Long Questions

Module 1
1. Difference between Micro and Macro Economics:
The points given below explains the difference between micro and macro economics in detail:

Microeconomics Macroeconomics

Meaning The branch of economics that studies the The branch of economics that studies the
behavior of an individual consumer, behavior of the whole economy, (both
firm, family is known as national and international) is known as
Microeconomics. Macroeconomics.

Deals with Individual economic variables like Aggregate economic variables like national
product, firm, household, industry, income, national output, price level,
wages, prices, etc... GDP,GNP, unemployment, monetary/ fiscal
policies, poverty, international trade...

Scope Covers various issues like demand, Covers various issues like, national income,
supply, product pricing, factor pricing, general price level, distribution, employment,
production, consumption, economic money etc.
welfare, etc.

approach bottom-up approach top-down approach

Business Applied to operational or internal issues Applied to Environment and external issues
Application

Importance Microeconomics determine the price of a Maintains stability in the general price level
particular commodity along with the and resolves the major problems of the
prices of factors of production. economy like inflation, unemployment and
poverty as a whole.

Limitations It is based on unrealistic assumptions it is possible that what is true for aggregate
may not be true for individuals too.

Examples Individual Demand, Price of a product, Aggregate Demand, National Income,

etc. GDP,GNP, unemployment, monetary/ fiscal
policies, poverty etc.

2. Law of Demand:
" Other things remain constant (ceteris
ceteris paribus) , the quantity demanded of a good falls when
the price of the good rises and vise versa . "
QD ∝1/ P
the quantity demanded of a good(QD) is inversly propotional to price(P).

Assumptions of the law: It is assumed that there is no change in income of consumers, quality of
product, substitute of the commodity, prices of related goods, taste and preference of consumers,
size of population, climate and weather conditions, tax rates and other fiscal measures.

Demand Curve: Demand Schedule:

The above demand schedule shows negative relationship between price and quantity demanded for
a commodity. This is the table that shows prices per unit of commodity ands amount demanded per
period of time.
Demand curve is graphical representation of law of demand & it slopes downwards.

Exceptions to the law:

Inferior goods(Giffen goods)
The law of demand does not apply in case of inferior goods. When price of inferior commodity
decreases and its demand also decrease and amount so saved in spent on superior commodity. The
wheat and rice are superior food grains while maize is inferior food grain.
Demonstration effect
The law of demand does not apply in case of diamond and jewelry. There is more demand when
prices are high. There is less demand due to low prices. The rich people like to demonstrate such
items that only they have such commodities.
Ignorance of consumers
The consumer usually judge the quality of a commodity from its price. A low priced commodity is
considered as inferior and less quantity is purchased. A high priced commodity is treated as superior
and more quantity is purchased. The law of demand does not apply in this case.
Less supply
The law of demand does not work when there is less supply of commodity. The people buy more for
stock purpose even at high price. They think that commodity will become short.
Depression
The law of demand does not work during period of depression. The prices of commodities are low
but there is no increase in demand due to low purchasing power of people.
Speculation
The law does not apply in case of speculation. The speculators start buying share just to raise the
price. Then they start selling large quantity of shares to avoid losses.
Out of fashion
The law of demand is not applicable in case of goods out of fashion. The decrease in prices cannot
raise the demand of such goods. The quantity purchased is less even though there is falls in prices.
Importance of the law
Price determination
A monopolist can help him to determine the most suitable price level.
Tax on commodities
The commodity must be taxed if its demand is relatively inelastic. A commodity cannot be taxed if
its sales fall to great extent.
Agricultural prices
When there are good crops, the prices come down due to change in demand. In case of bad crops,
the prices go up if demand remains the same.
Planning
Individual demand schedule is used in planning for individual goods and industries.

