Economy

Ina an economy some agents have surplus funds while others have deficient funds. The market where the exchange of funds between those who need and those who have in surplus takes place is called Financial Market

Financial Institutions

1. Banks
2. Mutual Funds
3. Insurance
4. Pensions
5. Post Office
6. Share Market

Financial Market

1. Money Market - short term loans upto 12 months
2. Capital Market - long term investments
   1. Debt or Bond Market - giving loans in return for fixed return
   2. Equity Market - buying shares in return for dividends or share appreciation
      1. Primary Market
      2. Secondary Market

Debt or Bond Market

• Investments through bond purchase by investor/lender/creditor
• When bond reaches maturity the investor redeems bond value + promised interest / dividend
• So profit or loss doesn't affect the return for investors
• Bonds are secured against collateral
• No ownership rights for investors
• During liquidation bonds are given priority over equity
• Types
  • Zero coupon bonds - Instead of interest, bonds are purchased at a discount and redeemed at issue price
  • Inflation indexed Bonds = Interest promised + inflation || bcos ( Real Interest Rate = Interest Rate + Inflation )
  • Convertible Bonds
    • Fully Convertible - Whole loan amount can be converted into equity
    • Partially Convertible - Only partial loan amount can be converted into equity
    • Non-Convertible - No part of loan can be converted into shares
  • Short-term Bonds (maturity less than 1 year)
    • Govt - issues Treasury Bills (for long term loans of 20-30 years G-Secs are issued)
    • Companies - issues Commercial Papers
    • Banks - issues Certificate of Deposits
    • 14 days, 91 days, 182 days, 364 days

Some terms

1. Bond price = Cost of the bond
2. Bond Yield = Interest rate on bond
3. Debentures = Debt Instrument without collateral
4. External Commercial Borrowing = Debt instrument to raise loans from foreign investors

Equity Market

• Investment through buying shares
• Investors earn or loose by trading the share to another investor when the share price goes up or down respectively
• Investors also earn through dividends released from the profits
• So profit or loss affects returns
• Investors owns a part of the company based on no of shares they have
• So there is no security against the the share purchased
• Types
  • Primary Market
    • IPO - Initial Public Offering - Initial or 1st time sale of shares to public - Underwriter who is an investment bank or investment banks buys the IPO shares before listing and sells it stock exchange
    • FPO - Follow-on Public Offering - Second or follow up share listing to raise capital by listed company after IPO
    • Private Placement - Sale of shares directly to big investors like banks or HNI without
  • Secondary Market
    • Stock Exchange - where existing shares are traded
    • Commodities Exchange - Where food products, metal and energy is traded
      • MCX - Multi-commodity Exchange
      • NCDEX - National Commodity and Derivatives Exchange
    • Derivative Market - Financial instrument that derives its value from an underlying asset or group of assets like stocks, bonds, commodities, currencies, interest rates, market indices
      • Future - obliged to buy or sell at future date at fixed price
      • Option - option to buy or sell at future data at fixed price
    • Forward Market - Future traded outside exchanges

Some more terms

1. Funds of stock exchange
   1. Domestic Funds
      1. Mutual Funds - can include both equity and bonds
         1. Open Ended - can be bought at any time
         2. Close Ended - can be bought or sold only in secondary market after closing date of issue
         3. Exchange traded fund - mutual funds that tracks price of stock, gold ..etc
            • Gold ETF - tracks only gold(govt wants to popularise this to reduce CAD)
      2. Pension Funds
      3. Insurance Funds
      4. Company's Investment
      5. Bank Investment
   2. Foreign Funds
      • Foreign Institutional Investors
      • Participatory Notes or P-Notes
      • Hedge Funds
2. Gild edge securities = Govt securities
3. Alternative Investment Funds
   • Privately pooled investment funds that doesn't come under jurisdiction of any regulatory agency in India
   • Includes venture funds, hedge funds, private equity funds, debt funds, infrastructure funds
4. Free floating market Capital = price of each share * no of shares of a company
5. SENSEX = Sensitive Index is weighted avg of FFMC of top 30 Companies listed in Bombay Stock Exchange
6. NIFTY = National Index fifty is weighted avg of FFMC of 50 most liquid or actively traded stocks in National Stock Exchange

Rising Fund in Foreign Capital Market

1. American Depository Receipt - Indian companies can list themselves in american stock exchange
2. Global Depository Receipt - Indian companies can list themselves in European stock exchange
3. Indian Depository Receipt - Foreign companies can enlist in Indian stock exchange

Why National Income Accounting is needed ?

