IMP OF MACROformulation & execution of

economic
policies,functioning of
eco,helps to understand
micro eco btr, study of eco
development,study of
welfare,theory of inflation
& deflation,international
comparisons.
LIMITATION- excessive
generalization, obsession
of aggregative
approaches,fallacy of
deductive
inferences,inconsistency
b/w overall & individual
change, problems of
measurement of
aggregates. TWO
SECTOR MODEL- six
assumptions-consist of
two sectors
(households&firms)*house
hold spend all their
income(y) on G & S or
consumptions(c)*no
saving*all output
purchased by firms is pur.
By hholds through their
exp(E)*no financial,govt,
foreign sector.

WITHDRAWLS/LEAKAGE
S-it is the amt which is
set aside by HH&firms
and is not spent on the
domestically produced
G&S over a period of
time. it reduces size of
circular flow.
INJECTIONS/ADDITIONS
- it is that amt which is
spent by the HH&FIRMS
in addition to their
incomes generated
within the regular eco.

it size of d circular flow.

THREE SECTORbalanced
,deficit,surplus budget
policy. A deficit BP
implies net injection
into d eco therefore it
expands d circular
flows. On the contrary
surplus BP implies net
withdrawls from the
eco therefore it
decrease circular flows.

FOUR SECTOR
MODEL- it depends on
trade balance,which is
equal to X-M(exportsimports).X represents
injections & M for
withdrawls. If X>M then
circular flow increases
and vice-versa.
S+T+M=I+G+X.

PROB IN ESTIMATION
NATIONAL INCOMEnon monetary
transaction,prob of
double
counting,underground
eco,petty
product,public
services,transfer
payment,capital gain or
loss,illetracy &
ignorance,price
changes.PRECAUTION
S- (transfer
payments,illegal
money,windfall
gains,indirect
taxes,income tax) not
included* (imputed
rent,death duties,gift)
is included. LIM OF NI
IN INDIA-output of
non-monetised
sector,non-availability
of data about d income
of small producers or
HH companies,lack of
differentiation in eco
functions,absence of
data on inc
distribution,unreported
illegal income.
KEYNESIAN THEORY
(LIQUIDITY PREF
THEORY)1)transaction demandt demand for money is
directly related to the
level of income* keynes
assumed prices to
remain constant* AD
for t money is sum of
individual demands*

AD for t money is a
func of d national
incm* thus, Mt=f(Y)
where , Mt=
transaction demand for
money & Y= real
income* the prop of
income held for
transaction purp is
constant & fairly stable
in the short run* thus
given d income, d short
run rltnshp b/w income
& t demand for money
is Mt= ky where k is
const prop of income
demanded for t purp.

2)precautionary
demand- Keynes
argued that both HH
and firms hold some
money in excess of
their t demand to
provide for unseen
contingencies like
fire,theft,accidents etc*
d money help for this
motive is called precau
demand for money* it
is directly related to the
level of income*
Mp=f(Y)* d money
demanded for
precautionary motive is
more interest elastic.
3)speculative demandacc to Keynes, ppl hold
a part of their income
in d form of idle cash
balance for speculative
purpose* this is done,
primarily to take
advantages of the
changes in d money
market* it involves an
element of risk* d price
of bond is inversely
related to the market
rate of interest* spec
demand for money is

inversely related to the

rate of interest* thus,
Msp=f(i) LIQUIDITY
TRAP- two kinds of
speculators- bulls-they
expect interest rate to
go down & bond prices
to go up in future. So,
they convert cash into
bonds. Bears- they
expect interest rate to
go up & bond prices to
go down. They sell
bonds & accumulate
cash* the liquidity trap
is the unlimited pref for
d idle cash balance
when d rate of interest
falls much below the
normal level* at this
stage, even the bulls
turn bears. They too
start blvng that the
interest rate would not
go any further down as
it has reached its
critical minimum
level.* instead they
expect that d interest
rate wud rise & bond
prices will fall.
Therefore,they too start
selling their bonds &
accumulating cash
balance* here, every1
prefers idle cash bal to
bond holding.

