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Banking – Notes for Class 12 Macro Economics

Introduction:

This is a textual description of commercial bank, credit creation by commercial bank, central bank and its functions.

Commercial Bank And Credit Creation By Commercial Bank

1. Commercial bank is a financial institution which performs the functions of accepting deposits from the public and making loans and investments, with the motive of earning profit.
2. Process of money creation/deposit creation/credit creation by the commercial banking system.
(a) Let us assume that the entire commercial banking system is one unit. Let us call this one unit simply “banks’. Let us also assume that all receipts and payments in the economy are routed through the banks. One who makes payment does it by writing cheque. The one who receives payment deposits the same in his deposit account.
(b) Suppose initially people deposit Rs.1000. The banks use this money for giving loans. But the banks cannot use the whole of deposit for this purpose. It is legally compulsory for the banks to keep a certain minimum fraction of these deposits as cash. The fraction is called the Legal Reserve Ratio (LRR). The LRR is fixed by the Central Bank. It has two components. A part of the LRR is to be kept with the Central bank and this part ratio is called the Cash Reserve Ratio. The other part is kept by the banks with themselves and is called the Statutory Liquidity Ratio.
(c) Let us now explain the process, suppose the initial deposits in banks is Rs.1000 and the LRR is 10 percent. Further, suppose that banks keep only the minimum required, i.e., Rs.100 as cash reserve, banks are now free to lend the remainder Rs.900. Suppose they lend Rs.900. What banks do to open deposit accounts in the names of the borrowers who are free to withdraw the amount whenever they like.
• Suppose they withdraw the whole of amount for making payments.
(d) Now, since all the transactions are routed through the banks, the money spent by the borrowers comes back into the banks into the deposit accounts of those who have received this payment. This increases demand deposit in banks by ?900. It is 90 per cent of the initial deposit. These deposits of Rs.900 have resulted on account
of loans given by the banks. In this sense the banks are responsible for money creation. With this round, increased in total deposits are now  Rs.1900 (=1000 + 900).
(e) When banks receive new deposit of ?900, they keep 10 per cent of it as cash reserves and use the remaining Rs. 810 for giving loans. The borrowers use these loans for making payments. The money comes back into the accounts of those who have received the payments. Bank deposits again rise, but by a smaller amount of Rs.810. It is 90 per cent of the last deposit creation. The total deposits now increase to Rs.2710 (=1000 + 900 + 810). The process does not end here.
(f) The deposit creation continues in the above manner. The deposits go on increasing round after round but Deposit Creation By Commercial Banks each time only 90 per cent of the last round deposits. At the same time cash reserves go on increasing, each time 90 per cent of the last cash reserve. The deposit creation comes to end when the total cash reserves become equal to the initial deposit. The total deposit creation comes to Rs.10000, ten times the initial deposit as shown in the table.

It can also be explained with the help of the following formula:

3. Banks required to keep only a fraction of deposits as cash reserves Banks are required to keep only a fraction of deposits as cash reserves because of the following two reasons:
(a) First, the banking experience has revealed that not all depositors approach the banks for withdrawal of money at the same time and also that normally they withdraw a fraction of deposits.
(b) Secondly, there is a constant flow of new deposits into the banks. Therefore to meet the daily demand for withdrawal of cash, it is sufficient for banks to keep only a fraction of deposits as a cash reserve.
4. When the primary cash deposit in the banking system leads to multiple expansion in the total deposits, it is known as money multiplier or credit multiplier.

