Friday, April 9, 2010

Average and Marginal Propensity to Consume

propensity to consume has been divided into two parts viz. average propensity to consume and marginal propensity to consume.
1. average propensity to consume
average propensity to consume is the ration of aggregate consumption to aggregate income. therefore, ration of consumption to income is known as average propensity to consume. average propensity to level of income. thus, the relationship between the gross national income and gross consumption expenditure is the average propensity to consume.
2. marginal propensity to consume
marginal propensity to consume is the relationship of the change in consumption to the change in aggregate income. it is also known as the rate of change in average propensity to consume. the change in consumption expenditure on the basis of the ration of the following year is given by the marginal propensity to consume. thus, marginal propensity to consume is obtained by dividing change in consumption expenditure with change in aggregate income.

phychological law of consumption

psychological law of consumption was propounded by Keynes. therefore, this law is also known as "Keynesian psychological law of consumption". the main basis of this law propounded by Keynes is the income. assorting to this law in any capitalistic or mixed economy the increase in income of the consumers will result in the increase in consumption expenditure also. but consumption expenditure won't increase proportionately as the increase in income. thus, this is also known as propensity to consume. consumption function is also based on the psychological law of consumption there is apparently no difference between these two. however due to definite importance of this law in the macro-economic analysis this law has been presented separately to make the nature of propensity to consume clear, the psychological law of consumption was propounded by Keynes. this law is mainly based on the following three facts:
1. when income increase, the consumption expenditure will also increase, but consumption expenditure will increase less proportionately than the increase in income.
2. increase in income is divided into consumption and saving in the same ration.
3. increase in income will result in the increase in both the consumption expenditure and savings.
Keynesian theory of consumption is basically dependent upon consumption expenditure does not increase as the increase in income.
1. assumptions of psychological law of consumption
Keynesian psychological law of consumption is based on the following three assumption:
(a) no change in institutional factors
among the factors influencing the consumer, only the income will change. other institutional factors such as, desire, behaviour, fashion population, price,etc. related to psychology do not change.
(b) normal situation
for the application of this law, the normal situation should always prevail in the economy. that is unusual situations such as war, revolution, hyper-inflation, etc. should not occur in the economy.
(c) government intervention
for the application of psychological law of consumption, there should be a capitalistic economy without any government intervention. this law is not application to socialist economy.
2. importance of consumption
psychological law of consumption has a great importance. some of the reasons for the implication of this law in the economy are as follows:
(a) need of government intervention
this law is in the concept that there should be government intervention in the economy. since consumption does not increase as the increase in income, the economy is not self-adjusting. as a result, aggregate unemployment will arise in the economy. in such a situation, government can formulate various kinds of public policies and decrease or remove unemployment by intervention.
(b) equilibrium of under- employment
psychological law of consumption is based on the equilibrium of under-employment. the point of effective demand which determines the level of employment is not the state of full employment rather it is the point of under-employment because people do not use all part of their uncreased income in consumption expenditure. this will result in the decrease in demand. unless all parts of one's income are used in consumption expenditure the state of full employment will never occur in the economy.
(c) importance of investment
according to law of consumption in the short run, there won't be any change in the propensity to consume. the consumption expenditure increase less than proportionately as compared to the increase in income . so, due to stability of consumption function the gap between income and consumption will increase. this will create the situation of unemployment. so, to reduce or remove the gap between income and consumption there is a great importance for investment because investment is also a kind of consumption or consumption expenditure.
(d) declining tendency of the marginal efficiency of capital
in capitalistic economy the demand for consumption goods does not increase proportionately as the increase in income of the people. as a result of this the stock of produced goods will increase . to sell this increased stock of goods, the price has to be reduced. this will decrease the profit. on the other hand, if production is reduced the marginal efficiency of capital will automatically decline. the entrepreneurs will reduce the demand for capital goods. this situation can be removed by increasing propensity to consume. so, to increase consumption there is a great importance of propensity to consume.
(e) explanation of depression
in developed countries the marginal propensity to consume is less as compared to poor countries or under-developed countries. that is , consumption expenditure is far lower than the income. thus, most part of the income will be saved. due to excessive saving, the aggregate supply will be far more than the aggregate demand. as a result of this depression and the state of unemployment will arise in the economy.
(f) explanation of induced investment
the marginal propensity to consume is very high in under-developed as well as developing countries. therefore, in such countries the consumption expenditure increase as the national income increases. but the gap between the consumption expenditure and national income will be very small or negligible. similarly, in such countries emphasis is given to the investment in such development projects which will increase the income level in the long run. this law has great importance in explaining the induced investment.






Thursday, March 25, 2010

determinants of consumption function

consumption function is influenced by various factors. consumer's propensity to spend, different situations, exhibition influence, etc. are the factors that influence the consumption function. analyzed the factors that determine the consumption function by dividing them into the following two sections:
1. subjective factors 2. objective factors
these subjective and objective factors can be explained ad follows:
1. subjective factors
subjective factors are also known as psychological factors because these are internal factors that determine the consumption function. these factors are related to human behavior and habits, social customs and traditions. by these factors the behavior of individuals as well as the behaviors of the entrepreneurs are influenced. in this manner, subjective factors are also divided into two parts viz. individual motives and business motives.
(a) individual motives
people cut down their consumption due to various individual reasons. such changes in consumption affects the consumption function in various ways. individual motives are divided into the following eight parts:
1. motive of foresightedness
people cut down their current consumption for the sake of their children future. this will result in the decrease in consumption function.
2. motive of precaution
people cut down their current consumption in order to tackle the miss happenings in the future.
3. motive of improvement
some people cut down their current consumption in order to improve their future life style. this will also reduce the current consumption.
4. motive of independence
some people improve their future life styles by reducing current consumption. this will also reduce current consumption vecause people are of the concept that they would be independent on the future. consumption function decrease in this manner also.
5. motive of pride
people are of the motive of retaining their pride in the future by maintaining a good economic status of their children with the reduction in current consumption. this will also reduce the consumption function.
6. motive of enterprise
some people even cut down their current consumption in order to save for the required investment in establishing an enterprise in the future. in this situation also the consumption function will be reduced.
7. motive of avarice
some people do not spend even in the necessary situation due to avarice as a result consumption function will decrease.
8. motive of calculation
there are some people in the society who calculate interest, profit,etc. fro their saving. so, such people will cut. down their present consumption to save for earning interests, profits,etc. in the future. such people will reduce their consumption function.
(b) business motives
among various factors determining the consumption function business motive is also one. due to business motives the individuals and the government cut down their current consumption. the business motive can be explained as follows:
1. motive of enterprise
some people come forward facing the risks to carry out the business activities. such, people cut down their current consumption to increase the savings that will be required for the development and expansion of their business in the future.
2. motive of liquidity
some entrepreneurs cut down their current consumption to increase the saving for liquidity that may be required to solve the problems that arise while running the business. this will also result in the decrease in consumption function.
3. motive of income improvement
any enterprising will required a huge amount of capital to increase the income. so, to increase work efficiency the current consumption is cut down. this will also decrease the propensity to consume.
4. motive of financial prudence
some entrepreneurs are farsighted and they cut down their current consumption for new investments in the future. to run the financial business also they cut down their current consumption. this will also result in the decrease in consumption function.

