Economics NCERT Notes | Class 12

Team Shashank Sajwan

• Economics is a social science concerned with the production, distribution, &

consumption of goods and services. It studies how individuals, businesses,
governments and nations makes choices about how to allocate resources.
• Adam Smith, the founding father of modern economics.
• Economic Agents: Those individuals or institutions which take economic decisions.They can
be consumers, producers, govt., private etc.
• Final good: An item that is meant for final use & will not pass through any more
stages of production or transformations is called final good.
o Consumption goods: goods that are consumed when purchased by their
ultimate consumers.
o Capital goods: other goods that are of durable character which are used in the
production process.
o Intermediate goods: Mostly used as raw materials or inputs for production of
other commodities. These are not final goods.
• ‘Depreciation’: Refers to an accounting method used to allocate the cost of a
tangible or physical asset over its useful life.
o Depreciation represents how much of an asset's value has been used.
• Net Investment: Total amount of money that a company spends on capital assets, minus
the cost of the depreciation of those assets.
o Net Investment = Gross investment - Depreciation
• Circular flow of income: Is a model of the economy in which the major exchanges are
represented as flows of money, goods & services, etc. between 'economic agents'.
o 'Expenditure method' (most common way to estimate GDP):
o A system for calculating GDP that combines consumption, investment, government
spending, and net exports.
• Investment: The purchase of goods that are not consumed today but are used in the
future to generate wealth.
• GDP (Gross domestic product) - The final value of the finished goods and services
produced within a country's territory.
• GNP (Gross National Product) - The final value of all the goods & services
produced by the 'nationals' of a country in the world.
GNP = GDP + Net factor income from abroad.
o Net factor income from abroad = Factor income earned by the domestic
factors of production employed in the rest of the world – Factor income
earned by the factors of production of the rest of the world employed
domestic economy.

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 o If we deduct depreciation from GNP the measure of aggregate income that we
obtain is called NNP (Net National Product)
NNP = GNP - Depreciation.
• National Income: The total value of final goods & services produced by the normal
residents during an accounting year, after adjusting depreciation. (It is Net National
Product (NNP) at Factor Cost (FC))
• Nominal and Real GDP:
o Nominal GDP is a macroeconomic assessment of the value of goods &
services using current prices in its measure; it's also referred to as the
current dollar GDP.
o Real GDP takes into consideration adjustments for changes in inflation.

Nominal GDP Real GDP

- The aggregate financial - The measure of GDP was
business value manufactured modified according to the
within a country changes in the general price
level.
- Inflation without GDP - Inflation-adjusted GDP
- Expressed in current market - Base year's market price
prices
- From Nominal GDP, - Real GDP is a good indicator of
economic growth can't be economic growth
analysed easily
• GDP Deflator: Measures the impact of inflation on the GDP of an economy during aperiod
of one specific fiscal year.
Normal 𝐺𝐷𝑃
Formula: GDP Deflator = x 100
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃
• Consumer Price Index (CPI): Another way to measure change of prices in an economy
which is known as 'Consumer Price Index'. Index of price of a given basket of commodities
which are bought by the representative consumer.
• Wholesale Price Index (WPI): Measures the changes in commodity prices at a selected
stage or stages before goods reach the retail level. Some countries use WPI changes as
a central measure of inflation.
o But now India has adopted new CPI to measure inflation. However, US now
reports a produce price index (PPI).
• Money & Banking:
o Money Commonly accepted 'medium of exchange'.
o Economic exchanges without the mediation of money are referred to as
barter exchanges/system.
o Money also acts as a convenient unit of account.
• Assets: Is any resource owned or controlled by a business or an economic entity. It is
anything that can be used to produce positive economic value.
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 o Assets are things a firm owns or what a firm can claim from others.
• Liabilities: Legally binding obligations that are payable to another person or entity.
o Liabilities for any firm are its debts or what it owes to others. (Liabilities =
Deposits) for e.g., a bank.
Net Worth = Assets - Liabilities
• Balance sheet: Summary of the financial balances of an individual or organization.
Statement of a business's assets, liabilities & owner's equity.
• CRR (Cash Reserve Ratio) - Percentage of deposits which a bank must keep as cash
reserves with itself.
• Lender of last resort: RBI ready to lend funds to banks at all times through various
instruments.
• Open Market Operations (OMO): Refers to buying & selling of bonds issued by the
Government in the open market. This purchase & sale is entrusted to the Central bank on
behalf of the government.
• Bank Rate: - RBI can influence money supply by changing the rate at which it gives loans to
the commercial banks.
• Repo Rate: the rate at which the central bank of a country lends money to
commercial banks 'in the event of any shortfall of funds'.
• Reverse Repo Rate: the rate at which the Central bank of a country borrows money from
commercial banks within the country.
o It is a monetary policy instrument which can be used to control the money
supply in the country.
gives money at % interest
Repo Rate: RBI Commercial Banks
Reverse Repo: RBI Commercial Banks
Borrows money at % interest

Monetary Policy
Reserve Ratios Policy Rates Operations Open Market
(OMO)
- CRR - Repo - Buying & selling of govt.
Securities.
- SLR - Reverse Repo
- MSF
- Bank Rate

• Monetary Policy - the control of the quantity of money available in an economy & the
channel by which new money is supplied.
o The RBI is vested with the responsibility of conducting monetary policy.
• Fiscal Policy - the use of government spending & taxation to influence the
economy.
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 o Governments use fiscal policy to promote strong & sustainable growth &
reduce poverty. e.g., tax cuts & increased govt. spending.
o Three Policies:
- Neutral Policy: Government Spending = Taxation
- Expansionary Policy: Government Spending > Taxation
- Contractionary Policy: Government Spending < Taxation
• Demonetization: New initiative by GOI in Nov 2016 to tackle the problem of
corruption, black money, terrorism & circulation of fake currency economy. Old
notes of 500₹ & 1000₹ were no longer 'legal tender'. New currency notes in the
denomination of 500₹ & 2000₹ were launched.
• Demand & Supply:
o Relationship between the quantity of a commodity that producers wish to sell
at various prices and the quantity that consumers wish to buy. It is the main
model of price determination used in economic theory.
o Supply and demand determine the Price of goods and quantities produced &
consumed.
o When the supply & demand curves intersect, the market is in equilibrium.
Relationship between the quantity of a commodity that producers have
available for sale & the quantity that consumers are willing & able to buy.

