mbf and i2b notes

8/21/2019 Mbf and i2b Notes

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PEACE STUDENT MOVEMENT (PEACE STM)

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ContentsQ#what is barter system? What are inconveniences of barter system? ..................................................................................................................... 2

Q#2 Define money. What are the functions of money? ............................................................................................................................................. 6

Q#3 what are the different kinds of money? Or what are the different stages in the evolution of money? Or what is the origin and growth ofmoney? ................................................................................................................................................... ................................................................... 8

Q#5 what are the qualities of good money? ................................................................................................................................................. ............ 10

Q #6 what are the merits and demerits of paper money? ......................................................................................................................................... 12

Q #7 What are the methods of note issue? ................................................................................................................................................. ............ 15

Q #8 What is inflation? What are different types of inflation? What are the measures to control inflation? ................. 18

Q #9 What is deflation? What are the measures to control deflation? .................................................................................................................... 22

Q10: Difference Between Inflation And Deflation? .................................................................................................................................... ............ 25

Q# 11 Critically examine the fishers quantity theory of money.27

Q #12 What is trade cycle? What phases of trade cycle? ....................................................................................................................................... 30

Q #13: What are the causes/ reasons of trade cycle also explain remedies of trade cycle? ...................................................................................... 32

Q14: What is an index number? Discuss its construction, advantages, limitation as well. 36

Q15: define foreign exchange. Discuss main objectives of foreign exchange control. ............................................................................................ 40

Q #16 what are the advantages and disadvantages of nationalization of banks in Pakistan. .......................................................................... 44Q #17. What is bank? What are the types of banks? (Or) what are the classifications of bank? .............................................................................. 48

Q#18 What is a commercial bank? What are the functions of commercial bank? ................................................................................................. 51

Q#19 Explain the role of commercial bank in economic development of country. .............................................................................................. 55

Q#20 What is the process of credit creation? What are the limitations on the powers of bank to create credit? .............. 58

Q#21 Explain the relationship between banker and customer. ............................................................................................................................... 61

Q#22 what are the circumstances under which the relationship between banker and customer comes to an end? ........ 64

Q#23 What are the rights and duties of banker and customer? Explain them in detail. .......................................................................................... 66

Q24: banking, discuss the procedure for opening current, saving and fixed deposit account with a bank? ..................... 68

Q#25 Define central bank. Explain the function of central bank. .......................................................................................................................... 70

Q#26 Differentiate central bank and commercial bank............................................................................................................................................ 73

Q#27 What are the objectives of monetary policy? Also explain the tolls of monetary policy. ............................................................................... 75

Q # 28 Explain tools of monetary policy or instruments of monetary policy? ............. ........................................................................................... 77

Q94(a) define cheque & bills of exchange? Discuss its features? Also point out the distinction between the two: ................................................. 79

Q.no 29 (b) define cheque & promissory note? Discuss its features also point out the distinction between the two?....................... 81

Q29 (C) Defines promissory note and bills of exchange? Distinction between promissory note and bills of exchange? 2001. ............................... 83

Q29 (D) What Is Difference between Promissory Note, Bill of Exchange & Cheque? ........................................................................................... 85

Q#30 Describe the parties of letter of credit; also explain the procedure for opening letter of credit. .................................................................... 86

Q#31 What are the types of letter of credit? ............................................................................................................................................... ............ 88

Q #32 What is business finance? What are the main types of business finance? ..................................................................................................... 90

Q #33 Define owner (equity) and debt finance. What are the advantages and disadvantages of debt and equity finance? .................................... 93

Q #34 Explain the various types of interest free or non interest modes of financing .......................................................................................... 97


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Q#1: What is barter system? What are inconveniences of barter system?

Answer: Barter System

At an early stage of mans economic life, the wants were very limited in number. Man can easily

satisfy all his wants. But as time passed, his needs began to increase. He lost his self-sufficiency.He began to produce some goods in greater quantity than he could consume himself. The

purpose was to exchange some of his products which he had in excess with those who had

surplus products with themselves.

Definition:

According To R.H. Parker:Barter is a system in which goods or services are directly exchanged with the

goods or services without the use of money.

According To Sloan:Direct exchange of commodity or services for another without the use of

money.Barter, however, is possible only under extremely simple condition of exchange. A pure barter do not

exist today

Inconveniences / Difficulties/ Hindrances /Barriers / Of Barter SystemFollowings are the difficulties that were faced in barter system.

1. Lack of coincidence of wants

2. Lack of common measure of value

3. Lack of subdivision4. Lack of store of value

5. Difficulty in future payments (credit)

6. Difficulty in transfer of wealth7. Difficulty in tax collection

8. Lack of specialization

9. Difficulty in budgeting

10. Exit at small scale11. No investment, no saving

1. Lack of coincidence of wants:Barter is possible only when there is double coincidence of wants. The main defect of barter is

that there is lack of coincidence of wants.

ExampleIf a person has surplus rice and he wants to exchange it with wheat. He will have to find a person

who has surplus wheat as well as he needs rice.

2. Lack of common measure of value:In barter system it is very difficult to measure the value of goods because there is no standard

measure for the valuation of goods.


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ExampleA man who has rice may assign the value to his 1kg rice as equal to 2 kg wheat. But the other

person may assign a value to his 1 kg wheat as equal to 3 kg rice.

3. Lack of subdivision:

In barter system another problem arises when the goods that are exchanged cannot be subdividedinto small parts (units).

Example

If a person has a cow and he wants to exchange it with a goat. It is clear that a cow has morevalue than a goat. The problem is what a part of cow is to be given in exchange of goat. The

transaction is impossible because cow cannot be sub-divided.

4. Lack of store of value:In barter system it is very difficult to store the commodities like fruit, vegetables and animal

skins. It means that one cannot secure his future by storing commodities.

5. Difficulty in future payments (credit):In barter system it is very difficult to lend goods to other people because at the time of repayment

commodities may lose their value so credit transitions are impossible.

Example

A person borrowed ( ) a goat for one month but at the time of return the goat may fall

sick and lose her value, so the payments in future under barter are difficult.

6. Difficulty in transfer of wealth:

Under barter system it is very difficult to transfer moveable and immovable property from one

place to another place.

Example

If a person has to transfer 100 goats from Faisalabad to Lahore, It would be very difficult for himto transfer them.

7. Difficulty in tax collection:Another difficulty which arises under barter is that the tax cannot be collected in form of goods.

If the tax is collected they will lose their value with the passage of time.

8. Lack of specialization:Under the barter it is very difficult to attain specialization in their fields, because the people

remain busy in meeting their own needs and they do not focus on effective ( ) utilization

( ) of resources.

9. Difficulty in budgeting:

Budgeting is an art of estimating of future expenses and revenues. Under the barter system it is

very difficult to estimate future expenses and incomes.


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10. Exit at small scale:Barter may only exist at small scale of trade. But if someone wants to expand the scale of

trade how he can do so.

11. No investment, no saving:

Under barter, there is no concept of investment and saving. Because it is very difficult tosave anything in batter system.

Elimination (Removal) Of Inconveniences Of Barter:

The introduction of money removed the above mentioned problems in the following ways:

1. Money as a Medium of Exchange:

The goods and services are now purchased and sold with the help of money. The

difficulty double coincidence of want has been removed.

2. Money as a Common Measure of Value:

Money is used as a common measure of value by which was can measure and comparethe values of different goods and services.

3. Money as a Standard of Future Payment:

In modern economy, goods and services are sold and bought on the promise to pay infuture. So it acts as the standard of future payment.

4. Money as a Store of Value:Under barter system goods, animals and commodities cannot be stored for a longer

period. Now a days wealth is stored in the form of money.

