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The basics of Economics

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GDPI Essay Module


The study of the economy as a whole, and the variables

that control the macro-economy.

The study of government policy meant to control and
stabilize the economy over time, that is, to reduce

fluctuations in the economy.

The study of monetary policy, fiscal policy, and supplyside economics.
While microeconomics studies individual components,
macroeconomics studies the economy as a whole.
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Macroeconomic Variables
Economic output

Interest rates
Government finances

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Functional Relationships between

Macroeconomic Variables
Many macroeconomic variables are interrelated. Some relationships
are positively related, while others are inversely related.

The growth in real GDP and the rate of unemployment are interrelated.
Greater output is associated with high levels of employment. It therefore follows that
increases in real economic growth would be associated with reductions in the rate of

The Phillips Curve

The Phillips curve represents a statistical relationship between unemployment and
inflation. It shows that rate of unemployment is inversely proportional to the rate
of inflation.

The dilemma posed by the curve is that the economy must accept inflation in order
to achieve full employment or to accept a high unemployment rate to control
Interest rates & inflation rate are interrelated
Usually, high interest rates lead to lower rates of inflation

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Factors influencing Business Environment

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National Income Analysis

National Income Account records the value of national
income that results from production and expenditure.

Producers earn income from buyers who spend money on goods

and services.
The amount of expenditure by buyers =
the amount of income for sellers =
the value of production.
National income is often defined to be the income earned by a
nations factors of production.
The two most popular measures of National Income are GDP &

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Gross Domestic Product

Gross domestic product (GDP) is the market value of all officially
recognized final goods and services produced within a country in a
year, or other given period of time.
GDP can be measured by the Income Approach or the Expenditure
Expenditure approach:

GDP = private consumption + gross investment + government spending +

(exports imports), or

Income approach:

GDP = Rents + Interests + Profits + Statistical Adjustments + Wages, or

[Statistical Adjustments = corporate income taxes + dividends]

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Gross National Product

Gross national product (GNP) is the market value of all officially
recognized final goods and services produced by the normal
residents (usually citizens) of a country in a year, or other given
period of time.
GNP = GDP + NR (Net income inflow from assets abroad or Net
Income Receipts) - NP (Net payment outflow to foreign assets).
Where, NFIA = Net Factor Income from Abroad (= NR NP)

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Circular Flow of Income

Circular flow refers to a simple economic model which describes
the reciprocal circulation of income between producers and
The inter-dependent entities of producer and consumer are
referred to as "firms" and "households" respectively and provide
each other with factors in order to facilitate the flow of income.
Firms provide consumers with goods and services in exchange for
consumer expenditure and "factors of production" from
There are two flows present within the model including flows of
physical things (goods or labor) and flows of money (what pays for
physical things).
It's a ''money go round'', in a sense!
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Circular Flow of Income 2 sector model

Assumes that there is no savings whatever is produced is consumed.

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Circular Flow of Income 3 sector model

Assumes that there are savings thereby necessitating the third sector - Financial.
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Leakages & Injections in the flow

Leakage means withdrawal from the flow. When households and
firms save part of their incomes it constitutes leakage. They may
be in form of tax payments and imports also. Leakages reduce the
flow of income.

Injection means introduction of income into the flow. When

households and firms borrow the savings, they constitute
injections. Injections increase the flow of income. Injections can
take the forms of (a) investment,(b) government spending and (c)
exports. So long as leakages are equal to injections circular flow
of income continues indefinitely. Financial institutions or capital
market play the role of intermediaries.

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Circular Flow of Income 5 sector model

Condition for Equilibrium:

Total Leakage = Total Injection

Two new sectors Government & Overseas (foreign trade)

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Government Sector & Foreign Trade

The Government Sector consists of the economic activities of
local, state and federal governments. The leakage that the
Government sector provides is through the collection of revenue
through Taxes that is provided by households and firms to the
government. For this reason they are a leakage because it is a
leakage out of the current income thus reducing the expenditure
on current goods and services. The injection provided by the
government sector is Government spending that provides
collective services and welfare payments to the community.
The overseas sector transforms the model from a closed economy
to an open economy through Foreign Trade. The main leakage
from this sector are imports, which represent spending by
residents into the rest of the world. The main injection provided
by this sector is the exports of goods and services which generate
income for the exporters from overseas residents. .
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Demand for Money

The demand for money refers to the desire to hold money; to keep your
wealth in the form of money, rather than spending it on goods and
services or using it to purchase financial assets such as bonds or shares.