2. objective factors
factors determining consumption function are such exogenous factors which sometimes bring about changes quickly and some other times bring about changes very slowly. some of such factors are as follows:
(a) fiscal policy
change in fiscal policy by the government brings about the changes in consumption and income. of the government increases the tax rate through fiscal policy then disposable income will decrease. this will result in the decrease in consumption. in contrary to this, if the government reduces the tax rate through fiscal policy, then the disposable income will increase, increasing the propensity to consume.
(b) windfall gains or losses
future expectations also affect the propensity to consume. if gains increase unexpectedly then consumption will also increase and if losses increase unexpectedly, then propensity to consume will decrease.
(c) future expectations
future expectations also affect the propensity to consume. due to possibility of rise in price in the future or possibility of war, the current demand for goods will increase. but contrary to this. if there is a possibility of decrease in price in the future, then current demand for goods will decrease.
(d) rate of interest
rate of interest also determines the consumption function. if the rate of interest increases then people will start saving. as a result current consumption will decrease . on the other hand, if the rate of interest decreases, then the people won't be in favour of saving. this will result in the increase in the propensity to consume.
(e) distribution of income
if the national income is equally distributes then the propensity to consume will be less. in such a situation, the income of people won't increase in high proportion. in contrary to this, if the national income is distributed unequally, then most part of the national income will be in the hands of rich people and their propensity to consume will be low. in such a situation there won't be a possibility for the increase in income of the poor people.
due to changes in these various factors the changes in the income of people will be resulted, and changes in the propensity to consume will occur. therefore, income is taken as the main factor that affects the propensity of consume. other factors are taken to have uncertain effects. these effects are effective only in the long run.


measures to increase in the propensity to consume

In the short run propensity to consume is stable because this can't be changed in a short period. increase in consumption function also increase output ,employment and income,since increase in consumption function has positive effect in the economy, this has to be increased . in the long run propensity to consume can be increased in the following ways:
1. redistribution of income
government should levy progressive tax on the rich and people with high income and provide various subsidies to the poor people. so, redistribution of income from rich people to poor people will increase the propensity to consume of the poor people.
2. wage policy
increase in wage rate increases the propensity to consume in the long run because daily wage earners are the people with low income. the more the increase in the wage rate, the higher is the consumption of such people. thus, propensity to consume can be increased with the increase in the wage rate.
3. increase in the social security
government can increase the propensity to consume by increasing the social security. unemployment allowances, pension,health insurance, etc. also, increase the consumption function of the people.
4. credit facility
easy and cheap credit facilities will enable the people to purchase durable goods such as motorcycles, televisions, fridges, etc. this will increase the consumption of people. similarly , installment and hire and purchase schemes will also increase the propensity to consume.
5. urbanisation
urbanisation also increase the propensity to consume because of the various modern facilities and necessities the city people will consume More goods and services than the rural people.
6. advertisement and publicity
various advertisements and publicity of goods and services also increase the propensity to consume of the people . newspapers, radio, television, etc. are the media for advertisement and publicity of goods. advertisements and publicity inform the people about the new goods and services and motivate them in consuming such goods and services.
7. development of means of transport
development of various means of transport also increase the propensity to consume of the people. goods produced at one place can be taken to the consumers easily by means of transportation. this will increase the consumption function of the consumers.


Wednesday, March 24, 2010

paradox of thrift

the amount left over after the consumption by an individual or society is known as the saving. people do not spend all of their incomes on consumption. since people are always worried about their future, they save some part of their incomes. this will free them from their future economic worries. individual saving will determine the national saving. though national saving is composed of individual saving, the effects of these savings in the economy are of different types.
the classical economists were of the view that the saving was good for the economy because according to them the investment was determined create national saving and this national saving would convert into national investment. therefore, the economists were of the concept that the saving and investment were inseparable from each other. but another economists criticized the concept of saving that was given by the classical economists. they were of the concept that saving would decrease the consumption in the economy. they explained that this would lead to the situation of under consumption. thus, decrease in consumption will result in the decrease in effective demand and as a result there will be over-production, unemployment and economic crisis in the economy.
another economists had a different view in regard to saving. he criticism the concept of saving given by the classical economists and said that saving being good or bad depends upon its use. if saving is invested then there won't be any decrease in effective demand. in such a situation, Savina won't have any kind of harm in the society. but if saving is kept hoarding instead of investing then this will have negative effect in the economy. from individual point of view saving is a virtue but form the social point of view saving is a social evil. if any individual cuts down the consumption and saves some part of the income, then it is good for that individual. but this won't help the society in any way. the reason for this is that the expenditure of one personify the income of the other. in a given period the saving of one individual is equal to the decrease in the income of the other individual. this will result in the decrease in the saving of the second individual or party. so, the more the single individual saves the less will be the social saving. explained the concept of saving under the macro-economics in accordance to social saving rather than individual saving, thus saving is vice but not virtue.
so , saving decrease effective demand in the economy resulting a decrease in the price and profit.as a result, investors will be discouraged to invest. this will further decrease the employment, production and income which in turn decrease the saving. this will convert the saving into social evil. so in the beginning saving is a virtue to the individual but to the society and the nation it will become harmful. this in the end and also harms the individual. therefore, saving turns in to misfortune. this is known as the paradox of thrift.

concept of investment

  1. in general investment means the purchase of shares securities and any sorts of assets. but in economics such activities are only known as transfer of ownership because this sort of investment does not increase the aggregate income and employment. therefore, such investment-is known as financial investment because this won't increase real investment. but in economics any transaction that increase the real capital and yields additional income is known as investment. for this reason money invested in the purchase of shares and securities of different companies cannot be taken as investment. such transactions don't increase the national income and national capital. thus any economic replication with the use of additional capital which increases the capacity of national production and additional income is known as investment.so, investment is the increase in supplant of capital which helps in the increase in the production and productivity. so , to spend on shares of different industries fixed capitals such as machinery and building, preparation of consumption goods by employing various raw materials, expenditure on development and construction, etc. area known as investment.
  2. investment means increase in the real capital fund. in other words investment is that part of the income which is spent to earn more income with the employment of capital goods. all the expenditures that her involved when establishing new factories, increasing the efficiency of old factories, improvement and expansion of transportation, construction of various buildings, etc. are taken to be investment. investment is also analyzed from individual as well as social point of view as the analysis of saving. personal investment is also of two types. they are:
  3. 1. financial investment
  4. when an individual uses the personal saving in purchasing shares and securities or bonds of any existing companies then that is known as financial investment. financial investment does not increase the quantity of real capital in the society because in such investment one does the selling and the other doer the purchasing. this won't increase the aggregate investment.
  5. 2. real investment
  6. if an individual uses the savings in a new company or construction of a new building instead of purchasing old shares and debentures of existing companies, then this will increase the real capital. this is known as the real investment. the main objective of real investment is to increase the capital assets and the amount of goods.

types of investment

Generally, investment can be dividend in to the following types:
1. gross and net investment
in any economy, the aggregate real investment is known as gross investment. such investment reflect es the amount spent on gross assets. all real investment in any sectors will not be used to increase the production capacity. some part of it will be used in the construction of basic infrastructure for production, for repairing and maintenance of old and broken machinery's and for keeping up-to-data the depreciation of fixed capital so, some part of grose investment will also be in the form of substitution demand. this will be used in repairing, maintenance and substituting old and broken machinery's. all these expenditures are known as Gross investment. GI = NI + Depreciation. net investment is that part of the investment which is used in increasing the gross production capacity which is exist in the economy. gross investment and net investment will be equal to each other when in the economy there won't be any problem of repairing and replacing old and broken machinery's as well as there will be no need of depreciation. but in real world such situation will not occur. for this reason net investment will be less then gross investment. if depreciation is deducted from the Gross investment, then net investment will be obtained.
2. private and public investment
investment by an individual or private institution in various industries and business withe the motive of earning profit is known as private investment. this type of private investment depends upon the marginal efficiency of capital is more then the rate of interest then the investment will increase. otherwise investment will decrease. on the other hand investment by government sectors or various bodies of government is known as public investment. in such investment public benefit is stressed more then the profit. investment in construction of roads, brides, canals, hospitals, educational institutions, transportation communication sectors, etc. is known as public investment. such investment will have indirect benefits rather than direct benefits.
3. induced and autonomous investment
investment determined by the change in direct production and income is known as induced investment. thus, this is known as the function of income. that is: so, induced investment is directly proportional to the income. in other words, induced investment increase as the income increase. the increase in the disposable income of the propel in the society increase the effective demand. so, quantity of induced investment depends upon the quantity of income.



