Economics Notes

ECONOMICS
NOTES
WHAT IS ECONOMICS?
Economics is the study of how we the people engage ourselves in production, distribution
and Consumption of goods and services in a society.
Law of Demand
Other things remaining the same when price of a good increase its demand Decreases and
vice-versa. Other factors are income, population, tastes, prices of all other goods etc.
Price
Demand
10
20
12
18
14
16
Demand curve:
A demand curve is a graph that obtains when price (one of the determinants of demand) is
plotted against quantity demanded.
Price (P)
14
Demand Curve
(inverse Relation with Demand and Price)
12
10
16
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18
20
Quantity Demanded (Q)
Page 1
Law of Supply
When Price of a good increases its supply also increase and vice versa..
Price
Supply
10
50
12
55
14
60
Supply curve:
A supply schedule is a table which shows various combinations of quantity supplied and
price.
Graphical illustration of this table gives us the supply curve.
Price (P) 14
12
Supply Curve
10
50
55
60
Supply
Page 2
Other Things also Called Assumption.
Assumption Demand
(I)
No Change in income
(II)
No Change in people or population
(III)
No change in season / Weather
(IV)
No change in Prices of selected goods
Assumption of Supply
(I)
No change in technology
(II)
No Change in Supply related Goods
(III)
No change in Season/weather
Related Goods
(I)
Substitute
(Exp Pepsi & Cock)
(II)
Compliment
(These are Also Called Jointly Use)
Page 3
Market Equilibrium
Its a Point where Quantities, Demand and Supply are equal at one price or point called
Equilibrium.
Price
Demand
Supply
10
10
20
12
80
40
14
60
60
16
40
80
18
20
100
Choose in Demand Supply
Extension and Contraction / Movement along the Curve ( Due to change in price)
Rise and Fall / Shifts in Curve (Due to Change in Other Factors)
Price (P)
b
P2
Edition
a
P1
Contraction
Qs1
Qs2
QS
Page 4
S
S1
Price (P)
Fall
Rise
QS
Price (P)
Fall Rise
D1
D
Qd
Extension means:
When increase due to change in price.
Rise:
when increase due to changes in other Factors
Page 5
ELASTICITY
It is responsiveness of one variable to changes in another. In proper words, it is the relative
response of one variable to changes in another variable.
The price elasticity of Demand is measure of degree of Responsiveness of changes in
quantity of demand to change in price of product in other word it is the Ratio of
Proportionate or percentage change in quantity of Demand to proportionate or percentage
change in the price of the product.
Ep= Proportionate / Percentage changes in Demand

Proportionate / Percentage changes in price
Price
Qd
10
20
12
15
Price
Qd
10
20
12
18
Product A has High Elasticity of Demand as compared to the product B

A
Price
Qd
10
60
13
43
17
Price
Qd
15
78
17
52
Ep
Ep
> 1 Where Price increase and quantity Decrease.
Ep
< 1 Where price decrease and Quantity increase.
26
Where Price and Quantity percentage are change equal.
Page 6
Method of Measurement
1-
Total Revenue / Total Expenditure
2-
Formula / Mathematical
3-
Geometrical
Total Revenue / Total Expenditure

According to this method the price Elasticity of Demand is observed by changes in price &
total Expenditure according to this method there three categories of Elasticity.
(I)
Price Elasticity Demand = 1
(ii)
Price Elasticity Demand > 1
(iii)
Price Elasticity Demand < 1
Page 7
THREE CORE RULES OF ELASTICTY

RULE #Ol
Less than
gieater than
Price elasticity Inerastic
Elastic
RULE #02
onnal good
Income elasticity
Inferior good
RULE #03
Substih1tes
Cross elasticity
Cornpletnents
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Page 8
Price Elasticity Demand = > 1
If Price and Total Expenditure/ Revenue make in Opposite Direction.

Price Elasticity Demand = 1
If due to change in price total expenditure remain the same.
For Exp.
Price
Qd
TR/TE = P x Qd
10
20
200
20
10
200
Price
Qd
TR/TE = PxQd
10
20
200
20
160
For Exp.
Price Elasticity Demand = < 1

If Price and Total Expenditure make in same direction.
For Exp.
P
Qd
TR/TE = PxQd
10
20
200
20
12
240
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Page 9
Formula / Mathematical Method
(I)
Point Elasticity
(II)
Arc Elasticity
Point Elasticity
Point elasticity is used when the change in price is very small, i.e. the two points between
which Elasticity is being measured essentially collapse on each other.
Formula point Elasticity