5. Money is an Instrument of Making Loans:People save money and deposit in the bank. The bank advances these saving to

businessmen and industrialists so savings are transferred to investment.

6. Liquidity to Wealth:Money imparts liquidity to various forms of wealth such as land, machinery, stocks and

stores etc. These forms of wealth can easily be converted into money.

7. Establishment of Financial Institutions.

The introduction of money has made it possible to establish financial institutions like the

central bank, commercial bank etc. which deal in currency, and near money assets such as bill ofexchange, bonds, shares etc.

8. Influence of Income and Consumption.

The use of money has helped in removing difficulties of barter system. The higher theincome, the higher will be production and consumption.


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9. Instrument of Economic Policy:In order to achieve growth, reduce unemployment, and maintain regular expansion of

economic activity, money is the most powerful factor.

10. Aids to Specialization, Production, and Trade:

The market mechanism, production of goods, specialization, and expansion of trade ispossible by use of money.

11. Circular Flow of Money.

In a monetary economy, there is circular flow money. Money flows from firms to thehouseholds. It flows again from household to the firms as the prices of goods and services.

12. Money and Problem of Subdivision:

The problem of subdivision was also solved by the use of money. Now with the help ofmoney we can purchase each and every kind of goods.

13. Money as a Tool of Monetary Management:Money is an instrument of monetary management if it is effectively used; it helps in

increasing, output, and employment,

14. Exist at Large Scale:If someone wants to expand the scale of his business, the money removes this defect

easily.

CONCLUSION:In conclusion we can say that barter system has many difficulties and problems so at is

better for everyone to use money. Even though at present many developing countries are using

the barter system. Even Pakistan was doing trade with Communist Countries like china andRussia.


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Q#2 Define money. What are the functions of money? Or define money. How money has facilitatedeconomy? Or define money. What are the advantages of money?

Answer:

Introduction:Everyone uses money. We all want it, work for it and think about it. If you don't know what

money is, you are not like most humans. However, the task of defining what money is, where itcomes from and what it's worth.

Definition: Money

Any circulating medium of exchange, including coins, paper money, and demand deposits.or

A current medium of exchange in the form of coins and banknotes; coins and banknotes

collectively.

Money has facilitated economy by providing the following functions.

1. Medium of exchange

2. Measure of value3. Future payments

4. Budgeting

5. Economic activities6. Transfer of wealth

7. Store of wealth

8. Determination of national income

9. Liquidity of wealth10. Promote to foreign exchange

11. Market mechanism

12. Basis of credit creation

1. Medium of exchange:

Money acts as a medium of exchange between the buyer and seller. Money is used to make

payments for goods and services. Goods can sold for money and that money can be used topurchase goods.

2. Measure of value:Value of different goods and services can be measured in Monterey terms, in the same as we can

measure weight in kg and distance in KM.

3. Future payments:

Future payments can be easily determined with the help of money. One can borrow loans frombanks and other financial institutions in form of money and repayment can be made as well in

form of money.

4. Budgeting:

Money helps government and companies in preparation of budgeting. Incomes and expenses are

estimated and recorded in terms of money.


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5. Economic activities:All type of economic activities such as investments, savings, credit are made in terms of money.

Money has played a vital role in economic growth of a society.

6. Transfer of wealth:

With the help of money wealth can be transferred easily form one place to another place. Onecan sold his property at one place against money and he can buy similar at some other place

7. Store of wealth:

Wealth can be stored easily in form of money. One can save his wealth by converting it inmoney.

8. Determination of national income:

With the help of money, it becomes easy to determine the income generated by a nation. It alsohelps in determination of Gross Domestic Product of a country.

9. Liquidity of wealth:Liquidity means conversion of property in form of cash. Wealth or property can be converted in

liquid from with the help of money.

10. Promote to foreign trade:Money has played a vital role in the growth of foreign trade. Foreign investments are made in

terms of money. Payments and receipts of other countries are made in terms of money.

11. Market mechanism:Market mechanism is based on the demand, supply and price of the goods. Demand and supply

are the two major factors of market which work only because of money. Money is the only factor

which determines the price, demand and supply of goods.

12. Basis of credit creation:

Banks create credit on the basis of cash deposits in banks. So it is not possible for banks to createcredit without the help of money.

Conclusion:We can conclude that money is very important invention of human life. Now a day all the

transactions are based on money. We can purchase and sale goods and service easily with the

help of money.


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Q#3 what are the different kinds of money? Or what are the different stages in the

evolution of money? Or what is the origin and growth of money?

Answer : Different forms of money:On the basis of evolution the money is classified in five main types,

1. Commodity money

2. Metallic money3. Paper money4. Bank money

5. Electronic money

1. Commodity Money:In commodity money, different commodities have been used as money like cattle, goats, horses,

animal skins, and arrows. Commodity money was used in barter system in which goods were

exchanged with other goods and services.

Problems of commodity money:

It was found that commodity money was not best to make payments due to the followingproblems.

i. Lack of coincidence of wants

I. Lack of common measure of value

II. Lack of subdivisionIII. Lack of store of value

IV. Lack of divisibility

V. Lack of transferability

2. Metallic Money:

Metallic money consists of gold coins, silver coins, and metal coins. In our country coins of Rs.

five, two and one are the metallic money. Metallic money cannot be eliminated from economy. Itis playing vital role in the economy. Metallic money is of three kinds.

i. Full bodied money

ii. Token moneyiii. Tender money

i. Full bodied money:In full bodied money, the metallic value of coin is equal to their face value. Full bodied money is

also called standard money or natural money. The gold silver and nickel are considered as full

bodied money. Now such money is not used anywhere in the world.

ii. Token money:In token money the face value of coin is higher than the metallic value. They are usually made of

silver, copper or nickel. In Pakistan full bodied money does not exist only token is used.

iii. Tender money

Any currency which is generally acceptable in discharge of debts is called tender money it can be

made of paper or metal. If someone offers tender money against debts, nobody can refuse to takeit. Tender money has two types,


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a. Limited tender money

b. Unlimited tender money

a. Limited tender money:Coins of small denominations are called limited tender money. Such as coins of RS 1, 2 and 5.

b. Unlimited tender money:Money which is compulsory o accept is called unlimited tender money. Coins of large

denominations are called unlimited tender money. Notes of Rs 5, 10, 50, 100, 500, 1000, 5000

are called unlimited tender money.

3. Paper money:

Paper money consists of notes issued by the state bank of Pakistan. The paper money is of

different denominations, colors and sizes. Paper money is more convenient than any other formof currency.

4. Bank money:Bank money includes cheques, bills of exchange, and drafts. Bank money is playing a vital role

in the economic development. Because varies transactions are settled without the use of paper

money. Bank money is safer than any other form of money. but bank money also have some

defects.Dishonor of cheque may delay payments.

Uneducated may not know the best use of cheque.

Cheque is not a legal tender; one can refuse to take it against the settlements of debts.

5. Electronic money:

With the development of computers and its application, the business and business transactions

are changing very fast. Now a days most of the transactions take place through electronicmoney. People prefer to use debit cards and credit cards instead of paper money or bank money.

With the passage of time electronic money may diminish the use of paper money.

Credit card

Debit card

6. Mobile money:

With the help of technology, transactions are very easy. We can make and receive payments withthe help of mobile. We make a transaction and payments are made with mobile.

Conclusion:

Consequently the money at present age is the outcome of evolution of money. After passingthrough above discussed stages, now it is the medium of exchange all over the world.


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Q#5What Are the Qualities of Good Money?

Answer: Introduction

Money is the greatest discovery of modern age. The word MONEY is derived from theLATIN word MONETA. It occupied a unique and important position in all the fields of life.

Generally speaking anything that people will accept in exchange of their goods and services and

at the same time by which they will purchase goods and formed the modern form.

