Module 4 (Macroeconomic concepts)

Circular flow of economic activities – Stock and flow – Final goods and intermediate goods -
Gross Domestic Product - National Income – Three sectors of an economy - Methods of
measuring national income – Inflation - causes and effects – Measures to control inflation
Monetary and fiscal policies – Business financing - Bonds and shares - Money market and
Capital market – Stock market – Demat account and Trading account - SENSEX and NIFTY.

4.1 Macro Economics

The word macro indicates the study about the whole and the word micro indicates the
study at the micro level i.e. about the individuals. Macroeconomics is the study of aggregate
economic behaviour of the economy as a whole. It studies the entire economic conditions
prevalent in the country. The subject matter of Macroeconomics includes national income,
employment, business cycles, exports, imports, inflation etc.
Apart from this it also includes aggregate demand and aggregate supply of goods. It
also studies economic policies like fiscal policy and monetary policy of the government.

4.2 Circular Flow of economic activities in a Two Sector Economy

A two sector economy consists of only households and firms. The households own
resources which are necessary inputs for the firms in the production process. These resources
are referred to as factors of production.

There are four factors of production.

(a) Land: It includes all natural resources.
(b) Labour: It represents the work force of an economy.
(c) Capital: It refers to the produced means for further production and includes machines,
money etc.
(d) Entrepreneurship: It refers to the individuals who organise production and take risks.

During the process of production, land receives rent, labour receives wages, capital
gets interest and the entrepreneur receives profits.
The circular flow of income is represented by a clockwise and a counter clockwise
flow. It is a cycle in which production creates income, income creates spending and spending
in turn induces further production. The entire income of the economy comes back to the
producers in the form of sales revenue.

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 Initially households supply the factors of production to the firms. Firms then make
payments to the households for the services they have provided. Households use this money
to purchase goods from firms.
The aggregate income earned by the factors of production must be equal to the
aggregate spending of the economy.
Assumptions
1. Households do not save.
2. There is no government sector.
3. Foreign trade is absent.

4.3 Circular Flow of Income in a Multi Sector Economy

In a multi sector economy, there are four sectors which are engaged in the three
economic activities of production, consumption and exchange of goods and services. The
four sectors are
(a) Households: Households are the owners and suppliers of factors of production. In return
they receive payments in the form of rent, wages, interest and profit. They use this income to
purchase goods and services.
(b) Firms: Firms employ the factors of production to produce various goods and services.
They make payments for factor services to households, pay taxes to the government and pay
for imports to the foreign sector. They receive revenue from households, government and
foreign sector from the sale of their goods and services. They also receive subsidies from the
government.
(c) Government: The government purchases goods from firms and factors of production from
households. It makes factor payments to households. It also purchases goods and services
from firms. The government receives taxes and spends money on subsidies and transfer
payments.
(d) Foreign Sector: The households, firms and the government import goods and services
from abroad and make payments. On the other hand all these sectors export their product to
various countries and in turn receive payments from abroad.

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 The economy works through the interaction of households, firms, government and
foreign countries. These four agents take economic decisions to produce goods and services
and exchange them for money.

4.4 Concept of Stock and Flow

Flows are defined over a period of time. A statement like a person earns 10000 rupees
is meaningless unless the time period is mentioned. The person may be earning it daily,
weekly, monthly or even annually which would then make a huge difference to his earning
capacity. Money is a concept that makes sense only when a time period is mentioned. It is
called as a flow because they occur in a period of time. A definite time period has to be
mentioned to get a quantitative measure of such concepts. Since a lot of accounting is done
annually in an economy, most of these variables are expressed annually.
E.g. money, income, output, profits etc.

Stocks are defined at a particular point of time. Capital goods or consumer durables
once produced do not wear out or get consumed in a specific time period. In fact capital
goods continue to serve through different cycles of production. The buildings or machines in
a factory are there irrespective of the time period. There can be addition to the stock when a
new machine is added. There can be a deduction from the stock when a machine is damaged
and is not replaced.
E.g. buildings, machines, vehicles, computers, furniture etc.

