MBA Semester I Sub Code: 15MBA12

Economics for Managers

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Course Objective:

To make the students able to analyse and evaluate the consequences of various
economic activities with respect to individual and social welfare.
To make them to understand about the basic economic concepts and its applications in
business situations and decisions.
To make the students able to identify the determinants of economic aggregates like
inflation, unemployment, Productivity and also challenges associated with it.
To understand and to create awareness regarding role of government policies on
economy

Course Content:

Module 1:
Managerial Economics: Meaning, Nature, Scope. & Significance, Uses of Managerial
Economics, Objectives and Theories of firm-Baumol's Model and Agency theory- Law of
Demand, Exceptions to the Law of Demand, Elasticity of Demand- Price, Income, Cross
and Advertising Elasticities, Uses of Elasticity of Demand for Decision Making, - Demand
Forecasting: Meaning and Significance. Problems on Elasticity of Demand.
Production Analysis: Concept, Production Function- Total, Average, & Marginal Product, -
Law of Variable Proportions & ISO-Quants & ISO Costs - Least cost factor combination-
Returns to Scale- Economies and Diseconomies of Scale - Technological progress and
production function. (12 Hours)
Module 2:

Cost and Revenue Profit Functions: Cost Concepts, Fixed and variable costs- Total Cost,
Average Cost, Marginal Cost, Opportunity Cost. - Short-run and Long-run Cost Curves Profits:
Determinants of Short-Term & Long Term Profits, Measurement of Profit. Break Even Analysis-
Meaning, Assumptions, Determination of BEA, Limitations and Uses of BEA in Managerial
Economics. (Problems on BEP).
Market Structure: Perfect Competition: Features, Determination of Price under
Perfect Competition - Monopoly: Features, Pricing under Monopoly, Price Discrimination -
Oligopoly: Features, Kinked Demand Curve, Cartel, Price Leadership - Monopolistic
Competition: Features, Pricing under Monopolistic Competition, Product Differentiation Pricing
- Descriptive Pricing- Price Skimming, Price Penetration. (12 Hours)
Module 3:

Indian Economic Environment: Overview of Indian Economy, Recent changes in Indian

Economy.
Measurement of National Income: Basic Concepts, Components of GDP- Measuring GDP and
GNP, Difficulties in measuring National Income, Growth Rate.
Business Cycle - Features, Phases, Economic Indicators, Inflation : Types, causes,
Measurement, Kinds of Price Indices, Primary, Secondary and Tertiary Sectors and their
contribution to the Economy, SWOT Analysis of Indian Economy. (6 Hours)

Module 4:
Industrial Policies and Structure: A critical look at Industrial Policies of India, New Industrial
Policy 1991; Disinvestment in PSUs - Private Sector- Growth, Problems and Prospects, SMEs -
Significance in Indian economy-problems and prospects
Industry Analysis: Textiles, Electronics, Automobile, FMCG, Telecom, Pharma. FDI in Retailing,
Infrastructure, Pharma, Banking & Insurance
Globalization and Indian Business Environment: Meaning and Implications, Phases, Impact
of Globalization on Indian Economy across Sectors.
Foreign Trade: Trends in India's Foreign Trade, Impact of WTO on India's Foreign Trade.
(10 Hours)
Module 5:
Economic Policies: Fiscal Policy: Objectives, Instruments, Union Budget, Monetary Policy:
Measures of Money Supply, Monetary Policy in India- objectives, tools for Credit Control. Role
and functions of Comptroller and Auditor General of India (CAG) . Workshops: 1.Policy analysis
2. Econometric model (10 Hours)

Course outcome:
Understanding the significance of economic environment and recognize its relevance to
business.
Know the importance of economic environment and various policies.
Understanding the relevance of economic policy to apply the same on current business
practices.
Familiar with application of these principles to appreciate the functioning of both
product and input markets as well as the economy.
To calculate optimal price of a product based on relevant cost, demand, and competitive
factors.
Text Books:
1. Paul A. Samuelson, William D. Nordhaus, Sudip Chaudhuri and Anindya Sen, Economics,
19th edition, Tata McGraw Hill, New Delhi, 2010.
2. Perloff and Brander, Managerial Economics and Strategy, 1st Edition, Pearson, 2014.
3. Craig H. Petersen, W. Chris Lewis, and Sudhir k. Jain, Managerial Economics, Pearson,
Ninth impression 2012.
4. Dwivedi D N, Macroeconomics Theory and Policy, Tata McGraw Hill, (3rd ed.), 2010.
Reference Books:
1. Dominick Salvatore,Managerial Economics- Principles and worldwide applications, , 6e,
Oxford Publication, 2010.
2. Jaswinder Singh, Dreamtech,Managerial Economics, publications, 2013.
3. YogeshMaheswari,Managerial Economics, , PHI, 2013.
4. KK Dewett and MH Navalur, Modern Economic Theory, S Chand Publication, 2013

Module I

Managerial Economics

Reading Objective:

At the end of the reading this chapter, the reader will be able to understand that economics is
the study of mankinds attempt to satisfy their unlimited wants with the help of limited
resources.

Introduction:
What is Economics? Economics is the study of how societies use scarce productive resources to
alternative uses ,to produce various commodities and distribute them among various groups.
Economics enables us to know the world we live in and the potential new worlds the reformers
are trying to propose to us.
Economics maybe divided broadly into 1) Micro Economics and 2) Macro Economics
Micro economics focuses on the behavior of the individuals, firms and their interaction in
markets. Macroeconomics is the study of the economic system as a whole. It deals with
aggregates like Determination of National Income, Savings, investment, employment at
aggregate levels, tax collection, government expenditure, foreign trade, money supply etc.
Managerial economics is an application of the principles of microeconomics and other related
disciplines like accounting, operations research, statistics etc in managerial decision making and
forward planning.

Human beings have limited number of needs which have to be satisfied if they are to survive.
While the needs are limited, individuals choose to enjoy a better standard of living. This is
because human wants (desire for the consumption of goods and services) are unlimited. Thus
we find that irrespective of their economic status people want better products. For example a
bigger house, a better car, a better bicycle etc. Therefore the basic economic problem is that
the resources are limited but wants are unlimited which forces us to make choices. Economics
is the study of the allocation of scarce resources and the choices made by economic agents.
An economy is a system which attempts to solve this basic economic problem.
There are different types of economies namely household economy, local economy, national
economy and International economy but all economies face the same problem. The
fundamental economic problems faced are

(i) What commodities need to be produced?

(ii) How should these goods be made?

(iii) For whom are these goods made?

a) What commodities to be produced and in what quantities. A society must determine how
much of each of the many possible goods and services it will make and when will they be
produced. Say pizzas or shirts; high quality shirts or low quality shirts. Will we make
consumption goods with the scarce resources or more of the investment goods which will
boost production and consumption tomorrow?

b) How are goods produced? Society to decide who will produce, with what resources and
what production techniques. Who will farm and who will teach? Is electricity from coal, oil or
from sun? Will factories be run by people or robots?

c) For who are goods produced? Who gets to eat the fruits of the economic activity? Is the
distribution of income and wealth fair and equitable? Are there many poor and many rich?

Market, Command and Mixed Economies:

What are the different ways in which society answers the questions of what, how and from
whom? Various societies are organized through alternate economic systems and economics
studies various ways the society can allocate the scarce resources.

Fundamentally at one extreme there is the Command economy where Government makes
most economic decisions. At the other extreme the decisions are made at the market place
where individuals and enterprises agree to exchange goods and services. An example like the
US is primarily a market economy where individuals and private firms make major decisions
about production and consumption.

Firms produce the commodities that yield the highest profits (what); by techniques of
production that are least costly (how). Consumption is determined by individuals decisions
about how to spend the wages and property incomes generated by their labor and property
ownership (for whom).

Extreme case of where govt. keeps its hands of all decisions is called laissez-faire economy.
Command economy is one where government makes all decisions.
Mixed economies have both the elements of the market and command. The resources
which are not scarce are called free goods. Resources which are scarce are
called economic goods.
Societys Technological Possibilities:
Every economy has a limited quantum of resources labor,technical knowledge,factories and
tools,land,energy etc.In deciding what and how things need to be produced, the economy
decides on how the resources need to be allocated to the many commodities and services.How
much land for growing wheat, for housing the population, for manufacturing bread etc.So the
continuing challenge for the economy is the allocation of the limited resources to the unlimited
wants.The kay decisions that need to be made are choosing from the potential bundle of
goods(the what),select the different techniques of production (the how),and decide who will
consume the goods(for whom).
Inputs and Outputs:
To answer the three questions the society needs to make choices about the economys inputs
and outputs. Inputs are commodities or services used to produce goods and services. The
economy uses the available technology to combine the inputs to produce the outputs.
Outputs are various useful goods or services that result from the production process and are
either consumed or employed for further production. Say a pizza, eggs, flour, energy, pizza
oven , chefs skilled labor are the inputs and the tasty pizza is the output.
Another term for inputs is factors pf production. These are:
Land: land used for various economic activity
Labor: Human time spent in production like working in automobile factory, tilling land,
teaching in a school
Capital: durable goods of an economy produced to produce yet another good. Includes
machines, roads, computers, washing machines, buildings etc.

This then addresses the three economic problems in terms of inputs and outputs:
1. What to produce and in what quantities
2. How to produce them; that is the techniques by which inputs can be combined to produce
the desired outputs
3. For whom the outputs should be produced and distributed.

Module I Managerial Economics:

The following details the topics covered under this section. They include:
 Why study Economics?
What is Managerial Economics?
Nature ,Scope and Significance of Managerial Economics
Uses of Managerial Economics
Objectives and Theories of the firm
Baumols Model and Agency Theory
Law of Demand
Exceptions to Law of Demand
Elasticity of Demand-Price, Income, Cross and Advertising Elasticities
Uses of Elasticity of Demand for decision Making
Demand Forecasting: Meaning and Significance
Problems on Elasticity of Demand
Review questions

Why Study Economics?

A good grasp of economics is vital for managerial decision making, for designing and
understanding public policy, and to appreciate how an economy functions. As a student who is
wondering what the subject is all about, you realize that many decisions taken are impacted by
economic decisions. As a manager you would want to know why there are economic
inequalities; why certain societies are advanced and others are lagging behind and so on.
Without economics it is difficult to know about international trade, economic impact of
internet, tradeoff between inflation and unemployment.
Reasons for Studying Economics:
It is a study of society and as such is extremely important.
It trains the mind and enables one to think systematically about the problems of
business and wealth.
From a study of the subject it is possible to predict economic trends with some
precision.
It helps one to choose from various economic alternatives.
Economics is the science of making decisions in the presence of scarce resources. Resources are
simply anything used to produce a good or service to achieve a goal. Economic decisions involve
the allocation of scarce resources so as to best meet the managerial goal. The nature of
managerial decision varies depending on the goals of the manager. A Manager is a person who
directs resources to achieve a stated goal and he/she has the responsibility for his/her own
actions as well as for the actions of individuals, machines and other inputs under the control of
the manage.
What is Managerial Economics?
Managerial economics is the study of how scarce resources are directed most efficiently to
achieve the desired outputs and managerial goals. The difference between the revenue earned
from selling the output and the costs incurred on the inputs is profits. To maximize the profits
and to attain other objectives, managers need to make several choices, including the
production techniques, quantity of output, number of workers, price at which output is sold
etc.In these they need to know the alternatives available to make the best choice. Such
economic decisions made by managers and firms is the scope of managerial economics. It is a
valuable tool for analyzing business situations to take better decisions. Several authors have
defined the subject some of which are given below.
According to Prof. Evan J Douglas Managerial Economics is concerned with the application of
economic principles and methodologies to the decision making process within the firm or
organization under the conditions of uncertainty
According to Milton H Spencer and Louis Siegelman Managerial Economics is the integration
of economic theory with business practices for the purpose of facilitating decision making and
forward planning by management
According to Mc Nair and Miriam, Managerial Economics consists of the use of economic
modes of thoughts to analyze business situations.
According to Salvadore Managerial Economics refers to the application of economic theory
and the tools of analysis of decision science to examine how an organization can achieve its
objectives most effectively.
The economic way of thinking about business decision making provides all managers with a
powerful set of tools and insights for furthering the goals of their organization. Successful
managers take good decisions, and one of their most useful tools is the methodology of
managerial economics.
Nature Of Managerial Economics?
1. Managerial economics is concerned with the analysis of finding optimal solutions to decision
making problems of businesses/ firms (micro economic in nature).While it draws from demand
analysis, cost and production analysis, pricing and output decisions from micro economics it
also draws market intelligence from national income, inflation ,stages of recession and
expansion which are macroeconomic in nature.
2. Managerial economics is a practical subject therefore it is pragmatic.
3. Managerial economics describes, what is the observed economic phenomenon (positive
economics) and prescribes what ought to be (normative economics).The subject has a
normative bias as it gives value judgements of what ought to be or prescribes what firms should
do to reach certain objectives. Example a manager of a soft drink company needs to know
whether he should advertise the product. Should the manager advertise on the same lines as
competitors or should he judge if the advertisement would have any impact on the consumers?
Managerial economics attempts to assess whether the probable outcome of managerial
decision is desirable and whether or not the managers should pursue the course of action that
will lead to such outcomes. Hence it is prescriptive or normative in nature.
4. Managerial economics is based on strong economic concepts.(conceptual in nature)
5. Managerial economics analyses the problems of the firms in the perspective of the economy
as a whole (macro in nature)
6. It helps to find optimal solution to the business problems (problem solving).Decisions taken
by firm results in the equilibrium of that firm. So it is a branch of economics where we do not
learn of the equilibrium of the economy but about a firm or an industry.
Scope and significance of Managerial Economics
Managerial Economics and Other Disciplines
Managerial economics has its relationship with other disciplines for propounding its theories
and concepts for managerial decision making. Essentially it is a branch of economics.
Managerial economics is closely related to certain subjects like statistics, mathematics,
accounting and operations research.
Uses of Managerial Economics
Managerial economics helps in estimating the product demand, planning of production
schedule, deciding the input combinations, estimation of cost of production, achieving
economies of scale and increasing the returns to scale. It also includes determining price of the
product, analyzing market structure to determine price of product for profit maximization,
which helps them to control and plan capital in an effective manner.
Successful mangers make good decisions, and one of their most useful tools is the methodology
of managerial economics. Managerial economics has a very important role to play by helping
managements in successful decision making and forward planning. To discharge his role
successfully, a manager must recognize his responsibilities and obligations. There is a growing
realization that the managers contribute significantly to the profitable growth of the firms.
We can conclude that managerial economics consists of applying economic principles and
concepts for decision making and forward planning.

Relationship of Managerial Economics with other disciplines:

Economic Theory Quantitative analysis

Micro economics:theory of Numerical and algebraic analysis

firm,consumer behavior,production Optimization
and cost, market structure and price Statistical estimation and
theories forecasting
Game theory
Macro economics:National
income,outputs ,business cycles Discounting and time value of
money

Managerial Economics

Solutions to Managerial Decision Making

Quantity and quality of products

Price of product
Marketing Management
Financial Management
Human Resources Management
Research and Development
Objectives and Theories of the Firm:
Nature of the firm:
A firm is an association of individuals who have organized themselves for the purpose of turning
inputs into outputs. The business firms are specialized organizations devoted to managing the
process of production. The firm organizes the factors of production to produce goods and
services to fulfil the needs of the house hold. Each firm lays down its own objectives which is
fundamental to the existence of the firm.

Objectives of the Firm:

The major objectives of the firm are:
To achieve the Organizational Goal
To maximize the Output
To maximize the Sales
To maximize the Profit of the Organization
To maximize the Customer and Stakeholders Satisfaction
To maximize Shareholders Return on Investment
To maximize the Growth of the Organization

Firms are established to earn profit and ensure that shareholders are satisfied. Therefore
business runs for profits. This is the most widely accepted objective of a firm. Traditionally
economists believed that the generation of the largest amount of absolute profit over a period
of time is the single most important objective of a business organization. The efficiency of the
firm is based on the profit earning capacity. Even the market value of a firm is dependent on
the profits earned. Also profits are a must for long term survival of a firm.
Profits = Total Revenue Total Cost
Economists believe that firms maximize their long run rather than their
short run profit. So managers have to make enough profit to satisfy the demands
of their shareholders and to maximize their wealth through the company

Difficulties arise in determining which measure of profits. And in a competitive market with
high level of customer awareness it may be difficult to maximize profits.

Another objective of a firm is maximization of sales. Maximization of sales will lead to increase
in market share.
Baumols Model of Sales Revenue maximization and Agency Theory

Baumol raised questions on the validity of profit maximization as an objective of the firm. He
stressed that in competitive markets, firms would rather aim at maximizing revenue through
maximization of sales. According to him sales volumes and not profit volumes determine
market leadership in competition.
He also stressed that in large organizations, management is separate from owners. So there
would be a dichotomy of managers goals and owners goals. Managers salary and other
benefits are linked with sales volume rather than profits.
Baumol hypothesized that managers attach more importance to companys revenue or sales
and so will attempt to maximize sales revenue rather than profits. Sales volume are a better
indicator of sales and growing sales strengthens the competitive spirit of the firm. Since
operations of a firm are in the hands of managers and managers performance is measured in
terms of achieving sales target, it follows that management is more interested in maximizing
sales with a constraint of minimum profits. Hence the objective is not to maximize profits but to
maximize sales revenue with minimum level of profits to keep shareholders satisfied. This
minimum level of profit I regarded as profit constraint.
Agency Theory
It is observed that there is usually a conflict of interest between the owners and the managers
of a firm. As per Williamsons Model, managers are more interested in maximization of their
own benefits instead of maximizing the corporate profits. This is an example of principal agent
problem which arises in the context of firms and is an offspring of the Agency Theory that
emerged during the 1970s.The question is who the principal is and who is the agent. Example:
suppose you are planning to go for a pleasure trip to Europe the next summer. You either make
all arrangements yourself or hire a travel agent to plan your trip. Similarly if you want to have
LPG connection you will contact your nearest LPG agent. What are we hinting at with these
examples? It refers to a principal-agent relationship. In both these examples you the consumer
are the principal and the service provider is the agent. In an organization context the Owners
are the principals and the managers are the agents.
Why would you hire an agent to execute a particular task? A major reason is between
knowledge of the particular task with the agent. A travel agent you may hire to plan your trip to
Europe, would be having better knowledge than you of the different places of interest, the
tariffs of different hotels and so on. It is better to get the agent to plan your trip. In an
organization context the owners(principals) hire managers (agents) who work on a well-defined
task, as the later have better knowledge of the market and are expected to steer the business.
This difference in information between two parties in any transaction (typically in the principal
agent problem) is cited as information asymmetry or a state of asymmetric information.
Because of the asymmetry the principal cannot directly observe the activities of the agent; the
agent may know some aspects of the situation which may be unknown to the principal.
To give another example, if a car manufacturing unit plans to launch a newly designed car, the
manager could have a better knowledge of the market mood and competition position to fix a
schedule for this launch compared to shareholder(the owners).This is due to asymmetric
information. Hence owners (principals) will have to depend upon the wisdom of managers
(agents) for the purpose.
Demand Analysis:
Reading Objective:
After studying the material on demand, the student will be able to appreciate the importance
of demand analysis as part of economic analysis .Areas related to the changes in demand or
elasticity of demand help the decision maker to factor in demand elasticity while taking
managerial decisions. It will also enable decisions on what to produce, quantity to produce,
timing of production and markets where they need to be distributed.
Since markets are unpredictable and volatile, a careful study of markets reveals forces
underlying the random movements. A case in point is the gasoline price and variations
observed in the demand and supply due to several factors. Economists refer to this as the
Theory of supply and demand .This theory explains that it is the consumer preferences which
determines the demand for commodities while aspects related to business costs form the basis
of the supply of commodities. Example the increase in price of fuel could be due to increase in
demand for fuel or a decline in the supply of fuel. This is applicable for all markets. Thus
changes in supply and demand drive changes in output and prices. Knowing how supply and
demand works enables in understanding the working of the market economy. This also takes
into consideration the competitive market forces.

Demand:
Demand is defined as want, need or desire which is backed by willingness and ability to
buy a particular commodity in a given period of time. Example if about 10 lakh motorcycles are
purchased in India during a year at a price of Rs. 1,00,000 then we say that the annual demand
for motorcycles is 10 lakh units at the rate of Rs. 1,00,000.So each consumer has a desire to
acquire a motorcycle and he is willing and able to buy the product. A final consumer derives
satisfaction from the good without any value addition.
Determinants of demand include
- Price of the product
- Income of the consumer
- Price of related goods
- Tastes and Preferences
- Advertising

Law of Demand:The Law of Demand states that other things remaining constant(ceteris
paribus) when the price of a commodity rises, the demand for that commodity falls and when
the price of a commodity falls the demand for that commodity rises.In other words the demand
for a product is inversely proportional to its price. Thus the demand function can be stated as
following to illustrate the Law of Demand.

Dx = f (Px)
Demand is therefore a negative function of price, ceteris paribus.

Exceptions to Law of Demand

Demand Schedule: There exists a direct relationship between market price of goods and the
quantity demanded of that good ,while other things are held constant. This relationship
between price and quantity bought is called a demand schedule. Table 1 presents a
hypothetical demand schedule for cornflakes.
Demand schedule for cornflakes
Details Price (Rs./box) P Quantity demanded
(Millions of boxes per year)Q
A 5 9
B 4 10
C 3 12
D 2 15
E 1 20

The above demand schedule relates quantity demanded to Price.

Demand Curve:
A graphical representation of the demand schedule is the demand curve

Graph Demand Curve

Exceptions to the Law of Demand: Though the Law of demand applies to all situations ,there
are a few cases where it does not apply and so these are regarded as exceptions to the Law.
Giffen Goods:In early Irland, it was observed that the poor population consumed two goods:
meat (which was costly) and bread (which was cheap)A strange phenomenon was observed
when the price of bread was increased. It made a large drain on the resources of the poor
people and raised the marginal utility of money to such an extent that they were forced to
curtail the consumption of bread and buy more bread which was still the cheapest good. This
implied that quantity demanded of bread (an inferior good) increased with increase in its price.
According to Robert Giffin,an economist, goods that display direct price-demand relationship
are called Giffen goods. These goods are considered inferior by the consumer but they occupy a
significant place in the individuals consumption basket.
Snob Appeal:
Opposite to Giffen goods there are certain goods which have a snob value for which the
consumer measures the satisfaction derived from these commodities not by their utility value
but by their social status. The consumer of these commodities wants to show it off to others
and so they buy less of it at lower prices and more of it at higher prices. Thus in this case price
and quantity move in the same direction. Diamond or antique works of art, latest model of
mobile phones, sports cars, and designer clothes are examples of such goods. Higher the price
of diamonds the higher the snob value and so the demand is higher.

Elasticity of Demand: The Law od demand gives only the direction of change in the quantity
demanded but not the magnitude of change. To ascertain the magnitude of change we need to
know the elasticity of demand.
In economics, the term elasticity means a proportionate (percentage) change in one variable
relative to a proportionate (percentage) change in another variable. The quantity demanded of
a good is affected by changes in the price of the good, changes in price of other goods, changes
in income and changes in other factors. Elasticity is a measure of just how much of the quantity
demanded will be affected due to a change in price or income.

Price Elasticity of demand: Price is considered the most important of all the independent
variables that affects the demand for any commodity. Price elasticity of demand ,e(p) is the
sensitivity of quantity demanded of a commodity to a given change in its price.

The response of the consumers to a change in the price of a commodity is measured by the
price elasticity of the commodity demand. The responsiveness of changes in quantity
demanded due to changes in price is referred to as price elasticity of demand. The price
elasticity of demand is measured by dividing the percentage change in quantity demanded by
the percentage change in price.
Price Elasticity = Proportionate change in the Quantity demanded /Proportionate change in
price

Percentage change in quantity demanded

= ----------------------------------------------
Percentage change in price
 Q / Q 10
= --------- = ------ = 0.5
P / P 20

Q = change in quantity demanded ( Q2-Q1)

P = change in price (P2-P1)
P = price
Q = quantity demanded

For example:
Quantity demanded is 20 units at a price of Rs.500. When there is a
fall in price to Rs. 400 it results in a rise in demand to 32 units. Therefore
the change in quantity demanded is12 units resulting from the change in
price of Rs.100.
The Price Elasticity of Demand is = 500 / 20 x 12/100 = 3

Degree of Price Elasticity:

While discussing the measurement of elasticity the same demand curve will show different
degrees of elasticity at its different points. Normally the Various degrees of elasticity are
depicted by different slopes of the demand curve. The flatter the demand curve the higher the
elasticity and steeper the demand curve the lesser the elasticity.
The following are the different degrees of elasticity:

a)Perfectly Elastic Demand (Ep = ) Unlimited quantity can be sold at the prevailing price and
a small change in price will change will result in zero quantity demanded.
b)Highly Elastic Demand Curve: When the proportionate change in the quantity demanded is
more than the given change in price, the commodity is regarded to have a highly elastic
demand . So ep > 1. This is shown as a flatter demand curve
c)Perfectly Inelastic Demand (Ep = 0) the quantity demanded does not
change regardless of the percentage change in price.

d)Unit Elasticity of Demand (Ep =1) the percentage change in quantity

demanded is the same as the percentage change in price that caused it
The Determinants Of Price Elasticity Of Demand
The exact value of price elasticity for a commodity is determined
by a wide variety of factors. The two factors considered by economists are
the availability of substitutes and time. The better the substitutes for a
product, the higher the price elasticity of demand.. The longer the period
of time, the more the price elasticity of demand for that product. The price
elasticity of necessary goods will have lower elasticity than luxuries.
The elasticity of demand depends on the following factors:
1. Nature of the commodity: The demand for necessities is inelastic
because the demand does not change much with a change in price.
But the demand for luxuries is elastic in nature.
2. Extent of use: A commodity having a variety of uses has a
comparatively elastic demand.
3. Range of substitutes: The commodity which has more number of
substitutes has relatively elastic demand. A commodity with fewer
substitutes has relatively inelastic demand.
4. Income level: People with high incomes are less affected by price
changes than people with low incomes.
5. Proportion of income spent on the commodity: When a small part of
income is spent on the commodity, the price change does not affect
the demand therefore the demand is inelastic in nature.
6. Urgency of demand / postponement of purchase: The demand
for certain commodities are highly inelastic because you cannot
postpone its purchase. For example medicines for any sickness
should be purchased and consumed immediately.
7. Durability of a commodity: If the commodity is durable then it is
used it for a long period. Therefore elasticity of demand is high. Price
changes highly influences the demand for durables in the market.
8. Purchase frequency of a product/ recurrence of demand: The
demand for frequently purchased goods are highly elastic than rarely
purchased goods.
9. Time: In the short run demand will be less elastic but in the long run
the demand for commodities are more elastic.

Income Elasticity of demand:

Income of the consumer is an important determinant of demand.Income elasticity of demand is

the degree of responsiveness of demand for a commodity to a given change in the income of
the consumer. When we measure the income elasticity of demand we assume that all other
variables including price of the good is constant (ceteris paribus).The equation for e(y) is
expressed as follows:

e(y) = Proportionate change in the quantity demanded of commodity X/Proportionate

change in income of consumer

= Q2-Q1/Q1
-------------------
Y2-Y1/Y1

Q1 = original quantity demanded

Q2= new quantity demanded
Y1 =initial level of income
Y2 = new level of income

Degree of Income elasticity:

Income elasticity of demand also has similar degrees of elasticity like price elasticity of demand
namely perfectly elastic (ey= infinity) ;perfectly inelastic (ey=0) ;relatively elastic(ey.1),relatively
inelastic(ey,1) and unitary elastic (ey =1).When the proportionate change in demand is more
than income demand is highly elastic .When the proportionate change in demand is less than
that of income demand is highly inelastic.Income usually has a positive impact on demand ;but
when the impact is negative such goods are called inferior goods.Hence the value of the income
elasticity can be either negative or positive depending on the nature of the product.

Positive Income elasticity of demand:

The positive income elasticity of demand can be classified as unity,

more than unity and less than unity. We can understand from the above
graphs that the product which is highly elastic in nature will grow faster
when the economy is expanding. The performance of firms having low
income elasticity on the other hand will be less affected by the economic
changes of the country.

The following graphs depict this.

1.Positive income elasticity >1 which is more than unity.

2.Income elasticity < 1 :Positive income elasticity which is less than unity

3. Unitary elasticity: Positive income elasticity which is unity.

Cross Elasticity of demand:

Another important determinant of demand for a commodity is the price of a related

commodities and this is referred to as the cross elasticity of demand.This explains the
responsiveness of demand for one good relative to the change in the price of another related
good (ceteris paribus).The cross elasticity of demand e(c) can be expressed as follows:

e (c) = Proportionate change in the quantity demanded of commodity

X/Proportionate change in the price of commodity Y

Qx2 Qx1/Qx1
= ------------------
Py2-Py1/Py1

Qx1 =original quantity demanded for commodity X

Qx2=new quantity demanded of commodity X
PY1=Initial price level of commodity Y
Py2=new price level of commodity Y.

The related goods can be either complements (joint demand) or substitutes (competing
demand)
Complements: If X &Y are related goods and an increase in price of Y results in a fall in quantity
demanded of X , it means that X and Y are complements.
Substitutes: If the increase in the price of Y increases the demand for X the two goods are
substitutes.
How will this knowledge benefit the seller? Helps in policy matters like how to respond to
changes in the price of another good, should it be ignored or should it be taken note of . Like
price and income elasticities, cross elasticity can be highly elastic or highly inelastic. In the case
of substitutes the value e (c ) would be positive and in the case of complements it would be
negative.

Advertising Elasticity of demand:

Advertising and promotion are vital tools in the competitive market to generate awareness of
the product and thus stimulate the demand. Consumer goods are more responsive to
advertising than capital equipment. Advertising is an expenditure and so its benefits needs to
be weighed against its cost. The advertising elasticity of demand can be expressed as follows:

E (a) = Proportionate change in quantity demanded (or sales) of commodity X/Proportionate

change in advertising expenditure

Q2 Q1/Q1
= -----------------
A2-A1/A1
Where Q1= original quantity demanded (volume of sales) ,Q2= new quantity demanded
(volume of sales). A1 =initial level of advertising expenditure, A2 = new level of advertising
expenditure.

Here also the degrees of elasticity are similar to those discussed in the context of price. The
decision making component is that when e ( a) > 1,one should go ahead with heavy expenditure
on advertising but when e ( a) < 1, it is not advisable to spend too much on advertisement and
promotion because the product is not sensitive to promotion. Thus we find advertisements for
lubricants, generators, invertors but not for electricity, petrol or diesel.

Uses of Elasticity of Demand for Decision Making:

The elasticity of demand is used for several decisions made in managerial economics. These
include :

1.Determination of price:Basis of determining the price of a product of a firm.

2. Basis of price discrimination: different prices for the same product based on place, use, time
etc. Higher price when demand is relatively inelastic.
3.Determination of rewards of factors of production: factors with inelastic demand are
rewarded more than those with elastic demand.
4.Government policies and taxes.

Demand Forecasting: Meaning and Significance:

Meaning of Demand Forecasting: Demand forecasting is an estimate of sales in dollar or

physical units for a specified future period under a proposed marketing plan. American
Marketing Association

The level of forecasting can be categorized are the

1. Firm (Micro) Level

2. Industry Level
3. Economy(Macro ) Level

Demand forecasting methods are as follows:

Demand Forecasting Methods:

1. Survey of buyers intension
2. Delphi method
3. Expert opinion
4. Collective opinion
5. Naive model
6. Smoothing techniques
7. Time series / trend projection
8. Controlled experiments
9. Judgmental approach

Some of the forecasting methods are explained below:

1. Survey of buyers intentions: best way to assess the demand of a commodity is to

take opinion of the users of the product. Consumers opinion survey, buyers are
asked about the future buying intentions of products, their brand preference,
quantities of purchase. Survey can be a census method or based on a sample.
Various sampling methods can be used like simple random sampling, stratified
sampling etc. More representative the sample the more reliable is the study.:
2. Delphi Method: This was developed by Rand Corporation during the Cold War to
forecast the impact of technology on warfare. This has a group of experts who brain
storm on a topic without any face to face interaction. A panel of experts is selected
 and each member is asked to give his or her opinion which is kept anonymous. This
process of collecting opinion is repeated several times till a consensus is reached.
This is then considered to be the correct answer.
3. Expert opinion: Opinion of experts is obtained with the help of brain storming
sessions and structured questions.
4. Collective opinion: is again collecting the opinions of experts and them drawing
conclusions.
5. Nave model :
6. Smoothing techniques: Most data series do not show a continuous trend, some
increase for which smoothing techniques are used when time series data show little
trend or seasonal variations but a great degree of irregular random variationse or
decrease in value can be seen in any time series.These seasonal or random
variations need to be smoothed. Some of the methods are
a. Moving averages : A simple moving average method forecasts on the basis of
demand values during the recent past.
The formula for simple moving averages is :
Sigma Di ( as I takes value from 1 to n)
Dn = __________________________________
n
where Di is the demand in the i th period in the moving average
b. Weighted Moving average: An improvement over simple moving average , in this
method we forecast the future value of sales on the basis of weights of the most
recent observation. Formula fr weighted moving average is :
Dn = Sigma wiDi as I takes value from 1 to 5.

c) Exponential Smoothing: the method gives greater weights to the most recent
data, in order to have a more realistic estimate of the fluctuations. This is applicable
to time series in which recent changes in data are a result of any actual change say
seasonal pattern, rather than erratic random fluctuations. Exponential smoothing
forecast is calculated using the following equation:

Exponential smoothing forecast is calculated using the following equation:

F(t+1) = a Dt + (1- a) Fi

Where Dt+1 =forecast for the next period; Dt is actual demand in the present period,
Ft= previously determined forecast for the present period and a= weighting factor,
termed as smoothing constant.
Econometric methods :Tools of economic theory, mathematics and statistics are
applied to economic phenomena. Two popular econometric methods are regression
analysis and simultaneous equations.
 Regression analysis: The parameters of any demand function can be estimated with
the help of regression analysis, considered the most popular method of quantitative
forecasting. A typical regression model would consist of a set of dependent variables
and independent variables and would establish a cause effect relation by estimating
the parameters in the regression equation.
A simple linear demand equation can be expressed as follows:

Dx = a1 +a2Px + a3Y+a4Py +a5A +a6t +a7Vn

Where Dx = the quantity demanded of X, Px =price of X, Py=price of Y, A =advertising

expenditure, t=tastes, Vn =other variables.
Next we estimate the values of the coefficients (a1,a2,a3 .a,7) in the above equation. This is
done using regression analysis.

Problems on Elasticity of Demand.

Module I Production Analysis:

Introduction:

To eat our daily bread someone should bake it. Similarly an economys ability to build cars,
generate electricity, write computer programs and deliver several goods and services which are
part of the gross domestic product depends on the productive capacity

The productive capacity is based on the size and quality of the labor force,by the quantity and
quality of the capital stock, by the nations technical knowledge and the ability to use the
knowledge and by the nature of the private and public institutions.
Questions that an economist would ask are why are living standards high in America? Why are
they low in Africa? Why are they low in India? To answer these we need to know how well the
production machinery is working in these economies.
Here we need to know how the market forces determine the supply of goods and services. We
also need to know the concepts of production cost and supply and see how they are linked. We
also understand the fundamentals of production theory and show how firms transform inputs
to desirable outputs. Production theories also tell us how productivity and living standards have
risen over time and how firms manage their internal activities.
Concept:
 In any typical modern economy, a number of productive activities are carried out. Example a
farm takes fertilizers, seed, land and labour and turns them into wheat or corn. Modern
factories take inputs like energy, raw material, computerized machinery and labor to produce
tractors, Tvs, Tubes of toothpaste .An airline would similarly have aircrafts, fuel, reservation
systems ,labor etc to enable passengers to travel quickly through its network of routes.
Similarly an accounting firm has pencils, office space, computers, labor to produce audits and
tax returns for its clients.
We assume in this that the farm, the factory, the airline and the accounting firm produce
efficiently that is at lowest cost. In this they try to produce the maximum level of output for a
given level of inputs. Also while deciding on what goods or services to produce the firms also
maximize the economic profits.

The Production Function:

In the examples we refer to inputs like land and labor and outputs like wheat and toothpaste. If
the input quantity is fixed then what would be the output quantity?This depends on the level of
technology and the engineering knowledge. On any day, given certain level of available
technical knowledge,land,machinery etc only a certain quantity of tractors or toothpaste can be
obtained from a given amount of labor. This relationship between the amount of input required
and the amount of output is called the production function.
The production function specifies the maximum output that can be produced with a given
quantity of inputs. This is for a given state of engineering and technical knowledge.

To cite an example the production function for generating electricity would specify the different
inputs and the level of electricity that will be generated. This would vary if the process of
generating electricity is through turbines, coal fired generating plants, nuclear power plants,
solar power plants and so forth. Together they form the production function for generating
electricity.
Or say digging a ditch with mechanized equipment in USA with few labors will take two hours
while the same job with labor intensive methods may take a full day in Vietnam.
Thus there are millions of production functions- one for each and every product or service.In
areas of technology like computer software and biotechnology the production function also
become obsolete. Thus the concept of the production function is a useful way of describing the
productive capacity of the firm.

Total , Average, & Marginal Product:

Based on the firms production function there are three important production concepts viz total,
average and marginal product.
The total physical product ie the total product designates the total amount of output produced
in physical units such as bushels of wheat or number of sneakers.
The following table gives the concept of total product. It also shows how total product responds
to given changes in the quantity of labor.It starts with 0 and with addition of labor it increases
to a maximum of 3900 with 5 units of labor.

Total, Marginal, Average Product

Units of labor inputs Total product Marginal Product Average Product

0 0
1 2000 2000 2000
2 3000 1000 1500
3 3500 500 1167
4 3800 300 950
5 3900 100 780

Given total product , the marginal product is determined. Marginal means extra ; So the
marginal product of an input is the extra output produced by 1 additional unit of that input
while other inputs are kept constant.For example if we hold land,machinery and other inputs
constant then the marginal product of labor is the extra output obtained by adding 1 unit of
labor. The third column of the above table gives the marginal product. The marginal product of
labor starts at 2000 for the first unit of labor and then falls to only 100 for the fifth unit of labor.
Marginal product calculations such as this are crucial for understanding how wages and other
factor prices are determined.
The final concept is the Average product which equals total output divided by total units of
inputs. The fourth column shows the average product of labor at 2000 units per worker with
one worker, 1500 units per worker with 2 workers, and so forth. It shows how average product
falls with increasing input of labour.

Fig 6.1 pg 109

The production function is a technical relationship between inputs and output. A commodity
can be produced by various methods using different combinations of inputs, with given states
of technology. Production function gives the several technically efficient methods of
production. Hence it is a technological relationship between physical inputs and physical
outputs over a period of time. Production function is ;
- Always related to a given period of time
- Always related to a certain level of technology
- Depends upon relation between inputs.
Cost of input does not form a part of the production function as cost is not a technical
factor.

