BASIC ECONOMIC

CONCEPTS

Submitted to:
Harsit buddy Group

Table of Contents
I.

GDP:..............................................................................................................................................2
A.

Nominal GDP:...........................................................................................................................2

B.

Real Gross Domestic Product (GDP).........................................................................................2

II.

Inflation:........................................................................................................................................3
A.

Causes of Inflation.....................................................................................................................3

B.

Costs of Inflation.......................................................................................................................3

C.

Tools to measure Inflation:........................................................................................................4

III.

The Aggregate Supply Curve.....................................................................................................4

IV.

The Aggregate Demand Curve...................................................................................................5

V.

Fiscal Deficit.................................................................................................................................6

VI.

Current Account Deficit.............................................................................................................6

VII.

Repo rate :- (8%).......................................................................................................................6

VIII.

Reverse repo rate:- (7%)............................................................................................................6

IX.

Definition of 'Balance Of Payments (BOP):..............................................................................7

X.

Statutory liquidity ratio (SLR).......................................................................................................7

A.

Determination of SLR................................................................................................................7

B.

Usage of SLR............................................................................................................................8

C.

Objectives of SLR......................................................................................................................8

XI.

Bank rate....................................................................................................................................8

XII.

Definition of 'Fiscal Policy'........................................................................................................8

XIII.

Definition of 'Monetary Policy'..................................................................................................9

XIV.

'Foreign Institutional Investor - FII'...........................................................................................9

XV.

Money Supply'...........................................................................................................................9

XVI. Definition of 'Business Cycle'..................................................................................................10

I.

GDP:- (4.6% current,2.3 trillion US dollars)

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The gross domestic product (GDP) is one the primary indicators used to gauge the health of a
country's economy. It represents the total dollar value of all goods and services produced over
a specific time period - you can think of it as the size of the economy. Usually, GDP is
expressed as a comparison to the previous quarter or year. For example, if the year-to-year
GDP is up 3%, this is thought to mean that the economy has grown by 3% over the last year.
Measuring GDP is complicated (which is why we leave it to the economists), but at its most
basic, the calculation can be done in one of two ways: either by adding up what everyone
earned in a year (income approach), or by adding up what everyone spent (expenditure
method). Logically, both measures should arrive at roughly the same total.
The income approach, which is sometimes referred to as GDP(I), is calculated by adding up
total compensation to employees, gross profits for incorporated and non incorporated firms,
and taxes less any subsidies. The expenditure method is the more common approach and is
calculated by adding total consumption, investment, government spending and net exports.
As one can imagine, economic production and growth, what GDP represents, has a large
impact on nearly everyone within that economy. For example, when the economy is healthy,
you will typically see low unemployment and wage increases as businesses demand labor to
meet the growing economy. A significant change in GDP, whether up or down, usually has a
significant effect on the stock market. It's not hard to understand why: a bad economy usually
means lower profits for companies, which in turn means lower stock prices. Investors really
worry about negative GDP growth, which is one of the factors economists use to determine
whether an economy is in a recession.
GDP(Y)=C+I+G+NX
Where,C=Consumption
I=Investment
G=Govt.Spending
NX=Export-Import

A.

Nominal GDP:

A gross domestic product (GDP) figure that has not been adjusted for inflation. Also known
as "current dollar GDP" or "chained dollar GDP." It can be misleading when inflation is not
accounted for in the GDP figure because the GDP will appear higher than it actually is. The
same concept that applies to return on investment (ROI) applies here. If you have a 10% ROI
and inflation for the year has been 3%, your real rate of return would be 7%. Similarly, if the
nominal GDP figure has shot up 8% but inflation has been 4%, the real GDP has only
increased 4%.

B.

Real Gross Domestic Product (GDP)

An inflation-adjusted measure that reflects the value of all goods and services produced in a
given year, expressed in base-year prices. Often referred to as "constant-price," "inflationcorrected" GDP or "constant dollar GDP".
Unlike nominal GDP, real GDP can account for changes in the price level, and provide a
more accurate figure.