Determinants of Demand:
When price changes, quantity demanded will change. That is a movement along the same demand
curve. When factors other than price changes, demand curve will shift. These are the determinants
of the demand curve.
1. Income: A rise in a person’s income will lead to an increase in demand & a fall will lead to a
decrease in demand for normal goods.
2. Consumer Preferences: Favorable change leads to an increase in demand, unfavorable change
lead to a decrease.
3. Number of Buyers: the more buyers lead to an increase in demand; fewer buyers lead to
decrease.
4. Price of related goods:
a. Substitute goods (those that can be used to replace each other): price of substitute and demand for
the other good are directly related.
Example: If the price of coffee rises, the demand for tea should increase.
b. Complement goods (those that can be used together): price of complement and demand for the
other good are inversely related.
Example: if the price of ice cream rises, the demand for ice-cream toppings will decrease.
5. Expectation of future:
a. Future price: consumers’ current demand will increase if they expect higher future prices; their
demand will decrease if they expect lower future prices.
b. Future income: consumers’ current demand will increase if they expect higher future income;
their demand will decrease if they expect lower future income.
Change in Demand:

3.Law of Supply:
"Other things remain constant (ceteris
ceteris paribus),
paribus) the quantity supplied of a good rises when
the price of the good rises and vise versa."
There exists a direct and positive relationship between price and quantity supplied of a commodity.
The functional relationship between quantity supplied and the price of a commodity can be
expressed as:
QS ∝ P
Assumptions:It assumed that there is no change in cost of production ,technology, climate,prices of
substitutes natural resources, price of capital goods, political situation, tax policy.
Supply Curve: Supply Schedule :
Determinants of Supply:
 Change in input prices
 Change in technology
 Change in taxes and subsidies
 Change in the prices of other goods
 Change in producer expectations
 Change in the number of suppliers

4. Market Equilibrium:
When the supply and demand curves intersect, the market is in equilibrium. This is where the
quantity demanded and quantity supplied are equal. The corresponding price is the equilibrium
price or market-clearing price, the quantity is the equilibrium quantity.

Here red dot shows market

Equilibrium.
Surplus:
If the market price is above the equilibrium price, quantity supplied is greater than quantity
demanded, creating a surplus. Market price will fall.

Example: if you are the producer, you have a lot of excess inventory that cannot sell. Will you put
them on sale? It is most likely yes. Once you lower the price of your product, your product’s
quantity demanded will rise until equilibrium is reached. Therefore, surplus drives price down.
shortage:
If the market price is below the equilibrium price, quantity supplied is less than quantity demanded,
creating a shortage. The market is not clear. It is in shortage. Market price will rise because of this
shortage.
Example: if you are the producer, your product is always out of stock. Will you raise the price to
make more profit? Most for-profit firms will say yes. Once you raise the price of your product, your
product’s quantity demanded will drop until equilibrium is reached. Therefore, shortage drives
price up.

If a surplus exist, price must fall in order to entice additional quantity demanded and reduce
quantity supplied until the surplus is eliminated. If a shortage exists, price must rise in order to
entice additional supply and reduce quantity demanded until the shortage is eliminated.
5. Elasticity of Demand :
 It explains the relationship between a change in determinant and consequent change in
quantity demanded.
 Degree of responsiveness in quantity demanded to a change in it's determinant.
There are 3 types of elasticity:
1. Price elasticity
2. Income Elasticity
3. Cross elasticity
1. Price elasticity:
The change in the quantity demanded of a product due to a change in its price is known as Price
elasticity of demand.
Price elasticity of demand = %change in quantity demanded
----------------------------------------
% change in price
Price elasticity of demand is a measure of the relationship between a change in the quantity
demanded of a particular good and a change in its price.

Inelastic demand is a change in price results in only a small change in quantity demanded. In other
words, the quantity demanded is not very responsive to changes in price. Examples of this are
necessities like food and fuel. Consumers will not reduce their food purchases if food prices rise,
although there may be shifts in the types of food they purchase. Also, consumers will not greatly
change their driving behavior if gasoline prices rise.
 Module 2

1. Explain break even analysis with graph, assumptions and limitations(BEP).

Meaning of Break-Even Point: IMP
 Break-even point represents that volume of production where total costs equal to total sales
resulting into a no-profit no-loss situation.

Total Sales (Revenue) = Total Cost

 If output of any product falls below that point there is loss and if output exceeds that point
there is profit.
 Thus, it is the minimum point of production where total costs are recovered.