The production function is written as follows:

 Q = f(x1,x2,x3 .xn) where Q is the maximum quantity of
output of a good being produced and x1,x2.xn are the quantities of various inputs
used in the production. If x1,x2 and xn are replaced by the factors of production then
the production function is written as:

Q=f( L,K,I,R,E)

Where Q = output; L=Labor ; K=capital ; I =land; R= raw material; E=efficiency

parameter.
In the short run inputs like land, plant and machinery cannot be changed and so the
producer trying to change inputs will do so by changing the variable inputs only. In the
long run all inputs can be varied.
Production Function with one variable input :
I the short run producers need to optimize with only one variable input.In a situation
where there are two inputs, capital and labor, capital is fixed and labor is variable input. As the
amount of capital is kept constant and labour is increased to increase output, the ratio in which
these two inputs are used will also change.So any change in output can be manifested through
change in labor input only.
Such a production function is called variable proportion production function. It is essentially a
short run production function in which production is planned with variable input. The short run
production function shows the maximum output a firm can produce when only one of its inputs
can be varied, other inputs remaining fixed.It is written as
Q=f(L,K )
Where Q is output, L is labor and K denotes the fixed amount of capital.It also implies that some
capital can be substituted by labor. Thus as units of variable inputs are increased the proportion
of use between fixed and variable input also changes. So the short run production functions are
governed by the Law of variable proportions.

To explain the Law of Variable Proportions in greater detail we give an example. Assume that a
manufacturer starts production with an investment of Rs.40 crores in plant and machinery. The
annual product of the frim is given the following table.

Law of Variable Proportions

Labor(00units) Total Product Marginal Average Product Stages

(000 tonnes) Product
1 20 - 20 *Increasing
2 50 30 25 *returns
3 90 40 30 *
4 120 30 30 &Diminishing
5 140 20 28 &returns
6 150 10 25 &
7 150 0 21.5 &
8 130 -20 16.25 ^Negative
9 100 -30 11.1 ^returns

It is observed that as the manufacturer increases units of labor keeping investment in plant
fixed, in the beginning marginal product of labor increases till 3 rd unit, then it decreases and
beyond 7units of labor, total output starts declining.

The following graph shows the same trend.

Fig 7.1 pg 190

The law of variable proportions states that as the quantity of the variable factor is increased
with other fixed factors, the marginal product and the average product of the variable factor
will eventually decline. With small increases in the units of labor,capital being constant,extra
units of labor manifests through an increase in output.But when after a point there are too
many workers with fixed capital, a part of the workforce becomes ineffective and the marginal
product of labour starts falling.
This law is based on the assumption that each unit of labor is homogeneous ie each worker has
the same skills and it is possible to use the variable factors in small units.
As the units of labor are increased, total output increases, but not necessarily at a constant
rate.In the beginning output increases at an increasing rate and finally increases at a
diminishing rate. Thus we have increasing marginal returns and diminishing marginal returns. It
must be understood that if one input is increased keeping others constant, ultimately output
will increase at diminishing rate. Therefore the Law of variable proportions is also called the law
of diminishing marginal returns.

The following figure explains the phenomenon.

Fig 7.1 191 pg

Increasing Returns to the Variable factor:

In this very first stage, when additional units of labour are employed, the total output increases
more than proportionately; so marginal product rises. In the figure we see that Stage I begins
from the origin and constinues to a point where APL attains its maximum value.In this range
MP> 0 and MP> AP. This stage is known as increasing returns to the variable factor.
Diminishing Returns to the Variable Factor:

In the second stage total output increases but less than proportionate to increase in labour.
Given the amounts of all other production factors,use of increasing amounts of a variable factor
in a production process beyond some point will result in diminishing marginal returns in total
output. In Stage II in the above figure, marginal product falls and this stage is known as
diminishing returns to the variable factor. Hence both AP and MP are positive but declining.
Hence MP>0, but AP is falling and MP< AP. Thus TP is increasing at a diminishing rate.

Negative Returns to the Variable Factor:

This stage is where MP<0 and TP is falling and is shown as stage III in the above figure.This is
technically an inefficient stage of production and a rational firm will never operate in this stage.

Production Function with two variable inputs:

In the long run all inputs are variable. So the firm has the choice to select combination of inputs
that maximize returns. When we restrict it to the most simplistic form of production function
with two variable inputs and a single output then we move to the relm of isoquants.

ISOQUANTS:

An isoquant is the locus of all technically efficient combinations ( or all possible factors of
production) for producing a given level of output. Isoquants are similar to indifference curves.
The distinction being that isoquants are different combination of inputs that correspond to the
same level of output. Since they render the same level of output, isoquants are also referred to
as iso product curves.
Indifference curves are different combinations of two consumption baskets corresponding to a
given level of utility.

Taking the production function as Q= f(L,K) and fixing the level of output Q at some given
quantity, we have an implicit relationship between units of labour(L) and Capital(K);
So an Isoquant is defined as Q =f(L,K)
It is possible to produce the same quantity of output using different combinations of inputs.
When these combinations are plotted on a graph we get a downward sloping curve which is the
Isoquant.

Graph 7.2 and fig 7.2 pg194

Characteristics of Isoquant:

Downward sloping: technological efficiency says that Isoquants must slope downwards
from the left to the right. So if more labor is used in the production process less capital
must be used in the production process.
Slope of the isoquant is Delta K/Delta L
Higher Isoquant represents a Higher Output. Thus a higher Isoquant curve say Q2 should
represent higher output than Q1.
Isoquants do not Intersect .Iso quants are two different units of inputs gives the same
level of outputs. If it intersects then it signifies a single input combination producing two
levels of output which is incorrect.
Convex to the Origin.Given substitutability between factor inputs, as the firm continues
to employ more of one input say capital a situation comes when it is difficult to
substitute labour for capital. Since labour and capital are not perfect substitutes
therefore as capital(K) is kept fixed to produce additional units of output only by
increasing labour.

Concept of Marginal Rate of Technical Substitution:

The Marginal Rate of Technical Substitution(MRTS) measures the reduction in per unit of one
input ,resulting in increase in the output that is just sufficient to maintain the same level of
output.Thus for the same quantity of output, marginal rate of technical substitution of labour
(L) for capital (K) (MRTS LK) would be the amount of capital that the firm would be willing to
give up for an additional unit of labour.Similarly the Marginal Rate of technical substitution of
capital for labour (MRTS KL)would be the amount of labour that the firm would be willing to
give up for an additional unit of capital.

Special shapes of Iso quants :

a. Linear Isoquants: When there is perfect substitutability between two factors the
isoquants would be linear.Isoquants are downward sloping straight lines

Fig 7.4
 b. Right Angle Isoquants : The other extreme is the isoquants are perfect complements.
Seen in the Leontief production technology in which capital is a perfect complement for
labour ,implying non substitutability between two factors.Such Iso quants are right
angled Iso quants.
Fig 7.4 pg197

ISOCOST:

The isocost line is the locus of points of all different combinations of labour and capital that a
firm can employ given the total cost and the price of inputs.

If the price of labour is wage(w) and the price of capital is interest (r) the total cost incurred by
the firm is summation of labour cost (wL) and capital cost (rK) and can be represented as :
C=wL+rK

The Iso cost line represents the locus of points of all the different combinations of two inputs
that a firm can procure given the total funds (Cost) and the prices of the inputs.If the total cost
of the firm is fixed and the input prices are given, the isocost line gives various combinations of
labour and capital.
Fig 7.5
The intercept of the isocost line on the capital axis is the maximum amount of capital employed
when labour is not used in the production process and is given by C/r. Similarly, the intercept
on the labour axis gives the maximum amount of labour used in the production process when
capital usage is zero and is given by C/w. The slope of the isocost line is

Slope = delta K/Delta L= C/r/C/w = w/r

Thus the slope of the isoquant line is equal to the ratio of the input prices ie the relative price of
labour to capital.

Least cost factor combination: Also called Producers Equilibrium:

The production function describes technology and not economic behaviour.But to be

economically efficient a producer must determine the combination of inputs that produces the
output at the minimum cost. A profit maximizing firm will try to use a combination of inputs
that will minimize its cost of producing a given level of output.

Ig 7.6 a ,b pg201.
The lowest cost of producing a given level of output is given at point E where isoquant
corresponding to this output Q2 is tangent to the isocost line AB. At this point the firm will
employ L* and K* units of labour and capital respectively.

Expansion Path:
His is defined as the line formed by joining the tangency points between various isocost lines
and the corresponding highest attainable isoquants

Fig 7.7 pg 202

Returns to scale:

1. Constant returns to scale: If a proportional increase in all inputs yields an equal

propotional increase in output then there is constant returns to scale

2. Decreasing returns to scale: If the proportionate increase in all inputs yields less than
proportionate increase in output then there is decreasing returns to scale.

3. Increasing returns to scale: If a proportional increase in all inputs yields more than
proportional increase in output the phenomena is known as increasing returns to scale.
Fih 7.8

Economics of scale : Economies refers to lower costs; hence economies of scale would mean
lowering the cost of production by way of producing in bulk. Economies of scale refers to
efficiencies associated with large scale operations.
It is a situation in which the long run average cost of producing a good or service decrease with
increase in the level of output.

Diseconomies of scale: refers to decrease in productivity when there are equal increases of all
inputs assuming that no input is fixed. If some cost of a business rises with an increase in size
By a greater proportion than the increase in the size of operations it is known as diseconomies
of scale.

Technological progress and the production function:

Much of the increase in the total output across nations has come due to technological change
which improves pproductivity and rises the standard of living.
There is process innovaton which has improved production techniques for existing products
and product innovation whereby improved products are introduced in the market place.
Technological change shifts the production function upwards.ph 114 fig 6.3

Concept, Production Function- Total, Average, & Marginal Product, - Law of Variable
Proportions & ISO-Quants & ISO Costs - Least cost factor combination- Returns to
Scale- Economies and Diseconomies of Scale - Technological progress and production
function.

Module 2: Cost and Revenue Profit Functions:

Everywhere there is production, costs follows closely behind. Firms need to pay for the
various inputs software, secretaries, statisticians etc. Profitable businesses are aware of this
as every rupee spend lowers their profits.
Role of costs goes beyond influencing production and profits.Costs affects input
choices,investment decisions and even the decision to stay in business.
Is it cheaper to hire a new worker or pay an existing worker overtime? To open a new factory
or expand a new one?To invest in new machinery domestically or relocate production
overseas? In all these , the unit would like to choose the most efficient method of production
and produce output at the lowest cost.

Cost Concepts: Economic Analysis of costs:

Total Costs : Fixed and Variable:

Consider a firm that produces a quantity of output ( say q) using inputs of capital,labor and
materials. The firm buys these inputs in the factor markets.The firmss accounts need to
calculate the total rupee cost incurred to produce output level q.
Table :Fixed,Variable, and Total cost

Quantity q Fixed Cost FC (Rs) Variable Cost VC (Rs) Total Cost TC(Rs.)
(1) (2) (3) (4)
0 55 0 55
1 55 30 85
2 55 55 110
3 55 75 130
4 55 105 160
5 55 155 210
6 55 225 280

The major elements of a firms costs are its fixed costs (which do not vary when output changes)
and its variable costs (which increase as output increases. Total costs are equal to the fixed plus
the variable costs.(TC=FC+VC)

Fixed Cost:
Columns (2) and (3) break total cost into two components: total fixed costs (FC) and total
variable costs(VC)
What are the fixed costs of a firm? Sometimes called overheads or suck costs they consist of
items such as rent for factory or office space, contractual payments for equipment,
interest payments on debts, salaries and so forth. These need to be paid even if the firm
produces output and they do not change with change in output . Say a Law firm has an
office on lease and it will have to pay for about 10 years. The firm is obliged to pay even
if its business shrinks to half the size. Since fixed cost is the amount to be paid regardless
of the output, it remains constant at Rs. 55/.
Variable Costs:

Column (3) in the above table shows the variable costs (VC).Variable costs are those which vary
as output changes. Examples include materials required to produce output (like steel to
produce automobiles, production workers to staff the assembly lines, power to operate
factories and others.In a supermarket the checkout clerks are a variable cost since
managers can adjust the clerks hours to the shoppers coming to the store.

By definition VC begins at zero when q is zero; VC is part of TC that grows with output.The
junmp in TC between any two outputs is the same as the jump in VC.This is because FC stays
constant at Rs. 55 throughout the output.
To summarise these cost concepts:
Total cost: represents the lowest total rupee expense needed to produce each level of output
q. TC rises as q rises.

Fixed cost: represents the total rupee expense that is paid out even when no output is
produced. Fixed costs is unaffected even when no quantity is produced.
Variable cost: represents expenses that vary with the level of output such as raw
materials,wages,fuel and includes all costs that are not fixed.

TC = FC+VC
Marginal cost:

Marginal cost is one of the most important concepts in economics. Marginal costs(MC) denotes
the extra or additional cost of producing 1 extra unit of output.If a firm is producing CDs and
the total cost of producing 1000 CDs is Rs. 10,000. If the total cost of producing 1001 discs I Rs.
10,006 then the marginal cost of production is Rs.6 for the 1001th CD.

At times the marginal cost for the extra unit of output is very low. Example an airline flying
empty seats , the added cost of an additional passenger is nearly zero. At times the marginal
cost can be very high.Example on a hot summer day when there is a huge demand for power,
there may be a need to use the old generator to meet the demand and this can be at a higher
cost.

The following table gives the details of how MC is calculated.

Output (q) Total cost (TC) Marginal Cost (MC)

0 55
1 85 30
2 110 25
3 130 20
4 160 30
5 210 50

Once the total cost is known it is easy to calculate the marginal cost.To calculate the MC of the
fifth unit we subtract the total cost of the fourth unit from the total cost of the fifth unit.

The marginal cost of production is the additional cost incurred in producing 1 extra unit of
output.
Marginal cost depicted as diagram:
The following graph gives that TC is related to MC in the same way that total product is related
to Marginal product or that Total utility Is related to marginal utility.

Fig 7.1 pg 127

Empirical studies have shown that for most production activities in the short run when capita
stock is fixed, marginal cost curves are U- shaped . This U-shaped curve falls in the initial phase,
reaches a minimum point and finally begins to rise.

Average Cost or unit cost :

Like marginal cost, average cost (AC) is a concept widely used in business. By comparing
average cost with price or average revenue businesses can determine whether they are making
profits. Average cost is the total cost divided by the total number of units produced.

That is Average cost =total cost/output=TC/q =AC

When only 1 unit is produced average cost is TC/1. When q =2 then the average cost is TC/2.
And so on. Average cost declines reach the minimum and then start to increase.
The following Table gives the cost data and the subsequent figures give the total, fixed and
variable costs at different levels of output.

Quantity Fixed Variable Total Marginal Average Average Average

(1) Cost Cost Cost Cost per Cost per Fixed Variable
FC VC TC=FC+VC unit unit Cost per Cost per
Rs. Rs. Rs. MC AC=TC/q unit unit
Rs Rs. AFC=FC/Q AVC=VC/q
Rs. Rs.
0 55 0 55 infinity infinity undefined
1 55 30 85 30 85 55 30
2 55 55 110 25 55 27 1/2 27
3 55 75 130 20 43 1/3 18 1/3 25
4 55 105 160 30
5 55 155 210 50 42 11 --
6 55 225 280 - 46 2/3 9 1/6 37
7 55 - 370 90 52 6/7 7 6/7 45
8 55 - 480 110 60 6 7/8 53 1/8

The following graphs depicts the total, fixed and variable costs at different levels of output

7.2 a 129

Figure below gives the total, fixed and variable costs at different average cost concepts along
with the smoothed marginal cost curve.
Graph (a) shows how total cost moves with variable cost while fixed cost remains unchanged.

Graph (b) Graph (b) plots the U-shaped AC curve and the AC curve is derived from the TC curve.
Figure 7.3 shows how marginal cost is related to the slope of the total cost curve.
Average Fixed and Variable Cost:

Just as how total cost is made up of fixed and variable costs, we also have the average cost
comprising of fixed and variable components.
Average Fixed Cost(AFC) is defined as FC/q. Since total fixed cost is constant, dividing it with
the increasing output gives a falling average fixed cost curve. Thus when a firm sells more
output it can spread the overhead costs to more number of units.The dashed AFC curve is a
hyperbola approaching both axes. It drops lower and lower approaching the horizontal axis as
the constant FC gets spread over more number of units.
Average Variable Cost (AVC) is equal to the variable cost /output or AVC= VC/q. AVC falls and
then rises.

Minimum Average Cost: Average cost should not be confused with Marginal cost. Average cost
can be higher or lower than marginal cost. Figure (b) shows that there is an important link
between MC and AC. When the MC of an added unit of output is below its AC ,its AC is
declining. When MC is above AC then AC is increasing.At the point where MC=AC the AC curve
is flat. For a typical U shaped AC curve, the point where MC=AC is also the point where AC hits
minimum level

Important rules to remember:

When marginal cost is below average cost, it is pulling average cost down
When MC is above AC it is pulling AC up
When MC=AC ,AC is neither rising nor falling and it is at its minimum. At the bottom of
the U shaped AC, MC =AC =minimum AC.

This is a critical relationship. It means that the firm searching for the lowest average cost of
production should look for the level of output at which marginal costs equal average costs.
Why is it so? When MC is below AC, the last unit produced costs less than average costs of all
previous productions. In contrast, if MC is above AC the last unit costs more than the average
cost of the previous units. When MC=AC then the last unit cost is exactly the same as the
average cost of all previous productions.

The Link between Production and Cost:

What determines a firms cost curve? Clearly the prices of inputs like labour and land are
important factors influencing costs. Higher rent and wages means higher costs.But the cost
curve of a firm also depends closely on the firms production function.If technological inputs
allow a firm to produce the same output with fewer inputs the firms cost curve will fall and the
cost curve will shift down.
The production function with factor prices will tell us the which is the least costly combination
of inputs the firm can select that can yield the output.

Table 7.4 gives the details

Diminishing Returns and the U shaped cost curve:

The relationship between cost and production helps to explain why average cost curve tends to
be U shaped. While analysing production we distinguished two time periods the short run and
the long run.
The same concepts apply to costs as well.
# Short run is a period of time where variable inputs can be adjusted like material and labour
but too short to change all inputs. In the short run fixed or overhead factors like plant and
equipment cannot be fully modified or adjusted. So in the short run labour and material costs
are variable while capital costs are fixed.
# In the long run all inputs can be adjusted including labour, materials, and capital. So in the
long run all costs are variable and none are fixed.

So a particular cost is fixed or variable depending on the length of time we are considering. In
the short run the number of planes of an airline is a fixed cost. But over the longer run the
airlines can control the size of its fleet by buying or selling planes. Typically in the short run the
airline will consider capital to be fixed cost and labour to be variable cost.
Why is the cost curve U shaped? Consider the short run in which capital is fixed but labour is
variable. Then there is diminishing returns to the variable factor(labour) because each
additional unit of labour has less capital to work with. So the marginal cost of output will rise
because extra output produced by each extra labour unit is going down. In other words
diminishing returns to the variable factor will imply an increasing short run marginal cost. It
shows why diminishing returns lead to rising marginal cost after some point. Ref fi 7.4 based on
data from table 7.4

Output Land inputs Labour inputs Land rent Labour wages Total cost
Tons of acres workers Rs. Per acre (Rs per
wheat worker)
0 10 0 5.5 5 55
1 10 6 5.5 5 85
2 10 11 5.5 5 110
3 10 15 5.5 5 130
4 10 21 5.5 5 160
5 10 31 5.5 5 210
6 10 45 5.5 5 280
7 10 63 5.5 5 370
8 10 85 5.5 5 480

Fi 7.4 pg 132
The U shaped marginal cost curve in (b) arises from the shape of the marginal product curve in
(a). With fixed land and variable labour , the marginal product of labour in (a) first rises to the
left of B, peaks at B and then falls at D as diminishing returns to labour sets in.
The marginal cost curve derives from the production data. In the region to the left of B in (b)
such as at point A the rising marginal product means that marginal cost is falling. At B peak
marginal product occurs at minimum marginal cost. To the right of B (at D0 the marginal cost of
producing output increases as the marginal product of labor falls.
Overall increasing and then diminishing marginal product to the variable factor gives a U
shaped marginal cost curve.

To summarise the relationship between productivity laws and cost curves we give the
following:
In the short run when factors such as capital are fixed, variable factors tend to show an
initial phase of increasing marginal product followed by diminishing marginal product.
The corresponding cost curve shows an initial phase of declining marginal costs followed
by increasing MC after diminishing returns have set in.

Opportunity cost:

An assumption we make is that resources are scarce. So each time we choose to use a resource
in one way we are giving up the opportunity to use the resource in another way. As consumers
we are constantly choosing between choices due to the limited resources.Should I go for a
movie or study for the next weeks test? And so on
In each case making a choice in effect costs us the opportunity to do something else. The best
alternative that is foregone is called opportunity cost. The immediate rupee cost of goint to a
movie instead of studying is the price of a ticket but the opportunity cost also includes a higher
grade in the exam.
The opportunity cost of a decision includes all its consequences whether they reflect monetary
transaction or not.
Decisions have opportunity costs because choosing one thing in a world of scarcity means
giving up something else. The opportunity cost is the value of the most valuable good or service
foregone.

Business decisions also have opportunity cost. But do all opportunity costs show up as the
balance sheet and profit and loss accounts.Not necessarity. Business accounts include
transactions in which only money actually changes hands.In contrast the economist tries to
measure the true resource cost of an activity.Economists include all costs whether they reflect
monetary transactions or not.
Several opportunity costs do not show up.Like
-unpaid hours of service by a family business
-Capital charges for the owners financial contribution
-cost of environmental damage when businesses dump material.
We illustrate the concept of opportunity cost by considering the owner of a Goli Vada Pav
venture.The owner puts in 60 hours per week buy earns no wages.At the end of the year the
firm makes a profit of Rs.37,000.This is the accounts interpretation of profits and is quite good.
But the economist would insist that we need to calculate the value of the factors of production
regardless of how the factor is owned. We need to count the owners own labor as cost even
though the owner does not get paid directly but receives compensation by way of profits.Since
the owner has alternate opportunities for work we need to value the owners labour in terms of
lost opportunities.
Here the owner ,by working for someone else can get an earnings of Rs.60,000. This is the
opportunity cost or the earnings foregone to handle the small business.
Given this by the economist, the true economic profits of the goli vada pav firm is measured
profits of Rs. 37,000 and subtract Rs.60,000 opportunity cost of owners labour and we get a
net loss of Rs. 23,000.
Thus even though the account may conclude that the goli vada pav venture is economically
viable the economist would pronounce that the firm is unprofitable.

Robert Frost

Two roads diverged in a wood, and I

I took the one less travelled by
And that made all the difference

Profits are net revenues or the difference between total sales and total costs. Firms are lured
by profits to enter businesses which have high demand for their products and which results in
high profits. In addition to wages, interest and rent, economists talk about a fourth category of
income called profits. What are profits? How do they differ from interest and the returns on
capital more generally?
Accountants define profits as the difference between total revenue and total costs. To calculate
profits start with total revenue from sales .Subtract all expenses (wages, salaries, rents,
materials, interest, excise, taxes etc) .What is the balance is called profits.

Determinants of Profits:

What determines the rate of profits in a market economy? Profits are a combination of various
elements including the implicit returns on owners capital, reward for risk bearing and
innovation profits.
a) Profits as implicit returns: To the economist business profits is a combination of
different elements. Much of the reported profits of the business is a return to the
owners of the firm for the capital and labour provided by the owners that is for factors
of production supplied by them.
Some profits is the return for the contribution of the owner to the business.Some could
be a part of the rent return on land owned by the firm. In large corporations profits are
 the opportunity costs of invested capital. These returns are called implicit returns(or
costs), which is the name for the opportunity cost of factors owned by firms.
So what is regarded as profits is actually implicit rentals, implicit rent and implicit wages.
b) Profits as reward for Risk Bearing: Profits includes the reward for riskiness of
Investment.
These include:
-risk of default
-insurable risks
-uninsurable or systematic risks :impact of business cycles
-sovereign risks : a nation defaults
Thus corporate profits which contain all of them, are the most volatile.
Investors who invest on stocks or equity earn a share of the profits through equity
premium.
c) Profits as reward for Innovation: A third kind of profits is the return on innovation and
invention. When new products are introduced ,and which are a result of research,
development and marketing we refer to the person who brought the new product as an
innovator. Innovators are individuals who have the vision, originality and daring to
introduce new ideas in business.
Some have huge profits from their innovations. Innovation profits called or
Schumpeterian profits is the temporary excess returns to innovators or entrepreneurs.

Break Even Analysis- Meaning, Assumptions, Determination of BEA

An important application of cost analysis used frequently in business is Break Even Analysis. It
examines the relationship between total revenue ,total costs and total profits of the firm at
different levels of output.
Break Even analysis is determining profits at different levels of output of the firm at different
profit levels.
Break Even is about determining profits at different level of sales., identifying the break-even
point and making a managerial decision regarding the relationship between sales and break
even point.
Break Even is used synonymously with Cost Volume Profit Analysis.It may be the first step in the
planning exercise.
What is the break even point? It is the point where total cost just equals total revenue also
called the no profit no loss point.

Break Even point is the intersection of the total revenue and total cost curves.

Example:
Let P be the price of a good, Q the quantity produced,AVC be the Average Variable Cost and
AFC the Average Fixed Cost. Let Q* be the breakeven output where total revenue equals total
cost. Now:
Total Revenue = P.Q
Total Cost =TFC +TVC=TFC+AVC.Q

We can say :

P.Q*=TFC+AVC.Q*
= (P-AVC)Q*=TFC

Q* = TFC/P-AVC

Contribution Margin:
Contribution margin per unit sales is the difference between price and average variable cost. P-
AVC.If represents the portion of the price of the commodity produced by the firm that can
cover the fixed costs and contribute to profits.

Contribution Margin =Sales-MARGINAL Cost

PV Ratio
Profit Volume ratio is the ratio of the contribution margin and sales. It is also called marginal
changes in profits to marginal changes in sales.

PV ratio =Contribution/Sales

BEP =FC/PVratio

Margin of Safety:

It refers to the volume of planned sales over and above the breakeven volume of sales. In other
words margin of safety =Planned sales Break even sales.

Limitations:
1. Does not consider changes in cost over time
2. No provision made for changes in selling price
3. Assumes that what is produced is sold
4. Does not allow for changes in market conditions.
Figure 7.2 127 gives the details of the TC curve.The fig 7.2 b gives the different average cost
concepts along with smoothed marginal cost curve.Graph shows how total cost moves with
variable cost while fixed costs remains the same.
Graph b plots the U shaped AC and aligns AC right below the TC curve from which it is
derived.Marginal cost is related to the slope of the total cost curve.

Average, Fixed and Variable Cost:

Fixed and variable costs- Total Cost, Average Cost, Marginal Cost, Opportunity Cost. -
Short-run and Long-run Cost Curves Profits: Determinants of Short-Term & Long Term Profits,
Measurement of Profit. Break Even Analysis- Meaning, Assumptions, Determination of BEA,
Limitations and Uses of BEA in Managerial Economics. (Problems on BEP).

MARKET STRUCTURE

PERFECT COMPETITION

Among the various market forms, perfect competition is most basic. It is theoretical and
hypothetical yet it deserves discussion because it is the most ideal form of market.

A perfectly competitive market is one in which economic forces operate unimpeded.

A perfectly competitive market must meet the following requirements:

a. Both buyers and sellers are price takers.

b. The number of firms is large.
c. There are no barriers to entry.
d. The firms' products are identical.
e. There is complete information.
 f. Firms are profit maximizers
g. Perfectly elastic demand curve
h. Perfect mobility of Factors of Production
i. No Government Intervention

Demand and Revenue of a Firm:

We examine the concept of revenue and cost of firm under perfect competition. The
assumption of rationality is that a firm aims to maximize the profits.
Also Total Revenue (TR) is the multiplicative product of the price and the quantity sold.
TR=P.Q

Since firms in a competitive market place are price takers, they can only adjust quantity
at a fixed price. Hence TR depends on quantity only. Following the concept of MR, we
observe

Marginal Revenue (MR) = dTR/dQ = d/Dq x PR

=Q.dP/dQ +P.dQ/Dq
=P

Marginal Revenue is the extra revenue that a firm makes by selling one extra unit of
output.
Under perfect competition AR=MR=P. Average revenue is the total revenue earned
divided by the total quantity produced.

MARKET DEMAND CURVE AND FIRM'S DEMAND CURVE :

The demand curves facing the firm is different from the industry demand curve.The
market demand curve for the whole industry is a standard downward sloping curve,
and shows alternative combinations of price and output available to buyers such that
an individual buyer is able to get the maximum amount of output at each existing
price at a given time.The demand curve for the individual firm is a horizontal straight
line.

A perfectly competitive firms demand schedule is perfectly elastic even though the
demand curve for the market is downward sloping.
 This means that firms will increase their output in response to an increase in demand
even though that will cause the price to fall thus making all firms collectively worse off

The market supply curve is upward sloping giving various combinations of price and
output. It shows the maximum output a firm is willing to produce and supply at each
specified price at a given time.

The following figure gives the details.

SHORT RUN EQUILIBRIUM

In the short run an individual firm under perfect competition may either earn
supernormal profits,normal profit or can incur losses. This depands on the positions of
the hort run cost curves. The three possibilities are shown by the three short run
equilibrium curves.
Case of Supernormal Profits: In the short run a perfectly competitive firm can earn
supernormal profits, where revenue exceeds costs. The Average Cost (AC) and Marginal
Cost (MC) curves are the usual short run cost curves. Firm maximizes profits when

a. at the point where MR= MC

b. Also where MC cuts MR from below.

Point of equilibrium of the frim is point A.

Case of Normal Profits: Some firms earn normal profits where revenue is equal to cost.
The equilibrium is at point A .

Case of Subnormal Profits: The point of equilibrium is at A where MC=MR. The firm
incurs a loss as the cost of producing is more than the revenue obtained.
SOME ADDITIONAL PERSPECTIVES ON PROFIT MAXIMIZING LEVEL OF OUTPUT

Since profit is the difference between total revenue and total cost, what happens
to profit in response to a change in output is determined by marginal revenue
(MR) and marginal cost (MC).

Marginal revenue (MR) the change in total revenue associated with a change in
quantity.
Marginal cost (MC) -- the change in total cost associated with a change in
quantity.
Marginal Revenue: Since a perfect competitor accepts the market price as
given, for a competitive firm, marginal revenue is price (MR = P).

MARGINAL COST

Initially, marginal cost falls and then begins to rise.

Marginal concepts are best defined between the numbers.

HOW TO MAXIMIZE PROFITS

To maximize profits, a firm should produce where marginal cost equals

marginal revenue.

Thus, the profit-maximizing condition of a competitive firm is MC = MR =

P.
THE SHUT DOWN POINT:

The firm will shut down if it cannot cover average variable costs.

A firm should continue to produce as long as price is greater than average

variable cost.

Once price falls below that point it makes sense to shut down temporarily and
save the variable costs.

The shutdown point is the point at which the firm will gain more by shutting down than
it will by staying in business.

As long as total revenue is more than total variable cost, temporarily producing at a
loss is the firms best strategy since it is taking less of a loss than it would by shutting
down.
MARKET SUPPLY CURVE AND FIRM'S SUPPLY CURVE

The demand curve of the firm is its average revenue curve. The short run supply curve needs to
be derived. As observed earlier , the perfectly competitive firm produces above the minimum
point of its AVC and discontinues production is price falls short of minimum AVC. This is
summed up with the following conditions

Condition I: If Price < minimum AVC, then shut down

Condition II: If Price > or = to AVC , then choose any output that will maximize the profits.

The supply curve of the firm is identical to the short run MC curve above the minimum point of
the AVC curve.

LONG RUN EQUILIBRIUM:

In the long run the perfectly competitive firm can earn only normal profits This is due to the
unrestricted entry into and exit of firms from industry in the long run. This is explained with two
extreme examples. First when existing firms enjoy supernormal profits in the short run and next
when the existing firms incur losses in the short run. If some of the existing firms earn
supernormal profits, this attracts new firms in the industry to gain profits. With the entry of
new firms the supply of the commodity in the market increases. Assuming no change in the
demand, this lowers the price. This process of adjustment continues till the price becomes
equal to the long run average cost (AR=AC=MR=MC). So super normal profits re squeezed till all
firms in the industry earn normal profits.

Alternatively if the firms are making losses in the short run, it would force some firms to leave
the industry in the long run as they will not be able to sustain losses for long. Their exit from the
industry causes reduction in the supply of the product and as a result the equilibrium price in
the industry rises. This process continues till the marginal firms do not incur losses. Equilibrium
occurs at a point where price is tangent to the long run average cost and all the firms make
normal profit in the long run .Thus perfectly competitive firm can earn only normal profits in
the long run. The condition of profit maximization in the long run is P=MC=MR=LAC

MONOPOLY:

Monopoly is the polar opposite of perfect competition.

Monopoly is a market structure in which a single firm makes up the entire market.

Monopolies exist because of barriers to entry into a market that prevent competition.

Barriers to entry include legal barriers, sociological barriers, and natural barriers

There are major differences between the perfect competitive firm and the monopoly.

FEATURES OF MONOPOLY

Single seller
Single product
 No difference between frim and industry
Independent decision Making
Restricted entry

TYPES OF MONOPOLY

Legal Monopoly
Economic Monopoly
Natural Monopoly
Regional Monopoly

DEMAND AND MARGINAL REVENUE CURVES FOR A MONOPOLY:

The Monopolist cannot set both price and quantity at its own will. Under perfect competition
the firm takes the market price . Unlike this the monopoly firm determines the optimal
combination of price and output and has a normal demand curve with a negative slope. The
reason behind the negative slope is that though the monopoly firm is in total control of the
market price, yet it can sell only when it reduces the price of its product. So a monopolist can
increase sales only when it reduces the price of the product and sales will go down if price is
increased.

As observed from the above figure the Demand curve is the AR curve which is downward
sloping while the MR curve is also downward sloping but is less than the AR curve.

The demand curve for the monopolist is price inelastic because there is no close substitute and
consumers have very little choice. If consumers want to buy the product they will have to buy
the product at the price charged by the monopolist. Does the monopolist charge high prices?
Not necessarily because the monopoly firm is affected by the market demand for the product
and the forces affecting demand also affects pricing. Also the demand curve for the monopolist
is not perfectly inelastic because pure monopoly does not exist in real life. It faces a normal
downward sloping demand curve .So the monopolist cannot set the price and quantity at its
own will.

The Average Revenue curve denotes the demand curve of the firm and also determines the
slope of the MR curve. In case of perfect competition the demand curve is perfectly elastic; so
the AR curve of a perfectly competitive firm is horizontal and coincides with the MR curve. In a
monopoly the AR and the MR curve is as given in the above figure. The reason is that the
monopolist faces a normal demand curve which is highly inelastic and so AR curve is downward
sloping and the MR curve lies below the AR curve.

PRICE AND OUTPUT DECISIONS IN THE SHORT RUN

A. Case of Super normal profits:

The occurrence of supernormal profits is the most acceptable position for a monopolist. The
following figure gives the details.

Following the condition of profit maximization the point of equilibrium is point B and the
equilibrium output is given by OQm. The price at which the monopolist will reach equilibrium is
given as OPm and this is the equilibrium price. Since the equilibrium price D is more than ATC
the firm earns super normal profits. The area ABCmPm is the super normal profits in the short
run and it is the difference between total Revenue and total Cost

B. Case of Normal Profits

The monopoly firm may also earn normal profits.in the short run. In the early years of
operations the firm may be able to manage normal profits. Normal profits are earned when
average cost is equal to average revenue.

In the figure it is at the point where the AC (ATC) curve is tangent to AR curve (Demand D)
curve. Equilibrium is at the point where MC curve cuts the MR curve .The profit maximizing
output is OQm and the profit maximizing price is OPm.

C. Case of Subnormal Profits.

In the short run the monopolist can incur losses. It happens when the average revenue is less
than the average cost or when the average cost cure is over and above the price line. The case
of loss is shown in the following figure.
The size of the market in the early years may be small and to sell the entire output the firm
may have to suffer losses. Secondly the monopolist firm may deliberately charge low prices to
keep competitors out of the market. Thirdly to curb monopoly the government may impose tax
on monopoly products which in turn increases profits. In the above figure the firm incurs a loss
of ABCmPm and this corresponds to a Quantity of OQm and Price ofOPm

PRICE AND OUTPUT DECISIONS IN THE LONG RUN :

As discussed the monopolist is in full control of the market prices and so it will not continue to
incur losses in the long run. It would reduce the cost of production by increasing the control of
raw materials. The monopolist may earn normal profits in the long run and super normal profits
due to entry restrictions in the market. So the firm will earn normal profits or super normal
profits in the short run.

Supply curve of the monopoly firm

A Monopolist is a price maker. The monopoly firm is a price maker and the firm sets the price
for its products instead of taking it from the market

Consequently there is no definite supply curve for the monopolist.

PRICE DISCRIMINATION OF THE MONOPOLIST REFER NOTES

MONOPOLIST COMPETITION

Under this form of competition also called Imperfect competition, a large number of sellers sell
heterogeneous or differentiated products and buyers have preferences for specific sellers. The
market can be called monopolist because each of these sellers makes the product unique by
some differentiation and has control over the small section of market just like a monopolist.

Features of Monopolistic Competition:

a. Large number of buyers and sellers

b. Heterogeneous products

c. Selling Costs

d. Independent Decision Making

e. Imperfect Knowledge

f. Unrestricted entry and Exit

DEMAND AND MARGINAL REVENUE CURVE OF A FIRM:

A firm under monopolist competition has a normal demand curve with a negative slope. The
main reason for the negative slope is that these firms sell heterogeneous products, which are
close substitutes to each other. Unlike perfect competition the firm under monopolist
competition is able to independently determine an optimal combination of price and output. If
the firm increases the price of its products slightly it will lose some but not all of its customers.
If it lowers the price it will gain some but not all of its customers.

AND OUTPUT DECISIONS IN THE SHORT RUN

As Joan Robinson has commented each firm has a monopoly over its product. When the
product is differentiated the firm has some monopoly power. Firms under monopolist
competition have limited discretion over price due to customer loyalty. Firm maximizes profits
when MR=MC.

Case of Super normal profits:

A firm earns super normal profits in the short run as it reaps the benefits of supplying product
which is differentiated or atleast perceived to be different from the products of rival firms.

The monopolistic Competitive firm earns super normal profits in the short run where MR=MC
and MC cuts MR from below

Case of Normal Profits: Not all firms make super normal profits. Some make normal profits also.
This is when the average cost is equal to average revenue and the AC curve is tangent to AR
(demand ) curve. Equilibrium occurs at point --- where the condition of profit maximization is
satisfied.
Case of Subnormal profits: In the short run the monopolist competitive firm incurs losses
where average revenue is less than average cost or AC curve is over and above the price line.