Central Bank And Their Functions

1. The central bank is the apex institution of a country’s monetary system. The design and the control of the country’s monetary policy is its main responsibility. India’s central bank is the Reserve Bank of India.
2. Functions of Central Bank.
(a) Currency Authority:
(i) The central bank has the sole monopoly to issue currency notes. Commercial banks cannot issue currency notes. Currency notes issued by the central bank are the legal tender money.
(ii) Legal tender money is one, which every individual is bound to accept by law in exchange for goods and services and in the discharge of debts.
(iii) Central bank has an issue department, which is solely responsible for the issue of notes.
(iv) However, the monopoly of central bank to issue the currency notes may be partial in certain countries.
(v) For example, in India, one rupee notes and all types of coins are issued by the government and all other notes are issued by the Reserve Bank of India.
(b) Banker, Agent and Advisor to the Government: Central bank everywhere in the world acts as banker, fiscal agent and adviser to their respective government.
(i) As Banker: As a banker to the government, the central bank performs same functions as performed by the commercial banks to their customers.
• It receives deposits from the government and collects cheques and drafts deposited in the government account.
• It provides cash to the government as resumed for payment of salaries and wages to their staff and other cash disbursements.
• It makes payments on behalf of the government.
• It also advances short term loans to the government.
• It supplies foreign exchange to the government for repaying external debt or making other payments.
(ii) As Fiscal Agent: As a fiscal agent, it performs the following functions :
• It manages the public debt.
• It collects taxes and other payments on behalf of the government.
• It represents the government in the international financial institutions (such as World Bank, International Monetary Fund, etc.) and conferences.
(iii) As Adviser
• The central bank also acts as the financial adviser to the government.
• It gives advice to the government on all financial and economic matters such as deficit financing, devaluation of currency, trade policy, foreign exchange policy, etc.
3. Banker’s Bank and Supervisor:
(a) Banker’s Bank: Central bank acts as the banker to the banks in three ways: (i) custodian of the cash reserves of the commercial banks; (ii) as the lender of the last resort; and (iii) as clearing agent.
(i) As a custodian of the cash reserves of the commercial banks, the central bank maintains the cash reserves of the commercial banks. Every commercial bank has to keep a certain percent of its cash reserves with the central bank by law.
(ii) As Lender of the Last Resort.
• As banker to the banks, the central bank acts as the lender of the last resort.
• In other words, in case the commercial banks fail to meet their financial requirements from other sources, they can, as a last resort, approach to the central bank for loans and advances.
• The central bank assists such banks through discounting of approved securities and bills of exchange.
(ii) As Clearing Agent
• Since it is the custodian of the cash reserves of the commercial banks, the central bank can act as the clearinghouse for these banks.
• Since all banks have their accounts with the central bank, the central bank can easily settle the claims of various banks against each other simply by book entries of transfers from and to their accounts.
• This method of settling accounts is called Clearing House Function of the central bank.
(b) Supervisor
(i) The Central Bank supervises, regulate and control the commercial banks.
(ii) The regulation of banks may be related to their licensing, branch expansion, liquidity of assets, management, amalgamation (merging of banks) and liquidation (the winding of banks).
(iii) The control is exercised by periodic inspection of banks and the returns filed by them.
4. Controller of Money Supply and Credit: Principal instruments of Monetary Policy or credit control of the Central Bank of a country are broadly classified as:
(a) Quantitative Instruments or General Tools; and
(b) Qualitative Instruments or Selective Tools.
(a) Quantitative Instruments or General Tools of Monetary Policy: These are the instruments of monetary policy that affect overall supply of money/credit in the economy. These instruments do not direct or restrict the flow of credit to some specific sectors of the economy. They are as under:
(i) Bank Rate (Discount Rate)
• Bank rate is the rate of interest at which central bank lends to commercial banks without any collateral (security for purpose of loan). The thing, which has to be remembered, is that central bank lends to commercial banks and not to general public.
• In a situation of excess demand leading to inflation,
-> Central bank raises bank rate that discourages commercial banks in borrowing from central bank as it will increase the cost of borrowing of commercial bank.
-> It forces the commercial banks to increase their lending rates, which discourages borrowers from taking loans, which discourages investment.
-> Again high rate of interest induces households to increase their savings by restricting expenditure on consumption.
-> Thus, expenditure on investment and consumption is reduced, which will control the excess demand.
• In a situation of deficient demand leading to deflation,
-> Central bank decreases bank rate that encourages commercial banks in borrowing from central bank as it will decrease the cost of borrowing of commercial bank.
-> Decrease in bank rate makes commercial bank to decrease their lending rates, which encourages borrowers from taking loans, which encourages investment.
-> Again low rate of interest induces households to decrease their savings by increasing expenditure on consumption.
-> Thus, expenditure on investment and consumption increase, which will control the deficient demand.
(ii) Repo Rate
• Repo rate is the rate at which commercial bank borrow money from the central
bank for short period by selling their financial securities to the central bank.
• These securities are pledged as a security for the loans.
• It is called Repurchase rate as this involves commercial bank selling securities
to RBI to borrow the money with an agreement to repurchase them at a later
date and at a predetermined price.
• So, keeping securities and borrowing is repo rate.
• In a situation of excess demand leading to inflation,
-> Central bank raises repo rate that discourages commercial banks in borrowing from central bank as it will increase the cost of borrowing of commercial bank.
-> It forces the commercial banks to increase their lending rates, which discourages borrowers from taking loans, which discourages investment.
-> Again high rate of interest induces households to increase their savings by restricting expenditure on consumption.
-> Thus, expenditure on investment and consumption is reduced, which will control the excess demand.
• In a situation of deficient demand leading to deflation,
-> Central bank decreases Repo rate that encourages commercial banks in borrowing from central bank as it will decrease the cost of borrowing of commercial bank.
-> Decrease in Repo rate makes commercial bank to decrease their lending rates, which encourages borrowers from taking loans, which encourages investment.
-> Again low rate of interest induces households to decrease their savings by increasing expenditure on consumption.
-> Thus, expenditure on investment and consumption increase, which will control the deficient demand.
(iii) Reverse Repo Rate
• It is the rate at which the Central Bank (RBI) borrows money from commercial bank.
• In a situation of excess demand leading to inflation, Reverse repo rate is increased, it encourages the commercial bank to park their funds with the central bank to earn higher return on idle cash. It decreases the lending capability of commercial banks, which controls excess demand.
• In a situation of deficient demand leading to deflation, Reverse repo rate is decreased, it discourages the commercial bank to park their funds with the central bank. It increases the lending capability of commercial banks, which controls deficient demand.
(iv) Open Market Operations (OMO)
• It consists of buying and selling of government securities and bonds in the open market by Central Bank.
• In a situation of excess demand leading to inflation, central bank sells government securities and bonds to commercial bank. With the sale of these securities, the power of commercial bank of giving loans decreases, which will control excess demand.
• In a situation of deficient demand leading to deflation, central bank purchases
government securities and bonds from commercial bank. With the purchase of these securities, the power of commercial bank of giving loans increases, which will control deficient demand.
(v) Varying Reserve Requirements
• Banks are obliged to maintain reserves with the central bank, which is known as legal reserve ratio. It has two components. One is the Cash Reserve Ratio or CRR and the other is the SLR or Statutory Liquidity Ratio.
• Cash Reserve Ratio:
-> It refers to the minimum percentage of a bank’s total deposits, which it is required to keep with the central bank. Commercial banks have to keep with the central bank a certain percentage of their deposits in the form of cash reserves as a matter of law.
-> For example, if the minimum reserve ratio is 10% and total deposits of a certain bank is Rs. 100 crore, it will have to keep Rs. 10 crore with the Central Bank.
-> In a situation of excess demand leading to inflation, Cash Reserve Ratio (CRR) is raised to 20 per cent, the bank will have to keep Rs.20 crore with the Central Bank, which will reduce the cash resources of commercial bank and reducing credit availability in the economy, which will control excess demand.
-> In a situation of deficient demand leading to deflation, cash reserve ratio (CRR) falls to 5 per cent, the bank will have to keep Rs. 5 crore with the central bank, which will increase the cash resources of commercial bank and increasing credit availability in the economy, which will control deficient demand.
(vi) The Statutory Liquidity Ratio (SLR)
• It refers to minimum percentage of net total demand and time liabilities, which commercial banks are required to maintain with themselves.
• In a situation of excess demand leading to inflation, the central bank increases statutory liquidity ratio (SLR), which will reduce the cash resources of commercial bank and reducing credit availability in the economy.
• In a situation of deficient demand leading to deflation, the central bank decreases statutory liquidity ratio (SLR), which will increase the cash resources of commercial bank and increases credit availability in the economy.
• It may consist of:
-> Excess reserves
-> Unencumbered (are not acting as security for loans from the Central Bank) government and other approved securities (securities whose repayment is guaranteed by the government); and
-> Current account balances with other banks.
(b) Qualitative Instruments or Selective Tools of Monetary Policy: These
instruments are used to regulate the direction of credit. They are as under:
(i) Imposing margin requirement on secured loans
• Business and traders get credit from commercial bank against the security of their goods. Bank never gives credit equal to the full value of the security. It always pays less value than the security.
• So, the difference between the value of security and value of loan is called
marginal requirement.
• In a situation of excess demand leading to inflation, central bank raises marginal requirements. This discourages borrowing because it makes people gets less credit against their securities.
• In a situation of deficient demand leading to deflation, central bank decreases marginal requirements. This encourages borrowing because it makes people get more credit against their securities.
(ii) Moral Suasion
• Moral suasion implies persuasion, request, informal suggestion, advice and appeal by the central banks to commercial banks to cooperate with general monetary policy of the central bank.
• In a situation of excess demand leading to inflation, it appeals for credit contraction.
• In a situation of deficient demand leading to deflation, it appeals for credit expansion.
(iii) Selective Credit Controls (SCCs)
• In this method the central bank can give directions to the commercial banks not to give credit for certain purposes or to give more credit for particular purposes or to the priority sectors.
• In a situation of excess demand leading to inflation, the central bank introduces rationing of credit in order to prevent excessive flow of credit, particularly for speculative activities. It helps to wipe off the excess demand.
• In a situation of deficient demand leading to deflation, the central bank withdraws rationing of credit and make efforts to encourage credit.