 P is the break-even point in the break-even chart where OS and CT—being the sales line and
total cost line—intersects. Loss results in the left side of P, i.e. before the break-even point is
reached, and, beyond P, profit starts to generate.
Formula for Break-even point :

OR BEP (in units)= FC

SP-VC

B.E.P.(in Rs.) = (F/C)*SP = BEP (in units)* SP

where, F= Fixed cost
C= Selling price – Variable cost

Profit/volume ratio (P/V ratio) = (Contribution/Sales)*100

[ Profit = Selling price – Cost price

= S*Quantity – [FC + (Variable cost*quantity)]

Total profit = Total contribution – Fixed cost

 B.E.P.(Rs.) = Fixed cost/ P.V. ratio

Margin of safety = Actual sales – BEP sales

Sales required to earn profit(units) = F+P/C

Sales required to earn profit(Rs.) = F+P/P/V ratio

Assumptions Underlying Break-Even Analysis:

 All costs can be separated into fixed and variable components,
 Fixed costs will remain constant at all volumes of output,
 Variable costs will fluctuate in direct proportion to volume of output,
 Selling price will remain constant,
 Product-mix will remain unchanged,
 The number of units of sales will coincide with the units produced so that there is no
opening or closing stock,
 Productivity per worker will remain unchanged,
 There will be no change in the general price level.

Uses of Break-Even Analysis:

 It helps in the determination of selling price

 It helps in the determination of sales volume
 It helps in forecasting costs and profit as a result of change in volume.
 It gives suggestions for shift in sales mix.
 It helps in making inter-firm comparison of profitability.
 It helps in determination of costs and revenue at various levels of output.
 It is an aid in management decision-making (e.g., make or buy, introducing a product etc.),
forecasting, long-term planning and maintaining profitability.

Limitations of Break-Even Analysis:

1. Break-even analysis is based on the assumption that all costs and expenses can be clearly
separated into fixed and variable components. In practice, however, it may not be possible to
achieve a clear-cut division of costs into fixed and variable types.

2. It assumes that fixed costs remain constant at all levels of activity. It should be noted that fixed
costs tend to vary beyond a certain level of activity.

3. It assumes that variable costs vary proportionately with the volume of output. In practice, they
move, no doubt, in sympathy with volume of output, but not necessarily in direct proportions..

4. The assumption that selling price remains unchanged gives a straight revenue line which may not
be true. Selling price of a product depends upon certain factors like market demand and supply,
competition etc., so it, too, hardly remains constant.

5. The assumption that only one product is produced or that product mix will remain unchanged is
difficult to find in practice.

6. Apportionment of fixed cost over a variety of products poses a problem.

7. It assumes that the business conditions may not change which is not true.

8. It assumes that production and sales quantities are equal and there will be no change in opening
and closing stock of finished product, these do not hold good in practice.

9. The break-even analysis does not take into consideration the amount of capital employed in the
business. In fact, capital employed is an important determinant of the profitability of a concern.

2.Write a note on different types of cost. (IMP)

Short run cost :

Short run costs are accumulated in real time throughout the production process. Fixed costs have no
impact of short run costs, only variable costs and revenues affect the short run production.
Long run cost :
Long run costs are accumulated when firms change production levels over time in response to
expected economic profits or losses. In the long run there are no fixed factors of production. The
land, labor, capital goods, and entrepreneurship all vary to reach the the long run cost of producing
a good or service.
Examples of long run decisions that impact a firm's costs include changing the quantity of
production, decreasing or expanding a company, and entering or leaving a market.

Fixed Costs (FC): The costs which don’t vary with changing output. Fixed costs might include
the cost of building a factory, insurance and legal bills. Even if your output changes or you don’t
produce anything, your fixed costs stays the same.

Variable Costs (VC): Costs which depend on the output produced. For example, if you produce
more cars, you have to use more raw materials such as metal. This is a variable cost.

Total Costs (TC) = Fixed Cost + Variable Costs

Marginal Cost – Marginal cost is the cost of producing an extra unit. If the total cost of 3 units is
1550, and the total cost of 4 units is 1900. The marginal cost of the 4th unit is 350.