Definition

(I). Walker Says:

Money Is What, Money Does.

(Ii) Prof Knap Says:

Money is anything which is declared as money by government, becomes Money.

(Iii) G.D.H. Coles:Purchasing power something which buys things.

Qualities of Good Money:Good money should have the following qualities.

1. Acceptability

2. Transferability3. Stability

4. Storability

5. Recognizable6. Malleability

7. Divisibility

8. Durability

9. Economy10. Elasticity

11. Homogeneity

1. Acceptability:Good money should have the quality of general acceptability. General acceptability means every

person must accept it for the settlement of payments. It should be accepted for purchase and saleof goods.

2. Transferability:

Good money is easily transferable from one place to another for doing business and makingpayments. Paper money is easy to transfer from one place to another place because it has

minimum possible weight.

3. Stability:Value of money should remain stable. If value of money is changing or fluctuating day by day

than it would not be considered reliable.


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4. Storability:The money should be storable. Value of money should not depreciate with time. If money

material is perishable it will lose its value in few days. Paper money has quality of storability.

5. Recognizable:

The money should be easily recognizable so that the holder of money may not confuse about thevalue of money. For example if every note has the same color it will not be easily recognizable.Paper money is easily recognizable because notes of different value have different color.

6. Malleability:The material which is used for making money should be malleable. The material which cannot

be melted is not fit for making coins. The gold, silver, copper and nickel coins are malleable.

7. Divisibility:Divisibly means ability to divide into small units without losing its value. Good money should be

divisible. In barter system, commodity money was not divisible into small units. Thats why it

was replaced by the paper money.

8. Durability:

The material used in making money should be durable and long lasting. Coins do not wear

quickly, so the quality of money remains stable.

9. Economical:

Good money should be economical. Economical means low cost of printing and more value. Ifthere is heavy cost on issuing money that is not good money.

10. Elasticity:

Supply of money should be elastic. Elastic means whenever it is needed, supply of money can beincreased or decreased. Paper money has the quality of elasticity.

11. Homogeneity:Homogeneity means the money should be identical, So that there is no ambiguity to the holder of

money.

Conclusion:We can conclude that good money is acceptable easily everywhere, everyone easily accept and

recognize it. It has long life.


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Q #6 what are the merits and demerits of paper money? Or What are the advantages and

disadvantages of paper money?

Answer: Paper money:Paper money means the Currency notes issued by central bank of country. In the present age

paper money has got a significant place in place of metallic money. Paper money is convenient

to carry and easy to handle and store. It is the most advance form of money. It fulfills nearly allthe characteristics of ideal money. It is believed that different attempts are made to introducepaper money i.e. in china during 9

th century, Iran 13

th century and finally paper money was

originated by gold smith of England in early 17th

century. Now in all developed and

underdeveloped countries of world, inconvertible paper money is used as medium of exchangeand standard of value.

Definition:

Prof. Hanson:Paper money means the paper instrument such as bank notes,

cheque bills and other forms which act as a currency.

According to F ,Perry:Paper money is documents representing money such as bank notes, promissory

notes, bills of exchange etc.

Money made up of paper is called paper money. It consists of the notes issued by the central

bank. In Pakistan notes of Rs 5 to 5000 are the examples of paper money.

Advantages of paper money:

Following are the advantages of paper money,

1. Economical2. Easy handling

3. Easy counting

4. Emergency needs5. Metal savings

6. Easy transfer

7. Easy payment

8. Uniform quality9. High value in small bulk

10. Stability

11. Recognizable

12. Storability13. Advantage for banks

1. Economical:Printing cost of paper money is less than the minting charges of metallic money. Paper money is

cheaper than the metallic money. A large quantity of paper money can be issued at very low cost

2. Easy handling:Paper money has lesser weight than metallic money. It is easy to handle paper money than coins.


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3. Easy counting:Paper money is easy to count than the metallic money. The counting of coins in larger sum in

coins takes more time. Paper money takes lesser time than the metallic money.

4. Emergency needs:

Paper money is friend in peace and war. Central bank can increase the supply of paper money formeeting the economic needs.

5. Metal saving:

Metal saving is possible when paper money is used rather than metallic money. Metals like goldand silver can be used for other productive purpose.

6. Easy transfer:

Transfer of paper money is easy and cheaper than metallic money because it is light weight andtakes less space.

7. Easy payment:

Payments of larger sums are easy and cheaper than the metallic money because paper money iseasy to count and easy to transfer.

8. Uniform quality:

Paper money has an also a uniform quality and holder of the paper money does not suffer losebecause old and new notes have the same value.

9. High value in small bulk:Paper money contains high value in small quantity as compared to the metallic money.

10. Stability:

Paper money is more stable in value but the value of coins do not remain stable due to wear andtear. The value of coins changes with the passage of time.

11. Recognizable:Paper money of every denomination is easily recognizable because of its different size, color and

design.

12. Storability:Paper money is easy to store because of more value in light weight. It takes less space so that a

large sum can be stored in small space even in pockets.

13. Advantage for banks:Banks have the great advantage of paper money they can easily count paper money buy using

counting machines.

Disadvantages of paper money:

1. Inflation

2. Limited acceptability3. Danger of cancellation


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4. Short life

5. Instability of exchange rate

6. Less confidence

1. Inflation:

Printing of paper money is easy. In time of need government may over issue currency notes. Thisover issue may cause inflation which increases the prices of goods and decreases the value ofmoney.

2. Limited acceptability:Paper money has limited acceptability. It is acceptable only in the domestic country and in other

countries of the world it is not acceptable.

3. Danger of cancellation:There is always a danger of cancellation. If government canceled the paper money then holder of

money just has the worthless piece of paper.

4. Short life:Paper money is less durable than the metallic money. Paper money can be easily destroyed by

fire, water or heat. So life of paper money is less than coins.

5. Instability of exchange rate:

Exchange rate means the rate at which the domestic money is exchanged with the foreign money.

Value of paper money depends upon the fluctuations. The instability of exchange rate directlyaffects the foreign trade.

6. Less confidence:

As value of paper money is less stable and it has no real value in it. So people have lessconfidence in paper money.

Conclusion:In conclusion we can say that paper money is very important invention. It has many merits and

demerits. But merits of paper money are more superior than its demerits.


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Q #7 What are the methods of note issue?

Answer:Introduction: In all over the world, all most all the countries have fiat standard andfiat paper money. The management regulations and control of paper money is normally assigned

to central bank of the country. The main advantage of this single authority control and

management is that is that there is uniformity in quality, size and design of all paper currencynotes.There are the following methods of note issue,

1. Fixed fiduciary system

2. Proportional reserve system3. Modified proportional reserve system / exchange management

4. Minimum reserve system

1. Fixed fiduciary system:According to this principle, central bank can issue notes up to a certain limit by keeping

government securities. If any time central bank wants to issue more notes, then the notes must be

issued by keeping 100% gold reserve.

Advantages:

Following are advantages of fixed fiduciary system.

i. No danger of over issue:

Under this system there is no danger of over issue of notes because 100% gold reserves are kept.

ii. No danger of inflation :There are no chances of inflation because money can be converted into gold at any time.

Disadvantages:Following are disadvantages,

i. Inelastic:In emergency, if there is gold is not available government cannot issue notes.

ii. Unnecessary lock up of gold:Large amount of gold is locked that can be used for other productive purposes.

2. Proportional reserve system:

Under this system central bank keeps certain percentage of note issue in form of gold reserve.This ratio may be different in every country. In Pakistan this ratio is 30%.

Advantages:

Following are advantages.

i. Elastic:

Under this system central bank can increase the supply of money easily whenever needed.


