Wednesday, 16 November 2016

Elasticity of demand- Price elasticity and Arc elasticity methods

Meaning and Definition of Elasticity of Demand

The term 'elasticity of demand' refers to the responsiveness of demand to changes in the price of a given commodity assuming that all other factors are remaining the same.

To be more specific, the Price Elasticity or Elasticity of Demand is a measure or tool employed in finding out the percentage change in quantity demanded of a good or service in response to a one percent change in the price of that good or service.

We are all aware that whenever the price of a commodity gets increased, we tend to curtail our demand for that commodity. So, the tool of the elasticity of demand tries to measure the quantum of those changes in demand with reference to the changes in prices of that commodity.

The Elasticity of Demand is also known as the price elasticity of demand.

These terms are expressed in abbreviated terms either as Ed or PED respectively.

The elasticity of demand is mostly negative in almost all cases except in cases of status goods (Veblen goods) or goods that have no substitutes (Giffen goods).

How to measure Elasticity of Demand?

The Elasticity of Demand is measured with the help of formulas just like Elasticity of Supply.
The general equation for Price Elasticity of Demand is expressed as follows:

Price Elasticity of Demand = Percentage change in quantity demanded divided by Percentage change in Price
ie. Ed = (dQ/Q)/ (dP/P)
In the above equation, Ed denotes elasticity of demand (price elasticity).
DQ refers to the changed quantity and Q refers to the original quantity demanded.
DP refers to changed price and P refers to the original price.
You can express the above equation as (Qd1/Qd) / (P1/P) where Qd1 denotes changed quantity and Qd original quantity. P1 is new price and P is original price.
But, we know that the demanded quantity decreases whenever the price increases and the demanded quantity increases whenever the price falls. So, there is always an inverse ratio in the equation excepting in the cases as mentioned above. Hence, the equation always gives a negative value.

Two more precise result yielding formulas are being used by economists nowadays to measure the elasticity of demand. These formulas are mentioned below.

1) The Arc Elasticity of Demand formula
This method is used when there is no exact equation for demand available or when we are not accustomed to taking derivatives.
2) The Point-Price (or Price-Point) Elasticity of Demand formula
This method is used when we have the exact equation with us or when we are capable of calculating the derivatives of equations.

Now, let us study these two methods of calculation.

Arc Elasticity of Demand method
The arc elasticity method gives us the average elasticity of demand between the two end points of an arc on a demand curve. So, it gives us the average elasticity of demand for that curve. It solves the problem faced by analysts in choosing one point as the original point and the other point as the new point and thus provides a great relief from the dilemma faced by the economists in calculating the elasticity. But, it may not provide the accurate figures as you are taking the average of two points on a curve.
The mathematical equation for arc elasticity of demand is as follows:

{(P1+P2)/2} / {(Qd1+Qd2)/2} x (change in quantity demanded/change in price)

So, Elasticity of Demand according to this formula = (the sum total of prices divided by the sum total of quantities demanded at each price) x (change in quantity divided by change in price)
You are taking the average of different prices on an arc and dividing it with the average of new quantities demanded by consumers at those changed prices. Then, you are multiplying the same by the derivative of change in quantity divided by the change in price at any point to decide the elasticity at that point.

Suppose, there are two price levels for a commodity Sugarat Rs.40 per kg and Rs.50 per kg.
Let us assume that at price 40, quantity demanded is 10kg and at price 50, quantity demanded is 8kg.
Now, according to above formula, Ed = {(40 + 50) divided by (10 + 8)} x {(10 - 8) divided by (40 - 50)} = (90/18) x (-2/10) = 5 x (-1/5) = -1 or 1%
ie. Demand changed by 1% per each percentage change in the price.

1% change in original price is 40 x 1/100 = 0.40 = 40 paise.
So for every 40 paise, it is assumed that the quantity changes by 1% according to this formula.

Point-price Elasticity of Demand method
Point-price method is used to determine the elasticity of demand at very small changes in prices. It is useful in determining the price elasticity of demand at a specific point on the demand curve. It studies the changes in demands at price-points very closer to each other on a demand curve.

It also uses the same formula of the percentage change in demand divided by the percentage change in price. But, instead of calculating each equation, we can take information from the demand equation to calculate the price elasticity of demand.

Ed = percentage change in demand / percentage change in price = (Qd1/Qd) / (P1/P) = (P/Qd) x (Qd1/P1)
Now, as I mentioned above, this method is applied when we have the exact equation for demand curve and the derivatives per unit of price cahnge.

Let us take an example.
The equation for elasticity of demand for a demand curve Q = 5000 - 50P
So, in this equation, Qd1/P1 = -50 (per one unit of price, the change in demand quantity is 50).
Now, suppose we have to find out the point-price elasticity of demand at a price of 40 and 25.
The quantity demanded at 40 will be 5000-2000=3000.
The quantity demanded at 25 will be 5000-1250=3750.

So, Ed at 40 is -50 (40/3000) = -2000/3000= -2/3= -0.666
Ed at 25 is -50 (25/3750) = -1250/3750= -1/3= -0.333

Wednesday, 5 October 2016

Put a Harness on your Wants and Desires - Save Resources for your Future Generations

Satisfaction of our wants leads to consumption of goods and services. Goods are available only when you produce them. Production and manufacture of goods involve consumption of raw materials and natural resources. So, your satisfaction of desires and wants leads to the erosion of resources. There is so much of consumption and production that is indulged in by people nowadays that more and more stocks of raw materials and resources are required to satisfy these activities.

You must be aware that resources are not unlimited nor abundant at any given period or place. The resources available are much limited in number or quantity to satiate every need of the enormous population of this present day world. And, the population is always growing at a rapid rate whereas resources are getting exhausted day-by-day.

So, the need arises for finding some solution to the everlasting exhaustion of resources. Controlling our consumption levels is the most appropriate approach that can keep the resources available to mankind for a longer duration. Other options like finding new horizons of the universe for bringing more resources to the availability of people, or tracing the un-trekked lands of this world to find more resources are not feasible.

Distinguish between Necessities, Comforts, and Luxuries
One should try to bifurcate all his wants or desires into necessities, comforts, and luxuries.

Necessities are those without which you can't lead your life. You need a home or shelter. You need food. You need clothes to wear. These are necessities. You can't live without them even for some period.