Average cost: Average cost is equal to total cost divided by the number of goods produced.

ATC (Average Total Cost) = Total Cost / quantity.

Opportunity cost – Opportunity cost is the value of next best alternative foregone. If you have
limited money With you & you have two options: either you can have pizza or can watch movie. If
you select to have pizza watching the movie is forgone. Value(fun) of movie is Opportunity cost.

Sunk Costs: These are costs that have been incurred and cannot be recouped. If you left the
industry you cannot reclaim sunk costs. For example, if you spend money on advertising to enter an
industry, you can never claim these costs back. If you buy a machine, you might be able to sell if
you leave the industry.

3.Factors of production: Factors of production are the inputs available for production.

All
factors of production are traditionally classified in the following four groups:

(i) Land:
It refers to all natural resources which are free gifts of nature. Land, therefore, includes all gifts of
nature available to mankind—both on the surface and under the surface, e.g., soil, rivers, waters,
forests, mountains, mines, deserts, seas, climate, rains, air, sun, etc.
(ii) Labour:Human efforts done mentally or physically with the aim of earning income is known as
labour. Thus, labour is a physical or mental effort of human being in the process of production. The
compensation given to labourers in return for their productive work is called wages (or
compensation of employees).
Land is a passive factor whereas labour is an active factor of production. Actually, it is labour which
in cooperation with land makes production possible. Land and labour are also known as primary
factors of production as their supplies are determined more or less outside the economic system
itself.
(iii) Capital:
All man-made goods which are used for further production of wealth are included in capital. Thus,
it is man-made material source of production. Alternatively, all man-made aids to production, which
are not consumed/or their own sake, are termed as capital.
It is the produced means of production. Examples are—machines, tools, buildings, roads, bridges,
raw material, trucks, factories, etc. An increase in the capital of an economy means an increase in
the productive capacity of the economy. Logically and chronologically, capital is derived from land
and labour.
(iv) Entrepreneur:
An entrepreneur is a person who organises the other factors and undertakes the risks and
uncertainties involved in the production. He hires the other three factors, brings them together,
organises and coordinates them so as to earn maximum profit. For example, Mr. X who takes the
risk of manufacturing television sets will be called an entrepreneur.
An entrepreneur acts as a boss and decides how the business shall run. He decides in what
proportion factors should be combined. What and where he will produce and by what method. He is
loosely identified with the owner, speculator, innovator or inventor and organiser of the business.
Thus, entrepreneur ship is a trait or quality owned by the entrepreneur.
Some economists are of the opinion that basically there are only two factors of production—land
and labour. Land they say is appropriated from gifts of nature by human labour and entrepreneur is
only a special variety of labour. Land and labour are, therefore, primary factors whereas capital and
entrepreneur are secondary factors.
4. Laws of Production:
1. Laws of Variable proportion - Law of Diminishing Return ( Short run production function
with at least one input is variable )
“If one of the variable factor of production increases, keeping other inputs fixed, the total
product(TP) will increase at an increase rate in the first stage, and in the second stage TP
continuously increase but at diminishing rate and eventually TP decrease.”
Stages in Law of variable proportion:
First Stage: Increasing return
TP increase at increasing rate till the end of the stage.
AP also increase and reaches at highest point at the end of the stage.
MP also increase at it become equal to AP at the end of the stage.
MP>AP
Second Stage: Diminishing return
TP increase but at diminishing rate and it reach at highest at the end of the stage.
AP and MP are decreasing but both are positive.
MP become zero when TP is at Maximum, at the end of the stage
MP<AP.
Third Stage: Negative return
TP decrease and TP Curve slopes downward
As TP is decrease MP is negative. AP is decreasing but positive.

Assumptions of law diminishing returns:

The production technology remains unchanged.
The variable factor is homogeneous.
Any one factor is constant.
The fixed factor remains constant.
2. Laws of Return scales – Long run production function with all inputs factors are
variable.
“Return to scale refers to the relationship between changes of outputs and
proportionate changes in the in all factors of production ”
 Module:3
Types of market structure/Forms of Market/Types of
competition
Market structure is the amount of competition within a market.
To distinguish between the market structures, consider the following elements:

 number of producers and consumers

 amount of business each company does within the market

 types of products being traded

 amount of information made available between companies and consumers.