Equilibrium is at point -----.

PRICE AND OUTPUT DECISION IN THE LONG RUN:

In the long run the firms will earn normal profits. If any firm is earning super normal profits it
will attract new firms to enter the industry. It will add to competition, shift the original demand
curve and MR curve of the firm downward which results in decrease in market share of the
original firm. Assuming the aggregate market demand remains the same , the shift will continue
till firms in the market will earn normal profits.

If firms are making losses, then they would exit the industry causing the demand curve to shift
upward to the right. The shift will continue till the firms make normal profits.

OLIGOPOLY:

One aspect that differentiates Oligopoly fromother market forms is the interdependence of
various firms. No firm can take the decisions without considering the action or reaction of rival
firms.

This continuous consciousness of rival actions is the main characteristic of oligopoly and this
often results in cut throat competition.This results in price rigidity that is a single price prevails
like perfect competition but the price is not governed by market forces but by a dominant firm.

FEATURES OF OLIGOPOLY :

a. Few Sellers

b.Product may be differentiated like cars ,motorbikes or homogeneous like petroleum

c. Entry Barriers

- Huge investment requirements

-Strong Consumer Loyalty for Existing Brands

-Economies of Scale

d. Interdependent Decision Making

e. Non price competition

f. Indeterminate Demand Curve

PRICE AND OUTPUT DECISIONS

Module III

3.0 Indian Economic Environment:

3.1 Overview of the Indian Economy:

(a) In d i a w i t h i t s p o p u l a t i o n o f 1,1 7 0 m i l l i o n i n 2 0 1 0 a n d w i t h i t s p e r c a p i t a i n c o m e o f $1 1 8
0 i s a m o n g t h e p o o r e s t o f t h e e c o n o m i e s o f t h e w o r l d . It h a d a s h a r e o f 1 7 . 0 p e r c e n t i n
w o r l d p o p u l a t i o n , b u t Accounts f o r o n l y 2 . 5 p e r c e n t o f W o r l d G N I (Gross National Income) o n e x
c h a n g e r a t e basis.T h e f i g u r e s q u o t e d a b o v e a r e o n e x c h a n g e r a te b a s i s . T h e u s e o f o f f i c i a l
e x c h a n g e rates
t o co n vert n at ion al curre n cy f igu re s t o th e US d o llar s d o e s no t at te mpt t o me asu re t he
relative d o m e s t i c p u r c h a s i ng P o w e r o f c u r r e n c i e s .
Based on the work of Prof I.V Kravis and others a method was d e v e l o p e d to M e a s u r e r e a l G D P a n d G N
P (o r
G N I ) o n a n i n t e r n a t i o n a l l y c o m p ar a b l e scale u s i n g p u r c h a s i n g p o w er p a r i t i e s ( P P P s ) i n s t e a
d o f e x c h a n g e rates as c o v e r s i o n factors.
E ven on PP P b asis,In d ia wit h a p er cap it a GN I of $ 4 ,15 9 con t inu es t o b e in th e grou p of lo
wer mid dle in come econ omie s,bu t with an a ccelerat ion in it s grow th rat e of GD P to an
a verage of
8 . 0 p e r c e n t d u r i n g 2 0 0 0 a n d 2 0 1 0 , I n d i a w i l l v e r y s o o n e n t e r t h e g r o u p o f u p p er m i d d l e i n
c o m e c o u n t r i e s . C h i n a , h o w e v e r , h a s e n t e r ed t h e u p p e r m i d d l e i n c o m e g r o u p.

(b) D e v e l o p i n g e c o n o m i e s a r e d i s t i n g u i s h e d from the d e v e l o p e d e c o n o m i e s o n t h e b a s i s o

f t h e i r p e r c a p i t a i n c o m e . T h o u g h per c a p i t a i n c o m e i s not t h e o n l y i n d i c a t o r , i t i s t h e m o s t
s ign ifi cant s i n g le c o m p a r i son f o r d i f f e r e n t e c o n o m i e s .

( c ) T h e c e n t r a l p r o b l e m o f d e v e l o p i n g e c o n omies i s t h e p r e v a l e n c e o f ' m a s s p o v e r t y ' w h i c

h I s t he
c a us e as w e l l as c o n s e q u e n c e o f t h e i r l o w l e v e l o f devel o p m e n t . Mass p o v e r t y i s t h e r e s u l t
o f l o w r e s o u r ce with t h e p o o r w h o o w n a v e r y s m a l l p o r t i o n o f t he assets i n t h e f o r m o f l a n
d , c a p i t a l , h o u s e p r o p erty , e t c . T h e l o w r e s o u r c e base o f t h e p o o r also inhi b i t s t h e m f r o m g i v i
n g edu cat ion and t r a i n i n g t o their c h i l d r e n . A s a r e s u l t , t h e c h i l d r e n o f t h e p o o r are
engaged by a n d l a r g e , e i t h e r i n u n s k i l l e d o c c u p a t i o ns o r some s e m i - s k i l l e d o c c u p a t i o n s .
T h i s enables them t o e a r n v e r y l o w a n d m e a g r e wages a n d t h us p e t u a t e p o v e r t y . I n o t h e r w
o r d s , i n e q u a l i t y i n t he distrib u t i o n o f a s s e t s i s t h e p r i n c i p a l c a u s e o f u n e q u a l dist r i b u t i o n
o f i n c o m e o n t h e o n e h a n d a n d u n e q u al distrib u t i o n o f o p p o r t u n i t i e s o n t h e o t h e r .
( d ) M a ss p o v e r t y i n d e v e l o p i n g e c o n o m i c s i s n o t d u e t o p o o r n a t u r a l r e s o u r c e s , b u t d u e t
o i n a d e q u a te d eve l o p m e n t o f t h e s e r e s o u r c e s a n d e x p l o i t a t i v e s o c i a l structure.

During the pre- British period the economy consisted of self sustaining villages and towns which were the seats of
administrative power Transportation and communication were undeveloped and the size of the market was small
The structure and organization of the village comprised of village community which was through simple division of
labor. Farmers cultivated the soil and tended to cattle. Similarly there were people called weavers ,goldsmiths,
carpenters, potters, cobblers etc. Their occupation was hereditary and passed on from father to son. They were paid a
stipend of the crop for the services rendered. These village communities as observed by Sir Charles Metcaalfe were mini
republics which are self sufficient
In contrast the towns were trading and commercial centers which existed on important trade routes. Towns were
different from villages with people engaged in variety of occupations and catering to a wider market.
Though India was primarily agrarian, yet industries and handicrafts in pre British India were well developed.. When
Western Europe , the seat of modern industrialization, was undeveloped, India was known for the wealth of its rulers
and the skills of its artisans.
The Economic Consequences of British Conquest led to the emergence of a new economic system whose interests
were rooted in foreign soil and policies were guided by their sole interest. The British rule in India comprised of two
phases namely the period from 1757 to 1858 under the East India Company and 1858 to 1947 under the British
Government. Due to the British influence Indian handicrafts progressively declined and there was a shift of people from
industry to agriculture.. This led to ruralization of the Indian economy.
During this period when British underwent a Industrial Revolution India became a supplier of raw material to British
Industry and an importer of machine made products from Britain.. This prevailed for the benefit of the British and
consequently led to deterioration in the standard of living of the Indian.. Large scale production led to reduction in costs
and these machine made products competed with Indian handicrafts. India became a classical example of a colonial
country supplying imperialist rulers raw material and foodstuff and being the market for imported manufactured
products. With the spread of education a new class emerged in India which were influenced by foreign rulers and this
resulted in change in the demand pattern. The destruction of handicrafts led to largescale unemployment. The
introduction of the Zamindari and Rayatwari system in Indian agriculture led to subsistence agriculture.
Commercialization of agriculture was another noteworthy change which retarded the process of industrialization of the
Indian economy. Another noteworthy trend was the frequency of famines that occurred in India.
The process of Industrial transition OF India was observed during the 19th Century when there was a decline of
indigenous industry and rise of large scale modern industry.

During the period 1850-1855 there was the establishment of the first cotton mill, first jute mill and first coal mine. By the
turn of the 19th century there were 194 cotton mills and 36 jute mills and coal production touched 6 million tons per
annum. Despite these developments on the industrial front India was gradually converted into an agricultural colony of
the British.. By 1900 India became a great exporter of rice, wheat, oilseeds, jute, tea and importer of British
manufacturers. During the 19th Century it was the British businessmen who pioneered industrial enterprise in India. But
their interest in Indian industry was for profits and not for economic development of India. The merchant class in the
country preferred trade as there is greater profits in this than the factory set up. People also did not have the expertise to
manage large scale factories.
Some of the causes for the slow growth of private enterprise in India's industrialization were:
Unimaginative enterprise
Problem of capital and private enterprise
Lack of Government support for the private enterprise
Development of infrastructure was to serve the colonial interests.
Protective duties were mainly to serve the European interest of exploiting the country.
Investments were made by British Multinationals through their subsidiaries. There were two major forms of
investments
 i) Direct foreign investment made in coal, mining companies, jute mills, tea coffee etc
ii)Sterling loans given to the British Government in India and public and semi-public organizations to undertake
investments in infrastructure.
While British economists have maintained that India lacked dynamic entrepreneurship, Dr. Bipin Chandra who
examined the impact of colonial rule on the country rejected these observations. He writes that " India under the
colonial rule did not undergo any transformation and that it remained traditional. Bt modernization of India was
within the political parameters of the colonial economy. The colonial link with Britain resulted in the progress of the
industrial revolution in Britain while it meant modernization of those sectors in the Indian economy which
strengthened the process of integration of the Indian economy with British capitalism. It was therefore seen that
India was integrated into the world capitalism without enjoying the benefits of capitalism and without taking part in
the industrial revolution. It was thus modernized and un-developed at the same time.
A close look at the economic development of India during the British period reveals that whenever India's colonial
economic links in terms of foreign trade and inflow of foreign capital was disrupted, Indian economy made strides in
industrial development.
Disruptions were experienced during the First World war, Great Depression and the Second World War..
Further it is incorrect to state that British capital was more adventurous than Indian capital as they worked under a
protected regime. According to Jawaharlal Nehru India became a passive agent of modern industrial capitalism suffering
all its ills and with hardly any of its advantages.

3. 1.2 BASIC CHARACTERISTICS OF THE INDIAN ECONOMY:

I n d i a is a l o w i n c o m e d e v e l o p i n g e c o n o m y. T h e r e i s n o d o u b t t h a t n e a r l y o n e - f o u r t h o f i t s
p o p u l a t i o n l i v e s i n c o n d i t i o n s o f m i s e r y . P o v e r t y is n o t o n l y a c u t e b u t i s a l s o a c h r o n i c m a
lady i n I n d i a . A t t h e s a m e t i m e , t h e r e e x i s t u n u t i l i s e d n a t u r a l r e s o u r c e s. I t i s, t h e r e f o r e ,
q u it e imp o rt an tt o un de rst an d t he b asic ch ara ct e rist ics o f t h e Ind ian e co no my,tre at In g
i t a s o n e o f t h e p o o r b u t d e v e l o p i n g e c o n o m i es o f t h e w o r l d.

(1) Low per capita income. D e v e l o p i n g e c o n o m i e s a r e m a r k e d b y t h e e x i s t e n c e o f l o w p e r c a p

i ta in co me .Th e pe r cap it a in co me o f an In d ian in 2 0 10 was $1 2 7 0 .Barrin g a f e w co
u n t r i e s , t h e p e r c a p i ta i n c o m e o f t h e I n d i a n p e o p l e i s t h e l o w e s t i n t h e w o r l d . D u r i n g 1 9 6 0
-80,developed ec on om i e s gr e w at a fa s t e r ra t e th an t h e I n d i a n e c o n o m y , b u t d u r i
ng 1990-2010,Indian e c o n o m y h a s g r o w n a t a f a s t e r r a te t h a n t h e d e v e l o p e d e c o
n o mie s .E ve n t h en th e d iff e re n ce in p e r cap ita in co me be t we en In dia an d th e d e ve lop e
d e c o n o m i e s i s q u i t e l a r g e.

(2) Occupation Pattern : Primary Producing One of the b a s i c c h a r a c t e r i s t i c s o f a n u n d e r d e v e

l o p ed econo m y is t h a t i t i s p r i m a r y p r o d u c i n g . A v e ry large p o r t i o n o f w o r k i n g p o p u l a t i o n i
s e n g a g e d i n agriculture t u r e , w h i c h c o n t r i b u t e s a v e r y l a r g e share i n the na t i o n a l i n c o m e .

I n I n d i a , i n 2 0 1 0 , a b o u t 5 8 p e r cent o f t h e w o r k i n g p o p u l a t i o n w a s e n g a g e d i n a g r i c u l t u re
and their
c o n t r i b u t i o n t o the n a t i o n a l i n c o m e w a s 1 8 . 9 p e r cent . Also the percentage of population engaged
in agriculture is low in developed c o u n t r i e s when compared to underdeveloped economies .
From the point of view of occupation pattern Indian economy is primary producing as the majority of the
population contributes 18% of the national income. Despite this the productivity per person is low per capita in
agriculture.

(3) Heavy Population Pressure: Main problem of India is the high growth rate in population. India's rate of growth
of population was 1.31 percent per annum between 1941 to 50 has risen to 1.93 per cent during 1950 to 2001.
The annual average growth rate during 2001-11 however declined .The fast rate of population growth
necessitates a higher standard of living r e q u i r e m e n t s o f f o o d , c l o t h i n g , s h e l t e r , m e d i c i n e, s c h
o o l i n g , e t c . T h u s , a r i s i n g p o p u l a t i on imp o se s gre at e r e con o mic b u rd en s an d, co n se
q u e n t l y, s o c i e t y has t o m a k e a m u c h g r e a t e r eff ort t o in itiate t he p rocess of growth.
M o r e o v e r , a rising p o p u l a t i on l e a d s t o a n i n c r e a s e i n t h e labo u r f o rce .A ccord in g t o t h eT
e n t h P l a n , b e t w e e n 2 0 0 2 a n d 2 0 0 7 a l o n e , l a b o ur f o r c e i s e xpe ct ed t o in cre as
e b y a b o u t 3 5 m i l l i o n i . e . , a t a n a n n u a l a v e r a g e r a t e o f 1.8 p e r c e n t . T h i s r a p id g r o w t h o f l a b
o u r f o r c e c r e a t e s a h i g h e r s u p p l y of l a b o u r t h a n i t s d e m a n d l e a d i n g t o unemp
lo yme nt .
(4) Prevalence of c h r o n i c unemployment and underemployment. I n I n d i a l a b o u r i s a n a b u n d a nt f a c t o
r an d ,co n seq ue nt ly,it is ve ry d iff i cu lt t o pro vid e gain fu l e mplo ymen t t o t he e nt ire wo rki
n g p op u lat io n .In d e ve lo p ed co un trie s,un e mp lo yme nt is o f a cyclical n at u re an d o ccu rs
due t o l a c k o f e f f e c t i v e d e m a n d. I n I n d i a u n e m p l o y m e n t i s s t r u c t u r a l a n d i s t h e r e s u l t o f a
d ef icien cy of cap ital .Th e I n d i a n e c o n o m y does n o t f i n d s u f f i c i e n t c a p i t a l t o e x p a n d
its i n d u s t r i e s t o s u c h a n e x t e n t t h a t t h e e n t i r e l a b o u r f o r c e i s a b s o r b e d. M o r e o v e r , i n
t he agricu lt u ral se ct or o f th e Ind ian e co no my,a

m u c h l a r g e r n u m b e r o f l a b o u r e rs a r e e n g a g e d i n p r o d u c t i o n t h a n a r e r e a l l y n e e d e d ..A c c
o r d i n g l y , t h e m a r g i n a l p r o d u c t o f l a b o u r i n a g r i c u l t u r e is o f t e n n e g l i g i b l e ;At ti mes m a y b e
zero or may e v e n be n e g a t i v e . T h u s , t h e r e e x i s t s ' d i s g u i s e d ' o r ' c o n c e a l e d ' u n e m p l o y m
e n t i n a g r i c u l t u r e . E v e n i f t h e s u r p l u s p o p u l a t i o n i s s i p h o n e d o f f , t h e t o t a l o u t p ut f r o m
a gri cu lt u re will n o t f all b e c a u s e t h o s e persons w h o w e r e w o r k i n g b e l o w c a p a c i t y , b e g
i n t o b e u t i l I s e d t o t h e f u l lD i s g u i s e d u n e m p l o y m e n t i n r u r a l a r e a s i s t h e r e s u l t o f h e a v y p
ressure of population on land and the absence of alternative employment opportun
i t i e s i n o u r v i l l a g e s . T h o u g h t here is n o d o u b t that u n e m p l o y m e nt e x i s t s i n a g r e a t e r
degree i n t h e u r b a n areas, t h e r u r a l areas t oo s u f f e r from the p r o b l e m o f u n e m p l o y m e n t a nd u n
d e r e m p l o y m e n t . O n t h i s p o i n t the T h i r d F i v e - Y e ar P l a n stated : " I n t h e r u r a l areas b o t h u n e m
p l o y m e n t a nd u n d e r e m p l o y m e n t e x i s t side b y side; t h e d i s t i n c t i on b e t w e e n t h e m I s b y n o
m e a n s sharpe. I n t h e v i l l a g es u n e m p l o y m e n t o r d i n a r i l y takes the f o r m o f u n d e r e m p l o y m e n t
. U r b a n and r u r a l u n e m p l o y m e n t i n fact c o n s t i t u t e a n i n d i v i s i b l e p r o b l e m . "

T h e P l a n n i n g C o m mi s s i o n o n t h e b a s i s o f t h e N S S d a t a has e s t i m a t e d that d u r i n g 2 0 0 4 - 0 5 ,
the r a t e o f u n e m p l o y m e n t has r i s e n t o 8 . 3 6 % as a g a i n s t 7 . 3 2 % i n 1 9 9 9 - 0 0 . T h e
E l e v e n t h P l an ( 2 0 0 7 - 1 2 ) w i l l h a v e a b a c k l o g o f 3 7 m i l l i o n u n e m pl o y e d . T h e r e v i s e d e s t i m a
t es of t he Plan n in g Com m i s s i on r e ve a l t h at 4 5 m i l li o n a re l i ke l y t o b e t he n e w e nt r
ant s t o th e lab o ur f o rce d urin g th e Elevent h P lan .T hu s,th e t o ta l jo b req u irement s of t
h e 11th Plan work out to be 82million ( 3 7 m i l l i o n b a c k l o g plus 45 million new entrants.
Providing of employment to those suffering from unemployment and underemployment Is a major task of the
planning process.

(5) Steadily Improving rate of Capital Formation: During the fifties and sixties of the 20th Century was capital
deficiency .reflected in low availability of capital per individual and low capital formation. .An important indicator of
low capital per head in the underdeveloped countries is the low consumption of energy. For example the energy
used in kgs per oil equivalent in 2010 was 560 *kgs/oil equivalent in India compared to 7225 kg/ oil equivalent in
the US ,3282kgs in UK 3883kgs in Japan and 1695* kgs in China. (*refers to 2009). During 2000-05 about 6.4 %
capital formation is required to offset the burden of rising population. Gross capital formation needs to be at 14%
to off set depreciation and ensure that the country is at the same standard of living . .A higher rate of capital
formation is essential for higher economic growth so that the standard of living improves .In 2003 India reached a
savings rate of 22% which was high .In 2010 the Gross Domestic Savings reached a level of 31.5 % and Gross
Capital Formation was high at 36.4 %.This was a welcome development.

(6) Maldistribution of Wealth/Assets : Surveys done on the distribution of assets of rural and urban house -holds
during July 1991 to June 1992 reveal sharp in equalities in asset distribution.

Example :
Rural House- holds:
In rural areas 27% of house -holds owned less than Rs. 20,000 worth of assets accounting for 2.4 % of total
assets.
Similarly 24% of house- holds in the asset range of Rs. 20,000 to 50,000 owned barely 7.5% of assets
So 51% of the bottom house- holds owned just 10% of total assets.

Also 9.6 % of rich house- holds owned assets of over Rs. 2.5 lakhs and above and account 49% of total assets.

Urban House Holds :

50.7% of urban house- holds owing less than Rs. 50,000 worth of assets account for 5.3% of assets.
 66% of total assets of all urban house- holds were held by 14.2% of house- holds each owning Rs. 2.5
lakhs and above

This implies that the asset distribution is worse in urban house-holds than rural house- holds.

Inequality in asset distribution is the principle cause of unequal distribution of income in the rural areas .It also
signifies that the resource base of 50 per cent of house- holds is so weak that it can hardly provide any thing
above the subsistence level of income. .NSS study shows that 60% of rural house holds have only 14% of cattle
heads and 10% of wooden ploughs.

(7) Poor Quality of Human Capital :

A glaring feature of an underdeveloped economy is t h e p o o r q u a l i t y o f h u m a n c a p i t a l . M o s t o f t h e

u n d e r d e v e l op e d c o u n t r i e s s u f f e r f r o m mass i l l i t e r a c y . I l l i t e r a c y r e t a r d s g r o w t h . A m i n i
mum level of
e d u c a t i on is n e c e s s a r y t o a c q u i r e s k i l l s as a l s o t o c o m p r e h e nd s o c i a l p r o b l e m s . R u r a l
areas w h e r e i l l i t e r a c y i s a r u l e , a r e t h e b a c k - w a t e r s o f c i v i l i z a t i o n and t h e c e n t r e s o f s u p e
r s t i t i o n , s o c i a l t a b o o s and c o n s e r v a ti s m . F a t a l i s m a n d a c c e p t a n c e o f m i s e r y as a p a r t o f l i f
e a n d b e l i e f i n a p r e - d e s t i n e d o r d e r a r e a l l a c c o m p a n i e d b y m a s s i l l i t e r a c y .B u t i f w e e
n large t h e def in ition of cap it al f ormatio n to in clud e th e u se o f an y re sou rce t hat en
h a n c e s p r o d u c t i v e c a p a c i t y , then b e s i d e s p h y s i c al c a p i t a l t h e k n o w l e d g e a n d t r a i n i n g o
f t h e p o p u l a t i on w i l l a l s o f o r m a p a r t o f cap ital.As a re su lt ,t h e e xp en d it u re o n ed u cat
i o n , s k i ll f o r m a t i o n , r e s e a r c h a n d i m p r o v e m e n t s i n h e a l t h are i n c l u d e d i n h u m a n c a p i t a
l.

T h e In d ian pu b lic expen d it ure on p rimar y t o h igh er ed u cat ion an d res earch an d de velop
ment in
2 0 0 2 - 0 4 w a s a 3 . 3 p e r c e n t o f G D P . T h e c o r r e s p o n d i n g f i g u re f o r t h e U S A . w a s 5 . 9 p e r c e n t
o f G D P . P u b l i c e x p e n d i t u r e o n h e a l t h i n I n d i a w a s m i s e r a b l y l o w a t 1 . 1% o f G D P i n 2 0 0 7 .
U n d e r t h e U n i t e d N a t i o n s D e v e l o p m e nt P r o g r a m m e ( U N D P ) , c o u n t r i e s h a v e b e e n r a n k e
d on t h e b a s i s o f H u m a n D e v e l o p m e n t I n d e x ( H D I ) . T h i s i n d ex is b a s e d o n l i f e e x p e c t a
nc y,adult l i t e r a c y , c o m b i n ed e n r o l m e n t r a t i o - f i r s t , s e c o n d a n d t h i r d l e v e l a n d r e al
G D P per c a p i t a (P u rchasin g Po wer P arit y b asis) in US D o llars.It is ve ry d ist re ssin g t o
n o t e t h a t I n d i a h a s b e en r a n k e d a t N o . 1 3 4 o n t h e b a s i s o f H D I i n 2 0 0 7 w h i l e C h i n a s t a n
d s at N o .9 2 . Ob viou sly, Ind ia h as st ill t o go a lon g way be f ore it re ach e s th e l e ve ls of d e
v e l o p ed c o u n t r i e s i n t e r m s o f h u m a n d e v l e o p m e n t i n d e x.

(8) Prevalence of Low level of Technology : In a developing economy like India the most modern t e c h n i q u e e x i
sts s i d e b y s i d e w i t h t h e mo s t p r i m i t i v e i n t h e s a m e i n d u s t r y , b u t t h e r e is n o g a i n s a y i n
g t he f a c t t h a t t h e m a j o r i t y o f t h e p r o d u c t i v e u n i t s a n d a m a j o r p a r t o f t h e o u t p u t i s p r o d
u c e d w i t h t h e h e l p o f t e c h n i q u e s w h i c h c a n b e d e s c r i b e d as i n f e r i o r j u d g e d b y m o d e r n
s cientific standards.The s h a rp d i f f e r e n c e s i n p r o d u c t i v i t y b e t w e e n d e v e l o p e d a nd
u nd erd eveloped n at ion s can b e t raced t o a con sid erab le d egre e t o th e app licat ion
o f s u p e r i o r t e c h n i q u es b y t h e f o r m e r . S i n c e n e w t e c h n i q u e s a r e e x p e n s i v e a n d r e q u i r e
a c o n s i d e r a b l e d e g r e e o f s k i l l f o r t h e i r a p p l i c a ti o n i n p r o d u c t i o n , t h e t w i n r e q u i r e m e n t s
f o r t h e ab so rp t io n of ne w te chn o lo gy are t he a vailab ilit y of capi t al an d trainin g of an a
d eq u at e nu mb er of p erson nel. It is n ecessar y t o h ave a b asic min imu m le vel o f edu
c a t i o n a m o n g the a c t u a l p r o d u c e r s i n o r d e r t h at t h e e c o n o m y c a n a b s o r b n e w t e c h n o l o
g y . D e f i c i e n cy o f c a p i t a l h i n d e r s t h e p r o c e s s o f s c r a p p i n g o f f t h e o l d t e c h n i q u e s a n d t h
e i n s t a l l a t i o n o f t h e u p - t o - d a t e a nd m o d e r n t e c h n i q u e s . I l l i t e r a c y a n d t h e a b s e n c e o f a
s killed labo u r fo r ce are t he o th e r majo r hu rdle s in t h e sp re ad o f t e ch no lo gy in t he e co
n o m y . T h e I n d i a n e c o n o m y s u f f e r s f r o m t h i s b a s ic w e a k n e s s . T h e l o w p r o d u c t i v i t y p e r h
e c t a r e i n I n d i a in a g r i c u l t u r e a n d t h e l o w l e v e l o f p r o d u c t i v i t y p e r w o r k e r i n a g r i c u l t u r e a
n d i n d u s t r y a r e l a r g e l y a c o n s e q u e n ce o f t e c h n o l o g i c a l b a c k w a r d n e s s . I n I n d i a , t h e v a s t
m a j o r i t y o f f a r m e r s a r e t oo p o o r t o b u y e v e n t h e e s s e n t i a l i n p u t s , s u c h as i m p r o v e d
seeds, f e r t i l i s e r s a n d i n s e c t i c i d e s , n o t t o s p e a k o f a f f o r d i n g t h e m o r e e x pe n s i v e p r o d u c e r
s ' goods l i k e h a r v e s t e r s , t r a c t o r s s o w i n g m a c h i n e s , e t c . I n m a n u f a c t u r e also, t h e v a st
majo rit y o f t h e en terprises in In d ia are run eit h er on an in d ivid u al o r o n a p artn e rsh ip
basis; a n d i t is b e y o n d the me a n s o f s m a l l e n t e r p r i s e s t o e m p l o y m o d er n and m o r e p r o d u c t i
ve techniques.
H o w e v e r , w i t h t h e l i b e r a l i s a t i o n o f t h e e c o n o m y , n e w t e c h n o l o g y i s b e in g a d o p t e d b y a l
arge n u mb er of ent erp rises fo r th eirsu rvival .

(9) Low level of l i v i n g of the average I n d i a n.

Failu re t o se cu re a b alan ce d d ie t man ife st s in Ind ia in t he lo w calorie int ake and lo w le v

el of c o n s u m p t i o n o f p r o t e i n . I n 1 9 9 9 t h e a v e r a g e c a l o r i e i n t a k e o f f o o d is o n l y 2 , 4 9 6
as c o m p a r e d t o o v e r 3 , 4 0 0 c a l o r i e s p e r d a y i n m o s t o f t h e d e v e l o p e d c o u n t r i e s . T h i s i s, s
l ight l y ab ove t h em in the mini m u m i n t a k e f o r s u s t a i n i n g l i fe e s t i m a t e d at 2 , 1 0 0 c a l o r i e s .
S ince nearly 28 percent of the p o p u l a t i o n i n I n d i a l i v e d b e l o w the p o v e r t y l i n e i n 2 0 0 4 -
0 5 , it i s ver y d ou bt fu l wh et h er t he p oo r g et a m in i mu m i n t a ke o f ev en 2 ,1 0 0 ca l or i e s .A
nother factor that has an important bearing
on t he h ealth o f th e peo ple is th at in In d ia cerea ls p red o min at e, bu t th e d iet in th e a
d v a n c e d c o u n t r i e s i s r i c h b e c a u s e i t i n c l u d e s f r u i t s , f i s h , m e a t , b u t t er and sugar. T h e p r o t e i
n intake is n e a r l y less t h a n h a lf l e v e l p r e v a l e n t i n a d v a n c e d c o u n t r i e s. A c c o r d i n g t o W
orld Development I n d i c a t o r s , 4 6 :% o f t h e c h i l d p o p u l a t i o n i n I n d i a s u f f e r s f r om cn. T h e
a v e r a g e p r o t e i n c o n t e n t o f t h e I n d i an is o n l y 5 9 g r a m s p e r d a y as a g a i n s t m o r e t h a n d o u
b le l e v e l i n d e v e l o p e d c o u n t r i e s . T h e p e r c a p i ta avail ability o f m i l k w h i c h w a s 4 8 k g s . i n 1 9 6 0
h a s g o ne in 2 0 0 3 - 0 4 . t h o u g h i t i s s t i l l m u c h l o w er in d e v e l o p e d c o u n t r i e s p e r a n n u m . N e a
r l y 6 0 per cent age o f t h e m among o t h e r s a r e m a l n o u r i s h e d . A c c o r d i n g t o the c e n s u s
o f 2 0 0 1 , o n l y 3 6 p e r c e n t o f t h e h o u s e h o l ds have a c e s s t o safe d r i n k i n g w a t e r , i m p l y i n g t a p w
a t e r . R e s u l t s i n d e v e l o p i n g less s t r e n g t h t o f i g h t d i s e a s es so p artl y resp on sib le f or t h e lo
w l e v e l o f e f f iciency o f t h e I n d i a n w o r k e r s . T h e p i c t u r e r e g a r d i n g hou sin g is eq ually bl
e a k.. According to t h e C e n s u s o f I n d i a ( 2 0 0 1 ) , o n l y a b o u t 5 2 % o f t h e h o u s e h o l d s w e r e l i v i n g i n
p e r m a n e nt hous e s . A b o u t 3 0 p e r c e n t w e r e l i v i n g i n s e m i - p e r m a n e nt houses a n d 18 p e r c
e n t w e r e l i v i n g i n t e m p o r a r y h o u s e s. . C o n d i t i o ns i n t h e r u r a l a r e a s w a s m u c h w o r s e w h e
re 4 per c e n t o f t h e p o p u l a t i o n l i v e d i n p e r m a n e n t a n d 5 9 p e r c e n t l i v e d i n s e m i - p e r m a n e n
t h o u s e s . C o m p a r a t i v e l y , t h e s i t u a t i o n i n u r b an India is muc h b e t t e r w h e r e 7 9 p e r c e n t h o u s
e h o l ds Iive i n p e r m a n e n t h o u s e s , 15 p e r c e n t i n s e m i - p e r m anent houses and 5 p e r c e n t i n t
e m p o r a r y house .It i m p l i e s
t h a t 9 2 m i l l i o n h o u s e s n e ed u p g r a d a t i o n 8 1 m i l l i o n i n t h e r u r a l a r e a s a n d 1 1 m i l li o n i n t h
e u r b a n areas.

T h e Wo r kin g Grou p on H ou sin g f o r th e Te nt h P lan h as o b se rve d t h at aro un d 90 p er ce nt o

f t h e h o u s i ng s h o r t a g e p e r t a i n s t o w e a k e r s e c t i o n s . T h e G o v e r n m e n t s h o u l d , t h e r e f o r e ,
come in a b igway t o ma ke a p ro gramme fo r h o u sin g f or t he wea ker s e ct ion s .3 4 .8 milli
on hou seh old s o c c u p y i n g t e m p o r a r y h o u s e s a l m o s t e n t i r e l y b e lo n g t o t h e w e a k e r s e
ction s of the society w h o r e q u i re u r g e n t a t t e n t i o n b y t h e Go v e r n m e n t . T h e W o r k i n g
G roup of theTenth Plan on Hou sin g h as est imated a sh ort age of 22.44 million h ou s
e s d u r i ng t h e T e n t h P l a n p e r i o d , o u t o f w h i c h 8 . 8 9 m i l l i o n i s t h e s h o r t a g e o f u r b a n h o u s i n
g an d13.55million of ru ral h ou sin g.Th is ap pears to b e an u nd er-est imat eif weconsi
d e r 3 4 . 8 m i l l i o n t e m p o r a r y h o u s e s , e s p e c i a l l y 1 2 .7 m i l l i o n t e m p o r a r y u n s e r v i c e a b l e h o
u s e s t o b e b u i l t a f r e s h. A n o t h e r v e r y r e v e a l i n g f e a t u r e o f t h e C e n s us ( 2 0 0 1 ) i s t h a t 3 4 . 5
p e r c e n t o f h o u s e h o l d d i d n o t o w n a ny o f t h e s p e c i f i e d assets, i.e., r a d i o , t r a n s i s t o r , t e l e v i s i o
n ,telep hon e,b icy cle,scoot er,mot orcycle or mop ed .

( 1 0 ) Demographic characteristics of an u n derdeveloped country. A m o n g t h e d e m o g r a p h i c charac t e r i s t i

cs asso ciat ed wit h u n derdevelop men t are h ighd en sit y o fp op u lation .Besid esth is,t h e
a verage e x pe c t a t i o n show i n f a n t m o r t a l i t y r a t e s a re h i g h . I t w o u l d b e p r o p e r t o e x a m i n
e t h e se c h a r a c t e r is t i c s .
T h e d e n s i t y o f p o p u l a t i o n I n I n d i a i n 2 0 0 6 w a s 3 7 3 p e r sq. k m . A s c o m p a r e d w i t h t h i s t h e a
v e r a ge d e n s i t y o f p o p u l a t i o n i n t h e w o r l d i s 5 0 p e r s q . k m . i n 2 0 0 5 . H o w e v e r , i n U . S . A . , t h e
density of p o p u l a t i o n i s 3 3 , i n C a n a d a a n d A u s t r a l i a nd i t i s b a r e l y 3 4 p e r s q . k m . E v e n i n
Ch i n a ,d en s i t y Is 1 41 p er sq . km .
O b v i ou s l y , a h i g h e r d e n s i t y i m p o s e s g r e a t e r b u r d e n s o n l a n d a n d o t h e r n a t u r a l r e s o u r c e
s.
A c c o r d i n g t o 2 0 0 1 c e n s u s , 3 3 . 5 p e r c e n t o f t h e t o t a l p o p u l a t i o n is i n t h e a g e g r o u p 014,
6 1 . 5 p e rc e n t i s i n t h e w o r k i n g a g e g r o u p , i . e . , 1564 a n d o n l y 5 . 0 p e r c e n t i n t h e a g e g r o u p
65 and above.In other words,the proportion of children is higher in India than in the
ad van ce d c o u n t r i e s . O b v i o u s l t h i s s i t u a t i o n i n c r e a s e s t h e d e p e n d e n c y l o a d , b e c a u se t h
e p r o p o r t i o n a n d s i z e o f t h e n o n - p r o d u c t i v e popula t i o n is h i g h e r . S u c h a s i t u a t i o n p e r s i s t s d u r i
ng a p e r i o d o f h i g h p o p u l a t i o n g r o w t h r a t e b u t w i l l a l t eri n f a v o u r o f p r o d u c t i v e p o p u l a t i o n as t
h e r a t e o f p o p u la t i o n g r o w t h s l o w s d o w n . T h e e x i s t e n c e o f a g r e a t er p r o p o r t i o n o f t h e p o p u l a
t i o n i n t h e l o w e r age g r o upa c t s a g a i n s t p r o d u c t i o n , b u t f a v o u r s a h i g h e r l e v e l o fc o n s u m p t i o n .
T h e h i g h e r d e p e n d e n c y l o a d o f t h ep o p u l a t i o n i s a t y p i c a l c h a r a c t e r i s t i c o f u n d e r d e v e l o p me
nt.
H o w e v e r , d e m o g r a p h i c c h a n g e i s t a k i n g p l a ce i n I n d i a . T h e p e r c e n t a g e o f c h i l d r e n ( B e l o w 15
y e a r s)
w h ich was3 5 .5 %of in2 00 1h asd e clin ed to 3 2 .1 % in2 00 6 an d islike lyt od e clin ef u rt he rto 23 .
3 %b y
2 0 26 . Co n seq ue nt ly,the p op ulat io n in th e wo rkin gage gro up (1 5t o 64 ye ars )ise xpe ct ed to i
n c r e a se
f ro mab out 6 3 %in2 00 6t o6 8 .4 %b y20 26 .D e mo g raph e rse xp e ct ad e clin e in th ed e pe nd en cy
l o a d o f t hep o p u l a t i o n . A s a c o n s e q u e n c e o f t h e l i k e l y i n c r e a s e i n t h e w o r k i n g a g e g r o u p , I n d i a
w i l l e x p e r i e n c e a d e m o gr a p h i c d i v i d e n d d u r i n g t h e n e x t t h r e e decade. T he m a j o r p r o b l e m f o r I
n d i a i s t o h a r n e s s t h e g r o w i n g w o r k i n g age p o p u l a t i o n i n e m e r g i n g areas o f t h e c o n o m y , b o t h i n
in du str yand se rvice s.Th iswillreq
u i r e t h e d e v e l o p m e n t o f n e w s k i l l s a m o n g t h e y o u thet o e n a b l e t h e m t o t a k e p a r t i n o c c u p a t i o
n s r e q u i r i ng b e t t e r s k i l l s a n d t r a i n i n g . T h e i s r e f e r r e d t o a s t he c h a l l e n g e o f d e m o g r a p h i c d i v i
d e n d f a c i n g t h e I n d i an e c o n o m y .
( 1 1 ) The Socio-economic indicators of consumption are characteristic of underdeveloped economy in I n d i a . U n d e
r
d e v e l o p m e n t a l o f India is is e x p r e s s ed t h r o u g h s e v e r a l s o c i o - e c o n o m i c I n d i c a t o r s, s u c h as
per c a p i t a i n t a k e o f c a l o r i e s , f a t s a n d p r o t e i n s, p o p u l a t i o n p e r T V set a n d p h y s i c i a n . I n T a
b l e 8, f i g u r es f o r a f e w s e l e c t e d c o u n t r i e s i n d i c a t e t h a t I n d i a i s f a r b e h i n d the d e v e l o p e d
c o u n t r i e s so f a r a s these i n d i c a t o r s o f s t a n d a r d o f l i v i n g a r e c o n c e r n e d . I l l i t e r a cy r a t e i s a l s o
v e r y h i g h i n I n d i a 3 5 % i n 2 0 0 1 , a s a g a i n st l e s s t h a n 5 p e r cent i n d e v e l o p e d c o u n t r i e s.

