New Law Collage

8/8/2019 New Law Collage

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New Law Collage

Economics I (General Principles)

Unit 1: Introductory Economics as a science & its relevance to law

Economics as a basis of social welfare and Social Justice

Free enterprise, Planned Economies & Mixed Economies

Unit 2: General Principles of Economics.

Demand & Supply

Markets, determination of prices, business organization

Labour & Wages

Capital & Money

Saving, Consumption, Investment

Unit 3: Economic Growth & Development

Technology & Economic Growth

Unit 4: Economic Policy, Fiscal Policy, Monetary Policy.

Unit 5: Banking

Commercial & Central Banking Role of Credit International Financial Institutions.


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Introduction

What is Economics?

A definition that captures much of modern economics is that ofLionel Robbinsin a 1932

essay: "the science which studies human behaviour as a relationship between ends andscarce means which have alternative uses."[3]Scarcitymeans that available resources are

insufficient to satisfy all wants and needs. Absent scarcity and alternative uses ofavailable resources, there is noeconomic problem. The subject thus defined involves the

study ofchoices as they are affected by incentives and resources.

The study of Economics has changed over the ages according to the changes in thought ,mentality & most importantly as per the changes in the world. Today economics

encompasses all the activities which begin with the creation of goods till they reach the

ultimate consumerEconomics is the social sciencethat studies theproduction,

distribution, and consumption ofgoods and services.

The term economics comes from the Ancient Greek (oikonomia,"management of a household, administration") from (oikos, "house") + (nomos, "custom" or "law"), hence "rules of the house(hold)".[1] Current economic

models developed out of the broader field ofpolitical economy in the late 19th century,owing to a desire to use an empiricalapproach more akin to the physical sciences.[2]

Economics aims to explain how economies work and how economic agents interact.

Economic analysis is applied throughout society, inbusiness,finance and government,but also in crime,[4]education,[5]the family, health,law,politics, religion,[6]social

institutions, war,[7] and science.[8]The expanding domain of economics in the social

sciences has been described aseconomic imperialism
http://en.wikipedia.org/wiki/Lionel_Robbinshttp://en.wikipedia.org/wiki/Lionel_Robbinshttp://en.wikipedia.org/wiki/An_Essay_on_the_Nature_and_Significance_of_Economic_Sciencehttp://en.wikipedia.org/wiki/An_Essay_on_the_Nature_and_Significance_of_Economic_Sciencehttp://en.wikipedia.org/wiki/Economics#cite_note-2%23cite_note-2http://en.wikipedia.org/wiki/Scarcityhttp://en.wikipedia.org/wiki/Scarcityhttp://en.wikipedia.org/wiki/Resource_(economics)http://en.wikipedia.org/wiki/Economic_problemhttp://en.wikipedia.org/wiki/Economic_problemhttp://en.wikipedia.org/wiki/Economic_problemhttp://en.wikipedia.org/wiki/Rational_choice_theoryhttp://en.wikipedia.org/wiki/Social_scienceshttp://en.wikipedia.org/wiki/Social_scienceshttp://en.wikipedia.org/wiki/Production_theory_basicshttp://en.wikipedia.org/wiki/Production_theory_basicshttp://en.wikipedia.org/wiki/Distribution_(economics)http://en.wikipedia.org/wiki/Consumption_(economics)http://en.wikipedia.org/wiki/Good_(economics_and_accounting)http://en.wikipedia.org/wiki/Service_(economics)http://en.wikipedia.org/wiki/Ancient_Greekhttp://en.wikipedia.org/wiki/Ancient_Greekhttp://en.wiktionary.org/wiki/%CE%BF%E1%BC%B0%CE%BA%CE%BF%CE%BD%CE%BF%CE%BC%CE%AF%CE%B1http://en.wiktionary.org/wiki/%CE%BF%E1%BC%B0%CE%BA%CE%BF%CE%BD%CE%BF%CE%BC%CE%AF%CE%B1http://en.wiktionary.org/wiki/%CE%BF%E1%BC%B6%CE%BA%CE%BF%CF%82http://en.wiktionary.org/wiki/%CE%BF%E1%BC%B6%CE%BA%CE%BF%CF%82http://en.wiktionary.org/wiki/%CE%BF%E1%BC%B6%CE%BA%CE%BF%CF%82http://en.wiktionary.org/wiki/%CE%BD%CF%8C%CE%BC%CE%BF%CF%82http://en.wikipedia.org/wiki/Economics#cite_note-etymology-0%23cite_note-etymology-0http://en.wikipedia.org/wiki/Political_economyhttp://en.wikipedia.org/wiki/Political_economyhttp://en.wikipedia.org/wiki/Empiricalhttp://en.wikipedia.org/wiki/Empiricalhttp://en.wikipedia.org/wiki/Economics#cite_note-Clark-1%23cite_note-Clark-1http://en.wikipedia.org/wiki/Economics#cite_note-Clark-1%23cite_note-Clark-1http://en.wikipedia.org/wiki/Economyhttp://en.wikipedia.org/wiki/Agent_(economics)http://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Financehttp://en.wikipedia.org/wiki/Governmenthttp://en.wikipedia.org/wiki/Governmenthttp://en.wikipedia.org/wiki/Crimehttp://en.wikipedia.org/wiki/Crimehttp://en.wikipedia.org/wiki/Economics#cite_note-3%23cite_note-3http://en.wikipedia.org/wiki/Education_economicshttp://en.wikipedia.org/wiki/Education_economicshttp://en.wikipedia.org/wiki/Economics#cite_note-4%23cite_note-4http://en.wikipedia.org/wiki/Economics#cite_note-4%23cite_note-4http://en.wikipedia.org/wiki/Family_economicshttp://en.wikipedia.org/wiki/Health_economicshttp://en.wikipedia.org/wiki/Law_and_economicshttp://en.wikipedia.org/wiki/Law_and_economicshttp://en.wikipedia.org/wiki/Public_choicehttp://en.wikipedia.org/wiki/Economics#cite_note-5%23cite_note-5http://en.wikipedia.org/wiki/Economics#cite_note-5%23cite_note-5http://en.wikipedia.org/wiki/Institutional_economicshttp://en.wikipedia.org/wiki/Institutional_economicshttp://en.wikipedia.org/wiki/Institutional_economicshttp://en.wikipedia.org/wiki/Economics#cite_note-6%23cite_note-6http://en.wikipedia.org/wiki/Economics#cite_note-6%23cite_note-6http://en.wikipedia.org/wiki/Sciencehttp://en.wikipedia.org/wiki/Economics#cite_note-7%23cite_note-7http://en.wikipedia.org/wiki/Economics#cite_note-7%23cite_note-7http://en.wikipedia.org/wiki/Social_sciencehttp://en.wikipedia.org/wiki/Social_sciencehttp://en.wikipedia.org/wiki/Economic_imperialism_(economics)http://en.wikipedia.org/wiki/Economic_imperialism_(economics)http://en.wikipedia.org/wiki/Lionel_Robbinshttp://en.wikipedia.org/wiki/An_Essay_on_the_Nature_and_Significance_of_Economic_Sciencehttp://en.wikipedia.org/wiki/An_Essay_on_the_Nature_and_Significance_of_Economic_Sciencehttp://en.wikipedia.org/wiki/Economics#cite_note-2%23cite_note-2http://en.wikipedia.org/wiki/Scarcityhttp://en.wikipedia.org/wiki/Resource_(economics)http://en.wikipedia.org/wiki/Economic_problemhttp://en.wikipedia.org/wiki/Rational_choice_theoryhttp://en.wikipedia.org/wiki/Social_scienceshttp://en.wikipedia.org/wiki/Production_theory_basicshttp://en.wikipedia.org/wiki/Distribution_(economics)http://en.wikipedia.org/wiki/Consumption_(economics)http://en.wikipedia.org/wiki/Good_(economics_and_accounting)http://en.wikipedia.org/wiki/Service_(economics)http://en.wikipedia.org/wiki/Ancient_Greekhttp://en.wiktionary.org/wiki/%CE%BF%E1%BC%B0%CE%BA%CE%BF%CE%BD%CE%BF%CE%BC%CE%AF%CE%B1http://en.wiktionary.org/wiki/%CE%BF%E1%BC%B6%CE%BA%CE%BF%CF%82http://en.wiktionary.org/wiki/%CE%BD%CF%8C%CE%BC%CE%BF%CF%82http://en.wikipedia.org/wiki/Economics#cite_note-etymology-0%23cite_note-etymology-0http://en.wikipedia.org/wiki/Political_economyhttp://en.wikipedia.org/wiki/Empiricalhttp://en.wikipedia.org/wiki/Economics#cite_note-Clark-1%23cite_note-Clark-1http://en.wikipedia.org/wiki/Economyhttp://en.wikipedia.org/wiki/Agent_(economics)http://en.wikipedia.org/wiki/Businesshttp://en.wikipedia.org/wiki/Financehttp://en.wikipedia.org/wiki/Governmenthttp://en.wikipedia.org/wiki/Crimehttp://en.wikipedia.org/wiki/Economics#cite_note-3%23cite_note-3http://en.wikipedia.org/wiki/Education_economicshttp://en.wikipedia.org/wiki/Economics#cite_note-4%23cite_note-4http://en.wikipedia.org/wiki/Family_economicshttp://en.wikipedia.org/wiki/Health_economicshttp://en.wikipedia.org/wiki/Law_and_economicshttp://en.wikipedia.org/wiki/Public_choicehttp://en.wikipedia.org/wiki/Economics#cite_note-5%23cite_note-5http://en.wikipedia.org/wiki/Institutional_economicshttp://en.wikipedia.org/wiki/Institutional_economicshttp://en.wikipedia.org/wiki/Economics#cite_note-6%23cite_note-6http://en.wikipedia.org/wiki/Sciencehttp://en.wikipedia.org/wiki/Economics#cite_note-7%23cite_note-7http://en.wikipedia.org/wiki/Social_sciencehttp://en.wikipedia.org/wiki/Social_sciencehttp://en.wikipedia.org/wiki/Economic_imperialism_(economics)