There are four basic market structures from least to most competitive—

 perfect competition,
 monopolistic competition,
 oligopoly,
 monopoly
1.perfect competition: Perfect competition describes a market where there are
many small firms producing homogeneous goods. There are many buyers and many sellers within
the market.
1. It is easy for a business to enter into pure competition.

2. It is relatively easy to acquire information as a competitive business or as a consumer.

3.Businesses are typically able to sell their products (e.g., wheat, silver, and hogs) in a way
to generate profits.

Characteristic:

 Large no. of buyers and sellers.

 Homogeneous product.
  Free entry and exist of firms in an industry..

 Perfect knowledge of market conditions.

 No transport cost.

 Firms are price takers.

 Uniform Price

2.monopolistic competition:

Monopolistic competition occurs in a market where there are a large number of businesses
controlling a small portion of the market share—portion or percentage of a total market that a
business serves.
1. Differentiated products are sold in a monopolistic competition.

2. It is easy for a business to enter into monopolistic competition and to have some control
over the price of its product.

3. Examples include restaurants, clothing, and grocery products.

Characteristic:

 A large number of buyers and sellers

 Product differentiation

 Free entry and exit of firm

 Non Price competition

 No association of firm

 Selling cost determines the

  demand for the product
 Lack of knowledge of the market

3. oligopoly,
An oligopoly is a market dominated by a small number of businesses. Since the
playing field is so small, each business in the market is keenly aware of the actions of its
competitors.
1. It is difficult to enter into an oligopoly market.

2. When conducting strategic planning, those businesses in the oligopoly must take
the actions and responses of other businesses in the market into consideration. Because
of this, the risk of fraud is high.

3. Examples include telecommunications,automobiles and aeronautics, OPEC

Characteristic:

 A few sellers
 Homogeneous product or close substitutes to each other
 Interdependent in decision making
 Advertisement and sales promotion costs.
 Element of monopoly
 Restriction on the entry and exit of firms
 Price rigidity
4.monopoly
monopoly occurs if there is only one provider for a product. Because there is no
competition (or very little), the company has significant control over price and availability.
1. Monopolies can occur naturally when mergers take place.

2. A monopoly is illegal when it does not allow any competition to enter the
marketplace.

 Single seller and large number of buyers.

  No close substitute.
 One firm in the industry.
 Restrictions on the entry.
 Control over the supply.
 Either price or supply fixation.
Summary of Forms Of Market:

NATIONAL INCOME
National income measures the total value of goods and services produced within
the economy over a period of time.
Stock and flow concept of national income:
It is the final outcome of all economic activities of a nation. In another words, it is the value of the
final goods and service produced in the country in a year.
Production of goods and service generates income and income give rise to demand for goods and
service, demand give rise to expenditure, and expenditure give further rise to production of goods
and service. Hence, there is a circular flow of production, income and expenditure.

On the basis of these flows, national income can be analysed at (1) as a flow of goods and services,
or (2) as a flow of incomes, or (3) as a flow of expenditure on goods and services.

Circular flow of economic activities and income:

The simple model of the circular flow assumes two players.

Firms :

Produce and supply the goods and services.

Require various factors of production to produce these goods and services.

Households :
Include a set of individuals living in the same house.

Take joint decisions about the consumption of goods and services.

Provide services in terms of factor inputs to the firm

Get paid for these services by firms which households spend on consumption

Money flows from firms to households as factor payments and from households to firms as
expenditure on goods and services.

It is a circular flow of money or income.