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ii. No lock of Gold:Under this system, a large amount of gold is not locked. Gold can be used for other productive

purposes.

iii. Emergency needs:

This system is very helpful in emergency needs of currency.


i. Danger of over issue:There is always danger of over issue of notes.

ii. Danger of inflation:There is always danger of inflation due to over issue of notes.

3. Modified proportional reserve system / exchange management:Under this system, central bank keeps certain percentage of note issue in form of gold, foreign

bills of exchange, foreign currency at some other country where gold system is used. This system

is used in many countries.

Advantages:

Following are advantages,

i. Elastic system:Central bank can increase supply of money easily.

ii. No lock of gold:Under this system, a large amount of gold is not locked. Gold can be used for other productive

purposes.


i. Lock up of foreign exchange:Under this system a large amount of foreign currency is locked up in unproductive sector.

ii. Over issue:There is always danger of over issue of currency notes.

4. Fixed minimum reserve system:

Under this system central bank keeps only a fixed amount of gold or silver reserves againstwhatever amount of note issue.

Advantages:Following are advantages,


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i. Elastic:

This system is highly elastic because central bank can issue a large amount of notes by keepingsmall reserve.

ii. No lock up of gold:A large amount of gold is not locked up that can be used for productive purpose

Disadvantages:

Following are disadvantages,

i. Over issue:

In this system, there is a great danger of over issue.

ii. Currency value:Under this system, central bank may fail to stable the price level.

Conclusion:

There are many principles and methods of note issue and countries use these according to their

need of time.


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Q #8 What is inflation? What are different types of inflation? What are the measures to

control inflation?

Answer: Inflation:Inflation is a process in which there is continuous increase in general price level and there is

continuous decrease in money value. Inflation is a situation where demand of goods and servicesexceeds available supply of goods.

Definitions:

According To R.P. Kent:Inflation is nothing more than a sharp upward movement in the price level.

According To Crowther:

In the state of inflation the prices are rising c.e. the value of money is falling.

According To Ackley:

A persistent and appreciable rise in general price level.

According To Coulborn:

Too much money chasing too few goods.

Type Of Inflation:

A. On The Basis Of Rate Of Inflation:

(i) Creeping Inflation:It is a situation where the increase. In the price level is very slow. i.e. 2% P.a. (Japan, USA,

Singapore)

(ii) Walking Inflation:In this situation increase in price level is more than creeping inflation i.e. 5% P.a.

(iii) Trotting Inflation:In this situation prices raise more than they are in creeping inflation i.e. 5-20% (Pakistan,

Greece, and Italy).

(iv) Galloping or Hyper Inflation:

It is situation where general price level rises rapidly within a short period of time.

B. On The Basis of Degree of Control:

(i) Open Inflation:

It is a situation when the inflation gets out of control and cannot be controlled by government

price control or similar measures.

(ii) Suppressed Inflation:

It is a situation when the inflation can be controlled by the government price control policy.


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C. On The Basic Of Causes:

i. Demand pull inflation:

Inflation that occurs due to high demand in the economy called demand pull inflation. The higherconsumption causes aggregate demand to grow, while aggregate supply lack behind.

ii.

Cost push inflation:It is the inflation that is result of higher cost of production. Production costconsists of direct material, direct labor and factory overhead. In this situation the supply

decreases due to cost increase.

iii. Budgetary inflation:When the government covers the budget deficit by borrowing then there will be

budgetary inflation.

iv. Monetary inflation:When there is an expansion in the currency notes in circulation then there will

be monetary inflation.

v. Income inflation:

The inflation that is occurred form high income level. Income may increase due

to change in salary or foreign remittance.

vi. Profit inflation:

Profit inflation is the result of the greed of businessmen. It usually occur in sucheconomy which are dominated by monopolies.

Measures Used To Control The Inflation :

The main measures used to control the inflation are;1. Monetary measures

2. Fiscal measures

3. Other measures

1. Monetary Measures:

Monetary measures are adopted by the central bank to control the supply of money.

i. Bank rate policy:

Bank rate or discount rate is the rate at which central bank lend loans to commercial banks.

Whenever central bank wants to control the inflation it increases the bank rate which help inreducing borrowings from commercial banks and inflation may be controlled.

ii. Open market operation:

In open market operation central bank sales or purchases the securities in open market. If there isinflation in the country the central bank sells the securities which reduce the supply of money. So

that inflation may be controlled.


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iii. Variable reserve ratio:In order to control inflation, the central bank increases the reserve ratio due to which more funds

of commercial banks are kept with the central bank. So the borrowings from commercial bankdeceases and inflation may be decreased.

iv. Credit rationing:Under this policy central bank advices commercial banks to stop issuing loans for some time. Inthis way inflation may be controlled.

v. Monetary reforms:The government can order commercial banks to exchange old notes by new one. In this way a

large amount of money can be blocked for some time. Repayment should be made after

achieving the objective.

2. Fiscal Measures:Fiscal measures are based on the demand management. Central bank may raise or lower down

the demand by controlling expenditures.

i. Decrease in tax rate:

In order to control inflation, central bank may decrease the tax rate. Resultantly industrialists

increase the level of production which reduces the price level.

ii. Decrease in government expenditures:

In government decreases expenditures on unproductive purposes the inflation is automatically

controlled.

iii. Deficit financing:

In order to control inflation the government should avoid from deficit financing.

3. Other Methods:

i. Increase the supply of goods:If the supply of goods is equal to the demand in the market, Inflation will be automatically

controlled.

ii. Population planning:Control on population by adopting different measures of family planning. It will reduce the

demand of goods which will help in controlling price level.

iii. Political stability:If there is political stability in country, it will encourage investment and increase in production

which may help in controlling prices.

iv. Smuggling of goods:

Shortage of supply is normally due to the smuggling of goods. If govt take actions to control

smuggling it will help in controlling price level.


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v. Price control policy:The government should adopt strict price control policy against the profiteers and hoarders. So

that inflation can be controlled.

Conclusion:

Inflation is bad for economy and measure should be taken to stop it. There are many methods forthe control of inflation. No country can be on the way to progress unless inflation is undercontrol.


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Q #9 What is deflation? What are the measures to control deflation?

Answer: Deflation:Deflation is a situation in which prices, output and employment are falling down. Inflation and

deflation both are harmful for the economy but the deflation is more harmful. It creates hurdle on

path of economic growth.

Definition:According to the Philips deflation is a period during which level of prices declines

and the value of money increases.

According to James Phillips:Deflation is a period during which level of prices declines and the value of money rises.

Causes of deflation:Followings are main causes of deflation.

1. Decrease in money supply:

The main reason of deflation is decrease in money supply. Sufficient money supply is necessaryto meet the economic need.

2. Strict banking policy:

Sometimes, restriction on lending is imposed by the central bank to decrease the money supply.This policy may decrease the investments.

3. High taxes:Sometimes government levied high taxes due to which the purchasing power of the people is

also decreased and the result is deflation in economy.

4. Excess production:If goods are produced more than the demand, then it also becomes the cause of deflation and

prices are decreased.

5. No storage facility:If businessmen have no storage facility than they are bound to sell goods even at low prices,

which may cause deflation.

6. Excess saving:

In case of inflation, commercial banks promote savings but unnecessary promotion of saving

May leads towards the deflation.

7. Heavy imports:

Imports in large scale quantity are also the cause of deflation. Due to increase in imports the

supply is also increased which is the cause of deflation.

8. Decrease in exports:

If exports are decreased, the goods and services will be increased in the market, hence price willbe decreased.


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9. Decrease in demand:

Decrease in demand of goods and services are another cause of deflation. Demand may bedecreased due to the fall in income.

10. Decrease in government expenditures:Sometimes the government decreases expenditures due to which demand for goods is alsodecreased.