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Economics as a science

Economics is a science that treats of those social phenomena that are due to wealthgetting and wealth using activities of Man. The word "Economics" is derived from the

Greeks word "Oikonomos" which means to manage the house. So it means the

management of a household especially in those matters, which are relating to the incomeand expenses of the family. After sometime, political economy term was also used for

this topic and slowly political economy adopted the shape of Economics.

Production of wealth as to how goods and services are produced by

combining the four factors of production. For example Mr. David wants to produce sugar

will combine the four factors of production. First of all, he purchases land, and then he

purchases machinery and raw material. Then he employees labourers and organizes thebusiness. After combining these factors he will produce sugar. Keeping in view the above

discussion we may find that economics is a science of wealth in which we study wealth

through its four aspects: production, exchange, distribution and consumption of wealth.

Economics combines elements of both science and art.

Economists try to develop analytical mathematical models which seek to explain

economic behaviour in a way that can be theoretically proved.

For example working out the elasticity of demand through using calculus.

In macro economic models there are many models which seek to explain macro variables

such as inflation, growth and unemployment.

Yet, when applied to the real world these models have significant limitations which canmake them of limited value.

For example, much of economic theory rests on an assumption of rational behaviour by

consumers. Especially in classical economics, economic theory is derived from a beliefthat consumers and firms will rationally pursue utility maximising decisions. Yet, in

practice human nature is much more complex.


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Economic Growth

Economic Growth can be defined as a rate of expansion that can move anunderdeveloped country from a near subsistence mode of living to substantially higher

level in a comparatively short period of time .i.e. In decade rather than centuries.

Economic Growth as discussed by Suchmpeter is a gradual & steady change in the long

run which comes about by a gradual increase in the rate of savings & population.

Schumpeter stresses that rise in income will lead to rise in savings & economic growthwill lead to an increase in the labour supply.

Friedman defines economic growth as an expansion of the system in one or more

dimensions without a change in its structure. i.e. the basic economic philosophy of thenation does not change. The system undergoes expansion in the existing entities

specifically related to production & distribution.

Kindleberger defines Economic Growth as more output derived from greater input &greater efficiency. i.e.

In short we can say that economic Growth is the summary measure of all the favourable

developments in the economy.

Features of Economic Growth1. There should be an increase in the output of goods & services in an economy over

a period of time.It also involves increase in the efficiency.

2. Economic Growth indicates long term steady increase in the GNP & PCI of thecountry.

3. Increase in GNP & PCI is gradual & steady i.e. consistent & is accompanied by

an increase in savings & labour supply.4. Economic Growth is basically a quantity concept which does not include

structural change.

5. Income actually means the combined payments made to the factors of production( land, labour capital, organization). It is the sum total of rent-( land), wages &

salaries ( labour), profit-( capital) & interest- (organization).Thus increase in

output & income leads to Economic Growth.

Economic Development

Economic Development is a process consisting of a long chain of interrelated changes infundamental factors of supply & demand, leading to a rise in the net national product of a

country in the long run.

Development is a gradual process. It is dependent upon economic, political, social,

educational, cultural & environmental factors. Development is not mechanization or self

sufficiency. It is a positive structural shift in the above mentioned factors. The focal point

of development is man or human being. In short,


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Qualitative Improvement

Development = Quantitative Growth

Structural ChangeThere are two approaches to Economic Development

Traditional Approach

Welfare Oriented Modern Approach

The definitions of Economic development under traditional approach are based on

economic concepts. According to Prof. Meier, Baldwin, Lewis economic development isincrease in the nations real national income or the nations per capita income over a long

period of time.

The Modern Approach takes into account the social factors along with the economicfactors.Thus it implies a progressive change in the socio- economic structure of the

country.Development as opined by a few modern economists is as follows.