However a change in stock over a specific period of time can be measured. The
number of machines that were added this year is measurable. Such changes in stocks are thus
flows, which can be measured over specific time periods. A particular machine can be part of

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the capital stock for many years (unless it wears out); but that machine can be part of the flow
of new machines added to the capital stock only for a single year when it was initially
installed.
To further understand the difference between stock variables and flow variables, take
the following example. Suppose a tank is being filled with water coming from a tap. The
amount of water which is flowing into the tank from the tap per minute is a flow. But how
much water there is in the tank at a particular point of time is a stock concept.

4.5 Final goods and intermediate goods

Goods which are sold to consumers for their own use and not used as a means for
further production are final goods. They do not need further processing since they are
finished products. They are also called as consumer goods. They are classified into durable
goods, non-durable goods and services.
E.g. cars, mobiles, shoes, refrigerators etc.
Goods which are used in the production of other goods are intermediate goods. It is a
product used to produce a final good. Intermediate goods are sold between industries for
resale or for the production of other goods. These goods need further processing since they
are semi-finished products. They are used as inputs to become part of the finished product.
They are not taken into consideration during the estimation of national income since their
value is included final goods.
E.g. raw materials like steel, copper, rubber, coal etc.

4.6 National Income Concepts

The purpose of national income accounting is to obtain some measure of the
performance of the entire economy.

Gross National Product

GNP is the total market value of all final goods and services produced in a year. It is
the basic social accounting measure.

GNP = Consumption + Government spending + Domestic Investment + Net

Foreign Investment
GNP = C + I + G + X - M
It only includes the market value of final goods and ignores transactions involving
intermediate goods. These are the goods purchased for final use and not for resale or further
processing. While calculating GNP, all non-productive transactions have to be excluded.

Gross Domestic Product

GDP is the total market value of all final goods and services produced within the
domestic territory of a country in a year.
GDP = GNP – Net Factor Income From Abroad (NFIFA)

Net National Product

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 NNP = GNP - Depreciation

It is the market value of all final goods and services after allowing for depreciation.
Depreciation is the fall in the value of capital goods like machinery as a result of wear
and tear. It is an annual allowance for wear and tear of a capital good. It is the cost of the
good divided by number of years of its useful life.
NNP is also referred to as national income as market prices. NNP is a better than GNP since
it makes allowances for the depreciation of machinery, equipment, buildings and the like.

Net Domestic Product

NDP = GDP - Depreciation

National Income
The entire NNP does not reach the people. The manufacturers have to pay indirect
taxes to the government. Thus, this part of total income will not be available to the people.
The government may also give subsidies on the production of certain goods like kerosene and
ration rice. Hence, these goods are sold at lower prices since the government bears a part of
the price in the form of a subsidy for these products. Therefore, to arrive at the correct
estimate of National it is necessary to subtract indirect taxes and add subsidies to NNP.

This is the actual national income of a country. It is also referred to as National

Income at factor cost.
NI (NI at factor cost) = NNP - indirect taxes + subsidies
NI at market Prices = NNP + indirect taxes – subsidies

Personal Income
It is the sum total of income actually received by all individuals in a country during a
given year.
PI = NI - social security contributions - corporate income taxes - undistributed
Corporate profits + transfer payments
Transfer payments refer to unemployment allowances, old age pension etc.

Disposable Personal Income

DPI = PI - Direct taxes

Per Capita Income

It is the average income per head in the country. It is a rough indicator of the standard
of living of the people in a country.

PCI = NI ∕ Population

4.7 Three sectors of an economy

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 An economy can be broadly classified into three sectors – primary, secondary and
tertiary sectors.
1. Primary Sector
The primary sector consists of agriculture and allied activities. This sector is made up
of activities that are undertaken by directly using natural resources. A good produced by
exploiting natural resources is an activity of the primary sector. The main activities coming
here are agriculture, mining and quarrying, forestry, fishing, animal husbandry, poultry etc.
2. Secondary Sector
The secondary sector is the manufacturing or the industrial sector. Here raw materials
are changed into other forms in the factory. For example cotton gets converted into finished
cloth in this sector.
3. Tertiary Sector
The tertiary sector is the services sector and provides various services like transport,
communication, banking, education, health etc. These activities generate services rather than
goods. As an economy advances the primary sector loses its importance. In developed
countries the tertiary sector is the largest contributor to the national income.