Tuesday, March 23, 2010

other factors influencing investment

factors influencing the marginal productivity of capital can be dividend into parts viz. short run and long-run factors.
(a) short run factors
in the short run, marginal productivity of capital and investment are influenced by the following factors.
1. consumer's demand: current demand for goods greatly affects the capital investment level in the economy. if the consumers continuously increase the current demand for goods, then there will a be and excessive increase in current investment. but contrary to this , if current demand for goods go on decreasing, then the investors won't be attracted or encouraged for investment. as a result , current investment will decrease.
2. level of income: if in the economy increase in wage and the price of goods increase the income if the people , then demand for increase the short run investment. contrary to this , if decrease in wage and the price of goods decrease the income of the people then the demand for goods will also decrease. so, decrease in the income level as a result of decrease in demand for goods will discourage the investors towards investment. as a result investment will increase.
3. expected demand: if the investoes expect the increase in demand for goods and services in the future, then the marginal productivity of capital increases currently and will be encouraged for investment. if decrease in demand is expected in the future, then the investors will be discouraged for current investment. in such a situation, investment will decrease . that is short run investment will decrease.
4. propensity to consume: of people consume most part of their income then demand for various goods will increase. if propensity to consume of people in high, then to meet the demand the investors will increase the investment. but contrary to this of consumer's propensity to consume is low and propensity to save it high, then demand for goods will decrease. due to decrease in such a situation, investment will decrease.
5. cost: if there is a possibility of crease in the production cost of various goods and services in the future, then marginal efficiency of capital will be more and the investors will be encouraged for investment. but contrary to this, if there is a possibility of increase in the production cost of goods and services in the future, the marginal efficiency of capital will be less and the current investment will decrease.
6. price and returns: price and returns also influence the encouragement in investment. if there is a possibility of increase in the price of goods in the future, then current investment increases because investors will expect more returns from this . this is because in such a situation, marginal productivity of capital will also be more. but if there is a possibility of decrease in the prices of goods in the future, then the investors will invest less because they will receive less returns.
7. uncertainty: if encouraging situation prevails in the industrial and business sector, then marginal productivity of capital increases. this discouraging situation prevails in the industrial and business sector, then marginal productivity of capital decreases. as a result, the investoes will decrease their investments.
8. government policy: the economic policy under taken by the government also affects the investment. if the government shifts various unnecessary burden of taxes on entrepreneurs and businessmen or nationalities the industries then marginal productivity of capital will decrease.as a result in the investors will be discouraged from investing. this will result in the decrease in investment. but contrary to this, if the government with the objective of encouraging the entrepreneurs and businessmen towards investment removes unnecessary taxes and provides various facilities the private entrepreneurs will be encouraged for investment. as a result, current investment will increase.
9. business stability: if there is a suitable environment for the business stability in the economy, then there will be an expectation of high returns from industrial investment. as a result of this , investors will be encouraged to invest at current situation. but contrary to this , of there is no suitable environment for industrial and business investment in the economy, then marginal productivity of capital will decrease resulting a decrease in investment.
10. political stability: political stability in the country also determines the investment. if there is political stability and stable government in the country, then the investors will be encouraged to invest. this will result in the increase in investment. contrary to this, if there is political instability and unstable government changing from time to time in the country, then the government policies will be ever changing. this will discourage the investors from investing and as a result the investment will decrease.

(b) long-run factors
long-run factors that influence the marginal productivity of capital and investment can be explained as follows:
1. population growth rate: population growth rate of a country has a long-run influence on investment. if the country's population growth rate is high, then permanent and stable market will be created for various consumption goods in the economy. so, to fulfill the demand of increased population, investment on the production of consumption goods will increase. if the size of the market for consumption goods will also be small. this won't encourage the investors towards investment. that is, investment will decrease.
2. development of new territories: the objective of the government will be to develop backward sectors successively. in such a situation, in the government undertakes policies to develop backward sectors successively, then new sectors will be open for because new cities will be developed. this will speed up the business as well as industrial development along with the economic development of the country. as a result, marginal productivity of capital will increase.
3. utilisation of capital equipment: if at current period capital equipments are not fully utilised, then to supply as per demand various capital equipments should be used with the increase in the long-run investment. this will increase the marginal productivity of capital.
4. technological progress: due to development of new technologies, the long-run investment increases. if various technologies are improved or new technologies are invented, then this will increase the product efficiency. this will reduce the price of produced goods and the consumers will start getting goods at new investment sectors. this will result in the increase in marginal productivity of capital. thus, increased marginal productivity of capital will encourage the investors towards the investment on new capital goods. development of new means of transportation, new house, etc. come under this, this will provide various facilities to the people.
5. new products: new products available in the market also influence the marginal productivity of capital and investment. if the probability of sale of new product in the market in very high, then investment in such sector will have high possibility of earning excessive profit. in such a situation, marginal productivity of capital will be high. for example, invention of television and computer has widely increased the demand for these products and every now and then, new types and new models of television and computers are produced. due to such new products investment increases.
6. rate of current investment: if at current period investment in any sector is very high, then it will be meaningless to invest more in that sectors. of invested in such sectors, the marginal productivity of capital will be less. as a result, investors will be discouraged from investment or they won't be interested in investing.
7. liquid assets: liquid assets with the investors also influence the investment, if more liquid assets is with the investors, then they are encouraged for more investment because they desire to earn more profits form such investments, contrary to this, if investors possess less liquid assets or not at all, then they won't be encouraged towards investment.



Thursday, March 18, 2010

phases and effects of trade cycle

as waves and tides continuously occur in the sea, in the economy also one phase follows the other as economic ups and downs fluctuations occur. according to American economists Arthur f. burns and Wesley c. Mitchell, in any trade cycle there will be two states of minimum "trough" and maximum "peak". two other state will be included in these two states. according to these facts the phase of trade cycle can be divided in to the following four parts:
1. Depression or contraction
2. Recovery or revival
3. Prosperity
4. Recession
1. depression or contraction
it is very difficult to point out the starting point of the trade cycle because depression follows the state of prosperity and the state of prosperity is again reached after the state of depression. most of the people have taken the state of depression as the starting phase of the cycle.
in the state of depression, there will be unfavorable situations everywhere in the economy. since price of the goods is in a decreasing state, the investors are discouraged to invest. due to less investment, output and employment will decrease. so, in the first phase of trade cycle the business will be in a very poor state. the wage of the labors will decrease as a result of decrease in investment. the purchasing power of the money will increase. there will be a lot of changes in the distribution of the national income. the profits of the investors will decrease and move towards a zero stare or even a negative state. despite the increase in purchasing power of money, the purchasing power of the people will be very low due to a great degree of unemployment. specially, the effect of trade cycle on the inductees of basic necessities such as food,clothing,etc. will be less . due to decrease in the price of raw materials used by construction industries, the farmers are also affected. due to this there will be discouragement everywhere in the economy. depression expanding widely in the following features can be seen in the economy with the state of depression:
(a) decrease in output and business.
(b) high degree of unemployment and very low of income.
(c) decrease in demand and fall in price level.
(d) excessive decrease in the price of raw materials and agricultural goods than the price of produced goods.
(e) decrease in credit demand is resulted due to decrease in investment.
(f) decrease in the rate of interest.
(g) decrease in the number of investors and the risk-bearers.
(h) failure in economic activities
(i) due to decrease in construction works, the state of closing down of industries will be created.
(j) there will be a state of discouragement everywhere in the economy.

