it in the table economy, demonstrating a "wealth cycle" (i.e., net production) among the three classes represented by the peasant, landowner, and barren classes.

Malthus, Sismondi and Marx in the 19th century dealt with macroeconomic issues. Walras, Wicksell and Fisher contributed modernly to the development of pre-Keynes macroeconomic analysis.

Certain economists such as Kassel, Marshall, Pigovian, Robertson, Hayek, and Hortley developed the Quantity Theory of Money and General Price Theory in the decade following World War I. But Keynes, who eventually developed the general theory of income, output, and employment in the wake of the Great Depression, has credit.

Economics is a science that deals with the production, Exchange and consumption of various goods in the economic system. It is a scarce resource that can lessen the abundance of human welfare. The central focus of Economics lies in the choice between resource scarcity and its alternative uses. The word "economics" is derived from two the Greek words oikos (House) and nemein (to manage) mean to manage the household budget "using the limited funds possible.

Scope of Macro Economics

Economics is the subject of dealing with every situation happening all over the world. This subject is used in many stances in our lives. For example, your mom does all the work in your home. From doing all the housework to maintaining a budget for rations to meeting all your needs. Thus, it is one subject that deals with the daily work of our lives. There are two major categories on the same subject: microeconomics and macroeconomics. One deals with individual units of the economy, such as consumers and households. But the latter deals with the whole economy. It deals with research on national income and output. This understanding of science is vast and of varying lengths. However, for simplicity, this article will only focus on the scope and need for macroeconomics.

Microeconomics:

As mentioned above, microeconomics is a branch of economics that deals with individual units of the economy. It includes research areas on individual units such as consumers and homes. The subject deals with issues related to determining the price of goods. These direct or indirect factors affect the supply and demand of goods and the procurement of individual satiety levels. The main purpose of microeconomics is to maximize profits and minimize costs incurred. It is used for future generations to be available and balanced.

Macroeconomics

The term macroeconomics was coined by Ragnar Frisch in 1933. However, the approach to economic problems began in the 16th and 17th centuries. As a result, this originated from mercantilists. It is the field of science that deals with the whole economy or the whole, including macro factors. The hope of macroeconomics does not involve studying individual units of the economy. But the whole economy studies the whole economy and the average National income, total employment, total savings and investment, aggregate supply and demand, and general price levels.

The subject of macroeconomics revolves around income and employment decisions.

Controlling the cycle of inflation and deflation was only possible by choosing current economic policies. These policies were developed at the macro level. Research on individual units has also become impossible. In addition, government participation through financial and fiscal measures in the economy is increasing. Therefore, the use of macro analysis is irrefutable.

Now we know that macroeconomics is a specialty of economics. Focus on the economy through the sum of the individual units and determine if it will have a significant impact on the country as a whole. All prominent policies and measures are based on this concept. For example, per capita income determines national income. This is nothing but the average of the total income of the people of the whole country.

Scope of Macroeconomics

Fig 1

Scope of Macroeconomics:

Governments, financial institutions and researchers analyse the general problems of the people and the economic well-being of the people.

It mainly covers the foundations of macroeconomic theory and measure theory, which is macroeconomic policy. Here, macroeconomic theories include theories of economic growth and development, national income, money, international trade, employment, and general price levels. In contrast, macroeconomic policy covers fiscal and monetary policy.

Research on issues such as India's unemployment, general price levels and balance of payments (BOP) issues is part of macroeconomic research as it is relevant to the economy as a whole.

Macroeconomic Theories:

The government is understood to be the national regulator. Consider various aspects that are important and have a direct impact on the lives of citizens. There are six theories within the scope of macroeconomics.

Theory of Economic Growth and Development:

Economic growth is also under the study of macroeconomics. Economic resources and capabilities are assessed based on the scope of macroeconomics. It plans to increase levels of national income, output, and environmental levels. They have a direct impact on the economic development of the economy.

Money theory:

Macroeconomics assesses the impact of reserve banks on the economy, capital inflows and outflows, and its impact on employment rates. Frequent changes in the value of money caused by inflation and deflation have many negative effects on the country's economy. They can be exacerbated by monetary policy, fiscal policy, and direct control of the economy as a whole.

National Income Theory:

This includes various topics related to measuring national income, such as revenue, spending, and budget. As a macroeconomic study, it is essential to assess the overall performance of the economy in terms of national income. At the beginning of the Great Depression of the 1930s, it was essential to investigate the triggers of general overproduction and general unemployment.

This led to the creation of data on national income. Helps predict the level of economic activity. It also helps to understand the income distribution among different classes of citizens.

International Trade Theory:

This is a research area focused on the import and export of products or services. Simply put, it points to the economic impact of cross-border commerce and tariffs.

Employment theory:

This macroeconomic scope helps determine the level of unemployment. It also determines the conditions that lead to such unemployment. Therefore, this affects production supply, consumer demand, consumption, and spending behaviour.

General Price level theory:

The most important of these are research on commodity prices and how inflation or deflation fluctuates a particular price rate.

Macroeconomic policy:

The RBI and the Government of India are working together to imply macroeconomic policies for national improvement and development.

It falls into two sections:

Fiscal policy:

It refers to how spending fills deficit income and describes itself as a form of budgeting under macroeconomics.

Financial policy:

The Reserve Bank is working with the government to establish monetary policy. These policies are measures taken to maintain the stability and growth of a country's economy by regulating various interest rates.

Q2) Explain macro economics in details? 8 marks

A2)

Malthus, Sismondi and Marx in the 19th century dealt with macroeconomic issues. Walras, Wicksell and Fisher contributed modernly to the development of pre-Keynes macroeconomic analysis.

Scope of Macro Economics

Microeconomics:

Macroeconomics

The subject of macroeconomics revolves around income and employment decisions.