Comforts are those which give some relief and aid you in leading your life smoothly. A dining table, mixie/grinder, motorcycle, computer, TV, etc. are examples for comforts which aid to your daily life. But, you can live even without them.

Luxuries are lavish expenses. A posh bungalow, a deluxe car, large LCD tv, expensive furniture, expensive clothes, beauty parlour visits are all examples of luxurious spending.

So, one should try to locate his own necessities and mostly stick to them along with some of those comforts and avoid indulging in luxurious spending.

Look at the realities around you
If you are sensitive enough to take a look into the real world around you, you will realise the seriousness of the problem.

There are so many poor and helpless around you that live in wretched conditions. They lack even the dire necessities of life whereas we live in posh bungalows and eat lavishly expensive food, wearing costly dresses and moving in luxurious cars. They don't have food to eat even for a single time in the day, wear dirty torn or worn out clothes thrown by us and walk and work for hours to get a single loaf of bread, dwelling on pavements.

This is because of the neglect of such people by the society. Instead of contributing to the welfare and development of such sections of the community we are indulging in satiating our desires. We never think of their desires or dreams. They are also human beings like us and have the same desires and dreams as we have. But, we do not like to realise this fact and reality. We simply ignore them to die their death.

If only we can put a harness on our wants and save some resources, the same could be spent for their well-being as well as for our future generations to come. These helpless people can be provided with some jobs and some welfare schemes so that they could fulfil some of their dire necessities.

Curtail your Spending Habits and Contribute to the Growth of Economy

What to do?

  1. Save Water. Be conscious about the unnecessary wastage of water. You can fix water saving nozzles to your taps to minimize the flow of water resulting in lesser consumption. Shower baths are good for saving water. While using flush outs in the toilet also you can save water by flushing only the required quantity of water instead of emptying the tank.
  2. Save Energy. Electricity consumption also needs to be saved as there is much shortage of production in this sector. Switch off the lights and fans whenever it is not necessary. Develop the habit of switching off before leaving the room into another room for more than one or two minutes. ACs and TVs should also be used only when there are people there. Whenever there is daylight available don't use lights. Fans and coolers are also not necessary when there is no heat.
  3. Save Fuel. While cooking, use the pressure cookers as far as possible to cook any kind of food. Only, topping and spicing can be done in other bowls or pans. This practice saves a lot of fuel. Further, keep everything ready before lighting the stoves or burners.
  4. Each month, try to keep some portion of your earnings for saving and investment. In this way, you can curtail your spending habits. Your savings are the seeds for the growth of the economy. Remember this fact always. Even if you can save 1% of your income, it makes a lot to the economy.
  5. You can also indulge yourself in acts of charity contributions and donations to welfare funds that work for the social wellbeing of people around you. There are so many helpless people all around you with no sufficient food, education, medical facilities. So, your donations to such organisations can reach for the rescue of these poor classes of the society.

Monday, 3 October 2016

Saving, Insurance and All About their Business

Saving and Insurance are two major economic activities just like capital formation and other activities. These two are becoming a part of the daily lives of our modern economy. People have somewhat become conscious of the insecurity of their lives and began to realise the necessity to secure their future by saving a little bit from their present consumption habits and also by adopting to insurance policies.


Need for Saving
If people go on consuming and spending all their income, and producers go on producing and thereby utilising all the resources of the economy, a day will come when there will be nothing more left to produce or to consume. So, people should curtail their consumption and spending habits and save some money and resources for future, and emergency needs.

Meaning and Definition of Saving
Saving is that portion of income or the excess value of the resource that has been left unused or unspent in a given period of time.

Saving is different from 'savings'. Saving is an economic activity whereas 'savings' is an accounting term. Savings is only a part of the total act of Saving.

In Keynesian economics, Saving has been defined as the excess of the amount or value left out of the available resources after consumption.

The total saving of an economy can be considered as the total income or value of the resources less the total expenditure or value of the resources consumed of that economy in a given period.

Suppose if a person 'X' gets an income of Rs.6,00,000 during a year and spends a total of Rs.5,00,000 during that period, then, the balance amount of Rs.1,00,000 is his Saving during that year.

So, when we add all the amounts of such Saving created by each and every member of that economy, it is the total Saving of that economy.

Saving not only constitutes the money saved, but it also includes the value of all the resources saved.

How to Save?
You can start it with a very simple method. Try to be conscious of saving at every step. You can save even a few coins or rupees from your purchases and collect that money at a safe place. You can experience the wonderful results of it. After a month, you may find out that you saved as much as Rs.500 or even Rs.5,000 depending upon saving habits and income. Now, you can deposit the money in a Bank. Maintain this practice continuously and make it a habit. This is the most simple thing to do if you are conscious of it.

Besides above, you can save amounts in lump sums at periodical intervals, whenever you receive some extra incomes such as Overtime payment or Bonus, etc. Invest some ample sum out of it in FD's or other Investment schemes.

Similarly, Producers and Manufacturers can also save much of their resources utilised by following some economic ways of production through different ratios of inputs or by implementing techniques like the location of wastages and leakages and managing labour efficiency, etc.

Benefits of Saving to the Economy
Whenever people save some amount of their income, they generally deposit the amount in Banks or invest in Investments like FDs, Stocks or Debentures, etc.

Bank deposits lead to the availability of ample funds with Banks. As they are not going to be immediately withdrawn by all of them at  the same time, Banks are naturally left with idle funds for a certain period. So, they can utilise these funds by lending to some of the needy customers who are willing to take loans to meet some of their urgent requirements and who will return the money along with some interest at a later time, either in instalments or in one lump sum.

In that way, Banks earn some income from those idle funds and they are able to pay some interest income to their depositors in return of their keeping funds in their bank.

So, you can see that the money saved by people not only creates increased income to the customers in way of interest, but they also help other people in meeting their urgent and unforeseen expenses because of this saving habit of people.

Besides this, the money saved and deposited in Banks or invested in Shares, Debentures or in Government Bonds, helps the businessmen and industries to further augment their production and add to the growth of the economy. The money saved results in increased produce and in increased capital formation. The money invested in Government Bonds helps governments to utilise the money for public welfare programmes like constructing roads and dams, irrigation canals, parks, schools and for many other purposes like providing subsidised schemes, midday meals to school children, etc. which all result in the welfare of public and the growth of the economy as a whole.


