ROYALE BUSINESS SCHOOL

NAME: - CHIRAG CHAVDA

YEAR: - PGDM-I (2010-12)

SUBJECT: - MACRO ECONOMICS

ASSIGNMENT ON ECONOMIC SURVEY

SUBMITTED TO: - KHYATI MADAM

 PHILLIP CURVE

Phillip curve (1958) introduced the price function to the erst while fixed price of the
real income and interest rate determination. He carried out an empirical study on
British annual data for the period 1861 through 1957 and found negative
relationship between the rate of change in the nominal base rate and rate of
unemployment.

The wage rate (W), is expected to move directly with the gap between the aggregate
demand (ADL) for an aggregate supply of labor (ASL)

W= F (ADL-ASL)

F1>0

ADL = Labor employed + vacancies, and ASL = Labor employed + unemployment

When the said relationship is changed to the rate of change, it would imply that the
rate of change in money wage rate is a negative function of the rate of
unemployment.

The nominal wage rate is positive related to the rate of inflation and the
unemployment rate negatively to the real income, the said relationship was
subsequently extended to the ones between the rate of inflation and rate of
unemployment (negative) and the rate of inflation and the real income (positive). In
honor of the founder all such relationship are known as PHILLIP CURVE.

Stagflation: A state of inflation without corresponding increase of demand and

employment.

Friedman argued that the Phillips curve relationship was only a short-run
phenomenon. He argued that in the long-run workers and employers will take
inflation into account, resulting in employment contracts that increase pay at rates
near anticipated inflation. Employment would then begin to fall until "full
employment" was reached, but now with higher inflation rates.
The short-term Phillips Curve looked like a normal Phillips Curve, but shifted in the
long run as expectations changed. In the long run, only a single rate of
unemployment (the NAIRU or "natural" rate) was consistent with a stable inflation
rate.

The long-run Phillips Curve was thus vertical, so there was no trade-off between
inflation and unemployment.

In the diagram, the long-run Phillips curve is the vertical red line. The
NAIRU (non-accelerating inflation rate of unemployment) theory says that when
unemployment is at the rate defined by this line, inflation will be stable. However,
in the short-run policymakers will face an inflation-unemployment rate tradeoff
marked by the "Initial Short-Run Phillips Curve" in the graph. Policymakers can
therefore reduce the unemployment rate temporarily, moving from point A to
point B through expansionary policy. However, according to the NAIRU, exploiting
this short-run tradeoff will raise inflation expectations, shifting the short-run curve
rightward to the "New Short-Run Phillips Curve" and moving the point of
equilibrium from B to C. Thus the reduction in unemployment below the "Natural
Rate" will be temporary, and lead only to higher inflation in the long run. The short-
run curve shifts outward due to the attempt to reduce unemployment, the
expansionary policy ultimately worsens the exploitable tradeoff between
unemployment and inflation.

KUZNETS CURVE
A Kuznets curve is the graphical representation of economic inequality increases
over time while a country is developing, and then after a certain average income is
attained, inequality begins to decrease.

Kuznets curve diagrams show an inverted U curve, although variables along the
axes are often mixed and matched, with inequality or on the Y axis and economic
development, time or per capita incomes on the X axis.

The Kuznets ratio is a measurement of the ratio of income going to the highest-
earning households (usually defined by the upper 20%) and the income going to the
lowest-earning households which is commonly measured by either the lowest 20%
or lowest 40% of income. Comparing 20% to 20%, perfect equality is expressed as
1; 20% to 40% changes this value to 0.5.

When graphed, the relationship between prosperity and environmental degradation

looks like an upside-down U. Initially, as countries grow, they trade off
environmental well-being for economic growth; the richer they get, the more
polluted. Then a wealth’s critical mass is reached, basic needs are met, and,
according to Maslow’s hierarchy of human needs, the concern goes to non-basic
needs, like a better environment.
 People have the time to form NGOs and to push for cleaner industry, and
technology is serving efficiency instead of brute production. The economy becomes
prosperous enough to shift their priorities and begin to seek out ways to grow more
cleanly.

O KUN’ S LAW

Okun’s law links Friedman’s specification of the Philips curve with the original
Philips curve. It describes the short run between the GNP gap and the
unemployment rate. Okuns law maintains the existence of negative relationship
between the deviation of unemployment rate from the natural rate and the deviation
of actual real income from the potential real income (THE GNP gap).
This law suggest that there is a threshold level of growth even for the maintaining
the current employment rate, which would only become worse if the economy
grows at a rate below if the economy grows at a rate below that minimum level.