11. Increasing cost:Increasing cost of production also becomes the reason for deflation. People may not have buying

power to purchase costly goods.

12. Lower profits:The lower profit rate is also the cause of deflation. Businessmen cut their profits to retain in the

market a stage becomes when the profit becomes zero. Business at this stage may decide to stop

production.

13. High bank rate:

An increase bank rate may also cause deflation. Increase in bank rate decreases the borrowings

which decreases the money supply. Decreases in money supply cause deflation.

14. Sale of securities:

Sale of securities (shares and bonds) is also the cause of deflation. The people may like to investtheir savings in shares due to this their purchasing power is decreased and they can buy fewer

goods.

Measure / methods to control deflation:By taking following measures government can get easily control on deflation.

1. Increase in supply of money:To control deflation, supply of money in the country can be increased. Central bank should issue

currency notes to meet the economic needs. When the supply is increased the demand for goods

and services is also increased.

2. Increase in wages:

Increase in wages also helps decreasing deflation. The purchasing power of the people will be

increased which will increase the demand of goods.

3. Decrease in reserve ratio:

Decrease in reserve ratio also helps in controlling deflation. It increases the borrowings from

commercial bank. Increase in borrowings increases the demand and price level.

4. Control on production:

Production of different commodities should be controlled and there should be equilibrium indemand and supply. Control on production helps controlling production.


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5. Decrease in interest rate:

The rate of interest on loans should be decreased. Loans should be provided to the producers toincrease the production and investment level. This will increase the incomes of people. Demand

for goods will be increased and deflation will be decreased.

6. Increase in private investments:The government should provide facilities to the industrialists to increase investment in country.

By setting up new industries, the employment opportunities will be increased, incomes of people

will also be increased which help to control inflation.

7. Tax reduction:

Government should reduce the taxes which will increase the incomes of people. Increase in

incomes increases the demand for goods and services which helps controlling inflation.

8. Increase in exports:

The excess supply of goods can be exported to control deflation. Increase in exports encouragesproducers for more production which helps in decreasing deflationary pressure.

9. Increase in investments:

Deflation can be controlled through new investments. The production and employment increasesdue to new investments. The use of idle money decreases the deflation.

10. Fixed prices:Deflation can also be controlled by fixing the price of goods and services. Government may

appoint a price commission who supervises the price level so that the producer is not

discouraged.

11. Public works:Government may start public works to eliminate the deflation. The amount is transferred from

government to public. The demand for the goods and services is increased and there is increasein production.

Conclusion:Deflation is bad for economy and measure should be taken to stop it. Production of goods is

decrease in time of deflation. No country can be on the way to progress unless inflation is under

control.


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Q10:Difference between Inflation and Deflation?

ANSWER:

Definition of inflation:Inflation is nothing more than a sharp upward movement in the price level.

Definition of deflation:Deflation is a reduction in the general price level due to a decrease in the economic activity of anation.

Inflation Deflation

1. Prices:The general price level goes up due to inflation in

the economy.

The general price level comes down due to

deflation in the economy.

2. output:The output of goods and services increases

due to inflation in a free market economic system

The output of goods services decrease due to

deflation. In a free market economic system.

3. Employment:The rate of employment increases due to ever

increasing a activities in the country.

The rate of employment decreases due to

decreasing activities in the country.

4. Business:

The business earns higher profits due to risingprices. The production factors are paid at old

rates but goods are sold at current market prices.

The business earning is disturbed due todeflation. The prices come down. the unsold

stock become a problem for the business person

during deflation.

5. Investment:

The shareholders feel comfort due to

inflation. The share prices and dividend increasesdue to expanding business activities

The shareholders feel sorry due to deflation. The

investment is unable to generate reasonableincome for them due to low activities.

6. Income:Inflation does not reduce the national income

of the country. The business works do not shrink

the size of income.

Deflation reduces national income of the country.

The low business activities shrink the size of

income.

7. Agriculture:

Inflation is a friend of agriculture. The pricesof goods and services go up. The farmers are

happy due to it.

Deflation is an enemy of agriculture. The pricesof goods and services come down. The farmers

feel burden due to it.

8. Saving:The saving is looted by inflation due to

decreasing value of money. The savers are

discouraged due to increasing prices.

The savers are encouraged due to deflation. Theycan buy more goods with their saving due to

decreasing prices.

9. Hoarding:

The boarding of goods is profitable duringinflation.

The hoarding of goods becomes unprofitable dueto decreasing prices.


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10. Quality:

The Quality of output is adversely affectedby inflation. The producers pay attention to

quantity rather than quality.

The quality of output is maintained duringdeflation. The producers can attract customers

due to better quality of goods.

11. Exports:

The demand for goods in overseas marketscomes down due to rising prices. The foreign

customers can buy goods form elsewhere.

The exports become necessary during deflation.The goods are cheaper for overseas customers the

demand for exports increases due to decreasing

prices.

12. Payments:The balance of payments position becomes

unfavorable due to inflation.

The balance of payments position can be

improved by exporting goods abroad.

13. Control:It is easy to control inflation the governments

can fix the prices of goods and services for some

time.

It is difficult to control deflation. The

government has to do a lot of work through fiscal

and monetary measures.

14. Time:The time period of inflation is short. It is

easy to fall. The government can take measure to

regulate the activities.

The time of deflation is longer. It takes a long

time to go up. The government can regulate the

activities through various measures.

15. Speculation:

Inflation helps the speculation activities. Thebusinessmen put their energies to make quick

profits. They do not take care of genuine

productive work.

Deflation cannot help speculators to earn profits.Artificial demand cannot attract investor to

indulge in non-productive activities.

16. Government:

The government is in trouble due toinflation. The revenue raised loses its value. The

ongoing projects remain incomplete due to high

prices.

The govt. revenue can be used to complete theprojects

17. Real Estate:The real estate owners lose their purchasing

power due to high prices. They collect rent at old

rates according to the agreements already made.

The real estate owners feel happy as they receive

rent at old rates but now prices are low so they

can buy more goods with the same income.

Conclusion:In conclusion we can conclude that both inflation and deflation is not good for a country. Both

are harmful for public and economy. It is duty of government to get control on inflation anddeflation.


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Q# 11 Critically examine the fishers quantity theoryof money. (Or) Explain and criticize

the fishers equation of exchange.

Answer: Statement of theory:The quantity theory of money was presented by jean Bodin in 1568 for the first time. Afterward

John Law, David Hume and J.S. Mill have also worked on this theory. But it was popularized byProfessor Irving Fisher with the help of an equation in his book purchasing power of money in1911.The quantity theory of money states that the quantity of money is the main determinant of the

price level or value of money.

Definition:

Other things remaining unchanged, as the quantity of money in circulation increases, the price

level also increases in direct proportion and value of money decreases and vice versa

Fisher equation of exchange

PT= MV+M1V1P= General price level.

M= Quantity of legal tender money.

M1= quantity of bank/ credit money.V= velocity of circulation of legal tender money.

V1= velocity of circulation of bank money.

T= total transaction.The above equation shows that a proportional change in quantity of money brings of money

brings proportional change in prices.

NUMERICAL EXAMPLE:Let M=100, M1=200, V=3, V1=3 T=90.

Putting the values in the equation of exchange.

P= (100x3) + (200x3)P = 300+600 =10

In order to prove that variation in money supply produces proportional change in price, we now

double the supply of money by keeping other variables

Constant:

P= (200x3) + (400x3) = 600+1200 = 1800 =20

90 90 90

The general price level has doubled by doubling the supply of money. Now we half the supply ofmoney and keeping V, V1and T constant.

P2= (50x3) + (100x3) = 150+300 = 450 =590 90 90


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The price is now one half what it was before and value of money is double now.