Ep
Qd x P1
P
Qd1
Arc Elasticity
Arc elasticity measures the average elasticity between two points on the demand curve.
Formula of Arc Elasticity

Ep
Qd x P2 + P1
P
Qd2 + Qd1
Where
Qd1 =
Initial Quantity of Demand
Qd2 =
New Quantity of Demand
P1
initial Period
P2
New Period
Qd =
Qd2 Qd1
P =
P2 P1
Page 10
Example:
Calculate Ep by Point and Arc Formula to Following Data.
Price
Qd
20
40
23
32
-8
Point Formula
=
Qd x P1
P
Qd1
-8
3
-8
6
Ep
-1.33
Ep
Qd x
P
-8
3
x 23+20
32+40
-8
3
x 43
72
-1.59
Ep
x 20
40
Arc Formula
Ep
P2 + P1
Qd2 + Qd1
Relationship between Price & Demand is Always Negative. Due to Negative Relationship
between Price & Quantity of Demand
Page 11
Example No 2
Price
Qd
23
32
20
40
-3
Point Formula
=
Qd x P1
P
Qd1
23
-12
Ep
-1.92
Ep
Qd x P2 + P1
P
Qd2 + Qd1
8 x
-3
8 x 43
-3
72
Ep
23
- 3 32
Arc Formula
Ep
43
-27
-1.59
20 + 23
40 + 32
The Point Formula is preferable when changes price and Demand are minor otherwise Arc
Formula give better result. Moreover Arc formula in general preferable because it gives
constant result if the value are inverse.
Page 12
Geometrical Method
According to this method price Elasticity of Demand is calculated in two cases.
(I)
(II)
When Demand Curve is Linear

When Demand Curve is Non Linear
When Demand Curve is Linear

In this case price Elasticity of Demand on the certain point of the linear Demand curve is
calculated by lower distance of Demand curve with upper distance of Demand curve.
infinity
Ep =
Ep = >1
C
Ep = 1
Ep = < 1
B
Ep = 0
Qd
Example
AB
8 cm
AC
4cm
cb
4cm
Page 13
When Demand Curve is Non Linear.

In this Price Elasticity of Demand on a certainty point of Non Linear Demand curve is
calculated by 1st making a tangent point and the dividing the lower distance of tangent with
upper distance.
BC +?
P
B
F
A
Ep = AC
BA
E
Ep = AC
FE
G
Qd
Kind / Types of Elasticity of Demand

1
Price Elasticity of Demand
(Ep)
Income Elasticity of Demand (E i)
Cross Elasticity of Demand (Ec)
Income Elasticity of Demand

Price Elasticity is a measure of Degree of Responsiveness of change in quantity of demand
to change in income of consumer in other words it is a ratio of proportionate of of
percentage change in Demand in income.
Ey
Proportionate / Percentage change in Demand

Proportionate / Percentage change in Income
Page 14
Measurement
Point Formula
Ey
Qd2 qd1
y2 y1
y1
= Qd x y1
y
Qd1
Arc Formula
Ey
Qd2 Qd1
Qd2 + Qd1
y2 - y1
y2 + y1
= Qd x y2 + y1
y
Qd2 + Qd1
Where
Qd1 =
Initial Demand
Qd2 =
New Demand
P1
initial Income
P2
New Income
Qd =
Qd2 Qd1
P =
Y2 Y1
Page 15
Qd
5000
10
55000
12
5000
Point Formula
Ey
Qd x Y1
y
Qd1
2 x
50,000 5000
10
100,000
50000
Ey
Ey
Qd x
y
Arc Formula
Ey
y2 + y1
Qd2 + Qd1
x 55000 + 50000
50
12
10
2
x 105,000
5000
22
1.91
For normal goods income Elasticity of demand is positive where as for inferior goods
income elasticity of Demand is negative.
Page 16
3-
Cross Elasticity of Demand (Ec)
Cross Elasticity of Demand is a measure of Degree of Responsiveness of Change in

quantity of Demand of one goods to change in price of an other goods. In other word its is a
ration of to proportionate / percentage change in demand one goods to proportionate /
percentage change price another goods.
Ec =
Proportionate\ Percentage change in Demand of X

Proportionate \ Percentage change in Price of Y
Measurement
(i)
Point Formula
Ey
Qdx2 Qdx1
Qdx1
P y2 P y1
P y1
= Qdx x P y1
Py
Qdx1
(ii) Arc Formula