FISCAL POLICY

Fiscal policy can be contrasted with the other main type of macroeconomic
policy, monetary policy, which attempts to stabilize the economy by controlling
interest rates and the money supply.
The two main instruments of fiscal policy are
1) Government expenditure, and
2) Taxation.

Changes in the level and composition of taxation and government spending can
impact on the following variables in the economy:

 Aggregate demand and the level of economic activity;

 The pattern of resource allocation;
 The distribution of income.

A fiscal deficit is often funded by issuing bonds, like treasury

bills or consoles and gilt-edged securities these pay interest, either for a fixed
period or indefinitely. If the interest and capital repayments are too large, a nation
may default on its debts, usually to foreign creditors.

ECONOMY EFFECT OF FISCAL POLICY

Governments use fiscal policy to influence the level of aggregate demand in the
economy, in an effort to achieve economic objectives of price stability, full
employment, and economic growth.

Keynesian economics suggests that increasing government spending and

decreasing tax rates are the best ways to stimulate aggregate demand.

• Governments can use a budget surplus to do two things:

1) To slow the pace of strong economic growth.

2) To stabilize prices when inflation is too high.

• The argument mostly centers on crowding out, a phenomenon where

government borrowing leads to higher interest rates that offset the simulative
impact of spending.

• When the government runs a budget deficit, funds will need to come from
public borrowing (the issue of government bonds), overseas borrowing,
or monetizing the debt.

• When governments fund a deficit with the issuing of government bonds,

interest rates can increase across the market, because government borrowing
creates higher demand for credit in the financial markets. This causes a lower
aggregate demand for goods and services, contrary to the objective of a fiscal
stimulus.

• When government borrowing increases interest rates it attracts foreign capital

from foreign investors. This is because, all other things being equal, the
 bonds issued from a country executing expansionary fiscal policy now offer a
higher rate of return.
• When foreign capital flows into the country undergoing fiscal expansion,
demand for that country's currency increases. The increased demand causes
that country's currency to appreciate.

• Once the currency appreciates, goods originating from that country now cost
more to foreigners than they did before and foreign goods now cost less than
they did before. Consequently, exports decrease and imports increase.

MONETARY POLICY

Monetary policy is exercised by the central policy of the country- the Reserve Bank
of India(RBI)-has instrument like bank rate, cash reserve ratio, open market
operation,statutary liquidity ratio, interest rate, selective credit control.

RBI control repo and reverse repo rate as well but these are basically to manage the
liquidity in the system.

In India we have managed floating exchange rate system, where the exchange rate
is determined basically by the free interplay of the demand for and supply of foreign
exchange.

INSTRUMENT OF MONETARY POLICY IN INDIA

 A) Net loans to central government (i.e. open market operations)
B) Net purchase of foreign currency assets.
C) Change in cash reserve ratio.
D) Changes in repo rate and reverse repo rate.
E) Bank rate.

EFFECT OF MONETARY POLICY

1) CONTROL INFLATION: - When inflation rises, the central bank typically

raises interest rates. High inflation makes the costs of goods higher. Central
banks want to keep inflation low to keep the prices of goods stable relative to
the value of the currency.
2) INTEREST RATE: - The central bank raises or lowers the prime rate, or
interest rate the central bank loans money to other banks, as a tool to impact
the economy.
3) SPENDING: - When a central bank decreases interest rates, more money is
typically spent in an economy. This increase in spending can equate to better
overall health for an economy.
4) EMPLOYMENT: - When inflation is low and an economy is stable or in an
expansionary phase, employment levels are higher than when inflation is high
and an economy is in a contraction phase. Changes in monetary policy that
maintain economic stability and minimize inflation tend to keep
unemployment low.

TABLE SHOWING DIFFERENT RATES AT MACRO

LEVEL

SR.NO FACTOR 2007-08 2008-09 2009-10

1 EMPLOYMENT
-agric 52%
-industry 14%
-service 34%
2 UNEMPLOYMENT 7.20% 10.7% 10.8%
3 INFLATION 4.1% 10.9% 11.7%
4 INTEREST RATE
(commercial bank
prime lending rate) 8.50% 12.19% 13.31%
5. NATIONAL
INCOME
-GDP 7.4% 7.4% 8.3%
6 FOREI. EXCHANGE
RATE(per US dollar) 43.319 48.405 46.163

IMPACT/REASON OF DIFFERENT MACRO LEVEL

1) UNEMPLOYMENT: - In India unemployment is rising from 7.20% to

10.7% i.e to 3.5%. It may rise due to following impact or reasons such that,
there are many causes of unemployment in India. The greatest cause of
unemployment is the overpopulation of the country. The population of the
country is increasing fast but the jobs cannot be increased in that proportion.
So a large number of people remain unemployed. Another cause of
unemployment in our defective system of education. The present education is
bookish. It should be job-oriented.

