Introductor y Macroeconomics Textbook in Economics for Class XII ISBN 81-7450-715-9 First Edition March 2007 Phalguna 1928 Reprinted February 2008 Magha 1929 February 2009 Magha 1930 January 2010 Magha 1931 January 2011 Magha 1932 January 2012 Magha 1933 January 2013 Pausa 1934 January 2014 Pausa 1935 December 2014 Pausa 1936 ALL RIGHTS RESERVED q No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without the prior permission of the publisher. q This book is sold subject to the condition that it shall not, by way of trade, be lent, re-sold, hired out or otherwise disposed of without the publisher’s consent, in any form of binding or cover other than that in which it is published. q The correct price of this publication is the price printed on this page, Any revised price indicated by a rubber stamp or by a sticker or by any other means is incorrect and should be unacceptable. PD 120T MJ © National Council of Educational Research and Training, 2007 OFFICES OF THE PUBLICATION DIVISION, NCERT NCERT Campus Sri Aurobindo Marg New Delhi 110 016 Phone : 011-26562708 108, 100 Feet Road Hosdakere Halli Extension Banashankari III Stage Bengaluru 560 085 Phone : 080-26725740 Navjivan Trust Building P.O.Navjivan Ahmedabad 380 014 Phone : 079-27541446 CWC Campus Opp. Dhankal Bus Stop Panihati Kolkata 700 114 Phone : 033-25530454 CWC Complex Maligaon Guwahati 781 021 Phone : 0361-2674869 ` 60.00 Publication Team Printed on 80 GSM paper with NCERT watermark Published at the Publication Division by the Secretary, National Council of Educational Research and Training, Sri Aurobindo Marg, New Delhi 110 016 and printed at Goyal Stationers, B-36/9, G.T. Karnal Road Industrial Area, Delhi 110 033 Head, Publication Division : N.K. Gupta Chief Production Officer : Kalyan Banerjee Chief Editor : Shveta Uppal Chief Business Manager : Gautam Ganguly Assistant Production Officer : Atul Saxena Cover, Layout and Illustrations Blue Fish Cartoonist Irfan Foreword ? he National Curriculum Framework (NFC) 2005, recommends that T children’s life at school must be linked to their life outside the school. This principle marks a departure from the legacy of bookish learning which continues to shape our system and causes a gap between the school, home and community. The syllabi and textbooks developed on the basis of NCF signify an attempt to implement this basic idea. They also attempt to discourage rote learning and the maintenance of sharp boundaries between different subject areas. We hope these measures will take us significantly further in the direction of a child-centred system of education outlined in the National Policy on Education (1986). The success of this effort depends on the steps that school principals and teachers will take to encourage children to reflect on their own learning and to pursue imaginative activities and questions. We must recognise that, given space, time and freedom, children generate new knowledge by engaging with the information passed on to them by adults. Treating the prescribed textbook as the sole basis of examination is one of the key reasons why other resources and sites of learning are ignored. Inculcating creativity and initiative is possible if we perceive and treat children as participates in learning, not as receivers of a fixed body of knowledge. These aims imply considerable change in school routines and mode of functioning. Flexibility in the daily time-tables is as necessary as rigour in implementing the annual calendar so that the required number of teaching days are actually devoting to teaching. The methods used for teaching and evaluation will also determine how effective this textbook proves for making children’s life at school a happy experience, rather than a source of stress or problem. Syllabus designers have tried to address the problem of curricular burden by restructuring and reorienting knowledge at different stages with greater consideration for child psychology and the time available for teaching. The textbook attempts to enhance this endeavour by giving higher priority and space to opportunities for contemplation and wondering, discussion in small groups, and activities requiring hands-on experience. The National Council of Educational Research and Training (NCERT) appreciates the hard work done by the textbook development committee responsible for this textbook. We wish to thank the Chairperson of the advisory group in Social Sciences, Professor Hari Vasudevan and the Chief Advisor for this textbook, Professor Tapas Majumdar for guiding the work of this committee. Several teachers contributed to the development of this textbook; we are grateful to their principals for making this possible. We are indebted to the institutions and organisations which have generously permitted us to draw upon their resources, material and personnel. We are especially grateful to the members of the National Monitoring Committee, appointed by the Department of Secondary and Higher Education, Ministry of Human Resources