Words that Matter

1. Commercial Bank: Commercial bank is a financial institution which performs the functions of accepting deposits from the public and making loans and investments, with the motive of earning profit.
2. Legal Reserve Ratio: It is the minimum ratio of deposits legally required to be kept by the commercial banks with themselves (Statutory Liquidity Ratio) and with the central bank (Cash reserve Ratio).
3. Money Multiplier or Credit Multiplier: When the primary cash deposit in the banking system leads to multiple expansion in the total deposits, it is known as money multiplier or credit multiplier.
4. Central Bank: The central bank is the apex institution of a country’s monetary system. The design and the control of the country’s monetary policy is its main responsibility.
5. Quantitative Instruments or General Tools of Monetary Policy: These are the instruments of monetary policy that affect overall supply of money/credit in the economy.
6. Qualitative Instruments or Selective Tools of Monetary Policy: The instruments which are used to regulate the direction of credit is known as Qualitative Instruments.
7. Bank rate: It is the rate of interest at which central bank lends to commercial banks without any collateral (security for purpose of loan).
8. Repo rate: It is the rate at which commercial bank borrow money from the central bank for short period by selling their financial securities to the central bank.
9. Reverse Repo rate: It is the rate at which the central bank (RBI) borrows money from commercial bank.
10. Open Market Operation: It consists of buying and selling of government securities and bonds in the open market by central bank.
11. Cash Reserve Ratio: It refers to the minimum percentage of a bank’s total deposits, which it is required to keep with the central bank.
12. Statutory Liquidity Ratio: It refers to minimum percentage of net total demand and time liabilities, which commercial banks are required to maintain with themselves.
13. Marginal requirement: Business and traders get credit from commercial bank against the security of their goods. Bank never gives credit equal to the full value of the security. It always pays less value than the security. So, the difference between the value of security and value of loan is called marginal requirement.
14. Moral suasion: It implies persuasion, request, informal suggestion, advice and appeal by the central banks to commercial banks to cooperate with general monetary policy of the central bank.
15. Selective Credit Controls (SCCs): In this method the central bank can give directions to the commercial banks not to give credit for certain purposes or to give more credit for particular purposes or to the priority sectors.

Money – Notes for Class 12 Macro Economics

Barter System And Its Difficulties, Money And Functions Of Money:

1. Barter system of exchange is a system in which goods are exchanged for goods.
2. For example, wheat may be exchanged for cloth; house for horses, etc., or a teacher may be paid wheat or rice as a payment for his/her services.
3. Such exchange exists in the C-C Economy (commodity to commodity exchange economy).
Note: In C-C Economy C stands for commodity. C-C economy is the one in which commodities are exchanged for commodities. C-C exchange refers to barter system of exchange. Hence, C-C Economy is an economy dominated by barter system of exchange.
4. Difficulties of barter system are:-Barter system as a system of exchange is faced with the following difficulties:
(a) Lack of double coincidence of wants:
(i) Barter is possible only if goods produced by two persons are needed by each other. It is double coincidence of wants.
(ii) Double coincidence of wants means that goods in possession of two different persons must be useful and needed by each other. It is the main basis of barter system of exchange. But it is rare.
(iii) It is difficult to find such a person every time. In barter system, exchange becomes quite limited.
(b) Lack of divisibility:
(i) In commodity exchange, difficulty of dividing the commodity arises.
(ii) For example, if a car is to be exchanged for a scooter, then car can not be divided. Similarly, animals can not be divided into smaller units.
(c) Difficulty in storing wealth:
(i) It is very difficult to store wealth for future use.
(ii) Most of the goods like wheat, rice, cattle etc. are likely to deteriorate with the passage of time or involve heavy cost of storage.
(iii) Further, the transfer of goods from one place to another place involves huge transport cost.
(iv) Transfer of immovable commodities (such as house, farm, land, etc.) becomes almost impossible.
(d) Absence of common measure of value:
(i) Different commodities are of different values. The value of a good or service means the amount of other goods and services it can be exchanged for in the market. There is no common measure of value under barter system.
(ii) In this situation, it is difficult to decide in what proportions are the two goods to be exchanged.
(e) Lack of standard of deferred payment: In a barter economy future payments would have to be stated in terms of specific goods or services. This leads to following problems:
(i) There could be disagreement regarding the quality of the goods or services to be repaid.
(ii) There would be disagreement regarding which specific commodities would be used for repayment.
5. Money: Money is something which is generally acceptable as a medium of exchange
and can be converted into other assets without losing its time and value.
6. Functions of money: Functions of money can be summed up as follow:
“Money is a matter of the following four functions:
A medium, a measure, a standard, a store”
We can conclude these four functions under the following two functions:
(a) Primary function
(b) Secondary function