Ey
Qdx2 Qdx1
Qdx2 + Qdx1
Py2 - Py1
Py2 + Py1
= Qdx x Py2 + Py1

P y
Qdx2 + Qdx1
Where
Qdx1 =
Initial Demand of Goods x
Qdx2 =
New Demand of Goods x
Py1
initial Price of Goods y
P y2
New Income price of goods y
Qdx =
Qdx2 Qdx1
Py =
P y2 Py1
Page 17
Example No 1
Py
Qdx
15
20
17
25
Point Formula
=
Qdx x P y1
Py
Qdx1
5 x
2
15
8
Ey
1.87
Ey
Qdx x
Py
Ey
15
20
Arc Formula
5 x
2
15 + 17
25 + 20
5 x
2
32
45
Ey
Py2 + Py1
Qdx2 + Qdx1
160
90
1.77
The cross Elasticity between substitute is positive where as cross Elasticity between
compliment is negative.
Page 18
Example.
Y
Petrol
KM driven
Factor or Determinant of Elasticity of Demand.

(I)
(II)
(III)
(IV)
(V)
(VI)
Nature of Goods
Availability of Substitute
No of uses of a product
Time period
level of income
Level of Price
Example
Example of Nature of Goods (Necessity, comfort, luxury)

In case of Availability Substitute Elasticity Demand is high
In case of Non Availability Substitute Elasticity Demand is Low
In Case of level of income Low + High (Elasticity Low) in case of Middle Elasticity High
In short time period Elasticity Demand is (Inelastic)
In long time period Elasticity Demand is (Elastic)
Elasticity of Supply:
Price Elasticity of Supply is a measure of Degree of Responsiveness of change in quantity
of supply to change in price of a product in other word it is a ratio of proportionate/
percentage change in supply to proportionate / percentage change in price.
Es
Proportionate/ percentage change in supply

Proportionate/ percentage change in price
Page 19
Measurement
(i)
Point Formula
Es
Qs2 Qs1
Qs1
P2 P1
P1
= Qs x P1
P
Ps1
(ii) Arc Formula

Ey
Where
Qs1 =
Qs2 Qs1
Qs2 + Qs1
P2 - P1
P2 + P1
= Qs x P2 + P1
P y
Qs2 + Qs1
Initial Supply of Goods
Qs2 =
New Supply of Goods
P1
Initial Price of Goods
P2
New price of goods
Qs =
Qs2 Qs1
P =
P2 P1
Example No 1
Qs
55
100
60
120
20
Elasticity of Supply is + ve
Page 20
D (Ep = 0)
S(Es = 0)
Qd
Demand
Supply
Qs
Qd
Qs
Page 21
Determinants / Factors of Elasticity of Supply

1
Level of Technology
(Advance technology High Elasticity)
Nature of goods
(Agricultural Low Elasticity + Industrial High Elasticity)
Productive Capacity of Firms
Mean of Transportation and Communication
Time Period
(Short time period low and long high elasticity)
Market Equilibrium and Govt Policy

1-
Price Floors and Price Ceilings
2-
Taxes and Subsidies

P
s
S1
S
Excess
Pc
Pc
Pe
E
E
pe
pf
Shortage
D
Qe Qe1
Q
S
Q
S
E
E
D
D
Page 22
Incidents of a Tax
Incident of tax denote the incident of a tax of producer & consumers its depend upon
relative Elasticity of Demand and Supply. Incident of tax is more on consumer if Demand is
less elastic than supply where as its more on producer if supply is less elastic than Demand.
Analysis of Cost
1-
In Short Run
2-
In Long Run
Deference in Short Run and Long Run

