ENGINEERING ECONOMICS

B.TECH. DEGREE COURSE

SCHEME AND SYLLABUS (2002-03 ADMISSION ONWARDS) MAHATMA GANDHI UNIVERSITY KOTTAYAM KERALA PRINCIPLES OF MANAGEMENT AND ENGINEERING ECONOMICS

M605 Part B Engineering Economics

3+1+0

Module 4 Basic concepts: Theory of demand and supply-price mechanism-factors of production-land, labour, capital and organization-national income-difficulties in estimation-taxation-direct and indirect-progressive and regressive-black money-inflation-demand pull and cost push-effects of price increases. Module 5 Indian financial system: Reserve bank of India-commercial bank systempublic sector banks-development financial institutions-IDBI, ICICI, SIDBI, IRBI-investment institutions-UTI-insurance companies-stock marketfunctions-problems faced by the stock markets-role of the public sectorprivatisation-multinational corporations and their impact on the Indian economy. References 1. K.K.Dewett 2. A.N.Agarwal 3. O.P.Khanna Modern Economic Theory Indian Economy Industrial Engineering & Management

MODULE 4
Introduction
Wants, efforts, satisfaction, this is the circle of economics. Human wants are too many: but nature is niggardly. All goods except the gifts of nature are produced. And in order to produce, the world is at work. The farm labourer, the factory worker, the miner, the teacher, the doctor, the clerk, they all are at work. The wheels of economic activity are whirling round. Economics deals with this world at work. Let us begin by asking why all this takes place. Mans basic wants are three food, clothing and shelter. He requires them to satisfy his wants. If he had no such wants or his wants could he satisfied without any effort on his part, he would not go to work. He works to earn money. But money is not far its own sake. He wants it far what it will buy i.e. to buy consumer goods. So a man works so that he may consume for the satisfaction of his wants. The farmer, the manufacture, the merchant, they all work in order to satisfy their wants. Hence it is the wants that consumer goods satisfy that give the main stimulus to economic activity or we may say that the rational of economic activity is to satisfy human wants by proceeding the consumer goods. Economic activity is ceaseless and economic conditions are constantly changing. But generally economic change or evolution in gradual. Consequently economic science is one of slow and continuous growth; though it is an old discipline it is the oldest of the art, the newest of the sciences, indeed the queen of the social sciences the origin of economics could be traces to the teachings of Greek philosophers. Plato and Aristotle who consider economics as a study of household management. The word economics has been derived from the Greek word polis (city state), oikos (house) and nomos (rule). Thus political economy or economics is concerned with the wealth getting and wealth using activities of man. Adam Smiths book an enquiry in to the Nature and Causes of Wealth of Nations published in the year 1776 laid the foundation of economics. So Adam Smith is rightly called the father of the Economics.

The Economic problem

Economic analysis is essentially the study of the economic problem. It is the problem of getting maximum satisfaction out of the limited means that we process. Or it is a question of economizing our resources so that we may maximize our satisfaction. The problem has two aspects the economic problem of the individual and the economic problem of the society.

The Economic problem of the Individual

The individual has many wants to satisfy. He is a bundle of wants. But all wants are not of the same importance. Some are more urgent than others. The individual satisfies his wants with the goods and services purchased with his money income. But the money income of any individual it limited or scarce. Therefore the goods and services, which he can purchase with his income, also are limited under these circumstances the individuals economic behavious assumes the form of choice. At any given time he chooses the most urgent want and satisfies them and sacrifies others. He divide his limited income among them in such a way that he maximizes his satisfaction out of it.

The Economic problem of the Society

Societys economics problem is essentially as that of the individual. But it is far more complicated and comprehensive. The problems facing society are 1. What to produce and how much of each. Society is an association of individuals and it has unlimited wants to satisfy. Therefore a society has to produce thousands of goods and services to satisfy these wants. Their goods and services are to be produced with the limited resources of the community. So the society has to choose the goods and services, which deserve priory and divide its limited resources among them. This is known as resource allocation. 2. How to produce the second problem facing the community in technological choice. There are different methods for the production of the same commodity. Which of the techniques should be adopted. The answer is that the most efficient method should be taken up. But this may not be always 4

possible because of the non-availability or over supply of reaomes. The technological choice means the choice of the best method in relation to the availability of resources. 3. For Whom To Produce:- It is the problem of sharing the total goods produced among the owners of resources. In a capitalist society the quantity of a factor and supplying by an individual and its market prices determine his share. In a socialist economy decisions are taken by the state. Thus economic problem of a society is essentially one of production and distribution of goods and services for want satisfaction.

Basic concepts
Wants: A want is a feeling of lack of satisfaction. The satisfaction of wants with goods and services are called consumption. In the order of urgency wants are classified into: 1. Necessaries: Necessaries sustain our life and are essential for efficiency. Eg. Food, clothing and housing. They are again divided into a. Necessaries for life: E.g. Food and clothing b. Necessaries for efficiency: Eg. Multiliousfood, good houses c. Conventional necessaries: Eg. Coffee, cigarettes 2. Comforts: Comforts are not necessary for life. But their consumption increases our efficiency and well-being. Eg. Electric fans, cushioned chairs etc. 3. Luxuries: Luxuries are not necessary for life or efficiency, they are superfluous wants. The above classification of wants is not rigid.

Characteristics of wants:
Human wants have several characteristics. 1. Wants are unlimited. Human wants and desires are countless in number and various in kind. The wants of the savage are few. But as men in the social scale and his powers over nature increase his wants increase continuously in

number. The progress of civilization has been characterised by the multiplication of wants. 2. Each separate want is strictly limited. Each want is satiable i.e. it is limited in its capacity for satisfaction. The amount of any commodity, which a man can consume within any period of time is limited. No matter how desirable a thing may be, within any period of time there is a certain quantity of it which is enough more than that would be useless or even distasteful. 3. Wants are alternative and competitive. Satisfaction of any wants can be secured by different things. These are several ways of satisfying a particular want ie. Different alternatives are opened to us. The hunger can be satisfied either by rise or tapioca. Again wants, which are of diverse characters, may compete with each other for satisfaction. One commodity competes against another for our choice. In a sense all our wants are competitive. 4. Wants are repetitive. A want, when it is satisfied disappears for the time being. But it will make its appearance again. A hungry man takes food and satisfied. But after sometimes how will again feel hungry. Thus many human wants are repetitive or recurring. 5. Wants are complementary. It is a common experience that we want many things in groups. The consumption of another good. E.g. Pen and paper, car and petrol. Again in a broad sense the want for a car is lead to others want of refined nature e.g. good house, good food etc.

Goods
Any things that satisfy a human want are called goods in economics. E.g. Air, books, clothing. Goods may be: 1. Material or Immaterial:- Material goods are called commodities and immaterial goods are called services. While commodities are tangible. Serviced are intangible. E.g. pen, clothing (material) Doctors services, legal advices (services) 2. Free goods and Economic goods:- Free goods are the free gifts of nature. They are abundant or unlimited in supply. We need not spend money or

effort on the e.g. air, water, sunlight. Economic goods are scarce or limited in supply. We have to spend money or effort on procuring them. E.g. breads, books, land. 3. Consumers goods and Producers goods:- Consumers goods or consumer goods directly satisfy our wants. So they are called direct goods or goods of the first order. E.g. pen, bread. Producers goods are also called capital goods or investment goods are useful only indirect. They are called indirect goods or goods of the second order. 4. Durable good and Perishable goods:- Durable goods can be used for a long time. Perishable goods cant be stored for a long time. E.g. Milk, fruits.

Wealth
Wealth refers to all scarce goods which are exchangeable. In the broad sense wealth can be anything, which satisfies human wants. Wealth has three attributes, utility, scarcity, and exchangeability. Only those things which posses utility or wants satisfying capacity are called wealth. Secondly wealth doesnt include everything that posses utility. It includes only those goods which are scarce or limited in supply. Thirdly wealth includes only those goods, which are marketable. Health intelligence, goodness etc are not exchangeable and hence are not wealth in the economic sense.

Values
The term value is in two different senses in economics. They are: 1. Value in use or the utility of a good. 2. Value in exchange or exchange value. Exchange value means the capacity of a thing to get other things in exchange value for itself. If one apple can get two mangoes in exchange we can say that the value of one apple in two mangoes.

Price
In modern world there are thousands of goods and services. We cannot express the value to everything in terms of every other thing. So we make use of money as a common measure of value. The value of anything and everything can be

expressed in terms of money. And value expressed in terms to money is called price.

Utility
The want satisfying capacity of a good is called utility. It is the significance attached by a person to a good. Thus it is essentially a subjective notion. Opium liquor is not desirable; but they convey utility to those who want to them. Being a subjective notion utility is not measurable. How ever economics believe that it can be measured indirectly in terms of money. Thus utility is measurable in subjective units called utils. Utility is also called value in use. Nothing can have exchange value if it does not posses utility. By changing the shape, place and time a good gets its utility. Total utility:- It refers to the sum total of satisfaction obtained from all the units of a commodity. If a person purchases 10 apples then total utility is the total satisfaction obtained from all the 10 apples. Marginal Utility:- It is the utility obtained from the marginal unit (final of last) of the commodity, it is the addition made to previous total utility by the purchase or consumption of another unit or it is the decrease in total utility caused by the removal of last unit. As we consume a commodity the total utility goes on increasing until a certain stage. But the marginal utility goes on decreasing. Finally it becomes zero & turns negative. Total utility increases as long as marginal utility is positive. It reaches its maximum when marginal utility is equal to zero. There after total utility also decreases. As we go on consuming a good unit after unit, the utility of every additional unit steadily diminishes. This phenomenon is known as the Law of Diminishing Marginal Utility.

THEORY OF DEMAND Demand in the economic sense depends on three conditions viz the desire for something, the means to purchase it and the willingness to use those means. Thus demand in economics is something more than desire through desire is an element in it. Desire merely indicates a wish for something. A beggar, for instances may desire food but for lack of means to purchase his desire is not effective. Hence the saying If wishes were horses even beggars might ride. So demand means effective desire i.e. desire backed by ability and willingness to pay or desire backed by the necessary purchasing power. The term demand has no significance unless a price is stated or implied because the amount brought of anything will vary considerably with its price. In other words the demand for a thing at one price is different from the demand for it at another price. Hence the demand for a commodity expresses the different amounts that will be purchased at different prices. Again the demand for a commodity even at a given price is the amount of it which will be bought per unit of time at that price. A demand schedule is a table which relates different prices of a commodity and the different qualities that would be purchased at those prices per unit of time. We may distinguish between individual demand schedules and market demand schedules.

INDIVIDUAL DEMAND
The individual demand schedule shows the different qualities of a good that will be purchased at different prices by an individual. An individual demand schedule is given below. Price of plantains/kg Rs 12 Rs 10 Rs 8 Rs 5 Quantity demanded Per week 1 2 4 6

The above demand schedule can be graphically represented in the figure price is marked on the vertical axes OY and the quantity demanded on the horizontal 9

axes OX. The points a, b, c and d show price quantity relationships. By joining these demand points we get the demand curve DD. It slopes downward from left to right showing that more will be demanded as price falls.

Market Demand
A market demand schedule is obtained by adding up the quantities demanded by all potential buyers in the market at various prices. Let us suppose that there are only two buyers of plantain in the market. Then the market demand schedule will be:Price of Plantain/kg in Rs 12 10 8 5 Quantity demanded per week By 1 buyer 1 2 4 6
st

By 2 buyer 2 3 5 7

st

Market demand per week (kg) 3 5 9 13

What is true of two buyers is true of any number of buyers. When there are large numbers of buyers instead of adding up the quantities, the quantities demanded by a single buyer at different prices may be multiplied by the number of buyers to get the market demand. The market demand schedule also can be represented on a graph. Thus we get the market demand curve. Just like the individual demand curve, it slopes downward from left to right showing that more will be demanded at low

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prices and less at high prices.

The Law of Demand

The law of demand states an important general principle underlying the consumers behaviour. It states that other things remaining the same, people buy larger quantities at lower prices and smaller quantities at higher prices. The term other things refers to the conditions of demand other than price. The demand curve illustrates the law of demand. In the figure DD1 is the demand curve. When price is OP the quantity demanded is OQ, where price falls to OP1 the quantity demanded increases from OQ to OQ1. the downward movement of the demand curve shows the fall in price and the right hand movement indicates the consequent increase in the quantity demanded. Thus the demand curve shows the inverse relationship between price and quantities.

Assumptions The law of demand operates only under certain assumption. 1. It is assumed that the buyer acts rationally. A rational consumer prefers to buy cheap rather than dear since his aim in to maximize his satisfaction. 11

However, a consumer may buy a large quantity at a high price out of shear ignorance or habit. 2. It is assumed that there is no change in the tastes and preferences of consumers. If tastes change people may buy a large quantity at a high price and a small quantity at a low price. 3. It is assumed that the consumers income remains unchanged. If his income increases he can buy a large quantity at a higher price. 4. It is assumed that the price of other related goods remain same. A fall in the price of coffee will lead to an appreciable increase in the quantity demanded only if there is no fall in the price of tea (substitutes). A fall in the price of car will increase the number of car demanded only if there is no considerable rise in the price of petrol (complimentary goods). 5. Further it is assumed that consumers do not expect that a change in price is a prelude to further changes. If they think that a rise in price is the beginning of a further rise, they buy more instead of less. Conversely if they expect that a fall in price in the beginning of further reductions they will purchase less. Why does the demand curve slopes downward from left to right? It implies that the consumer increases the quantity purchased as the price falls. This may he due to 1. Income effect when the price of a commodity falls, it is equivalent to a rise in the real income of the consumer. When income increases the consumer is induced to buy more of a commodity and vice versa. 2. Substitution effect. As the price of a good falls; it becomes cheaper in relation to other goods. 3. Maximisation of satisfaction. In order to maximize his satisfaction the consumer pushes his purchase up to point where the marginal utility is equal to the price of the commodity. So when the price falls the consumer must increase his purchase of the goods until its falling marginal utility becomes equal to the low price.