Importance of Insurance
Life is always uncertain. It is more like that in this present-day world. People often get sick due to the polluted water, air and atmosphere that are causing or spreading so many viral infections. Even the habits of people are deteriorating their health and resulting in premature deaths. Natural calamities, accidents, thefts and burglaries all cause loss to property. So, everything needs to be protected with a suitable insurance cover. Insurance provides a great relief to people as it reimburses them an ample portion of the losses suffered by them.

Meaning and Definition of Insurance
Insurance is a healthy tool available for the security of the people. It is a kind of an assurance from an undertaker to provide some compensation for a certain loss suffered by the victim like death, accident, fire, etc. in consideration for a nominal premium paid by him at the time of purchasing that assurance.

Insurance can be defined as "an arrangement or contract whereby a party or company facilitates its customers by providing financial compensation for the loss or damage incurred by them". It is generally represented by a policy guaranteeing to indemnify the loss in consideration for the onetime premium or periodical premiums paid by the victim.

Insurance Business and Income to Insurance Companies
An insurer takes the risk of taking the responsibility of reimbursing to the insured person a certain amount of loss on the occurrence of a certain loss or damage as covered in the agreement.

As a return for these services provided by them, they collect some monthly or other periodical insurance premiums from their customers towards their charges. Since people are always insecure of their lives, properties, and health, they look to these insurance coverages as their refuge. So, many people opt to purchase these insurance policies. As a result, insurance business generates a large pool of funds to the insurance company from which they have to reimburse only a certain amount of loss or damage that takes placing during a certain period. So, they can invest most of the money collected in some profit yielding investments or in real estate businesses and thus, earn comparatively good profits from their insurance business.

By managing the risk in an intelligent and smart way and by evaluating the weak points minutely in all respects, the insurance companies can make ample profits and minimise their incumbent reimbursement occasions.

Different Types of Insurance
There are many types of insurance policies to cover different types of losses.

a) Life Insurance
The life of a person is insured under this cover. Insurance companies examine the individual's health history and decide the claim amount to be covered for reimbursement under the policy. Normally, younger people can opt for higher covers with lesser premiums whereas older people are covered only for lesser cover amounts, that too at higher monthly premiums. This is because older people's life expectancy cannot be guaranteed so accurately and it is risky for the insurance companies to undertake their covers.

b) Health Insurance 
Health insurance policies undertake the job of covering hospitalisation and medical expenses. These policies also require some premium amounts to be paid periodically for covering the expenses. The health of the person concerned is examined in all respects before deciding the amount to be reimbursed. You can renew policies even yearly also. Most of the MNC's provide their employees with this Health Insurance cover nowadays. The medical expenses are reimbursed by insurance companies after scrutinising the bills and expenses. Some expenses are not reimbursed during the process as they are deemed as unnecessary by them.

c) Personal Accident Insurance
Personal accident insurance covers injury or death due to accidents. It undertakes only accident cases. The sum assured is generally limited to 5 or 6 years income of the person from his job earnings. It does not take into account other incomes of the person. If the insured is met with death or some serious irrecoverable loss of limbs, they will reimburse the whole sum assured. Otherwise, only a part of the sum assured is paid according to their own standards of calculation. The insured needs to pay some premium amount to activate the policy.

d) Auto Insurance
Auto insurance covers the damages incurred by vehicles due to accidents or other calamities. The insurance amount is calculated based on the value of the vehicle according to its ageing factor also. A new vehicle can be insured for its whole cost with higher premium payment. Old vehicles are insured for their residual value only with lower premium payments.

5) Other Insurance Policies
There are many other insurance options available for every kind of damages or losses suffered by people. Some of them are Fire Insurance, Theft or Burglary Insurance, Marine Insurance (for losses suffered during shipwrecks, etc.), Fidelity Insurance (losses due to dishonesty, etc.during employment), Travel Insurance, Credit Insurance (loss due to bad debts), Crop Insurance (for farmers due to natural calamities), Workmen Compensation Insurance (loss incurred during employment due to negligence of employer resulting in accidents).

Wednesday, 28 September 2016

Meaning and Definition of Bank | Functions of Banks

A Bank is an organization which is licensed by government or law to receive and safeguard deposits from the public, sanction loans and to act as an intermediary in their financial transactions.

Banking institutions have been in operation since ancient history where funds were pooled and loans were sanctioned to farmers and small traders for an overall development of economic conditions in their respective areas or kingdoms.

The modern banking system had its roots in the aftermath of the Renaissance Europe. Thereafter, gradually the modern banking concepts and practices developed from the 18th century onwards resulting in the present banking system and practices.

Definition of Bank
A Bank can be defined as follows:

"An establishment authorized or licensed by a government to accept/ receive deposits, pay interest on those deposits, issue loans, act as an intermediary in all financial transactions, and provide other related financial services to its customers."

Functions of Banks
From the above definition, it is evident that Banks perform all types of financial transactions like receiving deposits from their customers, maintaining their accounts, safeguarding those deposits and allow withdrawals or payments from those deposits, pay interest on those deposits, collection or payment of cheques and bills on their behalf, provide debit or credit cards based on those accounts to enable easy transactions of funds from any corner of the world, etc.

Now, these functions of banks can be grouped into two distinct sub-groups. They are primary functions and secondary functions. Let us discuss both these types of functions.

Primary Functions of Banks

The primary functions are also known as the main banking functions. Banks (mainly commercial banks) perform many banking functions like accepting deposits and lending of loans and advances in various forms.

A) Accepting Deposits

i) Current Account Deposits:
These accounts are mainly suitable for business people who need to make daily transactions of depositing cash or cheques and to withdraw cash or make their bill payments through cheques and drafts. These accounts are also known as Demand Accounts, as the banks should pay these amounts immediately on demand by the depositors without any limit or restrictions. No interest is paid on these accounts. Some service charges are debited to the account depending upon the transactions.

ii) Savings Deposits:
Savings deposits are aimed at creating a habit of savings among people. These deposits provide an incentive of interest to the customers (4% to 5% normally) which are credited to their accounts quarterly. There is a ceiling on withdrawals, presently 3 times per month. Any extra withdrawal is charged with some fees.

iii) Fixed Deposits or Term Deposits:
Fixed Deposits are also known as Term Deposits because they are deposited for a particular period or term. These deposits carry higher interest rates depending upon the period of deposit and as per the prevailing rates of interests of those banks.
Deposits made for lesser periods will be paid lower interest rates and higher periods are paid higher rates. The present rates applicable are 4% to 8% approximately varying according to periods.
The minimum period of deposit is 7 days and maximum period is 10 years.
If you withdraw money before maturity period, penalty charges are imposed and the amount is deducted from your maturity balance calculated as on that day of withdrawal.

