Module 4

Macroeconomic concepts
Topics:
Circular flow of economic activities – Stock and flow – Final goods and intermediate goods - Gross
Domestic Product - National Income – Three sectors of an economy- Methods of measuring
national income – Inflation- causes and effects – Measures to control inflation-Monetary and
fiscal policies – Business financing- Bonds and shares -Money market and Capital market – Stock
market – Demat account and Trading account - SENSEX and NIFTY.
Stock and Flow concepts:
Stock flow
1.A stock is a quantity measured at a A flow is a quantity measured over a
point of time. specified period.
E.g., Water in reservoir at a point of E.g.: Water in the reservoir between a
time, Bank deposit in a bank account period, savings, expenditure etc.
at a point of time
2. It has no time dimension. It has a time dimension, may be a week,
month, year per hour, per day etc.
3. It is a static concept. It is a dynamic concept.

Circular Flow of Income

Economic transactions generate two types of flows.
i) Product flow or real and
ii) money flow.
In the economy products and money flow in opposite directions in a circular flow. This is called
circular flow of income.
Circular Flow of Income in a Two Sector Economy
In a two-sector economy only 2 sectors are considered.
1) Households & 2) Firms
Each sector plays a dual role –
✓ Receives certain payments, and
✓ Make certain payments.
Households possess all factors of production. They supply these factor services to firms and
receive factor payments in the form of rent, wages, interest, and profit. This income is spent for
goods and services produced by firms.
Firms hire the factor services of households and produce various goods and services. They sell
these goods and services to the households and in turn receive payment of goods and services.
This model is built based on the assumption that the entire income received by the
households are spent on goods and services.

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 That is; Income of households (Y)=Factor payments (FP)= Value of goods and services (V). ( Y=
FP= V).
This model can be explained with the help of a chart.

Households may not spend their entire income on goods and services. They may save a part of
their income. This saving is coming to the capital market. Firms borrow the savings of households,
and they invest.
Circular Flow of Income in a Multi -Sector Economy:
(3/4 sector Economy)
➢ Circular Flow of Income in a Three Sector Economy:
In a three-sector model, three sectors are;
1. Households, 2) Firms, & 3) Government.

➢ Circular Flow of Income in a Four Sector Economy:

In a Four sector model, four sectors are.
1. Households, 2) Firms, 3) Government, 4) Foreign Sector.

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1. Household possess all factors of production. They supply these factor services to firms,
government, and foreign sector and receive factor payments. The households also pay tax to
the government and receive factor payments and transfer payments from the government. It
also receives export payments (factor payments) from foreign sector gives import payments to
foreign sector.
2. Firms supply goods and services to households, government, and to foreign sector and in turn
receive their payments. Firms also pay tax to the government and receives subsidy from the
government.
[Link] receives tax from households and firms, in turn provide transfer payments to
households and subsidy to firms.
Government also gives factor payments to households and goods payments to firms.
4. Foreign sector provides import payments to households and firms, and receives export payments
from households and firms.
National Income:
National Income is defined as the total money value of the goods and services produced in an
economy (country) during a specified period.
In India, the CSO (Central Statistical Organization) has been formulating national Income.
Concepts of National Income:
1. GNP (Gross National Product): is the money value of all final goods and services
produced in a country including net factor income from abroad (NFIA) during a financial
year.
GNP= GDP+ NFIA.

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2. GDP (Gross Domestic Product): is the money value of all final goods and services
produced within the domestic territory of a country during a financial year. (value of goods
produced outside the country will not be included)
GDP= GNP- NFIA.
3. NNP (Net National Product):
* NNP= GNP- Depreciation,
Or
* NNP= NDP+NFIA
Depreciation is the consumption of fixed capital or reduction in the value of
assets by wear and tear.
4. NDP (Net Domestic Product):
* NDP= GDP- Depreciation,
Or
* NDP= NNP – NFIA.
5. National Income at Factor Cost (NNP fc): -
NI at Factor Cost = NI at market price – Net Indirect Tax.
(Net Indirect Tax = Indirect Tax –Subsidy).
6. National Income at Market price (NNP mp): -
NI at market price = NI at Factor Cost + Net Indirect Tax.
(Net Indirect Tax = Indirect Tax –Subsidy).
7. Personal Income (PI): -
It is the income of household sector from all sources before the payment
of direct taxes.
8. Disposable Personal Income (DPI): -
DPI = Personal Income - Direct taxes.
9. Per capita Income: -
It is the income per head, or average income of the people in a country.
Per capita Income = National Income ÷ Population.
10. Private Income: -
It is the income of non-governmental entities (Firms & households) from all sources during an
accounting year.
11. GNP Deflator: - (Out of syllabus)
This is an adjustment factor used to convert nominal GNP into real GNP.
GNP Deflator=PIN of the chosen year ÷ 100, (Where, PIN-Price Index Number)
Real GNP= Nominal GNP ÷ GNP Deflator.