Charles KindlebergerHe opines Economic Development implies both more output & changes in technical &

constitutional arrangements by which it is produced. He says economic development ispermanent improvement in welfare. Along with eradication of poverty, decrease in

illiteracy, rate of birth & mortality, diseases is necessary. Also the increase, in age span &

working qualitative population is essential in welfare

Friedman

Economic development is an innovative process that leads to the structural

transformation of social system.

Jacob Viner,Prior to 1950 an economist Jacob Viner had given an opinion which said that untilpoverty was eradicated from a nation, its economic development was impossible. After

1970 the concept of economics development underwent a change. Along with eradication

of poverty the decrease in disparity of income & unemployment factors had to beeradicated.

Features of Economic Development

1. It is a gradual process. The rate of increase in GDP will vary in the course oftime as per variations in equilibrium

1. Human being or man is the focal point of development. Thus it is possible only

when the people of the country are ready to accept change.2. It means a vertical or structural change i.e. a complete transformation of the

society

3. Innovations or qualitative improvement is an integral part of economicdevelopment.

4. Lastly it implies a quantitative growth in economic factors like supply of capital,

technology, entrepreneurship etc as well as non economic factors which includepolitical climate, attitudes of people , social rigidity etc.


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Thus we can conclude that economic development is a process rather than the result of it

which results in a rise in real natural national income & the net national product must

have a sustained increase. In short we can say that it is a long period of dynamic progresswhich helps the developing nations to break the vicious circle of poverty and

simultaneously attain high levels of income, output, and employment & secure better

standard of living.

Prof Schumpeter says, Development is a discontinuous & spontaneous change in the

stationary state which for ever alters & displaces the equilibrium stage previouslyexisting, while Growth is a gradual & steady change in the long run which comes about

by a general increase in the rate of savings & population.

Broadly speaking Economic Development is a concept which is related to underdeveloped & the developing countries whereas the concept of Economic Growth is

related to the developed nations.

Factors Affecting Economic Growth & Development

The process of economic growth & development requires suitable climate for itsinitiation, maintenance & acceleration. This gigantic task can be influenced by a

group of factors economic, social, political, and technological & administrative.Prof

W.A.Lewis observed three main principal causes of economic development:(i) Efforts to economize

(ii) Increase in knowledge & its application

(iii) Growth depends on amount of capital or other resources

Similarly in a recent study a renowned economist has pointed out , The main

determinants of economic development are aptitude, abilities, qualities, capabilities &facilities.

The main factors that govern economic development are roughly divided into two

types.(i) Economic Factors & (ii) non-economic factors.

Economic Factors.

These factors directly influence the development of a country. The growth rate of theeconomy rises or falls as a result of changes in them. They are:

1. Availability of Natural Resources & their utilization:

This is the principal factor affecting the development .Natural resources meanthe gifts of nature like land area, quality of soil, water availability; mineral

wealth etc. Generally natural resources are under utilized, unutilized or mis-

utilised in under developed countries. What is essential is existence ofresources, optimum utilization & chanalization of existing resources.


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Non Economic Factors

According to Prof. M. Wright, The fundamental factors making economic growthare non-economic & non-materialistic in character. It is the spirit itself that builds the

body. The non economic factors comprise cultural, institutional, moral make-up,

social & political organizations which greatly influence the process of economicdevelopment. The various factors are:

1. Desire for Development.Development will be desired if people are convinced about the possibility of

achieving development. There cannot be progress unless people want it. All

must be willing to accept change & pay the price of initial inconvenience.

2. Political Factors.

The existence of strong, competent and honest administrative machinery is

another crucial determinant of economic development in a country. If the

controlling authority is weak, inefficient & corrupt there is chaos. Prof. Lewishas remarked that, The behaviour of the government plays an important role

in stimulating or discouraging economic activity.

3. Wide-spread Education.

Education is the only tool to widen the horizon of the public for accepting newmethods and new techniques. Education plays a pioneer role for the creation

of human, capital & social progress which in turn determines the progress of

the country on all fronts.

4. Social & Institutional Change

Social factors include social attitudes, social values and social instititutionswhich change with the expansion of education and transformation of culture.Generally conservative & rigid social setup such as caste system, traditional

values of life retard the pace of economic development. All this prevents

horizontal & vertical mobility of labour.

5. Religious Factors.

Certain religious beliefs like caste system, non-education of the female child,

wrong stress on the male heir also hamper the process of economicdevelopment.

Conclusion

In short economic growth & development is the net result of concentrated efforts of both

economic & non-economic factors. As rightly stated by UN experts Economic Progresswill not occur unless the atmosphere is favourable to it.& for any under developed

country to make rapid progress it is essential that the governing body undertake necessary

reforms in non economic factors and give due stress on requisite economical changes.


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Labour & Wages.Labour is a collective term used for the productive services embodied in human physical

effort, mental power, talent & skill. According to Marshall, Labour refers to any exertionof mind or body undergone partly or fully with a view to having some goods other than

pleasure derived directly from work.

Labour is the primary factor of production. It is the human resource. It refers to that part

of mans work or exertion, physical or mental whose object is not to yield leisure for

himself but to create utilities for others & to earn a living. Thus economic motive isfundamental to labour. Labour is always paid. The return on labour is termed as wages.

In short, in economic sense mere human effort is not labour.any effort which is paid for

& which directly aimed at production of wealth is labour. Thus work done by a house-wife in the house is not labour but the services of a maid servant employed for the same

work is labour. Similarly efforts of children learning to play cricket is not labour but the

efforts of the coach in teaching them is labour.

The contribution of labour to the national income depends not only on the labour force

but also on its quality. Here quality implies the productivity. A given labour force withhigh level of productivity will yield a larger national product & income.

Productive & Unproductive Labour

Labour which fails to create utility is regarded as unproductive labour. Adam Smith

considered that labour resulting into some material form of output is productive but one

which results in the output of immaterial goods like services is unproductive.

According to the modern economists all labour is whether resulting into material orimmaterial goods is productive. However wasted or misdirected labour is considered as

unproductive.

Division of Labour

An important factor in determining the efficiency of labour is the division of labour.

Division of labour may be simple or complex. Simple division refers to production of asingle commodity by a person. However in modern times the division of labour is

complex. Complex division of labour means that the making of an article is split up into

several processes & each process is carried out by a separate worker or a group of

workers. It refers to specialization in one operation or process.The advantages of Division of Labour are:

Increase in Productivity

Right man in the right place

Dexterity & skill

Inventions are facilitated

Saving in time

Economy in the use of tools

Use of Machinery Encouraged

Cheaper Goods

Rise of Entrepreneurs


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Characteristics of labourUnlike land & capital which are material factors, labour is a human factor of production.

It exhibits the following features.

1. Labour cannot be separated from the labourer. Contrary to land & capital which

are distinct from their owners i.e. landowners & capitalists, labour is not distinctfrom labourer.

2. Labourer does not sell himself, only his labour.In the present day & age thelabourer does not sell himself. He sells only his labour, his efforts; his services.