FRIEDMANS QTY
THEORY OF MONEY#it treats money as
any other durable good
& treats the demand
for money in exactly d
same as an economist
wud treat any other
durable good where
asked to construct a

model for demand for

it* therefore he applies
the standard theory of
demand for durable
goods to explain the
demand for money as
an asset or real wealth.
Diff b/w two kinds of
ultimate wealth
holders i.e individual
households & business
firms- Demand for
money by UWHS-for
UWHs money is one
form in which they
choose hold their
wealth. Following
variables- 1)total
wealth- it includes both
non-human(physical) &
human wealth. He
considers permanent
inc as a useful index of
total wealth.
2)proportion of human
wealth in total wealthone can buy physical
assets by using ones
current income.
3)expected rate of
return on money &
other assets-the
opportunity cost of
holding money. 4)other
variables that
determine utility of
money. Wealth holders
demand function- M/P=
f(y;w;Rm;Rb;Re;
changeinP/P;u) where
M demand for nominal
money* p=price index*
M/P=demand for real
income* w=fraction of
wealth in non human
form* Rm=expected
rate of return on
money* Rb=ER of
return on fixed value
securities* Re=E return
on
equities*changeinP/P=
ER of change of prices
of goods &hence d ER
of return on real
assets* u= any variable
other than income
which may affect d
utility attachd to d
services of money.
PROBLEMS in applying

due to- change in

distribution of real
income(y) and in
fraction of non human
wealth(w).demand for
money by business
firms- to firms money is
a producers good like
machinery or
inventories. 1)business
enterprises can
acquire additional
capital through d
capital market in order
to maximize der
returns.2)the division
of wealth b/w human&
non-human form hs no
special relevance to
business
enterprises.3)rate of
returns on money and
alternative assets are
as much imp for
business as for the
UWH.3)the variables
classified under u
maybe equally
important for both
kinds of wealth holders.
KEYNES VS
FRIEDMAN- 1)
Friedman uses a
broader definition of
money than that of
Keynes in order to
explain his demand for
money function.
2)Friedman postulates
a demand for money
function quite different
from that of Keynes. 3)
there is also the
difference between the
monetary mechanisms
of Keynes and
Friedman as to how
changes in the quantity
of money affect
economic
activity. 4)there is the
difference between the
two approaches with
regard to the motives
for holding money
balances.
MEASURES OF
MONEY SUPPLYM1=CU+DD+OD*
M2=M1 + savings
deposits with post

offices* M3=M1+ net

time deposits with the
commercial banks*
M4= M3+ total
deposits with post
offices(including
national saving
certificates)* CU is
currency held by
public* DD is net
demand deposits held
by commercial banks*
OD refers to other
deposits with the RBI*
M1 & M2 are known as
narrow money* M3&M4
are known as broad
money.
INFLATION-means a
considerable &
persistent rise in the
general level of prices
over a long period of
time. TYPES-moderate
inflation(creeping inf),
galloping, hyper,
opened& suppressed.
EFFECTS ONdistribution of income,
distri of wealth(assets
can b price
variable&fixed claim),
different section of
society(wage earners,
producers, fixed
income class,
borrowers & lenders,
government), economic
growth, employment.
DEMAND PULL
INFLATION(MONETARY
& REAL FACTORS. //
COST PUSH
INFLATION(WAGE
PUSH,PROFIT
PUSH,SUPPLY SHOCK)
MEASURES TO
CONTROL- monetary,
fiscal, price&wage
control, indexation.
IS CURVE- a curve
which shows
relationship b/w the
rate of interest &
national income, the
product remaining in
equilibrium, that is ,S=I
at different rates of
interest* it represents
the product market*
shows equilibrium path

of d product market at
different rates of
interest* investment is
not assumed to be
constant* at the point
of equilibrium in the
product market,Y=C+I*
the IS curve is
represented by d
function: Y=C(Y)+I(i)*

LM CURVE(LIQUIDITY
PREF & MONEY
SUPPLY CURVE)- this
curve shows the
relationship b/w the
rate of interest and
national income with
money market in
equilibrium* lm curve is
derived from money
market equilibrium
condition: Ms=Md ,
Ms=Md=Mt+Msp,
Ms=Ky+f(i).

MONETARY POLICYQUANT MEASURESopen market

operations,bank
rate,CRR QUAL-credit
rationing, change in
lending margins,moral
suasion,direct controls
FISCAL POLICYbudgetary balance
policy, govt exp,

taxation, public
borrowings.