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Numerical Example

2. Estimate NDPmp, NNPmp, and national income (or NNPfc) from the data given below.
GDPmp = 840, Depreciation=50, NFIA=210, Indirect Tax=50, Subsidy=40.
Ans: NDPmp = GDPmp – Depreciation
=850 – 50= 800
NNPmp = NDPmp + NFIA
=800 + 210 =1010
NNPfc = NNPmp – NIT (Where NIT- Net Indirect Tax
NIT= Indirect Tax – Subsidy)
= 1010 – (50 – 40) =1000
Measurement of National Income or
Methods for calculating National Income
National Income can be measured by three methods.
I. Product/Output method
II. Income method
III. Expenditure method

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 I. Product/Output method
According to production method, national income is an addition of money value of all goods and
services produced in all sectors during a given period. Economy is divided in to three sectors.
✓ Primary sector – consists of agriculture and allied activities.
✓ Secondary sector – consists of Industry and commercial activities.
✓ Tertiary sector – consists of service sector
Then, the gross product is found out by adding up net values of all the production that has
been taken place on these sectors during a given year.
o This method is suitable for primary sector.
Advantages:
The great advantage of this method is that it reveals the relative importance of different sectors of
the economy by showing their respective contributions to national income.
Problem: Double Counting is the major problem of this method. Double Counting means
estimating the value of an item more than once.
The output of many businesses is the inputs of some other business. For e.g., the output
of the tyre industry is the input of racing bike industry/ automobile industry. Counting the value of
final output of both industries will result in double counting of the value of tyre.
II. Income method:
According to Income method national income is the sum of the factor incomes in the economy
during an accounting year. Factor incomes are Rent, Wages, Interest, & Profit. It is an addition of
all factor incomes.
GDI (Gross Domestic Income) = Rent + Wage+ Interest + Profit + along with indirect taxes and
depreciation.
GNI (Gross National Income) =GDI + NFIA
NNI = GNI- Depreciation.
Advantages:
This method has the great advantage of indicating the distribution of national income among
different income groups such as landlords, capitalists, workers, etc.
➢ This method is suitable for tertiary sector.
➢ Problem: - Double counting.
[Link] method:
Expenditure method measures national income as the aggregate of all final expenditure
made by different agents of the economy during a year. It includes.
a) Personal (Individual/Households) consumption expenditure denoted by ‘C’.
b) Gross Domestic Pvt investment (‘I’)
c) Govt. expenditure (‘G’)
d) Net exports (Export – Imports) -> ‘X – M’.
Thus, GDP = C + I + G + (X-M).
GNP = GDP + NFIA

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 Combined Method:
As every method has its own drawbacks , it is difficult to have a particular satisfactory
approach for NI computation. Hence, the combined use of two or three methods are adopted
to have a correct measure of NI analysis.

Problems/ Difficulties in the computation of National Income:

There are two types of Difficulties.
A. Conceptual Difficulties:
▪ Service without remuneration is not included in national income, because payments not
made. E.g.- Services of Housewife. This underestimates the national income.
▪ Difficulty in the classification of goods as intermediate and final goods.
▪ Difficulty in estimating the value of output produced in the government sector.
B. Practical Difficulties:
✓ Double Counting
✓ Inadequacy of statistical data
✓ Illiteracy of farmers
✓ Lack of occupational specialization: people earn income from more than one occupation.
✓ Existence of a non-monetized sector
✓ Production for self-consumption
Uses/Significance/ importance of National Income Estimation:
✓ To evaluate the performance of the economy over the years.
✓ For economic planning and for the formulation of economic policies.
✓ To understand the contribution of each sector towards national income.
✓ To make comparison between the economic performance of two countries.
✓ To measure the inequalities in the distribution of income.
✓ To estimate the degree of inflation / deflation.
➢ Inflation-
✓ Inflation- refers to an economic situation of general rise in price level and a fall in the
value of money.
✓ On the basis of speed (of rise in price level), inflation can be classified as;
✓ Creeping inflation (less than 3% per annum)
✓ Walking inflation (3- 10%)
✓ Running inflation (10- 20%)
✓ Galloping or Hyperinflation (20- 100%)
Demand Pull Inflation & Cost Push Inflation
Causes /Types of Inflation:
➢ Demand Pull Inflation:
o Demand Pull Inflation is the result of excess demand.
o It occurs when the total demand for goods and services exceeds total supply. That is , total
demand > total supply. Hence the price level goes up.