A s a d e v e l o p i n g e c o n o m y , d u r i n g t h e last o v er f i v e decades o f d e v e l o p m e n t , I n d i a h a s b e e n a b l e
to i m p r o v e i t s G D P g r o w t h r a t e w h i c h w a s o n l y 3.5 p e r cent d u r i n g 1 9 5 0 - 5 1 t o 1 9 7 0 - 7 1 t o a l e v e l
o f n e a r l y 7 p e r cent d u r i n g 2 0 0 0 - 0 1 t o 2 0 0 4 - 0 5 . I t h a s b e e n a b l e t o r e d u c e p o v e r t y f r o m a l e v e l o
f abo ut 54 p er ce nt in1 96 0- 61 t oale ve lo f2 6 pe rce nt in1 9 99 -0 0 .Ith asbe e n ab let o imp ro ve lit
e r a c y f r o m a l e v e l o f 17 p e r cent i n 1 9 5 1 t o a b o u t 6 5 p e r c e n t i n 2 0 0 1 . I t h a s b e e n a b l e t o r a i s e t h e
r a te o f c a p i t a l f o r m a t i o n f r o m a b o u t 10 p e r cent o f G D P in 1 9 6 0 - 6 1 t o 3 0 p e r c e n t i n 2 0 0 4 - 0 5 . I t s l
i f e e x p e c t a n c y has i m p r o v e d f r o m 3 2 y e a r s i n 1 9 5 1 t o 6 3 . 3 y e a r s i n 2 0 0 3 . H o w e v e r , t h e r e are g l
a r i n g f a i l u r e s o n m a n y f r o n t s.

A c c o r d i n g t o H u m a n D e v e l o p m e n t R e p o r t ( 2 0 0 5 ) , I n d ia r a n k s at N o . 1 2 7 i n t h e w o r l d . I t s r e c o r
d i n t e r m s o f r e m o v i n g m a l n u t r i t i o n is p o o r , as 4 6 p e r c e n t o f t h e c h i ld p o p u l a t i o n s u f f e r s f r o m i
t . A c c o r d i n g t o 2 0 0 1 c e n s u s, o n l y 5 2 p e r c e n t o f t h e p o p u l a t i o n has p e r m a n e n t h o u s es a n d o n l y
3 6 p e r c e n t p o p u l a t i o n h a s a c c e s s t o safe d r i n k i n g w a t e r . A l t h o u g h p o v e r t y has b e e n r e d u c e d t
o a l e v e l o f 2 6 p e r c e n t , b u t s t i l l 2 6 0 m i l l i o n p e r s o n s a r e s t i ll p o o r a n d t h e b u r d e n o f p o v e r t y is q u
i t e m a s s i v e . T h e r a te o f u n e m p l o y m e n t at a l e v e l o f 9 . 2 p e r cent i n 2 0 0 1 - 0 2 i s v e r y h i g h . T o s u m
up, I n d i a n e c o n o m y has m a d e c o m m e n d a b l e p r o g r e s s o n m a n y f r o n t s , b u t i t h a s m i l e s t o go t o r
e m o v e p o v e r t y , m a l n u t r i t i o n a n d p r o v i d i n g s h e l t er a n d d r i n k i n g w a t e r t o i t s e n t i r e p o p u l a t i
o n.
3.1.3 Other details:

National Income estimates of India:

A National Income Estimate measures the volume of commodities and services turned out
during given period.
During the British period several estimates on National Income were made. Most significant
was the estimated given by Dr. V.K.R.V. Rao who used a combination of census of output and
census of input methods. National Income was assessed under two categories. The first
category included agriculture, pastures, mines, forest, fishing and hunting. The output method
was used to evaluate the product derived from these sectors. In the second category were
included industry, trade, transport, public services and administration etc. For these
occupations the income method was used. To these sub totals the income from house property
and other items not covered were included. From the gross aggregate income so obtained were
excluded the values of goods and services consumed in the production process. By adding the
net income from abroad the estimate of national income was made. Most of the estimates
were the results of individual estimates and suffered serious limitations. The assumptions were
arbitrary and hence not reliable. Besides the estimates were based on statistics from
agriculture sector and so highly un-dependable .
J R Hicks, M Mukerjee and S K Ghose calculated the rates of per capita income for the period
1860-1945 at 1970-71 prices. During the British period there was stagnation for a long period
with a growth rate of 0.5 per cent for 1860 to 1945.
In the post -independence period , the committee consisted of Prof. P.C Mahalanobis, Prof. D.R
Gadgil and Prof. V.K.R.V. Rao.The principle feature of the National Income Committee Report
were :
During 1950-51, agriculture which included animal husbandry, forestry and fisheries
contributed nearly half of the national income.
Mining, manufacturing and hand trade contributed one sixth of national income
Commerce, transport and communication accounted for a little more than one-sixth of
the national income.
Other services like professionals, liberal arts, administrative services, domestic services,
house property accounted for 15% of national income.
The share of commodity production derived from agriculture, mining ,factory
Services accounted for one third of total national income. Services include commerce,
transport, communication, administrative services, domestic help.
The share of the Government sector in net domestic product was7.6 percent in 1950-51.
The share of the Government in National Expenditure was 8.2%
The margin of error in this calculati9on worked out to 10%.
Trends in the National Income Growth and Structure:

The increase in the national income at current prices reflects the combination of the influence
of two factors
a) Increase in the production of real goods and services
b) Rise in prices.

If the increase in the national income is due to the first factor, it is an indicator of real growth
because it implies that more goods and services are available to the people. If it is due to the
second factor it represents unreal inflation of national income in money terms. Hence national
income is deflated at constant prices to eliminate the effect of any change in the price levels.
National income figures at constant prices are comparable but they conceal the effect of
population effect. To eliminate the effect of growth of population the per capita national
income is calculated.

GROSS DOMESSTIC PRODUCT BY INDUSTRY

Rs. Crores at 1999-00 prices

______________________________________________________________________________
___
Sectors 1999-00 2007-08 2010-11(QE)
______________________________________________________________________________
___

1. Agriculture, Forestry 4, 88,109 6, 19,121 8, 10,399

Fishing, Quarrying, Mining (27.3) (19.8) (16.6)

2. Manufacturing, Construction, 4, 10,646 7, 66,358 12, 51,254

Electricity, gas water supply (23.0) (24.5) (25.6)

3. Trade, hotels, transports, 3, 87,514 8, 75,398 13, 15,656

And communication (21.7) (28.0) (27.0)

4. Financing, Insurance, Real 2, 33,550 4, 57,584 8, 48,103

Estate and Business services (13.3) (14.6) (17.4)

5. Public Administration & defense 2, 66,707 4, 11,256 6, 52,431

And other services (14.9) (13.1) (13.4)
6. Gross Domestic Product at 17, 86,524 31, 29,717 48, 77,842
Factor Cost (100) (100) (100)

______________________________________________________________________________
__
Note: Figures in brackets are percentage of total GDP for respective year
Source : CSO
Base : 2004-05 QE Quick Estimates and RE Revised Estimates

TRENDS IN NET NATIONAL PRODUCT AND NATIONAL INCOME:

The growth of net national product at constant prices is the index of the total productive
capacity on the part of the community and indicates the rate of growth of goods and services
in the economy. The growth of per capita income at constant prices is an indicator of the
change in the standard of living of the people.

The Net National Product at constant prices taken for the year 1991-92 is observed to be as
follows:
During 1950-51 NNP was Rs.204,924 crores while per capita NNP was Rs.5,708
During 1960-61 NNP was Rs.3,09,045 crores while per capita NNP was Rs.7,121
During 1970-71 NNP was Rs.4,37,719 crores while per capita NNP was Rs.8,091
During 1980-81 NNP was Rs.5,83,548 crores, while per capita NNP was Rs.8,594
During 1990-91 NNP was Rs.9,67,773 crores, while per capita NNP was Rs.11,535
During 2000-01 NNP was Rs.16,47,903 crores while per capita NNP was Rs.16,172
During 2009-10 NNP was Rs. 39,59,653 crores at 2004-05 prices while NNP was
Rs.33,843
The QE for 2011-12 was Rs.45,49,652 crores and per capita income was Rs.37,851

RATE OF GROWTH :

During the 30 year period from 1950-51 to 1980-81, the rate of growth of National Income was
of the order of 3.5% and that of the per capita income was 1.4%. Calculated at current prices
the annual rate of growth of the net national product was of the order of 9% , while that of per
capita income was 6.7%.Much of this increase is illusory because of a sharp increase in the
prices during the Third Plan period.
During 1980-81 to 1990-91, the Net National Product grew at 5.6 % and per capita income at
3.2% at 1990-91 prices.

Perceptual improvement of NNP was observed during the 1980ies . During the period of two
decades 1980-81 to 2000-01, the average growth rate of NNP was 5.6 % while the per capita
income grew at 3.2 %. The economy did better during this period. During 2000-01 to 2004-05,
NNP grew at 6.4% while per capita income NNP grew at 4.7% per annum at 1999-00 prices.
During 2004-05 and 2011-12 the NNP growth rate is further accelerated to 8.2 % and that of
National Income to 6.7% at 2004-05 prices. This shows a further increase in National Income
and augurs a healthy trend.

GROWTH RATE DURING THE PLAN PERIODS:

The average annual growth rate during the plan periods at 1999- 00 prices was as follows:

o First plan (1951-56) NNP at factor cost 4.4% Per capita NNP 2.6%
o Second Plan(1956-61) NNP at factor cost 3.8% Per capital NNP 1.7%
o Third Plan (1961-66) NNP at factor cost 2.6% Per capita NNP 0.4%
o Annual Plans (1966-69) NNP at factor cost 3.9% Per Capita NNP 1.6%
o Fourth Plan (1969- 1974) NNP at factor cost 3.1% Per Capita NNP 0.8%
o Fifth Plan (1974-79) NNP at Factor cost 4.9%, Per capita NNP 2.6%
o Sixth Plan (1980-85) NNP at Factor cost 5.4%,Per Capita NNP 3.1%
o Seventh Plan (1985-90) NNP at Factor cost 5.5%, Per Capita NNP 3.3%
o Two Annual Plans (1990-92) NNP at Factor cost 5.5% ,Per Capita NNP3.3%
o Eighth Plan (1992-97) NNP at factor cost 6.7%,per capita NNP 4.5%
o Ninth Plan (1997-2002) NNP at factor cost 5.3%,per capita NNP 3.3%
o Tenth Plan (2002-07) NNP at factor cost 7.8%, per capita NNP 6.1%

-----------------------------------------------------------------------------------------------
Source : CSO :National Accounts Statistics and ECONOMIC Survey 2009-10

In nominal GDP terms India is the ninth largest in the world and the third largest by Purchasing
Power Parity (PPP)
India is set to emerge as the worlds fastest-growing major economy by 2015 ahead of China, as
per the recent report by The World Bank. Indias Gross Domestic Product (GDP) is expected to
grow at 7.5 per cent in 2015, as per the report.
The improvement in Indias economic fundamentals has accelerated in the year 2015 with the
combined impact of strong government reforms, RBI's inflation focus supported by benign
global commodity prices.
a. Market size
According IMF World Economic Outlook April, 2015, India ranks seventh globally in terms of
GDP at current prices and is expected to grow at 7.5 per cent in 2016.
Indias economy has witnessed a significant economic growth in the recent past, growing by 7.3
per cent in 2015 as against 6.9 per cent in 2014. The size of the Indian economy is estimated to
be at Rs 129.57 trillion (US$ 2.01 trillion) for the year 2014 compared to Rs 118.23 trillion (US$
1.84 trillion) in 2013.
The steps taken by the government in recent times have shown positive results as India's gross
domestic product (GDP) at factor cost at constant (2011-12) prices 2014-15 is Rs 106.4 trillion
(US$ 1.596 trillion), as against Rs 99.21 trillion (US$ 1.488 trillion) in 2013-14, registering a
growth rate of 7.3 per cent. The economic activities which witnessed significant growth were
financing, insurance, real estate and business services at 11.5 per cent and trade, hotels,
transport, communication services at 10.7 per cent.
Stating that its great time to invest in India, Minister of State for Finance Mr Jayant Sinha said
the Indian economy has potential to become a US$ 4-5 trillion economy in the next 10-12 years.
b.Investments/developments
With the improvement in the economic scenario, there have been various investments leading
to increased M&A activity. Some of them are as follows:
India has emerged as one of the strongest performers with respect to deals across the world in
terms of mergers and acquisitions (M&A). M&A activity increased in 2014 with deals worth US$
38.1 billion being concluded, compared to US$ 28.2 billion in 2013 and US$ 35.4 billion in 2012.
The total transaction value for the month of May 2015 was US$ 3.3 billion involving a total of
115 transactions. In the M&A space, pharma continues to be the dominant sector amounting to
23 per cent of the total transaction value.
Indias Index of Industrial Production (IIP) grew by 4.1 per cent in April 2015 compared
to 2.5 per cent in March 2015. The growth was largely due to the boost in
manufacturing growth, which was 5.1 per cent in April compared to 2.8 per cent in the
previous month.
Indias Consumer Price Index (CPI) inflation rate increased to 5.01 per cent in May 2015
compared to 4.87 per cent in the previous month. On the other hand, the Wholesale
Price Index (WPI) inflation rate remained negative at 2.36 per cent for the seventh
consecutive month in May 2015 as against negative 2.65 per cent in the previous
month, led by low crude oil prices.
India's consumer confidence continues to remain highest globally for the fourth quarter
in a row, riding on positive economic environment and lower inflation. According to
Nielsens findings, Indias consumer confidence score in the first quarter of 2015
increased by one point from the previous quarter (Q4 of 2014). With a score of 130 in
the first quarter (2015), India's consumer confidence score is up by nine points from the
corresponding period of the previous year (Q1 of 2014) when it stood at 121.
Indias current account deficit reduced sharply to US$ 1.3 billion (0.2 per cent of GDP) in
the fourth quarter of 2015 compared to US$ 8.3 billion (1.6 per cent of GDP) in the
previous quarter, indicating a shrink in the current account deficit by 84.3 per cent
quarter-on-quarter basis.
 India's foreign exchange reserve stood at a record high of US$ 354.28 billion in the week
up to June 12, 2015 indicating an increase of US$ 1.57 billion compared to previous
week.
Owing to increased investor confidence, net Foreign Direct Investment (FDI) inflows
touched a record high of US$ 34.9 billion in 2015 compared to US$ 21.6 billion in the
previous fiscal year, according to a Nomura report. The report indicated that the net FDI
inflows reached to 1.7 per cent of the GDP in 2015 from 1.1 per cent in the previous
fiscal year
India has the one of fastest growing service sectors in the world with annual growth rate
of above 9% since 2001, which contributed to 57% of GDP in 2012-13.[40] India has
capitalized its economy based on its large educated English-speaking population to
become a major exporter of ITservices, BPO services, and software services with $167.0
billion worth of service exports in 2013-14. It is also the fastest-growing part of the
economy.[6] The IT industry continues to be the largest private sector employer in
India.[41][42] India is also the fourth largest start-up hub in the world with over 3,100
technology start-ups in 2014-15[43] The agricultural sector is the largest employer in
India's economy but contributes to a declining share of its GDP (17% in 2013-14).
India ranks secondworldwide in farm output.[5] The Industry sector has held a constant
share of its economic contribution(26% of GDP in 2013-14).[44] The Indian auto industry
is one of the largest in the world with an annual production of 21.48 million vehicles in
FY 2013-14.[45] India has $600 billion worth ofretail market in 2015 and one of world's
fastest growing E-Commerce markets.[46][47].
3.1.4 Government Initiatives
Numerous foreign companies are setting up their facilities in India on account of various
government initiatives like Make in India and Digital India. Mr Narendra Modi, Prime Minister of
India, has launched the Make in India initiative with an aim to boost the manufacturing sector
of Indian economy. This initiative is expected to increase the purchasing power of an average
Indian consumer, which would further boost demand, and hence spur development, in addition
to benefiting investors. Besides, the Government has also come up with Digital India initiative,
which focuses on three core components: creation of digital infrastructure, delivering services
digitally and to increase the digital literacy.
Currently, the manufacturing sector in India contributes over 15 per cent of the GDP. The
Government of India, under the Make in India initiative, is trying to give boost to the
contribution made by the manufacturing sector and aims to take it up to 25 per cent of the
GDP. Following the governments initiatives several plans for investment have been undertaken
which are as follows:
Foxconn Technology group, Taiwans electronics manufacturer, is planning to manufacture
Apple iPhones in India. Besides, Foxconn aims to establish 10-12 facilities in India including data
centers and factories by 2020.
India Electronics and Semiconductor Association (IESA) and Nasscom have signed a MoU
to push electronics manufacturing share to 25 per cent of GDP by 2025. Under the MoU
approval has been given to 21 electronic clusters.
 Hyderabad is set to become the mobile phone manufacturing hub in India and is
expected to create 150,000 200,000 jobs. Besides, the Telangana Government aims to
double IT exports to Rs 1.2 trillion (US$ 18.7 billion) by 2019.
Ford Motor Company has started working on plans to manufacture EcoSport in India for
exporting it to US. The company has provided the quotation for 90,000 units every year,
which is greater than the vehicles it sells in India.
Hyundai Heavy Industries (HHI) and Hindustan Shipyard Ltd have joined hands to build
warships in India. Besides, Samsung Heavy Industries and Kochi Shipyard will be making
Liquefied Natural Gas (LNG) tankers.
Mercedes-Benz plans to increase the number of cars it manufactures in India by
doubling the capacity to 20,000 vehicles a year and has come up with a new plant in
Pune.
Under the Digital India initiative numerous steps have been taken by the Government of India.
Some of them are as follows:
The Government of India has launched a digital employment exchange which will allow
the industrial enterprises to find suitable workers and the job-seekers to find
employment. The core purpose of the initiative is to strengthen the communication
between the stakeholders and to improve the efficiencies in service delivery in the
MSME ministry. According to officials at the MSME ministry over 200,000 people have
so far registered on the website.
The Ministry of Human Resource Development recently launched Kendriya Vidyalaya
Sangthans (KVS) e-initiative KV ShaalaDarpan aimed at providing information about
students electronically on a single platform. The program is a step towards realising
Digital India and will depict good governance.
The Government of India announced that all the major tourist spots like Sarnath,
Bodhgaya and Taj Mahal will have a Wi-Fi facility as part of digital India initiative.
Besides, the Government has started providing free Wi-Fi service at Varanasi ghats.
Based on the recommendations of the Foreign Investment Promotion Board (FIPB), the
Government of India has approved 10 proposals of FDI amounting to Rs 2,857.83 crore (US$
445.21 million) approximately. Out of the 10 approved proposals, six belonged to the
pharmaceutical sector with a total value of Rs 1,415 crore (US$ 221.05 million) excluding the
outflows.
The Union Cabinet, chaired by the Prime Minister Mr Narendra Modi, has given its approval to
enter into a Memorandum of Understanding (MoU) for strengthening cooperation in the field
of Micro, Small and Medium Enterprises (MSMEs), between India and Sweden. The purpose of
the MoU is to achieve and promote cooperation between MSMEs of the two countries by
providing a structured framework and creating an environment to identify each others
technologies, strengths, markets, policies, etc.
The Government of India has launched an initiative to create 100 smart cities as well as Atal
Mission for Rejuvenation and Urban Transformation (AMRUT) for 500 cities with an outlay of Rs
48,000 crore (US$ 7.47 billion) and Rs 50,000 crore (US$ 7.78 billion) crore respectively. Smart
cities are satellite towns of larger cities which will consist of modern infrastructure and will be
digitally connected. The program was formally launched on June 25, 2015. The Phase I for
Smart City Kochi (SCK) is set to launch in July 2015 which will be built on a total area of 650,000
sq. ft., having a floor space greater than 100,000 sq. ft. Besides, it will also generate a total of
6,000 direct jobs in the IT sector.
3.1.5 Road Ahead
The International Monetary Fund (IMF) and the Moodys Investors Service have forecasted that
India will witness a GDP growth rate of 7.5 per cent in 2016, due to improved investor
confidence, lower food prices and better policy reforms. Besides, according to mid-year update
of United Nations World Economic Situation and Prospects, India is expected to grow at 7.6 per
cent in 2015 and at 7.7 per cent in 2016.
As per the latest Global Economic Prospects (GEP) report by World Bank, India is leading The
World Banks growth chart for major economies. The Bank believes India to become the fastest
growing major economy by 2015, growing at 7.5 per cent.
According to Mr Jayant Sinha, Minister of State for Finance, Indian economy would continue to
grow at 7 to 9 per cent and would double in size to US$ 45 trillion in a decade, becoming the
third largest economy in absolute terms.
Furthermore, initiatives like Make in India and Digital India will play a vital role in the driving the
Indian economy.
Exchange rate used: INR 1 = US$ 0.015 as on June 17, 2015
References: Press Information Bureau (PIB), Media Reports, World Bank, Department of
Industrial Policy & Promotion (DIPP), Grant Thornton, Database of Indian Economy
(DBIE);google web site

3. 2 Concepts of National Income:

"National income or product is the final figure you arrive at when you apply the measuring rod
of money to the diverse apples, oranges, battleships and machines that any society produces
with its land labour and capital resources " Paul A.Samuelson

One of the most important concepts in all economic systems is that of national income, which
gives us a means to measure the economic performance of an economy as a whole. National
Income accounting is a set of rules and definitions for measuring the economic activities of an
economy.

3.2.1Measurement of National Income

Introduction: In general terms , the National Income refers to the total value of goods and
services produced annually in a country. It refers to the total amount or the money value of
goods and services accruing to a country from economic activities in a years time and hence
called national income. It includes payments made to all resources in the form of wages,
interests, rent and profits.

Since the various goods and services produced in an economy cannot be added together in
physical form , the money value of the final goods is considered.

Basic Concepts: There are many concepts related to National Income.

Some common measures of national are Gross Domestic Product (GDP)Gross National
Product(GNP),Net Domestic Product (NDP) and Net National Product (NNP).

I. Gross Domestic Product:

A. Gross Domestic Product (GDP): What does it mean?

GDP is the total money value of goods and services produced within the domestic territories of
a country during the accounting year. This is calculated at market prices and is known as GDP
at market prices. Dernberg defines GDP at market prices as the market value of the output of
final goods and services produced in the domestic territory of a country during an accounting
year.

It includes income from exports and payments made on imports during the year. However it
does not include the earnings of nationals working abroad and also foreign nationals working in
our country. Many domestic companies have their branches or subsidiaries in foreign countries
as also subsidiaries and branches of foreign companies in your home country. The output
produced by all these individuals and businesses are not included in the GDP of the country.
This is done to avoid the incidence of double counting since the income earned by subsidiary
firms in different countries are added to the income of the parent company.If the income of
these subsidiary companies are counted in income of the country where they are located it will
amount to double counting of income.

GDP measures the final output and not intermediate goods . It also excludes items produced in
the previous year. Hence GDP can be written as

GDP = C+I+G+(X-M)

Here GDP which is the national income is measured by aggregate expenditure and it includes
consumption expenditure (C) ,Investment Expenditure (I), government expenditure (G), and net
of exports (X-M) where X represents exports and M represents imports.

3.2.2 Components of GDP:

GDP at Factor Cost and GDP at Market Price :

GDP is the money value of goods and services. Money flows in an economy in a circular manner
from the producers to the consumers and back from the consumers to the producers. Hence
goods and services can be converted in monetary terms in two ways

(i) By using the market value of goods and services

(ii) by using the payments for factor inputs

Conceptually, GDP at factor cost and GDP at market price must be identical.This is because the
factor cost (payments to factors) of producing goods must equal the final value of goods and
services at market prices. However, the market value of goods and services is different from the
earnings of the factors of production.

This is because in GDP at market price are included indirect taxes and are excluded subsidies by
the government. Also GDP at factor cost includes transfer payments which do not contribute to
national income.Therefore, in order to arrive at GDP at factor cost, indirect taxes are subtracted
and subsidies are added to GDP at market price.

Thus, GDP at Factor Cost = GDP at Market Price Indirect Taxes + Subsidies

Gross National Product

(B) GDP at Factor Cost:

GDP at factor cost is the sum of net value added by all producers within the country. Since the
net value added gets distributed as income to the owners of factors of production, GDP is the
sum of domestic factor incomes and fixed capital consumption (or depreciation).

Thus GDP at Factor Cost = Net value added + Depreciation.

GDP at factor cost includes:

(i) Compensation of employees i.e., wages, salaries, etc.

(ii) Operating surplus which is the business profit of both incorporated and unincorporated
firms. [Operating Surplus = Gross Value Added at Factor CostCompensation of Employees
Depreciation]

(iii) Mixed Income of Self- employed.

(C) Net Domestic Product (NDP):

NDP is the value of net output of the economy during the year. Some of the countrys capital
equipment wears out or becomes obsolete each year during the production process. The value
of this capital consumption is some percentage of gross investment which is deducted from
GDP. Thus Net Domestic Product = GDP at Factor Cost Depreciation.

(D) Nominal and Real GDP:

When GDP is measured on the basis of current price, it is called GDP at current prices or
nominal GDP. On the other hand, when GDP is calculated on the basis of fixed prices in some
year, it is called GDP at constant prices or real GDP.

Nominal GDP is the value of goods and services produced in a year and measured in terms of
rupees (money) at current (market) prices. In comparing one year with another, we are faced
with the problem that the rupee is not a stable measure of purchasing power. GDP may rise a
great deal in a year, not because the economy has been growing rapidly but because of rise in
prices (or inflation).

On the contrary, GDP may increase as a result of fall in prices in a year but actually it may be
less as compared to the last year. In both 5 cases, GDP does not show the real state of the
economy. To rectify the underestimation and overestimation of GDP, we need a measure that
adjusts for rising and falling prices.

This can be done by measuring GDP at constant prices which is called real GDP. To find out the
real GDP, a base year is chosen when the general price level is normal, i.e., it is neither too high
nor too low. The prices are set to 100 (or 1) in the base year.

Now the general price level of the year for which real GDP is to be calculated is related to the
base year on the basis of the following formula which is called the deflator index:

Suppose 1990-91 is the base year and GDP for 1999-2000 is Rs. 6, 00,000 crores and the price
index for this year is 300.

Thus, Real GDP for 1999-2000 = Rs. 6, 00,000 x 100/300 = Rs. 2, 00,000 crores
(E) GDP Deflator:

GDP deflator is an index of price changes of goods and services included in GDP. It is a price
index which is calculated by dividing the nominal GDP in a given year by the real GDP for the
same year and multiplying it by 100. Thus,

It shows that at constant prices (1993-94), GDP in 1997-98 increased by 135.9% due to inflation
(or rise in prices) from Rs. 1049.2 thousand crores in 1993-94 to Rs. 1426.7 thousand crores in
1997-98.

II. Gross National Product (GNP):

We have understood national income from the angle of goods and services produced
domestically. However a country interacts with other countries of the world as well and earns
income not only within the boundary of the nation but also abroad. Also nationals of other
countries also earn income in our country. While calculating GDP we include the trade of goods
but not of services to get a clear picture of the growth of economic progress. But income from
services form a substantial part of national income . Hence we have another measure of
national income namely Gross National Product.

Gross National Product is the aggregate final output of citizens and businesses of an economy in
a year.The difference between GNP and GDP is because of the fact that a part of any country's
total output is produced by factors which are owned by other nations. Thus Net Factor Income
from Abroad (NFIA) is the difference between income received from abroad for rendering
factor services and income paid towards services rendered by foreign nationals in the domestic
territory of a country.

GNP is defined as the sum of Gross Domestic Product and Net Factor Income from Abroad.

GNP= GDP +NFIA

We can express GNP as:

GNP =C+I+G+(X-M) +NFIA

GNP is the total measure of the flow of goods and services at market value resulting from
current production during a year in a country, including net income from abroad.
GNP includes four types of final goods and services:

(1) Consumers goods and services to satisfy the immediate wants of the people;

(2) Gross private domestic investment in capital goods consisting of fixed capital formation,
residential construction and inventories of finished and unfinished goods;

(3) Goods and services produced by the government; and

(4) Net exports of goods and services, i.e., the difference between value of exports and imports
of goods and services, known as net income from abroad.

In this concept of GNP, there are certain factors that have to be taken into consideration: First,
GNP is the measure of money, in which all kinds of goods and services produced in a country
during one year are measured in terms of money at current prices and then added together.

But in this manner, due to an increase or decrease in the prices, the GNP shows a rise or
decline, which may not be real. To guard against erring on this account, a particular year (say
for instance 1990-91) when prices are normal is taken as the base year and the GNP is adjusted
in accordance with the index number for that year. This will be known as GNP at 1990-91 prices
or at constant prices.

Second, in estimating GNP of the economy, the market price of only the final products should
be taken into account. Many of the products pass through a number of stages before they are
ultimately purchased by consumers.

If those products were counted at every stage, they would be included many a time in the
national product. Consequently, the GNP would increase too much. To avoid double counting,
therefore, only the final products and not the intermediary goods should be taken into account.

Third, goods and services rendered free of charge are not included in the GNP, because it is not
possible to have a correct estimate of their market price. For example, the bringing up of a child
by the mother, imparting instructions to his son by a teacher, recitals to his friends by a
musician, etc.

Fourth, the transactions which do not arise from the produce of current year or which do not
contribute in any way to production are not included in the GNP. The sale and purchase of old
goods, and of shares, bonds and assets of existing companies are not included in GNP because
these do not make any addition to the national product, and the goods are simply transferred.

Fifth, the payments received under social security, e.g., unemployment insurance allowance,
old age pension, and interest on public loans are also not included in GNP, because the
recipients do not provide any service in lieu of them. But the depreciation of machines, plants
and other capital goods is not deducted from GNP.

Sixth, the profits earned or losses incurred on account of changes in capital assets as a result of
fluctuations in market prices are not included in the GNP if they are not responsible for current
production or economic activity.

For example, if the price of a house or a piece of land increases due to inflation, the profit
earned by selling it will not be a part of GNP. But if, during the current year, a portion of a
house is constructed anew, the increase in the value of the house (after subtracting the cost of
the newly constructed portion) will be included in the GNP. Similarly, variations in the value of
assets, that can be ascertained beforehand and are insured against flood or fire, are not
included in the GNP.

Last, the income earned through illegal activities is not included in the GNP. Although the goods
sold in the black market are priced and fulfill the needs of the people, but as they are not useful
from the social point of view, the income received from their sale and purchase is always
excluded from the GNP.

There are two main reasons for this. One, it is not known whether these things were produced
during the current year or the preceding years. Two, many of these goods are foreign made and
smuggled and hence not included in the GNP.

Net National Product:

While calculating GDP or GNP we ignore depreciation of assets or capital consumption as this
will not reveal the complete flow of goods and services through various sectors. In reality the
process of production uses up a certain amount of fixed capital by way of wear and tear by a
process termed as depreciation or capital consumption allowance. To arrive at NNP we deduct
depreciation from GNP. Net refers to the exclusion of that part of total output which represents
depreciation, wear and tear and replacements during the year of accounting.

Hence

NNP =GDP Depreciation +NFIA

NNP = GNP Depreciation

NNP is the actual addition to a year's wealth and is the sum of consumption expenditure,
government expenditure net foreign expenditure, and investment less depreciation ,plus net
income earned from abroad. It is expressed as

NNP =C+I+G+(X-M)-Depreciation +NFIA

NNP AT FACTOR COST (OR NATIONAL INCOME)

You have seen that GDP can be measured either in terms of market price or factor cost. The
relationship GDP,GNP and NNP has also been elucidated. So Net National Product at factor cost
is the net output of an economy evaluated at factor prices or it is the sum total of income
earned by all the people at the nation within the national boundaries or abroad .It includes
income (wages and salaries, rent s, profits) earned by factors of production through
participation in the production process. It is also called National Income. This measure differs
from NNP at market prices in that indirect taxes are deducted and subsidies are added to NNP
at market prices in order to arrive at NNP at factor cost.

Thus NNP at Market Price =GNP-Depreciation

NNP at Factor Cost = NNP at Market Prices Indirect Taxes +subsidies

III Measurement of National Income:

National income is the measurement of aggregate production in an economy during a definite

time period. National Income can be looked at in three ways :

As a flow of production of goods and services, as a flow of income and as a flow of expenditure
of goods and services.

A. Measuring National Income :

Based on the above there are three different ways to measure National Income:

Product Method

Income Method and

Expenditure Method.

These three methods of calculating National Income yield the same result. This is because

National Product = National Income = National Expenditure.

1. The Product Method:

In this method, the market value of all goods and services produced in the country by all firms
across different industries during the year is added up together. In the earlier section when we
referred to national income at market prices , it referred to national income calculated by
product method.

This method involves the following steps:

i. the economy is divided on the basis of industries such as agriculture, fishing, mining and
quarrying large scale manufacturing small scale manufacturing electricity ,gas etc.

ii. The physical units of output are interpreted in money terms ie by taking market price of all
the products.

iii. The total value thus obtained is then added up.

Iv The indirect taxes are subtracted and subsidies are added. This gives the Gross Domestic
Product or Gross National Product as the case may be depending on what data is being used.

v. The Net Value is calculated by subtracting depreciation from the total value thus obtained in
order to arrive at NNP.

Only the goods produced in a particular year in their final form are to be considered. Example. If
a manufacturer sells a mobile phone to a retailer for Rs, 3.000 and the retailer sells it to the
consumer at Rs. 5000 how much has the mobile contributed to GDP? Is it Rs. 8000? No, if we do
that it is double counting. Instead we take the final value Rs. 5000 or value added at each stage
(Rs. 3000 by the manufacturer and Rs. 2000 by the retailer. The sum of all values added by all
industries in the economy is known as Gross Value Added (GVA) at basic prices.

Thus national income by Product method can be calculated in two ways:

a) FINAL PRODUCT METHOD:

According to this method the total value of final goods and services produced in a country
during a year is calculated at market prices. To find out the GDP the data of all productive
activities are collected and assessed at market prices. Only the final goods and services of all
sectors are included; intermediary goods and services are not taken into account. This avoids
double counting

b) VALUE ADDED METHOD:

Another method of measuring national income is value added by each industry of the economy.
The Value Added Method measures contributions of each producing enterprise of the
economy. The difference between the values of material outputs and inputs at each stage of
production is the value added. If all such differences are added up for all industries in the
economy we arrive at Gross Domestic Product. In the example National Income by Value
Added Method would require value addition at retailer level ie Rs. 3000 and again at final
consumer level Rs. 2000.Thus National Income will be Rs. 5000.

This is also known as the value added method to GDP or GDP at factor cost by industry of
origin. The following items are included in India in this: agriculture and allied services; mining;
manufacturing, construction, electricity, gas and water supply; transport, communication and
trade; banking and insurance, real estates and ownership of dwellings and business services;
and public administration and defense and other services (or government services). In other
words, it is the sum of gross value added.

If double counting is fully avoided the National Income by Final Goods Method and Value
Added Method should be the same.

Limitations of Product method:

i. Problem of Double Counting

ii. Not Applicable to Tertiary Sector

iii. Exclusion of Non Marketed products. :refers to several goods not assessed by money like
painting as a hobby by an individual . This has an opportunity cost

2. The Income Method:

This refers to the earnings of the people of the country. They produce GDP in a year and so
receive incomes for their work. Thus GDP by income method is the sum of all factor incomes:
Wages and Salaries (compensation of employees) + Rent + Interest + Profit. This corresponds to
the income from labor, land, capital and entrepreneurship. Income of self- employed
individuals is also added. According to the income method it is the net income received by all
citizens of a country in a particular year that is added up ie the total of the net rent, net wages,
net interest and net profits. However income received in the form of transfer payments is not
included. This is the Gross Domestic Product at factor cost; to ths we add money sent by
citizens of the nation from abroad and deduct the payments made to foreign nationals
(individuals and firms) to get Gross National Income (GNI)

Income method has the following steps:

i. The economy is divided on the basis of income groups such as wage/salary earners, rent
earners, profit earners so on.
ii. Income of each of these groups is calculated

iii. Income of all earners is added including income from abroad and undistributed profits.

Iv. From( iii) income earned by foreigners and transfer payments made in the year are
subtracted. In other words

GNP at Factor Cost = Rent+ Wage+ Interest+ Profit + Other Income from Abroad Payments
made to foreigners)- Transfer Payments

Limitations of Income Method:

1. Exclusi9on of Non -Monetary Income

2. Exclusion of Non Marketed Services

3. Expenditure Method:

Whatever is earned is spent either on consumption or on investment. It is possible to calculate

national income by expenditure method. The above two methods have their limitations and do
not ensure complete enumeration of national income data. According to the expenditure
method the total expenditure incurred by the society in a particular year is added together to
get the year's national income. Such expenditure include personal consumption expenditure ,
net domestic investment,, government expenditure on goods and services and net foreign
investments. This concept rests on the assumption that national income equals national
expenditure.

This method focuses on goods and services produced within the country during one year.

GDP by expenditure method includes:

(1) Consumer expenditure on services and durable and non-durable goods (C),This refers to the
payments by households for goods and services.

(2) Investment in fixed capital such as capital spending ( purchase of new materials and
equipment's by firms , residential construction ( ie construction of new buildings and
renovations of existing structurers) and non-residential building, machinery, and inventories (I),

(3) Government expenditure on final goods and services (G), This refers to payments fro goods
and services or investment in equipment and structurers.

(4) Export of goods and services produced by the people of country (X),
(5) Less imports (M). That part of consumption, investment and government expenditure which
is spent on imports is subtracted from GDP. Similarly, any imported component, such as raw
materials, which is used in the manufacture of export goods, is also excluded.

Thus GDP by expenditure method at market prices = C+ I + G + (X M), where (X-M) is net
export which can be positive or negative.

B Measuring GNP:

Three Approaches to GNP:

After having studied the fundamental constituents of GNP, it is essential to know how it is
estimated. Three approaches are employed for this purpose.

1. the income method to GNP

2. the expenditure method to GNP
3. the value added method to GNP.

Since gross income equals gross expenditure, GNP estimated by all these methods would be the
same with appropriate adjustments.

1. Income Method to GNP:

The income method to GNP consists of the remuneration paid in terms of money to the factors
of production annually in a country.

Thus GNP is the sum total of the following items:

(i) Wages and salaries:

Under this head are included all forms of wages and salaries earned through productive
activities by workers and entrepreneurs. It includes all sums received or deposited during a year
by way of all types of contributions like overtime, commission, provident fund, insurance, etc.