4.8 Methods of estimating national income

The circular flow of economic activity makes it possible to estimate national income
in three ways (a) as a flow of goods (b) as a flow of income and (c) as a flow of expenditure.
Accordingly there are three methods of estimating national income.

1. Output Method
In this method, the economy is divided into different sectors like agriculture, mining,
manufacturing, transport, communication, services etc. By adding up the net values of all the
production that has taken place in these sectors during a given year, the total output of the
country is obtained. The advantage of this method is that it shows the relative importance of
the different sectors by showing their contribution to national income.

NI = value of output from agricultural sector +

value of output from industrial sector +
value of output from services sector

2. Income method
Here national income is calculated by adding up the incomes of all individuals in the
country. Employees receive income in the form of wages and salaries, land receives rent,
capital gets interest and entrepreneurs receive profits. By adding up all incomes received in
the form of wages, rent, interest and profit the total income of the country is obtained.

NI = Rent + Wages + Interest + Profits

3. Expenditure Method
In this method, national income is derived by adding up all the expenditure made on
goods and services during a year.
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 NI = C + I + G + (X-M)
C = Consumption, I = Investment, G = Government expenditure, X = Exports and M =
Imports

All the above methods give the same result. This is because for a country,
Income = Expenditure = Output
In actual practice, more than one method is used in combination.

4.9 Difficulties in measuring national income

1. Existence of non-monetised transactions. A considerable part of the agricultural
output is consumed in the farm itself and does not come into the market for sale.
Hence they are not valued in terms of money and as such excluded from national
income estimates.
2. Double Counting. In national income estimates, the same product may be counted
more than once. This over inflates the national income. For example, tyres may be
initially counted in the tyre factory and later at the automobile factory since the value
of the automobile includes the value of its tyres also.
3. Most small manufactures do not keep accounts. It is thus difficult to get reliable
information from a large number of small producers.
4. Another problem is with regard to the treatment of income of foreign firms operating
in the country. The question is whether their income can be included in the national
income of the country in which they are operating.
5. Individuals may pursue more than one job and often end up under reporting their
actual income.
6. Lack of adequate statistical data in the hands of the various government agencies
make the estimation of national income difficult.
7. National Income of two or more years cannot be compared properly since within this
time prices of various products may change.

4.10 Inflation
Inflation is generally associated with rapidly increasing prices that cause a decline in the
purchasing power of money. Prof. Coulborn has defined inflation as too much money chasing
too few commodities. According to Prof. Crowther, inflation is a state in which the value of
money is falling. Prof. Shapiro has defined inflation as a persistent and appreciable rise in the
general level of prices.

It is a situation where demand for commodities exceeds the available supply. During a
period of inflation, the price level will rise.

Types of inflation

1. Demand Pull Inflation

This type of inflation is caused by an increase in the total demand for commodities and
services in the country. When new industries are started in the country, the income in the
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hands of the people increase and they use this money to demand more and more
commodities. This will result in an increase in the price of every product.

This inflation may occur when the government spends huge amounts of money for
financing a war or for financing development projects. Inflation occurs during war because
the one great aim at that time is that of winning the war. Since modern wars are so expensive,
the Government has to depend upon created money to finance war.

In the figure, DD is the demand curve and SS is the supply curve. The economy is in
equilibrium at E when the demand and supply curves intersect. There is full employment in
the economy, hence supply of output cannot be increased. The supply curve becomes a
vertical straight line after E. If there is an increase in demand, the price level tends to rise.

However, this type of inflation can easily be controlled by various tax policies.

2. Cost Push Inflation

It is caused by an increase in the cost of production. It is also referred to as wage or
profit inflation. This may occur due to:

a) An increase in profits. When companies try to make more profits by increasing the prices
of their products, other industries using that product as a raw material will be forced to
increase their own prices.

b) An increase in wages. Workers are often known to go on strike demanding higher wages.
Companies agree and will pass on the increase to customers by increasing the price of their
product. Soon workers in other industries will also demand higher wages.