iv) Recurring Term Deposits:
These are known as Recurring Deposits and are generally treated as Term Deposits and carry the same interest rates and rules as governed under Fixed Deposits.
The only difference between Recurring Deposits and Fixed Term Deposits is that in Recurring Deposits, you enjoy the facility of depositing monthly denominations of the deposits instead of a lump sum deposit.
These deposits are suitable for those who want to save money, but can not afford a one time deposit.
The minimum deposit accepted is Rs.1,000 and thereafter, you can deposit in denominations of Rs.100 and above every month till maturity.
The tenure of deposits ranges from 12 months to 10 years. The interest is calculated monthly or quarterly according to the denominations deposited and the amount will be paid on maturity of the entire period.
If you are unable to deposit an installment timely, you will be charged penalty charges from the due date to the next deposit date.

B) Lending of Loans and Advances
Banks lend various types of loans and advances to facilitate their customers. The main types of these loans and advances are classified into three types.

i) Cash Credit:
Cash Credit is a type of loan sanctioned generally to business people against their stocks, shares, bonds and other securities. It is allowed to current account holders as well as outsiders also. A fixed amount of credit limit is sanctioned after evaluating the security provided. The interest is charged on the amounts withdrawn, calculated by the number of days  those particular balances are outstanding. The customers can enhance their credit limits by providing further securities.

ii) Overdraft:
Overdraft facilities are provided to existing current account holders on their request up to a certain fixed limit after providing some personal guarantee or security. It is generally provided after assessing his creditworthiness and repayment capacity. It can be availed both for personal accounts and business accounts. Interest is charged on the overdraft amounts.

iii) Loans and Term Loans:
Term loans or simply loans are sanctioned by banks to customers either for a short-term or comparatively longer terms to facilitate their various needs against some security or lien.
Some of these loans are as follows to list a few.

a) Home Loans
b) Car Loan or Vehicle Loan
c) Educational Loan
d) Personal Loan (for short term needs of customers like meeting marriage expenses, hospital or medical expenses, etc.)

These loans and advances are credited to their account after approval and the customers can withdraw the money according to their needs. Interest is calculated on the whole amount credited and the loan amount is refundable in equal EMIs (including interest amount) which is calculated according to the rates of interest prevailing at the time of sanction of the loan.

Secondary Functions of Banks

Secondary functions of Banks are, generally, not performed by all banks. These may not be considered as essential functions of most commercial banks. So, they are known as Secondary Functions. These functions include many services provided by banks to facilitate customers and keep them around their banks.

The secondary functions of banks are classified into two types known as Agency Functions and Utility Functions.

The Banks charge their commission or bank charges for providing each one of these secondary functions.

1) Agency Functions of Banks

a) Discounting of Bills
Banks allow advances to their customers to facilitate their need for funds against bills of exchange drawn by them or of which they are the beneficiaries. The payments are made after deducting some charges. The bank will later collect the payment from the drawee of the bill or from the party that accepted the bill by presenting it after the maturity of the period.

b) Transfer of Funds
Banks transfer funds of their customers from one account to another, from one branch to another or to other banks both within the country or abroad at the request of customers in the form of demand drafts or mail transfers for which they charge some commission and bank charges.

c) Collection or Payment of Bills, etc.
Banks can also collect or pay your bills according to your instructions. This includes collection and payment of salaries, pensions, utility bills, interest amounts, insurance premiums, taxes, dividends, etc. Banks charge their charges for this service.

d) Portfolio Services
The banks can also provide the services of acting as your agent in the sales and purchase of stocks, bonds, and debentures,etc.

e) Other agency functions
Banks can also act as the trustees, executors and income-tax consultants of your deposits, deeds, wills and funds.

2) General Utility Functions

The banks offer some more general public services to facilitate their customers which are known as general utility functions.

a) Locker Facilities
Lockers are allowed to customers for safeguarding their valuable possessions like gold ornaments, title-deeds or documents, etc. by keeping them in the bank lockers.

b) Issue of Letter of Credit
Banks provide their customers with a letter of credit certifying their creditworthiness to facilitate their needs.

c) Issue of Traveller's cheques
Traveller cheques are also issued by banks to facilitate people on their journeys so that they need not carry huge cash balances with them while on a journey.

d) Underwriting of Securities
Banks undertake the function of underwriting or certifying the securities of their customers to facilitate the sales of those securities.

e) Purchase and Sale of Foreign Exchange
Banks are authorised to deal in the foreign exchange transactions by RBI. So, they provide the services of dealing with the purchases and sales of foreign exchange on behalf of their customers.

f) Collection of statistics and preparation of project reports
Banks collect statistics from markets regarding trade and commerce and thereby can provide the required information to their clients. They also prepare the project reports for their clients.

g) Social welfare programmes
Banks also indulge in activities of public awareness, public welfare, and literacy programmes as a service to the nation.

Monday, 30 May 2016

A study of the role of money in economy

By role of money, I refer to the part played by money in our modern economy.

Money is regarded as the pulse of our life. Without money, there is no life or activity in this modern economy. Everything is related to money here. From morning to evening, from birth to death, you need money for something or other.

Money plays very important role in our economy. It motivates and influences all our economic activity. The economic activities of consumption, production, supply, demand, and distribution are all influenced by the money supply and power of money in any economy.

  • As a consumer, you can purchase goods and services and make payments through money which is universally accepted by one and all. 
  • As a unit of exchange and as a measure of value, money guarantees for the real value of all your goods and services.
  • To be able to pay in terms of money, you need to procure money. So,you will be earning money by doing some business or by working in a company or by doing some labour. Thus, money gets generated and rotated through our activities.
  • Money facilitates economic activity in the shape of creating businesses either in the manufacturing sector or the services sector and thereby creates more jobs for more people in different fields, which in turn boosts the economy. 
  • Money further facilitates and ensures that goods and services are produced to meet the demands of consumers. Consumers can opt for better products and multiple options as they are free to buy as and when they desire to do so. This is possible because of the storage value of money.
  • Money facilitates easy transfer and distribution of goods and services to any corner of the world as you can make payments through money at any place.
  • Money plays another important role of equalising the marginal utilities of consumers. Consumers are able to shift towards higher utility proving goods by discarding lower marginal utility products as they can distinguish the differences in utilities with the help of money as a standard of value which sets the prices of goods in terms of money.
  • So, money facilitates a rational distribution of the income of consumers among different needs and necessities. He can draw a picture of his income and expenses and match them with utmost utility levels within the given income.
  • Money makes the maintenance of accounts of any business very easy as everything is accounted in terms of money. This facilitates accurate calculation of expenses and income of any business and aids in fixation of the prices of their products.
  • Money helps the governments in collecting their taxes and in planning for their projects as they can estimate their Revenue and prepare their Budgets and thereby enables them in boosting their economy.
  • Further, money enables a continuous flow of funds from one person to another and from one corner to the other corner of the country or the world.