(ii) Rents:

Total rent includes the rents of land, shop, house, factory, etc. and the estimated rents of all
such assets as are used by the owners themselves.

(iii) Interest:
Under interest comes the income by way of interest received by the individual of a country
from different sources. To this is added, the estimated interest on that private capital which is
invested and not borrowed by the businessman in his personal business. But the interest
received on governmental loans has to be excluded, because it is a mere transfer of national
income.

(iv) Dividends:

Dividends earned by the shareholders from companies are included in the GNP.

(v) Undistributed corporate profits:

Profits which are not distributed by companies and are retained by them are included in the
GNP.

(vi) Mixed incomes:

These include profits of unincorporated business, self-employed persons and partnerships.

They form part of GNP.

(vii) Direct taxes:

Taxes levied on individuals, corporations and other businesses are included in the GNP.

(viii) Indirect taxes:

The government levies a number of indirect taxes, like excise duties and sales tax.

These taxes are included in the price of commodities. But revenue from these goes to the
government treasury and not to the factors of production. Therefore, the income due to such
taxes is added to the GNP.

(ix) Depreciation:

Every corporation makes allowance for expenditure on wearing out and depreciation of
machines, plants and other capital equipment. Since this sum also is not a part of the income
received by the factors of production, it is, therefore, also included in the GNP.

(x) Net income earned from abroad:

This is the difference between the value of exports of goods and services and the value of
imports of goods and services. If this difference is positive, it is added to the GNP and if it is
negative, it is deducted from the GNP.

Thus GNP according to the Income Method = Wages and Salaries + Rents + Interest + Dividends
+ Undistributed Corporate Profits + Mixed Income + Direct Taxes + Indirect Taxes +
Depreciation + Net Income from abroad.

2. Expenditure Method to GNP:

From the expenditure view point, GNP is the sum total of expenditure incurred on goods and
services during one year in a country.

It includes the following items:

(i) Private consumption expenditure:

It includes all types of expenditure on personal consumption by the individuals of a country. It

comprises expenses on durable goods like watch, bicycle, radio, etc., expenditure on single-
used consumers goods like milk, bread, ghee, clothes, etc., as also the expenditure incurred on
services of all kinds like fees for school, doctor, lawyer and transport. All these are taken as final
goods.

(ii) Gross domestic private investment:

Under this comes the expenditure incurred by private enterprise on new investment and on
replacement of old capital. It includes expenditure on house construction, factory- buildings,
and all types of machinery, plants and capital equipment.

In particular, the increase or decrease in inventory is added to or subtracted from it. The
inventory includes produced but unsold manufactured and semi-manufactured goods during
the year and the stocks of raw materials, which have to be accounted for in GNP. It does not
take into account the financial exchange of shares and stocks because their sale and purchase is
not real investment. But depreciation is added.

(iii) Net foreign investment:

It means the difference between exports and imports or export surplus. Every country exports
to or imports from certain foreign countries. The imported goods are not produced within the
country and hence cannot be included in national income, but the exported goods are
manufactured within the country. Therefore, the difference of value between exports (X) and
imports (M), whether positive or negative, is included in the GNP.

(iv) Government expenditure on goods and services:

The expenditure incurred by the government on goods and services is a part of the GNP.
Central, state or local governments spend a lot on their employees, police and army. To run the
offices, the governments have also to spend on contingencies which include paper, pen, pencil
and various types of stationery, cloth, furniture, cars, etc.

It also includes the expenditure on government enterprises. But expenditure on transfer

payments is not added, because these payments are not made in exchange for goods and
services produced during the current year.

Thus GNP according to the Expenditure Method=Private Consumption Expenditure (C) + Gross
Domestic Private Investment (I) + Net Foreign Investment (X-M) + Government Expenditure on
Goods and Services (G) = C+ I + (X-M) + G.

As already pointed out above, GNP estimated by either the income or the expenditure method
would work out to be the same, if all the items are correctly calculated.

3. Value Added Method to GNP:

Another method of measuring GNP is by value added. In calculating GNP, the money value of
final goods and services produced at current prices during a year is taken into account. This is
one of the ways to avoid double counting. But it is difficult to distinguish properly between a
final product and an intermediate product.

For instance, raw materials, semi-finished products, fuels and services, etc. are sold as inputs by
one industry to the other. They may be final goods for one industry and intermediate for
others. So, to avoid duplication, the value of intermediate products used in manufacturing final
products must be subtracted from the value of total output of each industry in the economy.

Thus, the difference between the value of material outputs and inputs at each stage of
production is called the value added. If all such differences are added up for all industries in the
economy, we arrive at the GNP by value added. GNP by value added = Gross value added + net
income from abroad. Its calculation is shown in Tables 1, 2 and 3.

Table 1 is constructed on the supposition that the entire economy for purposes of total
production consists of three sectors. They are agriculture, manufacturing, and others,
consisting of the tertiary sector.

Out of the value of total output of each sector is deducted the value of its intermediate
purchases (or primary inputs) to arrive at the value added for the entire economy. Thus the
value of total output of the entire economy as per Table 1, is Rs. 155 crores and the value of its
primary inputs comes to Rs. 80 crores. Thus the GDP by value added is Rs. 75 crores (Rs. 155
minus Rs. 80 crores).
The total value added equals the value of gross domestic product of the economy. Out of this
value added, the major portion goes in the form wages and salaries, rent, interest and profits, a
small portion goes to the government as indirect taxes and the remaining amount is meant for
depreciation. This is shown in Table 3.

Thus we find that the total gross value added of an economy equals the value of its gross
domestic product. If depreciation is deducted from the gross value added, we have net value
added which comes to Rs. 67 crores (Rs. 75 minus Rs. 8 crores).

This is nothing but net domestic product at market prices. Again, if indirect taxes (Rs. 7 crores)
are deducted from the net domestic product of Rs. 67 crores, we get Rs. 60 crores as the net
value added at factor cost which is equivalent to net domestic product at factor cost. This is
illustrated in Table 2.

Net value added at factor cost is equal to the net domestic product at factor cost, as given by
the total of items 1 to 4 of Table 2 (Rs. 45+3+4+8 crores=Rs. 60 crores). By adding indirect taxes
(Rs 7 crores) and depreciation (Rs 8 crores), we get gross value added or GDP which comes to
Rs 75 crores.
If we add net income received from abroad to the gross value added, this gives -us, gross
national income. Suppose net income from abroad is Rs. 5 crores. Then the gross national
income is Rs. 80 crores (Rs. 75 crores + Rs. 5 crores) as shown in Table 3.

(C) Importance of the value added method:

The value added method for measuring national income is more realistic than the product and
income methods because it avoids the problem of double counting by excluding the value of
intermediate products. Thus this method establishes the importance of intermediate products
in the national economy. Second, by studying the national income accounts relating to value
added, the contribution of each production sector to the value of the GNP can be found out.

For instance, it can tell us whether agriculture is contributing more or the share of
manufacturing is falling, or of the tertiary sector is increasing in the current year as compared
to some previous years. Third, this method is highly useful because it provides a means of
checking the GNP estimates obtained by summing the various types of commodity purchases.

(D) Difficulties in using the value added method:

However, difficulties arise in the calculation of value added in the case of certain public services
like police, military, health, education, etc. which cannot be estimated accurately in money
terms. Similarly, it is difficult to estimate the contribution made to value added by profits
earned on irrigation and power projects.

(E) GNP at Market Prices:

When we multiply the total output produced in one year by their market prices prevalent
during that year in a country, we get the Gross National Product at market prices. Thus GNP at
market prices means the gross value of final goods and services produced annually in a country
plus net income from abroad. It includes the gross value of output of all items from (1) to (4)
mentioned under GNP. GNP at Market Prices = GDP at Market Prices + Net Income from
Abroad.

(F) GNP at Factor Cost:

GNP at factor cost is the sum of the money value of the income produced by and accruing to
the various factors of production in one year in a country. It includes all items mentioned above
under income method to GNP less indirect taxes.

GNP at market prices always includes indirect taxes levied by the government on goods which
raise their prices. But GNP at factor cost is the income which the factors of production receive
in return for their services alone. It is the cost of production.

Thus GNP at market prices is always higher than GNP at factor cost. Therefore, in order to arrive
at GNP at factor cost, we deduct indirect taxes from GNP at market prices. Again, it often
happens that the cost of production of a commodity to the producer is higher than a price of a
similar commodity in the market.

In order to protect such producers, the government helps them by granting monetary help in
the form of a subsidy equal to the difference between the market price and the cost of
production of the commodity. As a result, the price of the commodity to the producer is
reduced and equals the market price of similar commodity.

For example if the market price of rice is Rs. 3 per kg but it costs the producers in certain areas
Rs. 3.50. The government gives a subsidy of 50 paisa per kg to them in order to meet their cost
of production. Thus in order to arrive at GNP at factor cost, subsidies are added to GNP at
market prices.

GNP at Factor Cost = GNP at Market Prices Indirect Taxes + Subsidies.

(G) Net National Product (NNP):

NNP includes the value of total output of consumption goods and investment goods. But the
process of production uses up a certain amount of fixed capital. Some fixed equipment wears
out, its other components are damaged or destroyed, and still others are rendered obsolete
through technological changes.

All this process is termed depreciation or capital consumption allowance. In order to arrive at
NNP, we deduct depreciation from GNP. The word net refers to the exclusion of that part of
total output which represents depreciation. So NNP = GNPDepreciation.

(H) NNP at Market Prices:

Net National Product at market prices is the net value of final goods and services evaluated at
market prices in the course of one year in a country. If we deduct depreciation from GNP at
market prices, we get NNP at market prices. So NNP at Market Prices = GNP at Market Prices
Depreciation.

(I) NNP at Factor Cost:

Net National Product at factor cost is the net output evaluated at factor prices. It includes
income earned by factors of production through participation in the production process such as
wages and salaries, rents, profits, etc. It is also called National Income. This measure differs
from NNP at market prices in that indirect taxes are deducted and subsidies are added to NNP
at market prices in order to arrive at NNP at factor cost. Thus

NNP at Factor Cost = NNP at Market Prices Indirect taxes+ Subsidies

= GNP at Market Prices Depreciation Indirect taxes + Subsidies.

= National Income.

Normally, NNP at market prices is higher than NNP at factor cost because indirect taxes exceed
government subsidies. However, NNP at market prices can be less than NNP at factor cost when
government subsidies exceed indirect taxes.

(J) Domestic Income:

Income generated (or earned) by factors of production within the country from its own
resources is called domestic income or domestic product.

Domestic income includes:

(i) Wages and salaries, (ii) rents, including imputed house rents, (iii) interest, (iv) dividends, (v)
undistributed corporate profits, including surpluses of public undertakings, (vi) mixed incomes
consisting of profits of unincorporated firms, self- employed persons, partnerships, etc., and
(vii) direct taxes.

Since domestic income does not include income earned from abroad, it can also be shown as:
Domestic Income = National Income-Net income earned from abroad. Thus the difference
between domestic income f and national income is the net income earned from abroad. If we
add net income from abroad to domestic income, we get national income, i.e., National Income
= Domestic Income + Net income earned from abroad.

But the net national income earned from abroad may be positive or negative. If exports exceed
import, net income earned from abroad is positive. In this case, national income is greater than
domestic income. On the other hand, when imports exceed exports, net income earned from
abroad is negative and domestic income is greater than national income.

(K) Private Income:

Private income is income obtained by private individuals from any source, productive or
otherwise, and the retained income of corporations. It can be arrived at from NNP at Factor
Cost by making certain additions and deductions.

The additions include transfer payments such as pensions, unemployment allowances, sickness
and other social security benefits, gifts and remittances from abroad, windfall gains from
lotteries or from horse racing, and interest on public debt. The deductions include income from
government departments as well as surpluses from public undertakings, and employees
contribution to social security schemes like provident funds, life insurance, etc.

Thus Private Income = National Income (or NNP at Factor Cost) + Transfer Payments + Interest
on Public Debt Social Security Profits and Surpluses of Public Undertakings.

(L) Personal Income:

Personal income is the total income received by the individuals of a country from all sources
before payment of direct taxes in one year. Personal income is never equal to the national
income, because the former includes the transfer payments whereas they are not included in
national income.

Personal income is derived from national income by deducting undistributed corporate profits,
profit taxes, and employees contributions to social security schemes. These three components
are excluded from national income because they do reach individuals.

But business and government transfer payments, and transfer payments from abroad in the
form of gifts and remittances, windfall gains, and interest on public debt which are a source of
income for individuals are added to national income. Thus Personal Income = National Income
Undistributed Corporate Profits Profit Taxes Social Security Contribution + Transfer
Payments + Interest on Public Debt.
Personal income differs from private income in that it is less than the latter because it excludes
undistributed corporate profits.

Thus Personal Income = Private Income Undistributed Corporate Profits Profit Taxes.

(M) Disposable Income:

Disposable income or personal disposable income means the actual income which can be spent
on consumption by individuals and families. The whole of the personal income cannot be spent
on consumption, because it is the income that accrues before direct taxes have actually been
paid. Therefore, in order to obtain disposable income, direct taxes are deducted from personal
income. Thus Disposable Income=Personal Income Direct Taxes.

But the whole of disposable income is not spent on consumption and a part of it is saved.
Therefore, disposable income is divided into consumption expenditure and savings. Thus
Disposable Income = Consumption Expenditure + Savings.

If disposable income is to be deduced from national income, we deduct indirect taxes plus
subsidies, direct taxes on personal and on business, social security payments, undistributed
corporate profits or business savings from it and add transfer payments and net income from
abroad to it.

Thus Disposable Income = National Income Business Savings Indirect Taxes + Subsidies
Direct Taxes on Persons Direct Taxes on Business Social Security Payments + Transfer
Payments + Net Income from abroad.

(N) Real Income:

Real income is national income expressed in terms of a general level of prices of a particular
year taken as base. National income is the value of goods and services produced as expressed in
terms of money at current prices. But it does not indicate the real state of the economy.

It is possible that the net national product of goods and services this year might have been less
than that of the last year, but owing to an increase in prices, NNP might be higher this year. On
the contrary, it is also possible that NNP might have increased but the price level might have
fallen, as a result national income would appear to be less than that of the last year. In both the
situations, the national income does not depict the real state of the country. To rectify such a
mistake, the concept of real income has been evolved.

In order to find out the real income of a country, a particular year is taken as the base year
when the general price level is neither too high nor too low and the price level for that year is
assumed to be 100. Now the general level of prices of the given year for which the national
income (real) is to be determined is assessed in accordance with the prices of the base year. For
this purpose the following formula is employed.

Real NNP = NNP for the Current Year x Base Year Index (=100) / Current Year Index

Suppose 1990-91 is the base year and the national income for 1999-2000 is Rs. 20,000 crores
and the index number for this year is 250. Hence, Real National Income for 1999-2000 will be =
20000 x 100/250 = Rs. 8000 crores. This is also known as national income at constant prices.

(O) Per Capita Income:

The average income of the people of a country in a particular year is called Per Capita Income
for that year. This concept also refers to the measurement of income at current prices and at
constant prices. For instance, in order to find out the per capita income for 2001, at current
prices, the national income of a country is divided by the population of the country in that year.

Similarly, for the purpose of arriving at the Real Per Capita Income, this very formula is used.

This concept enables us to know the average income and the standard of living of the people.
But it is not very reliable, because in every country due to unequal distribution of national
income, a major portion of it goes to the richer sections of the society and thus income
received by the common man is lower than the per capita income.

4. Methods of Measuring National Income and their usage:

There are four methods of measuring national income. Which method is to be used depends on
the availability of data in a country and the purpose in hand.

(1) Product Method:

According to this method, the total value of final goods and services produced in a country
during a year is calculated at market prices. To find out the GNP, the data of all productive
activities, such as agricultural products, wood received from forests, minerals received from
mines, commodities produced by industries, the contributions to production made by
transport, communications, insurance companies, lawyers, doctors, teachers, etc. are collected
and assessed at market prices. Only the final goods and services are included and the
intermediary goods and services are left out.
(2) Income Method:

According to this method, the net income payments received by all citizens of a country in a
particular year are added up, i.e., net incomes that accrue to all factors of production by way of
net rents, net wages, net interest and net profits are all added together but incomes received in
the form of transfer payments are not included in it. The data pertaining to income are
obtained from different sources, for instance, from income tax department in respect of high
income groups and in case of workers from their wage bills.

(3) Expenditure Method:

According to this method, the total expenditure incurred by the society in a particular year is
added together and includes personal consumption expenditure, net domestic investment,
government expenditure on goods and services, and net foreign investment. This concept is
based on the assumption that national income equals national expenditure.

(4) Value Added Method:

Another method of measuring national income is the value added by industries. The difference
between the value of material outputs and inputs at each stage of production is the value
added. If all such differences are added up for all industries in the economy, we arrive at the
gross domestic product.

5. Difficulties in measuring National Income, Growth Rate.

There are many conceptual and statistical problems involved in measuring national
income by the income method, product method, and expenditure method.
We discuss them separately in the light of the three methods:
(A) Problems in Income Method:
The following problems arise in the computation of National Income by income method:
1. Owner-occupied Houses:
A person who rents a house to another earns rental income, but if he occupies the
house himself, will the services of the house-owner be included in national income. The
services of the owner-occupied house are included in national income as if the owner
sells to himself as a tenant its services.
For the purpose of national income accounts, the amount of imputed rent is estimated
as the sum for which the owner-occupied house could have been rented. The imputed
net rent is calculated as that portion of the amount that would have accrued to the
house-owner after deducting all expenses.
2. Self-employed Persons:
Another problem arises with regard to the income of self-employed persons. In their
case, it is very difficult to find out the different inputs provided by the owner himself. He
might be contributing his capital, land, labour and his abilities in the business. But it is
not possible to estimate the value of each factor input to production. So he gets a mixed
income consisting of interest, rent, wage and profits for his factor services. This is
included in national income.
3. Goods meant for Self-consumption:
In under-developed countries like India, farmers keep a large portion of food and other
goods produced on the farm for self-consumption. The problem is whether that part of
the produce which is not sold in the market can be included in national income or not. If
the farmer were to sell his entire produce in the market, he will have to buy what he
needs for self-consumption out of his money income. If, instead he keeps some produce
for his self-consumption, it has money value which must be included in national income.
4. Wages and Salaries paid in Kind:
Another problem arises with regard to wages and salaries paid in kind to the employees
in the form of free food, lodging, dress and other amenities. Payments in kind by
employers are included in national income. This is because the employees would have
received money income equal to the value of free food, lodging, etc. from the employer
and spent the same in paying for food, lodging, etc.
(B) Problems in Product Method:
The following problems arise in the computation of national income by product method:
1. Services of Housewives:
The estimation of the unpaid services of the housewife in the national income presents
a serious difficulty. A housewife renders a number of useful services like preparation of
meals, serving, tailoring, mending, washing, cleaning, bringing up children, etc.
She is not paid for them and her services are not including in national income. Such
services performed by paid servants are included in national income. The national
income is, therefore, underestimated by excluding the services of a housewife.
The reason for the exclusion of her services from national income is that the love and
affection of a housewife in performing her domestic work cannot be measured in
monetary terms. That is why when the owner of a firm marries his lady secretary, her
services are not included in national income when she stops working as a secretary and
becomes a housewife.
When a teacher teaches his own children, his work is also not included in national
income. Similarly, there are a number of goods and services which are difficult to be
assessed in money terms for the reason stated above, such as painting, singing, dancing,
etc. as hobbies.
2. Intermediate and Final Goods:
The greatest difficulty in estimating national income by product method is the failure to
distinguish properly between intermediate and final goods. There is always the
possibility of including a good or service more than once, whereas only final goods are
included in national income estimates. This leads to the problem of double counting
which leads to the overestimation of national income.
3. Second-hand Goods and Assets:
Another problem arises with regard to the sale and purchase of second-hand goods and
assets. We find that old scooters, cars, houses, machinery, etc. are transacted daily in
the country. But they are not included in national income because they were counted in
the national product in the year they were manufactured.
If they are included every time they are bought and sold, national income would
increase many times. Similarly, the sale and purchase of old stocks, shares, and bonds of
companies are not included in national income because they were included in national
income when the companies were started for the first time. Now they are simply
financial transactions and represent claims.
But the commission or fees charged by the brokers in the repurchase and resale of old
shares, bonds, houses, cars or scooters, etc. are included in national income. For these
are the payments they receive for their productive services during the year.
4. Illegal Activities:
Income earned through illegal activities like gambling, smuggling, illicit extraction of
wine, etc. is not included in national income. Such activities have value and satisfy the
wants of the people but they are not considered productive from the point of view of
society. But in countries like Nepal and Monaco where gambling is legalised, it is
included in national income. Similarly, horse-racing is a legal activity in England and is
included in national income.
5. Consumers Service:
There are a number of persons in society who render services to consumers but they do
not produce anything tangible. They are the actors, dancers, doctors, singers, teachers,
musicians, lawyers, barbers, etc. The problem arises about the inclusion of their services
in national income since they do not produce tangible commodities. But as they satisfy
human wants and receive payments for their services, their services are included as final
goods in estimating national income.
6. Capital Gains:
The problem also arises with regard to capital gains. Capital gains arise when a capital
asset such as a house, some other property, stocks or shares, etc. is sold at higher price
than was paid for it at the time of purchase. Capital gains are excluded from national
income because these do not arise from current economic activities. Similarly, capital
losses are not taken into account while estimating national income.
7. Inventory Changes:
All inventory changes (or changes in stocks) whether positive or negative are included in
national income. The procedure is to take changes in physical units of inventories for the
year valued at average current prices paid for them.
The value of changes in inventories may be positive or negative which is added or
subtracted from the current production of the firm. Remember, it is the change in
inventories and not total inventories for the year that are taken into account in national
income estimates.
8. Depreciation:
Depreciation is deducted from GNP in order to arrive at NNP. Thus depreciation lowers
the national income. But the problem is of estimating the current depreciated value of,
say, a machine, whose expected life is supposed to be thirty years. Firms calculate the
depreciation value on the original cost of machines for their expected life. This does not
solve the problem because the prices of machines change almost every year.
9. Price Changes:
National income by product method is measured by the value of final goods and
services at current market prices. But prices do not remain stable. They rise or fall.
When the price level rises, the national income also rises, though the national
production might have fallen.
On the contrary, with the fall in the price level, the national income also falls, though
the national production might have increased. So price changes do not adequately
measure national income. To solve this problem, economists calculate the real national
income at a constant price level by the consumer price index.

(C) Problems in Expenditure Method:

The following problems arise in the calculation of national income by expenditure
method:
(1) Government Services:
In calculating national income by, expenditure method, the problem of estimating
government services arises. Government provides a number of services, such as police
and military services, administrative and legal services. Should expenditure on
government services be included in national income?
If they are final goods, then only they would be included in national income. On the
other hand, if they are used as intermediate goods, meant for further production, they
would not be included in national income. There are many divergent views on this issue.
One view is that if police, military, legal and administrative services protect the lives,
property and liberty of the people, they are treated as final goods and hence form part
of national income. If they help in the smooth functioning of the production process by
maintaining peace and security, then they are like intermediate goods that do not enter
into national income.
In reality, it is not possible to make a clear demarcation as to which service protects the
people and which protects the productive process. Therefore, all such services are
regarded as final goods and are included in national income.
(2) Transfer Payments:
There arises the problem of including transfer payments in national income.
Government makes payments in the form of pensions, unemployment allowance,
subsidies, interest on national debt, etc. These are government expenditures but they
are not included in national income because they are paid without adding anything to
the production process during the current year.
For instance, pensions and unemployment allowances are paid to individuals by the
government without doing any productive work during the year. Subsidies tend to lower
the market price of the commodities. Interest on national or public debt is also
considered a transfer payment because it is paid by the government to individuals and
firms on their past savings without any productive work.
(3) Durable-use Consumers Goods:
Durable-use consumers goods also pose a problem. Such durable-use consumers goods
as scooters, cars, fans, TVs, furnitures, etc. are bought in one year but they are used for
a number of years. Should they be included under investment expenditure or
consumption expenditure in national income estimates? The expenditure on them is
regarded as final consumption expenditure because it is not possible to measure their
used up value for the subsequent years.
But there is one exception. The expenditure on a new house is regarded as investment
expenditure and not consumption expenditure. This is because the rental income or the
imputed rent which the house-owner gets is for making investment on the new house.
However, expenditure on a car by a household is consumption expenditure. But if he
spends the amount for using it as a taxi, it is investment expenditure.
(4) Public Expenditure:
Government spends on police, military, administrative and legal services, parks, street
lighting, irrigation, museums, education, public health, roads, canals, buildings, etc. The
problem is to find out which expenditure is consumption expenditure and which
investment expenditure is.
Expenses on education, museums, public health, police, parks, street lighting, civil and
judicial administration are consumption expenditure. Expenses on roads, canals,
buildings, etc. are investment expenditure. But expenses on defence equipment are
 treated as consumption expenditure because they are consumed during a war as they
are destroyed or become obsolete. However, all such expenses including the salaries of
armed personnel are included in national income. (Source: Smriti Chand database)

3.2 Business Cycle

3.2.1 Business Cycle: The business cycle or economic cycle is the downward and upward
movement of gross domestic product (GDP) around its long-term growth trend.[1] These
fluctuations typically involve shifts over time between periods of relatively rapid economic
growth (expansions or booms), and periods of relative stagnation or decline (contractions
or recessions).s decline and unemployment rate jumps to uncomfortably high levels as many
workers lose their jobs. Eventually the bottom is reached and recovery begins. Recovery may be
slow or fast. It may be incomplete or it may be strong to lead a new boom. It may be marked by
inflationary flare up of prices and speculation to be followed by another slump.

Upward and downward movements in output, inflation, interest rates and employment form
the business cycle that characterizes all market economies.

The business cycles show irregular expansion and contractions in economic activity and this is
depicted in the figure below.
Economic history shows that the economy never grows in a smooth and even pattern .A
country may enjoy many years of economic expansion and prosperity followed by a recession
or even a financial crisis or on rare occasions a prolonged depression. Consequently the
national output falls, profits and real income

A) Features: a business cycle is a period of time containing a single boom and contraction in
sequence.

Business cycles are usually measured by considering the growth rate of real gross domestic
product. Despite being termed cycles, these fluctuations in economic activity can prove
unpredictable.

It is an economy wide fluctuation in total national output, income, and employment usually
lasting for a period of 2 to 10 years. As a result there is expansion and contraction in most
sectors of the economy.
Economists divide business cycles into two main phases, recession and expansion .Peaks ad
troughs mark the turning points of the cycles.

A downturn of a business cycle is called a recession. A recession is a recurring period of decline

in total output, income, usually lasting for 6 months to a year with contractions of many sectors
of the economy. A depression is a recession that is major in both scale and duration.

A.1 Business cycles possess the following characteristics:

1. Cyclical fluctuations are wave-like movements.

2. Fluctuations are recurrent in nature.

3. They are non-periodic or irregular. In other words, the peaks and troughs do not occur at
regular intervals.

4. They occur in such aggregate variables as output, income, employment and prices.

5. These variables move at about the same time in the same direction but at different rates.

6. The durable goods industries experience relatively wide fluctuations in output and
employment but relatively small fluctuations in prices. On the other hand, nondurable goods
industries experience relatively wide fluctuations in prices but relatively small fluctuations in
output and employment.

7. Business cycles are not seasonal fluctuations such as upswings in retail trade during Diwali or
Christmas.

8. They are not secular trends such as long-run growth or decline in economic activity.

9. Upswings and downswings are cumulative in their effects.

Thus business cycles are recurrent fluctuations in aggregate employment, income, output and
price level.

A.2 Some characteristics of a recession:

Consumer purchases decline while inventories of durable goods increase. Businesses

react by curbing production, real GDP falls. Business investment in Plant and Equipment
also falls.
Demand for labor falls initially in the average workweek and later by way of layoff and
 higher employment.
As output falls inflation slows. Prices of services are unlikely to decline but they tend to
rise less rapidly in economic downturn.
Business profits fall sharply in recessions. As demand for credit falls interest rates also
falls.

A boom-and-bust cycle is one in which the expansions are rapid and the contractions are steep
and severe.

The study of Business Cycles falls in the realm of Macro Economics. It examines the forces that
affect the many firms, consumers and workers at the same time.

B) Phases:

Phases of a Business Cycle

A typical cycle is generally divided into four phases:

(1) Expansion or prosperity or the upswing;

(2) Recession or upper-turning point;

(3) Contraction or depression or downswing; and

(4) Revival or recovery or lower-turning point. These phases are recurrent and uniform in the
case of different cycles. But no phase has definite periodicity or time interval. As pointed out by
Pigou, cycles may not be twins but they are of the same family.

Like families they have common characteristics that are capable of description. Starting at the
trough or low point, a cycle passes through a recovery and prosperity phase, rises to a peak,
declines through a recession and depression phase and reaches a trough. This is shown in
Figure 1 where E is the equilibrium position. We describe below these characteristics of a
business cycle.
B.1Recovery:

We start from a situation when depression has lasted for some time and the revival phase or
the lower-turning point starts. The originating forces or starters may be exogenous or
endogenous forces. Suppose the semi-durable goods wear out which necessitate their
replacement in the economy. It leads to increased demand.

To meet this increased demand, investment and employment increase. Industry begins to
revive. Revival also starts in related capital goods industries. Once begun, the process of revival
becomes cumulative. As a result, the levels of employment, income and output rise steadily in
the economy.

In the early stages of the revival phase, there is considerable excess or idle capacity in the
economy so that output increases without a proportionate increase in total costs. But as time
goes on, output becomes less elastic; bottlenecks appear with rising costs, deliveries are more
difficult and plants may have to be expanded. Under these conditions, prices rise.

Profits increase. Business expectations improve. Optimism prevails. Investment is encouraged

which tends to raise the demand for bank loans. It leads* to credit expansion. Thus the
cumulative process of increase in investment, employment, output, income and prices feeds
upon itself and becomes self-reinforcing.
B.2Prosperity:

In the prosperity phase, demand, output, employment and income are at a high level. They
tend to raise prices. But wages, salaries, interest rates, rentals and taxes do not rise in
proportion to the rise in prices. The gap between prices and costs increases the margin of
profit.

The increase of profit and the prospect of its continuance commonly cause a rapid rise in stock
market values. The economy is engulfed in waves of optimism. Larger profit expectations
further increase investment which is helped by liberal bank credit. Such investments are mostly
in fixed capital, plant, equipment and machinery.

They lead to considerable expansion in economic activity by increasing the demand for
consumer goods and further raising the price level. This encourages retailers, wholesalers and
manufacturers to add to inventories. In this way, the expansionary process becomes cumulative
and self-reinforcing until the economy reaches a very high level of production, known as the
peak or boom.

The peak or prosperity may lead the economy to over full employment and to inflationary rise
in prices. It is a symptom of the end of the prosperity phase and the beginning of the recession.
The seeds of recession are contained in the boom in the form of strains in the economic
structure which act as brakes to the expansionary path.

They are:

(i) Scarcities of labor, raw materials, etc. leading to rise in costs relative to prices;

(ii) Rise in the rate of interest due to scarcity of capital; and

(iii) Failure of consumption to rise due to rising prices and stable propensity to consume when
incomes increase. The first factor brings a decline in profit margins.

The second makes investments costly and along with the first, lowers business expectations.
The third factor leads to the piling up of inventories indicating that sales (or consumption) lag
behind production. These forces become cumulative and self-reinforcing. Entrepreneurs,
businessmen and traders become over cautious and over optimism give way to pessimism. This
is the beginning of the upper turning point.

B.3Recession:

Recession starts when there is a downward descend from the peak which is of a short
duration. It marks the turning period during which the forces that make for contraction finally
win over the forces of expansion. Its outward signs are liquidation in the stock market, strain in
the banking system and some liquidation of bank loans, and the beginning of the decline of
prices.

As a result, profit margins decline further because costs start overtaking prices. Some firms
close down. Others reduce production and try to sell out accumulated stocks. Investment,
employment, income and demand decline. This process becomes cumulative.

Recession may be mild or severe. The latter might lead to a sudden explosive situation
emanating from the banking system or the stock exchange, and a panic or crisis occurs. When
a crisis, and more particularly a panic, does occur, it seems to be associated with a collapse of
confidence and sudden demands for liquidity.

This crisis of nerves may itself be occasioned by some spectacular and unexpected failure. A
firm or a bank, or a corporation announces its inability to meet its debts. This announcement
weakens other firms and banks at a time when ominous signs of distress are appearing in the
economic structure; moreover, it sets off a wave of fright that culminates in a general run on
financial institutions. Such was the experience of the United States in 1873, in 1893 and in
1907. In the words of M. W. Lee, A recession, once started, tends to build upon itself much as
forest fire, once under way, tends to create its own draft and give internal impetus to its
destructive ability.

B.4Depression:

Recession merges into depression when there is a general decline in economic activity. There is
considerable reduction in the production of goods and services, employment, income, demand
and prices. The general decline in economic activity leads to a fall in bank deposits. Credit
expansion stops because the business community is not willing to borrow. Bank rate falls
considerably.

According to Professor Estey, This fall in active purchasing power is the fundamental
background of the fall in prices that despite the general reduction of output, characterises the
depression. Thus a depression is characterised by mass unemployment; general fall in prices,
profits, wages, interest rate, consumption, expenditure, investment, bank deposits and loans;
factories close down; and construction of all types of capital goods, buildings, etc. comes to a
standstill. These forces are cumulative and self-reinforcing and the economy is at the trough.

The trough or depression may be short-lived or it may continue at the bottom for considerable
time. But sooner or later limiting forces are set in motion which ultimately tends to bring the
contraction phase to end and pave the way for the revival. A cycle is thus complete.
C) Economic Indicators

Any economic indicator is a statistic about an economic activity. With this it is possible to
analyze the economic performance and also predict the future performance. The economic
indicator can also be used for business cycles. Economic indicators include various indices,
earnings reports and summaries.

In the context of business cycles the economic indicators can be classified into three categories

Leading indicators
Lagging indicators
Coincident indicators

C.1Leading indicators: these indicators change before the economy changes. They are
useful as short term predictors of the economy.

The stock market return is a leading indicator which begins to decline before the
economy decline and recovers even before the economy recovers
Average weekly hours (mfg): Adjustment to the number of hours of existing are
made before hiring new employees or layoff of existing employees .So a measure of
average weekly hours is a leading indicator of change in unemployment.
The average weekly jobless claims for unemployment insurance
Manufacturers new orders for consumer goods/ material. This considered a leading
indicator because increase in orders for consumer goods and materials means
positive changes in production
Manufacturers new orders for non- defense capital goods shows positive changes in
production and rising demand.
Building permits
S&P 500
1.Money Supply (M2) The money supply measures demand deposits, traveler's
checks, savings deposits, currency, money market accounts, and small-
denomination time deposits stock index.
Thus, an increase in demand deposits will indicate expectations that inflation will
rise, resulting in a decrease in bank lending and an increase in savings.
2.Interest Rate Spread :it refers to the yield curve and indicates the direction of
interest rates in the short ;medium and long term.
3. Index of consumer expectations: is a leading indicator as it is based on
 expectations. This leads the business cycle as it predicts consumer spending.

Vendor performance which refers to the time taken to make deliveries to industrial
companies. Vendors performance leads the business cycle because increasing in
delivery time implies larger demand for the products. This performance of vendors can
be measured on a monthly basis through a survey.
C.2Lagging indicators:

Lagging indicators are those that change after the economy changes. Typically the lag is
a few quarters of a year. The unemployment rate is a lagging indicator: employment
tends to increase two or three quarters after an upturn in the general economy .
C.3Coincident indicators
Coincident indicators change along with the change in the whole economy, thus providing
information about the current state of the economy. There are many coincident economic
indicators, such as Gross Domestic Product industrial production, personal income and retail
sales. A coincident index may be used to identify the dates of peaks and troughs in the business
cycle.

There are four economic statistics comprising the Index of Coincident Economic Indicators:

Number of employees on non-agricultural payrolls

Personal income less transfer payments
Industrial production
Manufacturing and trade

3.2.2 Inflation: Inflation refers to a rise in the general level of prices. Inflation also refers to a
sustained increase in the general price level of goods and services in an economy which is
observed to happen over a period of time. So an increase in the price level fetches fewer goods
and services . Consequently, inflation reflects a reduction in the purchasing power per unit of
money a loss of real value in the medium of exchange and unit of account within the
economy. A measure of price inflation in the economy is the inflation rate, the annualized
percentage change in a general price index (normally the consumer price index) over time.
The Classical Economists sought the cause of inflation through the quantity theory of money.
According to them the general level of prices rise in proportion to the increase in money supply,
real output remaining the same.Thus the classical theory emphasizes the role of money and
ignores the real or the non-monetary factors causing inflation. Keynes attributed inflation to
excess aggregate demand at full employment level or the level of potential output.The excess
demand is called inflationary gap. Here Keynes emphasized non-monetary factors ie the
aggregate demand in real terms and ignored the influence of monetary expansion on the price
level .His theory too does not provide full explanation to the phenomenon of inflation.

The modern theories of inflation recognize both the demand side and the supply side factors on
the price level. It explains the causation of the demand side and supply side factors in the
general equilibrium framework.

Also inflation can be classified on the basis of its rates and causes. Inflation on rate is classified
as i) moderate inflation ii) galloping inflation and iii)hyper inflation. Inflation based on causes
can be i) demand pull inflation ii)cost push inflation

A.Types of Inflation:

A.1 Modern Theories of Inflation:

The modern theories of inflation follow the theory of price determination. That is the general
price is determined by aggregate demand for and aggregate supply of goods and services and
the variation in the aggregate price level is caused by the shift in the aggregate demand and
aggregate supply curves. The modern theory of inflation is a synthesis of Classical and
Keynesian theories of inflation.

Modern analysis of inflation shows that inflation is caused by one or both of demand-side and
supply-side factors. The factors that operate on the demand side are called demand -pull
factors and those operating on the supply side are called cost- push factors. In addition some
have referred to a third type called built-in inflation .

There are three major types of inflation, as part of what Robert J. Gordon calls the "triangle
model":

Demand-pull inflation is caused by increases in aggregate demand due to increased

private and government spending, etc. Demand inflation encourages economic growth
since the excess demand and favorable market conditions will stimulate investment and
expansion. Thus aggregate demand increases much more rapidly than the aggregate
supply. So given aggregate supply, aggregate demand increases substantially. Increase
in aggregate demand may be caused by a) monetary factors ie increase in money supply
 b) real factors ie increase in demand for real output.

Increase in Money Supply and Demand Pull inflation:

An important reason for demand-pull inflation is increase in money supply in excess of

increase in potential output. Whether this increase in money supply in excess of output
is the only cause of inflation is a debatable point . Yet the monetary expansion in excess
of increase in the level of output is one of the major causes of demand-pull inflation.

