Economic stability free essay sample

Q1. Economic stability implies avoiding fluctuations in economic activities. It is important to avoid the economic and financial crisis. The challenge is to minimize the instability without affecting productivity, efficiency, employment. Find out the instruments to face the challenges and to maintain an economic stability. Ans. Promoting economic stability is partly a matter of avoiding economic and financial crisis. A dynamic market economy necessarily involves some degree of instability, as well as gradual structural change. The challenge for policy makers is to minimize this instability without reducing the ability of the economic system to raise living standards through increasing productivity, efficiency and employment. Economic stability is fostered by robust economic and financial institutions and regulatory frameworks. Instruments to maintain economic stability: 1. Monetary Policy- Monetary policy deals with the total money supply and its management in an economy. It is essentially a program of action undertaken by the monetary authorities, generally the central bank, to control and regulate the supply of money with the public, and the flow of credit with a view to achieving economic stability and certain predetermined macroeconomic goals. We will write a custom essay sample on Economic stability or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page Monetary policy basically deals with total supply of legal tender money, i. e. , currency notes and coins, total amount of credit money, level of interest rates, exchange rate policy and general liquidity position of the country. 2. Fiscal Policy- The term â€Å"fisc† in English language means â€Å"treasury†, and the policy related to treasury or government exchequer is known as fiscal policy. Fiscal policy is a package of economic measures of the Government regarding public expenditure, public revenue, public debt or public borrowings. It concerns itself with the aggregate effects of government expenditure and taxation on income, production and employment. In short, it refers to the budgetary policy of the government. Fiscal policy is concerned with the manner in which all the different elements of public finance, while still primarily concerned with carrying out their own duties (as the first duty of a tax is to raise revenue), may collectively be geared to forward the aims of economic policy. † 3. Physical Policy or Direct Controls- Government interference with the forces of demand and supply in the market, and state regulation of prices of commodities are common features in these days. Thus, when monetary and fiscal measures are inadequate to control prices, government resorts to direct control. During wars, when inflationary forces are strong, price control involves imposing ceilings in respect of certain prices and prices are to be stopped from rising too high. In a planned economy, the objective of price control is to bring about allocation of resources in accordance with the objects of plan. Price control normally involves some control of supply or demand or both. These are done by control of distribution of commodities through rationing. Q2. Explain any eight macroeconomic ratios. Ans. Definition of Macroeconomics: Macroeconomics is that branch of economics, which deals with the study of aggregative or average behavior of the entire economy. In macroeconomics, we study the collective functioning of the whole economy. It deals with the gross aggregates of the economic system rather than with individual parts of it. It is the study of the entire forest rather than the study of individual trees. Hence, it is called as â€Å"Aggregative Economics. † Macroeconomic ratios are: 1. Consumption income ratio- Y= C + S. Out of a given income (Y); people can either spend or save (S), or they can consume (C) their entire income. Hence, C = Y – S. The consumption income ratio explains the relationship between two variables, i. e. , the amount of income and the amount of consumption. 2. Saving income ratio- Excess of income over expenditure is saving. The saving function can be easily derived by subtracting spending from income. Hence, S = Y – C where S = saving, Y = income and C = consumption. It is a function of income. S = f [Y]. It implies that there is a direct relationship between the two. Higher the income, higher would be the savings and vice-versa. The saving-income ratio indicates the amount of savings made out of a given level of income. 3. Capital output ratio- The concept of capital output ratio explains the relationship between the value of capital investment and the value of output. It is a ratio of increase in output or real income to an increase in capital. It refers to the amount of capital required to produce a unit of output. 4. Capital labor ratio- This ratio indicates the proportion of two factor inputs. It tells us the ratio between the numbers of laborers required for a given amount of capital invested in any business. This ratio is useful to work out the least cost combination by substituting one factor input to another. 5. Output-labor ratio- Output labor ratio expresses the relationship between the quantity of output produced and the number of laborers employed for a specific time period. It indicates productivity of labor. 6. Input- output ratio- This ratio explains the relationship between two variables of inputs and outputs. Input-output ratio indicates the quantity of inputs employed and the quantity of outputs obtained. It is also called as production function in economics. Production is purely physical in nature and as such, the ratio between inputs and outputs is determined by technology, availability of equipments, labor, materials, etc. 7. Value added output ratio- Value added output is the difference between the value of output produced and the value of inputs employed. In other words, it is a ratio of increase in the quantity of inputs employed and the corresponding increase in the output obtained. 