Thursday, 28 April 2016

Money - Different types of money | forms of money in economics

Do you realise that money is used nowadays, in the modern economy, in various types and forms?

Money can be broadly classified into four major types. This classification describes the abstract types or forms of money as opposed to physical forms of money.

Types of Money
  1. Commodity money.
  2. Representative money.
  3. Fiat money.
  4. Fiduciary money.

Commodity money
Commodity money represents commodities with intrinsic value. Gold and silver are examples of commodity money in our present economy. Their face value is equal to their real value. In older times, important commodities like rice, wheat, tobacco, seashells, pearls, valuable stones were also treated as commodity money. This kind of money is characterised by the scarcity of the commodity and the value attached to the commodity by the parties to the transaction. But, in present day economy, this kind of money is not of much significance even though Gold and Silver are used as a storage form of money.

Representative money 
Representative money is that which can be exchanged for a real commodity or money. For example tokens, papers or certificates issued a to a person which can be exchanged by the receiver of that token for some real commodity such as gold or silver or any other commodity. Coins and paper currency can be treated as representative money. It represents the quantum or degree of value that is backed by it. Gold certificates, Silver certificates are also some examples of it.

Fiat money
Fiat money is any money declared by governments to be legal tender money. This money by itself has no intrinsic value. It is not backed by any physical commodity. But, it is accepted and treated as money at all transactions due to its nature of being legal tender. For example, paper currency. You can not reject it. You are bound to accept it as money.

Fiduciary money
Fiduciary money represents a type of money based on the trust and reputation of the issuer. The issuer of the instrument of money, whether government or company or any trustee, promises to pay a certain amount of money or value as mentioned on the instrument and the beneficiary keeps faith and trust in it. Most of the transactions in present day economy are conducted through these fiduciary type of transactions.

Forms of Money
Now, coming to physical forms of money, some popular and more common forms of money are discussed here.

Coin Money
Different forms of coins are used like Gold, Silver, Copper, Bronze, Nickel, etc. for issuing coins that represent a certain value printed on it.

Paper Money or paper currency
This form of money constitutes the currency notes printed by the government or central bank and other forms of bills of exchange, promissory notes, checks, bank drafts, etc.

Bank Money or Demand Deposits money
Bank money is the money created through deposits made by the public into their bank accounts. Demand deposits are money deposited into banks by customers which are returnable to them on demand without any prior notice to banks. This money is characterised by the fact that original physical money available with the banks are manipulated into larger multiples due to the facility of minimum reserve rate ratio to be maintained by the banks. So, actual money available with the bank at any time will be much lesser than their account book balances.The total money created in this way can be known only by counting the actual money in circulation with public and then, adding to it the actual money with banks and also the value of cheques or drafts in hand with public and at the bank.  

Token Money
Token money is a form of money in which case, the tokens like coinage or paper currency in itself have no value but they represent and guarantee the value mentioned on them to be reimbursable to them.

Full bodied money
Full bodied money is the form of money where its real value represents its commodity or physical value. Gold coins and Silver coins are examples of full-bodied money or real money. They have the same physical value as their face value depicts. 

Standard Money
Standard money refers to the form of money used by different countries or economies for their accounting purpose. For example, the below-mentioned countries use the corresponding units of standard for their circulation and accounting purposes in their economies.
U.S.     Dollar ($)
U.K.     Pound (L)
India    Rupee (Rs.)
Europe  Euro  (E )
China    Yuan or Renminbi
Japan    Yen   (Y )

Legal Tender Money  
Legal tender money is that form of money which is acceptable legally. You cannot reject any payment made with legal tender money. Paper currency is fully legal tender money and one should accept all payments in that form. Coinage is not fully legal tender. Only small payments can be made through coins and you have the right to refuse payments made in large quantities of coins.
Electronic currency or Digital Money
Electronic money also known as e-money is a form of money that is transacted through the internet or electronic and digital transactions. Funds get transferred and payments or receipts made through internet transactions using computers and mobile phones. Examples for e-money are bank deposits operated through the internet, fund transfers made online, claims against banks and agencies resulting out of e-transfers or payments and account settlements. Paypal, Google Wallet, Apple Pay, Rupay, Bitcoins, etc. are most popular forms of this kind of money.

Sunday, 27 March 2016

Money - Meaning and Definition | Four functions of money

The importance of money
Money plays an important role in economics. It acts as a medium of exchange for goods and as the unit and store of value for execution of transactions. Without money, it would have been much difficult to procure your goods and services. In the ancient barter system, one has to search for the person who can exchange his goods with those of the goods required by him. So, both parties to the barter system should have the product desired by each other and/ or the need and interest for the same products. But, in the modern money economy, we need not search for the person who likes your product and exchanges it with the product needed by you. You can sell your product directly in the market and get money in return. Then you can buy with that money whatever is required by you. It becomes very easier for you to make any kind of transaction with money. You can buy goods or services at your own time, make payments of bills, keep it in banks for future uses, transfer it to any part of the world and utilise it there. So, this is the benefit and importance of money in your life.

What is money? Meaning and definition of money
Money is a medium of exchange that is generally acceptable to people as a unit of exchange and as a store of value. Generally, the currency notes and coins are considered as money by public. It is a kind of instrument having the purchasing power and capable of being stored for future uses.

The great economist Geoffrey Crowther, who was the editor of a newspaper "The Economist" during the 1930s and 1940s and later became the Managing Director and Chairman of Economist Newspaper Ltd., defined money in his book "An Outline of Money" as follows:

"Anything that is generally acceptable as a means of exchange and which at the same acts as a measure and store of value".

