MBA (Full Time)
Semester-II
Economic Environment of Business
Paper No: MBA CP-203
UNIT-2
Submitted by: Mohd Ebad Askari
Roll number: 19MBA043
Question 1 a)
What do you mean by Circular flow of Income? Explain.
Answer 1 a) The circular flow of income is a way of representing the flows of money
between the two main groups in society - producers (firms) and consumers
(households). These flows are part of the fundamental process of satisfying human
wants.
As we have already seen, a free market economy consists of two components,
or sectors, as they are called. These are firms and households. People in
households work for firms (selling their factor services) and receive wages in
exchange. On the scale of the whole economy, this is known as national income -
the total amount of income earned over a given time period. This money is spent
on food, clothing, transport, entertainment etc, and so it returns to the firms. This
is the circular flow.
Question 1 b)
What precautions should be taken while estimating National Income by value added
Method?
Answer 1 b)
Various precautions that should be taken while estimating National Income by value added are:
1. Value of the sale and purchase of second-hand goods are not included in the national income
of the current accounting year. This is because the value of these goods was included in the
national income in the accounting year in which they were produced. Thus, if the value of these
goods is also inciuded in the current year, then it will lead to the problem of double counting of
the value of such goods.
2. Although the value of the second hand goods are not included in the national income, but the
brokerage/commission paid to facilitate the sale or purchase of these goods is included in the
estimation of the value added.
3. Only the value of final goods and services are included in the estimation of value added and
value of intermediate goods is not included in the national income. This is because the value of
intermediate goods is already reflected in the value of the final goods.
4. At times, the producer/firm keeps a certain portion of the output for self-consumption. Such a
portion of production that is retained for self-consumption should also be included in the
estimation of the value added.
5. Similarly, the imputed rental value of the owner-occupied houses/land should also be taken
into account. This is because all houses/ land, whether owner-occupied or rented-out have a
rental value.
6. Some of the services that are meant for self-consumption such as the services of the
housewives, a father teaching his own child are not included in the national income. This is
because it is difficult to estimate the market value of such services.
Question 2)
Are we currently in an economic recession, depression or recovery? Provide support for
your opinion and explain the different phases of the Business Cycle.
Answer 2) Thebusiness cycle is the natural rise and fall of economic
growth that occurs over time. The cycle is a useful tool for analyzing
the economy. It can also help you make better financial decisions. 1
Key Takeaways
The business cycle goes through four major phases: expansion, peak, contraction, and trough.
All businesses and economies go through this cycle, though the length varies.
The Federal Reserve helps manage the cycle with monetary policy, while heads of state and
governing bodies use fiscal policy.
Consumer confidence plays a role in managing the economy and the current phase in the cycle.
Stages
Each business cycle has four phases. They are expansion,
peak, contraction, and trough. They don’t occur at regular intervals.
But they do have recognizable indicators.
An expansion is between the trough and the peak. That's when the
economy is growing. The gross domestic product, which measures
economic output, is increasing. The GDP growth rate is in the healthy
2% to 3% range. Unemployment reaches its natural rate of 3.5% to
2
4.5%. Inflation is near its 2% target. The stock market is in a bull
3 4
market. A well-managed economy can remain in the expansion phase
for years. That's called a Goldilocks economy. 5
The expansion phase nears its end when the economy overheats.
That's when the GDP growth rate is greater than 3%. Inflation is
greater than 2% and may reach the double digits. Investors are in a
state of "irrational exuberance." That's when they create asset
bubbles. 6
The peak is the second phase. It is the month when the expansion
transitions into the contraction phase.
The third phase is a contraction. It starts at the peak and ends at the
trough. Economic growth weakens. GDP growth falls below 2%. When
it turns negative, that is what economists call a recession. Mass
layoffs make headline news. The unemployment rate begins to rise. It
doesn’t happen until toward the end of the contraction phase because
it's a lagging indicator. Businesses wait to hire new workers until they
are sure the recession is over. Stocks enter a bear market as
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investors sell. 8
The trough is the fourth phase. That's the month when the economy
transitions from the contraction phase to the expansion phase. It's
when the economy hits bottom.
Question 3.
Write short notes on any one
a) Deflationary gap
Deflationary gap is the difference between maximum employment potential production and the
current amount of the economy's performance. All the tools of the economy are not being used to
the optimal degree for deflationary gaps and some are idle. That comes with joblessness and poor
production rates. A deflationary gap shows the amount by which aggregate demand must be
increased so that equilibrium level of income is increased to the full employment level.