8. Cash reserve ratio- The percentage of total deposits which the bank is required to hold in the form of cash reserves for meeting the depositors’ demand for cash is called cash reserve ratio. Thus, CRR indicates the ratio between the liquid cash with that of the total deposits of the bank. Q3. Define Inflation and explain the types of inflation. Ans. Inflation is commonly understood as a situation of substantial and rapid increase in the level of prices and consequent deterioration in the value of money over a period of time. It refers to the average rise in the general level of prices and fall in the value of money. Inflation is statistically measured in terms of percentage increase in the price index, as a rate (percent) per unit of time- usually a year or a month. The trend of price indices reveals the course of inflation in the economy. Usually, the Wholesale Price Index (WPI) numbers are used to measure inflation. Types of Inflation: Creeping inflation – When the rise in prices is very slow (less than 3%) like that of a snail or creeper it is called creeping inflation. Walking inflation – When the rise in prices is moderate (in the range of 3 to 7%) and the annual inflation rate is of single digit it is called walking inflation. It is a warning signal for the government to control it before it turns into running inflation. Running inflation – When the prices rise rapidly at a rate of 10 to 20% per annum it is called running inflation. Such inflation affects the poor and middle classes adversely. Its control requires strong monetary and fiscal measures; otherwise, it can lead to hyperinflation. Hyperinflation – Hyperinflation is also called by various names like jumping, runaway, or galloping inflation. During this period, prices rise very fast (double or triple digit rates) at a rate of more than 20 to 100% per annum and become absolutely uncontrollable. Such a situation brings a total collapse of the monetary system because of the continuous fall in the purchasing power of money. Demand-pull Inflation – The total monetary demand persistently exceeds the total supply of goods and services at current prices so that prices are pulled upwards by the continuous upward shift of the aggregate demand function. It arises as a result of an excessive aggregate effective demand over aggregate supply of goods and services in a slowly growing economy. Cost-push inflation – Prices rise on account of increasing cost of production. Thus, in this case, rise in price is initiated by growing factor costs. Hence, such a price rise is termed as ‘cost-push’ inflation as prices are being pushed up by rising factor costs. A number of factors contribute to the increase in cost of production. Q4. Define Fiscal Policy and the instruments of Fiscal policy. Ans. The term â€Å"fisc† in English language means â€Å"treasury†, and the policy related to treasury or government exchequer is known as fiscal policy. Fiscal policy is a package of economic measures of the Government regarding public expenditure, public revenue, public debt or public borrowings. It concerns itself with the aggregate effects of government expenditure and taxation on income, production and employment. In short, it refers to the budgetary policy of the government. Fiscal policy is concerned with the manner in which all the different elements of public finance, while still primarily concerned with carrying out their own duties (as the first duty of a tax is to raise revenue), may collectively be geared to forward the aims of economic policy. † Instruments of Fiscal Policy: 1. Public revenue: It refers to the income or receipts of public authorities. It is classified into two parts tax-revenue and non-tax revenue. Taxes are the main source of revenue to a government. There are two types of taxes. They are direct taxes such as personal and corporate income tax, property tax, expenditure tax, and indirect taxes such as customs duties, excise duties, sales tax (now called VAT). 2. Public expenditure policy: It refers to the expenditure incurred by the public authorities like central, state and local governments. It is of two kinds: development or plan expenditure and non-development or non plan expenditure. 3. Public debt or public borrowing policy: All loans taken by the government constitutes public debt. It refers to the borrowings made by the government to meet the ever-rising expenditure. It is of two types, internal borrowings and external borrowings. 4. Deficit financing: It is an extraordinary technique of financing the deficits in the budgets. It implies printing of fresh and new currency notes by the government by running down the cash balances with the central bank. The amount of new money printed by the government depends on the absorption capacity of the economy. 