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 o Once the economy reaches in full employment level any further increase in demand will
lead to price rise without any increase in output.
o This type of inflation can be controlled by suitable tax policies.
o It can be explained with the help of the following diagram.

In the figure, D, D1, & D2 represent the aggregate demand curves and ‘SS’ curve represents the
aggregate supply function. Initially the economy is in equilibrium at point ‘F’, where original
demand curve D, intersects with supply curve SS. At equilibrium point ‘F’, output is Y and price is
P. Beyond Y level of output, Supply curve becomes perfectly inelastic (vertical straight line). That
is the output cannot be increased beyond this level. Hence Y is the full employment level of
output. Any increase in aggregate demand (D1 &D2) beyond this level push the price up without
any change in output.

Cost Push Inflation:

➢ Cost Push Inflation is the result of increase in cost of production. It mainly due to increase
in wages. Increase in profit margin, or sudden fall in supply.
Increase in cost of production decreases the supply. Hence the supply curve shifts leftward.
Therefore, the price level goes up. This is shown in the diagram.

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 In the diagram, initially the economy is in equilibrium at point ‘E’, where aggregate supply
curve SS intersects with original demand curve DD. This is full employment equilibrium
where output is Y and price is P.
When aggregate supply curve decreases, the supply curve shifts left wards and the new
supply curves S1S & S2S intersect with demand curve DD at E1 and E2. Therefore, the
price goes up to P1 and P2.
Causes of Inflation:
Demand side & Supply(cost) side:

Demand side Supply(cost) side

a. Increase in money supply a. Shortage of factors of
b. Increase in disposable income and production
c. Increase in Government expenditure b. Increase in wages
d. Deficit financing c. Speculative hoarding or
e. Cheap money policy Artificial scarcity
f. Increase in population d. Natural calamities
e. Increase in exports
g. Black money
f. Industrial disputes.

Effects or Consequences of Inflation:

Inflation results in the economic, political social, and moral disturbance of society.
The important effects or cconsequences of inflation are the following.
1. Uncertainty in industry:
During inflation the prices of all commodities and raw materials increase. Industries will find

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 that the cost of the projects keeps on increasing.
2. Wage spiral effect:
During inflation, workers will demand higher wages. Which will result in rise in cost of
production and price level.
3. Depreciation in the value of money:
There is an inverse relation between price and the value of money. So during inflation more
money is needed to purchase the same quantity of products.
4. Discourage savings and investment
5. Investors:
Those who Invest in shares will gain, but invest in bonds and debentures will lose,
which carry fixed returns.
6. Bad effects on fixed income earners:
Their income does not grow, but the prices of goods are
increasing.
7. Farmers are gainers, they get more income because of rise in price.
8. Debtors are gainers while the creditors are losers.
During periods of rising prices, debtors gain, and creditors lose. When prices rise, the value of
money falls. This is because the value of money is less than when they borrowed the money.
Thus, the burden of the debt is reduced and debtors gain.
On the other hand, creditors lose. Although they get back the same amount of money which
they lent, they receive less in real terms because the value of money falls.
9. Businessmen:
Since price goes up businesspeople get more profit, and they gain from inflation.
10. Social and political effects: Inflation makes the rich richer and poor poorer. Hence people will
be unhappy and resort to black marketing adulteration etc. Corruption spreads in every walk of
life. All these reduces efficiency of the economy. Thus, there will be social unrest in the
economy.
Measures to control Inflation-
➢ There are three methods to control inflation.
I. Monetary policy measures
II. Fiscal policy measures, and
III. Other measures.
I. Monetary policy measures:
❑ These are the measures adopted by the Central bank (RBI) to control credit and money
supply in an economy.
❑ Price stability and economic growth are the 2 main objectives of monetary policy.
Classification: Monetary policy measures can be classifying in to two-
A. Quantitative credit control measures, &
B. Qualitative /Selective credit control measures.
Quantitative credit control measures:
The important Quantitative credit control measures are.