(a)Primary function or Main function: Primary function includes the most important functions of money, which it must perform in an economic system irrespective of time and place. The following two functions are included under this category.
(i) Medium of exchange
• Money when used as a medium of exchange helps to eliminate the basic limitation of barter trade, that is, the lack of double coincidence of wants.
• Individuals can exchange their goods and services for money and then can use this money to buy other goods and services according to their needs and convenience.
• Thus, the process of exchange shall have two parts: a sale and a purchase.
• The ease at which money is converted into other goods and services is called “liquidity of money”.
(ii) Measure of value /unit of account
• Another important function of money is that it serves as a common measure of value or a unit of account.
• Under barter economy there was no common measure of value in which the values of different goods could be measured and compared with each other. Money has also solved this difficulty.
• As Geoffrey Crowther puts it, “Money acts as a standard measure of value to which all other things can be compared.” Money measures the value of economic goods.
• Money works as a common denominator into which the values of all goods and services are expressed.
• When we express the values of a commodity in terms of money, it is called price and by knowing prices of the various commodities, it is easy to calculate exchange ratios between them.
(b) Secondary Functions
(i) Standard of deferred payments
• Credit has become the life and blood of a modern capitalist economy.
• In millions of transactions, instant payments are not made.
• The debtors make a promise that they will make payments on some future date. In those situations money acts as a standard of deferred payments.
• It has become possible because money has general acceptability, its value is stable, it is durable and homogeneous.
(ii) Store of vaiue
• Wealth can be conveniently stored in the form of money. Money can be stored without loss in value.
• Savings are secured and can be used whenever there is a need.
• In this way, money acts as a bridge between the present and the future.
• Money means goods and services. Thus, money serves as a store of value.
• It is also known as asset function of money.
7. Characteristics or features of money:
(a) Durability: Money must be durable and not likely to deteriorate rapidly with
frequent handling. Currency notes and coins are being used repeatedly and shall
continue to do so for many years.
(b) Medium of exchange: Money is the thing that acts as a medium of exchange for the sale and purchase of goods and services.
(c) Weight: Money must be light in weight. Paper money is better than metal coins because it is light in weight.
(d) Measure of value: It not only serves as medium of exchange but also acts as a measure of value. The value of all the goods and services is expressed in terms of money.
8. Money has overcome the drawbacks of barter system: Barter system makes
the exchange process very difficult and highly inefficient. Money has overcome the
drawbacks of barter system in the following manners:
(a) Medium of exchange
(i) Under barter system, there is lack of double coincidence of wants.
(ii) With money as a medium exchange individuals can exchange their goods and services for money and then use this money to buy other goods and services according to their needs and conveniences.
(iii) A buyer can buy goods through money and a seller can sell goods for money.
(b) Measure of value
(i) Under barter system, there was no common measure of value. Money has also solved this difficulty.
(ii) As Geoffrey Crowther puts it, “Money acts as a standard measure of value to which all other things can be compared.” Money measures the value of economic goods.
(iii) Money works as a common denominator into which the values of all goods and services are expressed.
(iv) When we express the values of a commodity in terms of money, it is called price and by knowing prices of the various commodities, it is easy to calculate exchange ratios between them.
(c) Store of value
(i) Under barter system it is very difficult to store wealth for future use.
(ii) Most of the goods are perishable and their storage requires huge space and transportation cost.
(iii) Wealth can be conveniently stored in the form of money.
(iv) Money can be stored without loss in value.
(v) Money can easily be stored for future use.
(d) Standard of deferred payments
(i) Under barter system, transactions on deferred payments are not possible.
(ii) With money, the debtors make a promise that they will make payments on some future dates. In these situations money acts as a standard of deferred payments.
(iii) It has become possible because money has general acceptability, its value is stable, it is durable and homogeneous.
9. Legal definition of money:
(a) Legally, money is anything proclaimed by law as a medium of exchange.
(b) Paper notes and coins (together called currency) is money as a matter of law.
(c) Nobody can refuse its acceptance as medium of exchange.
(d) In other words, it is legal tender. It means people have to accept it legally for different payments. Currency is also called FIAT money because it commands ‘FIAT’ (order/authority) of the government.
10. Functional definition of money: Functional definition of money refers to money as anything that performs four basic functions,
(a) It serves as a medium of exchange.
(b) It serves as a standard unit of value.
(c) It serves as a means for future / contractual payments or standard of deferred payments.
(d) It serves as a store of value.
According to this, definition of money includes both notes and coins as well as chequeable deposits with the banks.
11. Narrow definition of money: Functional definition of money is a narrow definition of money. It includes only notes, coins and demand deposits as money. In other words, in its narrow definition, money includes only those things that function as money in terms of:
(a) Medium of exchange.
(b) Measure of value.
(c) Standard of future/Deferred payments.
(d) Store of value.
12. Broad definition of money:
(a) A broad definition of money also includes time deposits/term deposits with the banks or post offices as a component of money.
(b) These deposits can be converted into demand deposits on a short notice, and are “Near money assets”. Money assets and near money assets together make up a definition of money.

Money Supply And Measures Of Money Supply

1. Money supply: The volume of money held by the public at a point of time, in an economy, is referred to as the money supply. Money supply is a stock concept.
2. Measures of money supply: On the recommendation of the second working group on money supply, the RBI presented four measures of money supply in its 1977 issues of RBI Bulletin, namely M₁, M₂, M₃ and M₄.
Measures of M₁ include:
(a) Currency notes and coins with the public (excluding cash in hand of all commercial banks) [C]
(b) Demand deposits of all commercial and co-operative banks excluding inter-bank deposits. (DD),
Where demand deposits are those deposits which can be withdrawn by the depositor at any time by means of cheque. No interest is paid on such deposits.
(c) Other deposits with RBI [O.D]
M₁ = C + DD + OD
Where, Other deposits are the deposits held by the RBI of all economic units except the government and banks. OD includes demand deposits of semi¬government public financial institutions (like IDBI, IFCI, etc.), foreign central banks and governments, the International Monetary Fund, the World Bank, etc.
Measures of M₂:
(i) M₁ [C + DD + OD]
(if) Post office saving deposits
Measures of M₃:
(i) M₁
(ii) Time deposits of all commercial and co-operative banks.
Where, Time deposits are the deposits that cannot be withdrawn before the expiry of the stipulated time for which deposits are made. Fixed deposit is an example of time deposit.
Measures of M₄:
(i) M₃
(ii) Total deposits with the post office saving organization (excluding national savings certificates).
3. High-powered money: High-powered money is money produced by the RBI and the government. It consists of two things: (a) currency held by the public and (b) Cash reserves with the banks.