He receives wages for his work not himself.

3. Labour is a perishable factor. It is not possible to store labour for further use. The

labour time once lost is lost for ever.

4. Labour lacks mobility. Social ties, attachment& labour psychology preferencesrestrict the geographical & occupational mobility of labour.

5. Supply of Labour is inelastic in the short run but in the long run it can be said that

it is elastic but it takes time to increase its overall supply by expanding population& providing them with suitable training and skills required

6. Efficiency of labour varies a good deal. The difference in the efficiency of

workers is due to their physical & mental capabilities as well as by training &skill imparted to them. Their productivity also differs due to the quality &

quantity of capital equipment available as well the technology utilized.

7. Feelings & emotions. Labour is a living factor. It has emotions, likes &

dislikes .Human psychology, experience etc are extremely important in decidingthe efficiency strategy of the human resource management.

8. Active & Heterogeneous. Labour is the most active factor of production. Also the

skill sets & efficiency differ from the person to person & as a labour force fromnation to nation

9. Supply of labour is fundamentally dependant upon population, the tendency towork & ability of the labour supply of the nation as a whole.

10. Human Capital Development. This implies improvement in the quality of labourthrough education, training, skill sets & on the job experiences.

11. Skilled & unskilled. Skilled labour involves the mind & talent whereas unskilledlabour is usually physical or manual.


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Capital

Capital can be defined as productive means of production. The fundamental

distinguishing feature of capital is that it is made by man. The term capital is used to

describe all those instruments of production which are deliberately made by man to beused to carry on production in the future.

Capital refers to the stock of capital assets like factories, machines, tools,eqiopments,raw materials,transport vaehicles etc.According to Collin Clark capital is a producible

wealth used for the process of production.

Thus capital occupies a unique position as man excerises complete control over itscreation.The main characteristics of capital are as follows:

1. Capital is man-made.

Capital is artificial not natural. It is a produced means of production,a man-maderesource.

2. The supply of capital is elastic.

3. Capital is a productive factor.

4. All capital is wealth.

5. Physical capital assets have durability but are subject to depreciation

6. The use of capital involves roundabout methods of production.

7. Capital entails social cost.

Types of capital

Capital may be classified on the basis of durability, mobility & the nature of capital.

Under the durability criterion capital may be classified into

(i) Fixed Capital:

Fixed Capital refers to durable physical assets like machinery, tools,equipment, factory plant etc; which are used again &again in the process

of production for a long period until they are worn out. Fixed capital once

installed remains fixed in the short period.


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(ii) Circulating or Working Capital:

It is a variable capital input. It refers to one time use to produce goods.

Working Capital is directly absorbed into finished products. It changes itsform completely in the process of production hence Working Capital. Its

employment varies directly with output.

Under The Mobility Criterion capital can be distinguished into

(iii) Sunk capital: Capital equipment of a very sophisticated type &havingsome specific use only is regarded as sunk capital.

(iv) Floating Capital. This refers to non-specific general type of capital like

electric power which can be used in any industry in a no. of ways.

On the basis of its nature capital can be classified into money capital & floating capital

(v) Money Capital:Usually in business capital implies money capital .It is the result of

monetary savings. Share capital provides financial or money capital to thecompanies. Money capital is also known as financial capital.

(vi) Real Capital

Real capital refers to physical capital goods such as machinery, rawmaterials, power, factory vehicles etc. Real capital is also known as

physical capital.

Another distinction is social capital (roads) & private capital (lorries)

Capital Formation.

Capital formation or accumulation of capital refers to the increase in the stock of real

capital in a country. Capital formation is the basis of economic development. Accordingto Prof Ragnar Nurske, The meaning of capital formation is that the society does not

apply the whole of its current productive activity to the needs & desires of immediate

consumption but directs a part of it to the making of capital goods - all the forms of real

capital that can so greatly increase the productive effort.

The term is sometimes used to cover human market as well as material capital ;it can be

made to include investment in skills , education & health a very important form ofinvestment.

Capital Formation can thus be interpreted in a narrow sense when the term refers only tophysical & material capital like machines , buildings etc & in a wider sense when it

includes intangible or invisible human capital (i.e. human skills, talents utilized for

improvement of social / mass welfare) along with material & physical capital.


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DOMESTIC Capital Formation.

The process of capital formation in a country involves three stages.

First stage: Creation of savings :

Capital formation begins with total savings .The level of savings depends upon the abilityto save i.e. income level & the willingness i.e. tendency to save.

Second Stage .Mobilisation of savings :Savings themselves do not maen capital. When a potion of the savings is invested by the

people &thus enter the market as lonable funds,then they become capital.Mobilisation of

savings depends upon the development of money market , the rate of interest etc.

Third Stage: Investment of savings in Real Capital

Savings just entering the market does not mean capital formation. Only when people

begin investing their savings into business to increase the real capital such as

upgradation, purchase of new machinary , new business which generate employmentincrease production which will lead to economic growth & development of the nation

theh will thye process of capital formation be complete.

Investment will take place only when the market conditions are conducive to investment.

i.e. there is inducement to invest. Inducement to invest depends upon the marginal

efficiency of capital & the size of the market. It also depends upon the political beliefs,the type of economy (Capitalistic etc), The governments attitude & willingness to invest

in real capital; increase real capital.

Obstacles in Capital Formation.

The major factors that hamper capital formation can be listed as below

Absence of a strong well developed financial system.

Majority of the population based in villages & primarily agrarian economy

Illiteracy , wide spread ignorance & distrust of investments

Tendency to hoard in form of gold

Expenditure on social & religious obligations

A high level of taxation leading to low level of savings

Inequality of income & disparity in income

Inflation & artificial shortage conditions

Wastages of resources & mis-utilisation

Failiure of the government in investment of revenue & adverse effects ofmeasures to redistribute income to weaker sections of the society.

Measures to increase capital formation include educating people to the benefits ofconverting savings to investments, optimum utilization of available resources,

development of the financial system so that it reaches the rural areas, efforts to reduce all

forms of unemployment so that income & savings increase ,spreading awareness so as toreduce the propensity to consume & reducing unnecessary social expenditure.


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Consumption, Savings & Investment

Consumption can be defined as the usage of the product of production. i.e. utilization ofthe material benefits created in the process of production. Consumption is equal to the

amount spent on consumption expenditure at a given level of income of a community.

Consumption expenditure is the major constituent of aggregate demand in an economy.Consumption expenditure of the people is dependent upon the level of income( real

income), past savings & the rate of interest prevailing in the market.

In specific terms, Keynes was of the view that current consumption depends upon the

current disposable income. A rise in income leads to a rise in consumption & vice versa.

Further studies in this area lead to the analysis of the Permanent Income Hypothesis, The

Relative Income Hypothesis & the Absolute Income Hypothesis. The empiricalconsumption income relationship is presented by the Consumption Function.

Consumption Function.