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Limitation of the law of demand There are certain exceptions to the law of demand. They are: 1. Necessaries. Whatever the prices of necessaries like rice and salt we purchase more or less the same commodity. 2. Articles of social distinction like diamond are purchased for their high price. 3. Inferior goods. These are goods whose consumption is reduced when consumers income increases or when the price of the good falls. Condition of demand There are many factors other than price which influence demand. 1. 2. 3. 4. 5. 6. 7. 8. 9. Income Tastes and preferences New commodities Population, size and composition State of trade - depression and boom Expectation of the consumers Price of the related goods Taxes and bounties Factors like change of seasons and epidemics will affect demand

Changes in demand increase of demand and decrease of demand When price falls the quantity demanded increases. This is called extension of demand. Conversely when price raises the quantity demanded decreases. This is known as condition of demand. These are movements along the same demand curve. But changes in demand means shifts in the demand curve due to conditions of demand i.e., factors other than variation in prices. So increase in demand implies that more will be purchased at a given price or the same quantity will be purchased at a higher price. It means an upward shift of the demand curve to the right. In the figure the original demand curve is D.

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At the price O-P1 the quantity demand was O-Q. The demand increases and the demand curve shifts upward to the right. The new demand curve is D1. Now at O-P1 price the quantity demanded is O-Q1 and the former O-Q will be purchased at a higher price OP. A decrease in demand means that less will be purchased at a given price or the same quantity will be purchased at a lower price. It means a downward shift of the demand curve to the left. In the diagram the original demand curve is DD.

The quantity purchased at Op price is OQ. The demand decreases and the

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demand curve shifts downward to the left. D1D1 is the new demand curve. Now at price OP only OQ1 will be demanded and the former quantity OQ will be demanded only at OP1 price. Movements along the same demand curve imply changes in price and the consequent changes in the quantities demanded. But shifts in the demand curve imply changes in the conditions of demand other than price.

Elasticity of Demand
Elasticity of demand refers to the rate at which the quantity demanded changes in response to price changes. It can be defined as the rate of change of the quantity demanded with respect to the rate of change of price. Thus Ed =
Proportionate change in quantity purchased Pr oportionate change in price Q Q dq P = dp P

Price elasticity of demand is commonly known as elasticity of demand. This is because price is the most influential factor affecting demand. Other important elasticitys of demand are 1. Income elasticity of demand. It shows the rate at which a consumers demand for the good changes as a result of a change in his income. 2. Cross elasticity of demand. It refers to the rate of change of quantity demanded of a commodity as a result of a change in the price of a related commodity (substitute or complimentary goods). Types of Price Elasticity of demand OR Degrees of price elasticity of demand 1. Perfectly inelastic demand: It refers to a situation where the quantity demanded in perfectly independent of price changes i.e., commodities are not responsive to a price change e.g: salt, insulin. The demand curve is vertical straight-line parallel to the y-axis. 2. Perfectly elastic demand: It refers to a situation where a minute change in price invokes an enormous change in quantity. A slight increase in price

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brings down the quantity demand to zero. The demand curve will be a horizontal straight line parallel to the x-axis. 3. Unitary elastic demand: It refers to a situation where the change in quantity exactly proportional to the change in price. The demand curve is a rectangular hyperbola. 4. Relatively elastic demand: Elasticity greater than 1. Here a slight fall or rise in price leads to a proportionally large increase or decrease in quantity demand. 5. Relatively inelastic demand: Elasticity less than 1. It refers to a situation where the percentage change in quantity is less than the percentage change in price.

SIGNIFICANCE OF ELASTICITY
The concept of elasticity of demand is highly useful to the producers and the government. E.g: if the demand for a commodity is elastic i.e. greater than 1, a small reduction in price will cause a large increase in sales. This will increase the profits and producers will be ready to effect a price. In taxation, the government must consider the elasticity of demand for the commodities on which the taxes are imposed. When a tax on a commodity for which there is inelastic demand, is raised, the rise in price will not considerably affect the quantity sold. So the tax revenue will increase. If on the other hand, the tax on a good, for which there is elastic demand, is raised, the total sales will considerably decline. The total tax revenue will fall. Thus the concept of elasticity of demand is of great significance to the finance minister.

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Theory of Supply
Theory of supply deals with the relationship between market prices and the quantities offered. The supply of a commodity means the quantity of it that will be offered for sale at a given price per unit of time. A good to be supplied must have utility and must be relatively scarce. An individual offers for sale different quantities of a good at different prices per unit of time. A supply schedule in a table which relates the different prices of a commodity and the corresponding quantities that will be supplied at those prices. An imaginary supply schedule of an individual sending plantain is given.

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Prices of plantain Per Kg Rs. 6 Rs. 8 Rs. 12 Rs. 15

Quantity of plantain supplied per week 10 15 20 30

The supply schedule shows that as prices rise the quantity supplied increases. The market supply schedule is obtained by adding up the quantities supplied by the sellers of a commodity in a market at different prices.

The Supply curve

As the supply schedule is plotted on a graph we get supply curve. In the diagram the quantities of plantain supplied are marked on the X-axis and the prices on the Y-axis. By joining the different points of price quantity combinations we get the supply curve SS. The supply curve slopes upward from left to right. Upward movement shows rise in price while the rightward indicates increase in the quantity supplied. Why does a seller a greater quantity at a higher price and a smaller quantity at a lower price. This behaviour can be explained of profit maximization. The producer or seller aims at maximizing his profits. Given the cause, the higher the price the greater the profits of the sellers. Hence a rise in the price of a commodity induces the producers to produce and supply more of it with the resources at this disposal or by diverting productive resources from other uses to the production of this particular commodity.

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The law of Supply

The law of supply states the general principle underlying the behaviour of producers and sellers of goods seeking to maximize other profit. It states that other things remaining the same the quantities of a good offered for sale will vary directly with its price. In other words, as prices the quantities supplied increases and as price falls the quantity supplied decreases. The supply curve illustrates the law of supply. It moves upward from left to right showing that more will be supplied at higher prices than at lower prices.

Assumptions
1. It is assumed that there is no technique of production. If there is an improvement in the methods of production, cost of production will fall and the quantities supplied will increase without a rise in price. 2. It is assumed that factor prices remain the same. If factor prices fall, cost will fall and the quantity supplied will increases and vice versa. 3. It is assumed that there is no change in the number of sellers in the market. If sellers increase the quantity supplied will increase without a rise in price. Conversely if the number of sellers decrease without a fall in price.

Conditions of supply
Conditions of supply include all the factors other than prices which influence supply. They are:1. Technology 2. Factor prices 19

3. Number of sellers 4. Related prices:- The changes in the price of related goods affect the supply of a given good. If the price of coffee the demand for tea will decrease and it will induce a supply of tea (substitutes). Arise in the price of cars will induce the demand for petrol and it will cause a decrease in supply of petrol (complementary). 5. Expectations: The expectations of producers and sellers regarding future will affect the supply of a commodity. E.g. an expectation of rise in price induces farmers to hoard food grains which will bring about decrease in supply at present. 6. Government policy: Taxes generally induce a decrease in the supply of goods while subsidies will lead to an increase in supply. 7. Changes in weather, wars, and epidemics affect the supply of goods. The failure of monsoon will considerably reduce the supply of agricultural output.

Changes in supply
Generally a rise in price cause an increase in the quantity supplied. This is called extension of supply. A fall in price leads to a decrease in the quantity supplied. This is called the contraction of supply. These are movements along the same supply curve. But changes in supply means shifts in the supply curve due to conditions of supply other than variations in prices. So increase of supply means that more will be supplied at a given price or the same quantity will be supplied at a lower price. It means a shift in the supply curve downward to the right. In the diagram SS in the original supply curve, the quantity supplied at OP price is OQ. S'S' is the new supply curve. Now a greater quantity OQ' will be supplied at the given price OP or the old quantity OQ will be supplied at a lower price OP'.

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A decrease in supply means that less will be supplied at a given price of the same quantity will be supplied at a higher price. It implies a shift in the supply curve upwards to the left.

In the figure Ss in the original supply curve and the quantity supplied at OP price is OQ. Now supply decreases and the supply curve shirts upward to the left. The new supply curve is S1S1. Now a smaller quantity OQ' will be supplied at the given price OP and the old quantity OQ will be supplied only a higher price OP'. Increase and decrease of supply are called changes in supply. Changes in supply take place as a result of changes in the conditions of supply.

ELASTICITY OF SUPPLY
Supply is responsive to price changes. The extend to which supply extends for a given price rise is known as elasticity of supply. It is the ratio of proportionate change in quantity supplied to the proportionate change in price. Thus Es = Proportionate change in supply Proportionate change in price Change in quantity supplied change in price Original quantity supplied original price Q P dv = Q P dp

TYPES OF ELASTICITY OF SUPPLY

1. Perfectly elastic supply: Supply of a commodity is said to be perfectly elastic when a very small change in price leads to an infinite change in the quantity

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supplied here the supply curve is a horizontal straight line parallel to x-axis and Es = 2. Perfectly inelastic supply: Here the quantity of the commodity supplied remains same irrespective of any rise or fall in price here the supply curve is a straight line parallel to y-axis. Es = 0 3. Unitary elastic supply: Here a change in price will cause a proportionate change in quantity supplied the supply curve is a positively sloped straight line passes through the point of origin And Es = 1. 4. Relatively elastic supply: Here the proportionate change in quantity is greater than the proportionate change in price. Here the supply curve is a straight line that intersects the vertical axis. And Es = > 1. 5. Relatively inelastic supply: When the proportionate change in quantity is less than the proportionate change in price, the supply is relatively inelastic. Any straight line that cuts the horizontal axis has an elasticity less than 1. Thus Es = <1.

FACTORS DETERMINING ELASTICITY OF SUPPLY

1. Nature of commodities: The supply of perishable goods like fish or vegetables is less elastic. But in the case of durable goods the supply is more elastic. 2. Time period: The supply will be more elastic in the long run than in the short run. 3. Mobility of factors of production will lead to more elastic supply of goods and vice versa. 4. The adoption of advanced technology of replacement of capital intensive techniques, in the place of traditional or labour intensive techniques makes the supply more elastic. 5. The supplies of agricultural goods are inelastic by nature. The influence of nature is more pronounced in agricultural, production.

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USES OF ELASTICITY OF SUPPLY

1. The elasticity of supply of a good is a major factor in determining as to how much of its price will alter when there is a change in the conditions of demand. 2. The elasticity of supply is significant in determining the extent of taxation.

EQUILIBRIUM PRICE AND QUANTITY

Demand for a commodity expands with a fall in price and contracts with a rise in price. But supply of a commodity contracts with a fall in price and expands with a rise in price. i.e at higher prices the quantity demanded falls while the quantity supplied rises and vice-versa. Thus the two forces demand and supply move in opposite directions the demand and supply forces intersect in the market and determine the market price. The price will be determined at the point where the quantity demanded equals the quantity supplied. The price so determined is called the equilibrium price. At the equilibrium price the two forces of supply and demand are exactly equal. If the price were greater than the equilibrium price the quantity supplied would exceed the quantity demanded. Then competition among sellers to sell more will bring down the price .The fall in price will induce the buyers to buy more thus price will be brought down to the equilibrium level. On the other hand if the price were lower than the equilibrium price, quantity demanded would exceed the quantity-supplied. Now, competition among buyers to purchase more will push up the price. This increase in price will induce the sellers to supply more. Thus price 23

will be brought down to the equilibrium level. PRICE 4 8 12 16 20 DEMAND FOR ARRANGES 1000 700 500 300 250 SUPPLY OF ORANGES 100 300 500 750 950

It is clear from the above table that R012 in the equilibrium price at this price the quantities demanded and supplied are equal. The diagrammatic representation of the equilibrium is given below. Numbers of oranges supplied and demanded are measured along the X-axis and Yaxis. DD in the demand curve and SS in the supply curve. These curves intersect at point P this point of intersection of supply and demand curves determine the equilibrium price. Any price higher than will create an excess supply in the market and any price lower than this will create an excess demand in the market. Both these cases are found waiting. It is clear that the price of a commodity is determined in the market neither by supply alone nor by demand alone but by the interaction of both supply and demand. Just as two blades of a pair of scissors are required for cutting, so also both supply and demand are necessary to determine the price.

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The equilibrium price will change if either the demand of the supply or both change due to a change in demand or supply conditions. Given the supply curve, an increase in demand i.e. a shift of the demand curve to the right, will raise the price and a decrease in the demand i.e a shift of the demand curve to the left will lower the price. On the contrary an increase in the supply i.e a shift of supply curve to the right, demand curve remaining the same, will lower the price and a decrease in supply i.e. a shift in the supply curve to the left will raise the price.

The effects of changes in both demand and supply on price and quantity is shown in the following diagram DD in the demand curve and SS the supply curve the equilibrium price in op. The demand curve shifted to D1d1 and the supply curve to S1S1. The new price is OP1 and the quantity is OQ1. From this diagram the following points can be noted.

If the increase in supply is greater than the increase in demand the price will be lower and the quantity higher. 25

If the increase in demand is greater than the increase in supply both price and quantity will increase.

When both demand and supply increase proportionately price will not change but quantity will increase.

If both demand and supply fall proportionately price will not fall but the quantity will fall.

The Price Mechanism

A capitalistic or free enterprise economy is characterised by economic freedom. Every individual is free to take up any job he likes and give up the one he does not like. He is free to work or not to work. He is free to own property and use it as he likes. He is free to enter into any contract. Thus (l) freedom of occupation, (2) freedom of owning and using property and (3) freedom of contract are three main pillars of capitalistic economy. But in capitalism there is no central agency guiding and controlling economic activity. Production, exchange and consumption all respond to changes in prices. As the price of a commodity rises, more of it will be supplied; but only less of it will be demanded. Conversely, when its price falls more of it will be demand; but less of it will be supplied. Similarly, distribution which depends on factor prices, has some relation to the prices of commodities. Thus capitalism is an automatic system based on prices mechanism. Through the price mechanism the product demand intention of the consumers or the households and the product supply decision of the firms result in a series of product prices. Similarly the resource demand decisions of the firms and the resource supply decisions of the households will result in a series of resources prices. The competitive price system is a mechanism both for communicating the decision of the consumers, producers and resource suppliers to one another and for synchronizing those decisions toward consistent production objectives. Thus the price mechanism enables the economy to tackle the fundamental problems of what to produce, low much to produce, how to produce and for whom to produce. The main functions of the price system are:-

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1. Co-ordination. With the price system in place, adjustments in the economic system take place automatically without any direction or dictation from a central authority. Price is the co-ordinator both of production and consumption. Consumers are able to convey their preferences through the prices they are willing to offer. Producers are able to convey their offering of output at acceptable prices. Similar co-ordination is possible in the factor market where services are bought and sold. Factor prices determine the sharing of the national income. 2. Harmonizes conflicting interests. The price mechanism is to harmonize the interests of both the consumers and the producers. It tends harmonize the desire of entrepreneurs for profits and the desire of consumers to satisfy their wants as fully as possible from the factors of production available. 3. Allocation of working force. The price system allocates the available labour force of a country among different trades, professions and occupations. A change in wages and terms of employment matches the demand for and supply of each type of workers. 4. Allocation of Resources. The productive resources of the community, human and material, are automatically allocated among the various uses in such a way that each makes a maximum contribution to the total output. Any misallocation will be rectified by transfer of resources from one use to another through the price indicator. 5. Making for adaptability. Price mechanism provides the much needed flexibility in the economy. As consumer's tastes and preferences change, new techniques of production are discovered and resource supplies undergo change, the particular allocation of resources will cease to be appropriate and efficient. Then adjustment to change takes place through price mechanism. In short price mechanism results in the most efficient allocation of resources. If provides freedom of enterprise for the businessman and freedom of choice for the consumers. The consumer in said to be a sovereign in capitalism; he is an uncrowned king.