Words that Matter

1. Barter system: Barter system of exchange is a system in which goods are exchanged for goods.
2. Double coincidence of wants: It means that goods in possession of two different persons must be useful and needed by each other.

 Class 12 economics revision notes national income and related aggregates

Goods :In economics a goods is defined as any physical object, manmade, that could command a price in the market andthese are the materials that satisfy human wants and provide utility

Consumption Goods : Those final goods which satisfy human wants directly. ex- ice-cream and milk used by the households.

Capital Goods :Those final goods which help in production. These goods are used for generating income. These goods are fixed assets of the producers.ex- plant and machinery.

Final Goods are those goods which are used either for final consumption or for investment.

Intermediate Goods refers to those goods and services which are used as a raw material for further production or for resale in the same year.

These goods do not fulfill needs of mankind directly.

Investment :Addition made to the physical stock of capital during a period of time is called investment. It is also called capital formation.

capital formation:- Change in the stock of capital is also called capital formation.

Depreciation :means fall in value of fixed capital goods due to normal wear and tear and expected obsolescence. It is also called consumption of fixed capital.

Gross Investment :Total addition made to physical stock of capital during a period of time. It includes depreciation. OR Net Investment + Depreciation

Net Investment :Net addition made to the real stock of capital during a period of time. It excludes depreciation.

Net Investment = Gross investment – Depreciation.

Stocks :Variables whose magnitude is measured at a particular point of time are called stock variables. Eg. National Wealth, Inventory etc.

Flows :Variables whose magnitude is measured over a period of time are called flow variable. Eg. National income, change in stock etc.

Circular flow of income :It refers to continuous flow of goods and services and money income among different sectors in the economy. It is circular in nature. It has neither any end and nor any beginning point. It helps to know the functioning of the economy.

Leakage :It is the amount of money which is withdrawn from circular flow of income. For eg. Taxes, Savings and Import. It reduces aggregate demand and the level of income.

Injection :It is the amount of money which is added to the circular flow of income. For e.g. Govt. Exp., investment and exports. It increases the aggregate demand and the level of income.

Economic Territory :Economic (or domestic) Territory is the geographical territory administrated by a Government within which persons, goods, and capital circulate freely.

Scope of Economic Territory :

(a) Political frontiers including territorial waters and airspace.

(b) Embassies, consulates, military bases etc. located abroad.

(c) Ships and aircraft operated by the residents between two or more countries.

(d) Fishing vessels, oil and natural gas rigs operated by residents in the international waters.

Normal Resident of a country: is a person or an institution who normally resides in a country and whose Centre of economic interest lies in that country.

Exceptions:- (a) Diplomats and officials of foreign embassy.

(b) Commercial travellers, tourists students etc.

(c) People working in international organizations like WHO, IMF, UNESCO etc. are treated as normal residents of the country to which they belong.

The related aggregates of national income are:-
(i) Gross Domestic Product at Market price (GDP_MP)
(ii) Gross Domestic Product at Factor Cost (GDP_FC)
(iii) Net Domestic Product at Market Price (NDP_MP)
(iv) Net Domestic Product at FC or (NDP_FC)
(v) Net National Product at FC or National Income (NNP_FC)
(vi) Gross National Product at FC (GNP_FC)
(vii) Net National. Product at MP (NNP_MP)
(viii) Gross National Product at MP (GNP_MP)

(i) Gross Domestic Product at Market Price : It is the money value of all the
final goods and services produced within the domestic territory of a country
during an accounting year.
GDP_MP = Net domestic product at FC (NDP_FC) + Depreciation + Net
Indirect tax.

(ii) Gross Domestic Product at FC : It is the value of all final goods and services
produced within domestic territory of a country which does not include net
indirect tax.
GDP_FC = GDP_MP – Indirect tax + Subsidy
or GDP_FC = GDP_MP – NIT

(iii) Net Domestic Product at Market Price : It is the money value of all final
goods and services produced within domestic territory of a country during an
accounting year and does not include depreciation.
NDP_MP = GDP_MP – Depreciation

(iv) Net Domestic Product at FC : It is the value of all final goods and services
which does not include depreciation charges and net indirect tax. Thus it is
equal to the sum of all factor incomes (compensation of employees, rent,
interest, profit and mixed income of self employed) generated in the domestic
territory of the country.
NDP_FC = GDP_MP – Depreciation – Indirect tax + Subsidy

(v) Net National Product at FC (National Income) : It is the sum total of factor
incomes (compensation of employees + rent + interest + profit) earned by
normal residents of a country in an accounting year
or
NNP_FC = NDP_FC + Factor income earned by normal residents from abroad –
factor payments made to abroad.

(vi) Gross National Product at FC: It is the sum total of factor incomes earned
by normal residents of a country along with depreciation, during an accounting
year.
GNP_FC = NNP_FC + Depreciation OR

GNP_FC = GDP_FC + NFIA

(vii) Net National Product at MP : It is the sum total of factor incomes earned by
the normal residents of a country during an accounting year including net
indirect taxes.
NNP_MP = NNP_FC + Indirect tax – Subsidy

(viii) Gross National Product at MP : It is the sum total of factor incomes earned
by normal residents of a country during an accounting year including
depreciation and net indirect taxes.
GNP_MP = NNP_FC + Dep + NIT

Domestic Aggregates

Gross domestic Product at Market Priceis the market value of all the final goods and services produced by all producing units located in the domestic territory of a country during an accounting year. It includes the value of depreciation or consumption of fixed capital.

Net Domestic Product at Market PriceDepreciation (consumption of Fixed capital). It is the market value of final goods and services produced within the domestic territory of the country during a year exclusive of depreciation.

It is the factor income accruing to owners of factors of production for suppling factor services with in domestic territory during an accounting year.

NATIONAL AGGREGATES

Gross National Product at Market Price ) is the market value of all the final goods and services produced by normal residents (in the domestic territory and abroad) of a country during an accounting year.

National Income  :It is the sum total of all factors incomes which are earned by normal residents of a country in the form of wages. rent, interest and profit during an accounting year.

Methods of Estimation of National Income:

National Income at Current Prices : It is also called nominal National income. When goods and services produced by normal residents within and outside of a country in a year valued at current years prices i.e. current prices is called national income at current prices.