So, money is anything that is legally and socially acceptable for buying and selling things or for making payments of goods and services utilised or in repayment of debts.

Four functions of money in economy
Money performs four major functions -
1) Money is the medium of exchange.
2) Money is a unit of account and measure of value.
3) Money functions as a store of value.
4) Money is a standard of deferred payments.

Of the above four functions, a medium of exchange and measure of value are regarded as primary functions of money. The functions of a store of value and standard of deferred payment are regarded as secondary functions of money as they are derived from the primary functions.

A) Primary functions of money:

1) Medium of exchange
Money is a medium of exchange in the sense that it is used to used to exchange for goods and services. The buyer buys goods and services and pays money for it. The seller sells goods whereas the service provider provides his services and in both cases, they receive money from the receiver of goods or services. Thus, money is an important medium of their transactions.

For example, you buy a chocolate and pay money for it. The seller of chocolate is receiving money in exchange of his chocolate. Similarly, you get the service of a barber to shave your beard and in exchange of it, you are paying the money. Thus, money serves as an important medium of exchange in all transactions.

2) Measure of value or unit of account
Money acts as a unit of account or measure of value. You value any goods or services in terms of money value. You are fixing monetary value per one unit of good or service. So, any goods or services that we buy or sell are quoted by its value per one unit in terms of money.

For example, a chocolate is quoted as of $5 value, a bread is quoted as of $10 value, a computer is quoted as of $10,000 value, so on. Similarly, one shave is quoted at $5 value, one haircut at $10 value, one car wash at $20 value like that. When you give the value per unit of good or service it becomes very easy to identify those goods and services and compare them with other similar products or services offered by different seller or providers.

B) Secondary functions of money:

1) Store of value
Money can be stored and used subsequently without losing its value for a certain period. Money can be used only when you need to buy or procure something. Till then, you can keep your money in your purse or wallet or you can keep it in your bank account. So money is stored for your future needs. With that, you can buy anything like rice, bread, chocolate, wheat flour, car, computer, so on. Thus, you are storing the purchasing power of money for a certain period, until you actually need the goods or services. So, you are much relaxed as you know that you can purchase anything with the stored value of money. This is one wonderful function performed by money.

This function of money comes from the primary functions of money acting as a unit of account and as a medium of exchange. It is because of those two functions, that you are capable of storing money. It is because of the fact that money is generally accepted as a medium of exchange, that you are keeping it in store. It is because of the fact that it is a unit of transaction, that you are procuring different denominations of money and using them for your purchases.

2) Standard of deferred payments
Money functions as a standard for deferred payments. When someone borrows money from you and agrees to return it after a certain period, he will pay back it in the form of money on that stipulated date along with interest if any charged by you for lending him the money instead of using it for other useful purposes by you. Millions of transactions are taking place now, which are not paid immediately.

Payments get deferred till a certain period of time or till the happening of a certain event or till the actual goods or services reach you. So, till such period, the payment gets postponed or deferred and nobody worries as money will not lose its value even if paid later under normal circumstances. You are able to defer the payment because of the standard value of money and its general acceptability. This function of money has given rise to the various financial institutions and lending businesses and thereby advanced the economic development also.

Wednesday, 2 March 2016

Definition and explanation of producer equilibrium in economics under different approaches

Just like the consumers indulge in maximising their satisfaction and utility levels by reaching towards consumer equilibrium, the producers also try to reach out to an equilibrium point of maximisation of their profits that is known as "producer equilibrium".

What is producer's equilibrium?
Producer's equilibrium is that point in the scale of production, at which point, the level of production of any particular commodity gives the maximum profit to the producer of that commodity. So, the total cost of production of that commodity will be much lesser than the total revenue obtained through sale of that commodity at that level. It is the maximum possible profit that any producer can obtain at that equilibrium point.

In other words, producer equilibrium refers either to the level of profit maximisation or otherwise, to the level of cost minimisation. Cost minimisation also results in profit maximisation.

Definition of producer equilibrium in economics

  • Producer's equilibrium can be defined as a state of economic condition that leads to achievement of that level of output after reaching which, no further maximisation of profit is possible.
  • It is that stage where there is no further inclination towards expansion or contraction of the output.
  • It is that point where there is maximum profitability and / or minimal loss.

Two approaches towards producer equilibrium

There are two approaches for reaching out to producer's equilibrium:
1) the TR - TC approach and
2) the MR = MC approach.

There can be two types of markets for studying producer equilibrium

a) Perfect competition market where prices remain constant and
b) Imperfect competition market where prices are either raising or falling constantly.
We need to study the equilibrium under both these conditions of the markets.

Now, let us study producer's equilibrium under all these different conditions, one by one.

I) Total Revenue - Total Cost (TR - TC) approach

Under TR - TC approach, the producer tries to attain equilibrium point by maximising his profits to the utmost possible level. So, this implies that the TR-TC approach should satisfy two conditions.

  • The difference between Total Revenue and Total Cost has been maximised.
  • Any further effort to increase output after that point will result in a fall of the total profit.

Let me explain this under both circumstances of perfect competition and Imperfect competition.

i) The producer equilibrium under perfect competition (When prices remain constant)
When prices are constant in perfect competition, producer goes on increasing output or sales and is able to enjoy maximum profit till a certain point after which, he may not be able to produce more without adding extra machinery or extra expenses and capital. So, addition of capital and machinery may result in increased costs of the product. Or, otherwise, he may not be able to sell more unless he decreases the price, which also may result in decrease of profits.

Let us study it through a table as below.

Price per unit       Output (units)      Total Revenue     Total Cost     Profit

      6                        1                          6                      5                  1
      6                        2                        12                     10                 2
      6                        4                        24                     19                 5
      6                        6                        36                     28                 8
      6                        7                        42                     34                 8
      6                        8                        48                     41                 7

From the above illustration, we can see that producer equilibrium has been achieved at the output level of 7 units, at which point you are able to maintain the maximum profit of 8 dollars by producing maximum output of 7 units. When you tried to increase the output by another unit, the profit decreased to 7 dollars.

The same thing can be illustrated in the form of a graph also.

ii) Now, watch producer equilibrium under imperfect competition (when prices are falling upon increased output )
There is no control over prices, and each producer has his own price fixation norms and sells products accordingly. But, after a certain level of output, he gets forced to lower the prices as he has got excess stocks of output. The below example illustrates this position.