Shortcomings
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1. It is pointed out that the economic freedom permitted by the price mechanism kills wholesome competition which is beneficial to the consumers and the workers. The self-seeking and profit-greedy entrepreneurs combine to extract highest prices from the consumers and pay the lowest wages to the workers. 2. There is a clash between private interest and social welfare. Entrepreneurs are trying to enrich themselves at the expense of the society. 3. It is wrong to assume that the price system leads to the production of goods which the consumer prefers the most. The consumer sovereignty is a myth. He is very often led by advertisement and propaganda. 4. The price system very often aggravates the inequalities in the distribution of both income and wealth. 5. Price mechanism do not indicate the collective wants of the community like public health system, libraries, parks etc. 6. The price mechanism has proved to be an imperfect mechanism for achieving full employment. 7. The price system does not help economy to adjust quickly to drastic changes in production targets.

Price mechanism in developing countries

In a developing economy like India were a substantial part of economic activity is in the private sector the price mechanism has an important role to play. But we cannot rely entirely on the free play of market forces. The prevailing price relation in a developing country are often the results of market imperfections and rigidities. The changes in relative prices by themselves always will not bring about the necessary re-allocation of resources. In these economic allocation of resources should be through direct controls, direct allocations, taxation and subsidies. Here the government has a positive role to play.

Factors of production
In economics production means creation of utility. The act of utility creation in possible by transforming inputs into output. Output will have greater utility than

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the inputs put together. The creation of utility or production of wealth requires the co-operations of certain agents or factors. They are called the factors of production or agents of production. In economic analysis there are four factors of production. They are land, labour, capital and organization. These factors are respectively provided by landlord, labourer, capitalist and entrepreneur. In return they get rent, wages, interest and profit as the remuneration for their co-operation in production.

I.

Land
In ordinary language land means soil or ground or the surface of the earth.

But in economics land has a special meaning. It refers to all gifts of nature which yield an income and which are under human control and ownership. It includes mineral deposits, seas, rivers, natural forest, vegetation, fisheries etc. Thus land in economics means the sum total of natural resources. Thus "by land is meant the materials and forces which nature give freely for man's aid in land and water, in air, light and heat." The most important aspect of land is the surface of the earth. This area is indispensable for the production of food and raw materials. Climatic condition is another aspect of land, affecting agricultural and industrial production. The position of land is important in the development of transport and trade. The external nature of land is important. Road, railways and communications can be more easily developed in plains than in mountainous regions. Mountainous regions with waterfalls are important for power generations. Minerals contained in the interior of earth are another aspect of land. Further land includes the sea since fishing is an important economic activity. Characteristics of land 1. Primary factor: Land just like labour is a primary factor of production. To start any business or production process we need the help of land. 2. Free gifts of nature: Land is a free gift of a nature. Since it is not man made it has no cost of production. But man can improve the quality of land by his efforts though he cannot create it.

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3. Fixed in supply: The supply of land is fixed in nature. Land has no supply price. Though the total quantity of land is fixed the actual amount in use may vary from time to time. 4. Land is permanent: Land cannot be destroyed. The fertility of the soil can be exhausted by continuous cultivations, but its form will remain the same ie "land is original and indestructible". 5. Immobile: Land as a factor of production in completely immobile. This property leads to the localization of its supply. 6. Heterogeneous: One piece of land differs from another in fertility, position, climate etc. Thus land can be classified into different grades. 7. Diminishing Returns: Land is subject to the law of diminishing returns. This is because the land is the fixed factor in agriculture. The law of D.R states that if we apply more and more capital and labour to the same piece of land, the average and marginal returns, after a certain stage will diminish. 8. Many uses: Land can be used in a variety of ways. It can be cultivated. playgrounds can be formed and factories can be constructed.

II.

Labour
Any work whether physical or mental which is undertaken for a monetary

consideration is called labour in economics. Mere exertion, physical or mental, cannot be called a labour. It must purposive i.e. It must be undertaken for the production of a good or services for usually reward. Work done out of love for others or because of the pleasure derived from it is not labour in the economic sense. Characteristics or Peculiarities of Labour 1. Free agent in production: Labour is supplied by the labourer and he is a free agent. He has a free will and can choose any work he likes. He can also abstain from work. 2. Active agent in production: Both land and capital are passive factors of production. They cannot yield anything without the participation of man in the production process. But the labourer is the active agent in production.

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3. In separable from labourer: Both the land and capital can be separated from their owner, but labour cannot be separated from the labourer. He must deliver it in person. He is selling his services for a given time. 4. Means and end of production: Labour is the cause of production and when production is made the labourer also consumes the products. He has a soul to save and a body to nourish. In other words he is the means as well as the end of production. Just like the two faces of the same coin, on the one side he is the producer and on the other side he is the consumer. 5. Perishable: Labour is the exertion of mind or body rendered through time. Hence one day's labour lost is lost forever. Labour power cannot be saved. The time during which he remains idle is irrevocably lost. Hence, labourers are faced to accept even low wages. 6. Mobile: Labour is mobile since labourers can move from one place to another place or from one trade to another trade. The movement from one place to another is called geographical or lateral mobility of labour. And the movement from one trade to another is known occupational or vertical mobility labour, however is less mobile than capital because of the differences in languages, custom, culture etc. 7. Labour has a very weak bargaining power. 8. Backward shifting supply curve: When wage rate increases the supply of labour may decrease. At high level of wages people prefer leisure wages. So they will substitute leisure for labour.

Effiency of labour
Effiency is the productive capacity of the labour. It refers to the various qualities of the labour which enable them to work in a better or more competent and within a shorter time. Effiency of a labour depend upon a number of factors. 1. Racial qualities: Some races are strong and stout and have posses more physical effiency than others. The Punjabis are physically strong and hardworking than many others in the country. Again a worker's effiency is also depends upon the qualities like mental alertness, honesty,

31

resourcefulness, sobriety, initiative etc. Further a child inherits the skill of his father by birth. 2. Educational and training: Effiency also depends upon education both formal and technical. An educated and well-trained person is more efficient and hence more productive. 3. Standards of living: A high standard of living is a precondition for a high level of efficiency. A good nourishing food, adequate clothing and a comfortable home are the ingredients of high standards of living. 4. Trade Unions: The trade unions can increase the effiency of the labour by way of getting more wages and making arrangements for higher training to their members. 5. Factory environment: Lack of proper lighting, ventilations and sanitary arrangements will adversely affect the productive capacity of a labour. A pleasant and cheerful surrounding will induce the labourer to put forth his best efforts. Similarly long and continuous hors of work will hamper labour effiency. There should be a reasonable interval for relaxation and recreation which has as important bearing on the effiency of the worker. 6. Prospects of promotion: If a worker is guaranteed that he will be promoted to a higher position if he performs more work, he will be work delightly and his effiency will increase. 7. Climate: A cool bracing climate induces people to work more whereas the extreme climate of the tropical or the Article regions make workers became tired both physically and mentally. 8. Social and religious factors: The caste system and the joint family system affect already affects the effiency of the labour. Religious behaves like fatalism affects the effiency of the labour. 9. Social security: A properly developed social security system will enhance labour productivity. Further job security will promote labour effiency. 10. Political condition: Political stability is an important determinant of labour effiency. 32

Division of Labour
Division of labour is an important aspect of present day production. There is hardly any production unit which does not organize production on the basis of division of the labour. Division of labour is associated with effiency of production. In the production process an article is split up into several process and each process is entrusted to a separate set of workers, it is called division of the labour.

Classification
1. Simple or functional division of labour. The society is divided into different occupational groups like carpenters, weavers, farmers etc. 2. Complex division of labour or division of labour proper. Here no group of workers makes a complete article. Instead the working of an article is split up into a number of processes and subprocesses and each process or subprocesses is carried out only by a separate group of people. 3. Territorial division of labour: This type of division of labour is also called localization of industries. Hence production takes place in certain localities, region or town. Advantages of division of labour 1. Increase in productivity. 2. Increase in dexterity and skill. 3. Inventions are facilitated. 4. Introduction of machinery facilitated. 5. Saving in time. 6. Diversity of employment. 7. Large-scale production. 8. Right men in the right place. Disadvantages 1. Monotony of the work.

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2. Retards human development. 3. Industry dehumanized. 4. Loss of skills. 5. Risk of unemployment. THE NATIONAL INCOME In an economy, every year certain net aggregate of goods and services is produced. It is not easy to add together different quantities of these goods and services. So for the sake of convenience the money value of all these goods and services are added up. This is the national income of that country during that year. Thus the national income of an economy can be defined as the money value of sum of goods and services produced during a year.

Estimation of National Income

There are three different methods for computing national income. They are:1) The output or production method: According to this method the market value of the output in different sectors of the economy is calculated. The contributions of agriculture, industry and services are taken into consideration. In order to avoid double counting the value of final goods is considered. In other words the value of intermediary goods should be excluded. 2) Income methods: It is the sum total of earnings of individuals supping services. In other words it is the sum total of rents, interest, wages and profits. These earnings are cost of production to firms. In addition, depreciation and taxes are costs to the firms. So they too must be added to costs in estimating the gross national product. 3) Expenditure method: National income according to their method is calculated by adding together all kinds of expenditure ie, spending on consumption goods and expenditure on capital goods by all individual, as well as government of a county during a year. Although there are three different methods, they all deal with one and the same thing, viz the national income of the county. The total value of goods and services must necessarily be equal to sum total of incomes. Again it must be equal to expenditure of the community on goods and services during a year.

National Income concepts

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1. Gross National Product (GNP): GNP is defined as the total market value of all final goods and services produced in an economy during a given year. If there are big prize changes form year to year the comparison of national income of different years becomes difficult. In that case national income of various years must be calculated at the price levels of a given year called base year. 2. Net National Product (NNP): It is the measure of the net value 0 total output. In the production of gross national product part of the capital undergo wear and tear and is called depreciation. NNP is obtained by deducting depreciation from GNP. 3. National Income (NI): It is calculated by subtracting depreciation and indirect taxes from GNP. Since NNP is GNP minus depreciation NI is found by deducing indirect taxes form NNP. 4. Personal Income (PI): It is the total income required by households form all sources before taxes. Personal income can be derived from national income by subtracting retained corporate profits, profit taxes and contributions to social inference. Transfer payments have to be added, since they are available to households as a form of income. 5. Disposable Personal Income (DPI): It is the personal income after personal taxes. It is the income available to households to spend for consumption or to save. DPI is the flow of gross national income that eventually individual households after governments and business firms have taken our taxes and retained profits. 6. Per capita income (PCI): It is the income per head of the population and it is obtained by dividing the national income by population of the country. 7. Gross Domestic Product (GDP): Total income generated by factors of production within the country form its own resources in known as GDP. Thus GDP-GNP-Net income earned form aboard.

Importance of National Income studies

The concept of national income is of great analytical and practical

35

significances. 1. National income figures gives us a picture of the economic life of the people. It reveals the standard of ling of the people. 2. The national income statistics are important in understanding the economic trends in a country. By comparing the national income figures of country of different times we can see the development of the country over the years. 3. A comparison of the national income and per capita income of different countries gives us an idea of their relative economic position. 4. The national income figures are of immense importance in taxation. Taxation can be increased. Safely only up to the taxable capacity of the people which is a certain percentage of the national income. 5. National income and per capital income figures help the government to adapt suitable employment policies. 6. In planned economics, the national income data are of great significance. Implementation of economic planning requires data on gross-income, output, saving, consumption, investment etc which are provided by national income studies.

Difficulties in the measurement of National Income

The calculation of national income is a complicated problem and is best with many difficulties i. Certain services are not paid for. As such there are not included in the estimates. Eg: the service of housewives ii. Administrative services of the government. It is not possible to identify the series which specifically contribute to production. iii. The greatest difficulty in calculating national income is of double counting. There always exists the fear of a good or a service being include more than once. If it so happens the national income would work out to be many times the actual.

36

iv. Income earned though illegal activities like gambling illicit liquor, black marketing etc are not included in national income. But by leafing them out the national income works out to be less than the actual. v. Capital gains or losses which occur to property-owners by increases or decreases in the market value of their capital artists are excluded from the GNP. vi. New products which did not exist in the base year cannot be evaluated with reference to the base prices. vii. Comparison between nations based on national income may be less meaningful because of the differences in the purchasing power of money and the package of goods that can be purchased with a unit of money in different countries. In addition to these difficulties, a developing, economy life India is beset with some additional problems. 1. Non monteised sector: There is a large non-monetised sector in a developing economy. A considerable part of out put does not come into the market. A major part of farm output is consumed at the form itself. So we have to compute the value of such output. 2. Lack of occupational specification: There is the lack of occupational specialization is these countries which makes the calculation of national income difficult. Formers in these countries are engaged in supplementary occupations like. Dairying, poultry, cloth making etc. But income form such productive activities is not included in the national income estimates. 3. Non-Market Transactions: People living in rural areas are able to avid expenses by building their own buts, tools, implements and other commodities. All such productive activities do not enter the market transactions and hence are not included in national income estimates. 4. Illiteracy: Many people in these countries are illiterate and they do not keep any accounts about the production and sale of their products. And even the available data are not dependable and non-reliable.