Scope of Macroeconomics

Fig 1

Scope of Macroeconomics:

Governments, financial institutions and researchers analyse the general problems of the people and the economic well-being of the people.

Research on issues such as India's unemployment, general price levels and balance of payments (BOP) issues is part of macroeconomic research as it is relevant to the economy as a whole.

Macroeconomic Theories:

Theory of Economic Growth and Development:

Money theory:

National Income Theory:

This led to the creation of data on national income. Helps predict the level of economic activity. It also helps to understand the income distribution among different classes of citizens.

International Trade Theory:

This is a research area focused on the import and export of products or services. Simply put, it points to the economic impact of cross-border commerce and tariffs.

Employment theory:

General Price level theory:

The most important of these are research on commodity prices and how inflation or deflation fluctuates a particular price rate.

Macroeconomic policy:

The RBI and the Government of India are working together to imply macroeconomic policies for national improvement and development.

It falls into two sections:

Fiscal policy:

It refers to how spending fills deficit income and describes itself as a form of budgeting under macroeconomics.

Financial policy:

Importance of macroeconomics:

Importance of Macroeconomics

Fig 2

Macroeconomics is an important concept that considers the whole country and works for the welfare of the economy.

1. Business cycle analysis

Timing of economic fluctuations helps prevent or prepare for financial crises and long-term negative situations.

2. Formulation of economic policy

The fiscal and monetary policy system relies entirely on the widespread analysis of macroeconomic conditions in the country.

3. Reduce the effects of inflation and deflation

Macroeconomics is primarily aimed at helping governments and financial institutions prepare for economic stability in a country.

4. Promote material welfare

This stream of economics provides a broader perspective on social or national issues. Those who want to contribute to the welfare of society need to study macroeconomics.

5. Regulate the economic system

It continues to guarantee or check the proper functioning and actual position of the country's economy.

6. Solve economic problems

Macroeconomic theory and problem analysis help economists and governments understand the causes and possible solutions to such macro-level problems.

7. Economic development

By utilizing macroeconomic data to respond to various economic conditions, the door to national growth will be opened.

Q3) Explain importance of macro economics? 5 marks

A3)

Malthus, Sismondi and Marx in the 19th century dealt with macroeconomic issues. Walras, Wicksell and Fisher contributed modernly to the development of pre-Keynes macroeconomic analysis.

Importance of macroeconomics:

Importance of Macroeconomics

Fig 2

Macroeconomics is an important concept that considers the whole country and works for the welfare of the economy.

1. Business cycle analysis

Timing of economic fluctuations helps prevent or prepare for financial crises and long-term negative situations.

2. Formulation of economic policy

The fiscal and monetary policy system relies entirely on the widespread analysis of macroeconomic conditions in the country.

3. Reduce the effects of inflation and deflation

Macroeconomics is primarily aimed at helping governments and financial institutions prepare for economic stability in a country.

4. Promote material welfare

This stream of economics provides a broader perspective on social or national issues. Those who want to contribute to the welfare of society need to study macroeconomics.

5. Regulate the economic system

It continues to guarantee or check the proper functioning and actual position of the country's economy.

6. Solve economic problems

Macroeconomic theory and problem analysis help economists and governments understand the causes and possible solutions to such macro-level problems.

7. Economic development

By utilizing macroeconomic data to respond to various economic conditions, the door to national growth will be opened.

Q4) Explain circular flow model? 8 marks

A4)

Circular flow model

Definition

The circular flow model demonstrates how money moves through society. Money flows from producers to workers as wages and flows back to producers as payment for products. In short, an economy is an endless circular flow of money.

Circular flow refers to a simple economic model which states the reciprocal circulation of income between producers and consumers. In the circular flow model, the interdependent entities of producer and consumer are referred to as "firms" and "households" respectively and provide each other with factors in order to facilitate the flow of income. Firms provide consumers with goods and services in exchange for consumer expenditure and "factors of production" from households.

In macroeconomics, we have the economy 2 sectors, 3 sectors and 4 sectors.

1. Economy 2 sectors: Household and Firm.

2. Economy 3 sectors: Household, Firm and Government.

3. Economy 4 sectors: Household, Firm, Government and International Trade.

The four macro economics sector

The Household Sector - This sector includes all the individuals in the economy. The primary function of this sector is to provide the factors of production. The factors of production include land, labour, capital and enterprise. The household sectors are the consumers who consume the goods and services produced by the firms and in return make payments for the same.
The Firms Sector - This sector includes all the business entities, corporations and partnerships. The primary function of this sector is to produce goods and services for sale in the market and make factor payments to the household sector.
The Government Sector - This sector includes the center, state, and local governments. The prime function of this sector is to regulate the functioning of the economy. The government sector incurs both revenue as well as expenditure. The government earns revenue from tax and non-tax sources and incurs expenditure for provide essential public services to the people.
The Foreign Sector - This sector includes transactions with the rest of the world. Foreign trade implies net exports (exports minus imports). Exports include goods and services produced domestically and sold to the rest of the world and imports include goods and services produced abroad and sold domestically.

The three markets-

The Goods Market - In this market the goods and services are exchanged among the four macroeconomic sectors. The consumers are the household, government and the foreign sector while the producers are the firms.
The Factor Market - The factors of production are traded through this market. For the production of final goods and services, the firms obtain the factor services and make payments in the form of rent, wages and profits for the services to the household sector.
The Financial Market - This market consists of financial institutions such as banks and non-bank intermediaries who engage in borrowing (savings from households) and lending of money.