 Module 4
BASIC ECONOMY PROBLEMS : POVERTY,
UNEMPLOYMENT, INFLATION

POVERTY
Poverty is the deprivation of food, shelter, money and clothing when people can’t satisfy their
basic needs. Poverty can be understood simply as a lack of money or more broadly in terms of
barriers to everyday human life.
Types of Poverty : There are two types of poverty:
Absolute poverty Relative poverty
Absolute poverty refers to a condition where a person does not have the minimum amount of
income needed to meet the minimum requirements for one or more basic living needs over an
extended period of time.
Families whose income fell below this poverty line were in absolute poverty. The definition of
absolute poverty is based on a fixed level, usually known as ‘poverty line’. It is the line below
which poverty begins and above which it ends.
Relative poverty: Relative poverty refers to individuals lack of resources when compared with that
of other members of the society—in other words, their relative standard of living.
Relative poverty is the condition in which people lack the minimum amount of income needed in
order to maintain the average standard of living in the society in which they live
The concept of relative poverty is used to measure the degree of poverty.
Causes of Poverty:

 High population growth

 Unemployment
 Inflation
 Under utilization of natural resources
 Backwardness of agriculture
 Social causes
 Political causes
Suitable measures to reduce poverty

 Employment opportunities
 Establishment of small scale industries
 Education
  Reduce inflation
 Check population growth
 Proper utilization of resources
 Uplift of agriculture
UNEMPLOYMENT
Definition:Unemployment refers to a situation in which the workers who are capable of
working and willing to work do not get employment.
Types of unemployment:
Voluntary unemployment: In every society, there are some people who are unwilling to work at
the prevailing wage rate and there are some people who get a continuous flow of income from their
property or other sources and need not work.
Frictional unemployment: Frictional unemployment occurs when a worker moves from one job to
another. It is a result of imperfect information in the labor market, because if job seekers knew that
they would be employed for a particular job vacancy, almost no time would be lost in getting a new
job, eliminating this form of unemployment
Casual unemployment: In industries, such as construction, catering or agriculture, where workers
are employed on a day to day basis, there are chances of casual unemployment occurring due to
short term contracts, which are terminable any time.
Seasonal unemployment: Seasonal unemployment occurs when an occupation is not in demand at
certain seasons. Example, agriculture, the catering trade in holiday resorts, some agro-based
industries like sugar mills and rice mills. People engaged in such type of work or activities may
remain unemployed during the off season.
Structural unemployment: Structural unemployment arises when the qualification of a person is
not enough to meet his job responsibilities. Conversely, structural unemployment arises when the
salary offered to a person falls short of the minimum wage that can be paid for the concerned job.
Technological unemployment: Due to the introduction of new machinery, improvement in
methods of production, labour-saving devices etc. some workers tend to be replaced by machines.
Cyclical unemployment: Cyclical or demand deficient unemployment occurs when the economy is
in need of low workforce. The demand for labor increases with the economy in the growth phase.
Again, when the economy passes through depression, demand for labor decreases and the extra
workers are released as the unemployed labor force.
Since cyclical phase is temporary, cyclical unemployment remains only a short-term phenomenon.
Chronic unemployment:When unemployment tends to be a long term feature of a country it is
called chronic unemployment. Underdeveloped countries suffer from chronic unemployment on
account of the vicious circle of poverty, lack of developed resources and their under utilisation, high
population growth, backward, even primitive state of technology, low capital formation etc
Disguised unemployment: It refers to a situation of employment with surplus manpower in which
some workers have zero marginal productivity so that their removal will not affect the volume of
total output.Underemployment of labour.In short, overcrowding in an occupation leads to disguised
unemployment. It is a common phenomenon in an over populated country.
CAUSES OF UNEMPLOYMENT:

 Illiteracy
  Growing population
 Inappropriate technology
 Inappropriate education system
SUITABLE MEASURES TO REDUCE UNEMPLOYMENT:

 Rapid industrialisation
 Population control
 Self employment development schemes
 Policies towards seasonal unemployment
 Reformation in the education system
INFLATION
Meaning of Inflation: Inflation is defined as a sustained increase in the price level or a fall
in the value of money.