When the monetary and real sectors are at equilibrium at the same level of output and
prices, the economy is also in general equilibrium. When the economy is in equilibrium,
the general price level corresponding to the general equilibrium is called equilibrium
price level. Now let money supply increase, other things remaining same. The increase
in money supply increases the real stock of money at each level of prices. This causes a
decline in the interest rate. So peoples desire to hold money increases. The decreases
in interest rate causes also an increase in investment and thereby increase the level of
income. Increase in income causes rise in consumption expenditure. The rise in
investment and consumer expenditures increases aggregate demand, with aggregate
supply remaining the same. The rise in aggregate demand is proportional to rise in
money stock. The rise in aggregate demand given aggregate supply causes increase in
the general price level which may be inflationary.

The German inflation of 1922-23 is often cited as example of demand-pull inflation

caused by increase in money supply. During 1922-23 the German government had fallen
under heavy post war debts and payment obligations. The government printed and
circulated billions of paper currency and so the general price level raised a billion fold.
The same was observed in Russia where the government financed its budget deficit by
printing roubles.

A.2 Demand Pull Inflation Due to Real Factors:

Demand Pull inflation can be caused by any of the following factors:

1. Increase in government expenditure without change in Tax revenue.

2. Cut in tax rates without change in government expenditure
3. Upward shift in investment function
4. Downward shift in savings function
5. Upward shift in export function
6. Downward shift in import function

The first four factors increase the level of disposable income. Aggregate demand being the
function of income, increase in aggregate income increases the aggregate demand causing
demand pull inflation. Example if the government increases spending through borrowing from
abroad, the rise in government spending generates additional demand and so aggregate
demand increases. Because of Full employment additional resources can be acquired by bidding
a higher price. This pushes the price up without increase in output. So the transaction demand
for money increases. In order to meet the additional transaction demand for money people sell
their financial assets like bonds and securities. So bond and security prices go down and the
rate of interest goes up. In the product market price increases to such an extent that additional
government spending is absorbed by price rise. This is how real factors also cause inflation.

Cost-push inflation: During the recession in 1958 in the western countries the aggregate
demand had declined.Yet there was no decrease in the price level. It tended to rise.In
recent times prices do not decrease during period of recession. Even during stagnation
in the economy there is no inflationary pressure and the general price levels continues
to increase which is a situation of stagflation. Investigation into this phenomenon led to
supply side theories known as cost-push theories and supply shock theories of inflation.
Cost push inflation is generally caused by monopolistic groups of the society like labor
unions and firms in monopolistic and oligopolistic marketing setting. Strong labor unions
succeed in forcing money wages to go up causing prices to go up. This kind of increase in
price is called wage push inflation. Cost push inflation is caused by a drop in aggregate
supply (potential output) This may be due to natural disasters, or increased prices of
inputs. For example, a sudden decrease in the supply of oil, leading to increased oil
prices, can cause cost-push inflation. Producers for whom oil is a part of their costs
could then pass this on to consumers in the form of increased prices. Sometimes firms in
monopoly and oligopoly firms push their profit margin by causing a general rise in price
level. This is called profit-push inflation. Another kind of cost push inflation is supply
shock inflation. Minimum wage legislation and administered prices causes not only keep
prices high but also create conditions for increase in price. Some of the cost based
inflations are:
a. Wage push inflation: which is caused due to labor unions having their money wages
enhanced more than the competitive labor market conditions would permit.
b. Profit push inflation: This is caused by use of monopoly power by monopolist and
oligopolistic firms to enhance profit margin which results in rise in price and inflation
c. Supply shock inflation: This is caused by unexpected decline in supply of major
consumer goods or key industrial output. Example food prices increase due to crop
failure and prices of key industrial inputs like coal, steel, cement etc go up due to a
labor strike, natural calamities

Built-in inflation is induced by adaptive expectations, and is often linked to the

 "price/wage spiral". It involves workers trying to keep their wages up with prices (above
the rate of inflation), and firms passing these higher labor costs on to their customers as
higher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past,
and so might be seen as hangover inflation.

B.0Causes of Inflation:

Demand-pull theory states that inflation accelerates when aggregate demand increases beyond
the ability of the economy to produce (its potential output). Hence, any factor that increases
aggregate demand can cause inflation. However, in the long run, aggregate demand can be held
above productive capacity only by increasing the quantity of money in circulation faster than
the real growth rate of the economy. Other causes are explained in the discussion above

B.1Measurement and kinds of Price Indices: The most widely used measure of inflation is the
consumer price index (CPI) .CPI measures the average change over time in the prices paid by
urban consumers for a market basket of consumer goods and services. The market basket
includes prices of food, clothing, shelter, fuel, transportation, medical care etc.

How are the different prices weighed in constructing price indexes? A price index is constructed
by weighing each price according to the economic importance of the commodity in question.

GDP Price Index: Another widely used price index is the GDP price index referred to as GDP
deflator. GDP Price index is the price of all goods and services produced in the country
(consumption, investment, government purchases and net exports) rather than a single
component like consumption .It is different from CPI because it is a chain weighted index which
takes into account the changing share of different goods.

3.2.3 Primary, Secondary and Tertiary Sectors and their contribution to the Economy

The objective of this part is know the three major sectors of Indian economy which the
households pursue to earn their living , to understand the role and importance of each of these
sectors in the economy and know the linkages among these sectors.

For a livelihood people pursue different types of activities based on their education, skill, family
tradition etc. Normally we classify them into three different sectors of the economy, such as

(i) primary sector,

(ii) secondary sector and
(iii) tertiary sector
(i)Primary Sector :Take the scenario in rural areas of India. How do the people, who are living in
villages, earn their livelihood? Many of them work on the fields to raise crops, which is known
as cultivation. They are known as farmers and agricultural labourers and the occupation is
called agriculture. There are different types of crops which are cultivated; such as food items
and non food items. Food items include cereal, pulses, fruits and vegetables etc. and non-food
items include cotton, jute etc. Similarly people also earn their livelihood from forestry which
refers to collection of forest products and selling them in the market. This occupation is called
forestry. Forest products include- timber, firewood, herbal medicines etc. Many people work in
mining area to extract minerals. There also people are engaged in raising live stock such as
poultry and dairy farming. Finally fishery is another occupation in which people catch fish in
ponds, rivers or sea to sell them in the market. All these activities i.e. agriculture, forestry,
mining, livestock and fishery are complementary to each other. We classify them as primary
production and place them in primary sector. So primary sector of our economy includes the
following (i) Agriculture and allied activities (ii) Fishery (iiii) Forestry (iv) Mining and Quarrying
Villages have been existing from ancient days in India and agriculture and the allied actives are
very traditional occupation of people. It comes naturally to them because food which comes
from agriculture is the basic need of life. But with progress of time human settlements have
expanded beyond villages. Towns and cities have come up in the process of development.
These are called urban areas. Jaipur, Ahmedabad, Pune, Bhubaneswar etc. are examples of
cities in India. Delhi, Chennai, Mumbai and Kolkata are called Metros because they are even
bigger cities. These urban areas are known for its non-agricultural occupation. We can divide
the non agricultural activities into two sectors. (i) Secondary Sector (ii) Tertiary sector.

(ii)Secondary Sector: This sector includes the following production activities (a) Manufacturing
(b) Construction (c) Gas, water and electricity supply Sectoral Aspects of Indian Economy .

a)Manufacturing: This implies production of goods by using raw materials in manufacturing

units called factories and industries. In terms of size and expenditure involved there are small
and large scale industries. Examples of small scale units are: shoe factory, textile unit, printing,
glass making, furniture etc. The large scale manufacturing includes steel, automobiles,
aluminum, etc. Skilled people work in manufacturing business.

b) Construction: This activity includes construction of residential and non-residential buildings,

roads, parks, bridges, dams, airports, bus stops and so on. It is a regular activity seen in urban
areas.

Another occupation people pursue in secondary sector is gas, water and electricity supply.
These are essential services.
c) Tertiary Sector: People are also engaged in tertiary sector activities which are different in
nature. This sector is called service sector where following services are provided. (i) Trade,
Hotels and Restaurants (ii) Transport, Storage and Communication (iii) Financial services such as
Banking, Insurance etc. (iv) Real estate and Business services (v) Public Administration (vi)
Others services.

Table

Occupational Distribution of working Population in India (percentage) in 2009-10

Sl. No.
1 Agriculture 50.19
2 Mining and quarrying 0.61
3 Manufacturing 13.33
4 Electricity, water etc 0.33
5 Construction 6.10
6 Trade, Hotels et 13.18
7 Transport, storage etc 5.06
8 Financial, business services etc 2.22
9 Other services etc. 8.97

The Table provides the percentage of working population in the above mentioned different sub
sectors for the year 2009-10.

1)Role and importance of Primary Sector

In the primary sector agriculture is the predominant occupation and has the largest share in
national income. So let us concentrate on the role and importance of agriculture Sectoral in the
Indian economy in terms of its share in the national income, providing employment food and
raw materials. Let us take them one by one.

1. Share in National income :At the time of independence agriculture was contributing more
than 50 percent to national income. In recent years its share has come down. In 2009-10
agriculture contributed around 15 percent to national income.

2. Providing employment to largest section of population: Agriculture is the mainstay of Indian

economy. It is the occupation of the largest section of Indias population. At the time of
independence about 70 percent of our population depended on agriculture and allied activities
to earn their livelihood. With development of manufacturing and service sector dependency on
agriculture has slightly reduced. About 50 percent of Indias population was working in
agriculture in the year 2009-10.

3. Providing Food to Millions: Food is the most basic requirement of life. Without agriculture
food production and supply would be non-existent. Indias food requirement is not only very
high but also increasing every year because of increase in its population. The total food grain
production of India in 2008-9 was around 234 million tons. This includes wheat, rice and pulses.

4. Providing raw materials to industries : Industries such as sugar, jute, cotton textiles,
vanaspati etc. get their raw materials from agriculture. Do you know how paper is made? It
requires a special type of grass, bamboo etc. Without agriculture paper production is not
possible. Look at the food processing industry which is supplying so many different varieties of
packed food items such as pickles, fruit jam, juice, biscuits, bread, semi prepared food etc.
Food processing industry is operating because of agriculture only.

2.Role and Importance of Secondary Sector:

In the secondary sector manufacturing industries form the major part. These industries are
categorized into small scale industry and large industry. What is a small scale industry? An
industry which can be established by spending a minimum of Rs. 25 lakh on plants and
machinery is called a small scale industry. These industries mostly use labour-intensive
technology. i.e. production process of these industries use more labour force. Large scale
industry, on the other hand needs huge amount of investment in the form of plant and
machinery. It is also physically spread over many acres of land and employs large number of
people. It also uses capital intensive technology in the form of big machines. Take for example
an iron and steel plant. The Tata Iron and steel plant is the oldest in the country. It is situated in
Jamshedpur over an area of about 37.31 km. square of land. The importance of Industrial
sector, both small and large, has been increasing after independence.

(i) Share in national income: The contribution of industrial sector has been increasing
slowly over time after independence. In 2009-10 the share of this sector was 28 percent
in Indias domestic product. At the time of independence it was only 14 percent. The
increase is due to increase in number of manufacturing units and increase in industrial
production.
(ii) Employment generation: Industrial sector has also largely contributed to providing
employment opportunities to Indias population. Nearly 3 crores 30 lakhs people are
engaged in both small and large scale industries combined. Out of this small industries
provide nearly 3 crore 12 lakh jobs.
(iii) Creation of Infrastructure: Today it has become easier to travel to distant places
because of existence of roads, highways, railways, airways. Think of the big Dam
projects such as Hirakud and Bhakra-Nangal which provide electricity and irrigation.
 Look at the big buildings which accommodate offices, shopping centers, factories,
institutions etc. and provide residences. Also see the Radio and Telephone towers
which facilitate communication. These are all part of infrastructure. You can imagine,
how impossible will it be to live without these facilities today? Infrastructure building is
possible because of contribution of large scale industries which make the machinery
and equipment needed build infrastructure.
(iv) Provision of consumer goods: The clothes you wear, the pen, the tooth brush, soap,
shoes, cycle, scooter, car etc. you use are produced by manufacturing industries. Today
the market is flooded with many goods of your choice. This is possible because of
industrialization.

3.Role and Importance of the Tertiary Sector

Service sector of India has been expanding and growing very fast. Example with the Indian
Railways the number of trains carrying people as well as goods has increased significantly.
There has also been growth in the Road Transport Sector .The number of buses have increased ,
so also the number of cars and trucks moving on the roads . This means that the transport
services have grown over time. More number of people is having telephones including mobile
phones. More number of schools has been built in the country to provide education. The
number of study centers under open schooling has increased so that more students can be
benefitted. You can also find hospitals; health centers etc are providing health services to
people. Banks have also opened their branches so that people can open their account,
withdraw money they want and take loans to purchase house, car, scooter etc. There are hotels
and restaurants in almost all public places to provide food to people. These are examples of
different types of services. It is difficult to think life in the economy without services. Hence it is
important to know the role and importance of service sector which we will discuss below under
the following heads. (i) Contribution of service sector to National income. (ii) Contribution of
service sector in providing employment (iii) Attracting funds from foreign countries. (iv)
Contribution of service sector in Exports.

(i) Contribution to National Income :Among all the three sectors i.e. agriculture, industry and
service, it is the service sector that has contributed maximum to the national income of India. If
Indias income is 100, then service sector contributed 55.20 in the year 2009-10 which is more
than half of the total

Table Contribution of services sector in GDP (2009-10)

Sl.No Details Contribution

1 Trade, Hotels etc. 16.3
2 Transport, Communication 7.8
 3 Finance, real estate, business 16.7
4 Community, social and others 14.4
5 Total service sector 55.2

Financial, real estate and business services contributed 16.7 percent out of the total 55.2.
Financial services include Banking and Insurance. Trade and hotel services contributed 16.3
percent. Community and social services which include public administration, defense etc. has
contributed 14.4 percent while transport and communication contributed 7.8 percent to
national income.

(ii) Contribution to Employment: Now a days more and more people are getting employment in
service sector. Out of total employment level in the country, this sector has absorbed 29.4
percent of them in 2009-10. In times to come this figure is going to increase further. The main
reason is that the number of educated people in India is increasing every year. They belong to
various fields such as matriculates, graduates in arts, commerce, science, engineering, medicine
and other professional and vocational streams. Service sector needs these people. In terms of
wages and salaries, service sector, pays more than that of agricultural sector. Compared to
agriculture, service sector provides more job opportunities. There is existence of large varieties
of services which are provided round the year. But there are some seasonal activities in
agriculture. So as people become more educated they move to service sector. So employment
in service sector is increasing.

(iv) Attracting Funds from Foreign Countries :Looking at the growth of service sector of
India people from foreign countries are showing more interest to invest money in this
sector to earn profit. Banking, insurance, Sectoral Aspects of Indian Economy
ECONOMICS Notes MODULE - 7 Indian Economy 77 trade, transport, hotel services
combined have attracted more than 1lac 18 thousand crores rupees from foreign
countries in the form of direct investment. Recently computer service has grown many
fold in India. This has attracted more than forty seven thousand crores of rupees from
foreign countries. If investments are made then more job opportunities are created.
This is advantageous for the nation.
(iii) Contribution of Service Sector to Exports: Exporting means selling goods and
services to citizens in foreign countries to earn foreign exchange in the form of dollar,
euro, yen, pound etc. In recent years Indias service sector has contributed a lot in
earning foreign exchange for the country through exports. Our business services which
include IT, consultancy, legal services, etc. have become world standard. In the year
2009-10 India earned nearly 4.35 lakh crores of rupees from exports i
 4. SWOT Analysis of Indian Economy
The term SWOT refers to the identification of the Strengths and Weaknesses of the
Indian economy and also know the Opportunities and Threats that the Economy is
facing in a globalized environment. Indian Industry has come a long way from
functioning under the license raj which was based on command and control to the
current set up where the emphasis is on exports, global markets and a drive for quality
.The following lists the Strengths ,Weaknesses, Opportunities and Threats of the Indian
Economy.
1. Strengths
Agriculture continues to be the backbone of the economy. Though it still
depends on the monsoons, yet this has enabled food sufficiency to some extent.
The country does not depend on imports of food grains. Some of the commercial
crops are even exported. Nearly 56.78% of land is cultivable land and with
improved techniques of production and farm mechanization there is significant
improvement in productivity and yield.
The country has a large English speaking population. Has infrastructure under
primary and higher education. Also has high level of skilled manpower. Country
has the 3rd largest pool of Engineers.
India is the 8th largest economy in terms of Nominal GDP and the third largest by
Purchasing Power Parity(PPP)
India is also rated as one of the fastest Developing Economic Superpower with a
potential to become the third largest superpower by 2020 or 2025.
The country is the 16th largest exported and the 8th largest imported in the
world.
Indias GDP grew by 9.3% in 2010-11. In 2012-2013 the economy slowed to 5%
compared to 6.2% in 2011-2012.Current revised growth rate is placed at about
6%.
Government is highly proactive with continued thrust on reforms
Have low cost skilled manpower
Large industrial base of Public Sector, Private Sector and SSI.
Hugh domestic market for various consumer and industrial goods.
2. Weaknesses
The fact that the country has a large population still dependent on
agriculture for their live hood is also a draw back as agriculture contributes
only 17.2% to the GDP.
High level of indebtedness has led to farmers resorting to extreme measures
 to meet the demands of the money lenders.
Though we talk of food sufficiency yet nearly 26% of the population live
below the poverty line. It is also said that 34% earn only about Rs.1.25 per
day.There is there fore high degree of inequality in the economy despite the
progress .
Infrastructure is inadequate and there are limited resources to build good
infrastructure.
The large population has compounded the problem of food, employment,
housing, health ,malnutrition etc.
Literacy levels are low
Rural and urban differences are stark. Some urban markets are saturated.
Government need to take more proactive steps to improve the conditions
Environmental waste management is a major challenge today.
3. Opportunities
With liberalization there is encouragement to the private sector.
FDI is allowed up to 51% in certain sectors, though there is a move to have it
up to 100%.
Country has built a huge foreign exchange deposit.
Country has made major strides in areas like biotechnology, space
technology, and software among others.
4. Threats
Because of liberalization, India also is affected by the trends in the global
market place.
Crude oil price volatility has impacted costs of inputs
Population is large and the rate of growth at 2.1% is still high
Inflation high at about 7%
There is high fiscal deficit.
The economy is considered robust; Banking and credit mechanism have
adapted to changed economic scenario.
Experts have expressed that the economy will be the third largest in the
world by 2025 after USA and China.

Module 4:

4.1Industrial Policies and Structure

1. A critical look at Industrial Policies of India

A) Industrial Economic policies of 1948

The emphasis was a Mixed economy with certain areas reserved for private and others
for public sectors. Further the Industries were divided into four categories.

Category I Central Arms & ammunitions, Atomic energy,

Government.
Railways

Category II State Coal, iron & steel, aircraft mfg ,of telephone
,telegraph instruments, wireless instruments
Government.

Category III Central Govt. Industries of basic importance.

Category IV Private Remainder of industries.

individuals, co-
operative.

B.Industrial Policy resolution of 1956:

During this time the First five year plan was completed. Significant developments had taken
place in India.Economic planning had proceeded in an organized manner.There was a need to
re look at the direction of economic planning.Need for a fresh statement of Industrial policy.

Hence the second industrial policy adapted in April 1956 had certain important provisions.:

1.New classification of industries .

Schedule A: State

Schedule B: Progressively State owned. Pvt. Enterprise will supplement State Government
effort.

Schedule C: Balance for Pvt sector.

2. Fair and non-discriminatory treatment for Private enterprise.

3. Encouragement to village and SSI

4. Removing regional disparities.

5. Attitude towards foreign capital

C.Industrial Policy Statement,1977

In Dec 1977 the Janatha Government announced a New Industrial Policy. During the last 20
years industry was governed by industry policy resolution of 1956 and the Impact was not
encouraging. The unemployment level had increased. At the same time the rural-urban divide
had increased. Further the rate of real investment had stagnated. The Growth of industrial
output was by 3-4%.

The New Policy statement laid thrust on the following aspects:

1.Small scale sector :The Development of the small scale sector was given priority. SSI was
classified into three categories:

Cottage and House Hold industries providing self-employment.

Tiny sector with investment in Plant & equipment upto Rs.1 lakh.
SSI with investment in Plant & Equipment up to Rs.10 lakhs and ancillary with
investment up to Rs.15 lakhs.

The Classification under this new policy was as follows:

807 items under reserved category as against 180 items.

District Industries Centre (DICs) set up as focal points of development.
Khadi and Village Industries Commission to enlarge its scope.

2. Areas for Large scale sector:

Here the emphasis is on development of basic industries. These include

Capital goods industries.

High technology industries.
Others which were outside the preview of SSI and which are considered essential for
 development of economy like machine tools, organic and inorganic chemicals.

3. Approach towards large business houses:

What was observed that their growth was disproportionate to their internal resources? Most of
the growth was based on borrowed capital but in reality it had to have growth with internal
resources. Funds would be made available for SSI.

4. Expanding role of Public Sector: The Public Sector was to be given greater emphasis.

5. Foreign Capital: The approach towards foreign capital should be such that activities are
within Indian control. Exceptions were observed.

6. Approach sick units: While studying with regard to sick units, the cost of protecting sick
units also had to be taken into consideration

7. Evaluation of 1977 Industrial Policy :

Encouragement of small and cottage industries.

Failed to ban MNC manufacturing Bread, biscuits, toffees, footwear etc.

Many welcomed the emphasis like SSI focus, contain growth of monopoly capital,
workers participation in ownership and management, larger role to public sector.

Before this could be implemented the Janatha Government fell

D. Industrial Policy of 1980

The Congress Government announced the Industrial Policy of 1980.

The philosophy behind the Industrial Policy of 1980 was based on the 1956 resolution which
reflected the value system of India and its attempt at constructive flexibility.

It reiterated that the task of improving the economic infrastructure in the country was
entrusted to Public sector due to greater reliability, large gestation required and so forth.

Measures suggested were:

Effective Operational Management of Public Sector:

Integrating industrial development in private sector by promoting the concept of
economic federalism
Redefining of small scale units:
 Increase investment in tiny units to 2 lakhs from 1 lakhs.
Ssi investment limit increased to Rs.20 lakhs from Rs.10 lakhs.

Investment limit in ancillaries increased to Rs.25 lakhs from Rs.15 lakhs.

4.There would be regulation of unauthorized excess capacity in private sector. FERA and MRTP
companies would be considered on selective basis. This was not given for items in SSI.

5. Automatic expansion for units in Schedule A of 1951 Industrial Development and Regulation
Act.

6.Industrial Sickness :Units which showed potential would be merged with larger units

D.I Assessment of Industrial Policy 1980:

The following are the observations on the above.

Endorsed the 1956 policy.

Regularize the excess capacity. Example installed capacity in excess of licensed capacity

Allowed automatic expansion of industry.

Big businesses welcomed liberalization of capacity proposed in 1980 Policy resolution.

Policy was guided by considerations of growth.

Blurred the distinction between SSI and large and lay emphasis on growth of later.

Followed a more capital intensive path of development and underplayed the

employment objective.

E. Industrial Licensing Policy:

These are spelt out in the following Act namely the Industries Development and
regulations Act 1951. According to this

i)No new industrial units would be established or expansions permitted without permission of
Government.

ii) Government could look into those industries if there was fall in production; quality is low,
rise in price of product or any tendency in this direction. Also they had to assess whether they
have used resources of national importance and whether they are likely to impact
shareholders.

iii) Government could take over failed entities which do not operate as per its instructions.

iv) Government could decide on prices, distribution channels, volume of production etc.

HAZARI Committee report:

i)Some leading houses like Birlas submitted multiple applications for same product and for
variety of products which were meant to foreclose licensed capacity.

ii) Followed first in first out procedure to issue licenses.

iii) Industrial licensing did not bring about balanced regional development or channel
investments

iv)Absence of follow up action showed that Birlas did not use over 50% of licenses obtained;
prevented others from entering the business.

Thus industrial licensing which was to act as instrument of industrial development actually
became an impediment.

Subrimal Dutt committee report:

The observations made by the Subrimal Dutt committee were as follows:

1.Licensing authorities were bought over by large industrial houses. About 73 large industrial
houses accounted for 56% of investment on machinery by private sector and 60% of value of
import of capital goods was by 73 large industrial houses.

2.Similarly it was not necessary to grant multiple licenses or additional capacities which is
higher that on techno-economic grounds .The objective was to concentrate on few units
belonging to large industrial sector. The idea of preventing monopoly has not come into
picture.

3.The areas reserved for Public sector were opened for private sector. Areas included machine
tools, aluminium, fertilizers, pharmaceuticals, rubber and chemicals and synthetic rubber.

4.Four industrially advanced states like Gujarat, Tamil nadu , Maharashtra,and West Bengal had
cornered 62 % of all licenses.

5. There was use of foreign collaboration for non-essential goods like refrigerators, radio
receivers, etc. Public sector received only 9% of finance and most of the funding was for large
industrial houses.
Also the Industrial licensing process failed to achieve planned economic development.

The Committee urged the monetary and fiscal machinery to fuel development and did not vote
against the licensing policy.

F. Liberalization of Industrial Licensing after 1980

The Industrial Policy of 1980 made a sea-change in terms of liberalization of licensing policy and
it favored large business houses and freeing them from the provisions of MRTP and FERA.

Important changes introduced were:

1. Liberalization of licensed capacity: automatic increase to make capacity viable and 49%
increase for modernization. In 1986 Government de-licensed 23 industries which were under
the hold MRTP and FERA and if they were located in backward area.

2. Introduced the concept of broad-banding: Licenses given for broad category so that
companies could decide on product mix based on market demand. Such as Machine tools,
motor cycles, paper, chemicals, pharmaceuticals, petro-chemicals, Fertilizer machinery and
entertainment electronics.

3. Raising the asset limit of MRTP companies: This was increased from Rs.20 crores to Rs.100
crores. About 112 companies were out of the purview of MRTP act. Further 49 industries were
exempted from Sec 22A of MRTP and FERA.

4. Relaxation of industrial licensing: Number of industries that required compulsory license

reduced from 56 to 26.Non-MRTP and Non-FERA did not require license of investment is over
Rs.50 crores and in backward areas.

5. Industrialization of backward areas: New units got IT exemption under section 80 HH.

G New Industrial Policy 1991:

This was announced by the P.V.Narasimha Rao led Congress Government.

The main objectives were:

1. Unshackle Indian Industrial economy from bureaucratic control.

2. Liberalization for integration of Indian economy with world economy.

3. Remove restrictions in Direct foreign Investment & free domestic entrepreneur from MRTP
Act restrictions.

4. Shed load of public enterprises which were incurring losses or had low ROI.

Government therefore took initiative in the following areas:

a) Industrial Licensing.

b) Foreign investments.

c) Foreign Technology Policy.

d) Public Sector Policy

e) MRPT Act.

H. Industrial Licensing Policy

Industrial licenses abolished for all projects except those related to security and
strategic concerns, social reasons, hazardous chemicals, and overriding environmental
reasons.
Industries reserved for SSI will continue to be so.
Industries requiring compulsory Industrial License: Coal, Lignite, Petroleum (excludes
crude), distilleries / breweries, Sugar, Animal fat, tobacco, Asbestos plywood, raw hide,
motor cars, paper, electronic aerospace, defense, industrial explosives, hazardous
chemicals, drugs and pharmaceuticals, entertainment electronics, white goods like
refrigerators, microwave ovens, washing machines, air conditioners.
No licensing for SSI setting up units in above reserved for SSI.
List of industries for Public sector: Arms, ammunition ,defense, atomic energy, coal,
lignite, mineral oil , mining of iron ore, manganese ore, chrome ore, gypsum, Sulphur,
gold diamond, copper, lead zinc, molybdenum, wolfram,specified minerals, railways.
Projects which require imported capital goods get automatic clearance if foreign
exchange is through foreign equity or if CIF value of imported capital goods is less than
25% of total value of plant and equipments upto Rs.2 crores.
Industries located in cities other than with more than 1 million population, did not have
the need for industrial license from Central Government except those which require
compulsory license.
In cities with greater than 1 million populations, for industries which are of non-
 polluting type will be located outside 25 Km pf periphery.
Existing units with broad banding facility.
Exemption of licensing for existing units going for substantial expansion.

I.0 FOREIGN INVESTMENTS:

To attract foreign investments in high priority industries which require large

investments and advanced technology approval of direct foreign investment of upto
51% was allowed.
To promote exports of Indian products Government would encourage foreign trading
companies to assist Indian exporters in export activities. Details are :
Approval given for FDI unto 51% foreign equity in high priority industries: foreign equity
should cover foreign exchange requirement for imported capital goods.
Import of components, raw material payment for know-how governed by policy
applicable for other domestic units.
Payment of dividends monitored by RBI so that outflow due to dividend payments are
balanced by export earnings over a period of time.
To access international markets foreign equity holdings upto 51% allowed for trading
companies engaged in export activities

J.0 Foreign Technology &Public sector policy:

To inject desired level of technology and dynamism in Indian Industry, Government

would provide automatic approval for technology agreements for high priority
industries. Hiring of foreign technicians, foreign testing of indigenous technologies were
allowed.

PSUs and their achievements:

low rate of return on capital invested.

Not able to go in for new investment or technology development.

Many were a burden than an asset.

Original concept of Public Sector Units (PSUs) was changed .There was takeover of sick
units from private sector. These formed 1/3 of total losses of Central public enterprises.

Also the other category of PSUs was those in consumer goods and services sector.

The 1991 Industrial Policy approach adopted a new approach to public enterprises. The
Priority areas for growth in public enterprises were identified to be:
1. Essential infrastructure, goods & services.

2. Exploration & exploitation of oil and mineral resources.

3. Technology development & building manufacturing capability in crucial areas for long
term economic development & private sector investment is inadequate.

4. Manufacture products of strategic importance like defence equipment.

Action points:

a) Government to strengthen PSUs in reserved areas, high priority areas, those which are
profit making by:

Greater management autonomy.

Introduce competition by inviting private sector participation.

Disinvest part of holdings in equity share capital.

The 1991 Industrial Policy approach

Sick units :

1. Portfolio of investments to be reviewed to focus on units of strategic, high-tech and

essential infrastructure. Some areas retained for PSUs and some from Private sector.

2. Those which are chronically sick to be referred to BIFR. Social security mechanism were
to protect workers.

3. To raise resources, part of Governments holding to be offered to mutual funds, financial

institutions and general public and workers.

4. Board of PSUs made more professional with greater powers.

5. Focus on performance improvement & greater autonomy through Memorandum of

Understanding

K. MRTP Act

To manage the complexity of industrial structure and to ensure economies of scale,

higher productivity and competitive advantage in international markets, Governments
interference through MRTP Act would be restricted. Under this the following were
followed:
 1. Pre-entry scrutiny of investment decisions by MRTP companies no longer required.
Instead there will be controlling and regulating monopolistic, restrictive and unfair trade
practices act.

2. No need for monopoly houses to get approval of Central Government for expansion,
establishment of new undertakings, merger, amalgamations etc.

3. Thrust is on controlling unfair or restrictive business practices.

FURTHER LIBRALIZATION BY DE-RESERVATION:

1.In 1993 Government removed 3 more items from 18 industries reserved for compulsory
licensing : motor cars, white goods and raw hides and skins. These were de-reserved as
there was growing market of middle class of 100-120 million and demand for white goods
like washing machine, refrigerator, air conditioner were to increase; these are no more
luxury goods. Leather, skins and patent leather would boost exports.

2. 16 categories of industries would enjoy automatic approval of up to 51% foreign equity

participation.

3.A list of 9 industries would get automatic approval of upto 74%.Areas include mining
related to oil and gas fields, basic metals, non-conventional energy, navigational,
meteorological, geophysical apparatus, electric generation and transmission, roads,
ropeways, ports, harbors, power plants, land transport and water transport and
warehousing services.

Thrust of these changes: no case by case approval for various proposals with Govt.

Policy will facilitate FDI in infrastructure ,core and priority sector, export oriented and
linked with farm sector

4.2 Evaluation of new Industrial Policy 1991

1. Licensing abolished for all industries except 18 industries.

2. Removed the limit of assets fixed for MRTP Companies and dominant undertakings. Business
houses setting up units or expanding ,mergers ,amalgamations did not require license from
Government. Bottle necks were removed and it was an end to the license permit raj.

4.3. Critique of the policy was:

a)Policy regarding foreign capital:

 The Policy allow FDI upto 51% of equity in high priority industries. Further 100% equity is
allowed if total output is exported. Contrary to Nehru model were foreign capital was for
transitional phase to develop self-reliant and self-generating economy. Free flow of foreign
capital allowed to investments; This may sell our sovereignty to MNCs .Indias share of
foreign capital low when compared to other economies as shown below:

India : $ 425 Million in 1989.

Indonesia $ 735 ,,

Argentina $ 1028 ,,

Thailand $ 1650. ,,

China: $ 1,400 ,,

4.4 Disinvestment in PSUs

Private Sector Critics say that with inflow of foreign capital the distinction between high
priority and low priority industries will disappear and low priority industries may set up
production facilities.

Implication of reverse flow of foreign exchange as foreign capitalist may want

remittances of profits, dividends, royalties. Payment of dividends will be monitored by
RBI to ensure outflow is balanced by export earnings over a period of time.

Allowing foreign equity of upto 51% in trading houses is also questioned by critiques as
Indian trading companies can work in foreign markets without the foreign equity
component.

a) Public Sector Policy: As most PSUs had low rate of return and were a burden
Government intended to strengthen them.
Public sector 2,780 crores 3% Consumer goods, textiles,
with ve rate investment technical consultancy,
of return construction

0-8% 9,990 crores 12%

 Non- 12,220 15%
redeemable crores

Redeemable 73,220 85% -focus on strengthenin g

crores By MOU.
-pvt sector competition.
-dis
investment .

C) Social security policy: No indication of how the retrenched workers would he be

rehabilitated. Industrial Policy mentions of referring these cases to BIFR.
Also Govt.was willing to sell these units to private sector at throw away prices but most
private sector bought them for real asset value.
A process of employee ownership to turnaround sick units needs to be considered.
d) MRTP Policy: MRTP Commission was authorized to initiate investigation on
complaints from individual consumers regarding monopolistic, restrictive and unfair
trade practices. But it was not successful.

4.5 Indian Economy: Growth, Problems and Prospects

According to a recent (2015)report by the World Bank India is set to emerge as the fastest
growing economy by 2015.The countrys GDP is expected to grow at 7.5% in 2015 as per this
report. Several reforms initiatives taken by the Government have improved the fundamentals
of the economy.RBI has taken a proactive effort in credit control and containing the inflation.

Market Size:The IMF World Economic Outlook for 2015 has ranked India 7th globally with regard
to GDP at current prices and it is expected to grow at 7.5% in the year 2016.

The country has experienced significant growth at 7.3% in 2015 as against a rate og 6.9% in
2014.The size of the Indian economy is estimated to be Rs. 129.57 trillion(US $ 2.01 trillion)
during 2014 compared to Rs.118.23 trillion (US$ 1.84 trillion) in 2013.

Government initiatives in various areas have shown positive results as Indias Gross Domestic
Product at factor costs at constant (2011-2012)prices 2014-15 is Rs.106.4 trillion ( US$ 1.596
trillion) as against Rs. 99.21 trillion (US$1.488 trillion) in 2013-14 registering a growth rate of
7.3% .Economic activities which were more prominent were financing ,Insurance, real estate
and business services at 11.5% and trade,hotels,transport and communication services at
10.75%. Reliable sources indicate that the Indian economy is projected to become as US$ 4-5
trillion economy in the next 10-12 years.