Price per unit       Output (units)      Total Revenue     Total Cost      Profit
       8                       2                          16                    10                   6
       7                       3                          21                    14                   7
       6                       5                          30                    21                   9              
       5                       6                          30                    23                   7

The producer equilibrium in the above example is attained at output level of 5 units. After that level, additional output of another unit resulted in fall of total profit.

II) Marginal Revenue = Marginal Cost Approach (MR = MC approach)

According to this approach, producer equilibrium is attained where the marginal revenue of additional output equals its marginal cost.

This approach should satisfy the following two conditions or assumptions:
1) MC = MR
2) Marginal cost becomes higher than Marginal Revenue if one more addition to output takes place after reaching the output level of MR = MC

Let us study this approach also under both the perfect and imperfect competition conditions of the market.

i) Producer equilibrium under perfect competition (when price is constant)
When price is constant, each unit of output is sold at the same price. So, the average price (AR) of any particular unit is same for each and every unit. The marginal revenue (MR) will be same as the AR and the marginal revenue (MR) also will be same as AR for each unit. So, you will enjoy the producer equilibrium until there is any rise in MC or fall in MR.

Let me illustrate this with a table as below.

Price (Rs.)    No.of units         TR            TC              MR            MC          Profit (TR-TC)
6                    1                     6                8                6                 8                -2
6                    2                    12              15                6                 7                -3
6                    3                    18              20                6                 5                -2
6                    4                    24              24                6                 4                 0
6                    5                    30              28                6                 4                 2
6                    6                    36              34                6                 6                 2
6                    7                    42              41                6                 7                 1

From the above, we can see that the producer was incurring losses initially and he went on increasing his output to nullify the losses and make profits. When he produced 4 units, there were no losses. At the level of 5 units production and 6 units production, he was able to make profits of 2 points. At the level of 6 units production, the MR is equal to MC. When he tried to increase output by one more unit, the profit decreased again. So, the producer equilibrium output is 6 units in this case.

ii) Producer equilibrium under imperfect competition (when price falls with increase in output)
When there is no perfect competition among sellers, the producers and sellers try to maximise their profits, by indulging in unhealthy practices. They take advantage of some monopolistic circumstances and charge very high prices to gain maximum profits. This is workable until certain stage. But when the quantity produced becomes too much with alternative identical products coming into the market, demand gets distributed among identical products and naturally each brand of product loses its demand in the long run. The effect will be fall in prices of products. So, too much increase in production will result in fall of prices. In such circumstances, the producer has to decide upon his maximum level of production based on producer equilibrium. He will try to match Marginal Cost with Marginal Revenue in deciding his level of production.

Let us consider an example to arrive at this producer equilibrium under changing prices of market.

Qty. produced   Price per unit           Total              Total       MR      MC      Profit 
                                                     Revenue           Cost                             (TR-TC)
           1                    8                        8                   6           8        6            2
           2                    7                       14                 11           6        5            3
           3                    6                       18                 15           4        4            3
           4                    5                       20                 18           2        3            2

In the above illustration, it is noticed that MR and MC are both equal to one another at the level of 3 units production. After that level, when production is increased to 4 units, the profit began decreasing as MC is higher than MR at that point. So, producer equilibrium level of output is 3 units in this case.   

From the above study of producer equilibrium, we are able to notice two salient features.
1) Under perfect competition (where prices remain constant), Price = MR = MC, ie. the product price, marginal revenue and marginal cost equal to one another at the equilibrium point.
2) Under imperfect competition (where prices fall with every increase in supply or production), Price is always greater than MC or MR as equilibrium is attained at a point of MC=MR and marginal revenue will be always decreasing with additions of supply.                  

Monday, 18 January 2016

Consumer Equilibrium, indifference curve and consumer behaviour

It is assumed that consumers are constantly engaged in efforts to maximise their total utility. They always try to satisfy their needs through different combinations and choices of goods to maximise utility. So, the solutions that they find after making so many experiments and  decisions in maximising their satisfaction is known as the consumer equilibrium. It is arrived at with a set of indifference curves depicting their preferences for goods.

An indifference curve is a curve formed on a graph by connecting the points of different combinations of two commodities that a consumer regards as of equal value and are giving him equal satisfaction. The consumer regards any combination on that curve as of equal value and so he is indifferent to each of those combinations.

With a given income and the present ranges of prices, the consumer has to choose among various alternative combinations of goods and services to get utmost satisfaction and enjoy most of those goods and services. The manner in which he responds and the solution that he finds at a particular level with a given combination is his equilibrium.

Consumer equilibrium definition
Consumer equilibrium is a state of balance achieved by the consumer of goods and products that refers to the quantum of goods and services he can purchase within his given level of income and at the prevailing current prices.

Consumer Equilibrium is the point of balance at which stage, the consumer is able to get maximum satisfaction from a reasonable combination of multiple goods at their given prices and within his income. At this point, he is able to achieve maximum utility level and any shifts from that point will only diminish his satisfaction level.

Assumptions underlying Consumer's Equilibrium
The following are some of the assumptions that are implicit in studying the consumer equilibrium.

  • Consumer's income is given and he has to act within that income.
  • The prices are set and stable for the time being under study.
  • It is assumed that there are two goods X and Y and he has to choose various combinations of those two goods.
  • The indifference curve is the maximum possible level of satisfaction within his income selected from the indifference map or set of indifference curves.

Now, let us take an example. Suppose your income is $100 and you have to purchase two goods within that income. Let us assume that price of product X is $10 and that of product Y is $20. Now if you want to purchase only one commodity, then you can purchase either 10 units of X or 5 units of Y. But, you can't have only one item. You want to buy both items to maximise your satisfaction levels. So, you will try different combinations and the results are depicted through the indifference curves in the below indifference map.

In the above figure, X axis depicts product X and Y axis depicts product Y. At the right hand side  tip of each curves IC stands for indifference curve. So, there are four indifference curves drawn by us named IC1, IC2, IC3 and IC4. You will be able to notice that points on IC1, 2 and 3 fall within your income range. But IC4 is completely out of your income range as it is away and out of the price line. Price line AB is tangent to the indifference curve IC3 touching it at point E. So, point E can be considered as the consumer equilibrium point at which he is able to maximise his satisfaction levels by purchasing Q1 units of product X and Q2 units of product Y. Any other points on lower levels touching the price line will be of lesser satisfaction. Further, he is not spending his full income at those points. Points at higher levels do not touch the price line AB and so they are not in his income range.