3. Creeping Inflation

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 In several countries around the world, here has been a tendency for prices and wages
to push one another upwards. This situation has been described as creeping or persistent
inflation.

4. Galloping or Hyper Inflation

This is a serious type of inflation. For example, it was experienced in Germany after
World War I and in Hungary and China after World War II. In this situation, prices rise to a
very great extent at high speed and high prices have to be paid even for cheap things. Money
becomes quite worthless and new currency has to be introduced. This situation is known as
galloping inflation or hyper-inflation.

5. Bottleneck Inflation
This refers to inflation that results from shortages, imbalances and rising costs as full
employment output is approached.

Causes of inflation

A. Demand pull factors

1. Increase in money supply. When the supply of money increases, demand will also
increase leading to higher prices.
2. Increase in disposable income. If the income in the hands of the people increases, it
will result in a direct increase in demand.
3. Increase in foreign demand and hence exports. If the demand for products of the home
country increases in foreign countries, income in the hands of the exporting industries
will increase.
4. Increase in population.

B. Cost push factors

1. Increase in oil prices. The world has witnessed several oil shocks which is causing
inflation in all oil importing nations.
2. Increase in wages and salaries. Any increase in wages and salaries will increase the
cost of production resulting in higher prices.
3. Decrease in imports. If there is a restriction in imports, prices are likely to stay high
inside the home country.

C. Other factors
1. Food inflation. Several unfavorable factors have resulted in a scarcity of food
products around the world resulting in a rapid increase in prices.
2. Climatic factors affecting agricultural output. Global warming, droughts and natural
calamities all are resulting in higher agricultural prices.
3. Hoarding by traders. Traders are known to stock agricultural products in their ware
houses in order to create an artificial scarcity.
4. Scarcity of skilled labour. Lack of skilled labour is affecting industrial production in
developing countries.

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 5. Deficiency of essential raw materials. As industrial development progresses at a rapid
pace, the world is facing a shortage of several basic raw materials. This will result in
an increase in the cost of production.
6. Failure by the government to stabilize agricultural prices.

Effects of Inflation
Inflation has resulted in serious imbalances in the Indian economy. Price relationships
were badly distorted and production pattern has gone out of line with demand. Resources of
the country need to be diverted to control prices and production has shifted from essential
commodities to non-essential ones.

1. Inflation results in business uncertainty in the country. During times of inflation, prices of
all commodities including those of the raw materials required by industry would be
increasing. Companies would find that the cost of a project keeps on increasing during its
lifetime and their initial profit calculations may go wrong.
2. Inflation leads to depreciation in the value of money. More and more income is required
for a family to purchase the same quantity of commodities in order to maintain the same
standard of life.
3. It discourages savings as the value of savings also declines as money value declines. With
the money that has been saved earlier, consumers can now purchase only a lesser number of
commodities. Hence they have the tendency to spend all of their income.
4. To escape from inflation, people may invest in foreign currencies. The reduction in the
value of the Indian rupee encourages people to invest their money in currencies like the
dollar, which are more stable. Thus, money that should have been deposited in Indian banks
goes to foreign ones.
5. Inflation badly affects the fixed income earners. People who have retired and those having
a fixed salary find that they can buy fewer commodities today than they could in earlier
years. Since their income does not grow while prices of commodities increase, they are left
with reduced purchasing power.
6. Traders, hoarders and speculators gain enormously through ever rising profit margins
7. Anticipating rising prices companies increase their holding of inventory and huge sums of
money get blocked in this unproductive activity.
8. When the prices of essential commodities increase, less money is available for purchasing
other products.
9. During inflation, debtors gain while creditors lose. Creditors are paid back money, which
now has less purchasing power.

4.11 Measures to control inflation (Monetary and fiscal policies)

Inflation has been the most pressing problem in India in the recent years. Controlling
inflation largely depends upon checking monetary expansion and controlling food prices.
With oil prices expected to go up further, controlling prices will be difficult. The following
steps are taken by the government to control inflation.