The circular flow of income in a two sector model

In this model, the economy is assumed to be a closed economy and consists of only two sectors, i.e., the household and the firms. A closed economy is an economy that does not participate in international trade. In this model, the household sector is the only buyer of the goods and services produced by the firms and it is also the only supplier of the factors of production. The household sector spends the entire income on the purchase of goods and services produced by the firms implying that there is no saving or investment in the economy. The firms are the only producer of the good and services. The firms generate income by selling the goods and services to the household sector and the latter earns income by selling the factors of production to the former. Thus, the income of the producers is equal to the income of the households is equal to the consumption expenditure of the household. The demand of the economy is equal to the supply.

In this model,

Y = C where, Y is Income and C is Consumption

The circular flow of income in a three sector model

The three sector model of circular flow of income highlights the role played by the government sector. This is a more realistic model which includes the economic activities of the government however; we continue to assume the economy to be a closed one. There are no transactions with the rest of the world. The government levies taxes on the households and the firms and it also gives subsidies to the firms and transfer payments to the household sector. Thus, there is income flow from the household and firms to the government via taxes in one direction and there is income outflow from the government to the household and firms in the other direction. If the government revenue falls short of its expenditure, it is also known to borrow through financial markets. This sector adds three key elements to the circular flow model, i.e., taxes, government purchases and government borrowings.

In this model, the equilibrium condition is as follows:

Y = C + I + G

Where, Y = Income; C = Consumption; I = Investment and G = Government Expenditure In a closed economy, aggregate demand is measured by adding consumption, investment and government expenditure. Thus, aggregate demand is defined as the total demand for final goods and services in an economy at a given time and price level and aggregate supply is defined as the total supply of goods and services that the firms are willing to sell in an economy at a given price level.

The circular flow of income in a four sector model

This is the complete model of the circular flow of income that incorporates all the four macroeconomic sectors. Along with the above three sectors it considers the effect of foreign trade on the circular flow. With the inclusion of this sector the economy now becomes an ‘open economy’. Foreign trade includes two transactions, i.e., exports and imports. Goods and services are exported from one country to the other countries and imports come to a country from different countries in the goods market. There is inflow of income to the firms and government in the form of payments for the exports and there is outflow of income when the firms and governments make payments abroad for the imports. The import payments and export receipts transactions are done in the financial market

In this model, the equilibrium condition is as follows:

Y = C + I + G + NX

NX = Net Exports = Exports (X) – Imports (M)

Where, Y = Income; C = Consumption; I = Investment; G = Government Expenditure; X = Exports and M = Imports.

Q5) Explain the importance of circular flow model?

A5)

Importance of circular flow-

The concept of the circular flow gives a clear-cut picture of the economy. We can know whether the economy is working efficiently or whether there is any disturbance in its smooth functioning. As such, the circular flow is of immense significance for studying the functioning of the economy and for helping the government in formulating policy measures.

1. Study of Problems of Disequilibrium:

It is with the help of circular flow that the problems of disequilibrium and the restoration of equilibrium can be studied.

2. Effects of Leakages and Inflows:

The role of leakages enables us to study their effects on the national economy. For example, imports are a leakage out of the circular flow of income because they are payments made to a foreign country. To stop this leakage, government should adopt appropriate measures so as to increase exports and decrease imports.

3. Link between Producers and Consumers:

The circular flow establishes a link between producers and consumers. It is through income that producers buy the services of the factors of production with which the latter, in turn, purchase goods from the producers.

4. Creates a Network of Markets:

As a corollary to the above point, the linking of producers and consumers through the circular flow of income and expenditure has created a network of markets for different goods and services where problems relating to their sale and purchase are automatically solved.

5. Inflationary and Deflationary Tendencies:

Leakages or injections in the circular flow disturb the smooth functioning of the economy. For example, saving is a leakage out of the expenditure stream. If saving increases, this depresses the circular flow of income. This tends to reduce employment, income and prices, thereby leading to a deflationary process in the economy. On the other hand, consumption tends to increase employment, income, output and prices that lead to inflationary tendencies.

6. Basis of the Multiplier:

Again, if leakages exceed injections in the circular flow, the total income becomes less than the total output. This leads to a cumulative decline in employment, income, output, and prices over time. On the other hand, if injections into the circular flow exceed leakages, the income is increased in the economy. This leads to a cumulative rise in employment, income, output, and prices over a period of time. In fact, the basis of the Keynesian multiplier is the cumulative movements in the circular flow of income.

7. Importance of Monetary Policy:

The study of circular flow also highlights the importance of monetary policy to bring about the equality of saving and investment in the economy. Figure 2 shows that the equality between saving and investment comes about through the credit or capital market.

The credit market itself is controlled by the government through monetary policy. When saving exceeds investment or investment exceeds saving, money and credit policies help to stimulate or retard investment spending. This is how a fall or rise in prices is also controlled.

8. Importance of Fiscal Policy:

The circular flow of income and expenditure points toward the importance of fiscal policy. For national income to be in equilibrium desired saving plus taxes (S+T) must equal desired investment plus government spending (I + G). S+ T represents leakages from the spending stream which must be offset by injections of I + G into the income stream. If S + T exceed I + G, government should adopt such fiscal measures as reduction in taxes and spending more itself. On the contrary.

If I + G exceed S+T, the government should adjust its revenue and expenditure by encouraging saving and tax revenue. Thus the circular flow of income and expenditure tells us about the importance of compensatory fiscal policy.

9. Importance of Trade Policies:

Similarly, imports are leakages in the circular flow of money because they are payments made to a foreign country. To stop it, the government adopts such measures as to increase exports and decrease imports. Thus the circular flow points toward the importance of adopting export promotion and import control policies.

10. Basis of Flow of Funds Accounts:

The circular flow helps in calculating national income on the basis of the flow of funds accounts. The flow of funds accounts are concerned with all transactions in the economy that are accomplished by money transfers.