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 1. Bank Rate
2. Reserve Ratio: - Cash reserve Ratio (CRR) & Statutory Liquidity Ratio (SLR).
3. Open Market Operations
[Link] Rate:
✓ Bank Rate is the rate at which the central bank advances loans to the commercial banks.
✓ It is also called discount rate because at this rate the central bank rediscount approved bills
of exchange.
✓ The bank rate and interest rate are move in the same direction. The rise or fall in the bank
rate is followed by a rise or fall in the interest rate of commercial banks.
The Central bank.
During inflation –increases the Bank Rate
During deflation- decreases the Bank Rate.
The increase in bank rate is called Dear Money Policy and decrease in bank rate is called Cheap
Money Policy. When bank rate is increased, the cost of borrowing increases and hence money
becomes dearer. So, the people takes less loans and reduces money supply and demand in the
economy. Similarly, higher rate of interest is an incentive to save more and spend less.
2. Reserve Ratio: - There are Two types of reserve Ratio.
Cash reserve Ratio (CRR) & Statutory Liquidity Ratio (SLR).
a) Cash reserve Ratio (CRR): - Every commercial bank should keep a certain percentage of their
deposit in the central bank in the form of cash reserve. This percentage is called Cash reserve Ratio
(CRR). This is mandatory.
The Central bank.
✓ During inflation –increases CRR.
✓ During deflation –decreases CRR.
When there is inflation the Central bank increases CRR. This reduces total cash with the
commercial banks and their lending capacity. Hence people get less money, and it helps to control
inflation.
b) Statutory Liquidity Ratio (SLR): - is the minimum percentage of deposits that a commercial bank
has to maintain in the form of gold, cash, or other approved securities. These are not reserved with
the central bank, but with banks themselves. The word statutory indicates that it is mandatory and
legally required.
The Central bank.
✓ During inflation –increases SLR.
✓ During deflation –decreases SLR.
3. Open Market Operations (OMO): -
Open Market Operations refers to the sale and purchase of government securities by the
central bank to regulate money supply in the economy.
The Central bank.
✓ During inflation –Sells securities and reduce money supply
✓ During deflation–buys securities and increase money supply.
Qualitative/Selective credit control measures:
The important Qualitative/Selective credit control measures are the following.
a. Margin Requirements

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 b. Regulation of Consumer Credit
c. Credit Rationing
d. Moral Suasion, &
e. Direct Action.
a. Margin Requirements:
▪ Margin refers to the difference between market value of security (offered by the borrower
against loan) and the loan amount granted.
▪ In other words, margin means that proportion of the value of the security against which
loan is not given.
▪ The Central bank.
✓ During inflation –increases the margin & reduce money supply
✓ During deflation–decreases the margin & increase money supply.
b. Regulation of Consumer Credit:
✓ Under this method the central bank lay down terms and conditions for the proper regulation
of consumer credit given by the commercial banks of a country. Its purpose is to reduce the
excess spending of the consumers.
C. Credit Rationing: -
✓ Credit Rationing means restrictions placed by the central bank on credit granted by the
commercial banks.
d. Moral Suasion: -
✓ Moral Suasion is the process in which the central bank requests or persuade the commercial
bank to co-operate with the general monetary policy of the central bank. (That is the central
bank morally influence the commercial bank).
e. Direct Action: -
Direct action refers to the penal actions taken by the central bank against those banks
which default /violate the rules and regulations of central bank. Eg; Levy penal interest rate,
cancel their licenses, refuse to grant finance etc.
II. Fiscal policy measures:
These are the measures adopted by the Government to control Inflation. The main
instruments of fiscal policy are.
A. Increase in Taxes
B. Reduction in public expenditure
C. Public borrowing
A. Increase in Taxes: - The main source of revenue is tax. When there is inflation, the government
increases the tax. The increase in direct tax reduces the disposable personal income and hence
they spend less money.
B. Reduction in public expenditure: -
During inflation the government cut down its expenditure on developmental activities and
welfare programmes. When the government spend less money, income of the individuals
decreases. Hence aggregate demand decreases.
C. Public borrowing: -

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 During inflation the government will delay the repayment of public dept. At the same time
the government should borrow more money from the public.
III. Other measures (Direct measures) to control Inflation:
Other measures to control inflation include.
1. Increasing the supply of goods and services: -
When there is price rise government take various measures to increase the supply of goods
and services. This can be done by importing essential products, banning the export of such items
and by encouraging the production of essential commodities.
2. Price control: -
Direct measures to control the price of goods and services. Essential commodities can be
distributed through the public distribution system at reduced prices.
3. Wage control: -Wage control helps to prevent the escalation of cost of production during
inflation and thus cost push inflation can be controlled.
Repo Rate & Reverse Repo Rate:
Repo Rate:
✓ It is the rate at which RBI lends short term funds to commercial banks when they are
facing financial crisis. Here, the central bank purchases the security.
✓ In this case, a repurchasing agreement is signed by both the parties stating that the
securities will be repurchased by the commercial banks on a later date at a predetermined
price.
✓ The repo rate is always higher than the reverse repo rate.
✓ Repo rate is used to control inflation
Reverse Repo Rate: -
o Reverse repo rate is the rate at which the RBI borrows money from commercial banks
within the country.
o It is the rate offered by the RBI to the banks that deposit funds with it.
o The reverse repo rate is always less than the repo rate.
o Reverse repo rate is used to control the money supply.
Repo Rate & Bank Rate: -
❑ Repo rate is the rate at which RBI lends short term funds to commercial banks. Bank rate is
the rate at which RBI lends long term funds to commercial banks.
❑ In the case of bank rate there is no repurchasing agreement signed.
❑ Bank rate is usually higher than Repo rate.
Current Rate
Bank rate - 4.25%
CRR - 4%
SLR - 18%
Repo rate – 4%
Reverse Repo rate -3.35%