Y = Q x P

Y = National income at current prices

Q = Quantity of goods and services produced during an accounting year

P = Prices of goods and services prevailing during the current accounting year

National Income at Constant Prices :It is also called as real national income. When goods and services produced by normal residents within and outside of a country in a year valued at constant price i.e. base year’s price is called National Income at Constant Prices.

Y’ = Q x P’

Y’ = National income at constant prices

Q = Quantity of goods and services produced during an accounting year

P’ = Prices of goods and services prevailing during the base year

Value of Output :Market value of all goods and services produced by an enterprise during an accounting year.

Value added :It is the difference between value of output of a firm and value of inputs bought from the other firms during a particular period of time.

Problem of Double Counting :Counting the value of a commodity more than once while estimating national income is called double counting. It leads to overestimation of national income. So, it is called problem of double counting.

Ways to solve the problem of double counting.

(a) By taking the value of only final goods.

(b) By value added method.

Components of Added by all 3 sectors

1. Value Added by Primary Sector(=VO-IC)

2. Value Added by Secondary Sector(=VO-IC)

3. Value Added by Tertiary Sectors(=VO-IC)

Hints

VO=Value of output

IC=Intermediate Consumption

VO=Price X quantity OR

Sales + Change in stock

(Change in stock = Closing Stock – Opening Stock)

Components of Final Expenditure:

1. Final Consumption Expenditure

a. Private Final Consumption Expenditure(C)

b. Government Final Consumption Expenditure(G)

2. Gross Domestic Capital Formation

a. Gross Domestic Fixed Capital Formation

i. Gross business Fixed Investment

ii. Gross Residential Construction Investment

iii. Gross public Investment

b. Change in Stock or Inventory Investment

3. Net Export(X-M)

a. Export(X)

b. Import(M)

Components of Domestic Income :

1. Compensation of Employees

a. Wages and salaries(Cash/or kinds)

b. Employers Contribution of Social security Schemes

2. Operating surplus

a. Rent

b. Interest

c. Profit

i. Corporate Tax

ii. Dividend

iii. Undistributed corporate profit

3. Mixed Income for self-Employed person

Net Factor Income from Abroad NFIA = It is difference between factor income received/earned by normal residents of a country and factor income paid to non-residents of the country.

Components of NFIA :

1. Net Compensation of Employees

2. Net Income from Property and entrepreneurship

3. Net Retained earning of resident companies abroad

Hints :NFIA : Net Factor Income Earned from Abroad.

NFIA = Factor Income Received from Abroad.

–Factor Income Paid to Abroad.

OR

NFIA = Net compensation of Employees

Net income from property and entrepreneurship.

+ Net retained earning of resident companies abroad.

Net National Disposable Income (NNDI): It is defined as net national product at Market price  plus net current transfer from rest of the world.

NNDI = NNP_MP

+ Net current transfers from rest of the world.

=National income + net indirect tax + net current transfers from the rest of the world.

Gross National Disposable Income (Gross NDI  + Net current Transfers from rest of the world.

Net National Disposable Income (Net NDI)  + Net current Transfers from rest of the world.

OR

= Gross NDI – Depreciation.

Concept of Value Added of One Sector or One Firm

1. Value output = Sales + Change in Stock. or value of output = price × qty. sold + ΔS.
2. Gross value added at market price  = Value of output – Intermediate consumption.
3. Net value added at market price  = – Depreciation.
4. Net value added at factor cost  = – Net indirect tax.
Note: By adding up of all the sectors, we get or Domestic Income.
Personal Disposable Income from National Income 

Private Income :Private income is estimated income of factor and transfer incomes from all sources to private sector within and outside the country.
Personal Income :It refers to income received by house hold from all sources. It includes factor income and transfer income.
Personal Disposable Income :It is that part of Personal income which is available to the households for disposal as they like.
GDP and Welfare :
In general GDP and Welfare are directly related with each other. A higher GDP implies that more production of goods and services. It means more availability of goods and services. But more goods and services may not necessarily indicate that the people were better off during the year. In other words, a higher GDP may not necessarily mean higher welfare of the people. There are two types of GDP:

Real GDP : When the goods and services are produced by all producing units in the domestic territory of a country during an a/c. year and valued these at base year’s prices or constant price, it is called real GDP or GDP at constant prices. It changes only by change in physical output not by change price level. It is called a true indicator of economic development.

Nominal GDP : When the goods and services are produced by all producing units in the domestic territory of a country during an a/c. year and valued these at current year’s prices or current prices, it is called Nominal GDP or GDP at current prices. It is influenced by change in both physical output and price level. It does not consider a true indicator of economic development.

Price index plays the role of deflator deflating current price estimates into constant price estimates. In this way it may be called GDP deflator.

Welfare mean material well being of the people. It depends on many economic factors like national income, consumption level quality of goods etc and non-economic factor like environmental pollution, law and order etc. the welfare which depends on economic factors is called economic welfare and the welfare which depends on non-economic factor is called non-economic welfare. The sum total of economic and non-economic welfare is called social welfare. Conclusion thus GDP and welfare directly related with each other but this relation is incomplete because of the following reasons.

Limitation of percapita real GDP/GDP as a indicator of Economic welfare :

Non-monetary exchange
Externalities not taken into GDP but it affects welfare.
Distribution of GDP.
All product may not contribute equally to economic welfare.
Contribution of some products may be negative.
Inflation may give falls impression of growth of GDP.        

Introduction to Macroeconomics and its Concepts – Notes for Class 12 Macro Economics

Introduction And Structure Of MacroEconomics:
1. Macroeconomics is the part of economic theory that studies the economy as a whole, such as national income, aggregate employment, general price level, aggregate consumption, aggregate investment, etc. Its main instruments are aggregate demand and aggregate supply. It is also called the ‘Income Theory’ or ‘Employment Theory’.
2. Structure of macro economy: As we know, Macroeconomics is concerned with economic problems at the level of an economy as a whole. Structure of Macroeconomics implies study of different sectors of the economy.
An economy may be divided into different sectors depending on the nature of study.
(a) Producer sector engaged in the production of goods and services.
(b) Household sector engaged in the consumption of goods and services.
Note: Households are taken as the owners of factors of production.
(c) The government sector engaged in activities like taxation and subsidies
(d) Rest of the world sector engaged in exports and imports.
(e) Financial sector (or financial system) engaged in the activity of borrowing and lending.
3. Circular flow of income.
It refers to flow of money, income or the flow of goods and services across different sectors of the economy in a circular form.
There are two types of Circular flow:
(a) Real/Product/Physical Flow
(b) Money/Monetary/Nominal Flow
(a) Real flow
(i) Real flow of income implies the flow of factor services from the household sector to the producing sector and corresponding flow of goods and services from the producing sector to the household sector.
(ii) Let us consider a simple economy consisting only of 2 sectors:
• Producer Sector.
• Household Sector.