Let's consider an example. Say in 2004, nominal GDP is $200 billion. However, due to an
increase in the level of prices from 2000 (the base year) to 2004, real GDP is actually $170
billion. The lower real GDP reflects the price changes while nominal does not.

II.

Inflation:- (7.96% as of July 2014)

Inflation is defined as a sustained increase in the general level of prices for goods and
services. It is measured as an annual percentage increase. As inflation rises, every dollar you
own buys a smaller percentage of a good or service.
The value of a dollar does not stay constant when there is inflation. The value of a dollar is
observed:
In terms of purchasing power, which is the real, tangible goods that money can buy. When
inflation goes up, there is a decline in the purchasing power of money. For example, if the
inflation rate is 2% annually, then theoretically a $1 pack of gum will cost $1.02 in a year.
After inflation, your dollar can't buy the same goods it could beforehand.
There are several variations on inflation:

A.

Deflation is when the general level of prices is falling. This is the opposite of
inflation.

Hyperinflation is unusually rapid inflation. In extreme cases, this can lead to the
breakdown of a nation's monetary system. One of the most notable examples of
hyperinflation occurred in Germany in 1923, when prices rose 2,500% in one month!

Stagflation is the combination of high unemployment and economic stagnation with

inflation. This happened in industrialized countries during the 1970s, when a bad
economy was combined with OPEC raising oil prices.

Causes of Inflation

Economists wake up in the morning hoping for a chance to debate the causes of inflation.
There is no one cause that's universally agreed upon, but at least two theories are generally
accepted:
Demand-Pull Inflation
This theory can be summarized as "too much money chasing too few goods". In other words, if
demand is growing faster than supply, prices will increase. This usually occurs in growing
economies.
Cost-Push Inflation
When companies' costs go up, they need to increase prices to maintain their profit margins. Increased
costs can include things such as wages, taxes, or increased costs of imports.

B.

Costs of Inflation

Almost everyone thinks inflation is evil, but it isn't necessarily so. Inflation affects different
people in different ways. It also depends on whether inflation is anticipated or unanticipated.
If the inflation rate corresponds to what the majority of people are expecting (anticipated
inflation), then we can compensate and the cost isn't high. For example, banks can vary their
interest rates and workers can negotiate contracts that include automatic wage hikes as the
price level goes up. Problems arise when there is unanticipated inflation:

C.

Creditors lose and debtors gain if the lender does not anticipate inflation correctly. For
those who borrow, this is similar to getting an interest-free loan.

Uncertainty about what will happen next makes corporations and consumers less
likely to spend. This hurts economic output in the long run.

People living off a fixed-income, such as retirees, see a decline in their purchasing
power and, consequently, their standard of living.

The entire economy must absorb repricing costs ("menu costs") as price lists, labels,
menus and more have to be updated.

If the inflation rate is greater than that of other countries, domestic products become
less competitive.

Tools to measure Inflation:

1. CPI: A measure that examines the weighted average of prices of a basket of consumer
goods and services, such as transportation, food and medical care. The CPI is
calculated by taking price changes for each item in the predetermined basket of goods
and averaging them; the goods are weighted according to their importance. Changes
in CPI are used to assess price changes associated with the cost of living.
CPI is one of the most frequently used statistics for identifying periods of inflation or
deflation. This is because large rises in CPI during a short period of time typically
denote periods of inflation and large drops in CPI during a short period of time
usually mark periods of deflation.
2. Producer price index: A family of indexes that measures the average change in selling
prices received by domestic producers of goods and services over time. PPIs measure
price change from the perspective of the seller. The PPI looks at three areas of
production: industry-based, commodity-based, and stage-of-processing-based
companies.
3. GDP deflator:
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4. The GDP deflator is another option for measuring prices and inflation. As the name
suggests, the GDP deflator is a price measurement tool that is used to convert nominal
GDP to real GDP. The GDP deflator is a broader measure than the CPI, as it includes
goods and services bought by businesses and governments.

III.