The Distinguish between short run and long run is that in the short run atleast one factor of
production is constant where as in long run all the four factor of production become
variable.
In Short Run
1-
Fixed Cost
(FC)
2-
Variable Cost
(VC)
3-
Total Cost
(TC)
FC + VC
4-
Average Fixed Cost
(AFC)
FC/Q
5-
Average Variable Cost
(AVC)
VC/Q
6-
Average Fixed Total Cost
(ATC)
TC/Q
7-
Marginal Cost
(MC)
TC/ Q
AFC + AVC
Page 23
Fixed Cost
Fixed Cost is that cost which Does not change with change in level of output. Fixed
cost consists of expenditure on Rent infrastructure supply of Administrative staff etc.
Variable Cost
Variable Cost is that cost which change with the level of output it consist of
expenditure on raw material Wages of Direct Labor Fuel and Electricity Maintenance etc.
Analysis of Cost
Q
FC
VC
TC
AFC
AVC
ATC
MC
300
300
300
300
600
300
300
600
300
300
400
700
150
200
350
100
300
440
740
100
146.67
246.67
40
300
450
750
75
112.50
187.50
10
300
500
800
60
100
160
50
300
600
900
50
100
150
100
300
780
1080
42.86
111.43
154.29
180
300
990
1290
37.50
123.75
161.25
210
300
1300
1600
33.33
144.44
177.78
310
10
300
1700
2000
30
170
200
400
Page 24
-Q
- Fe
- vc
-TC
10
11
700
600
500
400
300
200
AFC
AVC
ATC
-MC
100
0
1
10
Page 25
The three curves AVC, AVC & MC are U shave meaning that initially they fall and after
reacting a minimum point they rise again. The margin cost curve fall speedily and also rise
speedily and while rising it intersect the minimum point of AVC & ATC AFC curve is not
U shade but is L shave meaning that it fall continuously will rise in level of output.
In Long Run
Cost
LMC
LAC
TC
LTC
Page 26
Maximize
Profit =
TR TC
Loss =
TC TR
Main Object of Firm maximizes profit and minimize loss
Revenue under Perfect competition
Revenue under Imperfect competition
Market Structure
Perfect competition
Imperfect competition
Imperfect Competition
1- Monopoly
2- Duopoly
3- Oligopoly
4- Monopolistic competition
Page 27
Under perfect Competition
TR
AR
MR
10
10
10
10
10
20
10
10
10
30
10
10
10
40
10
10
10
50
10
10
Revenue
50
TR
40
30
20
10
AR =MR=P
0
1
Revenue
Page 28
Under imperfect competition
TR
AR
MR
10
10
10
10
18
24
28
30
30
28
-2
Page 29
Relationship Note
Where the total revenue is maximum minor revenue will be zero when total revenue start
falling margin revenue will become negative.
The MR Curve fall at the double speed than average revenue curve.
Speed Point
AR
MR
Perfect Competition
Perfect Competition is a market structure in which there is large number of firms
producing a homogenous product and there are no barriers in the market.
Characteristics / Futures
Many sellers and Buyers
Homogenous products
Free entry to exit of firms
Complete knowledge market condition
Free mobility of factor of production
Page 30
Equilibrium of firm under perfect competition
A-
In short Run
B-
In Long Run
In Short Run
1-
Firm Earning Abnormal Profit
2-
Firm Earning Normal Profit
3-
Firm Facing Normal Loss
4-
Firm Facing Abnormal Loss
Page 31
1-
Revenue cost
MC
ATC
Pe
AR=MR
A
B
Qe
Firm as in Equilibrium at point E, Where
MR= MC
So firm will produce OQe Units and Sell at OPe Price.
Profit=
TR TC
AR x Q AC x Q
OPe x OQe OA x OQe
OQeEPe
OQeEPe OQeBA
ABEPe
(Abnormal Profit)
(AR=MR=P)
Page 32
2-
Firm Earning normal Profit
Revenue cost
MC
ATC
Pe
Qe
AR=MR
Firm as in Equilibrium at point E, Where MR= MC

Profit =
TR TC
AR x Q AC x Q
OPe x OQe OPe x OQe
OQeEPe
OQeEPe OQeEPe
TC= (Rent + Wages + Interest + Normal Profit)

Firm earns normal profit which is including in its cost.
Page 33
3-
Revenue cost
MC
ATC
AVC
Pe
Qe
AR=MR

Loss =
TC TR
AC x Q - AR x Q
OA x OQe - OPe x OQe
OQeBA - OQeEPe
PeEBA
Page 34
4-
Revenue cost
MC
ATC
AVC
Pe
AR=MR
AFC
Qe

Loss =
TC TR
AC x Q - AR x Q
OA x OQe - OPe x OQe
OQeBA - OQeEPe
PeEBA
FC
The distance Between ATC & AVC will be Reduce
Page 35
In Long Run
Revenue cost
LMC
(Long Run Marginal Cost)
LAC
Pe
Qe
(Long Run Average Cost)
AR=MR

Profit =
TR TC
AR x Q AC x Q
OPe x OQe OPe x OQe
OQeEPe
OQeEPe OQeEPe
Page 36
Monopoly
Monopoly is a Market Structure in which there is only one firm producing or selling the
product and there are barriers in the market.
Characteristic of Monopoly
1-
Only one firm
2-
Product may be homogenous or differentiated
3-
Barriers in the market
4-
Complete information about the market
Equilibrium of firm
(In Short Run/ Time of start business)
1-
2-
3-
4-
Page 37
RC
MC
AC
Pe
A
MR
0
AR = P
Qe
Firm is in equilibrium at a point E Where MR = MC
Profit
TR TC
AR x Q AC x Q
OPe x OQe OA x OQe
OQecPe OQeBA
ABCPe
In Monopoly price and quantity decided according to own wish and take help
equilibrium point.
Under Perfect Competition