So, consumer equilibrium is that point of level, where the consumer is able to maximise his satisfaction by spending his full income on those products in a better way. In practical life, there are so many products that the buyer purchases and it is a more complicated problem. The decision making ability of consumer shows his smartness and prudence in attaining consumer equilibrium.

Monday, 4 January 2016

Price fixing and factors determining price line

What is price fixation? 
Price fixing is the process of determining the price of a product for sale in market. It is believed that it is rather a kind of agreement between businessmen to buy or sell goods at a price not lesser than a particular price. It is applied for safeguarding their minimum profits by averting competition from rivals who may try to sell at lower prices for their selfish gains.

But, it is not a good practice and governments try to safeguard the interests of consumers by prohibiting unhealthy practices through enforcement of laws and other measures.

Let us now look at how prices of commodities are determined under normal market conditions.

How prices are determined?

  • Under normal circumstances, in healthy market conditions, prices are determined by the interaction of supply and demand forces.
  • Generally, the supplier or manufacturer fixes the price of his product after taking into account all his cost factors and then adding a margin of profit for himself.
  • So, the price is fixed at a rate which includes cost + profit. 
  • But, producers and / or suppliers may try to add a higher percentage of profit to the cost in fixing their prices.
  • So, the forces of supply and demand in the market come to our rescue in safeguarding the interests of consumers by settling at an equilibrium point of price.

Major factors influencing price determination
The following are some of the important factors affecting price determination.

Cost of production
Cost of production is the basic element of price. The producer of the product incurs some basic costs towards raw materials and ingredients involved in the production of his products. He further incurs the labour cost, the salaries of staff, rent of the building, any machinery and godowns involved in producing the product and other costs like electricity, stationery and depreciation of assets and tools used in producing the output. So all these elements constitute the cost of his product.
So, the producer or supplier fixes his price by summing up all these costs and dividing that total cost with the quantity that is produced at any period. This average cost should be fully realised by him from the buyers.

Competition in market
Competition in market from similar product dealers also influences the price. If there are many sellers of the same commodity, each one of them will try to maximise his sales by giving incentives to buyers. Buyers generally buy from a dealer who offers the products at comparatively lower prices. Even a small fraction of a currency unit charged lower can allure the buyers. So, the producer or supplier needs to pay attention to this factor of market competition in fixing his prices.

Value of product to the buyer
This is one more important element in fixing the price. The value that buyers attach to the product is a very sensitive part of price. Necessities like food grains, salt, sugar are more important for consumers. So, they cannot live without these products. The producer or supplier can fix the prices with some margins in such products without losing market.

The forces of supply and demand
The forces of demand and supply play major role in price determination. Buyers normally tend to purchase products at reasonably lower prices to get maximum satisfaction. Similarly sellers try to maximise their profits by selling things at higher prices. So, when both these forces interact, the buyers will restrict their purchases when the prices increase and increase their purchases when prices fall. Naturally, when there are no buyers at increased prices, the supplier is forced to decrease his price a little to attract buyers. When price falls the buyers will increase their demand. Similarly, when the prices fall too much, there will be excessive demand for products but the supplier may not have enough supply to meet their demand. Then, buyer will be willing to buy at an higher price. Thereby, the prices will increase. In this way, the price level settles at a point of equilibrium where quantity demanded and quantity supplied matchup. Price gets influenced in this way with the forces of supply and demand.

Government policies
Government can always try to regulate the prices through its policies and laws to safeguard the interests of consumers. So, the producers and sellers have to fix their prices in accordance with those policies and guidelines or else they may have to face legal proceedings and bans.

Saturday, 2 January 2016

Law of Demand, demand schedule and demand curve

The law of demand states the relationship between the price of a commodity and the quantity demanded of it. It studies and explains the spending and purchasing habits of consumers at any time.

Whereas suppliers of goods and services tend to increase supplies of their product into market as a result of the increase in prices, the consumers tend to react inversely. Consumers begin to shrink their demand for those goods and services whose prices begin to increase.

This decrease in demand happens because, consumers have to make purchases from within their own financial capacities. Naturally, they tend to curtail their purchases of costly items and shift their attention towards lower cost commodities.

The law of demand is based on this trend of the decreasing demand for goods and services whose prices are spiralling upwards. It assumes that other factors remaining same, changes in prices will result in changes in demand.

So, the law of demand and law of supply are inversely related to each other.

The law of demand definition
Law of demand states that, other factors remaining constant, as the price of a good or service increases, the consumer demand for it will decrease. So, according to this law of demand, the price of a commodity and quantity demanded are inversely related to each other. If the price rises, demanded quantity will decrease and if the price falls, demanded quantity will increase.

  • The demand for any commodity is expressed as at a given price and as at a particular time or for a given period of time.

What is demand schedule
Demand schedule is a chart showing various prices of the commodity and the quantities demanded of it at each price range.

Let me give an example here.
Suppose a consumer goes to purchase Sugar. He buys 5 kg sugar when the price is at Rs.30 per kg. Suppose the price increases to Rs.40. Then he will buy only 4 kg. and if the price further increases to Rs.50, he will be buying only 3 kg. As the price goes on increasing, he will go on decreasing his quantities of consumption. Or, conversely, when the prices fall, he will be increasing the quantities of his purchases. The same thing can be represented in the demand schedule as below.

Demand Schedule for Sugar                                                      
Price of sugar
Qty. of demand
5 kg
4 kg
3 kg

The above example is for a particular person's  individual demand. So, if we consider the demand of other people also for the commodity of Sugar, then it will be deemed as the total market demand for sugar. Suppose there are 10 people and each one demand various quantities at each price level. Then, you will have to add all the quantities demanded by all people for each price level to know the total demand at each price level. This is known as market demand for sugar. 

Demand Curve
A demand curve is a graph representing the relationship between price of a commodity and the quantity demanded by consumers at each price level of that commodity. It is a graphical representation of the demand schedule.

So, from the above figures of demand for sugar at different prices, we can prepare the demand curve as shown in the figure below.

Demand Curve for Sugar

In the above figure drawn with hand by me, the demand curve is the slant line at the top right hand corner of the image. It slants downwards because, with every increase in price the demand comes down.

Regarding factors affecting supply and demand, you may view for details at this link.