2. Recovery or revival
recovery or revival is the second phase of the trade cycle. in this phase , the trade cycle slowly rises and moves towards the state of prosperity from the minimum trough. that is , recovery process starts after the economy reaches the trough and is in a very poor condition. in this phase, the economy will slowly rise towards the state of prosperity recovery seen in the economy will bring about hopes to the entrepreneurs and investors. the investors will be ready to bear risks in investing. in such a period, factors of production, the profit will start increasing. this will encourage the investors towards investment .many new industries will be established in the economy. due to increase in employment income. purchasing power of people, etc. the demand will also increase. as a result, prices of goods will also start rising. with the expectations of earning high profits the investors will increase the rate of investments. this will have direct cumulative effect on employment, income demand price,etc.
in such a situation, investors will start taking loans from banks and financial institutions. this will have a positive effect in the economy. the depression emerged in the first phase will be slowly removed. due to investments in new sectors there will be increase in public expenditure, investment, development of new production technologies, employment, velocity of money, etc. however, the entrepreneurs and investors will move forward very carefully with the clear view of the future because the effects of depression state will be fresh with them. as a result all economic activities of the economy will increase . the main features of the recovery of revival phase are as follows:
(a) increase in output and employment
(b) increase in income and demand
(c) increase in price
(d) increase in wage and interest rate
(e) increase in exchange
(f) increase in credit demand for investment
(g) prevailing of hopefulness everywhere in the economy

3. prosperity
after the phase of recovery, the phase of prosperity emerges in the trade cycle. this phase is the third phase of the trade cycle. prosperity is the best phase of the trade cycle. in the state of prosperity. real income and output will increase. employment level will increase as well as none of the factors of production will remain unemployed. as a result , business parties and entrepreneurs will earn maximum profits. more labors will be required for the higher level of production. this will bring about the state of full employment. Keynes has said that in such a situation, voluntary unemployment exists but the number will be very small. the purchasing power of the people will increase as well as new and improved machines will be used in the industry. in the state of prosperity , output,wages, price, income, employment, etc. will increase. in such a state,retailers will stock more goods than demanded with the view of earning profits. when price rises, with the expectations of excessive profits, the producers will also produce excessive quantity. the following are the features of the prosperity phase:
(a) excessive increase in the output and employment
(b) increase in demand and price
(c) increase in wage and interest rate
(d) increase in profits due to excessive increase in price relative to increase in production cost
(e) excessive increase in investment and product in
(f) excessive increase in loan and bank credits
(g) comprehensive expansion in industrialization
(h) excessive increase in stock and inventories
(i) good signs and full of hopefulness everywhere in the economy
(j) optimum utilization of all factors of production
4. Recession
in trade cycle, after the phase of prosperity , the phase of recession or contraction starts. in this state, the entrepreneurs and businessmen will start suffering loss in their productive activities. as a result, industries will start closing down. this will stop the new investments also. this will directly affect the productive and capital goods or additional consumption goods. as a result, wage,demand, price and investment will decrease. this will further result in the decrease in output, employment income, bank credits, profit,etc. in such a situation, negative multiplier will be active in the economy. this will have cumulative effect on recession. in the end, the trade cycle will enter into the state of depression.
so, the state of economy after the state of propriety in which the economy is heading downwards is known as the phase of recession.







marginal efficiency of capital

any individual, before investing at any place, has to think over the profits that can be earned from the investment. so, any investor when invests in the new sector definite amount of returns will be yielded from the investment which will be the profit. that is marginal productivity of capital is the marginal efficiency of capital. any entrepreneur when investing on new capital assets compares the expected rate of returns with the interest that will be required to be paid when buying such capital assets. if the return form the investment is more than the interest amount that is required for its payment then the investor will be encouraged to invest in such a new sector. contrary to this if the return from the investment is less than the interest rate, then no investor will be ready to invest in such a sector. so, expected profit that can be obtained in the future for the investment is known as the marginal efficiency of capital. this sort of profit is expected form the additional capital or additional investment. the amount of money that any entrepreneur invests on capital goods which produce any goods is known as supply price. this is also known as replacement cost. this investment on machines which are used in production is also known as proposed investment. this kind of investment which is expected to earn income in addition to the amount separated for depreciation fund is known as expected income.
so, any entrepreneur before investing has to think over three things. they are:
1. Cost of capital assets
2. Prospective yield from the life time of capital assets.
3. Rate of interest.

concept and definition of inflation

in general, increase in the price of goods and services in the economy is known as inflation. the main cause for inflation is the decrease in the value of money or the increase in the price of goods. the main reason for this is the increase in the monetary expansion. if the quantity of money used as the medium of exchange in the economy is more than the quantity of goods and services, then inflation will be created in the economy. this will result in excessive increase in the demand for goods and services. as a result, price of goods and services will also increase. due to disequilibrium between demand for and supply of goods, economic disequilibrium will be created in the economy.
other economists have put forward the concept that the inflation is related with employment and income. in reality, the relationship of inflation is with money various goods, employment and income.
different economists have given their own views in relation to inflation.while explaining their views they taken price increase and monetary values as the main reasons. according to modern economists, there are two types of inflation. they are demand pull inflation and cost push inflation. various definitions of inflation as given by different economists can be presented as follows
in any economy, if the goods and services increase in proportion with the increase in the quantity of money then this cannot be termed as inflation. but in the state, when quantity of money constant, if wage and profit increase, then inflation will occur, inflation occurs if demand for goods and services increase at a higher rate than the production of goods and services because the price of goods and services increase as the demand for such goods and services increases. therefore, in the time of inflation the price of goods will increase very rapidly.

Tuesday, March 16, 2010

cause of inflation

inflation in the economy will occur when effective demand and production cost increase excessively. in other words, inflation will occur when there is an excessive increase in effective demand and production cost in the economy. that is, disequilibrium created in the economy when aggregate demand is excessively higher than the aggregate supply is known as inflation. the main cause for the increase in the aggregate demand is the increase in monetary income or increase in the quantity of money. therefore, there are mainly two causes for inflation. they are:
1. increase in money income
demand for goods and services increase as monetary income increases. but if production does not increase in proportion with the increase in demand, then disequilibrium will be creased. due to such disequilibrium, price of goods and services will increase. main cause for the increase in money income are as follows:
(a) monetary and credit policy of government
monetary expansion will occur when the government undertakes the policy of spending excessive quantity of money. failure of proper control in such a situation will create inflation. similarly, bank rate policy of the central bank and open market operations will influence the quantity of credit. low interest rate will increase the demand for credit resulting the increase in the credit expansion. similarly. if securities sold through the central bank in the open market are purchased by the people then quantity of money will increase in the society. so, due to monetary policy of the government and the central bank, the credit as well as the income of the people will increase. this will result disequilibrium in production and income creating inflation in the economy.
(b) deficit financing
the budget in which income is less than the expenditure indicated in the public budget is known as deficit budget. that is, if government expenditure is more than income then to meet or fulfill such expenditures the government will issue excessive quantity of money through the central bank. in such a situation, the government taken loan from the central bank. thus taken loan when spent in various sectors will increase the monetary expansion. this will increase the money income of the people and the situation of inflation will arise in the economy.
(c) credit policy of commercial bank
if demand for credit increase excessively, then only small part of the deposits deposited by the deposits will be kept in the cash-fund by the commercial banks. this will increase the credit expansion of the commercial banks excessively. due to excessive increase in credit expansion, more quantity of money will be in use in the society. increase in the use of money in the society will create the state of inflation.
(d)increase in the velocity of circulation of money
due to increase in the propensity to consume of the people, the personal expenditure will increase. as a result of this, the saving of the people will decrease and the velocity of the circulation of money will increase. due to increase in the velocity of circulation of money, the demand will increase and supply will decrease.as a result, there will be an excessive increase in the price of goods and services, and inflation will be encouraged.
(e)financial mismanagement
due to failure of proper financial management by the government, the tax won't be collected properly, while sometimes the government will reduce the tax for various reasons. as a result of this, the quantity of unaccounted money will increase with the people and demand for goods and services. the price of the goods and services will also increase resulting inflation in the economy.
(f) export promotion policy
every developing country's trade will be in as unbalanced state. to solve this problem the government will undertake export promotion policy and will discourage imports. for this , the government will evaluated the domestic currency. as a result of this domestic goods will be cheaper in the international market of foreign countries, the quantity of goods in the country will be less relative to the demand for the goods. as a result of the disequilibrium between demand and supply , the price will increase creating inflation in the economy.
(g) increase in unproductive expenditure
the excessive expenditure of the government in various wars and internal defence or construction of various infrastructures of development such as, health, education, transportation, communication sectors etc. will increase the money income of the public. but the production of consumption goods of the public will be less compared to the increase in income. this will also increase demand excessively and inflation will be resulted.
2. decrease in production
due to various reason the production in the country will decrease. as a result of decrease in production. disequilibrium will be created between demand, supply and inflation will be resulted. the causes for decrease in production are as follows:
(a) nature causes
nature calamities that occur at different times, such as , floods, landslides, earthquakes, drought,etc. decrease agricultural production. that is these natural calamities affect badly the countries based on agriculture. in other words the countries whose economy is dependent upon agriculture will be badly affected by the natural calamities. along with the decrease in the agriculture product this will also result in scarcity if raw materials required for the industries required for the industries based on agriculture will increase. in such a situation, despite the constant money income, due to natural causes the production will decrease and inflation will be resulted.
(b) law of diminishing returns
the returns of land are not always in proportion. sometimes the law if increasing returns is applicable and sometimes the law of diminishing returns is applicable. if the law of diminishing returns is applicable, then low production will be resulted through high production cost. as a result of high production cost the price of the goods will increase and inflation will occur. when production is less in proportion to productions cost, inflation will be created.
(c) lack of raw materials
lack of raw materials required for production will decrease the production. due to decrease in production, disequilibrium will emerge between demand and supply resulting in the increase price of goods. this will lead to inflation.
(d) techniques of production
the quantity of production is also affected by the techniques of production. if the production technique is very old, then production will decrease instead of increasing. if modern and scientific methods of production are not used, then production will decrease with the increase in price. this will lead to inflation.
(e) trade and taxation policy of the government
if excessive tax is levied on the production of goods by the government , then the price of the produced goods will also increase. due to increase in price the demand will decrease and this will result in the decrease in production. in addition to this, if the government undertakes the export promotion policy and encourages export, then the quantity of goods in the country will be less. that is , there will be a shortage of goods in the domestic market. due to this shortage the price of goods will increase. thus,trade and taxation policy of the government will also create the state of inflation.
(f) industrial disputation
due to various disputations in the industrial sector of a country, such as, strike by lab ours, conflict between trade union and industrialist, instability in the country,etc. will force the industries and factories to be closed down. closing down of factories and industries will decrease the production and increase the price. this increase in price will create the state of inflation.
(g) increase in population
if the population of a county increases more rapidly than the increase in production, then there will arise a state of disequilibrium between demand and supply. the demand will be more than the supply and as a result the price will increase which will be the cause of inflation.
(h) structure of production
if disequilibrium arises in the structure of production, then in such a situation also inflation will occur. due to production of other goods in greater quantity than the daily consumption goods of the public the price of the daily consumption goods will increase. so , decrease in the production of consumption goods will increase the price of such goods leading the way to inflation.
due to these various reasons when the state of disequilibrium arises between the quantity of money and credit and the quantity of available output, then the state of inflation will occur. but this does not mean that the state of inflation will always occur due to increase in the quantity of money or decrease in the quantity of production inflation is the result of the state of disequilibrium between these two . increase in the quantity of money or monetary will result the "cost push inflation".