According to C.CROWTHER, “Inflation is State in which the value of money is falling and the
prices are rising.”
In Economics, the word inflation refers to general rise in prices measured against a standard
level of purchasing power.
Types of Inflation:

1. Demand-Pull Inflation
Demand-Pull or excess demand inflation is a situation often described as “too much money chasing
too few goods.” According to this theory, an excess of aggregate demand over aggregate supply will
generate inflationary rise in prices. Its earliest explanation is to be found in the simple quantity
theory of money.
2. Cost-Push Inflation
Cost-push inflation is caused by wage increases enforced by unions and profit increases by em-
ployers. Cost-push inflation is caused by wage-push and profit-push to prices for the following
reasons:
1. Rise in Wages
2. Sectoral Rise in Prices
3. Rise in Prices of Imported Raw Materials
3. Profit-Push Inflation:
Oligopolist and monopolist firms raise the prices of their products to offset the rise in labour and
production costs so as to earn higher profits. There being imperfect competition in the case of such
firms, they are able to “administer prices” of their products. “In an economy in which so called
administered prices abound there is at least the possibility that these prices may be administered
upward faster than cost in an attempt to earn greater profits
4 Sectoral Inflation:
Sectoral inflation arises initially out of excess demand in particular industries. But it leads to a
general price rise because prices do not fall in the deficient demand sectors.
Causes of Inflation
Inflation is caused when the aggregate demand exceeds the aggregate supply of goods and services.
We analyze the factors which lead to increase in demand and the shortage of supply.
Factors Affecting Demand.
1. Increase in Money Supply:
Inflation is caused by an increase in the supply of money which leads to increase in aggregate
demand. The higher the growth rate of the nominal money supply, the higher is the rate of inflation.
Modem quantity theorists do not believe that true inflation starts after the full employment level.
This view is realistic because all advanced countries are faced with high levels of unemployment
and high rates of inflation.

2. Increase in Disposable Income:

When the disposable income of the people increases, it raises their demand for goods and services.
Disposable income may increase with the rise in national income or reduction in taxes or reduction
in the saving of the people.
3. Increase in Public Expenditure:
Government activities have been expanding much with the result that government expenditure has
also been increasing at a phenomenal rate, thereby raising aggregate demand for goods and services.
Governments of both developed and developing countries are providing more facilities under public
utilities and social services, and also nationalizing industries and starting public enterprises with the
result that they help in increasing aggregate demand.
4. Increase in Consumer Spending:
The demand for goods and services increases when consumer expenditure increases. Consumers
may spend more due to conspicuous consumption or demonstration effect. They may also spend
more whey they are given credit facilities to buy goods on hire-purchase and instalment basis.
5. Cheap Monetary Policy:
Cheap monetary policy or the policy of credit expansion also leads to increase in the money supply
which raises the demand for goods and services in the economy. When credit expands, it raises the
money income of the borrowers which, in turn, raises aggregate demand relative to supply, thereby
leading to inflation. This is also known as credit-induced inflation.
6. Deficit Financing:
In order to meet its mounting expenses, the government resorts to deficit financing by borrowing
from the public and even by printing more notes. This raises aggregate demand in relation to
aggregate supply, thereby leading to inflationary rise in prices. This is also known as deficit-induced
inflation.
7. Expansion of the Private Sector:
The expansion of the private sector also tends to raise the aggregate demand. For huge investments
increase employment and income, thereby creating more demand for goods and services. But it
takes time for the output to enter the market.
8. Black Money:
The existence of black money in all countries due to corruption, tax evasion etc. increases the
aggregate demand. People spend such unearned money extravagantly, thereby creating unnecessary
demand for commodities. This tends to raise the price level further.
9. Repayment of Public Debt:
Whenever the government repays its past internal debt to the public, it leads to increase in the
money supply with the public. This tends to raise the aggregate demand for goods and services.
10. Increase in Exports:
When the demand for domestically produced goods increases in foreign countries, this raises the
earnings of industries producing export commodities. These, in turn, create more demand for goods
and services within the economy.
Factors Affecting Supply:
1. Shortage of Factors of Production:
One of the important causes affecting the supplies of goods is the shortage of such factors as labour,
raw materials, power supply, capital, etc. They lead to excess capacity and reduction in industrial
production.
2. Industrial Disputes:
In countries where trade unions are powerful, they also help in curtailing production. Trade unions
resort to strikes and if they happen to be unreasonable from the employers’ viewpoint’ and are
prolonged, they force the employers to declare lock-outs. In both cases, industrial production falls,
thereby reducing supplies of goods. If the unions succeed in raising money wages of their members
to a very high level than the productivity of labour, this also tends to reduce production and supplies
of goods.
3. Natural Calamities:
Drought or floods is a factor which adversely affects the supplies of agricultural products. The
latter, in turn, create shortages of food products and raw materials, thereby helping inflationary
pressures.
4. Artificial Scarcities:
Artificial scarcities are created by hoarders and speculators who indulge in black marketing. Thus
they are instrumental in reducing supplies of goods and raising their prices.
5. Increase in Exports:
When the country produces more goods for export than for domestic consumption, this creates
shortages of goods in the domestic market. This leads to inflation in the economy.
6. Lop-sided Production:
If the stress is on the production of comforts, luxuries, or basic products to the neglect of essential
consumer goods in the country, this creates shortages of consumer goods. This again causes
inflation.
7. Law of Diminishing Returns:
If industries in the country are using old machines and outmoded methods of production, the law of
diminishing returns operates. This raises cost per unit of production, thereby raising the prices of
products.
8. International Factors:
In modern times, inflation is a worldwide phenomenon. When prices rise in major industrial
countries, their effects spread to almost all countries with which they have trade relations. Often the
rise in the price of a basic raw material like petrol in the international market leads to rise in the
price of all related commodities in a country.
Measures to Control Inflation:
The various methods are usually grouped under three heads:
1. Monetary measures
2. fiscal measures
3. other measures.