They show the financial transactions among different sectors of the economy, and the link between saving and investment, and lending and borrowing by them. To conclude, the circular flow of income possesses much theoretical and practical significance in an economy.

Q6) Explain national income? 5 marks

A6)

National income: Meaning and Definition:

What is saved each year is consumed as regularly as it is I spent every year and almost at the same time. But that is consumed by another person. That part of him the income that rich people spend each year is almost always consumed by an idle guest that part he consumes every year immediately for savings, profits employed as capital and consumed at the same manners but by other people ", Adam Smith

Fisher ' s definition:

Fisher adopted "consumption" as the standard for national income, while Marshall and Pigot considered it production. "

It's a flaw:

However, from a practical point of view, this definition is less useful, because there are certain difficulties in measuring goods and services in terms of money. First, it is much more difficult to estimate the monetary value of net consumption than to estimate the monetary value of net production.
In a country, there are several people who consume specific goods in different places, so it is difficult to estimate their total consumption. Secondly, some consumer goods are durable and can be used for many years.
If we consider the example of a piano or coat given by Fisher, then only the services they provide within a year will be included in the income. If the coat costs Rs. 100 and lasting ten years, Fisher will consider only rupees. 100 as a year's national income, while Marshall and pigo will include rupees. 100 in the year of national income, when it is made.
In addition, it is not safe to say that this coat can only be used for ten years. It may last longer or for a shorter period of time. Third, durable goods are often constantly changing, resulting in changes in ownership and value as well.
Therefore, from a consumption point of view, it is difficult to measure the value of the services of these goods in money. For example, the owner of the Maruti car sells it at a price higher than its actual price, and the purchaser sells it further at the actual price after using it for several years.
The question now is, Should we consider its price, whether real or black market price, and then when it moves from one person to another, its value should be included in national income according to its average age?
But the definition proposed by Marshall, Pigot, and Fisher is not entirely flawless. However, Marshallian and Pigovian definitions tell us what affects economic well-being, while Fisher's definition helps us compare economic well-being over different years.

Modern definition:

From a modern point of view, Simon Kuznets defines national income as"the net output of goods and services that flow from the national production system into the hands of the end consumer in a year."”

On the other hand, in a United Nations report, national income is determined on the basis of a system of estimates of national income, as a net national product, as a supplement to the share of different factors, and as a country & apos; s net national expenditure over a period of one year. In fact, while estimating national income, any of these three definitions could be used, because if different items were correctly included in the estimate, the same national income could be derived

Q7) Explain net income accounting? 5 marks

A7)

Fisher ' s definition:

Fisher adopted "consumption" as the standard for national income, while Marshall and Pigot considered it production. "

It's a flaw:

However, from a practical point of view, this definition is less useful, because there are certain difficulties in measuring goods and services in terms of money. First, it is much more difficult to estimate the monetary value of net consumption than to estimate the monetary value of net production.
In a country, there are several people who consume specific goods in different places, so it is difficult to estimate their total consumption. Secondly, some consumer goods are durable and can be used for many years.
If we consider the example of a piano or coat given by Fisher, then only the services they provide within a year will be included in the income. If the coat costs Rs. 100 and lasting ten years, Fisher will consider only rupees. 100 as a year's national income, while Marshall and pigo will include rupees. 100 in the year of national income, when it is made.
In addition, it is not safe to say that this coat can only be used for ten years. It may last longer or for a shorter period of time. Third, durable goods are often constantly changing, resulting in changes in ownership and value as well.
Therefore, from a consumption point of view, it is difficult to measure the value of the services of these goods in money. For example, the owner of the Maruti car sells it at a price higher than its actual price, and the purchaser sells it further at the actual price after using it for several years.
The question now is, Should we consider its price, whether real or black market price, and then when it moves from one person to another, its value should be included in national income according to its average age?
But the definition proposed by Marshall, Pigot, and Fisher is not entirely flawless. However, Marshallian and Pigovian definitions tell us what affects economic well-being, while Fisher's definition helps us compare economic well-being over different years.

Modern definition:

Net income accounting

Definition

National income accounting refers to the government bookkeeping system that measures the health of an economy, projected growth, economic activity, and development during a certain period of time. It helps in assessing the performance of an economy and the flow of money in an economy. The double entry system principle of accounting is used to prepare the national income accounts.

Where,

Y – National income
C – Personal consumption expenditure
I – Private investment
G – Government spending
X – Exports
M – Imports

Importance of net income accounting

National income accounting provides statistics can be used to simplify the procedures and techniques used to measure the aggregate input and output of an economy.
The national income accounting provides data which is used to frame government economic policies
National income accounting provides information on the trend of economic activity level.
The national income accounting statistics is used by the central bank to vary the rate of interest and set or revise the monetary policy.
The government use data on GDP, investments, and expenditures to frame or modify policies regarding infrastructure spending and tax rates.
The national income accounting data shows the contribution of different sectors towards economic growth.

Q8) Explain Green GNP and NNP concepts? 5 marks

A8)

Green GNP is defined as “GNP which is indicator of a sustainable use of natural environment and equitable distribution of benefits of development”.

The following characteristics involves0

Sustainable economic development means development does not cause environmental degradation and depletion of natural resources.
Equitable distribution of benefits of its development.
Promotes economic welfare for a long period of time.

Equation

Green GNP = GNP – net fall in stock of national capital.

NNP concept

Definition

Net national product (NNP) is the monetary value of finished goods and services produced by a country's citizens, overseas and domestically, in a given period. It is the equivalent of gross national product (GNP), the total value of a nation's annual output, minus the amount of GNP required to purchase new goods to maintain existing stock, otherwise known as depreciation.