Development under the Chairpersonship of Professor Mrinal Miri and Professor G.P. Deshpande, for their valuable time and contribution. As an organisation committed to systemic reform and continuous improvement in the quality of its products, NCERT welcomes comments and suggestions which will enable us to undertake further revision and refinement. Director National Council of Educational Research and Training New Delhi 16 February 2007 iv Textbook Development Commitee ? HAIRPERSON, ADVISORY COMMITTEE FOR SOCIAL SCIENCE TEXTBOOKS AT THE HIGHER C SECONDARY LEVEL Hari Vasudevan, Professor, Department of History, University of Calcutta, Kolkata CHIEF ADVISOR Tapas Majumdar, Professor Emeritus of Economics, Jawaharlal Nehru University, New Delhi. ADVISOR Satish Jain, Professor, Centre for Economics Studies and Planning, School of Social Sciences, Jawaharlal Nehru University, New Delhi MEMBERS Debarshi Das, Lecturer, Department of Economics, Punjab University, Chandigarh Saumyajit Bhattacharya, Sr Lecturer, Department of Economics, Kirorimal College, New Delhi Sanmitra Ghosh, Lecturer, Department of Economics, Jadavpur University, Kolkatta Malbika Pal, Sr Lecturer, Department of Economics, Miranda House, New Delhi MEMBER-COORDINATOR Jaya Singh, Lecturer, Economics, Department of Education in Social Sciences and Humanities, NCERT, New Delhi Acknowledgement The National Council of Educational Research and Training acknowledges the invaluable contribution of academicians and practising school teachers for the mukherjee, Professor, JNU, for going through our manuscript and suggesting relevant changes. We thank jhaljit Singh, Reader, Department of Economics, University of Manipur for his contribution. We also thank our colleagues Neeraja Rashmi, Reader, Curriculum Group; M.V.Srinivasan, Ashita Raveendran, Lecturers, Department of Education in Social Sciences and Humanities (DESSH) for their feedback and suggestions. We would like to place on record the precious advise of (Late) Dipak Majumdar, Professor (Retd.), Presidency College, Kolkata. We could have benefited much more of his expertise, had his health permitted. The practising school teachers have helped in many ways. The council expresses its gratitude to A.K.Singh, PGT (Economics), Varanasi, Uttar Pradesh; Ambika Gulati, Head, Department of Economics, Sanskriti School; B.C. Thakur PGT (Economics), Government Pratibha Vikas Vidyalaya, Surajmal Vihar; Ritu Gupta, Principal, Sneh International School, Shoban Nair, PGT (Economics), Mother’s International School Rashmi Sharma, PGT (Economics), Kendriya Vidalaya, Jawaharlal Nehru University Campus, New Delhi. We thank Savita Sinha, Professor and Head, DESSH for her support. Special thanks are due to Vandana R.Singh, Consultant Editor for going through the manuscript. The council also gratefully acknowledges the contributions of Dinesh Kumar, Incharge Computer Station; Amar Kumar Prusty, Copy Editor in shaping this book. The contribution of the Publication Department in bringing out his book is duly acknowledged. Contents FOREWORD ? 1. INTRODUCTION 1.1 Emergence of Macroeconomics 1.2 Context of the Present Book of Macroeconomics 2. NATIONAL INCOME ACCOUNTING iii 1 4 5 8 2.1 Some Basic Concepts of Macroeconomics 2.2 Circular Flow of Income and Methods of Calculating National Income 2.2.1 The Product or Value Added Method 2.2.2 Expenditure Method 2.2.3 Income Method 2.3 Some Macroeconomic Identities 14 17 20 22 23 2.4 Goods and Prices 2.5 GDP and Welfare 25 27 3. MONEY AND BANKING 3.1 Functions of Money 3.2 Demand for Money 3.2.1 The Transaction Motive 3.2.2 The Speculative Motive 3.3 The Supply of Money 3.3.1 Legal Definitions: Narrow and Broad Money 3.3.2 Money Creation by the Banking System 3.3.3 Instruments of Monetary Policy and the Reserve Bank of India 4. INCOME DETERMINATION 8 33 33 34 34 36 38 38 39 43 49 4.1 Ex Ante and Ex Post 49 4.2 Movement Along a Curve Versus Shift of a Curve 4.3 The Short Run Fixed Price Analysis of the Product Market 4.3.1 A Point on the Aggregate Demand Curve 4.3.2 Effects of an Autonomous Change on Equilibrium Demand in the Product Market 4.3.3 The Multiplier Mechanism 52 53 54 54 56 5. THE GOVERNMENT: BUDGET AND THE ECONOMY 5.1 Components of the Government Budget 5.1.1 The Revenue Account 5.1.2 The Capital Account 5.1.3 Measures of Government Deficit 5.2 Fiscal Policy 5.2.1 Changes in Government Expenditure 5.2.2 Changes in Taxes 5.2.3 Debt 6. OPEN ECONOMY MACROECONOMICS 60 61 61 63 64 65 66 67 71 76 6.1 The Balance of Payments 6.1.1 BoP Surplus and Deficit 6.2 The Foreign Exchange Market 6.2.1 Determination of the Exchange Rate 6.2.2 Flexible Exchange Rates 6.2.3 Fixed Exchange Rates 6.2.4 Managed Floating 6.2.5 Exchange Rate Management: The International Experience 77 77 78 79 80 83 84 6.3 The Determination of Income in an Open Economy 6.3.1 National Income Identity for an Open Economy 6.3.2 Equilibrium Output and the Trade Balance 6.4 Trade Deficits, Savings and Investment 87 88 90 93 GLOSSARY 84 98 viii