Monday, March 15, 2010

types of inflation

inflation in all countries are not of the same types. in some countries price increases very slowly while in some countries price increases very rapidly. therefore, inflation is classified on the basis of increase in price. in some countries, inflation occurs even in the state of peace while in some countries inflation occur during the time of war. thus, inflation can be classified as follows:
1. on the basis of speed
2. on the basis of time
3. on the basis of scope
4. on the basis of government reaction
5. on the basis of employment
6. By cost push and demand pull induced

1. on the basis of speed
inflation can be classified on the basis of speed of increase in price of the goods. in the basis of speed, inflation can be divided into four types. they are:
(1) creeping inflation
creeping inflation is a slow inflation in this type of inflation, price increases about at the rate of 2 percent year. so, slow increase in price is not taken as bed.
(2) walking inflation
this is the second type of inflation. in this type of inflation price increase about at the rate of 5 percent every year. after the emergence of walking inflation in the economy the economic crisis will start.
(3) running inflation
this is the third stage of inflate. in this stage, the speed of increase in price is high. in this type of inflation price increase about at the rate of 10 percent every year.
(4) hyper inflation
this type of inflation is also known as galloping inflation. Keynes has taken this as the real inflation. in such a situation occurs after the state of full employment. this type of inflation was experienced by Germany in 1923 after "second world war". by Hungary in 1947 and by china in 1949.

2. on the basis of time
on the basis of time, inflation can be divided into type. they are:
(1) peace-time inflation
in developing countries, during the time of peace different projects will be in operation. in such projects the government will invest in great amount . but investment in such projects won't directly help in the production of consumption goods. only infrastructures for production or expansion of markets will be prepared. in such situation many people will increase their income as a result of being employed. as a result, a great gap will occur between income and consumption goods. that is, there will be disequilibrium between demand and supply and this will lead to inflation. inflation occurring in such situation is known as peace-time inflation.
(2) war-time inflation
inflation that occurs during the time of war is known as war-time inflation. since lots have to be spent on war, the government uses all the resources of the country for the purpose of war. in such a situation, despite the increase in the supply of money, the production of consumption goods won't increase. as a result a inflationary gap occurs and price increases.
(3) post-war inflation
in general, after the war the demand for consumption goods will increase. mostly during war people are highly taxed. but after the war the burden of tax will be removed which will result in the increase in great quantity, the production of consumption goods won't increase immediately. due to the higher demand for than the supply of goods the price of goods will increase creating inflation. this type of inflation after war is known as post- war inflation.
3. on the basis of scope
on the basis of scope, inflation can be divided into two type. they are:
(1) comprehensive inflation
increase in the price of all goods and services available in the country is known as comprehensive inflation. under this , the price of all goods and services production in the economy will increase.
(2) sporadic inflation
increase in the price in only one sector of the economy is known as sporadic inflation. this type of inflation occurs due to some specific reasons. for example. if production is stopped or decreased due to natural causes, then this type of inflation will occur.
4. on the basis of government reaction
on the basis of government reaction inflation can be divided into two types. they are:
(1) open inflation
if the government does not rake any measures to control the increase in price in the market and as a result price increases, then this type of inflation is known as the open inflation. in such a situation, price is determined in the market by the market structure. when any goods become scarce or less in the market, then the industries will increase the price of such goods. the inflation that occurred in countries like Germany, Australia, Russia, etc. after "first world war"and in countries like, Greece, china, Poland etc. after" \second world war" is the example of open inflation.
(2) suppressed inflation
in suppressed inflation, the government tries to control the increase in price through price control and different other policies. if the government fully succeeds in controlling the price in the economy, then the price of goods and services will remain constant and this will be known as suppressed inflation. suppressed inflation can have many types of negative effects in the economy. for the price control, price controller and suppliers have to be appointed. thus appointed people have to be skilled, efficient, experienced and trustworthy. that is it is very necessary for such people to possess good qualities. otherwise price increase will be comprehensive. Milton Friedman has said, "suppressed inflation is far more dangerous than open inflation." in Nepal, after the movement of 2046 B.S. , the government opened subsidy shops, but price increased in the market comprehensively. this can be taken as an example of suppressed inflation.
5. on the basis of employment level
on the basis of employment level also, inflation can be divided in to two types. they are:
(1) partial inflation
before the state of full employment,due to increase in income of people the available factors will be efficiently and fully utilized which will result in the increase in the level employment. but in such increase, the increase in the quantity of production will be less relative to the increase in employment. this type of increase in price is known as partial inflation.
(2) full inflation
after the state if full employment in the economy, the production will not increase in proportion to the increase in the quantity of money. so, inflation resulted due to disequilibrium between production and the quantity of money is known as full inflation.
6. cost push and demand pull inflation
in modern age two main through have emerged in relation to the causes of inflation. according to one thought, inflation occurs due to excessive demand. this inflation is known as "demand pull inflation" according to the other thought, inflation occurs due to increase in the cost. this inflation is known as " cost push inflation" .demand pull inflation and cost push inflation are interrelated because both of these will increase the inflation. these can be explained separately as follows:
(1) cost push inflation
modern economists have taken the increase in the production cost as the main reason for the increase in the price. that is if production cost of goods increases due to some reasons, then the price will increase,. the production cost increase when price of every factor of production is increased with the view of distributing national income equally. when price of any factors of production increase, the price of goods will also increase. increase in tax , increase in wage, international cause, increase in profit etc. are some of the main reasons for the increase in cost.
(2) demand pull inflation
according to the theory of "demand pull inflation", if aggregate supply i money required for current price of goods and services is in excess then" demand pull inflation" will be resulted. that is , according to the theory of quantity of money, when the state of full employment is created in the economy, then supply of money will increase resulting demand pull inflation. when market price increase comprehensively due to normal increase in the demand in the economy, the demand pull inflation will be resulted. for example, in Nepal , if the government proposes the deficit budget for the completion of various plans, then such deficit budget is met by raising internal loan or by issuing new note. this will help in the completion of various development and constructive works in the country. but this deficit budget will increase the income of the public, this will then result in the increase in demand and "demand pull inflation" will be created.
according to this concept, the inflation occurs when the demand further increase after reaching th state of full employment,. in such situation aggregate demand will be more than the aggregate supply because after the state of full employment supply won't increase despite the increase in demand. therefore, price of goods will increase. this is known demand pull inflation.