Assumptions of theory:Followings are main assumption of fisher`s theory.

1. Full employment:Theory assumes that there is full employment in the economy. It states that all the factors ofproduction are fully utilized no resource are idle.

2. Velocity of money is constant:It is assumed that the velocity of circulation of money remains unchanged in short run.

3. Volume of trade:

It is also assumed that the volume of trade remains constant in the short period because methodof production and habits of consumer remain unchanged.

4. Constant relationship between M and M:There must be constant relationship between M and credit money M.

5. Price level is passive factor:

P should be affected by the other factors but should not affect other factors.

6. Short period:

This theory applied to the changes in price level only in short period.

Criticism on theory:

Followings are main critics on fisher`s theory.

1. Other things may not remain same:The drawback of this theory is that other things are assumed to be unchanged. But in reality it is

not possible that the factors in an economy remain unchanged.

2. Variables are not independent:The various variables in the equation are not independent. The factors have great influence on

each other. In this equation p is assumed to be passive factors which do not affect other factorsbut in reality when price level is increased, it increases the profit rate and promotes trade

3. No proportionate change:

This theory assumes that if quantity of money is doubled, the prices are also doubled, thisassumption is wrong. There is no proportionate change in the money and prices.

4. Ignores the rate of interest:

This theory ignores the influence of rate of interest on the quantity of money. An increase in thequantity of money is due to the decrease in interest rates.


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5. Fails to explain trade cycle:This theory is failed to explain the trade cycle. According to this theory, if the quantity of money

is doubled the price level will also be doubled. During 1929 1933 the quantity of money wasincreased but it fails to increase price level. The depression was not eliminated. So theory has

failed to explain the causes of trade cycle.

6. Full employment:This theory assumes full employment in an economy which is not possible at all.

7. Static theory:The quantity theory of money is a static theory. The world is dynamic and things are changing at

fast speed. The ups and down in an economy cannot be explained with the help of this theory.

Conclusion:Thus it is clear that if the supply of money is doubled, the price level will also be doubled and

the value of money is one halved. Similarly if the supply of money is halved, the price level of

money is doubled. All modern theories accept that change in the quantity of money is one of thefactors affecting price level.


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Q #12 What is trade cycle? What phases of trade cycle?

Answer: Trade cycle:

Fluctuations (ups and down) in economic activities of a country is called trade cycle. Thesechanges or ups and down may be positive or negative. The duration of trade cycle may vary from

5 years to ten years or above.

ECONOMIC ACTIVITY

Phases of trade cycle

Trade cycle is composed of four phases which are given below,1. Depression / slum / trough2. Recovery

3. Boom / peak

4. Recession

1. Depression:

Depression is the most fearful stage of trade cycle. In the period of depression there is fall in

national income, employment, prices, and production. Cost of production is higher than the saleprice. During this phase of trade cycle factories are closed and workers become jobless.

Features of depression:

Low production

Low prices

Low employment

Low profit margin

Decrease in demand

Low interest rate

Low borrowings

2. Recovery:

Recovery is a stage of economy where demand of goods starts increasing. Profit margin start

rising because cost of production fall below the general price level. New investments are made indifferent productive activities or businesses. At this stage unemployment level start decreasing.

Features of recovery:

There is increase in level of production

Increase in demand

There is decrease in cost of production

Increase in public borrowings


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Improvement in level of employment

Rise in Investment opportunities

Improvement in business profit

3. Boom / peak:

It is a stage of economy where business activities attain maximum best level. After some timeeconomy moves from recovery to boom, At this stage national income, demand of goods, level

of production and employment level is growing rapidly. This is an ideal stage of an economy.

Features of boom:

High level of profit

Ideal level of national income

Maximum production

Low cost of production

Rapid increase in demand of goods

Growth in public borrowings

Low rate of unemployment Ideal investment opportunities

4. Recession:This is the level of economy where economic activities starts falling down. At this stage

economy moves from boom to recession and investments, employment, production starts

reducing. There is shrinkage in profit margin because cost of production exceeds the sale price,due to this poor firms close their business while other reduce their production.

Features of recession:

Decrease in production

Fall in employment level

Shrinkage in profit margin

Decrease in public borrowings

Decrease in demand

Decrease in price of product

Cut down in national income

Conclusion:In a nutshell, trade cycle means the whole course of business activities which passes through all

phases of prosperity and difficulty. Business cycle generally refers to those fluctuations which

take place in the business enterprise and occurs with a fair degree of regularity.


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Q #13: What are the causes/ reasons of trade cycle also explain remedies of

trade cycle?

Answer: Causes of trade cycle:

Trade cycle is affected by the two factors that are;

A. Internal factors:

Following are internal factor of trade cycle.

1. under consumption:

There is too much saving in the boom period. This reduces the price level. The price startincreasing but wages do not increase proportionately. The income of rich start increasing at

higher rate but incomes of poor do not increase as compared to the price level; the result is that

the demand for consumption goods decreases.

2. Unsold stock:Trade cycle is the result of inventories (closing stock). There is excess of goods and services but

people are unable to buy goods of their own choices due to their low incomes. Unsold stock

results in depression.

3. Imports

Imports are also the reason for depression. When the goods are imported, it increases the supplyof goods. Increase in supply of goods decreases the price level.

4. Liquid assets:

Liquid assets are includes coins, paper money, bonds and shares. Increase in liquid assets leadseconomy toward boom. The increase in liquid assets increases the investments, in this way the

stock exchange activities will flourish and economy leads towards prosperity.

5. Unfilled orders:Unfilled orders means the demand of goods is higher and the supply is low the manufacturers are

unable to meet the demand of customers. Increase in demand encourages the manufacturers toproduce more which leads toward boom.

6. Reserves / Excessive profits:

The retained profits are the source of capital but excessive reserves or profits are kept idle that isthe wastage of funds. During the boom period, this policy is bad because it leads towards the

depression.

7. Overcapitalization:The capitalization of profits is desirable for meeting emergency needs. if all the profit of the

company is capitalized and company do not pay dividend on shares. It may discourage

investment which causes the depression.

8. Trade union:

Trade union also becomes the cause of depression. They demand more wages which increasescost and resultantly price level rise. The increase in price level decreases the demand of product.


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9. Investments:

The changes in investment rates affects the trade cycle. High investment rate increase bringsboom in economy. If investment rate is low it will cause depression.

External factors:Following are external factor of trade cycle.

1. War:War is a major factor which affects trade cycle. The war brings damages to the country; fall in

investments and incomes, employment and price level. War becomes the reason of depression.

2. Population:

Population increases the aggregate demand of products which raises the price level higher. High

price brings the inflation. Investment and income level falls. There will be depression in theeconomy.

3.

Migration:The increase and decrease in migration affects the demand. Decreases in population due to

migration, deceases the demand of products. The supply of goods exceeds the demand which

brings depression

On the other hand if there is increases in population due to migration. The demand of goods ishigh and the supply is low. More demand encourage investors to produce more which brings

boom in the economy

4. Innovations:Innovations brings boom in the economy. When a new business is started or a new product is

introduced, it increases the demand for that product. This may encourage the investments in new

business which brings boom in the economy.

5. Invention:

Invention means discovery of new methods of productions, new machinery or material.Inventions reduce the cost of production which increases the competition and investment. That

results boom.

6. Weather:The weather also affects the produce of agriculture sector. In bad weather conditions there is low

yield of crops. The demand is the same but the output is low so the price level goes up.

7. Government purchases:When government purchases goods from supplier it increases the demand which leads towards

the boom and if government do not purchases goods, it reduces the demand of goods which

result in depression.

8. Export surplus:

Exports surplus is then, when exports are more than the imports. Exports surplus brings theprosperity in economy.