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National Income Estimates in India

Several estimates of national income were prepared in the British period. Notable among them were: Dadabhai Navaroji, Findlay Shirras, and Dr. V.K.R.V. Rao. Both Dadabhai Navaroji and Shirras estimated the value of the out put of the agricultural sector and then added a certain percentage as the income of the nonagricultural sector. Dr. V.K.R.V. Rao made use of a combination of output and income methods. These estimates were the results of the effects of individuals and as such they suffered form the series limitations. So soon after independence, the government of India appointed the National Income committee in 1949 under the chairmanship or Prof. P.C. Mahatanobis the committee submitted is report in 1954. The report provided for the first time a comprehensive data of national income for the whole of India. After the publication of the report, the task of national income estimation was entrusted to the central statistical organization (CSO). The CSO now publishes the annual National Accounts statistics which contain useful information on various aspects of the country national income.

Trends of National Income growth in India

The Indian economy during the British rule presents a picture of near stagnation over a long period with growth rate of 0.5 percent for 1860-1945. But during the 30 years period of 1950-1980, the annual rate of growth of national income (93-94 prices) was the order of 3.4% and that of PCI was 1.2%, calculated at current prices the annual rate of growth of net national product was of the order of 8.9% and that of the PCI was 6.6%. But there was a perceptible improvement in growth rate during the eighties. During 1980-90, net national product showed a growth rate of 5.4% and the per capita income increased by 3.2% per annum. During 1991-2001 the annual average rate of growth of net national product was 5.5 % and the NNP per capita was 3.4%. Along with the growth in national income there is change in the sectoral composition of national income n the post-independence area. The sectoral change is shown in the table.

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Share of GDP by Industry of Origin

Percentage Distribution 1950-51 I Primary sector (Agriculture) II Secondary sector (Industry) III Tertiary sector (Services) 57.7 14.8 27.5 100 1980-81 39.7 23.7 36.6 100 1999-00 25.2 27.0 47.8 100 06-07 18.5 26.4 55.1 100

The share of the primary sector which includes agriculture, forestry and fishery ahs gone down form 577% in the GDP in 1950-51 to 25.2% in 1999-2000. The share of the secondary sector which includes mining, manufacturing, construction, electricity, gas and water supply has shown a steady increase form 14.8% to 27% during this period. Similarly the share of the tertiary sector which includes trade, transport, storage, communication, banking, insurance, real estate, community and personal services improved form 27.5% to 47.8% during this period.

III

Capital
Capital may be defined as all produced means of production. It is that part

of a man's wealth which is used in producing further wealth. Man produces the instruments of production by working upon the material furnished by nature. The earliest examples of capital are the tools and live and the bow and arrones. With the development of agriculture man invented the plough and other agricultural instruments. The revolutions in industry and transport be ought in to existence machines, factories and various means of transport. Real capital includes all man-made instruments of production. These must be distinguished form money capital which is an amount of money for the acquisition of capital goods. Real capital consists of 1) The goods which are consumed by people which engaged in production. Eg. Food 2) The law materials out of which thighs are made. eg. iron

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3) Factories and machines which helps production and the means of transportation which help the distribution of goods. 4) Inventories of unfold stocks of goods.

Importance of Capital
Capital plays a crucial role in the economic system. Production without capital is rent to impossibility. The important characteristics of capital are 1) Productivity:- Capital is highly productive. It is due to this characteristic that man invented the use of capital is capitalistic round about. In order to produce consumer goods, capital goods have to be produced first. This indirect method of production n far more efficient than direct production. 2) Income Yielding Capacity:- Since capital is productive the owner of capital gets an income form it. The income yielding capacity of capital is based open its productivity. Thus capital is wealth which yields income. 3) Prospective ness: Unlike land and labour capital is prospective in the sense that it is related in future is the expectations of a future income. Capital formation is the result of saving and investment. 4) Produced and Reproducible: Unlike land and labour all capital in man-made. It is the result of saving and investment. Its supply is not fixed. It can be increased by human effort. It wears out in the process of production. So it has to be reproduced.

Capital Formation
Capital formation means the increase in the stock of real capital is a country during a year. Capital formation involves working of more capital goods which are used for further production. It simple means that society does not apply the whole of its current productive activity to the needs of and desires of immediate consumption, land directs part of its to the making of capital goods that can gradually increase the efficiency of productive effort. These capital formation or accumulations involves three distinct stages: 1) Creation of savings - Accumulation of capital depends on the level of

40

savings. The volume of savings depends on two sets of factors: a) The ability to save b) The willingness to save. The ability to save depends upon the average level of income and the distribution of material income. The higher the level of income the grater will be the amount of saving. Similar, the greater the inequalities in the distribution of income, the grater will be the amount of savings in the economy. Saving also depends upon the willingness to save various personal family and national considerations include people to save. People save in order to provide against old age and unforeseen emergencies. Some people desire to save a large sum to start business or to expand existing business. Further people want to make provision for education marriage and a good start n business for their children. 2) Mobilization of Savings - The second step in the process of capital

formation in the mobilization of savings of the households. Factors favorable for the mobilization of savings are:- a) Development of banking. The development of banking and other financial institution is of utmost importance in mobilizing savings. Eg:- the development of banking facilities un rural India after the nationalization of commercial banks has enforced savings to a considerable extends b) Development of Money and Capital market. The development of various institution in the money and capital market also offer enormous opportunities for people to save. A well developed money and capital market mobilizes the seathered and desmant savings of the people. 3) Investment of savings- Capital formation in possible only when

saving is converted into investment. But investment depends upon a) Large numbers of dynamic entrepreneurs b) Reasonable return (profit) on investment c) Cost of borrowing must be moderate d) Size of the market (optimum)

IV Organization
The fourth factor of production in organization which is provided by the

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entrepreneurs or organizer. The entrepreneur performs complex and complicated tasks of combining different factors of production like land, labour and capital together reorganizing production, undertaking risks and uncertainties that are involved in modern methods of production. That is why the entrepreneur is called the captain of industry. Organization of enterprise may be regarded as a special form of labour. But it is different from the other three factors in one importance respect. Land labour and capital are employed for a fixed rate of payment. But there is no certainty about the reward of the entrepreneurs. This reward, profit, is uncertain; it may be positive equal to zero or even negative. Functions of the entrepreneurs: The entrepreneurs performs certain functions. 1) Discovery of business opportunities - In a free enterprise economy the entrepreneur discovers business opportunities. This requires intelligence imagination and innovate abilities. 2) Decision making:- Once the business opportunity is discovered, the entrepreneurs takes a number of decisions. He decides what to produce, how much to produce and also the method of production, the firm of business organization and the location of the firm. The decisions of the entrepreneurs in an economy determines resource location and their payments to factors determine the distribution of the national income. 3) Organizing - Having taken the important decisions the entrepreneurs beings together and combines land, labour and capital in the required proportions for the purpose production. This is called organizing of production. 4) Risk and uncertainty bearing - An important function of the entrepreneurs in learning risks and uncertainty. He has to face ordinary risks and business risks. His factory may catch ire or his machines may break. These are ordinary risks which cab be injured. But these are business risks. Production is an anticipation of demand which is often uncertain. By the time the entrepreneurs has finished production the demand for his product my fall off or strong completion my appear. He must bear all these risks and

42

uncertainties. Profit as often regarded as the reward for risk and uncertainty baring. 5) Innovations. The entrepreneurs is responsible for innovation. Innovations imply the introduction of new commodities, new methods of production, discovery to new sources of raw materials and new markets for commodities. Though innovation the entrepreneurship economic progress. Thus entrepreneurs is the crucial factor in economic development. PUBLIC FINANCE Public finance deals with the finances of the public as an organized group under the institution of government. Public authority means the government the Central, the State and the local governments and their agencies. Governments have to perform the traditional functions of defence, maintenance of law and order and the provision of certain public works like roads, railways, etc.

Public revenue
Public revenue includes all receipts to the public authority other than the receipt from public borrowing and sale proceeds of public assets. Public revenue is divided into (1) tax revenue and (2) non-tax revenue. Taxes are compulsory payments to government without expectation of direct return in benefit to the taxpayer. The essence of a tax is the absence of a direct quid pro quo between the taxpayer and the public authority. Non-tax revenue is divided into: a) Grants and gifts: Grants are financial assistance by one government to another in the performance of specified functions in a specified manner. Gifts are voluntary contributions from non-government donors generally for specified purposes. b) Commercial revenues are received by government in the form of prices paid by the people for goods and services produced by government-owned enterprises. Eg. public utilities like railways, telephone, electricity, etc.

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c) Administrative revenues are receipts for the government when it comes into contact with particular individuals in the course of administrating its general functions. Eg. fees, licenses, permits, fines etc. Thus

MAJOR TAXES OF THE CENTRAL GOVERNMENT

I. Direct Taxes a. Personal income Tax Tax on individuals b. Corporation Tax Tax on companies c. Estate duty Tax on inheritance d. Wealth tax Tax on accumulated wealth e. Gift tax II. Indirect Taxes a. Central excise duty Tax on commodities produced with in the country. b. Service Tax Services like telephone, insurance, brokerage etc attract this tax. c. Customs duty Both import duties and export duties on commodities.

MAJOR TAXES OF THE STATE GOVERNMENTS

I. Direct Taxes a. Land Revenue b. Stamps and Registration c. Motor vehicle tax d. Agricultural income tax II. Indirect Taxes a. State excise duties duties on alcoholic liquors. b. General Sales Tax Now is being replaced by VAT.

DIRECT AND INDIRECT TAXES

Taxes are generally classified into direct and indirect taxes on the basis of 44

assessments. A direct tax is one which really paid by a person on whom it is imposed. An indirect tax although imposed on a person, is partly or wholly paid by another. When the money burden of a tax cannot be shifted or transferred it is said to be a direct tax. The personal income tax, wealth tax etc. In this case the impact and incidence of the tax are on the same person. When the taxpayer can shift or transfer the money burden of a tax to another person, the tax is said to be indirect. The sales tax is a good example of indirect tax. It is paid by the seller, but he transfers this burden to the buyer by raising the price of the commodity. Here the impact and incidence of the tax are on the different persons. Excise duties and customs duties are examples of indirect taxes. The recently introduced value added tax (VAT) is another example of indirect tax. Advantages of direct taxes 1. Direct taxes fulfill the causes of certainty since they are imposed on income, property etc. the government can therefore estimate with a fair degree of accuracy the yield from the direct tax. 2. Direct taxes satisfy the principle of equity or justice in taxation. They can be made progressive thus making broader shoulders bear the heavier burden. 3. Direct taxes are more easily collected. For example the income tax is usually deducted at the source itself and therefore tax evasion becomes difficult. 4. Direct taxes are highly productive as they bring substantial revenues to the government. 5. Since direct taxes are generally progressive in nature and therefore rich people are subjected to higher rates of taxation these taxes help to reduce the inequalities in income distribution. 6. Direct taxes are more elastic in nature so government gets more revenue simply by raising the tax rate. Also revenue from direct taxes increases along with rise in national income. Disadvantages of direct taxes 1. Direct taxes are more disliked by taxpayers since they are directly paid and there is little chance of escape. 45

2. If the tax administration is not efficient it may lead to large scale evasion of tax. This is evident in most developing countries where the tax machinery is not very sound. 3. Direct taxes are difficult to be administered because of evaluation of the objects taxes. 4. The principle of progression may not be always followed. A finance minister hand pressed for money may overlook the principle of justice for the sake of collecting more money. 5. Direct taxes are generally inconvenient in nature since taxpayers have to submit the statement of their income or wealth along with the sources. Moreover the payment of these taxes as a lump sum is not convenient to the taxpayer as the frequent payment of small amounts of indirect taxes. Advantages of indirect taxes 1. An indirect tax is more convenient to taxpayer and government. The taxpayer does not feel the burden as much as in the case of a direct tax since he is paying this along with the price of the commodity. It is convenient to government since it is collected in lump sum from merchants, producers, exporters and importers. 2. Unlike a direct tax, an indirect tax falls on all class of people, the rich and the poor alike. In a democracy it is good that every body contributes at least something to support the state. It will promote civic consciousness among the people. 3. Indirect taxes are difficult to evade since they are added to the price of the articles sold. 4. Indirect taxes can be used to discourage consumption of harmful things like liquor and to encourage the consumption of beneficial things. 5. Indirect taxes are highly productive as they bring large revenues to the coffers of the state.

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6. Indirect taxes can be elastic that is the revenue can be increased. Government can raise more revenue through indirect taxes provided that they are imposed on articles of inelastic demand. Disadvantages of indirect taxes 1. An indirect tax, especially one on essential commodities is unjust. It is likely to fall more heavily on the poor than the rich. 2. The yield from indirect taxes is always uncertain. Hence the government cannot estimate beforehand with accuracy the revenue from such taxes. 3. Since the cost of collection of these taxes maybe heavy. Indirect taxes may not be economical. To conclude it is considered a sign of financial virtue of the taxing authority, if a proper balance is maintained between direct and indirect taxes. Generally speaking, the burden of indirect taxes falls more heavily on the poorer section of the community and that of direct taxes mainly on the richer section of the community. The sladsanion statement, that direct and indirect taxes should be viewed as equally attractive sisters, neither of them should be pursued too ardently, is more appropriately in this context.

PROPORTIONAL PROGRESSIVE, REGRESSIVE AND DEGRESSIVE TAXES

Taxes can be classified into proportional, progressive, regressive and degressive according to the rate at which they are levied.