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 Business Financing:
Sources of Capital- Internal & External
A business can gain finance from either internal or external sources.
I. Internal sources of finance
Internal sources of finance refer to money that comes from within a business. The
important internal sources are.
[Link] Capital,
[Link] Profit And
[Link] Assets.
1. Owner’s capital refers to money invested by the owner of a business. This often comes
from their personal savings. This source of finance does not cost the business, as there are
no interest charges applied.
[Link] profit is when a business makes a profit, it can leave some or all of this money
in the business and reinvest it in order to expand. This source of finance does not incur
interest charges or require the payment of dividends.
3. Selling assets involves selling products owned by the business. This may be used when
either a business no longer has a use for the product, or they need to raise money quickly.
Business assets that can be sold include for example, machinery, equipment, and excess
stock.
II. External sources of finance:
External sources of finance refer to money that comes from outside a business. There are
several external methods including,
1. Shares,
2. Debentures and bonds,
3. Public Deposits,
4. Bank Loan,
5. Bank Overdraft,
6. Trade Credit.
[Link]:
✓ A business may sell more of their shares to raise money.
✓ A shareholder is an owner of the company.
✓ Buying shares gives the buyer part ownership of the business and therefore certain rights,
such as the right to vote on changes to the business.
✓ Shares can be issued at any time.
Types of shares: There are mainly two types of shares.
a) Ordinary shares/ Equity shares
b) Preference shares
Ordinary shares: - Ordinary shareholders get dividend depends on profit. If profits are larger,
they may get higher dividend.
Preference shares: Preference shareholders get fixed rate of dividend. As its name suggests,
it gets preference over other shares for getting dividend.
[Link] and Bonds:
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Leena CL, Assistant Professor, ASIET
 Companies get long term finance through the issue of Debentures and Bonds. These
are debt(loan) instruments. The buyers of debentures and bonds are the creditors of
companies. They get fixed rate of interest on the money invested in these securities. They
cannot claim for ownership.
A debenture/ a bond carries a promise or agreement by the company with the investor
to make interest payments of specified amount at specified time and to repay the principal
amount at the end of a specified period.
(Bonds are secured by collateral and offered by government agencies, financial institutions etc. But
debentures are unsecured debt instruments that are not backed up by security and are offered by
Private companies. The government does not issue debentures).
3. Public Deposit:
✓ Public Deposits are deposits accepted from public directly by the companies mainly to
finance working capital needs.
✓ A company can invite public deposits for a period of six months to three years. Therefore,
public deposits are primarily a source of short-term finance.
✓ These deposits generally carry a rate of interest higher than the deposits in commercial
banks.
✓ The cost of borrowing to the company is less than from the bank.
✓ Public deposits refer to the unsecured deposits because in the event of a failure of the
company, the depositors have no assurance of getting their money back.
[Link] loan:
A bank loan is money borrowed from a bank by an individual or business. A bank loan is
paid off with interest on guarantee/ pledge assets over an agreed period, often over several
years.
5. Bank Overdraft -
Overdraft is a short-term credit facility provided banks for current account holders to
withdraw more money than their bank account balances. Overdrafts should be used carefully
and only in emergencies as they can become expensive due to the high interest rates charged by
banks.
6. A trade credit:
✓ A trade credit must be agreed with a supplier/trader and forms a credit agreement with
them.
✓ This source of finance allows a business to obtain raw materials and stock but pay for them
later.
Differences between Bond & Shares:
Bond Shares
[Link] investor lends money to the [Link] investor owns part of the company.
company. [Link] are issued by corporate
[Link] issuers of bonds are govt. enterprises.
institutions, financial institutions,
companies etc. [Link] is very high.
[Link] is relatively low. [Link] get dividend, which is
[Link] holders get interest as a fixed not guaranteed.
payment. [Link] is uncertain.

