MODULE III

Final goods & Intermediate goods

► Final goods are those goods that are manufactured to be consumed directly
by the consumer.
► Intermediate goods are referred to as those goods that are used for producing
final goods.

Bread: A loaf of bread bought by a household is a final good.

Flour: The flour a baker uses to make bread is an intermediate good
National Income

► On output terms it is the money value of all final goods and

services produced in a country during an accounting year.

► On income terms it is the sum of factor incomes(Rent, interest,

wages and profit) received by all the individuals in a country.
Concepts related to national income

► Gross Domestic product at market price (GDPmp)

► Net Domestic Product at market price (NDPmp)

► Gross National Product at market price (GNPmp)

► Net National Product at market price (NNPmp)

► Net National Product at Factor Cost (NNPfc)

Gross Domestic Product

► Money value of all final goods and services produced by all normal residents
working within the domestic territory of a country but does not include net
factor income from abroad.

► GDP=C+I+G+(X-M)

► C=Consumption Expenditure
► I=Investment Expenditure
► G=Government Expenditure
► X-M=Net Exports
Net Domestic Product at market price
(NDPmp)

► When depreciation is deducted from GDP we get NDP. Depreciation is

the loss in the value of capital assets due to wear and tear during
production. The capital goods, like Machinery,wear out or fall in value
due to wear and tear as a result of continuous use in the production
process.

► NDPmp = GDPmp - Depreciation

Net National Product at market price
(NNPmp)
► GDP includes the money value of goods or income generated within the
domestic territory only. But a nation get income from abroad. When net
factor income from abroad (NFIA)is added to NDP we get NNP.
► NFIA is the difference between factor income received from abroad and factor
payments made to the rest of the world.

► NNPmp=NDPmp+NFIA
► When charges for depreciation are deducted from GNP we can calculate NNP.
► NNPmp=GNP-Depreciation
NNPfc or National Income

► NNP fc = NNPmp –Net Indirect Tax

Net Indirect Tax=Indirect-Subsidy

► NNP fc is the national income of a country. It is the total factor

income received by the factors of production land, labour,capital and
entrepreneur.
Gross National Product

► GNP is defined as the total market value of all

final goods and services produced in a country
including net factor income from abroad.

► GNP=GDP+NFIA
Methods of Measuring National Income

► Product Method

► Income Method

► Expenditure Method
Income Method

► In this method National Income is the Sum of all factor payments.

Steps
Economy divided on the basis of income groups such as wage earners, rent earners,
interest earners and profit earners. Also considering the mixed income of self employed
people.
Income of each group is calculated
Income of all earners are added including income from abroad.
Income earned by foreigners and transfer payments made in the year are subtracted
Ie;Rent+ Interest+ Profit+ wage+ mixed income= NDPfc
NNPfc=NDPfc+NFIA
Expenditure Method

► Total expenditure incurred by the society in a particular year is added

together.
► Economy is divided in to 4 sectors- Consumers, Investors, Government,
Foreign sector
► Expenditures of different sectors are added
► Total expenditure include, personal Consumption expenditure
► Gross Domestic Private Investment Expenditure
► Government Expenditure
► Net export.
► ie; GDP=C+I+G+(X-M).Once GDP is found we will calculate National Income or
NNPfc
Inflation
Inflation
Types of Inflation

► Creeping

► Walking

► Running

► Hyper or Galloping
Creeping

► It is the mildest form of inflation.

► Under creeping inflation, price rise is less than 3 % per
annum.
Walking Inflation

► Walking inflation occurs when the price rises moderately

► Under walking inflation, prices rise approximately by 3%-10 % annually.
► Inflation at this rate is a warning signal for government.
Running Inflation

► Price rises fast.

► Rate of inflation is 10%-20% per annum .
► Very dangerous situation for the economy.
Galloping /Hyper Inflation

► Price rises very fast.

► Price rise is 20% to 100% per annum.
► Total collapse of monetary system
► Also called hyper inflation
Types of inflation on the basis of speed

Type of Inflation Rate Feature

Creeping Less than 3% • Mildest form
• Good for economic
growth
Walking 3% to 10% Price rise is moderate

Running 10% to 20% • Price rises a Little

faster
• No measures leads to
galloping inflation.

Galloping 20% to100% • Uncontrollable

• Too much government
spending is one reason
Inflation
Theories of Inflation

► Demand pull Inflation

► Cost push inflation

Demand Pull Inflation

► Traditional Theory

► Also called Wage Inflation

► Aggregate demand exceeds aggregate supply leads to

increase in price level.
Demand Pull Inflation
Demand pull inflation -Diagram
Cost Push Inflation

► Modern theory of inflation.