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REMEDIES TO CONTROL CYCLE:

Trade cycle can be controlled by applying following methods:A. Monitory policy

B. Fiscal policy

C. International measures

A: Monetary Policy:

1. Bank Rate:

The central bank can increase bank rate when there is prosperity. The bank rate can bereduced in case of depression. The borrowing and lending is made according to bank rate. The

commercial banks help the central bank to control trade cycle.

2. Market Operation:The central bank can buy and sell bills and government securities. When money supply is

less as compared to its demand the central bank buy the securities and vice versa. The purpose is

the regulate supply.

3. Reserve Ratio:

The central bank can increase or decrease the reserve ratio. The rate of reserve is

decreased during depression, and increase in expansion.

4. Selective Control:

The central bank can provide credit to one sector at low rates and at high rate for anothersector. The central bank can check the loans granted by commercial banks, to control trade cycle.

B. Fiscal Policy:

5. Public Work:The government can start public works programs during depression and stop construction

of various projects during good trade period. Public works programs help to control trade cycle.

6. Taxes:The state can increase or decrease rates of taxes. The government can raise more taxes for

contraction of money supply. The tax rates may be lowered to provide excess money supply.

7. Budget:

The government can prepare surplus budget during boom period. There is need of deficit

budget during deflation. The government can use budge teary measure alone with other methodsto control trade cycle.

8. Public Debt:

The government must take loans during depression to meet various needs. In case ofboom the debt should be repaid. The government can overcome the difficulties of low business

activity through public debt.


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9. Imports:The government can allow import of goods, which are needed by public. during

depression there is no need to import the items, but when there is boom period the supply ofgoods can be maintained through imports.

C. International Measures:10.Production control:The production control measures can be made at international level. The goods produced

in excess of demand create problems. The producers can fix quota for production at world level.

In this way trade cycle can be controlled.

11.Buffer Stock:

Buffer stock can be kept in warehouses. When production is low the suppliers can meet

the demand from such stock. In case of excess production they hold surplus stock. Control oversupply means control over trade cycle.

12.

Investment Control;The government may allow investment in an area where there is low investment. Excess

investment in any sector may lead towards depression. There is need for balanced investment in

all economic sectors.

Conclusion:

In conclusion we can say that there are many causes of trade cycle and by take appropriate

measure a country can get control on it.


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Q14:What is an index number? Discuss its construction, advantages, limitation as well. Also

explain and construct the simple index number and weighted index number? 2003

ANSWER:A large number of commodities are offered for sale in every country of the world. The

prices of commodities sometimes fall or rise. So in order to find the relative changes in prices

level we use index number.

DEFINITION:D. Greenwald:index number is a measure of relative changes occurring in a series of values

compared with base year.

According To A. Haber:

An index number is a ratio, usually expressed as a percentage of prices, quantities, or

values that relates a given period with a comparison period

STEPS FOR CONSTRUCTION OF INDEX NUMBER:

1.

Selection of Base Year: (Period):One year is selected from past as base. Changes in prices are expressed in percentage (%)

from the base year.

2. Selection of Commodities:A number of commodities are selected. The class of consumers must be decided to select

the goods. The selection depends on the purpose for which the index number is prepared.

3. Price Quotations:The price quotations are obtained from selected markets only, and then the price of each

commodity is noted.

4.

Weighting:Each commodity is a weight. The weight shows the impotence, people give to different

commodities.

5. Percentages Changes:

The percentage changes in prices are calculated.

6. Calculation of Average:

The average of individual Indices ( ) is calculated. The individual indices are added

up and divided by no of weights. This average figure is called index number.

APPROPRIATE FORMULA:

Construction of Simple and Weighted Index No:

According to simple index number all items are equally important for the people.But in practical life it is not so. The commodities should be given due importance according to

their consumption.


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Simple Index Number:

Commodity Price in 1990 (Po) Base

1990=100

Price in 2000

(P1)

Relative price

(R)

A 20/ Kg 100 Rs. 25 125B 5/ Kg 100 10 200

C 15 Kg 100 30 200

D 40 Kg 100 50 125

E 200/ Quintal 100 450 225

N=5 R= 875

Formula: R= price in current year P1 x 100

Price in base period x 100 or Po1. 25 x 100= 125

202. 10 x 100 = 200

53. 30 x 100 = 200

15

4. 50 x 100 = 125

405. 450 x 100 = 2250

200Price index in 200 = R= 875 = 175

N 5

As the index is 175 which means that the price level rose 75% in 2000 over 1990.

Weighted Index Number:Now we assign high weights to commodities of greater importance to consumers and

lesser weights to commodities of lesser importance.

Commodity Weight

(w)

Prices in

1990 (Po)

Base year

1990= 100

Prices in

2000 (P1)

Price

relative

(R)

WxR

A 5 20 100 25 125 625

B 4 5 100 10 200 800

C 2 15 100 30 200 400

D 3 40 100 50 125 375

E 10 200 100 450 225 2250

w=24 WR=4450

The weighted index in 200 = WR= 4450 = 181.2

W 24

The weighted price index number is more accurate than the simple index number. The index181.2 shows that there is 81.2% rise in prices in 2000 as compared to 1990.


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Advantages (Uses) Of Index Number:

1. Comparison:Index number is very useful for comparing the values of things over two periods.

2. Forecasting:Index numbers are very helpful for forecasting economic and business conditions.

3. Policy Making:

Many economic policies are formulated with the help of index number.

4. Price Index Number:

Index numbers are used to compare the prices of two periods. It serve as a guide for

framing monetary and fiscal policy and other policies.

5. Cost Of Living Index Number:

It is very important in order to know the economic welfare of the people. Cost of livingindex numbers are very helpful in adjusting wages and in the settlement of wage disputes. It

must be taken into account while revising wages & salaries.

6. Production:Index numbers are useful for measuring the change in production level. The goods and

services produced during one year are compared with the goods and services output level. The

government can decide to import or export goods for welfare of people.

7. Investment:

Index number is helpful to note the changes in investment. The stock exchange prepares

index numbers to show the investment made by people from period the period.

8. Sales:

Index of sales is prepared to find out the quantities and value of total sale between times.

9. Changes in Employment Level:

Index numbers are useful to note the changes in employment level. The state can try toincrease the rate of employment, by creating new job opportunities.

10. Performance of Students:

Index numbers are useful to measure the intelligence and performance of students. Theteachers can check their efficiency through such index.

Limitations (Difficulties) Of Index Number:

1. Selection of Base Year:The base year must be accurate otherwise the results achieved will be misleading.


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2. Selection of Commodity:The pattern of consumption of all categories of people is not the same. So selection of

commodities is a difficult job.

3. Price Quotations:

An index number may be for wholesale or retail prices. Whole sale prices are easy toobtain, but they do not show the real cost of living.

4. Weighting:

The weight (preference, importance) people give to different commodities in base yearmay be changed, in current period due to change in taste and income etc.

5. Average:

An index number is an average. An average cannot give a complete picture of thesituation.

ConclusionIndex numbers are very important for economic analysis. They summarize movements in a group

of related variables. The consumer Price index is one of the most commonly used forms of index

number. It measures the changes in the retail prices.


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Q15:define foreign exchange. Discuss main objectives of foreign exchange control. Also point

out the methods employed for exchange control? (2000, 2001, 2002, 2002(s).

ANSWER:

INTRODUCTION:

The term foreign exchange denotes either a converted into another or means andmethods by which one currency is exchanged for another.It is related to the exchange methods and with international trade are made.

According To Ency Brit:The system by which commercial nations discharge their debts to each other.

According To Hartley:

Foreign exchange is a mechanism by which international indebtedness is settledbetween two countries.