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Leena CL, Assistant Professor, ASIET
 [Link] is certain. [Link] a company is declared bankrupt
[Link] bondholders have a higher claim on stocks will become worthless and investors
assets, investors may still recover some will lose 100% of their capital.
of their initial capital. [Link] amount of capital the investor gets
[Link] capital is paid back in full to the back depends on the share price when the
investor at maturity. stocks are sold.
[Link] period is fixed [Link] maturity period for shares.
A financial market:
• A financial market is a place/market where buyers and sellers come together to trade in
financial assets such as bonds, stocks, etc.
• Financial market can be classified in to two.
I. Money market and
II. capital market.
I. Money Market:
✓ Money market deals with short-term financial assets.
✓ It’s maturity period up to one year.
✓ The important instruments used in the money markets are call money,
commercial papers, collateral loans, certificates of deposit, treasury bills, etc.
✓ Main purpose is to achieve short term credit requirements of the trade.
Functions Money Market:
A. Financing Trade
B. Financing Industry
C. Profitable Investments
D. Financial mobility
E. Maintain Monetary Equilibrium
F. Economic growth.
A. Financing Trade:
Money market finance internal and international trade. Finance is made available to the traders
through bills of exchange, which are discounted by the bill market.
B. Financing Industry:
Money market contributes to the growth of industries. It helps the industries in securing short-
term loans through financial bills, commercial papers, etc.
C. Profitable Investment:
Money market enables the commercial banks other financial institutions to invest their surplus
reserves in short-term assets which are highly liquid.
D. Financial Mobility:
By transferring funds from one sector to another, the money market helps in financial mobility.
It is essential for the development of commerce and industry in an economy.
E. Maintain Monetary Equilibrium:
The money market brings equilibrium between demand and supply of money.

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F. Promote Economic Growth:
Since money market helps in the development of trade, industry and agriculture, it promotes
overall economic growth.
[Link] Market:
✓ Capital market deals with long-term financial assets.
✓ In other words, a capital market is a financial market in which long-term financial assets are
bought and sold.
✓ The maturity period is more than one year or sometimes it is incurable (no maturity).
✓ The important instruments used in the capital markets are stocks, bonds, debentures etc.
✓ It is controlled by government rules and regulations. It works under full control of Securities
and Exchange Board to protect the interests of investors
Classification:
A capital market is classified into two sections:
a) Primary Market and b) Secondary Market.
Primary Market: is a market where new or fresh securities are offered to the public for the
subscription purpose
Secondary Market: is a market where the securities that have already been issued (old securities)
are exchanged among investors. Eg; Stock market.
Functions Capital Market:
A. Allocative Function
B. Encourages saving
C. Encourages Investment
D. Promotes economic growth
E. Indicative function
F. Transfer function
G. Liquidity function.
A. Allocative Function:
Its roles in allocative function are:
*Acts as link between savers and investors.
* Mobilizing the savings and diverting them in productive investment.
B. Encourages Saving:
With the development of capital market, financial institutions provide facilities, which
encourage people to save more.
C. Encourages Investment:
It facilitates lending to the businessmen and to the government. Thus, encourages
investment. It provides facilities through financial and non-financial institutions.
D. Promotes Economic Growth:
The proper allocation of resources results in the expansion of trade and industry, thus promoting
balanced economic growth.
E. Indicative Function:

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 A capital market acts as a barometer showing not only the progress of a company but also of
the economy as a whole through share price movements.
F. Transfer Function:
It facilitates transfer assets among individuals’ units or groups.
G. Liquidity Function:
In a capital market, securities can be purchased and sold without delay. Hence, it ensures
liquidity.

Differences between Money Market & Capital Market

Difference Money Market Capital Market

[Link] Deals with short–term Deals with long - term securities
securities
[Link] Nature Informal in nature. Formal in nature
3. Instruments Commercial banks, non- Stock exchange, Commercial
financial institutions, central banks, non-financial institutions,
bank, etc. etc.

[Link] Liquidity Highly liquid. Comparatively less liquid.

5. Risk Involved Carry low risk. Carry high risk.
6. Maturity One year/less More than one year
[Link] served Increasing liquidity in the Stabilizing economy by
economy mobilization of savings.
[Link] on Low returns Comparatively high in capital
investment market

Stock Market:
✓ A stock market/exchange is a place where securities, shares, bonds, and other financial
instruments are listed and bought and sold by traders or brokers.
Stock Exchange in India
• Indian stock exchange is one of the oldest markets in Asia and is a yardstick to measure the
health and progress of the economy of the country.
• Over the course of the period, the market has transitioned into the electronic market and
securities are dealt in dematerialization form.