Net national product is also obtained by subtracting depreciation from the gross national product (GNP)

NNP= GNP – Depreciation

Or,

NNP= GDP+ income from abroad- depreciation

National income and economic welfare

Welfare is a happy and satisfied state of human mind. Pigou regards individual welfare as the sum total of all satisfactions experienced by an individual and social welfare as the sum total of individual welfares. Economic Welfare is that part of social welfare which can directly or indirectly be measured in money.

Relation between Economic Welfare and National Income

In terms of money there is a close relationship between economic income and national welfare. When national income increases, total welfare also increases and vice versa.

The effect of national income on economic welfare can be studied in two ways:

By change in the size of national income – The change in the size of national income may be positive or negative. The positive change in the national income increases its volume which leads to more consumption of goods and services, as a result leads to increase in the economic welfare.

While the negative change in national income results in reduction of its volume. As a result people get lesser goods and services for consumption which leads to decrease in economic welfare. But this relationship depends on a number of factors such as changes in price, working conditions, percapita income and methods of spending.

Changes in price – it is difficult to measure real change in economic welfare, if the change in national income is due to change in prices. When the national income increases as a result of increase in prices. It is more likely that the economic welfare would decline
Working conditions- f the increase in national income is due to exploitation of labour e.g., increase in production by workers working for longer hours, by paying them lesser wages than the minimum. Then the economic welfare cannot be said to be increased.
Per capita income - if per capita income is not kept in mind, national income cannot be a reliable index of economic welfare.
Method of spending - If with the increase in income, people spend on such necessities and facilities as milk, ghee, eggs, fans, etc. which increase efficiency, the economic welfare will increase. On the other hand, the expenditure on drinking, gambling etc. will result in decreasing the economic welfare.

2. By change in the distribution of national income.

By Transfer of Wealth from the Poor to the Rich: - transfer of wealth from poor to rich result in decrease in economic welfare. This happens when the government gives more benefits to the richer sections and imposes regressive taxes on the poor. Transfer of wealth from rich to poor - When the distribution of income takes place in favour of the poor through the methods such as fixing a minimum wage rate, by increasing the production of goods used by the poor, by fixing the prices of such goods, by granting financial assistance to the producers of these goods, by the distribution of goods through co-operative stores, the economic welfare increases.

Q9) Explain trade cycle.

A9)

A trade cycle refers to fluctuations in economic activities such as employment, output and income, prices, profits, etc.

The business cycle is associated with fluctuations in macro economic activity. It may be noted that these fluctuations as ‘cycle’ are periodic and occur regularly. Cyclical fluctuations are wave like movements found in the aggregate economic activity of a nation. A business cycle is characterized by recurring phases of expansion and contraction in economic activity in terms of employment, output and income.

The period of high income, output and employment has been called the period of expansion, upswing or prosperity, and the period of low income, output and employment has been called the period of contraction, recession, downswing or depression. These altering periods of expansion and contraction in economic activity have been called business cycle. They are also known as trade cycle. Trade cycle has been defined by different economist in different ways.

Definition

According to Keynes, “A trade cycle is composed of periods of good trade characterised by rising prices and low unemployment percentages altering with periods of bad trade characterised by falling prices and high unemployment percentages”.

According to Mitchell, “Business cycles are of fluctuations in the economic activities of organized communities. The adjective ‘business’ restricts the concept of fluctuations in activities which are systematically conducted on commercial basis.

According to Schumpeter, “the business cycle represents wave like fluctuations in level of business activity from the equilibrium.”

According to Fredric Benham, “A trade cycle may be defined rather badly, as a period of prosperity followed by a period of depression. It is not surprising that economic process should be irregular, trade being good at some time and bad at others.”

Features

Though different business cycles differ in duration and intensity they have some common features which are given below.

A business cycle is a wave like movement in macro economic activity like income, output and employment which shows upward and downward trend in the economy.
Business cycles are recurrent and have been occurring periodically. They do not show some regularity.
They have some distinct phases such as prosperity, recession, depression and recovery.
The duration of business cycles may vary from minimum of two years to a maximum of ten to twelve years.
Business cycles are synchronic. That is they do not cause changes in any single industry or sector but are of all embracing character. For example, depression or contraction occurs simultaneously in all industries or sectors of the economy. Recession passes from one industry to another and chain reaction continues till the whole economy is in the grip of recession. Similar process is at work in the expansion phase or prosperity.
There are different types of business cycles. Some are minor and others are major. Minor cycles operate for a period of three to four years and major business cycles operate for a period of four to eight years. Though business cycles differ in timing, they have a common pattern of sequential phases.
Expansion and contraction phases of business cycle are cumulative in effect.
It has been observed that fluctuations occur not only in level of production but also simultaneously in other variables such as employment, investment, consumption, rate of interest and price level.
Another important feature of business cycles is that downswing is more sudden than the changes in upswing.
An important feature of business cycles is profits fluctuate more than any other type of income. The occurrence of business cycles causes a lot of uncertainty for business and makes it difficult to forecast the economic conditions.
Lastly, business cycles are international in character. That is once started in one country they spread to other countries through trade relations between.

Q10) Explain phase of trade cycle? 8 marks

A10)

A trade cycle refers to fluctuations in economic activities such as employment, output and income, prices, profits, etc.

Definition

According to Schumpeter, “the business cycle represents wave like fluctuations in level of business activity from the equilibrium.”

Business cycles have shown distinct phases, the study of which is useful to understand their fundamental causes. Generally, a business cycle has four phases.

Prosperity (Expansion, Boom, or Upswing)
Recession (upper turning point)
Depression (Contraction or Downswing) and
Revival or Recovery (lower turning point)

Prosperity – Prosperity is ‘a stage in which the money income, consumption, production and level of employment are high or rising and there are no idle resources or unemployed workers.’