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 The various methods of credit control are (A) Monetary measures (B) Fiscal Measures
and (C) Non-monetary measures

A. Monetary measures

Monetary measures are classified into Quantitative and Qualitative.

1. Quantitative techniques
These techniques aim to regulate the volume of credit in the economy.

(a) Bank Rate Policy

The Bank rate is the minimum rate at which the central bank of a country will lend money
to all other banks. If the Reserve Bank of India increases the bank rate, the interest rates
charged by other banks go up. When the rate of interest goes up, businessmen will be
discouraged to borrow more money. Thus, to control inflation, the central bank will increase
the bank rate. Moreover loans will become more costly and people will postpone their
purchases.

(b) Open market operations

It is the purchase and sale of government securities by the central bank. If the RBI
sells securities, money will flow from the banks to the Central Bank and the amount of
money left with the banks to be given out as loans will be reduced. The central bank will sell
government securities to the banks and the amount of cash with the banks will come down
forcing them to reduce their loans.

(c) Variation in cash reserve ratio

CRR is the percentage of total deposits which commercial banks are required to
maintain in the form of cash reserves with the RBI. If CRR is raised, the banks now have to
keep more reserves forcing them to reduce the supply of loans.

(d)Statutory liquidity requirements

SLR is the proportion of total deposits which commercial banks are required to
maintain in the form of liquid assets like cash, gold, government securities etc.

2. Qualitative techniques (Selective Credit Control)

These are directives issued by the RBI to banks regarding their loans.
These techniques are employed to channelize the flow of bank credit for purposes that are
socially and economically desirable. It aims to divert bank loans into selected channels. They
direct the flow of credit into useful channels. The purpose of selective controls is the rational
allocation of scarce bank credit and its economic utilization. It also serves the purpose of
preventing speculative activities with the help of bank finance. These techniques are very
helpful in developing economies where overall credit restriction may hinder growth by
preventing the flow of credit for investment.

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 The common qualitative credit control techniques are:

(a) Defining the purposes for which loans may be given. The RBI may direct
control the loans given by banks for the purchase of shares.
(b) Fixing margins in respect of secured loans. In this case, the central bank
specifies the fraction of the purchase price of securities that must be paid in cash.
(c) Stating the maximum amt. of loan to any borrower.
(d) Banks have to obtain RBI’s authorization before loans beyond a certain
sum could be given out.
(e) Credit Monitoring Arrangement: Here RBI monitors all loans beyond a
certain amount
(f) Differential rates of interest. Different interest rates may be charged to
encourage certain sectors and to discourage certain other sectors. In India, this has been used
especially, to encourage exports, agricultural production and production in small scale and
cottage industries sector.
(g) Moral Suasion: It is the issuing of warnings threatening strict action if the
banks do not comply with the directives issued by RBI. The central bank requests banks not
to lend in some sectors. It may also want more loans to be given in certain sectors. There is
no legal compulsion behind their acceptance. Generally if a request is not carried out by the
member bank, the RBI may take such steps as banks are forced to accept. The central bank
will thus persuade the commercial banks to follow its policies.

B. Fiscal measures

1. Increasing taxes. If direct taxes are raised, the disposable income in the hands of the people
is reduced and public spending will come down. If taxes on commodities are raised, the cost
of purchases will increase and people will postpone consumption
2. Reduction in government expenditure. However, this is not easy since most of the
government spending is on infrastructure, health, education and defense.

C. Non-monetary measures

1. Controlling wages and salaries as far as possible

2. Controlling prices through an efficient system of fair price shops
3. Reducing the facilities for installment purchases
4. Increasing imports so that the supply of commodities which are in short supply can be
increased

4.12 Business financing: Bonds and shares

Bonds

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 A bond is a loan which pays investors a fixed rate of return. A bonds risk depends on
the credit worthiness of the issuer. The interest rate on the bond determines its value to the
investor. It is a type of fixed income security and pays back a regular amount to the investor.
Bonds are used by governments and companies that need huge a huge amount of money to
finance various projects.