According to the psychological law propounded by Keynes, Aggregate consumption is a

function of aggregate disposable income.The consumption function is based on this law.Keynes says that The psychology of the community is such that when aggregate real

income is increased,aggregate consumption is increased,but not by so much as

income.Keynes Psychological law depends upon three propositions

When aggregate income increases, consumption expenditure will also increase but

by a somewhat smaller amount

An increment of income will be divided in some ratio between saving & spending

An increase in income is unlikely to lead either to less spending or less saving

than before.

Consumption Function or the Propensity to Consume

Consumption function or the propensity to consume means the whole of the scheduleshowing consumption expenditure at various levels of income. It indicates a functional

relationship between total consumption expenditure & the gross national income. It

expresses the relationship between consumption & disposable income; how consumption

expenditure increases as income increases. If Consumption is C & income is Y thenpropensity to consume is C(Y).The relationship between income & consumption is

measured by the average & the marginal propensity to consume.

Average Propensity to consume.(APC)Average propensity to consume is the ratio of total consumption to total income in a

given period. Thus APC = C/Y where C is consumption & Y is income. The value ofAPC can be found by dividing consumption expenditure by the aggregate income.

Average Propensity to save.(APS)Average propensity to save is the ratio of total savings to total income.Thus APS = S/Y

where S is savings & Y is income.


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Marginal Propensity to consume (MPC)

Marginal Propensity to consume is the ratio of change in consumption to the change inincome. It is the relation between increase in consumption expenditure as a result of

increase in income. Thus

MPC = Change in C/Change in YWhere C is consumption expenditure & Y is income.

Marginal Propensity to save.Marginal Propensity to save is the complement of the marginal propensity to consume.

Thus MPS = 1-MPC

MPS = 1-Change in C/Change in Y

MPS = Change in S/Change in Y

The propensity to consume depends upon many factors which are psychological as well

as objective in nature. The psychological or subjective factors include desire for

expansion, desire for a better standard of living etc.

The objective factors include

Increase or decrease in the money income

Inflation & the price level in the economy

Income level

Availability of credit increases the propensity to consume

Equitable distribution of income will increase the MPC

Changes in expectations, consumers tastes

High Rate of interest means less consumption & viceversa

Preference for liquidity

Attitude towards thrift/miserliness

Taxes & Fiscal policy of the government

Savings

Savings can defined as the difference between income & consumption

expenditure. According to Keynes Everyone is agreed that saving means

the excess of income over expenditure on consumption.This definition of

savings applies to personal as well as the aggregate savings.The personal

savings can be expressed as Sp= Yd-Cp

Where Sp is personal saving, Yd is Disposable income & Cp is personal

consumption.

Aggregate Saving can be expressed as S= Y-C where Sis aggregate Savings,

Y Is Aggregate income & C is Aggregate Consumption Expenditure.


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Economic Policy Fiscal Policy Monetary Policy

Economic Policy

Economic Policy can be defined as the actions taken by the government to influence its economy.Types of economic policy actions can include setting Interest rates through Federal Reserve,

regulating the level of government expenditures, creating private property rights & setting tax

rates.

Economic policy refers to the actions that governments take in the economic field. Itcovers the systems for setting interest rates and government budgetas well as thelabour

market,national ownership, and many other areas of government interventions into the

economy.

Such policies are often influenced by international institutions like the InternationalMonetary Fund orWorld Bankas well aspoliticalbeliefs and the consequentpolicies of

parties.

Policy is generally directed to achieve particular objectives, like targets forinflation,

unemployment, oreconomic growth. Sometimes other objectives, like military spendingornationalizationare important. These are referred to as the policy goals: the outcomes

which the economic policy aims to achieve.

To achieve these goals, governments use policy tools which are under the control of thegovernment. These generally include theinterest rate and money supply, tax and

government spending, tariffs, exchange rates, labour marketregulations, and many other

aspects of government.

The government's economic policy determines the tools and hopes that they will achieveits goals. Government and central banks are limited in the number of goals they can

achieve in the short term. For instance, there may be pressure on the government to

reduce inflation, reduce unemployment, and reduce interest rates while maintaining

currency stability. If all of these are selected as goals for the short term, then policy islikely to be incoherent, because a normal consequence of reducing inflation and

maintaining currency stability is increasing unemployment and increasing interest rates.

A group ofeconomicadvisers appointed by thePresident to help formulate economic policy.

This group typically consists of three members, who work in anadvisory capacity and are not

responsible for actual implementation of the policy.

Fiscal policyis the means by which a government adjusts its levels of spending in order to

monitor and influence a nation's economy. It is the sister strategy to monetary policy with which a

central bankinfluences a nation's money supply. These two policies are used in various

combinations in an effort to direct a country's economic goals. Here we take a look at how fiscal

policy works, how it must be monitored and how its implementation may affect different people in

an economy.
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Economic effects of fiscal policy

Fiscal policy is used by governments to influence the level of aggregate demand in the

economy, in an effort to achieve economic objectives of price stability, full employmentand economic growth. Keynesian economics suggests that adjusting government

spending and tax rates are the best ways to stimulateaggregate demand. This can be usedin times of recession or low economic activity as an essential tool in providing theframework for strong economic growth and working toward full employment. The

government can implement these deficit-spending policies due to its size and prestige and

stimulate trade. In theory, these deficits would be paid for by an expanded economy

during the boom that would follow; this was the reasoning behind the New Deal.

During periods of high economic growth, a budget surplus can be used to decrease

activity in the economy. A budget surplus will be implemented in the economy if

inflation is high, in order to achieve the objective of price stability. The removal of fundsfrom the economy will, by Keynesian theory, reduce levels of aggregate demand in the

economy and contract it, bringing about price stability.

Some classical andneoclassical economistsargue that fiscal policy can have no stimulus

effect; this is known as the Treasury View[citation needed], and categorically rejected byKeynesian economics. The Treasury View refers to the theoretical positions of classical

economists in the British Treasury who opposed Keynes call for fiscal stimulus in the

1930s. The same general argument has been repeated by neoclassical economists up to

the present day. From their point of view, when government runs a budget deficit, fundswill need to come from public borrowing (the issue of government bonds), overseas

borrowing or the printing of new money. When governments fund a deficit with the

release of government bonds, an increase in interest rates across the market can occur.

This is because government borrowing creates higher demand for credit in the financialmarkets, causing a lower aggregate demand (AD), contrary to the objective of a budget

deficit. This concept is called crowding out.

How Fiscal Policy WorksFiscal policy is based on the theories of British economist John Maynard Keynes. Also known asKeynesian economics, this theory basically states that governments can influencemacroeconomic productivity levels by increasing or decreasing tax levels and public spending.This influence, in turn, curbs inflation (generally considered to be healthy when at a level between2-3%), increases employment and maintains a healthy value of money.