The major cause of unemployment is

 High population growth,
 Recessions,
 Inflation,
 Corruption,
 Disability to do the job,
 Nepotism,
 Demand of highly skilled labor,
 Attitude towards employers.

2) INFLATION: - As we see that in year 2007-08 inflation rate is 4.7% and in

10.9% in 2008-09. So there is increase in 6.2% that is increase at a very high
rate. Again in 2009-10 inflation rise to 0.8% so there is slightly increase
compare to last year.

Inflation is caused due to several economic factors:

 When the government of a country print money in excess, prices
increase to keep up with the increase in currency, leading to inflation.
  Increase in production and labor costs, have a direct impact on the
price of the final product, resulting in inflation.
 High taxes on consumer products, can also lead to inflation.
 Demands pull inflation, wherein the economy demands more goods
and services than what is produced.
 Cost push inflation or supply shock inflation, wherein non availability
of a commodity would lead to increase in prices.
 The Central Bank (India’s RBI) should maintain a balance between
money supply and production and supply of goods and services in the
economy. Money supply exceeds the availability of goods and services
in the economy, it would lead to inflation.
 Expansion of Bank Credit: Rapid expansion of bank credit is also
responsible for the inflationary trend in a country.

3) INTEREST RATES(COMMERICAL BANK PRIME LENDING

RATE):-
The prime lending rate in 2007-08 is 8.50% and in 2008-09 is 12.19% so
there is increase in 3.69% and in 2009-10 again it increase to 1.19%.
 The interest rate that commercial bank charge their best credit
worthiness to customer. It is minimum lending rate at which crdit line
is offered to prime borrower.
 It depends on the economy. If you want people and businesses to spend
more you lower interest rates. Its costs the people and businesses less
to borrow money. If the dollar is getting to stronger causing imports to
be cheaper which would start companies outsourcing, you lower the
interest rate to weaken the dollar.
 The problem right now is that we need spending as we lost a large
amount of liquid assets with the sub-prime crisis. Inflation as we
measure it is in control but Necessities as Food and Oil are in a rapidly
rising cost pattern.
 The actual lending rates charged to borrowers would be the base rate
plus borrower-specific charges, which will include product-specific
operating costs, credit risk premium and tenor premium.

4) NATIONAL INCOME (GDP):-

In 2007-08 and 2008-09 GDP remains the same but there is increase in 2009-
10 by 0.9%.
  GDP is the total dollar amount of all goods and services produced. The
growth rate is the percentage increase or decrease of GDP from the
previous measurement cycle.
 GDP measures national income and output of an economy of a
country. It measures total market value of goods and services in a
given time.
 GDP growth rate is determined by exports, government spending,
retail expenditures, and inventory levels. Growth can be negatively
affected by increase in imports
 Countries seek to increase their GDP in order to increase their
standard of living. Note that growth in GDP does not result in
increased purchasing power if the growth is due to inflation or
population increase.
 There are really only 2 ways you can increase GDP. First, have more
people working. This leads into the 2nd way to increase GDP, have
people work more efficiently.

5)FORIGN EXCHANGE RATE:-

In the year 2007-08 exchange rate is 43.319(per US Dollar) and in 2008-09 is
48.405 so there is increase in 5.086(per US Dollar). It means compare to US
dollar Indian rupee is become weaker, and in year 2009-10 again it becomes
strong by 2.242(per US dollar).

An increase in the supply of money is one other important factor that

influences the foreign exchange rates of the country's currency. With an
increase in supply, the global value for the currency comes down. More of
that currency will be required to purchase another country currency compared
to the past.

An increase in the supply of money may be due to any of the following

reasons:

• Increase in the number of export companies in the country.

• Growth of foreign investment in the country will cause an appreciation of
the country's currency value.
• Increase in the number of speculators who buy and sell the foreign
currency.
• Issue of excess currency by the country's Central Bank.