4.5.1Investments/developments

Positive improvement in the economic outlook, has resulted in various investments .This has
lead to increased M&A activity such as:
Increase in M&A activity in 2014 with deals worth US$ 38.1 billion being concluded,
compared to US$ 28.2 billion in 2013 and US$ 35.4 billion in 2012. The total transaction
value for the month of May 2015 was US$ 3.3 billion involving a total of 115
transactions. In the M&A space, pharma continues to be the dominant sector
amounting to 23 per cent of the total transaction value.
Indias Index of Industrial Production (IIP) grew by 4.1 per cent in April 2015 compared
to 2.5 per cent in March 2015. The growth was largely due to the boost in
manufacturing growth, which was 5.1 per cent in April compared to 2.8 per cent in the
previous month.
Indias Consumer Price Index (CPI) inflation rate increased to 5.01 per cent in May 2015
compared to 4.87 per cent in the previous month. On the other hand, the Wholesale
Price Index (WPI) inflation rate remained negative at 2.36 per cent for the seventh
consecutive month in May 2015 as against negative 2.65 per cent in the previous
month, led by low crude oil prices.
India's consumer confidence continues to remain highest globally for the fourth quarter
in a row, riding on positive economic environment and lower inflation. According to
Nielsens findings, Indias consumer confidence score in the first quarter of 2015
increased by one point from the previous quarter (Q4 of 2014). With a score of 130 in
the first quarter (2015), India's consumer confidence score is up by nine points from the
corresponding period of the previous year (Q1 of 2014) when it stood at 121.
Indias current account deficit reduced sharply to US$ 1.3 billion (0.2 per cent of GDP) in
the fourth quarter of 2015 compared to US$ 8.3 billion (1.6 per cent of GDP) in the
previous quarter, indicating a shrink in the current account deficit by 84.3 per cent
quarter-on-quarter basis.
India's foreign exchange reserve stood at a record high of US$ 354.28 billion in the week
up to June 12, 2015 indicating an increase of US$ 1.57 billion compared to previous
week.
Owing to increased investor confidence, net Foreign Direct Investment (FDI) inflows
touched a record high of US$ 34.9 billion in 2015 compared to US$ 21.6 billion in the
previous fiscal year, according to a Nomura report. The report indicated that the net FDI
inflows reached to 1.7 per cent of the GDP in 2015 from 1.1 per cent in the previous
fiscal year.
4.5.2Government Initiatives

Numerous foreign companies are setting up their facilities in India on account of various
government initiatives like Make in India and Digital India. Mr Narendra Modi, Prime Minister of
India, has launched the Make in India initiative with an aim to boost the manufacturing sector
of Indian economy. This initiative is expected to increase the purchasing power of an average
Indian consumer, which would further boost demand, and hence spur development, in addition
to benefiting investors. Besides, the Government has also come up with Digital India initiative,
which focuses on three core components: creation of digital infrastructure, delivering services
digitally and to increase the digital literacy.
Currently, the manufacturing sector in India contributes over 15 per cent of the GDP. The
Government of India, under the Make in India initiative, is trying to give boost to the
contribution made by the manufacturing sector and aims to take it up to 25 per cent of the
GDP. Following the governments initiatives several plans for investment have been undertaken
which are as follows:
Foxconn Technology group, Taiwans electronics manufacturer, is planning to manufacture
Apple iPhones in India. Besides, Foxconn aims to establish 10-12 facilities in India including data
centers and factories by 2020.
India Electronics and Semiconductor Association (IESA) and Nasscom have signed a MoU
to push electronics manufacturing share to 25 per cent of GDP by 2025. Under the MoU
approval has been given to 21 electronic clusters.
Hyderabad is set to become the mobile phone manufacturing hub in India and is
expected to create 150,000 200,000 jobs. Besides, the Telangana Government aims to
double IT exports to Rs 1.2 trillion (US$ 18.7 billion) by 2019.
Ford Motor Company has started working on plans to manufacture EcoSport in India for
exporting it to US. The company has provided the quotation for 90,000 units every year,
which is greater than the vehicles it sells in India.
Hyundai Heavy Industries (HHI) and Hindustan Shipyard Ltd have joined hands to build
warships in India. Besides, Samsung Heavy Industries and Kochi Shipyard will be making
Liquefied Natural Gas (LNG) tankers.
Mercedes-Benz plans to increase the number of cars it manufactures in India by
doubling the capacity to 20,000 vehicles a year and has come up with a new plant in
Pune.
Under the Digital India initiative numerous steps have been taken by the Government of India.
Some of them are as follows:
The Government of India has launched a digital employment exchange which will allow
the industrial enterprises to find suitable workers and the job-seekers to find
employment. The core purpose of the initiative is to strengthen the communication
between the stakeholders and to improve the efficiencies in service delivery in the
MSME ministry. According to officials at the MSME ministry over 200,000 people have
so far registered on the website.
The Ministry of Human Resource Development recently launched Kendriya Vidyalaya
Sangthans (KVS) e-initiative KV ShaalaDarpan aimed at providing information about
 students electronically on a single platform. The program is a step towards realising
Digital India and will depict good governance.
The Government of India announced that all the major tourist spots like Sarnath,
Bodhgaya and Taj Mahal will have a Wi-Fi facility as part of digital India initiative.
Besides, the Government has started providing free Wi-Fi service at Varanasi ghats.
Based on the recommendations of the Foreign Investment Promotion Board (FIPB), the
Government of India has approved 10 proposals of FDI amounting to Rs 2,857.83 crore (US$
445.21 million) approximately. Out of the 10 approved proposals, six belonged to the
pharmaceutical sector with a total value of Rs 1,415 crore (US$ 221.05 million) excluding the
outflows.
The Union Cabinet, chaired by the Prime Minister Mr Narendra Modi, has given its approval to
enter into a Memorandum of Understanding (MoU) for strengthening cooperation in the field
of Micro, Small and Medium Enterprises (MSMEs), between India and Sweden. The purpose of
the MoU is to achieve and promote cooperation between MSMEs of the two countries by
providing a structured framework and creating an environment to identify each others
technologies, strengths, markets, policies, etc.
The Government of India has launched an initiative to create 100 smart cities as well as Atal
Mission for Rejuvenation and Urban Transformation (AMRUT) for 500 cities with an outlay of Rs
48,000 crore (US$ 7.47 billion) and Rs 50,000 crore (US$ 7.78 billion) crore respectively. Smart
cities are satellite towns of larger cities which will consist of modern infrastructure and will be
digitally connected. The program was formally launched on June 25, 2015. The Phase I for
Smart City Kochi (SCK) is set to launch in July 2015 which will be built on a total area of 650,000
sq. ft., having a floor space greater than 100,000 sq. ft. Besides, it will also generate a total of
6,000 direct jobs in the IT sector.

4.5.3 Road Ahead

The International Monetary Fund (IMF) and the Moodys Investors Service have forecasted that
India will witness a GDP growth rate of 7.5 per cent in 2016, due to improved investor
confidence, lower food prices and better policy reforms. Besides, according to mid-year update
of United Nations World Economic Situation and Prospects, India is expected to grow at 7.6 per
cent in 2015 and at 7.7 per cent in 2016.
As per the latest Global Economic Prospects (GEP) report by World Bank, India is leading The
World Banks growth chart for major economies. The Bank believes India to become the fastest
growing major economy by 2015, growing at 7.5 per cent.
According to Mr Jayant Sinha, Minister of State for Finance, Indian economy would continue to
grow at 7 to 9 per cent and would double in size to US$ 45 trillion in a decade, becoming the
third largest economy in absolute terms.
Furthermore, initiatives like Make in India and Digital India will play a vital role in the driving the
Indian economy.
Exchange rate used: INR 1 = US$ 0.015 as on June 17, 2015
References: Press Information Bureau (PIB), Media Reports, World Bank, Department of
Industrial Policy & Promotion (DIPP), Grant Thornton, Database of Indian Economy (DBIE)

5.0 SMEs Significance in Indian economy-problems and prospects

In India the Small and Medium enterprises form the backbone of economic development. Their
model lays emphasis on local production with high export earnings, low investment
requirement, employment generation, and contribution to precious foreign exchange.In India
the contribution of SSI/SMEs has been remarkable.It has a share of 40% in the Industrial
production. Also 35% of the total manufactured exports of the country are accounted for by
this sector.It is next to agriculture in terms of generation of employment employing 14 million
people.SSI are less capital intensive and this suits the economy which has yet to tap its potential
resources.

By definition the Small and Medium enterprises are defined as follows:

In the case of the enterprises engaged in the manufacture or production of goods pertaining to

any industry specified in the first schedule to the Industries (Development and Regulation) Act,

1951, as

Micro Enterprise - A micro enterprise is, where the investment in plant and machinery does not

exceed twenty five lakh rupees;

Small Enterprise - A small enterprise is, where the investment in plant and machinery is more

than twenty five lakh rupees but does not exceed five core rupees; or

Medium Enterprise - A medium enterprise, where the investment in plant and Machinery is

more than five crore rupees but does not exceed ten crore rupees

Problems faced by MSMEs in India:

Extreme competition
Poor base with regard to Technology
Poor and inadequate infrastructure
Lack of skilled workers
Marketing and distribution problems
Delayed payments
Gradual withdrawal of payments policy and concessions given by the government.
Traditional MSME still prefer to get protection from the Government .However newer
enterprises are more prone to undertaking risks and are willing to try investments in
newer areas.
 Social welfare areas are neglected
Environment control measures require huge investments and this is an area that needs
to be attended by MSMEs.

Despite these conditions the performance of the MSMEs is shown in the following period pre
and post liberalization.

Performance of MSME in the Pre-liberalization and post liberalization period

Yea Units Prod. Employmen Expor Year Units Prod. Employmen Expor
r in Rs. In t t in Rs. In t t
millio crore Million nos. Rs. millio crore Million nos. Rs.
n nos s crores n nos s crores
73- 0.42 90-
74 91
74- 0. 91-
75 92
75- 92-
76 93
76- 93-
77 94
77- 94-
78 95
78- 95-
79 96
79- 96-
80 97
80- 97-
81 98
81- 99-
82 2000
83- 2000
84 -
2001
84- 2001
85 -
2002
86- 2002
87 -
2003
87- 2003
88 -
2004

The MSMEs in India face a tough situation due to extreme competition from large industries
due to withdrawal of subsidy, lack of infrastructure, anti dumping policy, challenges on product
standardization, total quality management etc. Though Globalization has increased
competitiveness in Indian MSMEs to certain extent, still Indian MSMEs are not adequately
prepared to compete with the global players. There has been a definite change in attitude of
the Govt. from protection to promotion of the MSMEs. The Govt. has taken several policy
initiatives but needs to ensure proper co-ordination and implementation of such schemes

4.2 Industry Analysis

4.2.1 Textiles: India is one of the largest producer of textiles and garments.Availability of raw
materials such as cotton,wool,silk and jute as well as skilled labour force have made the country
a sourcing hub.The country is the world's second largest producer of textiles and garments.The
Indian textiles accounts for about 24% of world's spindle capacity and 8% of rotor capacity as
of 2014-15.The potential size of the textile industry is expected to reach US$223 Billion by
2021.

The textile industry has made a major contribution to the national economy in terms of direct
and indirect employment generation and net foreign exchange earnings.The sector contributes
14% to industrial production, 5% to Gross Domestic Product (GDP) and 27% to country's foreign
exchange inflow.It provides direct employment to about 45 million people and indirect
employment to 60 million people. The textile sector is the second largets provider of
employment after agriculture. Hence its growth has a direct impact on the economy.
In 2012, apparel had a share of 69% of overall market and textiles contributed remaining 31%
percent.

Various Categories: Indian Textile industry can be divided into several segments some of which
can be listed as below:

Cotton: second largest cotton and cellulosic fibre producing country in the world.
Silk: India is the second largest producer of silk and contributes about 18% to the total
world raw silk production.
Wool : India has the 3rd largest sheep population in the world having 6.15 crores
sheep,producing 45 million kgs of raw wool and accounting for 3.1% of total world wool
production.
Man Made Fibres: the fourth largest in synthetic fibre and yarn globally
Jute: India is the largest producer and second largest exporter of jute goods.

The Indian textile industry is estimated at around US$ 108 billion and is expected to
reach US$141 billion by 2021.The textile industry has the potential to grow five fold
over the next ten years to touch US$ 500 billion mark on the back of growing demand
for polyster fabric. The US$500 Billion market figure consists of domestic sales of
US$315 billion and exports of US$185 Billion.The current industry size comprises of
domestic market of US$ 68 billion and exports of US$40 billion.

Apparel exports from India have registered a growth os 17.6% in the period April-
September 2014 over the previous year.India has the lowest per capita spend on garments
($37) compared to Australia which has the highest ($1,131). India is one of the top 5 garment
exorting countries along with China, Italy, Germany and Turkey.

The Indian domest c textile and garments consumption is valued at US$63 billion in 2013.
Within this the garment retail has the highest share of 73% contributing $ 46 billion , technical
textiles contributing $13 billion with a share of 21% and home textiles contributing $ 4 billion
with a share of 6%.

In 2013 India became the second largest exporter of textiles and garments in the world
surpassing Italy and Germany. India exorted textiles and garments goods worth $40 billion with
a share of 5% of global textile and garment trade.In terms of value India's textile and garment
exports is dominated by garment category which has a share of 40% followed by yarn,
fabrics,fibre,made-ups and other textiles including carpets and nonwoven etc.
Government Initiatives:

The Indian Government has come out with several export promotion policies for the textile
sector. It has allowed 100% FDI in the Indian textile sector under the automatic route.

Sector Policy:

Technology Upgradation Fund Scheme

Scheme for Integrated Textile Park
Integrated Procesing Development Scheme
Integrated Skill Development Scheme

Key Provisions of Budget 2014-15:

This includes allocation of funds for the following

Trade facilitation center & Crafts museum

Mega textiles clusters
Hastakala Academy to preserve and revive the handloom and handicrafts sector.
Pashmina promotion program
Duty free entitlement of trimmings and embellishments used in garment industry
increased from 3% to 5%.
Duty free import of embroidery motifs and prints
Custom duty exemption for import by handicrafts manufacturer- exports.
Specified goods imported for use in the manufacture of textile garments for exports
are fully excempt from Basic Custom Duty (BCD) and Countereiling Duty(CD).

Tax Incentives include:

o Industry/ private sponsored research program

o Companies engaged in manufacture having in-house R&D center
o State Incentives offered by each state
o Export Incentives
o Area Based incentives
4.2.2 Electronics:

India's booming Electronics market is projected to more than double to $228 billion in three
more yearsfrom over $ 100 billion in fiscal 2016-17, as expressed by the industry's trade body.

India's ESDM(Electronics System, Design & Manufacturing )Sector is poised to reach $228
billion by 2020 from $100 billion in 2016-17 growing at 16-23% annually as reported by the
Indian Electronics & Semiconductor Association (IESA) and global services firm Ernst&Young(EY)
at their summit.

The report's forecasts are based on the country's GDP(Gross Domestic Product) growth,
currency movement , inflation, trade pacts, consumer sentiments, policies, investments,
manufacturing entities and value addition.

The manufacturing of Electronics products is expected to increase in five years time from 17%
annual growth, while the electronics manufacturing services segment is projected to grow at
42-68% over the next five years to $6-13.2 billion from $ 1 billion in 2015 as reported by the
Chairman of the Electronics & Electrical Association.

The digital revolution and the Government's thrust on using technology to improve delivery of
its public services has opened up huge opportunities to develop and manufacture innovative
products and services across the country.. He further added that the Electronics & Electrical
industry had scaled up in terms of value addition and value proposition with a focus on design
and IP (Intelectual Property ) ownership to boost and sustain the manufacturing eco system.

The State Government has also got involved in the 12th Edition of IESA's Vision Summit.
Association President Mr. VidyaShankar has observed that designing was a key component for
innovation and development of electronic products.

He further asserted that they were promoting local manufacturing and focusing on design-led
growth of ESDM sector. With a Rs. 746 crore budgetary support through schemes like M-SIP
and EDF it is believed that India will be the next manufacturing power house asserted Mr.
Vidya Shankar former Additional Secretary of the Karnataka Government.

The Association has projected Rs.1,700 crore investment in the sector under the Central
Government M-SIPS (Modified Special Incentive Package Scheme) and EDF (Electronics
Development Fund) which are aimed at increasing the domestic production of Electronics
under the 'Make in India' Initiative.

The Association's Technovation Sarabai Award was given to the State run Indian Spacce
Research Organization (ISRO) as per Chairman A.S Kiran Kumar for leading the country's space
missions for various applications and explorations

The Association works with the State and Central Government in framing policies and taking
measurers to scale up indigeneous production to meet the rising demand for electronics.

4.2.3 Automobile:

Production of Automobiles increased at a CAGR of 9.4% over the financial year 06 to 16 with
the passenger vehicle segment witnessing the fastest growth at a CAGR of 10.09% followed by
the two wheeler segment which grew at 9.48% during the same period.

The total production of automobiles is as given below:

Passenger vehicles from 1.3 million in 06 to 2.4 million in 2010 to 3.2 million in 2015
and 3.4 million in 2016
Commercial Vehicles from 0.4 million in 2006 to 0.6 million in 2010 to 0.7 million in
2015 to 0.8 million in 2016
Three wheeler vehivles from 0.4 million in 2006 to 0.6 million in 2010 to 0.9 million in
2015 to 0.9 million in 2016
Three Wheeler vehicles from 7.6 million in 06 to 10.5 million in 2010 to 18.5 million in
2015 and 18.8 million in 2016

The Indian auto industry is one of the largest in the world. The industry accounts for 7.1 per
cent of the country's Gross Domestic Product (GDP). The Two Wheelers segment with 81 per
cent market share is the leader of the Indian Automobile market owing to a growing middle
class and a young population. Moreover, the growing interest of the companies in exploring the
rural markets further aided the growth of the sector. The overall Passenger Vehicle (PV)
segment has 13 per cent market share.

India is also a prominent auto exporter and has strong export growth expectations for the near
future. In April-March 2016, overall automobile exports grew by 1.91 per cent. PV, Commercial
Vehicles (CV), and Two Wheelers (2W) registered a growth of 5.24 per cent, 16.97 per cent, and
0.97 per cent respectively in April-March 2016 over April-March 2015.* In addition, several
initiatives by the Government of India and the major automobile players in the Indian market
are expected to make India a leader in the 2W and Four Wheeler (4W) market in the world by
2020.

Market Size

The sales of Passenger Vehicles, Commercial Vehicles and 2Wheelers grew by 9.17 per cent,
3.03 per cent and 8.29 per cent respectively, during the period April-January 2017.

Investments

In order to keep up with the growing demand, several auto makers have started investing
heavily in various segments of the industry during the last few months. The industry has
attracted Foreign Direct Investment (FDI) worth US$ 15.79 billion during the period April 2000
to September 2016, according to data released by Department of Industrial Policy and
Promotion (DIPP).

Government Initiatives

The Government of India encourages foreign investment in the automobile sector and allows
100 per cent FDI under the automatic route.

Some of the major initiatives taken by the Government of India are:

The Government of India plans to introduce a new Green Urban Transport Scheme with
a central assistance of about Rs 25,000 crore (US$ 3.75 billion), aimed at boosting the
growth of urban transport along low carbon path for substantial reduction in pollution,
and providing a framework for funding urban mobility projects at National, State and
City level with minimum recourse to budgetary support by encouraging innovative
financing of projects.
Government of India aims to make automobiles manufacturing the main driver of Make
in India initiative, as it expects passenger vehicles market to triple to 9.4 million units by
2026, as highlighted in the Auto Mission Plan (AMP) 2016-26.
The Government plans to promote eco-friendly cars in the country i.e. CNG based
vehicle, hybrid vehicle, and electric vehicle and also made mandatory of 5 per cent
ethanol blending in petrol.
The government has formulated a Scheme for Faster Adoption and Manufacturing of
Electric and Hybrid Vehicles in India, under the National Electric Mobility Mission 2020
to encourage the progressive induction of reliable, affordable and efficient electric and
hybrid vehicles in the country.
Road Ahead

Indias automotive industry is one of the most competitive in the world. It does not cover 100
per cent of technology or components required to make a car but it is giving a good 97 per cent,
as highlighted by Mr Vicent Cobee, Corporate Vice-President, Nissan Motors Datsun.

Leading auto maker Maruti Suzuki expects Indian passenger car market to reach four million
units by 2020, up from 1.97 million units in 2014-15.

Mr Young Key Koo, Managing Director, Hyundai Motor India Ltd, has stated that India is a key
market for the company, not only in terms of volumes but also as a hub of small products for
exports to 92 countries.

Mr Joachim Drees, Global CEO, MAN Trucks & Bus AG, has stated that India has the potential to
be among the top five markets, outside of Europe, by 2020 for the company, which is reflected
in the appointment of its most experienced managers to India for increasing volumes and
exports out of India.

The Indian automotive aftermarket is estimated to grow at around 10-15 per cent to reach US$
16.5 billion by 2021 from around US$ 7 billion in 2016. It has the potential to generate up to
US$ 300 billion in annual revenue by 2026, create 65 million additional jobs and contribute over
12 per cent to Indias Gross Domestic Product#.

According to Mr Guillaume Sicard, president, Nissan India Operations, the income tax rate cut
from 10 per cent to 5 per cent for individual tax payers earning under Rs 5 lakh (US$ 7,472) per
annum will create a positive sentiment among likely first time buyers for entry level and small
cars.

Exchange Rate Used: INR 1 = US$ 0.015 as on February 9, 2017

References: Media Reports, Press Releases, Department of Industrial Policy and Promotion
(DIPP), Automotive Component Manufacturers Association of India (ACMA), Society of Indian
Automobile Manufacturers (SIAM), Union Budget 2015-16, Union Budget 2017-18

Notes: *- As per the Society of Indian Automobile Manufacturers (SIAM)

# - As per the Automotive Mission Plan 2016-26 prepared jointly by the Society of Indian
Automobile Manufacturers (SIAM) and government
4.2.4 FMCG:

FMCG INDUSTRY

The fast moving consumer goods (FMCG) segment is the fourth largest sector in the Indian
economy. The market size of FMCG in India is estimated to grow from US$ 30 billion in 2011 to
US$ 74 billion in 2018.

Food products is the leading segment, accounting for 43 per cent of the overall market.
Personal care (22 per cent) and fabric care (12 per cent) come next in terms of market share.

Growing awareness, easier access, and changing lifestyles have been the key growth drivers for
the sector.

What are FMCG goods?

FMCG goods are popularly known as consumer packaged goods. Items in this category include
all consumables (other than groceries/pulses) people buy at regular intervals. The most
common in the list are toilet soaps, detergents, shampoos, toothpaste, shaving products, shoe
polish, packaged foodstuff, and household accessories and extends to certain electronic goods.
These items are meant for daily of frequent consumption and have a high return.

Rural set to rise

Rural areas expected to be the major driver for FMCG, as growth continues to be high in these
regions. Rural areas saw a 16 per cent, as against 12 per cent rise in urban areas. Most
companies rushed to capitalise on this, as they quickly went about increasing direct distribution
and providing better infrastructure. Companies are also working towards creating specific
products specially targeted for the rural market.

The Government of India has also been supporting the rural population with higher minimum
support prices (MSPs), loan waivers, and disbursements through the National Rural
Employment Guarantee Act (NREGA) programme. These measures have helped in reducing
poverty in rural India and given a boost to rural purchasing power.

Hence rural demand is set to rise with rising incomes and greater awareness of brands.

Urban trends

With rise in disposable incomes, mid- and high-income consumers in urban areas have shifted
their purchasing trend from essential to premium products. In response, firms have started
enhancing their premium products portfolio. Indian and multinational FMCG players are
leveraging India as a strategic sourcing hub for cost-competitive product development and
manufacturing to cater to international markets.

Top Companies

According to the study conducted by AC Nielsen, 62 of the top 100 brands are owned by MNCs,
and the balance by Indian companies. Fifteen companies own these 62 brands, and 27 of these
are owned by Hindustan UniLever.

The top ten India FMCG brands are:

1.Hindustan Unilever Ltd.

2. ITC (Indian Tobacco Company)
3. Nestl India
4. GCMMF (AMUL)
5. Dabur India
6. Asian Paints (India)
7. Cadbury India
8. Britannia Industries
9. Procter & Gamble Hygiene and Health Care
10. Marico Industries

Younger consumers express the greatest need for speed, not a huge surprise for the smartphone
generation. Datamonitor's 2013 Consumer Survey found that younger consumers those in the 15-
24 year old age group were twice as likely to say that "results are achieved quickly" has a "very
high amount of influence" on their health and beauty product choices than consumers in the
oldest age group, those aged 65 or older. Speed matters, and 2014 will almost certainly see the
introduction of new game-changing timesavers.

Road Ahead

FMCG brands would need to focus on R&D and innovation as a means of growth. Companies
that continue to do well would be the ones that have a culture that promotes using customer
insights to create either the next generation of products or in some cases, new product
categories.

One area that we see global and local FMCG brands investing more in is health and wellness.
Health and wellness is a mega trend shaping consumer preferences and shopping habits and
FMCG brands are listening. Leading global and Indian food and beverage brands have embraced
this trend and are focused on creating new emerging brands in health and wellness.According
to the PwC-FICCI report Winds of change, 2013: the wellness consumer, nutrition foods,
beverages and supplements comprise a INR 145 billion to 150 billion market in India, is growing
at a CAGR of 10 to 12%.

4.2.5 Telecom:

In the Indian Telecom industry wireless segment dominates the market.

In March 2016, Indias telephone subscriber base reached 1,058.86 million

In March 2016, the wireless segment (97.62 per cent of total telephone subscriptions)
dominated the market, with the wireline segment accounting for an overall share of 2.4
per cent
Urban regions accounted for 57.6 per cent share in the overall telecom subscriptions in
the country, while rural areas accounted for the remaining share of 42.4%.

The Composition of Telephone subscribers for the Financial 2016 is as follows:

Urban wireless 55.6%

Rural wireless 42%
Urban wireline 2%
Rural Wireline 0.4%

Source : TRAI and TechSci Research

Telecom subscriber base expands substantially

India is currently the second-largest telecommunication market and has the third highest
number of internet users in the world
Indias telephone subscriber base expanded at a CAGR of 19.96 per cent, reaching
1058.86 million during FY0716
In March 2016, total telephone subscription stood at 1,058.86 million, while teledensity
was at 83.36 percent
India is the world's second-largest telecommunications market, with over 1.0 billion subscribers
as of May 2015. The wireless segment (97.36 per cent of total telephone subscriptions)
dominates the market. It has also been growing at a brisk pace. During FY07-15, wireless
subscriptions witnessed a CAGR of 24.78 per cent to 969.8 million. . It is also the second largest
country in terms of internet subscribers. The country is now the worlds second largest
smartphone market and will have almost one billion unique mobile subscribers by 2020.

Indias telecommunications market is expected to experience further growth, fuelled by

increased non-voice revenues and higher penetration in rural market. Telecom penetration in the
nation's rural market is expected to increase to 70 per cent by 2017. The emergence of an affluent
middle class is triggering demand for the mobile and internet segments.

Strong policy support from the government has been crucial to the sectors development. Foreign
Direct Investment (FDI) cap in the telecom sector has been increased to 100 per cent from 74 per
cent.

The liberal and reformist policies of the Government of India have been instrumental along with
strong consumer demand in the rapid growth in the Indian telecom sector. The government has
enabled easy market access to telecom equipment and a fair and proactive regulatory framework
that has ensured availability of telecom services to consumer at affordable prices. The
deregulation of Foreign Direct Investment (FDI) norms has made the sector one of the fastest
growing and a top five employment opportunity generator in the country.

The Indian telecom sector is expected to generate four million direct and indirect jobs over the
next five years according to estimates by Randstad India. The employment opportunities are
expected to be created due to combination of governments efforts to increase penetration in
rural areas and the rapid increase in smartphone sales and rising internet usage.

International Data Corporation (IDC) predicts India to overtake US as the second-largest

smartphone market globally by 2017 and to maintain high growth rate over the next few years as
people switch to smartphones and gradually upgrade to 4G.

Market Size

Driven by strong adoption of data consumption on handheld devices, the total mobile services
market revenue in India is expected to touch US$ 37 billion in 2017, registering a Compound
Annual Growth Rate (CAGR) of 5.2 per cent between 2014 and 2017, according to research firm
IDC.

According to a report by leading research firm Market Research Store, the Indian
telecommunication services market will likely grow by 10.3 per cent year-on-year to reach US$
103.9 billion by 2020.

According to the Ericsson Mobility Report India, smartphone subscriptions in India is expected
to increase four-fold to 810 million users by 2021, while the total smartphone traffic is expected
to grow seventeen-fold to 4.2 Exabytes (EB) per month by 2021.
According to a study by GSMA, smartphones are expected to account for two out of every three
mobile connections globally by 2020 making India the fourth largest smartphone market. India is
expected to lead in the growth of smartphone adoption globally with an estimated net addition of
350 million by year 2020.## Total number of smartphone shipments in India stood at 25.8
million units in the quarter ending December 2016, and smartphone shipments during 2016 stood
at 109.1 million units, up by 5.2 per cent year-on-year. Broadband services user-base in India is
expected to grow to 250 million connections by 2017.

Investment

With daily increasing subscriber base, there have been a lot of investments and developments in
the sector. The industry has attracted FDI worth US$ 23.92 billion during the period April 2000
to December 2016, according to the data released by Department of Industrial Policy and
Promotion (DIPP).

Some of the major developments in the recent past are:

Bharti Airtel will buy Telenor's India operations in seven circles to receive 43.5
megahertz (MHz) spectrum in the 1800 MHz band.
Apple plans to produce iPhone SE at an upcoming facility in Bengaluru, owned by its
partner Wistron.
Ortel Communications, Odishas largest multi-system operator, plans to invest around Rs
300 crore (US$ 45 million) over the next two years, for upgrading its infrastructure, along
with strengthening its reach, efficiency and competitiveness in the market.
Reliance Communications Limited (RCom) has signed a binding agreement with
Brookfield Infrastructure Partners to sell a 51 per cent stake in Reliance Infratel, RComs
tower unit, for Rs 11,000 crore (US$ 1.65 billion).
Private equity giant KKR & Co LP and pension giant Canada Pension Plan Investment
Board (CPPIB) are in talks to acquire a significant stake in Bharti Infratel, which is
expected at around US$ 4 billion.
Chinese smartphone manufacturers, Oppo and Vivo, have both planned to invest in
setting up large scale manufacturing capacity in the state of Uttar Pradesh in India, with
an aggregate investment size of Rs 4,000 crore (US$ 600 million).
Samsung India has expanded its service network to over 6,000 talukas across 29 states
and seven union territories in India, by introducing over 535 service vans equipped with
engineers, key components, diesel generator (DG) sets and key equipment, for providing
quick response and on-spot resolution.
LeEco, a Chinese technology company, has entered into a partnership with Compal
Technologies and invested US$ 7 million to set up manufacturing facility at Greater
Noida in order to start manufacturing Le2 smartphones in India.
Chinese telecom gear maker Huawei has set up its largest global service centre (GSC) at
Bengaluru in India, with an initial investment of Rs 136 crore (US$ 20.4 million), which
will extend its support to Huawei's domestic and international telecom carrier customers
in about 30 markets across Asia, Middle East and Africa.
 Chinese smartphone maker Gionee, which currently assembles smartphones in
partnerships with contract manufacturers Foxconn and Dixon, plans to invest Rs 500
crore (US$ 75 million) to set up a manufacturing facility in India.
Singapore Telecommunications Limited (Singtel), the major shareholder in Bharti Airtel,
announced that it has signed an agreement with its majority owner Temasek Holdings
Private Limited to purchase a 7.39 per cent stake in Bharti Telecom Limited, the parent
company of Bharti Airtel Limited, in a deal worth US$ 659.51 million.
Axiata Digital, a subsidiary of Malaysias largest telecom firm Axiata Group Berhad, has
made its entry into Indian e-commerce market by investing Rs 100 crores (US$ 15
million) in Bengaluru-based StoreKing.
Chinese smartphone manufacturer OnePlus has partnered with Foxconn to start
manufacturing its products in India as part of its plan to have 90 per cent of the devices
sold in India to be locally manufactured by the end of 2017.
Government of India to make a windfall gain from sale of spectrum in 2016-17 and
achieve its fiscal deficit target of 3.5 per cent of GDP for the year.
Vodacom SA, a subsidiary of Vodafone Plc, has entered into an agreement with Tata
Communications Ltd to buy the fixed-line assets of TataComm's South African telecom
subsidiary Neotel Pty Ltd.
Reliance Communications Ltd, Indias fourth largest mobile services provider, has agreed
to acquire Sistema Shyam TeleServices Ltd (SSTL), the local unit of Russian company
Sistema JSFC, in a deal valued at Rs 4,500 crore (US$ 675 million), which includes
payments to the government for spectrum allotted to Sistema.
American Tower Corporation, a New York Stock Exchange-listed mobile infrastructure
firm, has acquired 51 per cent stake in telecom tower company Viom Networks in a deal
worth Rs 7,635 crore (US$ 1.14 billion).
Swedish telecom equipment maker Ericsson has announced the introduction of a new
radio system in the Indian market, which will provide the necessary infrastructure
required by mobile companies in order to provide Fifth-Generation (5G) services in
future.

Government Initiatives

The government has fast-tracked reforms in the telecom sector and continues to be proactive in
providing room for growth for telecom companies. Some of the other major initiatives taken by
the government are as follows:

The Government of India has allocated Rs 10,000 crore (US$ 1.5 billion) for rolling out
optical fibre-based broadband network across 150,000 cumulative gram panchayats (GP)
and Rs 3,000 crore (US$ 450 million) for laying optical fibre cable (OFC) and procuring
equipment for the Network For Spectrum (NFS) project in 2017-18.
The Ministry of Communications & Information Technology has launched Twitter Sewa,
an online communications platform for registration and resolution of user complaints in
the telecommunications and postal sectors.
The TRAI has released a consultation paper which aims to offer consumers free Internet
services within the net neutrality framework and has proposed three models for free data
delivery to customers without violating the regulations.
 The Government of India has liberalised the payment terms for spectrum auctions by
allowing two options of payments to telecom companies for acquiring the right to use
spectrum, which include upfront payment and payment in instalments.
The Department of Telecommunications (DoT) has amended the Unified Licence for
telecom operations which will allow sharing of active telecom infrastructure like antenna,
feeder cable and transmission systems between operators, thereby lowering the costs of
operations and leading to faster rollout of networks.
The TRAI has recommended a Public-Private Partnership (PPP) model for BharatNet, the
central governments ambitious project to set up a broadband network in rural India, and
has also envisaged central and state governments to become the main clients in this
project.
The Ministry of Skill Development and Entrepreneurship (MSDE) signed a
Memorandum of Understanding (MoU) with DoT to develop and implement National
Action Plan for Skill Development in Telecom Sector, with an objective of fulfilling
skilled manpower requirement and providing employment and entrepreneurship
opportunities in the sector.
The TRAI has directed the telecom companies or mobile operators to compensate the
consumers in the event of dropped calls with a view to reduce the increasing number of
dropped calls.

Road Ahead

India will emerge as a leading player in the virtual world by having 700 million internet users of
the 4.7 billion global users by 2025, as per a Microsoft report. With the governments favourable
regulation policies and 4G services hitting the market, the Indian telecommunication sector is
expected to witness fast growth in the next few years. The Government of India also plans to
auction the 5G spectrum in bands like 3,300 MHz and 3,400 MHz to promote initiatives like
Internet of Things (IoT), machine-to-machine communications, instant high definition video
transfer as well as its Smart Cities initiative.

Exchange Rate Used: INR 1 = US$ 0.015 as on February 9, 2017

References: Media Reports and Press Releases, Cellular Operators Authority of India (COAI),
Telecom Regulatory Authority of India (TRAI), Department of Telecommunication (DoT),
Department of Industrial Policy and Promotion (DIPP)

Notes:! - GSMA report 'The Mobile Economy: India 2015', @ - Ericsson Mobility Report
November 2015, # - Ericson report India 2020, -^ - According to a report by International Data
Corporation (IDC), &- According to a report by Assocham-KPMG, ## - GSMA report GSMA
Intelligence Consumer Survey 2016

4.2.6 Pharma:

Increasing investments in the sector

 The Indian pharmaceuticals market increased at a CAGR of 17.46 per cent during 2005-
16 with the market increasing from US$ 6 billion in 2005 to US$ 36.7 billion in 2016 and
is expected to expand at a CAGR of 15.92 per cent to US$ 55 billion by 2020.
By 2020, India is likely to be among the top three pharmaceutical markets by incremental
growth and sixth largest market globally in absolute size.
Indias cost of production is significantly lower than that of the US and almost half of
that of Europe. It gives a competitive edge to India over others.

Revenue of the Pharmaceutical sector in US$ Billion is as follows:

$ 6 B in 2005
$ 12 B in 2013
$ 30 B in 2015
$ 36.7 B in 2016
$ 55 in 2020 (Forcast)

Introduction

The Indian pharmaceuticals market is the third largest in terms of volume and thirteenth largest
in terms of value, as per a report by Equity Master. India is the largest provider of generic drugs
globally with the Indian generics accounting for 20 per cent of global exports in terms of
volume. Of late, consolidation has become an important characteristic of the Indian
pharmaceutical market as the industry is highly fragmented.

India enjoys an important position in the global pharmaceuticals sector. The country also has a
large pool of scientists and engineers who have the potential to steer the industry ahead to an
even higher level. Presently over 80 per cent of the antiretroviral drugs used globally to combat
AIDS (Acquired Immuno Deficiency Syndrome) are supplied by Indian pharmaceutical firms.

The UN-backed Medicines Patent Pool has signed six sub-licences with Aurobindo, Cipla,
Desano, Emcure, Hetero Labs and Laurus Labs, allowing them to make generic anti-AIDS
medicine TenofovirAlafenamide (TAF) for 112 developing countries.

Market Size

The Indian pharma industry, which is expected to grow over 15 per cent per annum between
2015 and 2020, will outperform the global pharma industry, which is set to grow at an annual
rate of 5 per cent between the same period!. The market is expected to grow to US$ 55 billion by
2020, thereby emerging as the sixth largest pharmaceutical market globally by absolute size, as
stated by Mr Arun Singh, Indian Ambassador to the US. Branded generics dominate the
pharmaceuticals market, constituting nearly 80 per cent of the market share (in terms of
revenues).
India has also maintained its lead over China in pharmaceutical exports with a year-on-year
growth of 11.44 per cent to US$ 12.91 billion in FY 2015-16, according to data from the
Ministry of Commerce and Industry. In addition, Indian pharmaceutical exports are poised to
grow between 8-10 per cent in FY 2016-17. Imports of pharmaceutical products rose marginally
by 0.80 per cent year-on-year to US$ 1,641.15 million.

Overall drug approvals given by the US Food and Drug Administration (USFDA) to Indian
companies have nearly doubled to 201 in FY 2015-16 from 109 in FY 2014-15. The country
accounts for around 30 per cent (by volume) and about 10 per cent (value) in the US$ 70-80
billion US generics market.

India's biotechnology industry comprising bio-pharmaceuticals, bio-services, bio-agriculture,

bio-industry and bioinformatics is expected grow at an average growth rate of around 30 per cent
a year and reach US$ 100 billion by 2025. Biopharma, comprising vaccines, therapeutics and
diagnostics, is the largest sub-sector contributing nearly 62 per cent of the total revenues at Rs
12,600 crore (US$ 1.89 billion).

Investments

The Union Cabinet has given its nod for the amendment of the existing Foreign Direct
Investment (FDI) policy in the pharmaceutical sector in order to allow FDI up to 100 per cent
under the automatic route for manufacturing of medical devices subject to certain conditions.

The drugs and pharmaceuticals sector attracted cumulative FDI inflows worth US$ 14.53 billion
between April 2000 and December 2016, according to data released by the Department of
Industrial Policy and Promotion (DIPP).

Government Initiatives

The Government of India unveiled 'Pharma Vision 2020' aimed at making India a global leader
in end-to-end drug manufacture. Approval time for new facilities has been reduced to boost
investments. Further, the government introduced mechanisms such as the Drug Price Control
Order and the National Pharmaceutical Pricing Authority to deal with the issue of affordability
and availability of medicines.

Mr Ananth Kumar, Union Minister of Chemicals and Petrochemicals, has announced setting up
of chemical hubs across the country, early environment clearances in existing clusters, adequate
infrastructure, and establishment of a Central Institute of Chemical Engineering and Technology.

Some of the major initiatives taken by the government to promote the pharmaceutical sector in
India are as follows:

The Government of India plans to set up around eight mini drug-testing laboratories
across major ports and airports in the country, which is expected to improve the drug
regulatory system and infrastructure facilities by monitoring the standards of imported
and exported drugs and reduce the overall time spent on quality assessment.
 India is expected to rank among the top five global pharmaceutical innovation hubs by
2020, based on Government of India's decision to allow 50 per cent public funding in the
pharmaceuticals sector through its Public Private Partnership (PPP) model.#
Indian Pharmaceutical Association (IPA), the professional association of pharmaceutical
companies in India, plans to prepare data integrity guidelines which will help to measure
and benchmark the quality of Indian companies with global peers.
The Government of India plans to incentivise bulk drug manufacturers, including both
state-run and private companies, to encourage Make in India programme and reduce
dependence on imports of Active Pharmaceutical Ingredients (API), nearly 85 per cent of
which come from China.
The Department of Pharmaceuticals has set up an inter-ministerial co-ordination
committee, which would periodically review, coordinate and facilitate the resolution of
the issues and constraints faced by the Indian pharmaceutical companies.
The Department of Pharmaceuticals has planned to launch a venture capital fund of Rs
1,000 crore (US$ 149.11 million) to support start-ups in the research and development in
the pharmaceutical and biotech industry.

Road Ahead

The Indian pharmaceutical market size is expected to grow to US$ 100 billion by 2025, driven
by increasing consumer spending, rapid urbanisation, and raising healthcare insurance among
others.

Going forward, better growth in domestic sales would also depend on the ability of companies to
align their product portfolio towards chronic therapies for diseases such as such as
cardiovascular, anti-diabetes, anti-depressants and anti-cancers that are on the rise.