Supply & Demand

D S

Price (P)

Quantity 2
• Mixed Economy: An economy in which there is both the private sector & the
government is known as Mixed Economy.
• Annual Financial Statement - Budget
o Revenue Budget: Those that relate to the current financial year only are
included in the revenue account.
o Capital Budget: Those that concern the assets & liabilities of the govt. into the
capital account.
• Redistribution Function: The govt. through its budgetary policy attempts to promote
fair & right distribution of income in an economy. This is done through taxation &
expenditure policy.
• Stabilisation Function: - Economic stability means absence of large-scale
fluctuations in price level which cause uncertainty & hardships to people.
o In inflationary situation, govt. can discourage spending by increasing taxes &
reducing its own expenditure.
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 GOVERNMENT BUDGET

Revenue Budget Capital Budget

Revenue Receipts Revenue Expenditure Capital Capital

Receipts Expenditure

Tax Non-tax Plan Non- Plan Plan Capital Non-Plan

Revenue Revenue Revenue Revenue Expenditure Capital
Expenditure Expenditure Expenditure

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• Balanced Budget: Government may spend an amount equal to the revenue it
collects.
o When tax collection exceeds the required expenditure, the budget is said to be
in surplus.
o When expenditure exceeds revenue, this is when the govt runs a budget
deficit.
• Revenue Deficit: Refers to the excess of government's revenue expenditure over
revenue receipts.
Revenue deficit = Revenue exp. - Revenue Receipts.
• Fiscal Deficit: The difference between the government's total expenditure & it's total
receipts excluding borrowing.
Gross fiscal deficit = Net Borrowing at home + Borrowing from RBI + Borrowing
from abroad.
• Goods & Services Tax (GST)
o Indirect tax used in India.
o Comprehensive multistage, destination-based tax.
o Subsumed almost all the indirect taxes.
o Goods & services are divided into five different tax slabs for collection of tax:
0%, 5%, 12%, 18%, 28%.
o Petroleum products, alcoholic drinks & electricity are not taxed under GST &
are taxed separately by the individual state governments.
o The tax came into effect from 01-July-2017 by the 101st Amendment.
(One Nation, One Tax, One Market)
• An open economy is one which interacts with other countries through various
channels.
• Three ways:
o Output Market: An economy can trade in goods and services with other
countries.
o Financial Market: Most often an economy can buy financial assets from other
countries.
o Labour Market: Firms can choose where to locate production & workers to
choose where to work.
• Foreign exchange rate: The price of one currency in terms of another country.
(Exchange rate)
• Current Account: is the record of trade in goods & services & transfer payments.
o Trade in goods includes exports & imports of goods.
o Trade in services includes factor income & non-factor income transactions.
o Gifts, remittances & grants could be given by the govt. or by private citizens
living abroad.

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 Components of Current Account
Current Account

Trade in goods Trade in Services Transfer Payments

Exports Imports of Net factor Income Net Non-factor Consists of gifts,

of goods. Income. remittances & grants.
goods.

Net income Net Shipping,

from investment Banking,
compensation Income insurance,
of employees. tourism,
software
services, etc.

Current Account Surplus Balanced Current Account Current Account Deficit

Receipts > Payments Receipts = Payments Receipts < Payments

• BOT (Balance of Trade): The difference between the value of exports & value of
imports of goods of a country in a given period of time (only visible items).
o BOT is said to be in balance when exports of goods are equal to the
imports of goods.
• Net Invisibles: The difference between the value of exports & value of imports of a
country in a given period of time.
o Invisibles include services, transfers & flows of income that take place
between different countries.
• Capital Account: Capital account records all international transactions of assets.
(Money, stocks, bonds, govt. debt. etc.)

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 Components of Capital Account
Capital Account

Investments External Borrowings External Assistance

Direct Investments Portfolio Investment E.g., external E.g., govt. aid, inter-
Commercial borrowings, governmental
Short-termdebt multilateral and bilateral
loans.

E.g., FDT, equity E.g., FII, offshore

capital, reinvested funds.
earnings.

o Capital account is in balance when capital inflows are equal to capital outflows.
- Outflows: Repayment of loans, purchases of assets/shares.
- Inflows: Receipt of loans from abroad, sale of assets/shares in foreign companies.
• Foreign Exchange Market (FOREX): A global market for exchanging national
currencies with one another.
o The major participants in the foreign exchange market are commercial banks,
foreign exchange brokers and other authorised dealers & monetary
authorities.
o Forex Rate: the price of one currency in terms of another.
o Appreciation: When the domestic currency in terms of foreign currency (dollar)
increases.
o Depreciation: When the price of domestic currency in terms of foreign
currency (dollar) decreases.
• Fixed Exchange Rates: The government fixes the exchange rate at a particular level.
o Devaluation: - When some government action increases the exchange rate
(thereby, making domestic currency cheaper)
o Revaluation: - When the government decreases the exchange rate.
(making domestic currency costlier)

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