PROPORTIONAL TAXES
The tax is said to be proportional when the same percentage is applied on all incomes or the value of property or wealth. It is a definite proportion or percentage of income or the value of the object taxed. Here the rate of taxation remains constant as the tax base changes. In case of proportional taxation the multiplier remains constant with changes in the multiplicand. Eg. A 10% income tax is imposed on all incomes then:

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Tax rate 10% 10% 10%

Income 1000 10000 100000

Tax 100 1000 10000

Net 900 9000 90000

Merits of proportional taxation 1. Even after the imposition of the tax the relative status of the taxpayer remains the same. It does not disturb the existing system of distribution of wealth and income. 2. One chief merit of proportional tax is its simplicity. It can be uniformly applicable. It avoids the complicated rate structure of the progressive tax. 3. Proportional taxation does not lead to abuses which progressive taxation can commit. 4. Proportional taxation has been supported on the ground that the willingness to work more and the ability to save more are not adversely affected. Demerits of proportional taxation A system of proportional taxation would not lead to equitable and just distribution of the burden of taxation as it falls more heavily on the small incomes than on higher incomes. This is because the marginal utility of money diminishes more rapidly as the income increases. Hence the sacrifice involved in paying of a tax in proportion to the income is greater for the poor than for the rich. 2. A system of proportion taxation means that the tax rates for the rich and the poor are the same. Hence the state cannot obtain from the richer sections of the community as much as they can give. 48

3. If the tax rate of smaller income group is already heavy government cannot raise the tax rate for the rich alone under a proportional tax system. Thus the government is unable to raise its revenue in times of emergencies. Therefore the tax system is not elastic.

PROGRESSIVE TAXATION
A tax is said to be progressive then the rate or percentage of tax increases with the increase in income or the value of property. Thus progressive tax is one in which the rate of taxation increases as the tax base increases. Here the multiplier increases as the multiplicand increases progressive taxation is universally accepted especially with the evolution of the idea of the welfare state. Personal income tax rate Income Upto 50,000 50,000 to 60,000 60,000 to 1,50,000 1,50,000 to 3,00,000 nil 10% 20% 30% Tax ...... 1000 18000 45000

Arguments in favor of progressive taxation 1. Progressive taxation satisfies better the principle of justice in taxation Richer people have greater ability to pay taxes. Hence it is only just that they are taxed at higher rates.

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2. It is justified by the principle of diminishing utility of money. The marginal utility of money to the poor is far greater than the marginal utility of money to the rich. Hence rich people should be taxed at higher rates than the poor. 3. Progressive taxation corrects the anomalies in the distribution of wealth and income and thus helps the state to achieve the goal of social justice and a certain measure of economic equality which are essential for the success of the democratic form of government. 4. In times of inflation progressive taxation is a powerful weapon in the hands of the government: the richer people have greater spending capacity. By taking larger shares from their income the government can reduce their expenditure. 5. Progressive taxation can be justified on the ground that they are economical, at the cost of collection does not rise with increase in the rate of taxes. 6. Progressive taxes are elastic. Public revenue can be increased anytime by increasing the rate of taxes. 7. Progressive taxes have been justified because public revenue increases automatically with economic growth without any change in the tax rate. 8. The loss of satisfaction for the community as a whole will be minimum under the conditions of progressive tax system. The principle of least sacrifice states that the sacrifice imposed on the community as a whole will be the least if the richer sections are taxed at higher rates and the poorer sections are either exempted from taxation or are taxed at lower rate. Arguments against progressive taxation 1. Progressive taxation is arbitrary in nature. There is no guiding principle by which tax rates are determined. Progressive taxation is compared to a man at sea without rudder or compass. 2. Progressive taxation is based on the assumption that the marginal utility of money is less to a rich man than to a poor man. But satisfaction is a mental phenomenon: one mans satisfactory cannot be compared to that of anothers.

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3. Progressive taxation may adversely affect savings and investments. Thus it may adversely affect economic growth. 4. It is argued that progressive taxation punishes prudence and virtue and rewards extravagance and idleness. According to this view a graduated tax is a graduated robbery. 5. The possibility of wide spread tax evasion is another problem of progressive taxation. Progressive tax is a tax on honesty. If the tax administration is not very efficient the yield from progressive taxation is not satisfactory.

REGRESSIVE TAXATION
Taxation is said to be regressive when the rate or percentage of tax decreases with increase of income or wealth in a Regressive tax the multiplier decreases as the multiplicand increases. Commonly we refer to the regressive effect of a tax which may not be technically regressive at all. eg. A sales tax is typically a proportional tax because its rate is constant no matter how large or small the base. But if the amount of tax is related to buyers income, such a tax may be regressive with respect to income. There are no examples of regressive taxes used in the strict sense. The best approximation is the poll tax. Income 10000 20000 30000 40000 Tax rate 10% 7% 5% 4% Tax 1000 1400 1500 1600

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DEGRESSIVE TAXATION
Taxes which are mildly progressive so that high income do not make a due sacrifice. In degressive taxation a tax may be slowly progressive up to a certain limit, after that it may be changed at a flat rate. Income 10000 20000 30000 40000 >40000 Tax rate 10% 11% 12% 13% 14% Tax 1000 2200 3600 6200 .........

Value Added Tax (VAT)

Value Added Tax is the newest form of indirect or commodity taxation. VAT is employed as an alternative to the commonly levied sales taxation. France was the first country to implement this tax in 1954. At present a large number of countries have implemented this tax. VAT is a multi staged sales tax that exempts the purchase of intermediate goods from the tax base. A VAT is a tax on the value that is added to goods and services by producers at each stage of production and distribution. Value added by a business firm is the difference between the firms sales proceeds and its expenditure in purchasing intermediate goods and services

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from other firms. VAT is administered by the invoice method. All transactions are taxed at a fixed proportional rate irrespective of whether they are final or intermediate transactions. Tax payers are then allowed to deduct the taxes paid on intermediate purchases. That is the tax is reimbursed to the producer who used the taxed inputs. Invoice method in also called the tax credit method. Thus tax liability = tax payable on sales Tax paid on intermediate purchases We can illustrate this with an example. Let us assume that a farmer sells his produce (raw material) at Rs. 1000. The manufacturer who bought the raw material for his factory has to pay, let us assume 4% tax. The output is sold at Rs. 1600. Let VAT be 12.5%. Sales price in VAT = 1600 + 200 under the old system tax burden was 200 + 40 = 240. But in VAT it is (240 - 40). Now the purchase price for the merchant is 1600 + 200 (VAT). Let the merchant sold the product at Rs. 2000. Tax burden in the old system at 12.5% is 490 (240 + 250). So the sale price at old level might have Rs. 2490. But price at the new dispensation is 2250 (2490 - 240). So the consumers has to pay Rs. 2250 for the product under VAT instead of Rs. 2490 in the old system. This is because tax at earlier stages are being deducted in each successive stages. So generally commodity prices must be lower under VAT. From the administrative point of view a single rate is preferable to a multirate VAT. But to reduce regressivity, the VAT can be supplemented by a luxury tax with two or three rates. In many countries certain essential items like unprocessed food, life saving medicines etc are exempted from VAT. Also special treatment is accorded to small business under VAT. Further zero rating is accorded to exports in most countries. Merits of VAT VAT is considered as superior form of indirect taxation. 1. VAT is a transparent tax system. 2. VAT prevents the cascading effects of an indirect tax. 3. Taxes paid on raw materials are drawn back on all late stages of production. 53

4. VAT promotes export and import substitution, Drawback of taxes is possible at all stages of exports. 5. VAT has a much broader base. The tax rate is almost uniform and lower. VAT provides a firm base for raising State revenues by an increase in tax rates compared to the multiple taxes. There was a significant growth in revenue in most countries where VAT has been implemented. 6. Tax evasion is minimum in VAT because most of the tax is collected from relatively large scale manufactures and wholesalers. 7. Capital goods are eligible for tax deductions. Demerits 1. Collection costs may be high in VAT for larger administrative personnel are needed. Tax payers in our costs in keeping records, but this is a short run phenomenal. 2. VAT is against the principal of equity in taxation. Practically VAT is regressive in nature. 3. Prices may rise more than proportionate to the rise in VAT. A ratchet effect is likely, prices may go up the full amount of VAT but not come down by the full extent if VAT is reduced. People should be well informed about VAT for its successful implementation. The committee on Indirect Taxation observes that the introduction of VAT in almost all countries was proceed by detailed public debate in chambers of commerce, industry, associations and other forms in parliament and educational institutions. Experience of many countries revealed that VAT can be implemented in developing countries quite successfully. But it requires careful planning and investment in strengthening tax administration. India has introduced the modified VAT in 1986. A comprehensive VAT begin is to regime, encompassing all the states, on first April 2005. It is proposed that small traders are exempted from VAT. eg. In Kerala small traders having an annual turnover of less than 10 lakhs are exempted from VAT. The presumptive tax of one percent under the VAT regime would now 54

cover turnover from Rs. 10 lakhs to Rs. 50 lakhs. PARALLEL ECONOMY AND THE PROBLEM OF BLACK MONEY Parallel Economy means the simultaneous functioning of an unaccounted economy with the official whose objectives run parallel to the official economy. This is also called black economy, unaccounted economy, illegal economy, nonsanctioned economy or subterranean economy. The term parallel economy refers to a confrontation with the objectives of the official or normal economy. Parallel economy is based on black money. Black money or unaccounted money is generated by activities that are kept secret. Thus any economic or monetary transactions that are unaccounted for may create black money. The money involved in parallel economy is very large. The National Institute of Public Finance Policy has estimated that the sum involved is about 40,000 crore rupees. Another estimate is that it will come up to 20% of the GDP. In the early 90s of the last century, Suraj B. Gupta puts the size of the black money at over 50% of the GDP and the growth of black money is higher than the annual growth in GDP. But all these studies are guest mates. Effects The functioning of the parallel economy has adversely affected the economy. 1. Misdirection of national resources. A major part of the black money is used for unproductive activities like real estate purchases or for the acquisition of gold and diamond or for conspicuous consumption. 2. Black money has worsened the problem of unequal distribution of national income. Emergence of the parallel economy made national income distribution in India highly skewed in favour of the rich. 3. A direct and immediate effect of black money is the loss of revenue to the State as a result of tax evasion. 4. Parallel economy is a big handicap in making correct analysis and formulation of right policies.

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5. Black money results in transfer of funds from India to foreign countries through clandestine channels. 6. Black money has eroded the value system of the society. The virtues of honesty and hard work are undermined. Causes 1. The higher marginal rates of taxes was considered to be an important reason for tax evasion and the consequent black money creation. At one time the marginal rate of income tax was 97.5%. 2. War time shortages led to the emergence of black marketing and tax evasion. Black marketers made huge profits out of the shortage-dominated war economy. 3. Many controls: Large controls contributed a lot to the spread and growth of the parallel economy. The license and control Raj of the planned economy in India was a fertile land for the growth of black money. Bribes or grease money were used to secure permits, quotas or licenses. Cuts, commissions, kickbacks are rampant in all economic activities. 4. Illegal real estate transaction is an important reason for black money creation. Under valuation of property, the pugari system, the violation of the building rules, etc are generating black money. 5. Over-invoicing and under-invoicing of foreign trade is another reason.

Remedies or measures taken

1. Special schemes: The government at various times adopted special schemes to eliminate black money. The voluntary disclosure scheme was introduced in 1951, 1965 and in 1975. The scheme envisaged a voluntary disclosure of concealed income. The demonetization of 1000-rupee notes was introduced in 1978. Special Bearer Bonds with nominal interest was another scheme. Putting money with the National Housing Bank with complete immunity is another scheme.

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2. Tax efforts: A reduction tax rate, it is argued, will dampen the urge for concealing income to evade taxes. Since 1986 direct taxes were drastically reduced. Further efforts were made at raising the tax revenues through administrative measures like simplification of tax laws, tax procedures and of tax raids. Though the measures mentioned above have achieved something, considering the size of the black money, the outcome is too little. So some other steps need to be taken to eliminate the menace of black money. Taxes should be manipulated to arrest tax evasion. Penalty for unreported transactions should be made more severe. Opportunities for corruption should be eliminated. But the most important thing is that the attitude of the people must be changed. INFLATION Inflation is a major economic problem. It is anal pervasive problem. In countries the problem is chronic. Depending upon the rate of change in price, inflation may be: 1. CREEPING INFLATION - If the annual rise in price is less than 3% 2. WALKING INFLATION 3 6 % is the rise in price per annum 3. RUNNING INFLATION 10 % 4. HYPER INFLATION 20%

DEMAND PULL OR EXCESS DEMAND INFLATION

Demand pull inflation is generally characterized by a situation in which there too much money chasing too few goods. According to this theory an excess 57

aggregate demand over aggregate supply will generate inflationary rise in prices. Thus the process of rising prices is initiated and perpetuated by the conditions of excess demand for goods and services over the level of their supply. The theory is explained in the diagram. The horizontal axis measures income and the vertical axis, the price level. The aggregate demand curves D, D1, D2 have been sloping downwards. The aggregate supply curves rises upwards from left to right and becomes vertical at its level of full employment. Given the aggregate demand DD and the full employment level of real output, the price level is P0 as the aggregate demand function shifts up and the aggregate supply being fixed the price level moves up from P0 to P1 and then to P2.

COST-PUSH INFLATION
Cost-push inflation is caused by wage increases enforced by trade unions or profit increases by employers. The basic cause of cost-push inflation is the rise in money wages more rapidly than the productivity of labor. In advanced countries trade unions are very powerful. They press employers to grant wage increases considerably in excess of increases in the productivity of labor, thereby raising the cost of production. Employers in turn raise prices of their products. The increase in prices induces union to demand still higher wages. Thus the wages cost spiral

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continues, there by leading cost push inflation. An increase in prices of domestically produced or imported raw materials may lead to cost-push inflation. Since raw materials are used as inputs by the manufactures of finished goods, they enter into the cost of production of the latter. Another cause of cost-push inflation is profit push. Big co-operations are raising the prices of their products to offset the rise in labor and production costs so as to earn higher profits. Thus these firms are making up the prices of their produce calculating direct costs per unit of output and adding to these a certain percentage of it. The cost inflation caused by wages or profits can be illustrated through the following diagram.

In the diagram DD is the aggregate demand function and SS is the aggregate supply function the supply curve becomes perfectly inelastic at full employment level of income Y0. P0 in the equilibrium level of price determined by the intersection of DD and SS. Let us assume that the aggregate supply curve shift up as a result of rise in the cost of production. The new supply curve is S1. S and supply curve shifts to S1, the equilibrium is determined at Y1 and the price level is P1, the level of both income and employment falls. A further shift of supply curve to S2 causes the equilibrium income to fall to Y2 while the price level rise to P2. Thus in the cost push inflation a rise in price is followed by a fall in output and income.