Under Perfect competition a firm is called price taker.
Under Monopoly
Under monopoly a firm is called price setter.
Page 38
RC
MC
AC
Pe
MR
AR = P
Qe
Profit
TR TC
AR x Q AC x Q
OPe x OQe OPe x OQe
OQeAPe OQeAPe
Page 39
RC
MC
B
AC
AVC
Pe
MR
AR = P
Q
Qe

Loss =
=
=
=
=
TC
OQeBA
FC + VC
DFBA + OQeFD
Loss
< FC
PeCBA < DFBA

Page 40
Loss Portion should must be less than F.C.

(Shut down position)
RC
MC
A
AC
AVC
Pe
MR
0
AR = P
Qe
Loss =
TC TR
AC x Q AR x Q
OA x OQe OPe x OQe
OQeBA OQeCPe
PeCBA
Page 41
Monopolistic Competition
Monopolistic Competition is a market structure in which there are large number of firms
producing or selling differentiated product and there are no barriers in the market.
Characteristic of Monopolistic competition
1-
Large number of buyer & seller
2-
Differentiated Product
3-
Free entry and exit of firms.
4-
Complete market information
Page 42
It is a mixture of Perfect Competition & Monopoly.

Example of monopolistic Competition Curve
Price & Demand Curve also called AR
Pe
AR = MR
Perfect Competition
Monopolistic Competition
Oligopoly
Duopoly
Monopoly
In monopolistic all Four cases are same like monopoly just the AR & MR Curve more
flat.
Monopolistic Competition Curve
AR
Page 43
RC
MC
C
AC
Pe
A
MR
0
Qe
AR = P
Q
Profit
TR TC
AR x Q AC x Q
OPe x OQe OA x OQe
OQecPe OQeBA
ABCPe
Under Perfect Competition

Under Perfect competition a firm is called price taker.
Under Monopoly
Under monopoly a firm is called price setter.
Page 44
RC
MC
AC
Pe
MR
0
Qe
AR = P
Q
Profit
TR TC
AR x Q AC x Q
OPe x OQe OPe x OQe
OQeAPe OQeAPe
Page 45
RC
MC
A
AC
AVC
Pe
D
MR
0
AR = P
Qe

Loss =
TC
TC TR
AC x Q AR x Q
OA x OQe OPe x OQe
OQeBA OQeCPe
PeCBA
OQeBA
FC + VC
DFBA + OQeFD
Loss
<
FC
PeCBA < DFBA

Page 46
RC
MC
AC
B
C
AVC
Pe
MR
0
Qe
AR = P
Q
Firm is in equilibrium at point E Where MR = MC
Loss =
TC TR
AC x Q AR x Q
OA x OQe OPe x OQe
OQeBA OQeCPe
=
PeCBA
Page 47
Monopoly
Equilibrium of Firm in Long Run
RC
LMC
LAC
Pe
A
E
MR
0
Qe
AR
Q

Profit
TR TC
AR x Q AC x Q
OPe x OQe OA x OQe
OQeCPe OQeBA
ABCPe
Page 48
Monopolistic competition
Equilibrium of Firm in Long Run
Firm Earning Normal Profit:
RC
LMC
LAC
Pe
MR
0
Qe
AR
Q
Profit
TR TC
AR x Q AC x Q
OPe x OQe OPe x OQe
Page 49
OQeAPe OQeAPe
Macro Economics
National Income and Its Concepts

National income is the aggregate of market value of all final goods and services produce
by the country during one year.
Concept of National Income

1-
Gross Domestic Product
(GDP)
2-
Net Domestic Product
(NDP)
3-
Gross National Product
(GNP)
4-
Net National Product
(NNP)
5-
Personal Income
(PI)
6-
Disposable Personal Income
(DPI)
Page 50
1-
Gross Domestic Product
(GDP)
Gross domestic Product is the aggregate of market value of all final goods &
Services produce inside the country during one year.
2-
Net Domestic Product
(NDP)
Net domestic product (NDP) is obtained by subtracting depreciation from GDP.