1. Monetary Measures:
Monetary measures aim at reducing money incomes.
(a) Credit Control:
(b) Demonetisation of Currency:
(c) Issue of New Currency:
2. Fiscal Measures:
Monetary policy alone is incapable of controlling inflation. It should, therefore, be supplemented by
fiscal measures. Fiscal measures are highly effective for controlling government expenditure,
personal consumption expenditure, and private and public investment.
The principal fiscal measures are the following:

(a) Reduction in Unnecessary Expenditure:

The government should reduce unnecessary expenditure on non-development activities in order to
curb inflation. This will also put a check on private expenditure which is dependent upon
government demand for goods and services. But it is not easy to cut government expenditure.
Though economy measures are always welcome but it becomes difficult to distinguish between
essential and non-essential expenditure. Therefore, this measure should be supplemented by
taxation.
(b) Increase in Taxes:
To cut personal consumption expenditure, the rates of personal, corporate and commodity taxes
should be raised and even new taxes should be levied, but the rates of taxes should not be so high as
to discourage saving, investment and production. Rather, the tax system should provide larger
incentives to those who save, invest and produce more.
Further, to bring more revenue into the tax-net, the government should penalise the tax evaders by
imposing heavy fines. Such measures are bound to be effective in controlling inflation. To increase
the supply of goods within the country, the government should reduce import duties and increase
export duties.
(c) Increase in Savings:
Another measure is to increase savings on the part of the people. This will tend to reduce disposable
income with the people, and hence personal consumption expenditure. But due to the rising cost of
living, people are not in a position to save much voluntarily. Keynes, therefore, advocated
compulsory savings or what he called ‘deferred payment’ where the saver gets his money back after
some years.
For this purpose, the government should float public loans carrying high rates of interest, start
saving schemes with prize money, or lottery for long periods, etc. It should also introduce
compulsory provident fund, provident fund-cum-pension schemes, etc. compulsorily. All such
measures to increase savings are likely to be effective in controlling inflation.
(d) Surplus Budgets:
An important measure is to adopt anti-inflationary budgetary policy. For this purpose, the
government should give up deficit financing and instead have surplus budgets. It means collecting
more in revenues and spending less.

(e) Public Debt:

At the same time, it should stop repayment of public debt and postpone it to some future date till
inflationary pressures are controlled within the economy. Instead, the government should borrow
more to reduce money supply with the public.
Like the monetary measures, fiscal measures alone cannot help in controlling inflation. They should
be supplemented by monetary, non-monetary and non-fiscal measures.
3. Other Measures
(a) To Increase Production
(b) Rational Wage Policy
(c) Price Control
(d) Rationing