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Leena CL, Assistant Professor, ASIET
 • There are two major stock exchanges in India-
✓ National Stock Exchange of India (NSE) and
✓ Bombay Stock Exchange (BSE).
National Stock Exchange was established in Mumbai in 1992 and started trading in 1994. Bombay
Stock Exchange was established in 1875 in Mumbai.
Functions of Stock Exchange/
Stock Market:
1. Providing liquidity and Marketability to Existing Securities: Stock Exchange provides a
ready and continuous market for buying and selling securities. It provides a platform where shares
can be sold and bought by buyers and sellers.
2. Pricing of Securities: Based on the forces of demand & supply, Stock Exchange helps in putting
a value on the securities which provide instant data to both buyers and sellers and thus helps in
the pricing of securities.
3. Safety of Transaction: All participants associated with a stock exchange are well regulated
and are required to work within the legal framework given by the regulator. Such a system ensures
the safety of transactions. In India, all trading is regulated by SEBI. (Securities and Exchange Board
of India
4. Contributes to Economic Growth: People get a chance to buy and sell their shares, letting
them invest money. Stock exchange provides a platform by which savings get channelized into the
most productive investment proposals, which leads to capital formation & economic growth.
5. Spreading of Equity Culture: Stock exchanges have extensive information on the listed
companies, which is further available to the public. This data helps in educating public about
investments in securities which leads to spreading of wider ownership of shares.
6. Providing Scope for Speculation: Securities, when purchased solely with a view of gaining
profit through price movement to a target is called speculation. Stock exchanges provide scope
within the provisions of law for speculating in a restricted and controlled manner.
NSE & BSE
There are two major stock exchanges in India -
✓ National Stock Exchange of India (NSE) &
✓ Bombay Stock Exchange (BSE).
Companies list their shares for the first time on a stock exchange through an IPO (Initial Public
Offering). Investors may then trade in these shares through the secondary market.
NSE (National Stock Exchange)
✓ NSE is the leading stock exchange of India, located in Mumbai.
✓ NSE was established in 1992
✓ It was the first dematerialized electronic exchange in the country.
✓ It is the world’s 10th largest stock exchange according to May 2021 data.
✓ It was recognized as a stock exchange by SEBI in April 1993 and commenced operations in
1994.
✓ Electronic trading platform was first introduced by the NSE in India since 1995.

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Leena CL, Assistant Professor, ASIET
 ✓ In 1996, the NSE was the first exchange in India that planned to trade derivatives specifically
on an equity index.
✓ In February 2000, the NSE started an Internet trading system.
✓ NSE provides a trading platform for various types of securities for investors under one roof-
equity, debentures, Central and State government securities, treasury bills, commercial
papers, certificate of deposits, mutual fund units etc.
• During the year 1995 - 1996, NSE launched Nifty 50 - the benchmark index of NSE. Nifty 50
tracks the 50 largest and most liquid stocks out of more than 1600 stocks listed on
NSE. These 50 largest companies represent different industrial sectors which collectively
represent the Indian economy. You will have a clear idea of the Stock market and the
economic trends if you keep a track of Nifty 50. Investors can choose the best stocks to
invest in. They also aid companies for raising capital.
BSE (Bombay Stock Exchange)
✓ BSE (Bombay Stock Exchange) was founded in 1875. it is the first-ever stock exchange in
Asia. It is the oldest stock exchange, not just in India but in Asia.
✓ It provides trading in financial instruments like equity, currencies, debt instruments,
derivatives, mutual funds.
✓ The Institution was founded by Premchand Roychand, and it was then called The Native
Share & Stockbrokers Association, which later became BSE.
✓ Only in 1957, BSE got its recognition as a premier stock exchange from the Central
Government of India.
✓ SENSEX or Sensitive Index is the benchmark index of BSE, and it is the first equity index in the
country.
It is derived from the words sensitive and index. and it is the first equity index in the
country. Sensex comprises of 30 stocks.
✓ It tracks the top 30 largest and leading companies that are listed under BSE. These
companies belong to more than 10 sectors, and they represent the trends in the Indian
Economy and the stock market.
✓ It tracks the top 30 largest and leading companies that are listed under BSE. These
companies belong to more than 10 sectors, and they represent the trends in the Indian
Economy and the stock market.
✓ Sensex is internationally traded on Eurex and various leading exchanges of Brazil, Russia,
China, and South Africa.
Stock Exchange Indices:
Major Stock Exchange Indices are.