Depreciation is the reduction in the value of a capital good due to the wear and
tear caused during production. The total market value of all final goods and
services produced within the political boundaries of an economy during a given
period of time, usually a year, after adjusting for the depreciation of capital.
NDP = GDP Depreciation allowance
3-
Gross National Product
(GNP)
Gross National Product is the Aggregate of Market Value of all Final goods &
Services produced by the Nationals of the country.
4-
Net National Product
(NNP)
NNP = GNP Depreciation allowance

5-
Personal Income
(PI)
Personal Income is the aggregate of all incomes actually received by all

individuals of a
country during one years
Personal income is equal to = National income social security Contribution

Corporate Taxes Undistributed Corporate Profit + Transfer Payments
(Gifts, Pension, Grants)
Page 51
6-
Disposable Personal Income (DPI)

DPI= Personal Income Direct Tax
Relationship between GDP and GNP
GNP = GDP + Net Foreign Income

Net Foreign Income = Income of Home Factors engaged abroad Income of
Foreign factors engaged at home
Method of Measurement of National Income
1- Product or Output Method

2- Income Method
3- Expenditure Method
1 Product or Output Method
According to Product Method National Income is the aggregate of Market value of

all final goods and services produced in various sector of the economy. The major
sector of the economy includes agriculture, Manufacturing, transport and
communication, services, Mining, Fishery, Forestry etc.
Page 52
2-
Income Method
According to income method national income is the aggregate of the following items.
1- Wages & Salaries

2- Rents of Houses, Land, Buildings
3- Interest on capital
4- Profits of unincorporated enterprises
5- Profits of incorporated enterprises (like dividend)
6- Undistributed corporate profit
7- Corporate Taxes
8- Indirect taxes
9- Depreciation
10-
3-
Net income from abroad
Expenditure Method
According to expenditure Method National income is the aggregate of following

four items.
(i)
Conception Expenditure
(C)
(ii)
Investment Expenditure
(I)
(iii)
Government Expenditure
(G)
(iv)
Net Expenditure
(X M)(X = Export Earning, M = Import Payment)
( Development + Non Development)

Page 53
National Income
C + I + G + (X M)
Difficulties in Measurement of National Income
1- Barter Transaction
2- Services Without Reward
3- Self Consumed Production
4- Income Earned Through illegal activities
5- Part time Jobs
6- Non Co-Operation of Public
7- Non Maintenance of accounts
8- Price changes
Circular Flow of National Income
The circular flow of National income shows how National income moves between
household sector and Business sector in the economy. This circular flow also includes
some leakages and injections which effect National income in a positive and negative
way.
Page 54
There are three types of Leakages and Injections.

Leakages
Injections
123-
Investments
Government Expenditures
Exports
Savings
Taxes
Imports
Leakages:
leakages cause reduction in national income
Injections:
injections cause increase in national income
Inflationary and Deflationary Gaps

1- Aggregate Supply Curve
2- Aggregate Demand Curve
Aggregate Supply Curve

Aggregate supply curve shows aggregate of goods and services produced and supplied at
various price levels. Aggregate supply curve can be shown with the following diagram.
Page 55
Price Level
(P)
AS
Where Yf National income
At full employment level.
Yf
AS
Aggregate supply curve has + ve relation with price.
Aggregate Demand Curves

Aggregate demand curve shows the aggregate of goods and services consumed or
demand at different price levels. Aggregate Demand shown with following diagram.
Price Level (P)
ADC has inverse relation with price.
AD
AD
Page 56
Ideal Situations
Price Level
(P)
AS
Pi
Pi (ideal price level)
Means equality of
ASC &ADC.
AD
Yf
AS,AD
Note:
In this situation aggregate Demand curve intersects aggregate supply curve at full
employment level and the price level determined by this situation is called ideal price level.
Inflationary Gape
Inflationary gaps occur when aggregate demand curve intersects aggregate supply curve
at a higher point than full employment level of income. It can be shown with following
diagram.
Page 57
AS
E
Pe
Inflationary
Gap
Pi
AD
Yf
AS,AD
Note:
In the diagram the difference between equilibrium price and ideal price is inflationary
gap because equilibrium price is higher than ideal price.
Deflationary Gap
Deflationary gap occurs when aggregate demand curve intersects aggregate supply at
less than full employment level of income .It shown with following diagram.
Page 58
Deflationary
Gap
AS
Pi
Pe
AD
Y1
Yf
AS, AD
Price are less than received level
In this diagram equilibrium price is less than ideal price and the difference is called
deflationary gap.
Measure to Remove inflationary and Deflationary gaps