Types of bonds
1. Fixed coupon rate bonds. In this type of bonds the interest rate is fixed from the date
of issue.
2. Floating coupon rate bonds. In this type of bonds the interest rate fluctuates.
3. Zero coupon bonds. In this type the bond holder receives the face value of the bond
upon maturity.
4. Sovereign gold bonds. These are substitutes for holding physical gold.
5. Tax free bonds. The interest earned on these bonds are completely tax free.
6. Perpetual Bonds. These are bonds with no maturity date. The issuer pays the interest
till it is in existence.
Advantages
1. Bonds are relatively safe.
2. They provide a fixed rate of return.
3. Bonds pay interest at predictable intervals.
Disadvantages
1. They carry low interest rates.
2. The bond issuer may not be able to pay the investor on time, hence bonds have a
default risk.
3. Inflation can reduce the returns from bonds.

Shares
Shares are units representing ownership in a company. Companies issue equity shares
to investors in return for capital. Shares of privately held companies are owned by the
founders or partners. As small companies grow, shares are sold to outside investors like
friends and venture capitalists. If the company continues to grow it will seek to raise
additional equity capital by selling shares to the public through an initial public offering.
After an IPO, a company’s shares are listed in the stock exchange and its shares are said to be
publically traded.
The shareholders collectively own the company. They enjoy the rewards and bear the
risks of ownership. They have a claim to the income of the firm. Being owners of the firm
they elect the board of directors and have a right to vote on every resolution placed before the
company.
Advantages
1. It represents permanent capital
2. There is no liability for repayment.
3. Equity shareholders enjoy the controlling power over the firm.
4. The rewards of equity capital are very high.

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Disadvantages
1. The cost of equity capital is very high.
2. Sales of equity shares to outsiders results in dilution of control of existing owners.
3. They have a low priority if there is a claim to the income or assets of the firm.
4. Equity stock prices tend to fluctuate widely, making equity investments risky.

4.13 The Money Market

The money market is the financial market for lending and borrowing of short term
funds. Banks and other financial institutions lend their surplus funds for the short term in the
money market. Banks, companies and the government are the borrowers. The main money
market instruments are:

1. Commercial Bills
The bill market is an important part of the money market where short term
commercial bills of up to 90 days are bought and sold.

2. Treasury Bills
The 91 days treasury bills is the most common way in which the Government of
India raises funds for the short period.

3.14 Day Treasury Bills

These bills cater to the needs of institutions which have surplus funds that can be
invested for very short periods.

4. Call Money Market

It is the market for very short term funds. The public sector banks, the private sector
banks and the foreign banks are the major players in this market.

5. Certificate of Deposit
It is a certificate offered by banks at a discount to the face value. The maturity value is
equal to the face value. CD’s are freely transferable and have become popular with banks for
raising resources at competitive rates of interest.

6. Commercial Paper
It is a promissory note issued by companies in the format prescribed by the RBI. It is
issued by companies for raising funds for the short period. The purpose of CP is to enable
high level corporate borrowers to diversify their short term borrowing.

4.14 The Capital Market

It is the market for long term funds. It refers to all the facilities for borrowing and
lending long term funds. The back bone of the capital market is the stock market comprising
of all the stock exchanges operating in the country.

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The stock market
It refers to the organized market where shares and securities issued by
the various companies are traded. It is a most important source of funds for companies. This
market consists of all the recognized stock exchanges operating under the rules laid down by
the government. The main stock exchanges in India are Bombay Stock Exchange (BSE),
National Stock Exchange (NSE) and Over The Counter Exchange of India (OTCEI). Positive
or up trends are referred to as bull markets; negative or down trends are referred to as bear
markets.