► Modern economists says that an increase in Cost

of production leads to increase in price level.
Cost Push Inflation
Cost push inflation-Diagram
Reasons for Inflation

► Demand side reasons

► Supply Side reasons

Demand side reasons

► Deficit financing

► Increase in Public Expenditure

► Reduction in taxes

► Increase in population

► Increase in exports

► Hoarding
Supply side reasons

► Less Production

► Rise in wages

► Increase in Taxation

► Technical changes

► Natural Calamities
Effects of Inflation

► Uncertainty in Industry

► Decreases the value of currency

► Discourages savings

► Hoarding and speculation

► Affect fixed income group

► Social unrest
Measures to control Inflation

► Monetary Policy

► Fiscal Policy
Monetary Policy

► Measures taken by Central Bank to control inflation is

called Monetary Policy

► Monetary Policy includes

► Quantitative techniques

► Qualitative techniques
 Monetary Policy-Quantitative techniques

These instruments are used to regulate the total amount of money and volume of
bank credit in the economy.
► Bank Rate
Cash Reserve
Ratio
► Open Market operations

► Variable Reserve Ratio-

Statutory
Liquidity Ratio
Bank Rate

► Bank rate is the rate that the central bank charges on the loans and advances
to the commercial banks.

► During periods of high inflation, the RBI raises the bank rate to reduce the
flow of money in the economy. Lending rates rise, making borrowing more
expensive for businesses and industries, slowing investment and money supply
in the market. It aids in the control of inflation.
Open Market Operations

► Purchase and sale of government securities by RBI

► At the time of inflation, central bank sells government securities .

► At the time of deflation, central bank purchases government
securities .
Variable Reserve Ratio includes

► Cash Reserve Ratio(CRR) and Statutory Liquidity Ratio(SLR)

► To combat inflation, the RBI must raise the CRR. When the
CRR is raised, banks are required to keep a larger amount
of cash with the RBI. As a result, the bank's ability to lend
to the market declines, lending rates rise. Market liquidity
will shrink, as a result, inflation is controlled.
Statutory Liquidity Ratio

► To combat inflation, the RBI must raise the SLR.

► When the SLR is raised, banks are required to keep a larger amount in safe
and liquid assets. As a result, the bank's ability to lend to the market
declines, lending rates rise. Market liquidity will shrink, as a result, inflation
is controlled.
► The RBI must decrease SLR to fight deflation, which works the opposite way.
Qualitative Techniques( selective tools
of credit control) used by the RBI:

Qualitative tools of monetary policy are aimed at controlling the use and direction
of credit
► Rationing of Credit
RBI fixes a credit amount to be granted for commercial banks. For certain purposes,
the upper credit limit can be fixed, and banks have to stick to that limit. This helps
in lowering the bank's credit exposure to unwanted sectors.
► Regulation of Consumer Credit
In this instrument, consumers' credit supply is regulated through the installment of
sale and hire purchase of consumer goods. Here, features like installment amount,
down payment, loan duration, etc., are all fixed in advance, which helps to check
the credit and inflation in the country.
Contd….

► Change in Margin Requirement

Margin is referred to the certain proportion of the loan amount that is not
offered or financed by the bank. Change in margin can lead to change in the
loan size. This instrument is used to encourage the credit supply for the
necessary sectors and avoid it for the unnecessary sectors. That can be done
by increasing the marginal of unnecessary sectors and reducing the marginal
of other needy sectors.
► Moral Suasion
Moral suasion refers to the suggestions to commercial banks from the RBI
that helps in restraining credits in the inflationary period. RBI implies
pressure on the Indian banking system without taking any strict action for
compliance with rules.
Contd….

► Direct Action
The central bank (RBI) can give advice and punish banks for not following the
guidelines provided under the monetary policy.
Repo Rate

► Repo rate is the amount or the rate of interest which is paid by the
commercial banks to the Reserve Bank of India when the RBI lends money to
the commercial banks.
► • The technical meaning of the word ‘Repo’ means ‘Re-purchasing Option’ or
the ‘Repurchase Agreement’.
► When the inflation is high, which means that the liquidity of money is also
high, then the Reserve Bank of India increases the repo rate which
automatically reduces the amount of money available with the commercial
banks as they have to pay a higher interest to the Reserve Bank of India.
► • This reduces their capacity to lend to their borrowers which automatically
reduces the level of spending, thereby reducing the liquidity of money in the
economy.
Reverse Repo Rate

► Reverse repo rate is the amount or the rate of interest which is provided to
the commercial banks by the Reserve Bank of India when the RBI borrows
money in the form of securities from the commercial banks.
► When the level of inflation is high, which means that the liquidity of money is
also high in that economy, then the Reserve Bank of India increases the
reverse repo rate.
► This means that the commercial banks get a higher interest rate to deposit
their money in the RBI which automatically reduces the amount available with
them to lend to their customers.
► This reduces the level of spending in the economy and thus reduces the
liquidity of money.
Fiscal Measures

This involves measures related to government revenue and expenditure.

Government can increase tax rates to generate more revenue and discourage
expenditure of the common public.

During the demand-pull inflation, the inflation rate can be controlled by regulating public
expenditure.
Government should stop repayment of public debt and postpone it to some future date till
inflationary pressures are controlled within the economy.
Instead, the government should borrow more to reduce money supply with the public.
Deficit financing means generating funds to finance the deficit which results from excess of
expenditure over revenue. The gap being covered by borrowing from the public by the sale of bonds
or by printing new money. Government should not use deficit financing at the time of inflation.