This stage is characterized by increased production, high capital investment, expansion of bank credit, high prices, high profit, a high rate of interest, full employment income, effective demand, inflation MEC, profits, standard of living, full employment of resources, and overall business optimism etc.

The prosperity comes to an end when forces become weak and therefore, bottlenecks start to appear at the peak of prosperity. Due to high profit, inflation and over optimism make the entrepreneurs to invest more and more. But because of shortage of raw material and scarcity of factors of production prices of goods and services rises. As a result there is fall in demand and profit, business calculations go wrong. Thus their over optimism is replaced by over pessimism. Thus prosperity digs its own grave.

2. Recession- When the phase of prosperity ends, recession starts. Recession is an upper turning point. This is a phase of contraction or slowing down of economic activities. Recession is generally of a short duration.

After boom, demand falls, production becomes excess and investment results in over investment. Finally, it leads to recession.

During this phase profit, investment and share prices falls significantly, Because of lack of investment the demand for bank credit, rate of interest, income employment, and demand for goods and services falls.

If recession continues for a long period of time then finally, it reaches to the phase of depression.

3. Depression – It is a period in which business or economic activity in a country is far below the normal. Depression is ‘a stage in which the money income, consumption, production and level of employment falls, idle resources and unemployment increases.’

It is characterized by a sharp reduction of production, mass unemployment, low employment, falling prices, falling profits, low wages, and contraction of credit, fall in aggregate income, effective demand, MEC, a high rate of business failure and atmosphere of all round pessimism etc. The depression may be of a short duration or may continue for a long period of time.

After a period of time, moderate increase in the demand for goods and services helps to increase in investment, production, employment, income and effective demand. Finally, it leads to recovery.

4. Recovery – Depression phase is generally followed by recovery. Various exogenous and endogenous factors are responsible for reviving the economy. When the economy enters the phase of recovery, economic activity once again gathers momentum in terms of income, output, employment, investment and effective demand. But the growth rate lies below the steady growth path.

Thus, a recovery phase starts which is called the lower turning point. It is characterized by improvement in demand for capital stock, rise in demand for consumption good, rise in prices and profits, improvement in the expectations of the entrepreneurs, slowing rising MEC, slowly increasing investment, rise in employment, output and income, rise in bank credit, stock market becomes more sensitive and revival slowly emerges etc.

The phase of recovery once started, it slowly takes the economy on the path of expansion and prosperity. With this the cycle repeats itself.

Q11) Explain Say’s law of Markets – Features? 5 marks

A11)

The classical theory assumes over the long period the existence of full employment without inflation.

Given wage-price flexibility, there are automatic competitive forces within the economic system that tend to keep up full employment, and make the economy produce output at that level within the end of the day .

Thus, full employment is considered a standard situation and any deviation from this level are a few things abnormal since competition automatically pushes the economy toward full employment.

The classical theory of income, output and employment relies on the subsequent assumptions:

1. There's a standard situation of full employment without inflation.

2. There's a laissez faire capitalist economy without foreign trade.

3. There's perfect competition in labour, money and goods markets.

4. Labour is homogeneous.

5. Total output of the economy is splited between consumption and investment expenditures.

6. The amount of money is given. Money is just a medium of exchange.

7. Wages and prices are flexible.

8. Money wages and real wages are directly related and this relationship is proportional.

9. Capital stock and technological knowledge are given within the short run.

Now we study the three pillars of classical theory.

Say’s Law of Markets:

Say’s Law of Markets is that the core of the classical theory of employment. Jean Baptiste Say, an early 19th century French Economist gave the proposition that “supply creates its own demand.” this is often referred to as Say’s Law. In Say’s own words, “It is production which creates markets for goods. A product is not any sooner created than it, from that instant, affords a marketplace for other products to the full extent of its own value. Nothing is more favourable to the demand of 1 product, than the supply of another.”

In its original form, the law was applicable to a barter economy where goods are ultimately sold for goods. Every good delivered to the market creates a demand for a few other goods. Say argued that since work is unpleasant, nobody will work to create a product unless he wants to exchange it for a few other product which he desires.

Therefore, the very act of supplying goods by a huge number of small producers implies a demand for them from producers of other goods. In each a situation there can't be general over-production because supply of goods won't exceed demand as an entire .

Classical conceded that specific good could also be overproduced because the producer incorrectly estimates the number of the product which others want. But this is"> this is often a temporary phenomenon for the surplus production of particular product can be corrected in time by reducing its production.

Even after 100 years, James Mill supported Say’s Law in these words, “Consumption is coextensive with production and production is that the cause, and therefore the sole explanation for demand. It never furnishes supply without furnishing demand, both at the same time and both to an equal extent…. Regardless of the amount of annual produce; it can never exceed the amount of annual demand.”

Thus supply creates its own demand and there can't be general overproduction and hence general unemployment.

The classical logic was that existence of money doesn't alter the working of the fundamental law. “Say’s law, during a very broad way, is,” as Professor Hansen has said, “a description of a free-exchange economy. So conceived, it illuminates the reality that the major source of demand is that the flow of factor income generated from the method of production itself. When producers obtain the varied inputs (land, labour and capital) to be utilized in the assembly process, they generate the required income accruing to the factor owners in the type of rent, wages and interest.

This, in turn, causes adequate demand for the goods produced. During this way, supply creates its own demand. This reasoning relies on the assumption that all income earned by the factor-owners is automatically spent in buying commodities which they assist to produce.

Classical further maintained that what's not consumed is saved which all saving out of income is automatically invested through the capital market. Thus, during a state of equilibrium saving must equal investment. If there's any divergence between the 2, the equality is maintained through the mechanism of the rate of interest. To the classicists, interest is a reward for saving.