Nifty:
o NIFTY is a market index introduced by the National Stock Exchange.
o NIFTY contains a host of indices-NIFTY 50, NIFTY IT, NIFTY Bank, and NIFTY Next 50.
o During the year 1995 - 1996, NSE launched Nifty 50 - the benchmark index of
NSE. Nifty 50 tracks the 50 largest and most liquid stocks out of more than 1600 stocks listed
on NSE. These 50 largest companies represent different industrial sectors which collectively
represent the Indian economy. You will have a clear idea of the Stock market and the

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Leena CL, Assistant Professor, ASIET
 economic trends if you keep a track of Nifty 50. Investors can choose the best stocks to
invest in. They also aid companies for raising capital.
o Nifty is owned by India Index Services and Products Ltd. (IISL). It is calculated using
the free float market capitalization weighted method where the level of index reflects the
total market value of the stock’s relative to a particular base period. The base period
selected for calculating Nifty50 index is the close price on Nov 3, 1995. The base value has
been set at 1000. The electronic trading system helped remove the paper-based settlement
system from trading.

SENSEX:
✓ SENSEX or Sensitive Index is the benchmark index of BSE, and it is the first equity index in the
country.
✓ It is derived from the words sensitive and index. and it is the first equity index in the
country. Sensex comprises of 30 stocks.
✓ It tracks the top 30 largest and leading companies that are listed under BSE. These
companies belong to more than 10 sectors, and they represent the trends in the Indian
Economy and the stock market.
✓ It tracks the top 30 largest and leading companies that are listed under BSE. These
companies belong to more than 10 sectors, and they represent the trends in the Indian
Economy and the stock market.
✓ Sensex is internationally traded on Eurex and various leading exchanges of Brazil, Russia,
China, and South Africa.

BSE SENSEX is a free-float market-weighted stock market index of 30 well-established and

financially sound companies listed on Bombay Stock Exchange. These 30 companies are known as
blue chip companies. Published since Ist January 1986, the S&P BSE SENSEX is regarded as the pulse
of the domestic stock markets in India. The base value of the SENSEX was taken as 100 on 1 April
1979 and its base year as 1978-79. Historically Sensex used the weighted market capitalization
methodology, but from September 1, 2003, it shifted to free float Market Capitalization
methodology.
If a person wants to trade in the stock market, he must obtain a Demat and Trading account.
Demat Account:
✓ Demat account is used to hold the shares purchased in d1g1tal or electronic form.
✓ During online trading, shares are bought and held in Demat Account, thus facilitating easy
trade for the users.
✓ A Demat account holds all the investments an individual makes in shares, government
securities, exchange-traded funds, bonds, and mutual funds in one place.
✓ At any point or time, Demat account will show the shares and securities that a person is
currently holding. In other words, it is a storage space to hold the shares and securities purchased.
It is only a repository.
✓ It is like a bank account in which we hold deposits with the bank and the record of debit/credit
balances are maintained in a bank passbook. In the same way, when we purchase or sell shares,
it will be credited or debited to/from our Demat Account respectively.

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Leena CL, Assistant Professor, ASIET
 ✓ Dematerialization is the process of converting the physical share certificates into electronic
form, which is a lot easier to maintain and is accessible from anywhere throughout the world.
✓ An investor who wants to trade online needs to open a Demat with a Depository Participant
(DP - broker).
✓ The purpose of dematerialization is to eliminate the need for the investor to hold physical
share certificates and facilitating a smooth tracking and monitoring of holdings.
Merits:
• Demat account is an easy and convenient way to hold securities.
• It is safer than paper-shares and reduces paperwork for transfer of securities.
• It also reduces transaction cost, and a single account can hold investments in both equity
and debt instruments.
• Another advantage is that a person can trade from anywhere.
Trading Account:
✓ Trading account is used to buy and sell shares and securities in the stock market.
✓ It provides an interface to buy and sell shares from the stock market.
✓ Most commonly, trading account refers to a day trader's primary account. These investors
tend to buy and sell assets frequently, often within the same trading session.
✓ In the online method, the buyers and sellers don't have to be physically present at the stock
exchange to place orders. Instead, they open a trading account with a registered stock
market broker, who conducts trading on their behalf.
✓ Each trading account has a unique trading ID which is utilized to perform online
transactions. Nowadays, brokers provide facilities to the investors to perform transactions
by themselves.
✓ A trading account acts like a link between demat account and bank account of an investor.
When an investor wants to buy shares, he places an order through his trading account. The
said transaction goes for processing in the stock exchange. Upon execution, the required
number of shares get credited into his demat account and a proportionate sum gets
deducted from his bank account.
✓ A similar kind of process is followed to sell equity shares.
✓ The investor places a sale order with the help of his trading account. It goes for processing
in the relevant stock exchange. When the order is executed, the required number of shares
are debited from his demat account, and a proportionate sum gets credited to his bank
account. At any point of time, a trading account will show the transactions we carried out
in the stock market.
Thus, if we want to trade in the stock market, we need both the accounts. To open these
accounts, documents like proof of identity, address proof, Pan card etc. are needed.

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Leena CL, Assistant Professor, ASIET