stagflation

in the years after the "second world war"the economic development in most of the countries of the world became very rapid. the industrial countries developed and improved their economy even more. but after the year 1973, almost all the industrial countries economy had to face new type of economic crisis. the inflation rate of such countries became very high. this resulted recession in the economic development of such countries . as a result, industrial recession started in these countries and unemployment increased. so, comprehensive price increase in the economy in the state of recession and stagnation in known as stagflation or slumplflation. in stagflation slump and stagnation occur together. the mixed from of slump and inflation in the slumpflation.
the state of stagflation is the mixed form of normal unemployment and inflation. in such situation, inflation and recession both occur at once in the economy. despite the increase in price level and wage rate people will have hard time getting employment. goods produced in the economy will remain unsold. stagflation and inflationary recession are looked upon as one. so. stagflation is such concept in which both inflation and normal unemployment state occur at once.

Sunday, March 14, 2010

effect of inflation

inflation affects the different sectors of the economy differently. in general, effects of inflation seem to be negative. but if the rate of inflation is low, then this provides some motion to the economy. this sort of motion increase the employment and leads the economy towards development and prosperity. but, when the rate of inflation is high, then this will affect the economy negatively. this will hinder the capital formation as well as create the black market and artificial scarcity with decrease in the quantity of goods. if the income of people increases in proportion to the increase in the price of goods, then this is not regarded as harmful. but if the price and income do not increase proportionately in the economy, then this will affect different sectors of the society differently. the sector having fixed income will be affected more than the other sectors, thus, effects of inflation can be explained more clearly by dividing them into two part. they are :
1. economic effects
2. non-economic effects

1. economic effects of inflation
economy is deeply affected by inflation. the economic effects of inflation can be divided into two parts. they are:
i. effects on production
creeping inflation has positive effect in the economy because in the beginning the increase n price is very small. in such situation, due to small increase in the cost of production, the profit also increases by a small scale. this affects the economy positively. when hyper inflation occurs in the economy, then due to uncertainly there will be negative effect in production. therefore, hyper inflation is harmful to the economy. the negative effects on production can explained as follows:
(1) disrupts in price system: inflation will disrupt the price system which will increase slowly. as a result if this the factors won't be mobilized properly.
(2) discourage to foreign capital: inflation not only decrease the saving of domestic capital, it also result in the devaluation of money . as a result, there won't be profit for the foreign investors and this will discourage the foreign capital investment.
(3) reduction in capital accumulation: inflation badly affects saving and capital formation because high price needs to be paid for the goods when price increase. as a result there won't be any saving and sources of investment will be closed.
(4) encourages hoarding: when prices increase people will increase the stock to create artificial scarcity in order to earn more profits. from this , the businessmen specially the black marketers will make excessive profits. due to fear of further increase in price people will start hoarding more goods and this will increase the price even more.
(5) encouragement to speculation activities: inflation encourages speculation activities withe further increase in prices. businessmen instead of producing proper goods for earning profits, shift to easy and fast profit making activities.
(6) reduction in the volume of production: inflation reduces the volume if production in two ways. firstly, there won't be any capital formation due to lack of saving. secondly, due to uncertainty in the business, the producers are not ready to bear risks. therefore, there will reduction in the volume of production.
(7) effects on the pattern of production: hyper inflation brings about the change in the pattern of production. due to inflation, income of some people will increase comprehensively while income of some other people will decrease. people with increased income will demand for luxury goods in greater quantity. therefore, production of luxury goods will increase and the production of necessary goods will decrease.
(8) decrease in quality: in the state of inflation, the inflation of the sellers in the market will increase. as a result, to earn more profit, they will reduce the quality of the goods.
ii.effects on distribution of wealth
inflation badly affects on the distribution of wealth. when price increases in the economy, some class ofthe society will benefit and some class will face loss. in any society, there will be two classes of people. one having constant income and the other having variable income. if the inflation prevails for a long period then businessmen, industrialists and rich people will become even richer while the poor class and people with fixed income ( servicemen, teachers, people dependent on pension and some kind of rent) will become poorer facing even worse situations. so, effects of inflation on different people of the society are as follows:
(1) debtor and creditor: when price increases, the debtor will benefit and the creditor will suffer loss. when price increases, then the value of money will decrease. the money returned by the debtor will be able to purchase less quantity of goods and services than before. what is clear from this is that, the value of money is more at the time if taking loan and the value of money is less at the time of returning the loan. therefore, debtor will have some sort of benefit and the creditor will have some loss during the time of inflation.
(2) wage and salary earners
daily wage earners and salary earners are affected more by inflation. there are mainly two reasons for this. firstly wage and salary do not increase in proportion to the increase in price. secondly, the gap between the increase in price and the increase in wage and salary will become even wider. in such a situation, labors and servicemen not associated with labor union will be affected more. that is . they will suffer more loss.
(3) fixed income earner group: people dependent on fixed income, such as pension, house- rent and previous saving will be affected by inflation. thus is, inflation will harm the people having fixed income. but people having variable income, such as, industrialists, businessmen and share-holders will benefit from inflation . the income of such people will increase during the time of inflation.
(4) business community: all types of business communities, such as producers businessmen, entrepreneurs, speculation group etc, earn profit deuing the time of inflation. to earn more profit in short period. they will increase the price of goods more than the increase in the cost of production of such goods. similarly , since the value of the assets of such people increase such communities will be in profit.
(5) investors: investors are affected by inflation in two ways because there are two types of investors. the first type of investors are those having fixed income and the other type having variable income. investors with fixed income are those who earn income at a fixed rate as interest for providing their capital for investment. such a investors are not affected by the profit or loss in th business. in such situation excessive increase in the price of the goods will decrease the purchasing power. contrary to this, investors having variable income will benefit from inflation because they share the profits and losses of the industry,if profit is resulted, then their profit will also increase proportionally. since level of profit is more during the time of inflation , the income of the investors will also be more because they will get their shares.
(6) farmers: normally, price of the goods is more than the cost of production during the time of inflation. for this reason the farmers are also benefited. but Small farmers won't be able to share this benefit. small farmers normally don't produce goods for selling in the markets. as a result, they will have to purchase some goods for consumption.
2. non-economic effects of inflation
due to excessive increase in demand during the time of inflation, the production and employment also increase. this will benefit the debtors, producers and business communities. but, this does not mean that the effects of inflation are always good. inflation harms the consumers, investors and creditors . as a result inflation also has various non-economic effects.
" non -economic effects" means crisis in social, political and moral sectors. corruption, black market, bribery, etc. are resulted due to inflation. the government. so, the effect of inflation is economically unsound, politically dangerous and socially as well as morally disastrous. non-economic effects of inflation can be explained as follows:
(1) social effects : inflation has various effects in the society. inflation makes rich people even richer and poor people even poorer. as a result of this , conflict starts between the rich class and the poor class.
(2) moral effects : inflation negatively affects the morality of people. as a result of this, black market, bribery and corruption will increase in the society. this will provide protection to the speculation activities. with the objective of earning more profits businessmen will mix goods with inferior goods which will even reduce the quality of goods.
(3) political effects: inflation not only has economic, social and moral effects but it also has political effect. during the time of inflation, people will be dissatisfied with the government. as a result, unhealthy competition will start in politics. opposition parties try to become ruling body by heavily criticizing the government and turning the people against the government. they try all means to remove the ruling government. the inflation of 1920 in Germany made Hitler a dictator


Thursday, March 11, 2010

remedies or control of inflation

since inflation has negative effect in the economy the government should control it. but control of inflation does not mean that the price is kept constant totally. excessive inflation will have serious social, political economic effects. therefore, for the equilibrium of the economy, the inflation has to be controlled. to control the rate of inflation the following measures can be undertaken:

1.monetary measures

2.fiscal measures

3.direct measures

1. monetary measures

the inflation in the economy can be controlled by the monetary policy of the central bank. for the control of inflation, the central bank will undertake the following monetary measures:

(1) increase in bank rate

to control the inflation the central bank will increase the bank rate. this will increase the intertest rate for the loan provided by the bank. thus, increased interest the will decrease the demand for loans. decreasing the monetary expansion. this will control inflation to some extent.