The Indian government has taken many steps to reduce costs and bring down healthcare
expenses. Speedy introduction of generic drugs into the market has remained in focus and is
expected to benefit the Indian pharmaceutical companies. In addition, the thrust on rural health
programmes, lifesaving drugs and preventive vaccines also augurs well for the pharmaceutical
companies.

Exchange Rate Used: INR 1 = US$ 0.0150 as on February 9, 2017

References: Consolidated FDI Policy, Department of Industrial Policy & Promotion (DIPP),
Press Information Bureau (PIB), Media Reports, Pharmaceuticals Export Promotion Council

4.2.7 FDI in Retailing

FDI in Retail Sector

Until 2011, foreign direct investment (FDI) was not allowed in multi-brand retail,
forbidding foreign companies from any ownership in supermarkets, convenience
stores or any retail outlets. Even single-brand retail was limited to 51 per cent
ownership. In January 2012, India allowed 100 per cent FDI investment in single-
brand stores, but imposed the requirement that the single brand retailer would
have to source 30 percent of its goods from India. On 7 December 2012, India
allowed 51 per cent FDI in multi-brand retail. It was felt that this would be
beneficial for both consumers and farmers. Agricultural marketing was also
expected to be benefited with the introduction of new technologies.
With this decision, international companies, especially the supermarkets, were
able to increase their presence in the multi-brand retail sector of India. However,
they were not allowed to own more than 51 per cent stakes in these
establishments. This step was regarded as the most important one in the last two
decades, especially with regard to reforms in India.
Reasons for promotion of FDI in Retail
The major benefit of FDI is that it is both supplementary and complimentary with
regards to local investment. FDI lets a company gain better access to top class
technology and supplementary funds. They are also exposed to management
practices in vogue around the world and also get the chance to become a part of
the global market system.

The Indian government had commissioned Indian Council for Research on

International Economic Relations (ICRIER) to perform a study on the effect of
organized retailing practices on its unorganized counterpart.

ICRIER submitted the report during 2008. The study hinted at the advantages that
the growth of organised retail will have for various participants like the
consumers, manufacturers, and farmers.

The government decided on the basis of the results in other countries and the
ICRIER study that this decision would result in a greater influx of FDI in both back
and front end infrastructure. It was expected that the agricultural sector would
become more efficient and be in a better position to use technology.
It was also expected that this decision would result in more and better jobs being
created and the best practices around the world will be introduced in India. Both
farmers and consumers will see more convenient prices and higher quality in
future and this will help both the classes.

The government also put in an obligatory condition before foreign companies for
procuring 30 percent supplies from local producers in order to provide a fillip to
the manufacturing sector in India. Jobs are expected to be available in both rural
and urban areas thanks to greater back and frontal operations resulting from
more FDI.

Domestic retail entities and traders are expected to pull up their socks and
increase their efficiency ever since this decision. Consequently, the consumers are
expected to receive better services and the producers who provide the source
products also get better payment.

Process of FDI in Retail

There is no such procedure for short listing the companies. International

companies who are willing to invest in either single or multi-brand retail can put
in their applications with the Department of Industrial Policy and Promotion.

Here the applications are reviewed in an effort to determine their suitability as

per the stated guidelines. Subsequently, the Foreign Investment Promotion
Board, Ministry of Finance will consider the applications before providing the final
approval.

Advantages of FDI in retail

India's retail industry is one of the biggest around the world when it comes to the
privately owned ones. The industry has seen some major restructuring thanks to
the FDI structure becoming more liberal than before. The benefits of FDI in retail,
as per experts, carry greater weightage than the cost related implications.

With FDI in retail, operations in distribution and production cycles are expected to
become better. Owing to factors such as economic operations, the cost of
production facilities will come down as well. This will mean a greater choice of
products at lesser and justifiable prices for the customers.

As a result of FDI, companies will be able to bring in technology and skills from
other countries and this will help in infrastructural development of India. This will
also help in creating more value for money for the buyers.

After FDI in retail, it is possible to set up a properly organised chain of retail stores
as the capital to do is readily available. The investment can be regarded as a long
term one as the physical capital put into a domestic company is not liquidated
easily. This is its main difference from equity capital.

ICRIER had also predicted that if FDI in retail was introduced in India during 2011-
12, the Indian economy could have grown by 13 per cent, the unoganised sector
could have seen a 10 per cent growth and the organised sector could have
increased by 45 per cent.

Disadvantages of FDI in retail

Experts say that while analysing the positives and drawbacks of FDI in retail, both
the government and the opposition did not refer to the Parliament Committee
report where its effects had been studied in great detail. The committee had
taken into cognizance many witnesses, NGOs, individuals, and trade associations
to come up with the said report.

The Committee visited various corners of India and also went through reports and
gathered knowledge about the experience of similar decisions in other countries.
It also enquired from several government departments regarding the matter.

The Committee had surmised in its report that the number of people getting jobs
will be lesser than the amount of people losing the same as a substantial amount
of marginal and small farmers will be wiped out. Some other problems expected
out of this were aggressive pricing and prevalence of monopoly.

As per the Committee's report almost 8 percent of India's workforce is employed

in the unorganised retail sector. This comes up to roughly 40 million people. It has
been stated that FDI in retail will generate 2 million jobs. However, the
Committee had stated that it is not a proper indication as it does not take into
account the number of people who already work in the retail sector.

ICRIER had executed a second study on the effects of FDI in retail during 2011 and
in that it had stated that FDI will bring about a fantastic shopping experience for
the consumers. It had actually interviewed 300 people from the middle and high
income groups. Thus, in effect, the efforts of the Parliament Committee were
overlooked for a private organisation.

Experts have questioned the logic of ICRIER to question 300 people in a country
with a 1.2 billion population and more than 40 per cent who can be termed as
poor.

The Parliamentary Committee report on FDI was never discussed in Parliament

itself, and as per experts, it is not a good sign as far as the democratic system in
India is concerned.

As per ICRIER, consumerism is positive for economic growth. In 2008 the first
survey had dealt with 2020 small and unorganised retailers whereas the total
count of such entities in India at that time was 6 million.

Leading economic experts from outside India have also posed the same question.
They have also pointed at the labour practices of organisations such as Wal-Mart.
Most of these are not exactly healthy for workers. This has also led them to ask if
such processes were really required in India.

It is being said that the lobby favouring FDI in retail in India has invested at least
Rs 52 crore and experts opine this could have had a major say in the way things
turned out.

4.2.8 Infrastructure:

Indian construction equipment revenues on an uptrend

 By FY20, construction equipment industrys revenue is estimated to reach to US$ 5
billion.
Revenues increased at a CAGR of 8.38 per cent during FY07- 14 and is further estimated
to rise at a CAGR of 2.34 per cent between FY07-20, owed to the rapid infrastructure
development, undertaken by the Government of India.

In FY16, India construction equipment industry grew at a YoY of around 3.45 per cent over the
previous year

Growth in Revenue from construction equipment in US$ Billion for the Financial years is as
follows:

Financial year 2007 3.7 Billion

Financial year 2010 4.6 Billion
Financial year 2013 3.9 Billion
Financial year 2014 6.5 Billion
Financial year 2016 3 Billion
Financial year 2020 5 Billion Estimate

Source : BCG Group; Mahindra Website;TechSci Research

Introduction

Infrastructure sector is a key driver for the Indian economy. The sector is highly responsible for
propelling Indias overall development and enjoys intense focus from Government for initiating
policies that would ensure time-bound creation of world class infrastructure in the country.
Infrastructure sector includes power, bridges, dams, roads and urban infrastructure development.
In 2016, India jumped 19 places in World Bank's Logistics Performance Index (LPI) 2016, to
rank 35th amongst 160 countries.

Market Size

Foreign Direct Investment (FDI) received in Construction Development sector (townships,

housing, built up infrastructure and construction development projects) from April 2000 to
March 2017 stood at US$ 24.3 billion, according to the Department of Industrial Policy and
Promotion (DIPP).

Investments

India is witnessing significant interest from international investors in the infrastructure space.

Government Initiatives
The Road Transport & Highways Ministry has invested around Rs 3.17 trillion (US$ 47.7
billion), while the Shipping Ministry has invested around Rs 80,000 crores (US$ 12.0 billion) in
the past two and a half years for building world class highways and shipping infrastructure in the
country. The Government of India is expected to invest highly in the infrastructure sector, mainly
highways, renewable energy and urban transport, prior to the general elections in 2019.

A total of 6,604 km out of the 15,000 km of target set for national highways in 2016-17 has been
constructed by the end of February 2017, according to the Minister of State for Road, Transport
& Highways and Government of India.

The Government of India is taking every possible initiative to boost the infrastructure sector.
Some of the steps taken in the recent past are being discussed hereafter.

In the Union Budget 2017-18, the Government of India has taken the following measures
for the development of infrastructure.
o Increased total infrastructure outlay and defence capital expenditure by 10 per
cent and 20.6 per cent to Rs 396,135 crore (US$ 59.18 billion) and Rs 86,488
crore (US$ 13.1 billion) respectively, over FY17 revised estimate.
o Railway expenditure allocation has increased by 8 per cent to Rs 131,000 crore
(US$ 19.58 billion) for laying down 3,500 km of railway lines in 2017-18.
o Affordable housing has been given infrastructure status.
o Lock-in period for long-term capital gains on land and buildings has been reduced
from three to two years.

In addition several affordable housing projects have also been launched.

The Government of India plans to invest Rs 11,421 crore (US$ 1.77 billion) to improve basic
urban infrastructure in 61 cities and towns of Uttar Pradesh, having population exceeding
100,000 each by 2019-20, under the Atal Mission for Rejuvenation and Urban Transformation
(AMRUT) scheme. The government has also approved investments in Tamil Nadu (Rs 11,237
crore or US$ 1.74 billion), Maharashtra (Rs 6,759 crore or US$ 1.05 billion), Haryana (Rs 2,544
crore or US$ 394.32 million), Chattisgarh (Rs 2,192 crore or US$ 339.76 milion), Manipur (Rs
180 crore or US$ 27.90 million) and Sikkim (Rs 39 crore or US$ 6.05 million) by 2019-20,
under the same scheme

The Central Electricity Authority (CEA) expects investment in India's power

transmission sector to reach Rs 2.6 lakh crore (US$ 38.85 billion) during the 13th plan
(2017-22), and to enhance the transmission capacity of the inter-regional links by 45,700
megawatt (MW).
The monetisation of 75 publicly funded highway projects of value Rs 35,600 crore (US$
5.32 billion) via toll-operate-transfer (TOT) mode will fetch adequate funds to finance
road construction of 2,700 km length of roads.*
The Indian Railways plans to set up a US$ 5 billion Railways of India Development Fund
(RIDF), which will serve as an institutional mechanism for the Railways to arrange funds
from the market to finance various infrastructure projects.
 The Ministry Of Urban Development has approved investment of Rs 2,863 crore (US$
433 million) in six states under the Atal Mission for Rejuvenation and Urban
Transformation (AMRUT) scheme, for improving basic urban infrastructure over FY
2017-20.
Airports Authority of India (AAI) plans to increase its capital expenditure for 2017-18 by
25 per cent to Rs 2,500 crore (US$ 0.37 billion), primarily to expand capacity at 12
airports to accommodate increase air traffic, as per the Chairman of AAI.
The Government of India and the Asian Development Bank (ADB) have signed US$ 375
million in loans and grants for developing 800 kilometer (km) Visakhapatnam-Chennai
Industrial Corridor, which is the first phase of a planned 2,500 km East Coast Economic
Corridor (ECEC).
Road Ahead
Sweden is interested in smart cities development in India and has put forward a Common
Plan of Action for developing sustainable and environment-friendly public transport
solutions and solid waste management for the smart cities under development.
The Ambassador of Japan to India, Mr Kenji Hiramatsu, has conveyed Government of
Japan's inclination to invest and offer any other feasible support for various ongoing as
well as upcoming development and infrastructure projects in the North-Eastern region of
India.
Exchange Rate Used: INR 1 = US$ 0.0155 as of April 17, 2017.
References: @ - As per a report released by the Indian Construction Equipment
Manufacturers Association (ICEMA), * - As per Indian Credit Rating Agency (ICRA).

4.2.9 Pharma contd.

Introduction

The Indian pharmaceuticals market is the third largest in terms of volume and thirteenth largest
in terms of value, as per a report by Equity Master. India is the largest provider of generic drugs
globally with the Indian generics accounting for 20 per cent of global exports in terms of
volume. Of late, consolidation has become an important characteristic of the Indian
pharmaceutical market as the industry is highly fragmented.

India enjoys an important position in the global pharmaceuticals sector. The country also has a
large pool of scientists and engineers who have the potential to steer the industry ahead to an
even higher level. Presently over 80 per cent of the antiretroviral drugs used globally to combat
AIDS (Acquired Immuno Deficiency Syndrome) are supplied by Indian pharmaceutical firms.

The UN-backed Medicines Patent Pool has signed six sub-licences with Aurobindo, Cipla,
Desano, Emcure, Hetero Labs and Laurus Labs, allowing them to make generic anti-AIDS
medicine TenofovirAlafenamide (TAF) for 112 developing countries.

Market Size
The Indian pharma industry, which is expected to grow over 15 per cent per annum between
2015 and 2020, will outperform the global pharma industry, which is set to grow at an annual
rate of 5 per cent between the same period!. The market is expected to grow to US$ 55 billion by
2020, thereby emerging as the sixth largest pharmaceutical market globally by absolute size, as
stated by Mr Arun Singh, Indian Ambassador to the US. Branded generics dominate the
pharmaceuticals market, constituting nearly 80 per cent of the market share (in terms of
revenues).

India has also maintained its lead over China in pharmaceutical exports with a year-on-year
growth of 11.44 per cent to US$ 12.91 billion in FY 2015-16, according to data from the
Ministry of Commerce and Industry. In addition, Indian pharmaceutical exports are poised to
grow between 8-10 per cent in FY 2016-17. Imports of pharmaceutical products rose marginally
by 0.80 per cent year-on-year to US$ 1,641.15 million.

Overall drug approvals given by the US Food and Drug Administration (USFDA) to Indian
companies have nearly doubled to 201 in FY 2015-16 from 109 in FY 2014-15. The country
accounts for around 30 per cent (by volume) and about 10 per cent (value) in the US$ 70-80
billion US generics market.

India's biotechnology industry comprising bio-pharmaceuticals, bio-services, bio-agriculture,

bio-industry and bioinformatics is expected grow at an average growth rate of around 30 per cent
a year and reach US$ 100 billion by 2025. Biopharma, comprising vaccines, therapeutics and
diagnostics, is the largest sub-sector contributing nearly 62 per cent of the total revenues at Rs
12,600 crore (US$ 1.89 billion).

Investments

The Union Cabinet has given its nod for the amendment of the existing Foreign Direct
Investment (FDI) policy in the pharmaceutical sector in order to allow FDI up to 100 per cent
under the automatic route for manufacturing of medical devices subject to certain conditions.

The drugs and pharmaceuticals sector attracted cumulative FDI inflows worth US$ 14.53 billion
between April 2000 and December 2016, according to data released by the Department of
Industrial Policy and Promotion (DIPP).

Government Initiatives

The Government of India unveiled 'Pharma Vision 2020' aimed at making India a global leader
in end-to-end drug manufacture. Approval time for new facilities has been reduced to boost
investments. Further, the government introduced mechanisms such as the Drug Price Control
Order and the National Pharmaceutical Pricing Authority to deal with the issue of affordability
and availability of medicines.

Mr Ananth Kumar, Union Minister of Chemicals and Petrochemicals, has announced setting up
of chemical hubs across the country, early environment clearances in existing clusters, adequate
infrastructure, and establishment of a Central Institute of Chemical Engineering and Technology.
Some of the major initiatives taken by the government to promote the pharmaceutical sector in
India are as follows:

The Government of India plans to set up around eight mini drug-testing laboratories
across major ports and airports in the country, which is expected to improve the drug
regulatory system and infrastructure facilities by monitoring the standards of imported
and exported drugs and reduce the overall time spent on quality assessment.
India is expected to rank among the top five global pharmaceutical innovation hubs by
2020, based on Government of India's decision to allow 50 per cent public funding in the
pharmaceuticals sector through its Public Private Partnership (PPP) model.#
Indian Pharmaceutical Association (IPA), the professional association of pharmaceutical
companies in India, plans to prepare data integrity guidelines which will help to measure
and benchmark the quality of Indian companies with global peers.
The Government of India plans to incentivise bulk drug manufacturers, including both
state-run and private companies, to encourage Make in India programme and reduce
dependence on imports of Active Pharmaceutical Ingredients (API), nearly 85 per cent of
which come from China.
The Department of Pharmaceuticals has set up an inter-ministerial co-ordination
committee, which would periodically review, coordinate and facilitate the resolution of
the issues and constraints faced by the Indian pharmaceutical companies.
The Department of Pharmaceuticals has planned to launch a venture capital fund of Rs
1,000 crore (US$ 149.11 million) to support start-ups in the research and development in
the pharmaceutical and biotech industry.

Road Ahead

The Indian pharmaceutical market size is expected to grow to US$ 100 billion by 2025, driven
by increasing consumer spending, rapid urbanisation, and raising healthcare insurance among
others.

Going forward, better growth in domestic sales would also depend on the ability of companies to
align their product portfolio towards chronic therapies for diseases such as such as
cardiovascular, anti-diabetes, anti-depressants and anti-cancers that are on the rise.

The Indian government has taken many steps to reduce costs and bring down healthcare
expenses. Speedy introduction of generic drugs into the market has remained in focus and is
expected to benefit the Indian pharmaceutical companies. In addition, the thrust on rural health
programmes, lifesaving drugs and preventive vaccines also augurs well for the pharmaceutical
companies.

Exchange Rate Used: INR 1 = US$ 0.0150 as on February 9, 2017

References: Consolidated FDI Policy, Department of Industrial Policy & Promotion (DIPP),
Press Information Bureau (PIB), Media Reports, Pharmaceuticals Export Promotion Council
4.2.10 Banking, & Insurance

4.3 Globalization and Indian Business Environment

4.3.1 Meaning and Implications, Phases,

Globalization is the process of integrating various economies across nations such that there is
free flow of goods and services, technology, capital and even labor. Globalization has four
parameters:

Reduction of trade barriers to enable free flow of goods and services between nations
Creation of an environment where there is free flow of capital between nations
Creating conditions for free flow of technology
Also creating an environment for free flow movement of labor.
There are varying thoughts on the aspect of free movement of labor between nations
particularly with the developed economies.

Globalization signifies internationalization and liberalization. According to Stiglitz,

Globalization is the integration of the countries and people of the world through
reduction of costs of transportation and communication, and the breaking down of
artificial barriers to the flow of goods and services, capital, knowledge and to a lesser
extent people across borders.
Jagdish Bhagavathi defines globalization in the following manner Economic
globalization constitutes integration of national economies into the international
economy through trade, direct foreign investment (by corporations and multi
nationals),short term capital flows ,international flow of workers and technology.
In recent times the World Trade Organization (WTO) has advocated integration of
various states. Globalization is the modern version of the Theory of Comparative Cost
Advantage which was propagated by the classical economist for the unrestricted flow
of goods from great Britain to other less developed economies.
The current advocates of globalization desire an export led pattern of growth rather
than an import substitution led pattern followed earlier.
Supporter of the concept of globalization favor it due to the following reasons:
Globalization will direct foreign investment and so developing countries can raise capital
easily.
 Developing countries can access the technology of developed countries
Wider market access of developing countries to developed countries for the export of
their products and in return the consumers in developing countries can access foreign
products.
There is faster dissemination of relevant knowledge and this can help the developing
countries in improving their production and productivity.
Globalization reduces the costs of transport and communication, reduces tariffs and
enlarges share of foreign trade as percentage of GDP.
In general globalization supports growth, technical advancement, improving the
productivity, creates employment and reduction of poverty with the developing
economies

4.3.2 Impact of Globalization on Indian Economy :

According to the World Commission on the Social Dimension of Globalization
(WCSDG) set up by the ILO the following are the observations. According to it the
world path of globalization has to change. We need to expand human well being
and freedom and bring democracy and development to local communities.
a. Trade: Globalization aims to expand trade in goods and services. But the World
Commission has observed that there has been no uniformity with nations and
only industrialized countries and 12 developing countries account for the lions
share.Also most developing countries did not experience significant trade
expansion.
During the 18 year period (1995 -2010) Indias merchandise exports increased at
13.8% per annum from $ 30.63 billion to $ 313.2 billion while for China it
increase faster at 16.2 % and for Maxico at 9.1percent. The worlds average
annual exports increased at 7.5% during the period and compared to this India
did benefit from globalization in increasing it growth rate. Indias share in world
merchandise exports improved marginally from 0.59 per cent in 1995 to 1.65 %
in 2013.
In the service sector exports was relatively better as it increased from $ 10.0
billion in 1995 to $148.6 billion in 2013 indicating an annual growth rate of
16.1% during the period.This increase has been software exports to USA and to
EU .Compared to average growth in commercial services of 7.8%,India benefitted
with the service sector exports.
Combining the goods and service sector exports, Indias export of goods and
services increased from $ 40.69 billion in 1995 to $ 461.9 billion in 2013
indicating an average annual growth rate of 14.4%.Thus Indias share in world
exports improved from 0.63 per cent in 1995 to 1.95% in 2013. Chinas share
 improved from 2.7% in 1995 to 10.25% in 2013 and that of Maxico from 1.4
percent to 1.69 per cent. The annual average exports of goods and services from
India increased by 14.4 per cent while the performance of China was 15.85 per
cent which is a little more than China.
India has gained from globalization by improving its share of the world exports to
1.92 per cent. Given the size of the economy this gain is much smaller when
compared to South Korea,Mexico and China.

a) Increase of Imports far greater than Increase of Exports:

It was believed that with globalization and liberalization India could

access foreign markets and increase exports. Past data shows that
exports increased from 5.8% of GDP in 1990-91 to 9.1% of GDP in 1995-
96. Then there has been gradual increase in exports to reach 16.7% of GP
in 2013-14.The trend in imports shows an increase from 8.8 per cent of
GDP in 1990-91 to 23.9% in 2013-14. Even when there was a decline in
exports, imports continued to increase. Some of the data is given as
follows:

Imports Export
1990-91 8.8% 5.8%

2000-01 12.6% 9.9%

2013-14 23.9% 16.7%

So the trade deficit during 1996-97 and 2000-01 ranged between 3.1 per
cent and 4.0 per cent of GDP.In 2001-02 and 2002-03 the trade deficit
came down to 2.4% and 2.1 percent of GDP respectively. In 2008-09 the
trade deficit sharply increased to 10.6% of GDP .In 2013-14 it was 7.2 per
cent of GDP. Thus foreign companies have been able to penetrate the
Indian market more than India penetrating the foreign markets
b) Foreign Investment Flows:

Globalization should improve flow of foreign investment. Foreign investment takes two
forms viz foreign direct investment(FDI) and foreign portfolio investment(FPI).FDI improves the
productive capacity of the country while FPI is more speculative in nature.

About 10 sectors have attracted FDI flows .During April 2000 to March 2014 nearly 47%
pertained to five sector viz service sector, construction and development, telecommunication,
computer soft ware and hard ware and drugs and pharmaceuticals. Actual inflows revealed a
wide gap between FDI approvals and actual inflows. Example: out of a total approval in the
energy sector of the order of Rs. 77,825 crores, actual FDI inflows was a mere 9.802 crores
(12.6%) between January 1991 and March 2004.

c.Indias Share in FDI inflows:

A review of the FDI inflows shows that 38.9% of total inflows are made to
developed countries, 53.6% to developing countries and only 7.4 % to Central
and East Europe in 2013.Of this flow India received only 1.9percent, Brazil got
4.4% and Maxico got 2.6% but China received a bif share at 8.5% in 2013.The
point to be noted is that nearly 46.3% of FDI inflow go to benefit Developed
Countries and Eastern European economies and 53.6 per cent to provide
assistance to developing countries.
d. Employment situation in India during the era of Globalization:

The employment situation in India during the era of globalization has worsened . The
rate of growth of employment which was 2.04 percent per year during 1983-94
declined to a low level of 0.98 percent during 1994-2000.This was due to negative
growth rate of employment in agriculture which has 65% of total employed workers
as also a sharp decline in community, social and personal services to 0.55% during
1994-2000 as against 2.9% during 1983 to 94.Organized sector failed to generate
adequate employment.
e. Inequality and Poverty: ILO has reported that globalization has increased the
inequality and poverty levels. Only a certain segment like the highly educated
people, working in MNCs have benefitted .Globalization has resulted in high degree
of concentration of wealth. Those who have benefitted most are those associated
with successful MNCs (shareholders, managers, workers, sub-contractors) and
internationally competitive national enterprises. Those adversely affected are those
associated with uncompetitive enterprises and have not been able to survive in the
face of trade liberalization. Cheap imports have led to closure of a large number of
small enterprises as they have been affected by the informal economy as well as
agriculture.
f. In India poverty has declined from 36% to 26% in 1999-2000 but there is unanimity
with economists that inequality has increased. The condition of the socially deprived
has even been worst ;particularly there has been exploitation of the tribal
communities with the reform process.
g. Slowing down of the process of poverty reduction: Based on the consumer
expenditure data of the 55th round of NSS, poverty ratio is calculated for 1999-2000
as 27.1% for the rural areas,23.6% for the urban areas and 26.1% for the country as
a whole.
 According to a World Bank published paper the key determinants of the rate of
poverty reduction at the state level are agricultural yields, growth of non-farm
sector, development spending and inflation.
The growth rate of GDP has been estimated to be higher in 1990s than in 1980s.The
paradox of higher growth of GDP and lower rate of poverty reduction is the direct
result of the in equal distribution of income between the rich and the marginalized
sections of the population. Main reason for the slow decline in poverty reduction is
the geographical pattern of growth promoted by the policies of liberalization,
privatization and globalization.

h) Double standards of Developed Countries:

According to Stiglitz, Western economies have poor countries to eliminate trade

barriers but have kept up their own barriers preventing developing countries from exporting
their agricultural products and depriving them of the income.

i) Feminization of labor in low wage jobs:

Globalization has brought more women workers in low paid jobs in manufacturing.
This is observed in sectors like garments, shoes, and electronics. Another category of
labor is the home based labor with more shares of females. By exploiting the
unorganized home-based workers they are able to reduce the costs. This unfair
treatment of female workers needs remedial measures.
j) Weakening of the welfare state in favor of markets:
Advocates of globalization have propagated minimal role for the state and maximum
role for the market. There is erosion of sovereignty of nation states. Pressure from
multi- national corporations force governments to take decisions on privatization of
public enterprises, opening of FDI in several sectors like retail, consumer goods like
potato chips ,hurting small and medium enterprises leading to their closure and
unemployment.
It is clear that globalization lacks social responsibility and to restore more social
responsibility and the need to create decent work and a decent society which cares
for the poor ,the weaker sections, small entrepreneur, it is necessary to strengthen
the regulatory and promotional role of the state.

4.4 Foreign Trade

Prior to Independence India being a colony essentially exported raw materials and

Foodstuff and relied on import of machinery, plant and equipment.

 With independence the colonial pattern changed to suit the needs of a developing
country. So during the early years of development imports have to be increased. So
this will result in adverse balance of trade.To earn foreign exchange the developing
countries have to export products other than foodstuff and raw materials. Here the
developed countries can reduce the trade barriers and facilitate the process of
industrialization.

1.0Trends in India's Foreign Trade:

The trends of Indias foreign trade since Independence can be discussed in 7 phases.

1948-49 to 1950-51 : On the Eve of Planning:

Foreign trade showed an excess of imports over exports. Rise of imports was due to pent up
demand of the war and post war period, shortage of food and basic raw material,and the need
for import of machinery and equipment.

1951-51 to 1955-56: The First Plan period:

The average value of imports during the First Plan was Rs. 730 crores and of exports was Rs.
622 crores with a trade deficit of Rs. 108 crores. This was due to industrialization and no
improvement in exports.

1956-57 to 1960-61 :The Second Plan:

During the Second Plan there was massive program of industrialization. This included setting up
of steel plants, heavy expansion and renovation of railways modernization of heavy industries;
maintenance imports and also food grain imports. Export earnings was Rs.613 crores and the
figure was lower than that of first plan.

1961-62 to 1965-66 The Third Plan periods:

The record of exports during the Third Plan shows that average export earnings was Rs. 747
crores. And the annual imports was Rs.1224 crores. Import increase was due to 3 factors viz

- Industrialization required import of machinery, raw material,

technical knowhow.
- Defense needs increased with aggression by China and Pakistan.
- Food grain imports due its availability and failure of crops.

Devaluation in 1966 and the period upto 1973-74:

Due to adverse balance of trade since 1951 and so adverse balance of payments, acute
shortage of foreign exchange, extensive borrowing by India from foreign countries and
international institutions like IMF to overcome balance of payment problem India devalued the
rupee by 36.5% in June 1966. Rupee was devalued to boost exports, create favorable balance of
trade and payments. Though exports increased, imports also being inelastic, sored and so there
was adverse trade balance .Imports was Rs. 1992 crores in 1966-67 and 1967-68 and so the
balance of trade worsened. Due to the policies of import restriction and vigorous export
promotion the country had a favorable balance of trade for the first time in 1972-73.But this
was lost during 1973-74 due to several international factors which pushed up the prices of
petroleum products ,steel and non ferrous metals. Trade deficit during the fourth plan was
much lower than compared to the Second plan, Third plan and the annual plans.

1974-79: The Fifth Plan Period:

The hike in oil prices which started in October 1973 affected trade throughout the world
including India. Value of Imports during the fifth plan period reached very high levels with high
share of imports of petroleum, fertilizers and food grains. There was increase in Indias exports
as they rose every year during the Fifth Plan period. The rise was so fast that by 1976-
77,exports at Rs.5143 crores exceeded imports by Rs. 69 crores balance of trade surplus
emerged for the second time since 1951.Export of fish, and fish preparations, coffee, tea,
groundnuts ,cotton fabrics, readymade garments and handicrafts recorded substantial increase.

1980 onwards: The Sixth and Seventh Plan Period.

Due to increase in prices of petroleum products by OPEC the import bill shot up from Rs. 6811
crores to over Rs.9142 crores in 1979-80 and further to Rs. 12,549 crores in 1980-81 and to
Rs.13,608 crores in 1981-82. Though exports continue to rise, value of exports fell short of
imports causing trade deficit from Rs. 2450 crores to in 1979-80 to Rs. 5,838 crores in 1980-81.
This deficit forced the Government to approach the IMF in November 1981 for a huge loan.

Trade deficit continued to rise despite import of POL declined from Rs. 5,263 crores in 1980-81
to Rs. 4,832 crores in 1983-84 due to international prices of oil showing a downward trend and
because domestic production of crude increased by ONGC. Trade deficit was of the order of Rs.
6,061 crores in 1983-84.

Imports in Sixth Plan was(1980-81 to 1984-85) were of the order of Rs. 14,603 crores as against
exports of the order of Rs. 8,987 crores. So the annual average trade deficit of the order of
about Rs. 5,716 crores was witnessed during the Sixth Plan.

Data about Seventh Plan period (1985-86 to 1989-90) reveal that on account of the policies of
indiscriminate liberalization followed by the Congress Govt and later endorsed by the Janatha
Dal Government, average imports shot up to Rs.25,112 crores but exports averaged 17,382
crores .The trade deficit was of the order of Rs. 7,730 crores

The trade deficit made the government approach the World Bank/IMF for an unprecedented
loan of over Rs. 6.7 billion.

2.0 Impact of WTO on India's Foreign Trade

Module 5

5.0 Economic Policies

5.1 Fiscal Policy

1.0Objectives, Instruments,

2.0 Union Budget

5.2 Monetary Policy

1.0 Measures of Money Supply

2.0 Monetary Policy in India

3.0 Objectives, tools for Credit Control

It Was important to have the monetary and fiscal policy to support the planned
economic development program in the country with the introduction of the 5 year plan.
The Monetary Policy has been in operation since 1952.It lay emphasis on the twin
objectives viz:

1. Speed up economic development in country to improve standard of living and national

incomes.

2. To control and reduce the inflationary pressure in the economy.

RBIs monetary policy was of controlled expansion which was adequate financing of
economic growth and ensuring reasonable price stability. RBI also appreciated and
developed the need for expansion of credit and money supply for rapid development and
diversification of the economy. RBI was also aware that money supply and credit would lead
to inflationary conditions which may not be healthy.The thrust of the Monetary Policy is
seen from 1952-57.
 Since 1972,RBIs Monetary Policy focus has been anti-inflationary. Several conditions
necessitated the RBI to abandon the policy of controlled expansion and go for policy of
credit restraint or tight monetary policy.

These were:

rapid increase in money supply with public and banking system; expansion of trade
credit to finance trade and industry, inflation due to fluctuating agricultural production
etc.

Other considerations of the monetary policy were control the depreciation of the rupee
by dealing in the foreign currency market. Also the East Asian crisis and its impact had to
be curtailed.

Long term objective has been to ensure low level of inflation.

Some of the major weapons of the Monetary Policy are

RBI which is the central authority has two major weapons under the Monetary Policy. These

Include the following:

1. Quantitative Controls: These are used to control the volume of credit and control the
inflationary and deflationary pressure on the economy.

Bank Rate.

Cash Reserve Ratio

Statutory Liquidity ratio:

2. Qualitative Controls:

QUANTITATIVE CONTROLS:

A) GENERAL Credit control :

Economic Conditions:

1955-56 & particularly 1973-74 there has been price rise caused due to Government
spending .

Since 1973 inflation had been raising due to deficit financing, increases in prices, wages
and income; hoarding of essentials caused inflation,
 1)Bank rate: Of the quantitative controls, Initially a cheap money policy was followed with
bank rate at 3 % and remained at that level till 1953. The Bank Rate rose to 3.5 % in
November 1953. It gradually raised to 10% in July1981.and remained at 10% from 1981 to
1991.Further the Bank rate was revised to 11% in July 1971 and 12% in October 1981.

Bank rate is an important instrument in monetary policy and reflects the RBIs monetary
policy and its approach in using interest rate while handling economic development.

Bank rate In India has limited role because RBI decides the structure of rates to commercial
banks. Also the bank rate is not automatically adjusted. Other observations on the bank rate
are as follows:

Commercial banks enjoy refinance facilities and so it is not necessary to discount their
eligible securities with RBI at the bank rate.

The Bill market undeveloped and the submarkets of money markets are not influenced
by the bank rate.

In India bank rate is not a pace setter and money market rates and market rates of
interest do not adjust themselves to changes in bank rate.

Also the deposit rate and the lending rates of the bank are not related to the Bank rate.

The Government of India &RBI usually review rules to make the bank rate an active
instrument of monetary policy.

In1995,India passed through a severe liquidity crunch. At this time prime lending rate
was ruling high and the industrial production were affected. RBI reduced the bank rate
from 12% to 11% in April 1977 and gradually to 6.5% .This was to induce borrowing from
banks. Other tools used were:

2.Cash reserve ratio:

Yet another instrument for credit control is the CRR. It refers to variable cash reserve
requirement under RBI Act 1934. Minimum CRR of 5% is specified against time deposits
and 2% against demand deposits. Since 1962 RBI was empowered to vary the CRR
between 3% and 15% of total demand and time deposits .In 1973 RBI raised the
statutory reserve requirements to 5% and subsequently to 7%. Over the years RBI has
raised or lowered the CRR to provide large quantity of cash with banks to enable them
 to extend credit to industry. Due to cash crunch, RBI reduced the CRR to 8% in Oct 1997
and to 5% in 2002.Pressure to reduce CRR to international levels and to not use it as an
instrument for monetary control. RBI has tried to reduce CRR to statutory minimum of
3%.

3. Statutory Liquidity Ratio

Under this the banks are to maintain liquid assets in the form of cash, gold and
unencumbered deposits equal to 25% of time and demand deposits under the Banking
Regulation Act 1949,sec 24.
RBI later raised this liquidity ratio to 38.5% for 2 reasons:
i)Higher ratio would force banks to keep larger amount as liquid assets and reduce their
capacity to grant loans. This process is also Anti-Inflationary. Further higher SLR diverts
funds from lending to Government Expenditure.
Having higher SLR and CRR will meet the same objective of being anti-inflationary
Based on Narasimhan committee recommendation SLR was reduced to 25% in Oct
1997.There was a move to remove it altogether.
4. Open market operations
Banks use open market operations which refer to buying and selling of eligible securities
in the money market, to impact the volume of cash reserves with commercial banks
which will affect the quantum of loans and advances given by them to industry and
commerce.When RBI sells Government securities in the open market it reduces the cash
with commercial banks and hence their ability to lend for industrial and commercial
activity.In contrast when RBI buys Government securities and pay for them. Commercial
banks have surplus funds and so can lend to industry and commerce. This Policy of
buying Government securities is done to reverse recession.
5 SELECTIVE AND DIRECT CREDIT CONTROL

RBI can direct the terms of advances ( sec 21of Banking Regulation Act.1949).It can
cover the following areas:
Purpose
Margins
Maximum amount
Maximum guarantees
Interest rate charged

Selective control is used to check the rising prices of individual commodities used for
common consumption. In1964-65 RBI fixed minimum margins to be maintained by
commercial banks for advances against food grain, oil seeds, Vanaspati.
In 1970 Commercial banks had to get prior approval for purchase of shares and
 debentures in joint stock companies of upto Rs.1 lakh.
GENERAL RULE OF RBI:
Minimum margin for lending against specific securities.
Credit amount.
Interest rate.

6. CREDIT AUTHORISATION SCHEME

It is one form of credit control. This was introduced by RBI In 1965. Under this the
Commercial banks got permission from RBI for lending beyond Rs.1 crore and this was
raised to Rs. 6 crore in 1986 for borrowing in private and public sector and later to R. 7
crores.93% of total amount of Rs.21,670 crores was for working capital needs. I was
further liberalized in 1987.Under this scheme commercial banks had to furnish data on
borrowing concerning their mode off working in areas like inter corporate lending,
investment, inventory buildup, diversion of short term funds for fixed assets. Aim is to
lend based on appraisal and needs of the borrowing concern.

7. CREDIT MONITORING ARRANGEMENT CMA

Under this RBI has to scrutinize loans in excess of Rs. 5 crores for working capital and Rs.
2 crores for term loans. Post sanction scheme was called CMA. Over 930 parties under
CAS/CMA. RBI imposes selective credit control

8. EVALUATION OF THE MONETARY POLICY:

The objective of Monetary Policy is controlled expansion. Under this the Used Bill
market scheme is to expand bank credit to industry. Used quantitative (general
credit restraint) and selective credit control to check that loans and advances are not
used for speculative purpose.So the Monetary Policy has twin aims
Expansion of economy.
Control of inflation.

4.0 Role and functions of Comptroller and Auditor General of India (CAG)