Balancing ActThe idea, however, is to find a balance in exercising these influences. For example, stimulating astagnant economy runs the risk of rising inflation. This is because an increase in the supply ofmoney followed by an increase in consumer demand can result in a decrease in the value ofmoney - meaning that it will take more money to buy something that has not changed in value.
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a. Direct Physical Control

b. Increase in the rates of existing taxes

c. Imposition of new taxes

d. Surplus from public enterprises

e. Public borrowing of a non-inflationary nature

f. Deficit financing

Thus taxation is the most important source for raising revenues to finance development

programmes in the absence of adequate voluntary saving.

2. To Accelerate The Rate of Economic Growth

The fiscal means such as taxation, public borrowing & deficit financing etc should be

used in such a combination so that the production, consumption & distribution are not

adversely affected but the economy as a whole should develop so as to increase the

national income &per capita income rapidly. It is now considered of utmost importance

that interdependent sectors, such as agriculture & industry should grow simultaneously.

In the words of Prof. Raja J. Chelliah, The most fruitful line of advance lies along the

path of a balanced development of agriculture & industry.

3. To Encourage Investment into Socially Desirable Channels.

Fiscal Policy should aim at rapid economic development & must induce a flow of

economic resources into those sectors of the economy which are considered essentials

for rapid economic development & socially desirable. Also, the unproductive investment

such as speculative investment in land or gold should be subjected to heavy taxation so

as to divert the resources, from unproductive channels to productive & socially desirable

channels.

4. Inducement to Investments

Apart from granting rebates, concessions, subsidies etc the government must try to build

up economic & social overheads like transport & communication, irrigation facilities

power installations i.e. general infrastructural facilities which are helpful for widening the

size of the market reducing the cost of production & increasing the social marginal

productivity of investment.

5. The Pattern of investment

Under the optimum pattern of investment of an underdeveloped country, preferenceshould be given to those investment projects whose social marginal productivity is

highest. However the application of principle of social marginal productivity is in the

context of planned allocation of resources will have to be interpreted within the usual

dynamic complex.

6. Fiscal Policy & Price Stability


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The fiscal policy should aim at curbing inflationary pressures inherent in a developing

economy. Such economies are characterized by the imbalance between demand &

supply of the real resources. This leads to inflationary rise in prices. The fiscal measures

to check the inflationary tendencies are taxation & borrowing, as theses measures

remove purchasing power from circulation. However these measures have to be

supplemented with monetary measures to make them more effective.

7. Fiscal Policy & Distribution.

The existence of extreme inequalities in income & wealth distribution may have an

adverse effect on the economic development. They create political & social discontent,

generate economic instability & hence the removal of inequalities of income & wealth is

extremely important. A redistributive tax policy should aim at imposing heavy taxation on rich

& exempting the poorer section of the community. The tax system should be steeply

progressive. It should discourage commodity taxation as they are regressive in effect.

However a highly progressive tax structure may go against the objectives of economic

development. Thus according to some economists, Though functional inequality may be

maintained to some extent, non functional inequality should be eliminated.

Fiscal Policy in a nutshell.

To increase the rate of investment & capital formation so as to accelerate the rate of

economic growth.

To check the actual & potential consumption so as to increase the rate of savings &

investments in the private sector

To encourage the flow of investment into socially desirable channels

To regulate the flow of purchasing power in order to achieve the objective of economic

growth with price stability

To reduce the large inequalities of income & wealth To remove the regional imbalance in the economy

To divert the investment &spending from unproductive uses like production &

consumption of intoxicants to productive channels

To raised the standard of living of the country as a whole.

Conclusion

One of the biggest obstacles facing policymakers is deciding how much involvement the

government should have in the economy. There have been various degrees of interference

by the government over the years. Generally, it is accepted that a degree of government

involvement is necessary to sustain a vibrant economy, on which the economic well being of

the population depends. The greater the percentage of the national income & expenditurerepresented by the government budget, the greater would be the influence of the fiscal policy

on aggregate economic policy. Fiscal role of the government should be to remove bottlenecks

& structural rigidities, planned development of various sectors, physical control of essential

products; their purchase & sale & maintaining the general price stability.


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Monetary Policy

Monetary policy is the process by which the government,central bank, or monetary

authority of a country controls (i) the supply of money, (ii) availability of money, and(iii) cost of money or rate ofinterest, in order to attain a set of objectives oriented

towards the growth and stability of the economy.[1]

Monetary theory provides insight intohow to craft optimal monetary policy.

Monetary policy is one of the tools that a national Government uses to influence itseconomy. Using its monetary authority to control the supply and availablity of money, a

government attempts to influence the overall level of economic activity in line with its

political objectives. Usually this goal is "macroeconomic stability" - low unemployment,low inflation, economic growth, and a balance of external payments. Monetary policy is

usually administered by a Government appointed "Central Bank", e.g. the Bank of

Canada and the Federal Reserve Bank in the United States.

Monetary policy is referred to as either being an expansionary policy, or acontractionarypolicy, where an expansionary policy increases the total supply of money in the

economy, and a contractionary policy decreases the total money supply. Expansionary

policy is traditionally used to combat unemploymentin a recession by lowering interest

rates, while contractionary policy involves raising interest rates in order to combatinflation. Monetary policy is contrasted with fiscal policy, which refers to government

borrowing, spending and taxation.[2]

Monetary policy rests on the relationship between the rates of interest in an economy,(i.e. the price at which money can be borrowed), and the total supply of money. Monetary

policy uses a variety of tools to control one or both of these, to influence outcomes like

economic growth, inflation, exchange rates with other currencies and unemployment.Where currency is under a monopoly of issuance, or where there is a regulated system ofissuing currency through banks which are tied to a central bank, the monetary authority

has the ability to alter the money supply and thus influence the interest rate (in order to

achieve policy goals). The beginning of monetary policy as such comes from the late19th century, where it was used to maintain the gold standard.

Objectives of Monetary Policy

In the pre Keynesian days the monetary policy was the single established instrument of

macro economic policy with price stability as its established objective. Subsequent to thegreat depression & the Keynesian revolution the objective of maintenance of Full

Employment commonly described as Economic stability came into existence. Post theSecond World War & since 1950 the objective of Rapid Economic Growth has beenadded to the objectives of monetary policy. In the early 1960s Balance of Payments

Equilibrium has also become a goal of the monetary policy.

Thus the objectives can be summarized as

Price Stability

Full Employment / Economic Stability

Rapid Economic Growth
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A central bank can only operate a truly independent monetary policy when theexchange

rate is floating. If the exchange rate is pegged or managed in any way, the central bank

will have to purchase or sell foreign exchange. These transactions in foreign exchangewill have an effect on the monetary base analogous to open market purchases and sales of

government debt; if the central bank buys foreign exchange, the monetary base expands,

and vice versa. But even in the case of a pure floating exchange rate, central banks andmonetary authorities can at best "lean against the wind" in a world where capital is

mobile.

Developing countries

Developing countries may have problems establishing an effective operating monetarypolicy. The primary difficulty is that few developing countries have deep markets in

government debt. The matter is further complicated by the difficulties in forecasting

money demand and fiscal pressure to levy theinflationtax by expanding the monetarybase rapidly. In general, the central banks in many developing countries have poor

records in managing monetary policy. This is often because the monetary authority in adeveloping country is not independent of government. So good monetary policy takes a

backseat to the political desires of the government or are used to pursue other non-monetary goals.