• Knowing how much wealth a country produces helps budgeting for national development
• "Wealth of the nation is the 'value of total goods and services produced'" - Adam Smith

Who are the players in an Economy ?

1. Individuals or Households
2. Business Firms or Investor
3. Government
4. Foreign Nationals or Rest of the World
5. Financial Market

What is circular flow of goods and services ?

• Five sector flow of goods and services
• But here consider only two players - Households and Firms
• Households supply Land, Labour, Capital and Entrepreneurship to Firms
• In return firms give rent, wage Interest and Profit respectively
• Wage, rent, Interest and Profit are expenditure to firms but income to households
• So one's income(households) = other's expenditure(firms)
• So National Income = Income of all or Expenditure of all
• G&S produced by firms are consumed by households
• So Value of G&S produced(Product Method) = Expenditure of households(Consumption Method) = Income of household(Income method) = National Income

How is a wealth of a nation calculated ?

• Product Method or Output Method or Value added Method - gives GDP, NDP
• Income Method - gives GNI, NNI
• Expenditure Method or Consumption Method - gives GDP, NDP

Some Economic Terms

1. GVA(Basic Price) / GVA(Producer's Price) = Gross value addition without product taxes and product subsidies but includes production taxes less production subsidies
2. GVA(Basic Price) = Output of 11 industries - Intermediate Consumption
   • Output of 11 industries = Input material & services + Value Added
     1. e.g Carpenter buys logs from woodcutter for Rs.100
     2. gives it to ply maker to convert it into plain ply for Rs.300
     3. makes a table and sells it for Rs.600
     4. Value Added = 600 - (100+300) = Rs.200
     5. Output = Input (100) + Service(300) + Value added(200)
     6. Intermediate Consumption = Input material(100) + Services(300)
3. GVA(Basic Price) = CFC + CE + OS/MI + Production Tax less Production Subsidy
   • CFC = Consumption of fixed capital (depreciation of machines and tools)
   • CE = Compensation to Employees (wages for producing)
   • OS/MI = Operating Surplus or Mixed Income (profit to entrepreneur)
   • Production Tax = Land revenue, stamp fee and license fee - incurred irrespective of production made or not
   • Production Subsidy = Subsidies to railways, industries
   • Product Tax = GST, excise duty, sales tax
   • Product subsidy = food, petroleum, fertilizer subsidy
4. GVA(Factor Cost) = GVA(Basic Price) - Production taxes less production subsidies
5. GVA(Factor Cost) = CE + OS/MI + CFC
6. GVA(Market price) = GVA(Basic Price) + Product taxes less product subsidies
7. GVA(Market price) = GVA(Factor Cost) + production taxes less production subsidies + product taxes less product subsidies

How to calculate GDP & NDP using Production Method ?

"GDP at market prices is equal to the sum of gross value added of all resident units plus taxes, less subsidies on products "

1. GDP(Market Price) = GVA(Basic Price) + Product taxes including import duties - product subsidies { New series since 2015 }
   • GVA(Basic Price) = Value addition by any one within Indian economic territory includes KFC but not NRI in USA.
   • GVA is sector specific and GDP is summation of GVA of all sectors of economy
2. NDP = GDP - Consumption of fixed capital

How to calculate GNI & NNI using Income Method ?

"GNI is the aggregate value of the gross balances of primary incomes of all resident institutional units"

1. GNI = GDP + Net primary income from rest of the world
2. GNI = GDP + Net compensation of Employees from ROW + Net property and Entrepreneurial Income form ROW
3. NNI = GNI - Consumption of Fixed Capital
4. NNI = a.k.a National Income
5. NNI/Total population = per capita income
6. Primary Incomes
   1. Factor Income (by factors of production)
      1. Wage income to individuals
      2. Property income like rent and interest
   2. Tax income to Govt
7. Primary Income doesn't include
   1. Current Transfer
      1. Current taxes on income, wealth
      2. Social contributions and Benefits such as old age pension, PF, unemployment compensation, disaster relief payment
      3. Other current transfer

How to calculate GDP using Expenditure Method ?