(iii) These two sectors are dependent on each other in the following ways:
• Producers supply goods and services to the households.
• Household (as the owners of factors of production) supplies factors of production (or factor services) to the producers.
This interdependence can be explained with the help of the diagram given here.
(b) Money Flow
(i) Money flow refers to the flow of factor income, as rent, interest, profit and wages from the producing sector to the household sector as monetary rewards for their factor services as shown in the flowchart.

(ii) The households spend their incomes on the goods and services produced by the producing sector. Accordingly, money flows back to the producing sector as household expenditure as shown in the flowchart.

Circular Flow Of Income In Two Sector Model:

The following assumptions with regard to a simple economy with only two sector of economics activity are:
(i) There are only two sectors in the economy; that is, household and firms.
(ii) Household supply factor services to firms.
(iii) Firms hire factor services from Households.

(iv) Households spend their entire income on consumption.
(v) Firms sell all that is produced to the households.
(vi) There is no government or foreign trade.
Such an economy described above has two types of markets.
(i) Market for goods and services, that is product market.
(ii) Market for factors of production, factor market.
As a result we can derive the following, in the case of our simple economy:
(i) Total production of goods and services by firms = Total consumption of goods and services by Household Sector.
(ii) Factor Payments by Firms = Factor Incomes of Household Sector.
(iii) Consumption expenditure of Household sector = Income of Firm.
(iv) Hence, Real flows of production and consumption of Firms and households = Money flows of income and expenditure of Firms and Households.

Phases Of Circular Flow:

There are three types of phases of Circular flow.
(i) Production Phase:
• It deals with the production of goods and services by the producer sector.
• If we study it in term of the quantity of goods and services produced, it is a Real Flow. But, it is a Money flow, if we study it in terms of the market value of the goods produced.
(ii) Distribution Phase: It means the flow of income in the form of rent, interest, profit and wages, paid by producer sector to the household sector. It is a Money Flow.
(iii) Disposition Phase:
• Disposition means expenditure made. This phase deals with expenditure on the purchase of goods and services by households and other sectors.
• This is a Money Flow from other sectors to the producer sector. These phases are illustrated in the figure given here.