The Aggregate Supply Curve

The aggregate supply curve shows the relationship between a nation's overall price level, and
the quantity of goods and services produces by that nation's suppliers. The curve is upward
sloping in the short run and vertical, or close to vertical, in the long run.
Net investment, technology changes that yield productivity improvements, and positive
institutional changes can increase both short-run and long-run aggregate supply. Institutional
changes, such as the provision of public goods at low cost, increase economic efficiency and
cause aggregate supply curves to shift to the right.
Some changes can alter short-run aggregate supply (SAS), while long-run aggregate supply
(LAS) remains the same. Examples include:

Supply Shocks - Supply shocks are sudden surprise events that increase or decrease
output on a temporary basis. Examples include unusually bad or good weather or the
impact from surprise military actions.

Resource Price Changes - These, too, can alter SAS. Unless the price changes reflect
differences in long-term supply, the LAS is not affected.

Changes in Expectations for Inflation - If suppliers expect goods to sell at much

higher prices in the future, their willingness to sell in the current time period will be
reduced and the SAS will shift to the left.

IV.

The Aggregate Demand Curve

The aggregate demand curve shows, at various price levels, the quantity of goods and
services produced domestically that consumers, businesses, governments and foreigners (net
exports) are willing to purchase during the period of concern. The curve slopes downward to
the right, indicating that as price levels decrease (increase), more (less) goods and services
are demanded.
Factors that can shift an aggregate demand curve include:

Real Interest Rate Changes - Such changes will impact capital goods decisions
made by individual consumers and by businesses. Lower real interest rates will lower
the costs of major products such as cars, large appliances and houses; they will
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increase business capital project spending because long-term costs of investment

projects are reduced. The aggregate demand curve will shift down and to the right.
Higher real interest rates will make capital goods relatively more expensive and cause
the aggregate demand curve to shift up and to the left.

Changes in Expectations - If businesses and households are more optimistic about

the future of the economy, they are more likely to buy large items and make new
investments; this will increase aggregate demand.

The Wealth Effect - If real household wealth increases (decreases), then aggregate
demand will increase (decrease)
Changes in Income of Foreigners - If the income of foreigners increases (decreases),
then aggregate demand for domestically-produced goods and services should increase
(decrease).
Changes in Currency Exchange Rates - From the viewpoint of the U.S., if the value
of the U.S. dollar falls (rises), foreign goods will become more (less) expensive, while
goods produced in the U.S. will become cheaper (more expensive) to foreigners. The
net result will be an increase (decrease) in aggregate demand.
Inflation Expectation Changes - If consumers expect inflation to go up in the future,
they will tend to buy now causing aggregate demand to increase. If consumers'
expectations shift so that they expect prices to decline in the future, t aggregate
demand will decline and the aggregate demand curve will shift up and to the left.

V.

Fiscal Deficit (2013-4.9%,2014-4.6%)Calculated on GDP

A government's total expenditures exceed the revenue that it generates (excluding money
from borrowings). Deficit differs from debt, which is an accumulation of yearly deficits.When

VI. Current Account Deficit ( 32.4 US billion dollars)(4.9% of

GDP)
A measurement of a countrys trade in which the value of goods and services it imports
exceeds the value of goods and services it exports. The current account also includes net
income, such as interest and dividends, as well as transfers, such as foreign aid, though these
components tend to make up a smaller percentage of the current account than exports and
imports. The current account is a calculation of a countrys foreign transactions, and along
with the capital account is a component of a countrys balance of payment.
A current account deficit represents a negative net sales abroad.

VII. Repo rate :- (8%)

It is the rate at which the central bank of a country (RBI in case of India) lends money to
commercial banks in the event of any shortfall of funds.

Definition: Repo rate is the rate at which the central bank of a country (Reserve Bank of India
in case of India) lends money to commercial banks in the event of any shortfall of funds.
Repo rate is used by monetary authorities to control inflation.
Description: In the event of inflation, central banks increase repo rate as this acts as a
disincentive for banks to borrow from the central bank. This ultimately reduces the money
supply in the economy and thus helps in arresting inflation.

