Kishor Bhanushali

Kishor Bhanushali

Real refers the fact that the data have been adjusted for changes in the level of prices Nominal GNP are expressed in current rupees Real GNP is the GNP at current rupees deflated for changes in prices of items included in GNP Price index called GNP deflator is constructed to a price index to reveal the cost of purchasing the items included in GNP during the period relative to the cost of purchasing the same items during the base period

1. 2. 3. 4.

5. 6.

Choice of the base year Selection of commodities Price list for each commodity Represent price of each commodity for the base year as 100 and the price of the same commodity in the current year as a percentage of price for the base year Assigning weights Computation of index

Laspeyre’s Index= = (The cost of purchasing the base year basket in current year / The cost of purchasing the base year basket in base year ) *100 = Laspeyre’s index is weighted sum of price relatives for the ‘n’ goods the weights being share of the ‘n’ good in the total consumption expenditure in the base year

Item

Pulses

Quantit Price in Price in Relativ y in base current e base year year prices year 10 kg 7.50 9.00 120

weight s

index

0.20

24.00

Rise

20 kg

5.00

7.00

140

0.27

37.80

Cotton cloths

10 mtr

15.00

20.00

133

0.40

53.20

Electric ity

100 units

0.50

0.75

150

0.13

19.50

Laspeyre’s Consumer Price Index

134.5

Value of money is the quantity of goods and services in general that will be exchanged for a unit of money Value of money is purchasing power i.e. quantity of goods and services that a unit of money can purchase Value of money has inverse relationship with the general level of prices Cash Transaction approach Cash balance approach Income approach : Keynesian approach

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Other things remaining constant, changes in general price levels are to be explained with reference to the changes in the quality of money in circulation so that an increase in the quantity of money leads to rise in the price level, while contraction in the quantity of money will lead to a fall in general price level The changes in general price level, other things remaining the same, are directly proportional to changes in the money supply Velocity of circulation of money Credit instruments Barter transactions Volume of transaction

Equation of Exchange Prof Irving Fisher P= MV+M’V’/T P = Price level T = Transactions to be performed by money M=Metallic money M’=Credit money V= Velocity of metallic money V’ = Velocity of credit money In short run period T, V, V’,remains constant Therefore P varies inversely with M

Equation of Exchange 1. 2.

3. 4. 5.

Process not spelt out Money not merely a medium of exchange Not independent variables M & V differs Not useful

Cash Balance Approach – Cambridge Equation – Neoclassical

Value of money depends on demand for cash balances and the supply thereof at any given time An individual keeps only a fraction of his income in the title as legal tender(liquid cash)to carry on his business smoothly and to guard against emergences M =kpR M =quantity of money R = Real national income p =average price level pR= monetary national income k= desire of the public to have liquid

Classical Theory of Interest Rate of interest is determined by the fund demanded for investment and supply of savings Rate of interest is determined where demand for investible resources and supply of savings are equated

Classical Theory of Interest

Interest Rate

S

E’

R2 E

R1

S I2 I1

Savings and Investments

Classical theory assumes income to be given and savings to be a unique function of income. But saving is also function of income Classical theory assumes investment as a function of interest rate only. But investment also depends on income, marginal efficiency of capital and also cost of capital

Three motives - Transaction, Precautionary and Speculative Mt = f (Y) Mt = kY Interest Rate

o Mt