The higher is that the rate of interest, the upper the savings, and the other way around . On the contrary, the lower the rate of interest, the higher the demand for investment funds, and the other way around . If at any given time, investment exceeds saving, the rate of interest would rise.

Saving would increase and investment would decline till the 2 are equal at the complete employment level. This is often because saving is considered an increasing function of the rate of interest and investment a decreasing function of the speed of interest. This helps establish the equilibrium condition of saving-investment equality.

The process of generation of the equality between saving and investment is shown in Figure 3.1 where SS is that the saving curve and II is that the investment curve. The 2 curves intersect at E where the rate of interest gets determined at the extent of Or and both saving and investment are adequate to OA. If there's a rise in investment, the investment curve shifts to the proper and is shown as it curve.

At the rate of interest Or, investment is greater than saving. Consistent with the classical economists, the saving curve SS remains at its original level when there's any increase in investment. To take care of the equality between saving and investment, the rate of interest will rise.

This is shown within the figure to rise from Oe to Or’. At this rate of interest , the saving curve SS intersects the investment curve IT at E’. Consequently, both saving and investment equal the quantity shown as OB. Thus whatever is saved gets invested through rate of interest flexibility.

Q12) Explain Propositions and Implications of the say’s Law? 5 marks

A12)

Say’s law of markets is the core of the classical theory of employment. An early 19th century French Economist, J.B. Say, enunciated the proposition that “supply creates its own demand.” Therefore, there can't be general overproduction and the problem of unemployment in the economy.

Propositions and Implications of the Law:

Say’s propositions and its implications present truth picture of the market law.

These are given below:

1. Full employment in the Economy:

The law is predicated on the proposition that there's full employment in the economy. Increase in production means more employment to the factors of production. Production continues to increase until the level of full employment is reached. Under such a situation, the extent of production will be maximum.

2. Proper Utilization of Resources:

If there's full employment in the economy, idle resources will be properly utilized which can further help to produce more and also generate more income.

3. Perfect Competition:

Say’s law of market is based on the proposition of perfect competition in labour and product markets.

Other conditions of perfect competition are given below:

(a) Size of the Market:

According to Say’s law, the size of the market is large enough to make demand for goods. Moreover, the size of the market is also influenced by the forces of demand and supply of various inputs.

(b) Automatic Adjustment Mechanism:

The law is based on this proposition that there's automatic and self-adjusting mechanism in different markets. Disequilibrium in any market is a temporary situation. For instance , in capital market, the equality between saving and investment is maintained by the rate of interest while in the labour market the adjustment between demand and supply of labour is maintained by the wage rate.

The law relies on the proposition of a barter system where goods are exchanged for goods. But it's also assumed that the role of cash is neutral. Money doesn't affect the production process.

4. Laissez-faire Policy:

The law assumes a closed capitalist economy which follows the policy of laissez-faire. The policy of laissez-faire is crucial for an automatic and self-adjusting process of full employment equilibrium.

5. Saving as a Social Virtue:

All factor income is spent in buying goods which they assist to produce. Whatever is saved is automatically invested for further production. In other words, saving could be a social virtue.

Q13) Explain Criticisms of Say’s Law? 5 marks

A13)

J.M. Keynes in his General Theory made a frontal attack on the classical postulates and Say’s law of markets.

He criticised Say’s law of markets on the subsequent grounds:

1. Supply doesn't create its Demand:

Say’s law assumes that production creates market (demand) for goods. Therefore, supply creates its own demand. But this proposition isn't applicable to modern economies where demand doesn't increase as much as production increases. It's also not possible to consume only those goods which are produced within the economy.

2. Self-adjustment not Possible:

According to Say’s law, full-employment is maintained by an automatic and self-adjustment mechanism in the long run. But Keynes had no patience to wait for the long period for he believed that “In the long-run we are all dead.” it's not the automated adjustment process which removes unemployment. But unemployment is often removed by increase in the rate of investment.

3. Money isn't Neutral:

Say’s law of markets is based on a barter system and ignores the role of money in the system. Say believes that money doesn't affect the economic activities of the markets. On the opposite hand, Keynes has given due importance to money. He regards money as a medium of exchange. Money is held for income and business motives. Individuals hold money for unforeseen contingencies while businessmen keep cash in reserve for future activities.

4. Over Production is Possible:

Say’s law is based on the proposition that supply creates its own demand and there can't be general over-production. But Keynes doesn't agree with this proposition. According to him, all income accruing to factors of production isn't spent but some fraction out of its saved which isn't automatically invested. Therefore, saving and investment are always not equal and it becomes the problem of overproduction and unemployment.

5. Underemployment Situation:

Keynes regards full employment as a special case because there's underemployment in capitalist economies. This is often because the capitalist economies don't function according to Say’s law and supply always exceeds its demand. For example, millions of workers are prepared to work at the current wage rate, and even below it, but they do not find work.

6. State Intervention:

Say’s law relies on the existence of laissez-faire policy. But Keynes has highlighted the need for state intervention in the case of general overproduction and mass unemployment. Laissez-faire, in-fact, led to the great Depression.

Had the capitalist system been automatic and self-adjusting. This would not have occurred. Keynes, therefore, advocated state intervention for adjusting supply and demand within the economy through fiscal and monetary measures.

7. Equality through Income:

Keynes doesn't agree with the classical view that the equality between saving and investment is brought about through the mechanism of rate of interest . But actually , it's changes in income rather than the rate of interest which bring the two to equality.

8. Wage-cut no Solution:

Pigou favoured the policy of wage-cut to solve the matter of unemployment. But Keynes opposed such a policy both from the theoretical and practical points of view. Theoretically, a wage-cut policy increases unemployment instead of removing it. Practically, workers aren't prepared to simply accept a cut in money wage. Keynes, therefore, favoured a versatile monetary policy to a flexible wage policy to boost the level of employment in the economy.

