Basic Concepts of Economics [Simplified]

Economics is one of the most important topics in General Knowledge. Many concepts like GDP, GNP, NDP, NNP, Repo, Reverse Repo, SLR, CLR, CRAR – there are difficult to understand.

For this one needs to have a thorough knowledge of the subject. To simplify the subject we are have divided the subject into smaller topics and are providing you with the notes for the same. These notes will help you revise effectively.

Basic Concepts of Economics

The main areas covered are – national income, monetary policy, fiscal policy, and balance of payments(BoP).

National Income

You might have heard terms such as GDP, GNP, NNP, etc. under the topic of national income.

Gross Domestic Product (GDP) is the total value of the final goods and services produced in a given year in a country's economic territories.

The total value of goods and services produced in India for 2014-15 is projected to be around 100 lakh crore Indian rupees or around 2 trillion US dollars at current market prices. This is the value of Indian GDP when expressed at current market price.

GDP stands for the total value of goods and services produced inside the territory of India irrespective whether it was produced by Indians or foreigners.

The total value of goods and services produced by a country's people in a given year is the Gross National Product (GNP). It's not a specific territory. If we look at India's GNP, we can see that GNP is lower than GDP.

Monetary Policy

Monetary policy refers to the Central bank's policy. Monetary policy is the responsibility of the Reserve Bank of India (RBI). Repo, Reverse Repo, CRR, SLR and so on are all part of monetary policy.

REPO rate: REPO means Re-Purchase Option – the rate at which RBI gives loans to other banks. Bank re-purchases the securities deposited with RBI at the REPO rate. The present rate is 6%.

Reverse REPO rate: The rate at which RBI borrows from banks is at a rate lower than REPO rate, and that rate is known as Reverse REPO rate (now 5.75%). Repo rate and Reverse Repo rate are two major options under LAF (Liquidity Adjustment Facility).

Marginal Standing Facility (MSF): MSF is the rate at which scheduled commercial banks could borrow money overnight from RBI against approved securities. Borrowing limit of banks under the marginal standing facility is 2 per cent of their respective Net Demand and Time Liabilities (NDTL).

Bank Rate: Bank rate is a higher rate, (1% higher than REPO rate) charged by RBI when it gives loans to commercial banks. Present bank rate is 6.25%. Bank rate is different from MSF in the nature that Bank rate is long term, applies for all commercial banks and there is no limitation like 2 per cent of their respective Net Demand and Time Liabilities (NDTL).

Cash Reserve Ratio: CRR corresponds to Cash Reserve Ratio. It corresponds to the percentage of liquid reserves each bank have to keep as cash reserve with RBI (in their current accounts) corresponding to the deposits they have. Banks will not get any interest for these deposits. Present CRR is 4%.

SLR (Statutory Liquidity Ratio): It corresponds to the percentage of liquid reserves each bank have to keep as cash reserve with themselves corresponding to the deposits they have. Banks have to mandatory keep reserves corresponding to SLR locked with themselves in the form of gold or government securities. Present SLR is 19.25%. The main difference between CRR and SLR is that banks need to keep CRR with RBI, but SLR with themselves, but locked.

Capital to Risk Weighted Assets Ratio (CRAR): It is arrived at by dividing the capital of the bank with aggregated risk-weighted assets. The higher the CRAR of a bank the better capitalized it is.

Fiscal Policy

Fiscal policy refers to the policy actions of the Government. Budget, tax, subsidies, expenditure etc. form part of the fiscal policy. You might need to understand various deficits like Fiscal Deficit and Primary Deficit as part of Fiscal Policy.

Fiscal Deficit (FD): The fiscal deficit is the difference between the government’s total expenditure and its total receipts (excluding borrowing). In layman’s term, FD corresponds to borrowings and other liabilities.

Balance of Payments

Current Account Deficit (CAD): Current Account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid). Current account deficit in simple terms is dollars flowing in minus dollars flowing out.

Capital Account Deficit: Capital account Deficit occurs when payments made by a country for purchasing foreign assets exceed payments received by that country for selling domestic assets. (For example, if Indians are buying a lot of properties in the US, but if Americans are not buying any properties or buildings in India, India will have a Capital Account Deficit.)

A deficit in the capital account means money is flowing out the country, but it also suggests the nation is increasing its claims on foreign assets. In other words at times of Capital Account Deficit, foreign investment in domestic assets is less and investment by the domestic economy in foreign assets is more. If you need to know more about BoP, refer our notes on Balance of Payments.

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Basic Concepts of Economics [Simplified]