The preferences for money over other kinds of assets is known as the
preference of liquidity.
Liquidity describes the readiness with which an asset can be converted
into cash without any significant loss in value.

Wealth held in the form of money provides people with the maximum
freedom of action, because it is readily convertible into any other type of
It is usual to distinguish three reasons why people want to hold their
assets in the form of money, which are transaction, precautionary and
speculative motives.

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Three types of Demand for Money

1.Transactions demand for money: the demand for money for
exchange purposes is called transactions demand for money. If the
transaction is very high then the quantity of money demanded for
transaction is high too. Therefore, the transaction demand for money
is seen as moneys role as a medium of exchange.

2.Precautionary demand for money: that is to hold money for

unexpected expenditures, and emergencies.

3. Speculative demand for money: the demand for money balances

that people desire as a store of value. This kind of demand for money
people wish to hold because of its liquidity and lack of risk. The asset
demand for money varies inversely with the interest rate.
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Four Market Models

Pure Competition
Pure Monopoly

Monopolistic Competition
Market Structure Continuum


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Perfect competition characteristics

Many buyers and sellers
Product homogeneity (standardized products)

Low cost and accurate information

Free entry and exit
The firm is a price taker

There cannot be pure perfect competition. Best regarded as a benchmark

to compare other market structures and their efficiencies.

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Pure Monopoly characteristics

Single Seller
No Close Substitutes

Price Maker
Blocked Entry
Non-price Competition
Two types:

Regulated Monopolies

Unregulated monopolies

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Monopoly barriers to entry

Economies of Scale public utilities
Legal Barriers to Entry

Patents - Pharmaceuticals

Licenses Radio & TV stations

Ownership or Control of Essential Resources DeBeers

Pricing and Other Strategic Barriers to Entry Windows

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Monopolistic Competition
Most firms have distinguishable rather than standardized products
and have some discretion over the price they charge.
Competition often occurs on the basis of price, quality, location,
service and advertising.
Entry to most real-world industries ranges from easy to very
difficult but is rarely completely blocked

Monopolistic Competition mixes a small amount of monopoly

power, with a small amount of competition.

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An oligopoly is a market dominated by a few producers, each of
which has control over the market. It is an industry where there is
a high level of market concentration.
Normally an oligopoly exists when the top four firms in the market
account for more than 60% of total market demand/sales.
In some situations, the firms may employ restrictive trade
practices (collusion, market sharing etc.) to raise prices and
restrict production in much the same way as a monopoly. Where
there is a formal agreement for such collusion, this is known as a
cartel. A primary example of such a cartel is OPEC which has a
profound influence on the international price of oil.

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Certain Important Terms

Goods & Services Tax in India

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Benefits of GST
The biggest benefit is that multiple taxes that currently exist will no longer remain
in the picture. This means that taxes like octroi, CENVAT, central sales tax, state
sales tax, entry tax, license fees, turnover tax etc will no longer be present and all
that will be brought under the GST.
Under GST, the taxation burden will be divided equitably between manufacturing
and services, through a lower tax rate by increasing the tax base and minimizing
It is expected to help build a transparent and corruption-free tax administration.
GST will be levied only at the destination point, and not at various points (from
manufacturing to retail outlets).
Currently, a manufacturer needs to pay tax when a finished product moves out
from a factory, and it is again taxed at the retail outlet when sold.
It is estimated that India will gain $15 billion a year by implementing the Goods
and Services Tax as it would promote exports, raise employment and boost

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Banking Transaction Tax in India needed?

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Tapering is a term that exploded into the financial lexicon in May 2013, when
U.S. Federal Reserve Chairman Ben Bernanke stated that Fed may taper - or
reduce - the size of the bond-buying program known as quantitative easing (QE).
The program, which is designed to stimulate the economy, has served the
secondary purpose of supporting financial market performance in recent years.
While Bernanke's surprising pronouncement led to substantial turmoil in the
financial markets during the second quarter (even Indian Stock Market was
affected negatively), the Fed did not officially announce its first reduction in QE
until December 18, 2013, at which point it reduced the program to $75 billion per
month from its original level of $85 billion.
The second round of tapering has just started now the Fed will buy bonds worth
$ 65 billion a month.
Tapering isnt an immediate, dramatic event. Instead, it is likely to take place
gradually throughout 2014 so as to create minimal market disruption.

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The Food Security Act, 2013

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The Food Security debate

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To be continued
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