(2) open market operation

for the control of inflation the central bank sells the government securities to the businessmen and public through open market operation. this will bring the money from the hands of businessmen and public to the hands of central bank. the quantity of money in the hands of businessmen and public will decrease and as a result inflaton will be controlled.

(3) increase in the minimum cash reserve ratio

central bank will increase the minimum cash reserve ratio of the commercial banks. so, commercial banks will have to deposit more amount of cash in the centeal bank. this will decrease the credit creation capacity of the commercial banks and as a result inflation will be controlled.

(4) decrease in the credit facility

if credit facilities and instalment facilities are given for the durable goods, such as televisions, cars, washing machines, refrigerators, etc. then demand for such goods will increase. to control inflation in such a situation, the central bank will increase the amount of first instalment. this will decrease the demand for such goods and as a result inflation will be controlled.

(5) changes in the margin requirement of securities

when inflation occurs in a country, then to control this the central bank will arrange a system for commercial banks to provide less amount of loan than the value to the securities. as a result of this , customers will get less amount of loan for the higher value of securities. this will decrease in the monetary-expansion and inflation will be controlled.
2. fiscal measures
to control the inflation that occurs in the economy, the government has to undertake fiscal measures along with the monetary measures. government can control inflation through different types of fiscal policies which can be explained as follows:
(1) increase in the rate of taxation
government has to increase the tax rate in various sectors of the economy. this will decrease the quantity of money in the hands of people of different sectors and as a result inflation will be controlled. in addition to this due to new taxes demand for goods will decrease and price increase will be checked.
(2) balanced budget
to control inflation, the government has to prepare balanced budget as far as possible. this is because to fulfill deficit budget the issuing of new notes will be required. as the issuing of new notes creares inflation it is conreolled by preparing balanced budget.
(3) decrease in the government expenditure
increase in the public expenditure by the government will increae the quantity of money in the hands of the public. this will increase in the demand for goods creating the state of inflation. so, there should be decrease in the government expenditure. this will decrease the demand and inflation will be controlled.
(4)encouragement to saving
government has to encourage saving and decrease consumption through different fiscal policies. this will decrease the demand and inflation will be controlled.
(5) over valuation of money
in the time of inflation demand for goods will increase excessively. to control this , the export of domestic goods to foreign countries should be checked. for this , the domestic currency should be over-valued. this will make the domestic goods expensive in the foreign markets. this will decrease the demand for domestic goods by customers of the foreign markets. that is, export from the domestic country to the foreign countries will decrease. as a result, domestic goods will be available in the domestic market at lower price and this will help in controlling inflation.

3.direct measures
to control inflation, in addition to monetary and fiscal policies the government can under table some other types of direct measures. with inflation by determining an appropriate wage rate. the wage of the labors should be determined on the basis of their productivity. this will also control inflation.
(1) control of the wage rate
due to high wage rate demand increase in the economy and as a result inflation will occur. in such a situation, the government can control inflating by determining an appropriate wage rate. the wage of the lab ours should be determined on the basis of their productivity, this will also control inflation.
(2) increase in production
if production increase in the same proportion as the increase in the quantity of money, then inflation won't occur in the economy. while increasing production, the government should encourage the production of necessity goods rather than the production if luxury goods. this will increase the production of necessary goods as per demand and the inflation will be controlled.
(3) change in investment pattern
during the time of inflation, income increase due to increase in the quantity of investment. but production of directly necessary goods won't increase. as a result of this, inflation will occur. in such a situation, the government should encourage investment in the production if direct consumption goods rather than in the construction of infrastructures of production.
(4) direct control
the government can control inflation by the direct control over the increase in price. in such a situation, the goods whose demand is more than the production, the government should supply those goods under "rationing". this will control the increase in demand for such goods and inflation will be controlled.



Tuesday, March 9, 2010

significance of fiscal policy in developing countries

the fiscal policy has a main role in the economic development of developed as well as developing or underdeveloped countries. however, for developing countries the fiscal policy is such an instrument or tool, which works as a directive for capital formation, economic development, increase in production, increase in employment, increase in social welfare, etc.
decrease in national income in underdeveloped or developing countries is not only the problem of fiscal policy. in such countries, "vicious circle of poverty" and "high propensity to consume"will decrease "propensity to save" decreasing the investment. as a result of this, employment and income will be directly affected. so , the effect of "vicious circle of poverty"will be directly on effective demand.as a result of this,

national income of such countries will decrease due to low liters, unemployment, malnutrition. decrease in production, etc. to gain freedom from such situations, the government of underdeveloped or developing countries should formulate and implement appropriate and feasible fiscal policies to break the "vicious circle of poverty" and to increase economic activities. for this, the government has to undertake appropriate tax-system, so that without any negative effects in the social structure the collection of government revenues will be increased. people having high income will pay a larger amount of tax while people having low income will pay a smaller amount of tax. this will increase in saving and as a result capital formation will also be increased.

after government revenues, the next major part of fiscal policy is the public expenditure. the revenues of the government from various sources should be spent on public sectors according to priority and necessity. the government expenditure may create inflation in the economy. therefore, appropriate fiscal policy should be formulated according to the state of the economy. so, due to proper fiscal policy production will increase. in addition to this , as a result of optimum mobilisation of resources, employment and income will increase with the increase in effective demand also.

the third tool of fiscal policy after public expenditure is the policy of public borrowing. through public borrowing also the employment, production and capital formation required for a country's economic growth will increase accelerating the economic development. since capital formation in underdeveloped country is slow, the loan can be obtained in two ways viz. internal and external. internal borrowing will mobilise the capital in stock while insufficient capital will be fulfilled with the loan from foreign countries or donor organisations to enhance the economic activities. the dependence of large population of the country on agriculture, high population growth rate, lack of capital formation ,lack of industrial and technological development, very low per capital income, adverse balance of payment, inequality in the distribution of income, etc. are the main causes for the occurrence of such states in the underdeveloped countries. improvement in these various causes should be brought about through fiscal policy. therefore, in underdeveloped and developing countries the role of the fiscal polity will be to meet the objectives as has been mentioned above. in addition to these things, the important role of the fiscal policy is in the following things:

1. appropriate income and expenditure system

in underdeveloped or developing countries their occurs evils in social, economic and political structures. government plays an important role to control evils on such sectors by controlling public economic administration with appropriate income and expenditure system.

2. maintaining regional balance

in underdeveloped countries the development of all sectors won't be in the same rate. the reasons for this are the geographical structure of the country,culture, customs and traditions of the people. the government plays an important role in developing the underdeveloped sectors through fiscal policy and public expenditures.

3. increase in foreign trade

in underdeveloped countries due to inadequate capital, industries won't increase. as a result, necessary goods will be imported from foreign countries. this will increase it he quantity of imports and balance of payment will be unbalanced. but the government will encourage the production of export goods and tries to decrease imports through fiscal policy. for this the government will provide various subsidies and facilities on the export goods. this will encourage the investors towards investment,as a result, foreign trade will increase and adverse balance of payment will decrease.