There are two methods.
1-
Fiscal Policy
2-
Monitory Policy
Page 59
Measure to Remove Inflationary Gap
In case of inflationary gap contractionary Fiscal and monitory policy are

required which means that government expenditure should be reduced and
government earning should be increased through taxes and other measures and
in case of monitory policy the circulation of money and credit should be
reduced to reduced inflation in the economy.
Measure to Remove Deflationary Gap
In case of deflationary gap expansionary Fiscal and monitory policies are

required In Case of Fiscal policy government expenditure should be increased
and taxes should be decreased. In case of monitory policy circulation of money
and credit should be increased in ordered to increase prices and economic
activity in the economy.
Fiscal Policy
Fiscal policy is the policy of regulating and controlling revenue and expenditure of the
government to achieve macro economics objective.
Budget:
Budgeting is the picture of Fiscal policy
Budget Deficit : Difference Between Revenue and Expenditures is Called Budget Deficit.
Page 60
Budget Deficit is also called deficit Financing.
Budget
Revenue
Expenditures
Current Exp.
Tax Revenue
Direct Taxes
Development Exp.
Non Tax Revenue
Indirect Taxes
Deficit Financing
Internal
Bank Borrowing
External
Public Debt / Borrowing
Objectives of Fiscal Policy/ Macro Economics Objectives

1-
High growth of national income
2-
Fair Distribution of national income
3-
High Employment
4-
Price Stability
5-
Reduction in regional disparities
Page 61
6-
Discouraging Production and Consumption of unnecessary goods
7-
Reduction in deficit in balance of payment
Instruments/ Tools of Fiscal Policy

A-
Automatic / Built in Stabilizers (Non Discretionary Tools)
B-
Discretionary Tools
Automatic /Non Discretionary Tools

1-
Progressive taxation
2-
Unemployment allowance
3-
Support price policy
4-
Corporate and Family saving
Discretionary Tools
1-
Changes in tax rates
2-
Changing public works expenditure
3-
Changing in transfer payment
4-
Credit aids
Business Cycles
The fluctuation in economic activities comprising National income and employment is

called business cycle or trade cycle.
Page 62
Phases
1-
Recovery
2-
Boom / peek
3-
Recession
4-
Depression
Economic
Activities
Recovery Boom
Depression
Recession
Time
Boom
Recovery
Recession
Depression
Page 63
Features
1-
One business cycle is said to be completed when it passes through all the four phases.
2-
There is no hard and Fast rule regarding time period for the completion of a trade
cycle whoever the research has shown that it takes from two to ten years for its
completion.
3-
The recovery phase is said to be longer than the recession phase.
4-
Every next Boom or Depression will be at higher level of economic activity than
previous one.
Business Cycle and Fiscal Policy

The role of government in controlling fluctuations comes in the form of changes in
Fiscal policy in the period of boom government operates a contractionary Fiscal policy
in which it increases the tax rates and revenue and decreases its expenditure. Where as in
the time of depression government operate expansionary Fiscal policy in which it
decreases tax rates and its revenue and increases its expenditure to move out the
economy from depression.
Monitory Policy
Monitory policy is the policy of controlling supply and demand for money and credit in
the economy.
Monitory policy is the policy of central Bank and Fiscal policy is the policy of government.
Page 64
Features of Monitory Policy
1-
Creation and expansion of financial institutions.
2-
A suitable interest rate policy.
3-
Debt management (Public Debt)
4-
Proper adjustment between supply and demand for money.
5-
Credit control
(I)
Quantitative Measures
(II)
Qualitative Measures
Quantitative Measures
1-
Open Market operation
2-
Bank Rate policy
3-
Variable reserve rate
1-
Open Market Operation

Open Market operations are the sale and purchase of government securities through
financial institutions in order to increase the money supply. These securities are
purchased back from the public while to decrease money supply more securities are sold
to the public through financial institutions.
2-
Bank Rate Policy
The Bank rate is that rate of interest at which central bank provides loan to
reduced. Where as to decreased the supply of credit the bank rate is increased.
Page 65
3-
Variable Reserve Ratio
Commercial Banks are directed to keep a certain portion of their demand and time
deposits to meet their daily cash requirements. If the purpose is to increase credit supply
their reserve ratio is decreased where as to decreased credit supply this reserve ratio is
increased.
Qualitative Measures
1-
Selective Credit Control.
1-
Selective Credit Control
Selective credit control means different interest rates for different sectors or public
requirements for loans on preference basis. For Example A low rate of interest may be
charged for the a farmers to purchase seeds, Fertilizers, Pesticides machinery etc.
Similarly a low interest rate may be charged for public on loans for Houses, Car
Financing, Foreign Development.
Page 66
Unemployment And its kinds

1-
Employed
2-
Unemployed
3-
Not in Labour Forces
4-
Labour Force
1-
Employed
The employed are those persons who perform any paid work and those who
have jobs but are absent from work due to illness strike or vocations.
2-
Unemployed
Unemployed are those persons who are not employed but are actively
looking for work not labour force.
3-
Not in Labour Force