Inflation targeting

Under this policy approach the target is to keep inflation, (under a particular definition

such as Consumer Price Index), within a desired range.

The inflation target is achieved through periodic adjustments to the Central Bankinterest

rate target. The interest rate used is generally theinterbank rate at which banks lend toeach other overnight for cash flow purposes. Depending on the country this particularinterest rate might be called the cash rate, call money rate or something similar.

The interest rate target is maintained for a specific duration using open market operations.

Typically the duration that the interest rate target is kept constant will vary between

months and years. This interest rate target is usually reviewed on a monthly or quarterlybasis by a policy committee.

Changes to the interest rate target are made in response to various market indicators in an

attempt to forecast economic trends and in so doing keep the market on track towards

achieving the defined inflation target.

Monetary aggregates

In the 1980s, several countries used an approach based on a constant growth in the money

supply. This approach was refined to include different classes of money and credit (M0,

M1 etc). This approach is also sometimes called monetarism.
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A Comparison of Monetary & Fiscal Policies

Impact on the Composition of Output

Monetary policy is seen as something of a blunt policy instrument affecting all

sectors of the economy although in different ways and with a variable impact.

Fiscal policy changes can be targeted to affect certain groups (e.g. increases inmeans-tested benefits for low income households, reductions in the rate ofcorporation tax for small-medium sized enterprises, investment allowances forbusinesses in certain regions)

Monetary policy expansion

Lower interest rates will lead to an increase in both consumer and fixed capitalspending both of which increases current equilibrium national income. Since

investment spending results in a larger capital stock, then incomes in thefuture will also be higher through the impact on LRAS.

Fiscal policy expansion

An expansion in fiscal policy (i.e. an increase in government spending) addsdirectly to AD but if financed by higher government borrowing, this may resultin higher interest rates and lower investment. The net result (by adjusting theincrease in G) is the same increase in current income. However, sinceinvestment spending is lower, the capital stock is lower than it would havebeen, so that future incomes are lower

Differences in the Effectiveness of Monetary and Fiscal Policies

When the economy is in a recession (when business and consumer confidence is verylow and perhaps where deflationary pressures are taking hold) monetary policy may beineffective in increasing current national spending and income. The problemsexperienced by the Japanese in trying to stimulate their economy through a zero-interest rate policy might be mentioned here. In this case, fiscal policy might be moreeffective in stimulating demand. Other economists disagree they argue that shortterm changes in monetary policy do impact quite quickly and strongly on consumerand business behaviour. Consider the way in which domestic demand in both theUnited States and the UK has responded to the interest rate cuts introduced in the

wake of the terror attacks on the USA in the autumn of 2001.However, there may befactors which make fiscal policy ineffective aside from the usual crowding outphenomena. Future-oriented consumption theories hold that individuals undogovernment fiscal policy through changes in their own behaviour for example, ifgovernment spending and borrowing rises, people may expect an increase in the taxburden in future years, and therefore increase their current savings in anticipation ofthis


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Current Developments in Indian Monetary Policy.( As of 26.10. 09)

Mumbai, Oct 26 (IANS) Indias central bank will review its monetary policy for the

current fiscal here Tuesday amid growing signs of recovery in the industrial sector butconcerns over rising inflation, especially due to high food prices.

Reserve Bank of India (RBI) Governor D. Subbarao will review the policy before the

chief executives of commercial banks amid expectations that key rates will be left

untouched but the cash reserve ratio may be hiked to curb money supply.

In the first quarter review of the policy three months ago, the central bank had kept thekey rates unchanged, but cautioned that inflation rate could balloon to 5 percent.

In April, Subbarao had cut the repo and the reverse repo rates by 25 basis points each,

even as the bank rate, the statutory liquidity ratio and the cash reserve ratio were left

unchanged.

The repo rate, currently at 4.75 percent, is the interest charged by the RBI on borrowings

by commercial banks. A reduction in it lowers the cost of borrowings for commercial

banks.

The reverse repo rate, currently at 3.25 percent, is the rate at which the central bankborrows money from commercial banks. A lowering of this rate makes it less lucrative

for banks to park funds with the central bank.

The cash reserve ratio, now at 5 percent, is the amount banks have to retain in the form of

cash, while statutory liquidity ratio, at 24 percent, is the amount these institutions have to

invest in specified securities.


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Money .Functions of Money

Money is anything that is generally accepted aspaymentforgoods and services and

repayment ofdebts. The main functions of money are distinguished as: a medium ofexchange, a unit of account, a store of value, and occasionally, a standard of deferred

payment. Money is anabstraction,ideaorconcept,token instancesof which are thephysicalbills orcoins which are carried and traded.

Money originated as commodity money, but nearly all contemporary money systems atthe national level are fiat money systems. Fiat money is without value as a physical

commodity, and derives its value by being declared by a government to belegal tender;

that is, it must be accepted as a form of payment within the national boundaries of thecountry, for "all debts, public and private". By law, the refusal of a legal tender (offering)

extinguishes the debt in the same way acceptance does.

The money supplyof a country is usually held to consist ofcurrency(banknotes and

coins) and demand deposits or 'bank money' (the balance held inchecking accounts andsavings accounts). Thesedemand deposits usually account for a much larger part of the

money supply than currency. Bank moneyis intangible and exists only in the form of

various bank records. Despite being intangible, bank money still performs the basic

functions of money, as checks are generally accepted as a form of payment and as ameans of transferring ownership of deposit money.

In the past, money was generally considered to have the following four main functions,

which are summed up in a rhyme found in older economics textbooks: "Money is amatter of functions four, a medium, ameasure, a standard, a store." That is, money

functions as a medium of exchange, a unit of account, astandard of deferred payment,

and a store of value. However, most modern textbooks now list only three functions, thatofmedium of exchange, unit of account, and store of value, not considering a standard ofdeferred payment as a distinguished function, but rather subsuming it in the others.

There have been many historical disputes regarding the combination of money's

functions, some arguing that they need more separation and that a single unit is

insufficient to deal with them all. One of these arguments is that the role of money as amedium of exchange is in conflict with its role as a store of value: its role as a store of

value requires holding it without spending, whereas its role as a medium of exchange

requires it to circulate. Others argue that storing of value is just deferral of the exchange,but does not diminish the fact that money is a medium of exchange that can be

transported both across space and time. The term 'financial capital' is a more general andinclusive term for all liquid instruments, whether or not they are a uniformly recognizedtender.
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Banking System in India Commercial Banks & Central Banks

Commercial Banks

Definition:

According to the Banking Companies Act 1949 a Banking Company has been defined asone, which transacts the business of banking which means accepting for the purpose oflending or investment , of deposits of money from the public, repayable on demand or

otherwise & withdrawable by cheque, draft, order or otherwise.