National income can be calculated by compiling income of all or expenditure of all

1. Income = Consumption Expenditure + Savings
2. Savings used in fixed and financial assets = capital formation
3. GDP = PFCE + GFCE + Export of G&S - Import of G&S + GCF / Investment Expenditure + Discrepancies
   1. PFCE = Pvt Final consumption expenditure ( Economic Territory & ROW)
   2. GFCE = Govt Final consumption expenditure
   3. GCF = Gross capital formation
   4. Discrepancies = b/w expenditure method and production method bcos time difference between production and consumption

Related Terminology

1. Nominal GDP = GDP at prevailing price
2. Real GDP = GDP calculated at base price
   1. e.g a country produces 100 litre oil @ Rs.2/litre in 2021
   2. 80 litre oil @ Rs.4/litre in 2022
   3. Nominal GDP in 2021 = Rs. 100 * 2 = Rs.200
   4. Nominal GDP in 2022 = Rs. 80 * 4 = Rs.320
   5. But Real GDP in 2022 = Rs. 80 * 2 = Rs.160(2021 as base year)
3. Real GDP adjust for inflation from base year
4. GDP Deflator = Ratio of Nominal GDP to Real GDP = 320 / 160 = 2(means prices doubled in 2022)
5. Gross National Disposable Income (GNDI) = GNI + Net Current Transfer from ROW
6. Net National Disposable Income (NNDI) = GNDI - Consumption of Fixed Capital (CFC)
7. Disposable income = Income after paying income tax

New GDP calculation vs Old GDP Calculation

• In place of GDP (Factor Cost), GVA (Basic Prices) is used (bases on SNA 2008 of US) since 2015
• But we need GDP to compare with other economies.
• GVA (Basic Prices) is sector specific and GDP is summation of GVA (Basic price)
• So, GDP (Market Price) = GVA(Basic Price) + Product Taxes including import duties - Product subsides
• So ultimately GDP (Market Price) is used instead of GDP (Factor Cost)
• GDP (MP) includes production taxes less subsides and product taxes less subsidies
• So India's GDP looks impressive since 2015 but actually deceptive. (Kudos Modiji)
• And also earlier for sectoral analysis RBI's Industrial outlook survey and CSO's Annual Survey of Industries(ASI) was used - called as establishment method
• Industrial Outlook survey uses Sampling Method
• Now IIP data and MCA 21 data is used
• MCA data base cover 5 lakh companies - So it captures data on value addition completely rather than capturing sample data -called as Enterprise-based Method

Trends in India's GDP (as on March,2020)

Economic Growth VS Economic Development

• Economic development is both quantitative and qualitative while economic growth is purely quantitative
• Economic growth focuses solely on GDP and per capita income
• Economic development focuses on improvement in quality of life measured by variables like nutrition, health, education, standard of living, drinking water, mortality ...etc in addition to GDP and per capita income
• To quantify economic development Prof. Amartya Sen and Dr. Mahbub ul Huq coined the term HDI which ranks countries as per economic, education and health achievements of its people.
• On the same lines several other indicators like Inclusive Development Index, Multi-dimensional Poverty Index, World Development Indicators and Gross National Happiness Index came up

Human Development Index

• It is the geometric mean of normalized indices for each of the three dimensions
  • health : life expectancy at birth
  • education : no of years of schooling for adults aged 25 years
  • standard of living : per capita income

Gross National Happiness

• Coined by King of Bhutan - Jigme Wangchuk in 1970s
• 4 pillars
  • Good Governance
  • Socio-Economic Development
  • Cultural Development
  • Environmental Development
• These 4 pillars have 9 parameters
  • Psychological Well being
  • Health
  • Time use
  • Education
  • Cultural diversity and resilience
  • Good Governance
  • Community Vitality
  • Ecological diversity and resilience
  • Living standards

Inclusive development Index

• by World Economic Forum
• has 12 performance indicators
• has 3 pillars
  • Growth and development
  • Inclusion and Inter generational Equity
  • Sustainability

World Development Indicators

• by World Bank Group
• Includes indicators to help measure the 169 targets of the 17 SDG's

Limits of GDP calculation or things that escape GDP calculation

• Non-monetised sectors - farm produce for personal consumption or household works
• Barter traded products in villages
• Unorganised sector income like chaiwalas
• Illegal income
• Land deals escape from GDP figures