DEMAND PULL VERSUS COST-PUSH

There has been a lot of controversy over the issue of whether inflation is the consequence of the demand pull or cost-push. The issue involved was what should be 59

blamed for the rise in prices and what should be the most appropriate antiinflationary policies. If demand-pull is the cause of inflation the government is blamed for overspending and taxing little and the central bank blamed for keeping interest rates low and for expansion of too much credit. On the other hand if costpush is cause of inflation then trade unions are blamed excessive wage increases industry blamed for grading them, big firms for raising administered prices and government is blamed for not persuading or forcing unions and industry from raising their profits and wages. But it is quite unrealistic to view the demand pull and cost-push in exclusion of each other. What happens is that prices increase as a consequence of a complex interactions among wages, cause, excess demand in goods market and in money market.

EFFECT OF INFLATION
The effects of inflation upon the economic system can be classified into:a) Effects on economic activity A moderate rise in prices has beneficial effects upon the economic activity especially when there is unutilized or under utilized productive capacity exists in the economy. Inflation, if mild, has a tonic effect on the economy. Rising prices generate optimistic expectation among the producers for higher profits. Rising profits induce greater investment with the consequent expansion in income output and employment. But inflation if uncontrolled has many evil effects. The process of capital formation is seriously jeopardized by the rising prices. As the purchasing power of money decreases, the people are no longer inclined to increase their savings. Both the willingness to save and the ability to save are affected. As the prices raise it become more and more profitable to hold larger stocks of goods. This will lead to hoarding and black marketing and the consequent shortages in the economy. The process of rising prices has quite adverse effects on the pattern of investment. A larger proportion of investment is of the type of speculative financial investment. Again there is a preference on investment of quick yielding nature. Further a diversion of resources takes place from the production of essential commodity to the production of goods for conspicuous consumption. 60

b)

Redistributive effects When the general price level rises during the inflationary times, the

individual prices change in a disproportionate manner and produce substantial changes in the distribution of income and wealth. Many people like workers, government servants, traders, pensioners, renters, persons living on past saving, are fixed income earners. As prices raise, the value of money depreciates and the real purchasing power of these people decreases. Thus though the money income of these people are unaffected their real income come down. Debtors and creditors. While debtors gain creditors loose with the general rise in prices. Debtors make repayments in terms of money, the purchasing power of which goes down as compared to time when the funds where borrowed. Creditors are losers because they receive less in real terms than what they would have when prices where low. Thus inflation tends to redistribute income and wealth in favor of debtors and against creditors. Rise in general prices has beneficial effects upon the business community as the rising prices tend to profit. The value of their inventories increases in monitory terms. Savers are severely affected by inflation. Fixed interest returns and a depreciating value of money reduces their relative economic positions. While land lords are affected by inflation, the percent proprietors gain substantially. The farm labors are badly affected by inflation for they receive fixed income. c) Other effects Inflation disrupts the social, political fabric of the society. Inflation amounts to a steeply regressive taxation upon the poor and middle class. The inequalities in income and wealth thus continue to increase. Thus inflation destroys the social harmony. Inflation will destroy the peaceful and orderly political life of the society. Antisocial; activities like gambling, hoarding, black-marketing, smuggling, speculation, taxavation..... may appear. Corruption becomes rampant.

CONTROL OF INFLATION
A package deal approach is required to contain an unwarranted rise in general prices. This deal involve:-

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1) The monitory measures: The central bank of the country can regulate the economic activity through influencing the availability, direction, use and cost of credit. The main instruments that the monitory authority can employ for controlling the supply of money and credit may be divided two main groups. a) Quantitative credit controls which can be divided into Bank rate policy Open market operations Variations in reserve ratio

b) Qualitative or selective controls Variations in margin requirements Regulation of consumer credits Credit rationing, direct action Moral suasion Variation in statutory liquidity reason

2) Fiscal measures: a) Taxation policies Increase in the rates of existing taxes Imposition of new taxes Widening the tax base Proper combination of direct and indirect taxation

b) Expenditure policies unproductive and wasteful public expenditure must be curtailed. c) Public borrowing: Floating of new public debts, postponement of the repayment of existing public debts and the conversion of old debts into new debts.

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3) Administration policy: a) Price policy: Price controls, minimum price support policy, distribution of essential commodities through fair prices shops etc. b) Income policy: It attempts to half price increases by providing money wages from rising faster than productivity. INCIDENCE, IMPACT AND SHIFTING OF TAXES When a tax is levied an individual makes the payment. He may bear the tax himself or he may be able to shift the burden to someone else. Incidence of a tax refers to the final or ultimate resting place of a tax. It is a problem of who pays the tax. It refers to the point at which tax chickens finally come to roost. Incidence of a tax is upon those who bear the direct money burden of the tax. Impact of the tax on the other hand refers to the point of original assessment. If the person who pays the tax in the first instance finds that he cannot transfer the burden to anyone else, the impact of the tax as well as the incidence is on the same person. The money burden sticks where it falls. If the taxpayer is able to transfer the burden to someone else, tax shifting has taken place. Then the original taxpayer has been able to remove the incidence of the tax or the money burden of the tax from his shoulders. Thus impact of the tax means only the indirect money burden of a tax. Let us suppose that the government levies a tax on textiles and collects the amount from the mill owner. Then the impact of the tax is on the mill owner. If he is able to pass the money burden of the tax to the wholesaler by means of raising the price of textiles by the amount of the tax, then tax incidence is on the wholesaler. If the process of shifting continues form the manufacturer to the wholesaler, then to the retailer and finally to the consumer, then incidence is on the consumer who ultimately bears the money burden of the tax. Two general principles can be laid down from the above analysis. (1:) other things being equal, the more elastic the demand for the object of taxation, the more will the incidence of the tax be upon the seller.(2:) other things being equal, the more elastic the supply of the object of taxation, the more will the incidence of the tax be

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upon the buyer. If a seller is faced with inelastic demand, he will find it easier to raise the price and pass on the money burden to the consumer, e.g., salt, sugar, tobacco, etc. On the other hand, if the product has elastic demand, the seller cannot raise the price, e.g., luxuries. Thus, incidence will depend partly upon the nature of demand. The greater the inelasticity of demand, the higher the possibility of incidence being shifted to the consumers; the greater the elasticity of demand, the more will the incidence be on the seller. Tax shifting and incidence also depend upon the supply of the commodity. If the supply of the commodity is elastic, the tax burden will full on the buyers. On the other hand, if tax is levied on a commodity with inelastic supply, incidence will be on the sellers. The theory of incidence and shifting can be conveniently illustrated by geometrical method. (Refer the graph on page 6) Let DD be the demand curve and SS the supply curve for a commodity, PM the price per unit and PN the amount sold per unit of time. Now the government imposes a tax on the commodity and collects it from the seller. Let S 1S1 be the new supply curve, P1M1 the new price, P1N1 the new amount sold and P1R the tax per unit. The price rise by P1Q and the sales fall by PQ. The incidence of the P1R is divided between buyers and sellers. The buyers bear P1Q and the sellers QR. Now elasticity of demanded = (MM1/OM)/(P1Q/PM) And elasticity of supplyes = (MM1/OM)/(QR/PM) P1Q/QR = es/ed i.e. the incidence is divided between buyers and sellers in the ratio of the elasticity of supply to the elasticity of demand. The above analysis can be summarized thus: the direct money burden of a tax (incidence) imposed on any object is divided between the buyers and the sellers in the proportion of the elasticity of supply of the object taxed to the elasticity of demand for it. When the elasticity of supply is equal to the elasticity, of demand, the burden is equally divided, the price 64

of the object taxed rises by half the amount of the tax. PUBLIC DEBT Public debt is the sum total of the State's debt to its own citizens at home and to foreigners indicates the debts of the central and state governments and local bodies. There was a time when public debt was considered a "financial plague" which must be avoided at any cost. But the requirement of financing was development expenditure like construction of dams, highways, provision of public utilities and welfare services like education and public health etc compelled governments to borrow. The desire of the state to ensure full employment was another compelling reason for public borrowing. Classification of public debt 1. Productive and unproductive debt 2. External and internal debt 3. Voluntary and compulsory debt 4. Long term and short term 5. Redeemable and Irredeemable Sources of borrowing 1. Borrowing from individuals 2. Borrowing from non-Banking financial institutions 3. Borrowing from commercial banks 4. Borrowing from the central bank 5. Borrowing from external sources International institutions like IMF. IBRD (world bank) From foreign governments

Burden of public debt Public debt constitutes some economic burden upon the society incurring it. 1. The burden of internal debt. Here the people owe themselves the debt.

It is like the right hand helping the left hand. If the people who pay the taxes for 65

repaying the debt are also the owners of the public debt, the burden of the public debt is insignificant. But very often the taxpayers and the owners of the public debt are different groups of people. Hence the burden. 2. The burden of external debt. In the case of external debt payment on

the debt will amount to real burden. It involves the transfer of goods and services to the creditor country in settlement of the debt. To that extent external debt will lead to a lowering of national income. But in both cases it should be considered whether the debt is productively invested If the debt is productively invested there will be no net burden and it may increase the welfare of the people. Redemption of debt Debt redemption means the repayment of public debt. The methods used are 1. Sinking fund. A part of government's revenue is invested at compound interest, which in turn can be used for the repayment of the debt. 2. Capital levy. This is the imposition of a very heavy tax on property holders for the repayment of the debt once for all. 3. Refunding. This is an extension of the date of repayment when the government finds it difficult to redeem it. 4. Conversion. This is the substitution of a new debt for an old debt but at a lower rate. Indias public debt The government of India both during the colonial period and in the postindependence period resorted to public borrowings as a method of financing its expenditure programme. Over the years the magnitude and composition of the public debt was increasing. The following table reveals the growth of public debt in India since Independence.

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1950-51 Internal debt External debt Total Rs. 2830 (99%) Rs. 30 (1%) 2860

2002-03 (in crores 1,504,220 (96%) 57650 (4%) 1561570

The main features of India's public debt are 1. The size of the public debt has been on the rise 2. Internal debt constituted a larger proportion of the total public debt. 3. Of the different constituents of the internal debt, loans from the public and market borrowings form a significant proportion. 4. Small savings too become sizable with the passage of time. 5. External borrowing rose sharply in absolute terms, say from Rs 30 crore to Rs 57,650 crore. If we convert them at the prevailing exchange rate it would come to Rs 452.250 crore. 6. Generally public debt has been incurred to meet developmental expenditure 7. The burden of servicing of public debt in becoming heavier with every passing year. Interest payment of the Centre in 2002-03 was Rs 115,660 crores. Debt position of the States The debt position of the states in India is shown in the following table 1961 -20023 (Rs in crores) 1961 Internal debt Loans and advances from the Central Government Provident funds etc Total 590 2,020 130 2,740 2003 (Rs in crore) 309,610 258,130 115,430 683,170

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The following points can be observed 1. The aggregate public debt of State Governments is increasing over the years and is around 2.7% of the GDP. 2. The relative importance of internal debt and the comparative fall in the loans and advances from the central government. 3. That the Union Government is in a position to raise loans at more favorable terms than the States.

Deficit financing
Deficit financing is an important technique of development finance in developing countries to meet the financial needs of planned development. Deficit financing implies the, financing of a deliberately created gap between public revenue and public expenditure either by running down its accumulated balances or by borrowing from the Central Bank. Deficit financing generally involves the following elements: (1) borrowing from the Central Bank (2) withdrawal of cash balances (3) issue of new currency (4) borrowing from commercial banks. Deficit financing had been an effective monetary device rigidly resorted to for securing war finance. Subsequently deficit financing got itself labeled as the Keynesian technique to fight depression. Lastly deficit financing has been resorted to for purposes of economic development of underdeveloped countries under the term "developmental deficit financing". Developmental deficit financing may be defined as a device for diverting resources from current consumption to capital formation. The theoretical justification for deficit financing in advanced economies is based on the assumption that the major cause of depression is the fall in effective demand. Deficit financing in such a case would increase money supply and the purchasing power of the people leading to fuller utilization of resources and thereby the revival of the tempo of economic activity. Deficit financing if kept within proper limits can prove to be of immense value in promoting economic development. 1. The urgency of economic development in underdeveloped countries where finance is the limiting factor justifies the creation of new money especially 68

when other sources like taxation, surplus from public enterprises and public borrowing are limited. So long as the unutilized and underutilized physical resources are lying idle, are mobilized through created money, deficit financing is justified. 2. In a developing country there is a relatively large non-monetized sector which tends to shrink under the impact of planning. The additional money created through deficit financing will go to meet the increased demand for money from the newly monetized sector. 3. Deficit financing is an alternative to rigorous austerity measures. 4. A mild dose of inflation has toxic effect on the economy so long as it gives price incentives to the producer. Limits of deficit financing If not kept within limits deficit financing may cause unwelcome results. So 1. Deficit financing should be limited to the needs of the economy. These limits are set by the relationship between money supply and general price level, the rate of growth of GDP, the rate at which the barter part of the economy is being monetized etc. 2. The limit of deficit financing also depends upon the effectiveness of the tax system to mobilize the surplus money and the saving schemes prevailing in the economy for the same. 3. An effective programme of price control of wage goods and a central distribution of essential commodities. Evils 1. The expansion of money supply may be larger than what the economy could bear. If output is not rising as fast as the rise in money supply inflation sets in. 2. The burden of development under inflationary conditions falls heavily on the lower and fixed income groups; the debtors become gainers and creditors the losers.

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3. Saving in real terms suffered. 4. Investment may be distorted through the production of non-essential goods. Revenue deficit Revenue deficit is the difference between the revenue expenditure and revenue receipts of the Central Government. Revenue expenditure of the government is composed of both plan and non plan expenditure. And revenue receipts is the sum total of tax revenue and non tax revenue. Thus revenue deficit = revenue expenditure - revenue receipts. Till the middle of the 1970s the revenue receipts of the Central government exceeded its revenue expenditure. But with the growth of general administration, defence, interest payments and subsidies revenue deficit became a continuous feature of the Central budget. Budget deficit Budget deficit occurs when total expenditure exceeds total revenue. Total expenditure is composed of both the revenue expenditure and capital expenditure. Similarly total revenue is the sum of both the revenue receipts and capital receipts (including market borrowings and other liabilities). Thus: budget deficit = Total expenditure - total revenue. It was this budgetary deficit which was called deficit financing by the government of India in the 1950s. Fiscal deficit Fiscal deficit is budgetary deficit plus market borrowings and other liabilities of the government. Fiscal deficit shows the gap between government receipts and government expenditure. It indicates the total borrowing requirements of the government from all sources. Fiscal deficit is related to the GDP. 2003-04 = Rs 153,640 (crore) = 5.6% of GDP. Primary deficit Primary deficit is fiscal deficit minus interest payments, ie, 153,640 123,220 = 30,420 crore (2003-04).