Functions

1. It translates short-term investments into long-term funds for companies. Investors are
interested in getting quick returns. Companies however need finance for the long term. Since
the shares can be transferred from one person to the other, the investor can get his money any
time he wants by selling the shares to other investors. During this transaction, the company’s
funds remain unaffected.
2. It directs the flow of capital into the most efficient companies. Companies, which make
more profits, will find that their shares are in demand.
3. It ensures a certain measure of safety for investments. The stock exchanges operate under a
regulatory framework, which seeks to protect the interests of investors. In India, there is the
Securities Exchange Board of India (SEBI) to ensure that a reasonable level of safety is
provided to investors and transactions take place under competitive conditions.
4. It induces companies to raise their standard of performance. When the equity share of a
company is listed in the stock exchange, the company’s performance is reflected in its share
price. This price is available to the public since it is displayed at the stock exchange. Such a
public exposure induces companies to keep on improving their performance year after year.
5. The stock market is often considered to be the primary indicator of the economic strength
and development of a country.
6. The stock exchanges allow investors to quickly and easily sell shares and are an attractive
feature of investing in shares, compared to other less liquid investments such as real estate.

Problems faced by the stock market in India

In the recent times, the stock market in India has witnessed unparalleled growth.
However, this growth could not be sustained and a crash occurred. From then on, the market
has been fluctuating. These fluctuations were not always in response to a company’s financial
strength. As a result, today most of the small investors stay away from the market. The major
reasons for this sad state of our stock market are:

1. The Indian stock market is dominated by the actions of large institutions like Unit Trust of
India, LIC and Foreign Institutional Investors. When these institutions buy shares, prices
move up and when they sell the market crashes. Since the volume of shares they deal in is
very huge, any one of their actions affects the entire market.

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2. The Indian stock mkt. suffers from inadequate rules and regulations. The market is
regulated by SEBI. Even though this organization has huge powers, the regulation in practice
is ineffective since it is impossible to monitor all aspects of the functioning of the market.
3. Most of the trading is of a speculative nature where the objective is to make money from
short-term price fluctuations. It is estimated that genuine investments represent less than 10%
of total transactions.
4. In the stock market, a new set of information can be quickly converted into money. It
should be possible for investors to get information about the performance of companies as
soon as the results are declared.
5. Most of the stock brokers lack the professional skill required to advice their clients on the
buying and selling of shares
6. The market suffers from insider trading. It is the trading in a security based on material
information that is not available to the public. A company insider is someone who has access
to the important information about a company that affects its stock price.
7. There is no assurance of growth of investment because many factors such as govt. policies,
natural disasters, political issues, introduction of new products, competition from other
companies etc. all influence the market
8. In case of certain small capitalisation companies, there is a very high risk of loss of
investment.
9. The new investors often depend upon stock market tips from various sources which may
ultimately result in losses.

4.15 Demat account and Trading account

A demat account along with a trading account is necessary to invest in the share
market.

Demat account
In the early days of the stock market, shares were held in a physical form by way of
share certificates. It made the entire process of share trading difficult to carry at short notice.
Certificates were often lost or damaged. In order to eliminate these issues demat accounts
were started. In India, the National Securities Depository Limited (NSDL) was established to
start demat accounts.
Demat account or dematerialised account is used to hold the shares of companies in
an electronic form. It is similar to a bank account in that the account of the user is credited
each time shares are bought and debited each time shares are sold. It eliminates the need for
maintaining shares in physical form.
Dematerialisation is the process of converting the physical share certificates into
electronic form. It is designed to offer paperless transactions, security and increase the speed
of trading.

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Advantages
1. Demat account eliminates the need for unnecessary paperwork.
2. Investors enjoy automatic updating of their accounts as and when they buy or sell
shares.
3. Increases transparency.
4. Increases share trading volume.
5. Increases market participation.

Trading account
A trading account is used to buy or sell shares in the stock market. The investor
registers for the trading account with a stock broker. Each account comes with a unique ID
which is used for conducting transactions. A trading account acts as a link between the demat
account and bank account of an investor. When an investor wants to buy shares he places an
order through his trading account. Upon completion shares get credited into his demat
account and the required amount gets deducted from his bank account.
Earlier the stock exchanges functioned on the basis of the open outcry system in
which traders used hand signals and verbal communication to convey their buying or selling
decisions. This was replaced by the online system where the physical presence of traders are
not required in the stock exchanges. Each individual opens a trading account with a registered
stock market broker who conducts trading on their behalf.
Advantages
1. A trading account provides online access to different stock exchanges.
2. It helps an individual keep a track of his investments from anywhere.
3. Increases transparency since proof of identity, address and bank account details are
needed to open the trading account.
4. Increases share trading volume since the entire process of share trading is now secure
and quick.
5. Trading accounts have made the procedure for fund transfer easy and reliable.