5. Built in stabilizers or automatic stabilizers (BIS): The automatic or built-in stabilizers imply automatic changes in tax collections and transfer payments or public expenditure program so that it may reduce the destabilizing effect on aggregate effective demand. When income expands, automatic increase in taxes or reduction in transfer payments or government expenditures will tend to moderate the rise in income. On the contrary, when the income declines, tax falls automatically and transfers and government expenditure will rise and thus built-in stabilizers cushion the fall in income. Q5. Investment is a part of income which can be used for various purposes. It is necessary to create employment in an economy and to increase national income. To understand the benefits of income, study the various types of investment. Ans. Meaning of Investment: Investment, according to Keynes, refers to real investment. It implies creation of new capital assets or additions to the existing stock of productive assets. It refers to that part of the aggregate income, which is used for the creation of new structures, new capital equipments, machines, etc that help in the production of final goods and services in an economy. Creation of income – earning assets is called investment. Thus, investment must generate income in the economy. Investment also refers to an addition to capital with such investment occurring when a new house is built or a new factory is built. Investment means making an addition to the stock of goods in existence. Types of Investment: 1. Private investment- It is made by private entrepreneurs on the purchase of different capital assets like machinery, plants, construction of houses and factories, offices, shops, etc. It is influenced by MEC and interest rate. It is profit –elastic. Profit motive is the basis for private investment. Private entrepreneurs would take up only those projects which yield quick results and generally those that have a small gestation period. 2. Public investment- It is undertaken by the public authorities like central, state and local authorities. It is made on building infrastructure of the economy, public utilities and on social goods, for example, expenditure on basic industries, defense industries, construction of multipurpose river valley projects, etc. In this case, the basic criterion and motto is social net gain, social welfare and not profits. 3. Foreign investment It consists of excess of exports over the imports of a country. It depends on many factors such as propensity to export of a given country, foreigners’ capacity to import, prices of exports and imports, state trading and other factors. 4. Induced Investment- Induced investment is another name for private investment. Investment, which varies with the changes in the level of national income, is called induced investment. When national income increases, the aggregate demand and level of consumption of the community also increases. In order to meet this increased demand, investment has to be stepped up in capital goods sector which finally leads to increase in the production of consumption goods Therefore, we can say that induced investment is income – elastic i. e. , it increases as income increases and vice-versa. 5. Autonomous investment- Autonomous investment is another name for public investment. The investment, which is independent of the level of income, is called as autonomous investment. Such investments do not vary with the level of income. Therefore it is called income-inelastic. It does not depend on changes in the level of income, consumption, rate of interest or expected profit. Q6. Discuss any two laws of returns to scale with example. Ans. Laws of returns to scale The concept of returns to scale is a long run phenomenon. In this case, we study the change in output when all factor inputs are changed or made available in required quantity. An increase in scale means that all factor inputs are increased in the same proportion. In returns to scale, all the necessary factor inputs are increased or decreased to the same extent so that whatever the scale of production, the proportion among the factors remains the same. Increasing returns to scale Increasing returns to scale is said to operate when the producer is increasing the quantity of all factors [scale] in a given proportion leading to a more than proportionate increase in output. For example, when the quantity of all inputs are increased by 10%, and output increases by 15%, then we say that increasing returns to scale is operating. In order to explain the operation of this law, an equal product map has been drawn with the assumption that only two factors X and Y are required. Figure 5. 9 depicts the operation of the law of increasing returns to scale. In the figure, Factor X is represented along OX axis and factor Y is represented along OY axis. The scale line OP is a straight line passing through the origin on the iso quant map indicating the increase in scale as we move upward. The scale line OP represent different quantities of inputs where the proportion between factor X and factor Y is remains constant. When the scale is increased from A to B, the return increases the output from 100 units to 200 units. The scale line OP passing through origin is called as the â€Å"expansion path†. It is very clear that the increase in the quantities of factor X and Y [scale] is small as we go up the scale and the output is larger. The distance between each isoquant curve is progressively diminishing. It implies that in order to get an increase in output by another 100 units, a producer is employing lesser quantities of inputs and his production cost is declining. Thus, the law of increasing returns to scale is operating. Constant returns to scale Constant returns to scale is operating when all factor inputs [scale] are increased in a given proportion leading to an equi-proportional increase in output. When the quantity of all inputs is increased by 10%, and output also increases exactly by 10%, then we say that constant returns to scale are operating. Figure 5. 10 depicts a graph for constant returns to scale. In the figure, it is clear that the successive isoquant curves are equidistant from each other along the scale line OP. It indicates that as the producer increases the quantity of both factors X and Y in a given proportion, output also increases in the same proportion. Economists also describe constant returns to scale as the linear homogeneous production function. It shows that with constant returns to scale, there will be one input proportion which does not change, whatever be the level of output.