VIII. Reverse repo rate:- (7%)

It is the rate at which the central bank of a country (RBI in case of India) borrows money
from commercial banks within the country.
Definition: Reverse repo rate is the rate at which the central bank of a country (Reserve Bank
of India in case of India) borrows money from commercial banks within the country. It is a
monetary policy instrument which can be used to control the money supply in the country.
Description: An increase in the reverse repo rate will decrease the money supply and viceversa, other things remaining constant. An increase in reverse repo rate means that
commercial banks will get more incentives to park their funds with the RBI, thereby
decreasing the supply of money in the market

IX.

Definition of 'Balance Of Payments (BOP):

A statement that summarizes an economys transactions with the rest of the world for a
specified time period. The balance of payments, also known as balance of international
payments, encompasses all transactions between a countrys residents and its non-residents
involving goods, services and income; financial claims on and liabilities to the rest of the
world; and transfers such as gifts. The balance of payments classifies these transactions in
two accounts the current account and the capital account. The current account includes
transactions in goods, services, investment income and current transfers, while the capital
account mainly includes transactions in financial instruments. An economys balance of
payments transactions and international investment position (IIP) together constitute its set of
international accounts.

X.

Statutory liquidity ratio (SLR)

It refers amount that the commercial banks require to maintain in the form of gold or govt.
approved securities before providing credit to the customers. Here by approved securities we
mean, bond and shares of different companies. Statutory Liquidity Ratio is determined and
maintained by the Reserve Bank of India in order to control the expansion of bank credit.

A.

Determination of SLR

It is determined as percentage of total demand and time liabilities. Time Liabilities refer to
the liabilities, which the commercial banks are liable to pay to the customers after a certain
period mutually agreed upon and demand liabilities are such deposits of the customers which
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are payable on demand. example of time liability is a fixed deposits for 6 months, which is
not payable on demand but after six months. example of demand liability is deposit
maintained in saving account or current account, which are payable on demand through a
withdrawal form of a cheque.

B.

Usage of SLR

SLR is used by bankers and indicates the minimum percentage of deposits that the bank has
to maintain in form of gold,cash or other approved securities.Thus, we can say that it is ratio
of cash and some other approved liabilities(deposits). It regulates the credit growth in India.
The liabilities that the banks are liable to pay within one month's time, due to completion of
maturity period, are also considered as time liabilities. The maximum limit of SLR is 40%
and minimum limit of SLR is 22% In India, Reserve Bank of India always determines the
percentage of SLR. There are some statutory requirements for temporarily placing the money
in government bonds. Following this requirement, Reserve Bank of India fixes the level of
SLR. At present, the minimum limit of SLO that can be set by the Reserve Bank is 22% AS
ON 5 August 2014. A reduction of SLR rate looks eminent to support the credit growth in
India

C.

Objectives of SLR

The main objectives for maintaining the SLR ratio are the following:

XI.

to control the expansion of bank credit. By changing the level of SLR, the Reserve
Bank of India can increase or decrease bank credit expansion.
to ensure the solvency of commercial banks.
to compel the commercial banks to invest in government securities like government
bonds.

Bank rate (9%)

It is also referred to as the discount rate in American English,[1] is the rate of interest which
a central bank charges on the loans and advances to a commercial bank.Whenever a bank has
a shortage of funds, they can typically borrow from the central bank based on the monetary
policy of the country.