Commercial Bank is an institutionwhichaccepts deposits, makes businessloans, and offers

related services.Commercialbanks also allow for a variety ofdeposit accounts, such as

checking, savings, and time deposit. These institutions are run to make aprofit and owned by

agroup ofindividuals, yet some may be members of the Federal Reserve System. While

commercial banks offer services to individuals, they are primarily concerned with receiving

deposits and lending to businesses.

The Role of Commercial Banks

Commercial banks engage in the following activities:

processing of payments by way of telegraphic transfer, EFTPOS, internet

banking, or other means

issuingbank drafts andbank cheques

accepting money on term deposit

lending money by overdraft, installment loan, or other means

providing documentary and standby letter of credit, guarantees,performance

bonds, securities underwriting commitments and other forms of off balance sheetexposures

safekeeping of documents and other items insafe deposit boxes

sale, distribution orbrokerage, with or without advice, ofinsurance,unit trustsand similar financial products as a financial supermarket

traditionally, large commercial banks alsounderwrite bonds, andmake markets in

currency, interest rates, and credit-related securities, but today large commercialbanks usually have an investment bank arm that is involved in the mentioned

activities.

Functions of Commercial Banks

The functions of commercial banks are divided into two categories:

A) Primary functions, and

B) Secondary functions including agency functions.
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A) Primary functions:

The primary functions of a commercial bank include:

I) Accepting deposits; and

II) Granting loans and advances;

I) Accepting deposits

The most important activity of a commercial bank is to mobilize deposits from the public.People who have surplus income and savings find it convenient to deposit the amounts

with banks. Depending upon the nature of deposits, funds deposited with bank also earn

interest. Thus, deposits with the bank grow along with the interest earned. If the rate of

interest is higher, public are motivated to deposit more funds with the bank. There is alsosafety of funds deposited with the bank.

Different modes of Acceptance of Deposits

Banks receive money from the public by way of deposits. The following types of deposits

are usually received by banks:

i) Current deposit

ii) Saving deposit

iii) Fixed depositiv) Recurring deposit

v) Miscellaneous deposits

i) Current Deposit

Also called demand deposit, current deposit can be withdrawn by the depositor at any

time by cheques. Businessmen generally open current accounts with banks. Currentaccounts do not carry any interest as the amount deposited in these accounts is repayable

on demand without any restriction. The Reserve bank of India prohibits payment of

interest on current accounts or on deposits upto 14 Days or less except where priorsanction has been obtained. Banks usually charge a small amount known as

incidental charges on current deposit accounts depending on the number of transaction.

Savings deposit/Savings Bank Accounts

Savings deposit account is meant for individuals who wish to deposit small amounts out

of their current income. It helps in safe guarding their future and also earning interest on

the savings. A saving account can be opened with or without cheque book facility. Thereare restrictions on the withdrawals from this account. Savings account holders are also

allowed to deposit cheques, drafts, dividend warrants, etc. drawn in their favour for

collection by the bank. To open a savings account, it is necessary for the depositor to beintroduced by a person having a current or savings account with the same bank.


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Fixed deposit

The term Fixed deposit means deposit repayable after the expiry of a specified period.

Since it is repayable only after a fixed period of time, which is to be determined at thetime of opening of the account, it is also known as time deposit. Fixed deposits are most

useful for a commercial bank. Since they are repayable only after a fixed period, the bank

may invest these funds more profitably by lending at higher rates of interest and forrelatively longer periods. The rate of interest on fixed deposits depends upon the period

of deposits. The longer the period, the higher is the rate of interest offered. The rate of

interest to be allowed on fixed deposits is governed by rules laid down by the ReserveBank of India.

Recurring Deposits

Recurring Deposits are gaining wide popularity these days. Under this type of deposit,the depositor is required to deposit a fixed amount of money every month for a specific

period of time. Each installment may vary from Rs.5/- to Rs.500/- or more per month and

the period of account may vary from 12 months to 10 years. After the completion of

the specified period, the customer gets back all his deposits along with the cumulativeinterest accrued on the deposits.

Miscellaneous Deposits

Banks have introduced several deposit schemes to attract deposits from different types of

people, like Home Construction deposit scheme, Sickness Benefit deposit scheme,

Children Gift plan, Old age pension scheme, Mini deposit scheme, etc.

II) Grant of loans and advances

The second important function of a commercial bank is to grant loans and advances. Suchloans and advances are given to members of the public and to the business community at

a higher rate of interest than allowed by banks on various deposit accounts. The rate of

interest charged on loans and advances varies depending upon the purpose, period and themode of repayment. The difference between the rates of interest allowed on deposits

and the rate charged on the Loans is the main source of a banks income.

i) Loans

A loan is granted for a specific time period. Generally, commercial banks grant short-

term loans. But term loans, that is, loan for more than a year, may also be granted.

The borrower may withdraw the entire amount in lump sum or in installments. However,interest is charged on the full amount of loan. Loans are generally granted against the

security of certain assets. A loan may be repaid either in lump sum or in installments.

ii) Advances

An advance is a credit facility provided by the bank to its customers. It differs from loan

in the sense that loans may be granted for longer period, but advances are normallygranted for a short period of time. Further the purpose of granting advances is to meet the

day to day requirements of business. The rate of interest charged on advances varies

from bank to bank. Interest is charged only on the amount withdrawn and not on the

sanctioned amount.


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Different methods of Granting Loans by Bank

The basic function of a commercial bank is to make loans and advances out of the money

which is received from the public by way of deposits. The loans are particularly grantedto businessmen and members of the public against personal security, gold and silver and

other movable and immovable assets. Commercial bank generally lend money in the

following form:

i) Cash Credit:

A cash credit is an arrangement whereby the bank agrees to lend money to the borrowerupto a certain limit. The bank puts this amount of money to the credit of the borrower.

The borrower draws the money as and when he needs. Interest is charged only on the

amount actually drawn and not on the amount placed to the credit of borrowers account.

Cash credit is generally granted on a bond of credit or certain other securities. This is avery popular method of lending in our country.

ii) Loans:

A specified amount sanctioned by a bank to the customer is called a loan. It is grantedfor a fixed period, say six months, or a year. The specified amount is put on the credit of

the borrowers account. He can withdraw this amount in lump sum or can draw chequesagainst this sum for any amount. Interest is charged on the full amount even if the

borrower does not utilise it. The rate of interest is lower on loans in comparison to cash

credit. A loan is generally granted against the security of property or personal security.

The loan may be repaid in lump sum or in installments. Every bank has its own procedureof granting loans. Hence a bank is at liberty to grant loan depending on its own resources.

The loan can be granted as:

a) Demand loan, orb) Term loan

a) Demand loan

Demand loan is repayable on demand. In other words it is repayable at short notice. Theentire amount of demand loan is disbursed at one time and the borrower has to pay

interest on it. The borrower can repay the loan either in lump sum (one time) or as agreed

with the bank. Loans are normally granted by the bank ag

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