The persons who are not in labour force include retired, aged and not looking
for work.
4-
Labour Force
The labour force include those persons who are either employed or
unemployed.
Labour Force = Employed + Unemployed
Unemployment Rate
The unemployment rate is equal to the number of unemployed people / labour force
Unemployment Rate
Number of unemployed people

Labour Forces
Page 67
Okun's Law
For every two persons that GDP falls relative to potential GDP the
unemployment rate rises about one percentage point
For example it mean that if GDP begins at 100% of its potential level and falls to 98%
of its potential the unemployment rate rises by 1% point. For example 6 % to 7 %.
Kind of unemployment
1-
1-
Frictional Unemployment
2-
Structural Unemployment
3-
Cyclical Unemployment
4-
Disguised Unemployment
5-
Voluntary Unemployment
6-
Involuntary Unemployment
Frictional Unemployment
Frictional unemployment arises because of movement of people between
regions and jobs. It is possible that in a full employed country there is a
frictional unemployment at a moderate level.
2-
Structural Unemployment
Structural unemployment arises due to a mismatch between supply and

demand for workers when structure and technology of the economy changes.
Page 68
3-
Cyclical Unemployment
Cyclical Unemployment arises when demand for labour decreases in recession

due to a fall in aggregate demand.
4-
Disguised Unemployment
Disguised unemployment arises when people seem to work but their work do not
contribute to the productivity.
For example: In rural area if five worker are needed but that works is done by ten
workers then five workers are called disguised unemployed.
5-
Voluntary unemployment arises when people do not want to work at existing
wage rates and they considered that the wage rate is lower than their education
skill or experience.
6-
Involuntary unemployment arises when people are willing to work at existing

wage rates but they do not find work due to low demand for labour. In this
situation markets existing rate is higher than market clearing wage rate due to
minimum wage laws or labour unions.
Page 69
Wage Rate
SL
Equilibrium Wage Rate

E
We --------------------- ------------
DL
LT
Labour Force
Wage Rate
SL
Involuntary
Unemployment
Minimum Wage Rate
Wm
We --------------------DL
LT
Labour Force
Page 70

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ECONOMICS

(inverse Relation with Demand and Price)

Quantity Demanded (Q)

Other Things also Called Assumption.

No Change in people or population

No change in season / Weather

No change in Prices of selected goods

No Change in Supply related Goods

(Exp Pepsi & Cock)

(These are Also Called Jointly Use)

Choose in Demand Supply

Rise and Fall / Shifts in Curve (Due to Change in Other Factors)

When increase due to change in price.

when increase due to changes in other Factors

Ep= Proportionate / Percentage changes in Demand

Product A has High Elasticity of Demand as compared to the product B

> 1 Where Price increase and quantity Decrease.

< 1 Where price decrease and Quantity increase.

Where Price and Quantity percentage are change equal.

Total Revenue / Total Expenditure

Total Revenue / Total Expenditure

Price Elasticity Demand = 1

Price Elasticity Demand > 1

Price Elasticity Demand < 1

THREE CORE RULES OF ELASTICTY

Price elasticity Inerastic

Price Elasticity Demand = > 1

If Price and Total Expenditure/ Revenue make in Opposite Direction.

Price Elasticity Demand = < 1

Formula / Mathematical Method

Formula point Elasticity

Formula of Arc Elasticity

Initial Quantity of Demand

New Quantity of Demand

Calculate Ep by Point and Arc Formula to Following Data.

When Demand Curve is Linear

When Demand Curve is Linear

When Demand Curve is Non Linear.

Kind / Types of Elasticity of Demand

Price Elasticity of Demand

Income Elasticity of Demand (E i)

Cross Elasticity of Demand (Ec)

Income Elasticity of Demand

Proportionate / Percentage change in Demand

Cross Elasticity of Demand (Ec)

Cross Elasticity of Demand is a measure of Degree of Responsiveness of Change in

Proportionate\ Percentage change in Demand of X

(ii) Arc Formula

= Qdx x Py2 + Py1

Initial Demand of Goods x

New Demand of Goods x

initial Price of Goods y

New Income price of goods y

Factor or Determinant of Elasticity of Demand.

Example of Nature of Goods (Necessity, comfort, luxury)

Proportionate/ percentage change in supply

(ii) Arc Formula

Initial Supply of Goods

New Supply of Goods

Initial Price of Goods

New price of goods

Determinants / Factors of Elasticity of Supply

(Advance technology High Elasticity)