XII. Definition of 'Fiscal Policy'

Government spending policies that influence macroeconomic conditions. Through fiscal
policy, regulators attempt to improve unemployment rates, control inflation, stabilize
business cycles and influence interest rates in an effort to control the economy. Fiscal policy
is largely based on the ideas of British economist John Maynard Keynes (18831946), who
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believed governments could change economic performance by adjusting tax rates and
government spending.
To illustrate how the government could try to use fiscal policy to affect the economy,
consider an economy thats experiencing a recession. The government might lower tax rates
to try to fuel economic growth. If people are paying less in taxes, they have more money to
spend or invest. Increased consumer spending or investment could improve economic
growth. Regulators dont want to see too great of a spending increase though, as this could
increase inflation. Another possibility is that the government might decide to increase its own
spending,say,by building more highways. The idea is that the additional government spending
creates jobs and lowers the unemployment rate. Some economists,however,dispute the notion
that governments can create jobs, because government obtains all of its money from taxation,
in other words, from the productive activities of the private sector.
One of the many problems with fiscal policy is that it tends to affect particular groups
disproportionately. A tax decrease might not be applied to taxpayers at all income levels, or
some groups might see larger decreases than others. Likewise, an increase in government
spending will have the biggest influence on the group that is receiving that spending, which
in the case of highway spending would be construction workers.

XIII. Definition of 'Monetary Policy'

The actions of a central bank, currency board or other regulatory committee that determine
the size and rate of growth of the money supply, which in turn affects interest rates. Monetary
policy is maintained through actions such as increasing the interest rate, or changing the
amount of money banks need to keep in the vault (bank reserves).
Monetary policy is the process by which the monetary authority of a country controls the
supply of money, often targeting a rate of interest for the purpose of promoting economic
growth and stability. The official goals usually include relatively stable prices and low
unemployment. Monetary economics provides insight into how to craft optimal monetary
policy.
Monetary policy is referred to as either being expansionary or contractionary, where an
expansionary policy increases the total supply of money in the economy more rapidly than
usual, and contractionary policy expands the money supply more slowly than usual or even
shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a
recession by lowering interest rates in the hope that easy credit will entice businesses into
expanding. Contractionary policy is intended to slow inflation in order to avoid the resulting
distortions and deterioration of asset values

XIV. 'Foreign Institutional Investor - FII'

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An investor or investment fund that is from or registered in a country outside of the one in
which it is currently investing. Institutional investors include hedge funds, insurance
companies, pension funds and mutual funds.
The term is used most commonly in India to refer to outside companies investing in the
financial markets of India. International institutional investors must register with the
Securities and Exchange Board of India to participate in the market. One of the major market
regulations pertaining to FIIs involves placing limits on FII ownership in Indian companies.

XV.

Money Supply'

The entire stock of currency and other liquid instruments in a country's economy as of a
particular time. The money supply can include cash, coins and balances held in checking and
savings accounts. Economists analyze the money supply and develop policies revolving
around it through controlling interest rates and increasing or decreasing the amount of money
flowing in the economy. Money supply data is collected, recorded and published periodically,
typically by the country's government or central bank. Public and private sector analysis is
performed because of the money supply's possible impacts on price level, inflation and the
business cycle. In the United States, the Federal Reserve policy is the most important
deciding factor in the money supply.

XVI. Definition of 'Business Cycle'

The fluctuations in economic activity that an economy experiences over a period of time. A
business cycle is basically defined in terms of periods of expansion or recession. During
expansions, the economy is growing in real terms (i.e. excluding inflation), as evidenced by
increases in indicators like employment, industrial production, sales and personal incomes.
During recessions, the economy is contracting, as measured by decreases in the above
indicators. Expansion is measured from the trough (or bottom) of the previous business cycle
to the peak of the current cycle, while recession is measured from the peak to the trough.

Cash Reserve Ratio:- (4%)

Under CRR a certain percentage of the total bank deposits has to be kept in the current
account with RBI which means banks do not have access to that much amount for any
economic activity or commercial activity. Banks cant lend the money to corporates or
individual borrowers, banks cant use that money for investment purposes. So, that CRR
remains in current account and banks dont earn anything on that.
RBI uses CRR either to drain excess liquidity or to release funds needed for the growth of the
economy from time to time. Increase in CRR means that banks have less funds available and
money is sucked out of circulation. Thus we can say that this serves duel purposes i.e.
1. Ensures that a portion of bank deposits is kept with RBI and is totally risk-free

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2. Enables RBI to control liquidity in the system, and thereby, inflation by tying the

hands of the banks in lending money.

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