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MODULE 5

THE INDIAN FINANCIAL SYSTEM

The financial system is comprised of (a) financial instruments (b) financial institutions and (c) financial markets. The financial system provides financial services which help in mobilizing savings of the economy and allocating the same among the investors. The essence of financial system lies in its role as an intermediary between those who have surpluses to lend and those who want to borrow. The lenders are the savers and the borrowers are the investors. The financial system provides financial assets in which savers keep their savings. It transfers the funds thus collected to the borrowers against the securities offered by them. The users of financial services are classified into (1) The households or individuals. Households use the financial services for lending and borrowing. The households are a group, are generally a net lender, though a few are availing credit from the system (2) The business: The business sector is a net borrower. The internally generated resources of this sector fall short of their requirements. The business sector requires short-term credit as working capital and long-term funds to finance capital expansion (3) The government sector: This sector is also a net borrower. Governmental revenue falls short of its expenditure. Hence government borrows from banks and non-bank financial intermediaries. The financial system caters to the needs of both lenders and borrowers. For lenders several alternative avenues are made available. The savings can be kept in the form of deposits of varying maturity, marketability and yield. The borrowers are also served by the financial system in a variety of ways. The financial system contributes enormously to the expansion and diversification of an economy. It facilitates the expansion of trade, savings and investment. There are several types of institutions providing financial services. (1) The Central Bank (RB.I) (2) Deposit and credit institutions (commercial banks) (3) Contractual saving institutions (L I C) (4) Collective investment institutions (mutual funds) (5) Securities markets (money and capital markets) (6) Informal financial

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enterprises (indigenous banks). During the last three decades there was a considerable degree of proliferation of financial institutions and instruments and a vast expansion in the volume of transactions. Still the Indian financial system is beset with certain problems: 1. The people bank-office ratio in India is still very high with reference, to developed countries. 2. The financial system in India is inefficient. Its productivity is low, hence not profitable. 3. Existence of financial dualism. The Indian financial system is characterized by the simultaneous working of a modern sector and an unorganized sector. 4. The working of the financial system is marked by a number of distortions. A significant part of the credit is directed credit. Further a significant part of the credit is given on lower interest rate.

FINANCIAL ASSETS
Financial assets are generally classified into (1) primary or direct securities (2) secondary of indirect securities. The former are financial claims against real sector, e.g. bills, bonds, equities etc. The secondary securities are financial claims issued by financial institutions against themselves to raise funds from the public, e.g.: bank deposits, insurance policies etc. In the present day Indian economy, important financial claims are currency, bank deposits, post office savings, insurance policies, bonds, shares, units of UTI, chit funds etc. INDUSTRIAL DEVELOPMENT OF INDIA India had a glorious industrial past. The Dacca muslin and Kashmir shawls were world famous. Indian cotton, silk, embroideries and jewels were traded by the East India Company. But these industries declined with the advent of the British rule. Unfair competition of machine-made goods, the step motherly policy of the British, lack of industrial finance etc were some of the reasons for their decline. But post-

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independence period witnessed unprecedented growth in the industrial sector. India now occupies the 10th rank among the most industrialized countries in the world. The most noteworthy feature is the great diversification of the Indian industry. Innumerable new industries and new products have made their appearance. Industrialization has a major role to play in the development of an economy. The gap in the per-capita incomes between the developed and the undeveloped countries is reflected in the disparity in the structure of their economies. The developed countries are largely industrial economies while undeveloped countries are predominantly given economies with limited output. The industrial factor contributes significantly to the achievement of a self-sustaining economy with continued high levels of industrialization is also associated with the development of mechanical knowledge, attitudes and skills of industrial management. Industrialization will enhance the productivity of agriculture and will absorb the surplus labour in the sector.

Industrial pattern and structure

Historically industrial development has proceeded in three stages: 1. The processing of primary products: milling grain, extracting oil, tanning leather, spinning vegetable fibers, preparing textiles and smelting ores. 2. Transformation of materials: make bread and confectionaries, footwear, metal goods, cloth, furniture and paper. 3. Manufacture of machines and other capital equipment to be used for the production of consumer goods. The industrial pattern during the British rule was marked by 1. Low capital intensity 2. Limited development of medium-sized factory enterprises and 3. Imbalance between consumer goods and capital goods industries. With the advent of planned economic development, the Government of India launched the process of industrialization as a conscious and deliberate policy of economic growth. Industrialization in India was used as

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1. a base for the growth of agriculture sector 2. as a catalytic agent for the development of infrastructure 3. as a stimulant to generation of technologies through R&D and 4. as a growth multiplier. The process of industrialization under Industrial Policy Resolution of 1956 and vigorously implemented under the Five Year Plans, involved heavy investments in building up capacity over a wide range of industries. As a result, industrial production went up by five times. The industrial structure has been widely diversified covering broadly the entire range of consumer, intermediate and capital goods. Indias imports of manufactured goods have steadily declined. At the same time, industrial products particularly engineering goods have become a growing component of India's exports. India has attained self-sufficiency in almost all consumer goods. Growth of capital goods production has been impressive. An impressive industrial capacity has been achieved in mining and metallurgical industries, chemical and petrochemical industries, fertilizer production, capital goods industries including sophisticated equipment of steel mills, fertilizer plants, chemical plants, light-medium and heavy engineering industries, power and transportation industry, construction industry etc. Overall growth in industrial production since 1951 has been over 6%, through not steady in nature. Besides the uptrend in the growth rate, the industrial sector has been marked by a change in the structural composition. Since the Second Five Year plan the basic and capital goods industries witnessed a rapid growth. As a result, the industrial structure now leans quite heavily towards capacity-building industries. The growth rate of intermediate and consumer goods has been lower than the general growth rate. Of the two types of consumer goods, the durable goods witnessed a higher rate than the non-durable goods. Structural Classification of the Indian Industry-2001 Basic Goods 35.6 Capital Goods 9.3 Intermediate Goods 26.5 Consumer Goods 28.6

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Inadequacies of the programme of industrialisation Post-independent industrial development was beset with certain problems: 1. Unsteady volume of growth. Industrial development through reasonably good was marked by fluctuations in the growth rate. Not only the overall growth rate but also structural growth was erratic and fluctuating. 2. Inefficient working. Many industrial units, particularly in the public sector, were working inefficiently. So the cost per unit of product is very high. Productivity is rather low. So the competitive power of the Indian product in the world market is very low. 3. Industrial sickness. Many industries are coming under the category of sick units. This in turn will lead to their closure. Industrial sickness in characterized by failure to meet statutory liabilities like provident fund, failure to pay timely installment of principal and interest on loans taken from financial institutions, increase in salaries, low capacity utilization etc. 4. Regional Imbalances. An unhealthy feature of the Indian industrial scenario is the regional disparities in their distribution. States like AP, Gujarat, Tamilnadu and Maharashtra account for a very large proportion of industrial units in the country. Bihar, UP, MP, etc come in the bottom line of this grouping. 5. Low employment creation. Industrialization in India failed to create employment to a significant level. This is particularly true in the case of large scale industries which are generally capital industries in nature.

INDUSTRIAL SICKNESS
The problem of sickness in industries has become very acute in India. It has already affected the health of the industrial sector in par1icular and the economy in general. The Sick Industrial Companies Act 1985 defined a company as sick if (1) it was registered for at least five years; (2) it incurred cash losses for the current and the previous year; (3) its net worth was eroded. The problem of industrial sickness has grown over the years and a large number of industrial units in the small scale sector and non-small scale sector are affected by it, e.g., the total number of

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sick/weak units in 1980 was 24,550 with outstanding bank credit of Rs. 13798 crore. The extent of industrial sickness varies by sectors and across regions. In the category of large and medium sick units, engineering and textile industries accounted for about 33% of the total credit outstanding and 30% of the number of total units in the category of large and medium sick units. Causes Causes of industrial sickness are divided into two categories: they are I. External causes. (a) Power cuts. A large number of industrial units face power cut from time to time. (b) Erratic supply of inputs. Some units depend on scarce raw materials whose supply is erratic. This results in disturbing the production schedule causing losses to the unit (c) Demand and credit constraints. At times recession in the market causes steep decline in the demand resulting in unsold stocks and losses to individual units. The fall in demand is aggravated by the imposition of credit restraints. (d) govt. policy. Sudden changes in govt. policy relating to imports, exports, industrial licensing, taxation, etc, can make viable units sick overnight. II. Internal causes: (a) Faults at the planning and construction stage. Wrong location of the industrial unit absence of market analysis, underestimation of the project costs, etc, may disturb the normal functioning of these units. (b) Defective plant and machinery. By selecting defective plant and machinery, the units suffer losses and will turn sick (c) Financial problems. A number of units face acute financial problems right from the stage of planning and construction to the stage of implementation and beyond. Often these units borrow from financial institutions but are unable to meet the repayment schedules. (d) Many persons setting up industrial units are incompetent entrepreneurs. Further faulty managerial decisions in the field of production, marketing, finance, personnel of management, etc, can ruin a business. (e) In some cases, acute labour- problems have resulted in strikes, lockouts and even c1osure of industrial units. Consequences of industrial sickness Industrial sickness can have serious consequences: (1) India is a labour

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surplus economy. Accordingly closure of an industrial unit is likely to render workers unemployed. (2) Closure of a unit causes labour unrest. (3) Industrial sickness will lead to wastage of resources, (4) Sickness in one unit is likely to affect adversely a number of other related units, (5) Closure of a large sick unit creates a psychology of despair among investors. (6) Closure of industrial units causes substantial financial losses to banks and other financial institutions. (7) Sickness in industrial units results in loss of revenue to the central, state and local governments. Remedial measures Financial institutions grant various concessions to sick industrial units in a bid to rehabilitate them. (a) Grant of additional working capital facilitates to overcome the shortage of working capital. (b) Recovery of interest at reduced rates, (3) Suitable moratorium on payment of interest. (d) Freezing a portion of outstanding in the account. Government has also provided certain concessions to assist revival of sick units (1) Tax benefits are given to healthy units when they take over sick units. A scheme for provision of margin money to sick units in the small scale sector on soft terms to enable them to obtain necessary funds from banks and financial institutions to implement their revival scheme is introduced. The government established the Industrial Reconstruction Corporation of India with a view to reviving and rehabilitating sick units. The government announced a scheme for the grant of excise loan to sick\weak units. Accordingly, selected sick/weak units are eligible for excise loan not exceeding 50% of the exercise duty actually paid for 5 years. Further, the government of India set up the Board for Industrial and Financial Reconstruction (BIFR) for determining the preventive ameliorative, remedial and other measures to be taken in respect of sick industrial companies. In addition to the above mentioned measures, certain other steps are to be taken to remedy this problem Reduction in custom duties, deregulation, delicensing and decontrol in several spheres of activities are required so that these units can operate competitively in the market. Upgradation of technology is an important requirement for competition particularly in the world market.

TRADE UNIONS

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Trade unions are voluntary organisations of workers formed to promote and protect the interests of workers through collective action, The first quarter of the 20th century saw the birth of the trade union movement in India. The Trade Union Act was passed in 1926. The Act gave a formal recognition to the workers' right to organize. The Act provides for the registration of trade unions. Any 7 or more members of a trade union may apply for registration of their union under the Act. The important central trade union organisations in India are: INTUC, AITUC, HMS and BMS. Membership of trade unions was growing over the years, e.g., the list submitted by trade unions in 1951 contained a member-ship of 20 lakh. It has increased to 41 lakh in 1994. And there were over 50,000 registered trade unions at that time. Rationality of trade unions As an Institution trade unions play an important role in the economy. In a market economy trade unions are needed to overcome the weakness of labour. (l) Workers in their individual capacity are at a disadvantage as compared to employers. (2) Their power of bargaining is inherently weak because they cannot store labour when its price, ie wage, is low (3) With large labour supply workers are susceptible to the manipulations on the part of employers. Weakness: There are certain defects in the Indian trade union movement. They are (1) predominance of small-sized unions. (2) Poor finance of the unions on account of the small size and also on account of the small subscriptions. (3) Absence of whole-time paid officers (4) Union movement has not as yet spread to the labour in the unorganized sector. (5) There is a proliferation of unions with little corresponding expansion in membership. (6) There is rivalry among unions. (7) The leadership of many unions has been from outside. (8) The administration of the trade unions is weak. Benefits: Labour when organized can do a lot to improve its own conditions. (1) Trade unions through their collective bargaining power can gain much. The fight through offer of negotiation, threat to strike, actual strike, etc is mounted to secure higher wages, reduced hours of work, share in profits etc. (2) They are doing some fraternal functions of help to workers in times of need such as

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during illness, litigations, etc, facilities for improving their efficiency, spreading education, etc. (3) In some countries trade unions fight election to capture political power. Suggestions for improvement (1) Eradication of illiteracy among workers. This will help in the growth of leadership from among the workers. (2) Unions must provide welfare facilities to workers, such as mutual assistance in times of need and distress, performance of cultural and social functions, etc, This will create a spirit of belonging. (3) The structure of trade unions must be reformed. Avoidance of casteism and communalism, establishment of one union in one industry, the use of ballet system to elect the representative of trade union, elimination of outside political interference etc are needed. (4) Attitudes of the trade unions must be changed. Trade unions should not be mere fighting bodies. Instead they must act as cooperative agencies. While fighting for the cause of workers, they must cooperate with the employers in the production process. It is through such cooperation between workers and employers that the issue of workers' involvement in the management can become a live reality.

INDUSTRIAL LABOUR
Labour is the most important factor or production. It acts both as a producer and as a consumer. It is the human factor of production. Industrial labour stands for all labour engaged in large and small industrial establishments, including cottage industries. But in India industrial labour refers to those workers who are employed in organized industries. Industrial labour is only 3% of the total working population or about 32% of workers engaged in industries. But on account of its organisation and contribution to national income, industrial labour occupies an important place in our economy. Industrial labour in India has exhibited certain features. (1) Most industrial workers have their roots in villages. (2) They are largely uneducated. (3) Industrial labour in India is not united but is divided and subdivided on the basis of region, religion, language and caste (4) Indian workers do not remain in the same job for a considerable amount of time.