4. equal distribution of national income

in underdeveloped countries their will be inequality in the distribution of the national income. most part of the national income will be concentrated In the hands of a few people. this is taken as inappropriate from the view of social as well as economic justice. such a situation will create political instability in the country. to be free from such problems the government has to undertake appropriate fiscal policy. the government has to implement progressive tax system through fiscal policy. as a result, the government will tax the rich people heavily. thus obtained revenue will be spent by the government for the benefit of poor people such as education, health, employment generation activities , etc. this on one hand will save the expenditures of poor people in such sectors and on the other will get employment. so , the fiscal policy plays an important role in the equal distribution of national income.

5. maximum social welfare

in underdeveloped and developing countries the government plays an important role in the equal distribution of national income and providing maximum social welfare through fiscal policy. fiscal policy plats an important role in taxing rich people heavily and investing such revenue in productive sectors. so, there will be a great importance their social policy to increase the income level of poor class for increasing their social and economic welfare.

6. increase in per capital income

fiscal policy tries to involve all people of the country in employment. this will increase the per capital income of the country. due to investment in different sectors the national income will increase. this will help in the increase in per capital income.

7. expansion of industries

through government fiscal policy on one hand capital formation increases resolution development and expansion of industries while on the other hand due to open fiscal policy internal and external investment increase resulting expansion of industries. in addition to these various things, basically the main role of the fiscal policy is to fulfill the objectives maintained above.

Sunday, March 7, 2010

objectives of fiscal policy

the government of any country formulates the fiscal policy with reference to the prevailing situation in the country. therefore, developing and developed countries will have different fiscal objectives and policies. due to economic development, developed countries won't have economic problems as those in developing countries. however, from time to time due to economic instability that arises in the economy creates the problems of trade cycle. therefore, in such countries the main objective if fiscal policy is to establish economic stability. but in under-developed to developing countries there will be many types of problems. there won't be adequate development in the resources and factors available in the country. the economy will be in semi-developed or undeveloped state. thus, in such countries the objective of fiscal policy will be optimum utilization of resources and factors, price stability, increase in employment, balance of payment, removal of inequality in the distribution of income, etc. for the economic growth and development. the government tries on its own to solve such problems because in such countries the government has the main role in the economic development of the country. therefore, the main objectives of the fiscal policy of the under-developed or developing countries can be presented as follows:
1. capital formation
for any developing country, the main objective of fiscal policy is the capital formation because in such countries the marginal propensity to consume of the people will be high. that is the people of such countries consume most part of their income. this will result in no saving or least saving. as a result, there won't be capital formation due to lack of saving. capital formation is very essential for the economic development. therefore, the government aims in capital formation through its fiscal policy. due to the majority of poor people in the country, the private sectors won't invest in such sectors. the government tries to mobilise its investment policy in such sectors. investments in such sectors will attract private sectors towards investment. for this the government invests in the construction and development of infrastructures required for development, such as, development of roads and transportation, development of electricity and communication development of irrigation facilities, etc. this will increase the income of public. for the capital formation the government mobilizes saving. different government securities will be sold to the public. this will increase the propensity to save of the people. the government invests the saving of the public in different productive sectors. so, in this manner the government forms and mobilises the capital through internal debt.
2. full employment
the "great economic depression" of 1930 A.D.created a state of great unemployment in the economy . before that the leading classical economist J.B. say's law of market that, "supply always creates its own demand" was widely accepted. the "great economic depression" proved J.M. Keynes. in the year 1936 A.D. in his book ,"general theory of employment interest and money" presented the concept that the state of unemployment is created due decrease in effective demand. that is , due to decrease in investment there won't be capital formation and as a result unemployment will emerge in the economy. for this, national production should be increased otherwise there will be unfavorable effect on employment. production also depends upon effective demand. increase in effective demand increase employment and decrease in effective demand decreases employment and decrease on effective demand decrease employment. so, according to Keynesian concept employment fully depends upon effective demand. according to the concept of developed countries in reference to full employment all people who are qualified to work or who are capable of working should immediately ger employment at the prevailing wage rate when desired to work. however, this does not mean that there won't be any people unemployed. that is, for the creation of employment the government has to implement its fiscal policy. in under-developed countries the main objective of he fiscal policy is to increase the level to employment for the increased population due to excessive increase in population. for this , the government invests for the development of small cottage industries as well as different training will be provided to the public in relation to the cottage industries.
3. mobilization of the resources
in developing countries adequate amount of natural resources will be available. the capital of the country won't be used for the moboilisation of such resources. this is because private investors cannot mobilize such resources. so, finding the means of mobilizing such resources is the main objective if the government fiscal policy. under-developed countries lack capital and technological knowledge. through fiscal policy. the government collects capital and develops technological knowledge. for this the government will require to collect capital. to fulfill this requirement the government creates suitable environment for the internal as well as external loans. so, with the mobilisation of misused resources the government will increase employment, production, income, etc. in the economy.
4. economic stability
economic stability is an important objective of the fiscal policy. economic problems such as, unemployment, inflation, deflation,etc. keep on occurring is the economy from time to time. as a result of this, the states of prosperity and depression occur in the economy. these create instability in the economy. economic instability drags the economy towards even worse state. the
"great economic depression" of 1930 A.D. created economic instability with the massive decrease in production, employment, income, price, saving and investment of every country of the world. for the elimination of such economic crisis, the government has to formulate its fiscal policy.for the economic stability in the developed and under-developed countries different fiscal policies have to be formulated and implemented.
there are two main objectives of the fiscal policy in the developed countries. firstly, to maintain the state of full employment in the economy and secondly to control ups and downs economy such as, inflation and deflation. to fulfill these objective in such countries, effective demand has to be increased through fiscal policy. as a result, problem of business cycle won't occur in the economy. to maintain the national income at some fixed level the government expenditure works as a balancing factor. government expenditures can fully control such ups and downs that occur in the economy. if in the economy there is a state of depression, the government expenditure has to be increased and in the state of inflation, the government expenditure has to be decreased with the implementation of compensatory fiscal policy. in the state of depression, through government fiscal policy the production sectors should be taxed less so that discouraging environment won't be created in production. similarly, in the time of inflation, the government has to raise internal loan as well as to impose heavy taxes. this will decrease in demand for the elimination of the state of depression the government has to spend on the development of public utilities such as, construction of roads, irrigation, health sector, education sector, etc. such public work programmes increase the government expenditure. this will mobilise the resources and the unemployed will get employment. this will increase the income and the marginal propensity to consume of the people. thus, increase in demand increase investments in government as well as non-government sectors.
5. economic development
the economic growth rate if the underdeveloped countries will be very small. the government aims in accelerating the economic development through fiscal policy. for the economic development, the resources and factors available in the country should be mobilizable efficiently. in underdeveloped or least-developed countries the natural resources are usually wasted while in some situations these resources are also misused. the government formulates the fiscal policy for the proper and efficient mobilisation of such resources and factors. in such countries, the marginal propensity to counselor of the people will be high and saving will be low. the government can collect dispersed saving for capital formation to invest in appropriate sectors.
the following things should be looked upon very carefully for the economic development in the underdeveloped or least developed countries.
(1) investment in productive sector
the objective of the government fiscal policy should encourage investment in productive sectors from both government and non-government sectors.
(2) monetary stability
along with the increase in various activities of the economy the monetary stability should also be established.
(3) distribution of national income
when national income increase then careful thought should be given to whether it is equally distributed or not.
so, for the economic development of underdeveloped countries the investors, savers, stability and redistribution should be given a clear thought.
6. control of inflation
different economic activities in a country increase inflation in every country day after day. deficit budget of the underdeveloped countries and adverse balance of payment, the economy has been badly affected. to face such economic crisis the government has to undertake appropriate fiscal policy which will proved stability for economic growth in the economy. these sorts of situations are seen specially in underdeveloped countries. in these , in addition to deficit budget, production do not increase due to misuse of resources, lack of credit facilities. lack of necessary raw materials ,lack of technological knowledge, etc. but due to high population growth inflation occurs. to control this is the work of the government. first, the government traces out the cause for the inflation and then will formulate appropriate fiscal policies for its control. if aggregate effective demand is more than the aggregate supply of goods and services, then demand pull inflation will occur in the economy. so, the government has to formulate appropriate fiscal policies to control demand pull inflation. thus, in such countries, the objective of fiscal policy is also to control inflation.