9. Demand creates its own supply:

Say’s law of market is predicated on the proposition that “supply creates its own demand”. Therefore, there cannot be general overproduction and mass unemployment. Keynes has criticized this proposition and propounded the other view that demand creates its own supply. Unemployment results from the deficiency of effective demand because people don't spend the whole of their income on consumption.

Q14) Explain features and phases of trade cycle? 12 marks

A14)

A trade cycle refers to fluctuations in economic activities such as employment, output and income, prices, profits, etc.

Definition

According to Schumpeter, “the business cycle represents wave like fluctuations in level of business activity from the equilibrium.”

Features

Though different business cycles differ in duration and intensity they have some common features which are given below.

A business cycle is a wave like movement in macro economic activity like income, output and employment which shows upward and downward trend in the economy.
Business cycles are recurrent and have been occurring periodically. They do not show some regularity.
They have some distinct phases such as prosperity, recession, depression and recovery.
The duration of business cycles may vary from minimum of two years to a maximum of ten to twelve years.
Business cycles are synchronic. That is they do not cause changes in any single industry or sector but are of all embracing character. For example, depression or contraction occurs simultaneously in all industries or sectors of the economy. Recession passes from one industry to another and chain reaction continues till the whole economy is in the grip of recession. Similar process is at work in the expansion phase or prosperity.
There are different types of business cycles. Some are minor and others are major. Minor cycles operate for a period of three to four years and major business cycles operate for a period of four to eight years. Though business cycles differ in timing, they have a common pattern of sequential phases.
Expansion and contraction phases of business cycle are cumulative in effect.
It has been observed that fluctuations occur not only in level of production but also simultaneously in other variables such as employment, investment, consumption, rate of interest and price level.
Another important feature of business cycles is that downswing is more sudden than the changes in upswing.
An important feature of business cycles is profits fluctuate more than any other type of income. The occurrence of business cycles causes a lot of uncertainty for business and makes it difficult to forecast the economic conditions.
Lastly, business cycles are international in character. That is once started in one country they spread to other countries through trade relations between.

Phase of business cycle

Business cycles have shown distinct phases, the study of which is useful to understand their fundamental causes. Generally, a business cycle has four phases.

5. Prosperity (Expansion, Boom, or Upswing)

6. Recession (upper turning point)

7. Depression (Contraction or Downswing) and

8. Revival or Recovery (lower turning point)

Prosperity – Prosperity is ‘a stage in which the money income, consumption, production and level of employment are high or rising and there are no idle resources or unemployed workers.’

After boom, demand falls, production becomes excess and investment results in over investment. Finally, it leads to recession.

If recession continues for a long period of time then finally, it reaches to the phase of depression.

After a period of time, moderate increase in the demand for goods and services helps to increase in investment, production, employment, income and effective demand. Finally, it leads to recovery.

The phase of recovery once started, it slowly takes the economy on the path of expansion and prosperity. With this the cycle repeats itself.

Q15) Explain Say’s law of Markets - Features, Implications and Criticism? 12 marks

A15)

The classical theory assumes over the long period the existence of full employment without inflation.

Thus, full employment is considered a standard situation and any deviation from this level are a few things abnormal since competition automatically pushes the economy toward full employment.

The classical theory of income, output and employment relies on the subsequent assumptions:

1. There's a standard situation of full employment without inflation.

2. There's a laissez faire capitalist economy without foreign trade.

3. There's perfect competition in labour, money and goods markets.

4. Labour is homogeneous.

5. Total output of the economy is splited between consumption and investment expenditures.

6. The amount of money is given. Money is just a medium of exchange.

7. Wages and prices are flexible.

8. Money wages and real wages are directly related and this relationship is proportional.

9. Capital stock and technological knowledge are given within the short run.

Now we study the three pillars of classical theory.

Say’s Law of Markets:

Thus supply creates its own demand and there can't be general overproduction and hence general unemployment.

Classical further maintained that what's not consumed is saved which all saving out of income is automatically invested through the capital market. Thus, during a state of equilibrium saving must equal investment. If there's any divergence between the 2 , the equality is maintained through the mechanism of the rate of interest. To the classicists, interest is a reward for saving.

Say’s Law:

Propositions and Implications of the Law:

Say’s propositions and its implications present truth picture of the market law.

These are given below:

1. Full employment in the Economy:

2. Proper Utilization of Resources:

If there's full employment in the economy, idle resources will be properly utilized which can further help to produce more and also generate more income.

3. Perfect Competition:

Say’s law of market is based on the proposition of perfect competition in labour and product markets.

Other conditions of perfect competition are given below:

(a) Size of the Market:

According to Say’s law, the size of the market is large enough to make demand for goods. Moreover, the size of the market is also influenced by the forces of demand and supply of various inputs.

(b) Automatic Adjustment Mechanism:

The law relies on the proposition of a barter system where goods are exchanged for goods. But it's also assumed that the role of cash is neutral. Money doesn't affect the production process.

4. Laissez-faire Policy:

5. Saving as a Social Virtue:

All factor income is spent in buying goods which they assist to produce. Whatever is saved is automatically invested for further production. In other words, saving could be a social virtue.

Criticisms of Say’s Law:

J.M. Keynes in his General Theory made a frontal attack on the classical postulates and Say’s law of markets.

He criticised Say’s law of markets on the subsequent grounds:

1. Supply doesn't create its Demand:

2. Self-adjustment not Possible:

3. Money isn't Neutral:

4. Over Production is Possible:

5. Underemployment Situation:

6. State Intervention:

7. Equality through Income:

8. Wage-cut no Solution:

9. Demand creates its own supply:

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