According: To H.E. Evitt:The means and methods by which rights of wealth expressed in terms of the currency of

one country are converted into rights to wealth in terms of the currency of another country are

known as foreign exchange.

In Simple Words, the term foreign exchange is used

1. It is the currency of the other country.

2. It is the procedure by which international payments are made.3. It is the rate at which foreign currency is bought and sold.

Exchange Control:

Exchange control refers to restrictions put by the government on the private foreignexchange dealings. In Pakistan foreign exchange regulation act 1947 is used to control and

regulate foreign payments, import and export of currency, bullion and foreign exchange.

According To G.V. Labeler:The state regulation excluding the free play of economic forces forms the foreign

exchange market.

According To G.N. Helm:

Exchange control refers to measure which replace part of the equilibrating functions of

the foreign exchange market by regulation alien to the pricing process.

OBJECTIVES Of EXCHANGE CONTROL:

Exchange controls are basically implemented to safe guard the interest of whole of the

economy.The main objectives are as under:


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1. to Correct Adverse Balance of Payments (Bop):One of the main objectives is the correction of adverse BOP. This objective is achieved

by curtailing the volume of import.

2. to Conserve Foreign Exchange:

A country may introduce exchange control for conserving hard earned foreign exchange.There reserves are exclusively used for, (i) payment of external debt (ii) import essential goods.(iii) Purchase of defense material.

3. To Protect Home Industry:Exchange control is also employed to protect home industry. If some industries face

competition from abroad and the govt. desires to protect them, then foreign exchange control is

employed.

4. To Stabilize Exchange Rate:The fluctuation in exchange rate cause disequilibrium in the economy. In the government

officially fixes the exchange rate.

5. To Promote Economic Growth:

Exchange controls are used by low_ income countries for promoting economic growth.

They are very useful for allocating resources according to development plans.

6. Payment of Foreign Debts:

Exchange controls are also adopted for the purpose of acquiring foreign exchange to payforeign debts.

7. Substitute for Tariffs:

Exchange controls may be employed as a substitute for tariffs and other restrictions onimports for the purpose of protecting home industries form foreign competition.

8. To Increase The Foreign Exchange Reserves:Every government wants to increase foreign exchange reserves, so to get this objective

exchange control policy is adopted.

9. Control over Flight of Capital:Exchange control may be used to check capital fights to foreign countries. Capital flights

in and out of the country are of vital importance. This is very serious problem for those

underdeveloped countries which are experiencing political instability.

10. Source of Income:

Exchange controls are also source of income for the government. Since during exchange

controls the government directly retains the foreign exchange and as foreign exchange is directlysold by govt. so difference between buying and selling rate goes income to govt.


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11. Under-Valuation:It means to fix a rate, lower than it would be in a free floating exchange system. The

basic aim of this to protect local industry and favour of local exporters.

12. Over Valuation:

It means exchange rate is fixed over and above its normal level. This policy is adopted infollowing cases:1. When supply of local currency is extra ordinary.

2. When country is facing high inflation.

3. When a country has a massive foreign debts.

METHODS OF EXCHANGE CONTROL:

1. Exchange Pegging:

Exchange pegging means the act of fixing the exchange rate (value) of a currency tosome chosen rate. When exchange rate is fixed (pegged) higher than the market rate, it is called

pegging up

When exchange rate fixed lower than market rate it is called pegging down (undervaluation). This is a temporary measure to remove fluctuations in the foreign exchange rate,

England adopted it during WWI

2. Import Quotas and Licenses:For maximum effectiveness import quotas and licenses are used. The govt. fixes quotas

for the importation of goods.

3. Blocked Accounts:If a country prohibits the transfer of funds of foreigners held in its banks, the accounts are

said to be locked and funds to be frozen. The account holders cannot draw cheques without the

permission of the central bank of the blocking country.

4. Clearing Agreements:

Under this system, the governments of two countries agree to clear the accounts in homecurrency through their central banks.

5. Stand Still Agreement:This is also a method to control exchange the short term debt is converted to long term

debt or gradual payments in (installments) is allowed.

Germany adopted it in 1931.

6. Exports Bonus Scheme:To encourage the exporters, a certain (specific) part of foreign exchange is given to the

exporter for their personal use.

7. Compensation Agreements:

According to this agreement the two countries import and export the commodities of

equally valued. Since no payment is made to foreign exchange. Problem of foreign exchangedoesnt arise.


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8. Payment Agreement:The payment agreements are made between a debtor and creditor country. This method is

used in such a way that debtor country makes more & more exports to creditor country andimports less and less quantity forms it. In this way the transactions are settled and cleared.

9. Rationing Of Foreign Exchange:The government requires that all foreign exchange receipts should be handed over to thecentral bank then the govt. through the central bank rations or allocates this foreign exchange

among the importers.

10. Exchange Equalization Account:Exchange equalization account is the device adopted for smoothing out temporary or

short term fluctuations in the rate of exchange as a result of any abnormal movement of capital.

England adopted it in 1932. France and USA in 1936. So a fund is created for the purposeof buying & selling foreign currencies to control exchange rate fluctuations.

11. Multiple Exchange Rate Practice:Sometimes two or more exchange rates are employed for buying and selling foreign

currencies. The major objective of this multiple exchange rate is to encourage or discourage

certain types of imports and exports.

CONCLUSION


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Q #16 what are the advantages and disadvantages of nationalization of banks in

Pakistan.

Answer:

Nationalization:Nationalization means the transfer of ownership, management and control to the state. In 1974,

13 banks were nationalized under nationalization of banks act 1974.

Definition:According to Alan Isaacs; nationalization is the process of bringing the assets of a company into

the ownership of state.

According to the Robert Millard; nationalization is the act of converting the privately owned

resources into the one owned by the central government.

Advantages of Nationalization:

1. Distribution of credit:

Nationalized helped in the fair distribution of credit. Before nationalization the credit wasconcentrated in few hands. Nationalization ensured the fair distribution of wealth.

2. Banking management:

The government has setup and executive board to look after the administrative work of thebanks. The business of banking has improved due to better management.

3. End of monopoly:There was complete control of few industrialists over the banking system. They used bank assets

and deposits of public for their personal interest. With the nationalization of banks their

monopoly comes to an end.

4. Benefit to employees:Before the nationalization the rights of employees were not protected. Employees rights are

protected by the nationalization of banks. They are promoted on merit basis nationalizationincreased the job security and job satisfaction.

5. Control over expenses:Nationalization of banks has controlled non- development expenses to a large extent. The useless

expenses on entertainment and advertisement have been reduced which improved the rate of

profit for commercial banks

6. Increase in employment:Nationalization resulted in creation of jobs opportunities for talented and educated people in the

banks. As far as new branches are opened, hundreds of people got employment.

1. Rural bank branches:

The nationalized banks have opened many branches in rural areas. It is due to the rural branches

that the idle funds are being used into the productive sectors.


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8. Foreign bank branches:The performance of foreign bank branches has also increased; the employees are posted on the

merit basis. Number of branches has also increased to promote banking at international level.

9. Increase in government income:

Before nationalization the income of the bank was gone into the hands of their owners. Now theincome of the banks is transferred to the government treasury which can be used for the commoninterest of the nation.

10. Increase in public confidence:Nationalization helped in increasing the public confidence. They do not feel hesitation in

depositing their savings in banks because they know that the banks are working under the

supervision of government.

11. Black money:Before the nationalization the corrupt officers and traders were used to keep their black money in

banks. But now the protection to black money is not possible because the government can checkthe amounts of bank at any time.

12. Control over credit:

Commercial bank can create credit, but unnecessary expansion of credit can create inflation.Nationalization enables the state bank of Pakistan to control the activities of commercial banks.

13. Economic development:Nationalization increased the resources of the government. The government was

mbf and i2b notes

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