4.16 SENSEX and NIFTY

An index number in statistics is a measurement of change in a variable during

a given period. A stock market index is a statistical tool to track the performance of the stock
market.
Since the number of listed companies in a stock exchange is large, it is not possible to
look at the price of each share to find out whether the market is showing an upward or
downward trend. Indexes measure the performance of a basket of shares to find out the
performance of the market. They mirror the stock market behavior and give a broad outline of
the market movement. The most widely followed indexes in the US are the S&P 500, Dow
Jones and Nasdaq Composite. The notable indices in India are BSE Sensex & NSE Nifty.
Most of the trading in the Indian stock market takes place on its two stock exchanges:
the Bombay Stock Exchange and the National Stock Exchange. Almost all the significant
firms in the country are listed on both the exchanges.

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BSE Sensex
Sensex is the oldest market index in India and consists of the shares of 30 firms listed
on the BSE. Sensex is derived from the two words sensitive and index.
The companies that make up the sensex are taken from the Bombay Stock Exchange
and are chosen based on the trading volume, liquidity and industry representation. The sensex
is used by most investors as a barometer of the overall state of the Indian economy. The index
is operated by Standard and Poor’s and is also known as the S&P BSE Sensex.
Initially it used the full market capitalization methodology but later shifted to the
more common free float market capitalization methodology. Instead of using a company’s
outstanding shares it uses its float or shares that are available for trading. The companies
comprising the index are given importance according to their share in the total market
capitalization. It gives more weight to the largest companies and those with higher trading
volume. The base value of the sensex was taken as 100 on 1st April 1979.

NSE Nifty
Nifty is a market index of the National Stock Exchange. Nifty is derived from the two
words National Stock Exchange and fifty.
It consists of fifty of the top performing companies traded on the NSE. These shares
span across several diversified sectors and include IT, finance, oil, automobiles, telecom,
construction, pharmaceuticals, cement, metals, entertainment etc. It is considered as a
benchmark index of India and is an indicator of the performance of the Indian economy.
It uses a free float market capitalization methodology. The base period for the Nifty50
index is 3 Nov 1995 and the base value was set at 1000.

Problems:-

1. In a country, the total expenditure of the people on various goods and services is Rs. 820
crores for the year 2021. The government spending is Rs.200 cr while the total investment in
the country is Rs.150cr.Exports are Rs.50 cr and imports are Rs.80 cr. The depreciation is
expected to be Rs.30 crores. Find (a) GNP (b) GDP and (c) NDP

2. From the following data, calculate (a) GDP (b) National Income at factor cost (c) If the
Disposable Personal Income is Rs. 6300 crores what is the aggregate value of transfer
payments in the economy?

(a) Gross National Product = Rs. 10000 crore

(b) Net Factor Income from abroad = Rs. 500 cr
(c) Undisbursed Profit = Rs.1400 cr
(d) Corporate Income Tax = Rs.500 cr
(e) Depreciation = Rs.1500 cr
(f) Indirect taxes = Rs. 1100 cr
(g) Income Tax = Rs. 500 cr

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3. A company producing watches makes Rs.50000 every day by selling them. Over this day
the equipment of the company depreciates by Rs. 5000. Out of this, it pays GST of Rs.3000,
gives the owner Rs. 20000 and retains Rs. 22000 for its expansion activities. The owner pays
Rs. 2000 as income tax from his income. Compute the firm’s daily contribution to the
following measures of national income. (a) GDP (b) NDP (c) NI (d) Personal Income (e)
Disposable Personal Income.

4. What is the implication of the following statement?

GNP is Rs.58, 33,558 crore and NNP is Rs. 55, 01,067 crore.

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