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The wage situation in India presents a picture of no uniformity One important feature of the wage situation of the country is the existence of many wage rates \Vit1un the major industrial group the number of wage rates is as many as industries. Another feature is that the wage structure is grossly distorted so that workers of the same category are getting different wages. There are huge differentials between different types of wages and salaries, e.g., top salaries in certain enterprises are 16 to 18 times as high as wages of unskilled workers. The higher wages and salaries are more a result of organized oligopolistic class interest rather than an index of their productivity. Within the organized sector, the wage levels are determined by unionized action. Outside the organized sector, workers are paid wages which are almost equal to distress selling of labour. Very often wage rates in the organized industry bear little relations with their productivity. Industry wise wage boards, long-term wage settlements, unconscious of the benefits of such wages both by the management and the labour etc are the reasons for this.

Industrial disputes
Capitalist economies are plagued with frequent disputes in the industrial sector for the interests of the capitalists (employers) and the workers are often at variance. While the former are interested in reducing the wages and increasing the hours of work, the latter are interested in increasing wages and bettering the conditions of work Industrial disputes often lead to strikes and lockouts. Strikes are resorted to by workers to safeguard their interests, while lockouts are resorted to by capitalists to pressurize the workers and compel them to tow their lines. The progress of industrialization has been accompanied by increases in industrial disputes in India. The desire for higher income, steep price increases and rising costs of living etc have compelled workers to resort to strikes. Political reasons also lead to the stoppage of work and the loss of man days. The total loss of man days due to lockouts and strikes in 1951 was 38 lakh. This has increased to 288 lakh man days in 2000. The industrial unrest is not only large but also spreading extensively. The industries affected have been of large variety, producing consumer goods, intermediate goods and capital goods. The work stoppages have resulted in huge losses to the country. The

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workers suffered a lot on account of wage cuts or nonpayment of wages. The society suffered in terms of reduced production. All those who were engaged in supplying inputs and those employed in the distribution of goods also suffered. Government also loses revenue due to production loss, through commodity and income taxes. The society also suffers through emotional upsets, physical injury, law and order problems, etc.

Industrial relations
For the smooth functioning of industries, the cooperation of workers and employers is a pre-requisite. It is of utmost necessity that industrial disputes do not occur or if they do, they do not last long. Industrial relations refer to manifold contacts between the workers and the employers in, about, and around the work. The conditions of service in respect of fixation and payment of wages, leave, bonus, hours of work, the facilities for work, the welfare activities etc all bear upon the mode and manner of contact between the parties. These relations are based upon interests that are common between workers and employers, as also interests that are opposed to each other. The healthy industrial relations are the key to progress. The most important benefit is that this ensures continuity of production. Peaceful industrial relations promote healthy work ethos. Further peaceful industrial relations provide stability to social setup. India's industrial relations policy has had the following two basic objectives: (1) Prevention and peaceful settlement of disputes. (2) Promotion of good industrial relations

COTTAGE AND SMALL-SCALE INDUSTRIES

Small-scale enterprises are divided into cottage industries and small scale industries. A cottage industry is one which is carried on wholly or primarily with the help of the members of the family either as a whole time or part-time occupation. The important features of cottage industry are 1. Most of the cottage industries are associated with agriculture.

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2. They are generally found in rural areas. So they are also called village industries. 3. They are generally carried on with the help of members of a family. 4. The capital investment is small. 5. They are working with the locally available raw materials. 6. They are carried out as subsidiary occupations to farming. 7. They mainly use hand power. Small scale industries include all industrial units with a capital investment of Rs.1 crore (for ancillary industries, Rs.5 crore). 1. They generally provide whole time occupation to their workers. 2. They are located in urban and suburban areas. 3. They use machines and they produce modern goods. 4. They employ a large number of hired workers.

Role of cottage and small scale industries

Cottage and small scale industries are playing a very important role in the economy of our country. They form the second largest sector in our country; the first being agriculture. it is estimated that out of every 5 persons employed in industries, 4 persons are engaged in small scale enterprises. Even in advance countries cottage and small scale industries occupy a very important role, e.g., more than 50% of the population f Japan depend on small scale undertakings employing less than 5 workers. 1. Small scale industries are labour intensive. In a country like India, the problem of unemployment can be solved by developing small scale industries. 2. They require less capital. In a country like India, where capital is scarce small scale industries are most suitable. 3. Small scale industries do not require the services of highly skilled personnel.

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4. As agriculture is seasonal, fanners get employment only during certain seasons in a year. They can find employment and earn income in off season also from cottage industries. 5. Small scale industries do not normally require imported machinery. This reduces the need for foreign exchange earnings. 6. Cottage and small scale industries are quick yielding. The quick yield from investment will have a controlling effect on inf1ation. 7. As small scale industries are capital light, skill light and import light, they can be started anywhere in the country. This will help the balanced growth of the country. 8. Unlike large scale industries, small industries do not lead to concentration of wealth and income in the hands of a few. 9. Large industries are usua1ly concentrated in big cities and towns. This creates problems like overcrowding, slum housing, pollution etc. Development of cottage and small scale industries creates no such problems. 10. Small scale industries can produce and supply parts and components to large scale industries. This will help the speedy development of large scale industries. Problems Cottage and small scale industries face a number of problems. 1. The techniques of production used in cottage and small scale industries in India compared to those used in advanced countries are out-moded. 2. Lack of adequate finance hinders the growth of small scale industries in India. 3. The supply of raw materials and transport facilities are quite inadequate. 4. Imported finished products and unhealthy competition from large scale industries impede the growth of small scale industries. 5. Shortage of power very often prevents the smooth functioning of these industries. 83

Promotional measures
A variety of measures have been taken by the government to support and promote cottage and small scale industries since Independence. 1. In order to protect the small scale industries from the stiff competition of the large scale industries, the government has reserved certain items for the exclusive production of small scale industries. 2. The National Small Scale Industries Corporation gives assistance to these industries to obtain a greater share of government purchases for civil and defence uses. Certain products of these industries are bought even at a higher price. 3. Loans are given to these industries at concessional rates of interest. 4. Arrangements are made for the supply of machineries and raw materials and for the marketing of finished goods. 5. Technical advise and other assistance are provided. 6. Several All India Boards, like Khadi Board, have been set up to deal exclusively in specified commodities. 7. Creation of industrial estates where entrepreneurs are provided with accommodation and other basic facilities. The small scale industrial sector has recorded a high rate of growth since Independence. The number of registered units has gone up from 16,000 units in 1950 to 33.7 lakh units in 2001. And the small scale sector has progressed from the production of simple consumer goods to the manufacture of many sophisticated and precision products like electronics control system, micro-wave components, electromedical equipment, T.V. sets etc. INDUSTRIAL POLICY At the time of independence, the industrial base of the Indian economy was very small and the existing industries were beset with many problems. The major problems were shortage of raw materials, deficiency of Capital, poor industrial relations and the low level of technology. Besides the investors were not sure about

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the industrial policy of the national government, Accordingly the government of India issued the first industrial policy resolution in 1948

Features of the policy

1. Acceptance of the importance of both private and public sectors. The new policy accepted the importance of both public and private sectors in the economy. The policy adopted a two-pronged strategy- a) expansion of the state Sector in areas where it was operating and in new lines of production. b) allowing the private sector to subsist and expand albeit under proper direction and regulation. 2. Division of industrial Sector. The policy divided industries into 4 categories. a) Industries where State had a monopoly arms and ammunition, atomic energy and road transport. b) Mixed sector 6 industries were specified in this category -Coal, Iron and steel, air craft manufacture, ship building, manufacture of telephone and mineral Oil. Here the State was to have exclusive right to setting up new undertakings. Existing private 1.mdertakings were allowed to continue for lO years after. which the government would review the situation and acquire any existing undertaking after paying compensation 00. a fair and equitable basis. c). The field of government controll8 industries of national importance were included in this category. The government did not undertake the responsibility of developing these industries but considered them of such importance that their regulation and direction was necessary -heavy chemicals, heavy engineering, machine tools etc. d) The field of private enterprise, All other industries were left open to the private Sector. 3. The Role of small and cottage industries. The 1948 policy accepted the importance of small and cottage industries. These industries are particularly suited for the utilization of local resources and for the creation of employment opportunities. 4. Other features. The role of foreign capital in industrial development of the economy was recognized but they must be regulated and controlled. Indians should have a major say in the ownership and management. The policy called 85

for a harmonious relations between the management and labour in industrial units.

Industrial policy of 1956

In 1956 the ruling congress party had declared socialist pattern of society as the goal of the country. Hence the need for a new industrial policy. The objectives of the 1956 policy were 1) to accelerate the rate of growth industrialisation 2) to develop heavy and machine making industries 3) to expand public sector 4) to reduce disparities in income and wealth 5) to build up a large and growing co-operative sector 6) to prevent monopolies and the concentration of wealth and income in the hands of a small number of individuals.

Features of the policy

1. Division of industrial sector. The new policy divided industries into three categories,. a) Monopoly of the State 17 industries were included in this category. They were defence industries, heavy industries, minrals , transport and communications and power. However existing units in the private sector were allowed to subsist and expand b) Mixed sector of public and private enterprise. In this section 12 industries were included. In these industries State would increasingly establish new units and increase its participation. ego road transport, drugs, fertilizers etc. c) Industries left for the private sector. All other industries were left open to the private sector. 2. Mutual dependence of public and private sector. The public and private sectors were not be exclusive and totally independent of one another. The government could establish units in any of the industries on the one hand and could also allow the private sector to operate in any field reserved for the public sector except arms and ammunition atomic energy, railways and air transport. The government could assist expansion and development of private sector through participation in tis risk capital and share capital and by providing other types of services, fiscal incentives etc. 3. Reduction of regional inequalities. The 1956 policy called for reduction in regional imbalances and inequalities

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4. Importance of small scale and cottage industries was recognized by the policy. 5. The 1956 industrial policy advocated the establishment of proper technical and managerial cadres through the apprenticeship schemes of training on a large scale, establishment of technical institutions, organisation of management courses in universities etc. Many significant amendments were made on the 1956 policy resolution while retaining the basic nature of the policy. ego in 1973 the idea of joint sector was incorporated to the 1956 policy. In 1980 the government of India allowed the private sector to expand its activities and even set up industries in the sector reserved for the State.

New industrial policy 1991

The liberalization of the Indian economy pursued by the Rajiv Gandhi regime in the early 80's gather momentum in the early 90's under the Narasimha Rao dispensation. Indian economy witnessed a new era of liberalisation, privatisation and globalisation. And a new industrial policy was accordingly announced in July 1991. This new policy de-regulates the industrial economy on India in a substantial manner. The major objectives of the new policy were to build on the gains already made, correct the distortions or weaknesses that might have accept in, maintain a sustained growth in productivity and gainful employment and to attain international competitiveness. In pursuit of these objectives the government announced a series of initiatives in the new industrial policy. 1. Abolition of industrial licensing. In a major move to liberalise the economy the new industrial policy abolished all industrial licensing, irrespective of the level of investment except for certain industries related security and strategic concerns, social reasons, concerns related to safety and overriding environmental issues, manufacture of products of hazardous nature and articles of elitist consumption. 2. Diluted public sector. The number of industries reserved for the public sector has been reduced to 6 Industries which continue to be reserved for the public sector were in areas where security and strategic concerns predominate. For enterprises remaining in the public sector will be provided a much greater 87

degree of management autonomy. The government has also announced its intention to offer a part of government shareholding in the public sector enterprises to mutual funds, financial institutions, the general public and the workers. 3. MRTP limit goes. The new industrial policy scrapped the threshold limit of assets (Rs 100 crores) in respect of Monopolies and Restrictive Trade practices and dominant undertakings. These firms are now be at par with others. 4. Free entry to foreign investment technology, The new industrial policy has prepared a list of high technology and high investment priority industries wherein automatic permissions be available for direct foreign investment up to 51 percent foreign equity. Further 9 categories are eligible for 74 percent foreign equity. A third group of industries are allowed to work with 100 percent foreign equity. 5. The new industrial policy provides that in locations other than cities of more than I million population there will be no requirement of obtaining industrial approvals from the centre except for industries subject to compulsory licensing. 6. Other features. The phased manufacturing programmes have been abolished in the new policy Similarly contents requirements was also done away with. Further the mandatory convertibility clause imposed by financial institutions was removed. LARGE SCALE INDUSTRIES The basis of distinction between the large scale and small scale industries in generally the size, capital resources and labour force of the individual unit. The industries Act 1951 considered employing less than 50 watts with power and less than 100 watts without power as small scale field. Any units working above these conditions are listed as large - scale sector. Another criterion related to the fixed capital investment in a unit, the investment limit for small- scale sector was fixed at Rs 3 crore in 1997.

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The main features of large -scale industries are as follows.

1. Comparatively large capital is required. 2. They are largely capital intensive, providing employment to a few people. 3. They are generally corporations or joint stock companies. 4. Personal supervision is not possible for these concerns. Instead management is required for their operation. 5. They are using the most modem technique of production. 6. Volume of output is very large. 7. Yielding more revenue to the government.

SOME MAJOR INDUSTRIES OF INTRODUCTION

1. The iron and steel industry. 2. The jute Industry 3. The cotton textile industry 4. The sugar industry 5. The Cement Industry 6. The paper industry 7. The petrochemical Industry 8. The engineering industry

MAJOR TAXES OF THE CENTRAL GOVERNMENT

I. Direct Taxes a. Personal income Tax - Tax on individuals b. Corporation Tax - Tax on companies c. Estate duty - Tax on inheritance d. wealth tax - Tax on accumulated wealth. II. Indirect Taxes

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a. central excise duty- Tax on commodities produced with in the country. b. Service Tax - Services like telephone, insurance, brokerage etc attract this tax c. Customs duty- Both import duties and export duties on commodities.

MAJOR TAXES OF THE STATE GOVERNMENTS

I Direct Taxes a. Land Revenue b. Stamps and Registration c. Motor vehicle tax d. Agricultural income Tax

II

Indirect Taxes
a. State excise duties- duties on alcoholic liquors b. General Sales tax- Now is being replaced by VAT

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