Some Basic Concepts Of MacroEconomics

1. Factor Income
(a) Income earned by factor of production by rendering their productive services in the production process is known as Factor Income.
(b) It is a bilateral [Two-Sided] Concept.
(c) It is included in National Income as it contribute something in the flow of goods and services.
Examples: Rent, interest, wages and profit.
2. Transfer Income
(a) Income received without rendering any productive services is known as transfer income.
(b) It is a unilateral [one-sided] concept.
(c) It is not included in National Income as it does not contribute anything in the flow of goods and services.
Examples: Old Age Pension, Scholarship, Unemployment allowance.
There are two types of transfers:
(i) Current transfers (ii) Capital transfers
(i) Current Transfers
• Transfers made from the income of the payer and added to the income of the recipient (who receive) for consumption expenditure are called current transfers.
• It is recurring or regular in nature.
For example, scholarships, gifts, old age pension, etc.
(ii) Capital Transfers
• Capital transfers are defined as transfers in cash and in kind for the purpose of investment to recipients, made out of the wealth or saving of the donor.
• It is non recurring or irregular in nature.
For example, investment grant, capital gains tax, war damages, etc.
3. Stock
(a) Any economic variable which is calculated at a particular point of time is known as stock.
(b) It is static in nature, i.e., it do not change.
(c) There is no time dimension in stock variables.
For example, Distance, Amount of Money, Money Supply, Water in Tank, etc.
4. Flow
(a) Any economic variable which is calculated during a period of time is known as flow.
(b) It is dynamic in nature, i.e., it can be changed.
(c) There is time dimension in flow variables.
For example, Speed, Spending of Money, Water in River, Exports, Imports, etc.
5. Economic territory or Domestic Territory:
(a) According to the United Nations, economic territory is the geographical territory administered by a government within which persons, goods and capital circulate freely.
(b) The above definition is based on the criterion “freedom of circulation of persons, goods and capital”. Clearly, those parts of the political frontiers (or boundaries) of a country where the government of that country does not enjoy the above “freedom” are not to be included in economic territory of that country.
(i) One example is embassies. Government of India does not enjoy the above freedom in the foreign embassies located within India. So, these are not treated as a part of economic territory of India. They are treated as part of the economic territories of their respective countries. For example the U.S. embassy in India is a part of economic territory of the U.S.A. Similarly, the Indian embassy in Washington is a part of economic territory of India.
(ii) International organizations like UNO, WHO, etc. located within the geographical boundaries of a country.
(iii) In layman terms, the domestic territory of a nation is understood to be the territory lying within the political frontiers (or boundaries) of a country. But in national income accounting, the term domestic territory is used in a wider sense. Based on ‘freedom’ criterion, the scope of economic territory is defined to cover:
• Ships and aircrafts owned and operated by normal residents between two or more countries. For example, Indian Ships moving between china and India
i regularly are part of domestic territory of India. Similarly, planes operated by Air India between Russia and Japan are part of the domestic territory of India. Similarly, planes operated by Malaysian Airlines between India and Japan are a part of the domestic territory of Malaysia.
• Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents of a country in the international waters where they have exclusive
rights of operation. For example, Fishing boats operated by Indian fishermen in international waters of Indian Ocean will be considered a part of domestic territory of India.
• Embassies, consulates and military establishments of a country located abroad. For example, Indian Embassy in Russia is a part of the domestic territory of India. ‘Consulate’ is an office or building used by consul (an officer commissioned by the government to reside in a foreign country to promote the interest of the countiy to which he belongs).
6. Citizenship/Nationalship
(a) Citizenship is basically a legal concept based on the place of birth of the person or some legal provisions allowing a person to become a citizen.
(b) It means, Indian citizenship can arise in two ways:
(i) When a person is born in India, he acquires automatic citizenship of India.
(ii) A person born outside India applies for citizenship and Indian Law allows him to become Indian Citizen.
7. Normal Resident/Resident
(a) A Normal residenf, whether a person or an institution, is one whose centre of economic interest lies in the economic territory of the country in which he lives.
(b) The centre of economic interest implies in two things:
(i) The resident lives or is located within the economic territory for more than one year and
(ii) The resident carries out the basic economic activities of earnings, spending and accumulation from that location
(c) There is a difference between the terms normal resident (resident) and citizen (or national).
(i) A person becomes a national of a countiy because he was born in the country or on the basis of some other legal criterion.
(ii) A person is treated resident of a country on the basis of economic criterion.
(iii) It is not necessary that a resident must also be the national of that country. Even foreigners can be the residents if they pass the above stated economic criterion.
For example, a large number of Indian nationals have settled in U.S.A., England,
Australia, etc. as residents (and not as nationals) of these countries. For India, they
are Non-resident Indians (NRI) but continue to remain Indian nationals.
Following are not included under the category of Normal residents:
(i) Foreign visitors in the country for such purposes as recreation, holidays, medical treatment, study tours, conferences, sports events, business etc. (they are supposed to stay in the host country for less than one year. In case they continue to stay for one year or more in the host country, they will be treated as normal residents of the host countiy).
(ii) Crew members of foreign vessels, commercial travelers and seasonal workers in , the country (Foreign workers who work part of the year in the country in response to the varying seasonal demand for labour and return to their households and border workers who regularly cross the frontier each day or somewhat less regularly, (i.e. each week) to work in the neighbouring country are the normal residents of their own countries. Example: Nepal.
(iii) Officials, diplomats and members of the armed forces of a foreign country.
(iv) International bodies like World Bank, World Health Organisation or International Monetary Fund are not considered residents of the country in which these organisations operate but are treated as residents of international territory. However, the staffs of these bodies are treated as normal residents of the country in which the international body operates. For example, international body like World Health Organisation located in India is not normal resident of India but Americans working in its office for more than a year will be treated as normal residents of India.
(v) Foreigners who are the employees of non-resident enterprises and who have come to the country for purposes of installing machinery or equipment purchased from their employers. (They are supposed to stay for less than one year. In case they continue to stay for one year or more, they will be treated as normal residents of the host country).
8. Final Goods
(a) These are the goods that are used for:
(i) Personal Consumption (like bread purchased by consumer household), or (if) Investment Or Capital Formation (like building, machinery purchased by a firm)
(b) In other words, final goods are those, which require no further processing and are available in an economy for consumption purpose or investment. These give direct satisfaction to a consumer.
(c) According to production boundary, if a good crosses the imaginary line around the production unit and reaches to final consumer or investment made by a producer within the imaginary line of production unit is known as the final good.
9. Intermediate Goods
(a) These are the goods that are used for:
(i) Further processing (like sugar used for making sweets); or
(ii) Resale in the same year (If car purchased by car dealer for resale).
(b) In other words, intermediate goods are the ones, which require further processing and are not available in an economy for the purpose of consumption. These goods give indirect satisfaction to a consumer.
(c) According to the production boundary, if a good does not cross the imaginary line around the production unit and reaches to other firm within the production boundary, is known as intermediate good.
10. Point to Remember for Final Goods and Intermediate Goods
(a) Basis of Classification: If a good is used for:
(i) Personal consumption; or (ii) Investment
Then it is a final good, whereas, if a good is used for:
(i) Further processing; or
(ii) Resale in the same year, then it is known as intermediate good.
Thus, the basis of classification between these two goods is not the commodity itself, but the use made of it.
For example, bread used by a consumer household is a final goods, but the same used by a bakery for making a sandwich is a intermediate goods.
(b) Production Boundary
(i) Production boundary plays a vital role to differentiate between intermediate and final goods. The production boundary is the imaginary line around the production unit.
(ii) According to the production boundary, if a good crosses the imaginary line around the production unit and reaches to final consumer or investment made by a producer within the imaginary line of production unit, it is known as final good.
As against it, if a good does not cross the imaginary line around the production unit and reaches to other firm within the production boundary, it is known as intermediate good.

In the given diagram, there are 3 production units. The thick border drawn around these three units is the Production Boundary.
Within this limit, wheat and flour are intermediate goods.
Bread is final good as it lies outside the purview of production boundary.
11. Important Points about
Intermediate Goods: As far as intermediate consumption of general government is concerned, it’s purchased goods ranges from ordinary writing paper, pencils and pens to sophisticated fighter aircrafts. The goods and services purchased include both durable goods and non-durable goods and services. The intermediate consumption of the general government includes the following items:
(a) Value of all Non-durable Goods and Services such as petrol, electricity, lubricants, stationery, soaps, towels etc. including repair and maintenance of capital stock: Non-durable goods and services are those which have an expected life time of use of less than one year. Repair and maintenance of capital stock mean expenditure incurred for maintaining fixed assets and keep them in good working order. This includes the expenditure on new parts of the fixed assets. The life of the new parts may be around one year or slightly more and the value should be relatively small. For example, replacement of the tyres of a truck is an intermediate consumption, but not the replacement of its engine.
(b) Expenditure on Military Equipment missiles, rockets, bombs, warships, submarines, military aircrafts, tanks, missile carriers and rocket-launchers etc. whose function is to release weapons. Military vehicles and light weapons.
(c) Value of goods received from foreign governments in form of gifts or as transfers. Examples of these transfers in kind are food, clothing, medicines, vegetable oils, butter, toys sent by the government of one country to the other in times of natural calamities or as a token of goodwill and friendship between two countries.
However, the goods received for distribution to consumer households without renovation or alternation should not be included in intermediate consumption as these goods go into the final consumption of consumer households.
(d) As we know, intermediate goods are purchased by one production unit from another production unit within the production boundary.
However, it’s not necessary that all purchases by one production unit from other production units are intermediate purchases. For example, purchases of building, machinery, etc. are not intermediate purchases (if they are not meant for resale in the same year). Rather, these purchases are meant for investment and are termed as final product.
(e) Research and development
• Commodities consumed. In research and exploratory activities (like oil exploration in different parts of India by the Oil and Natural Gas Commission) or improving the technology of a particular production process.
• Commodities used in basic scientific research.
• Advertisements, market research and public relationship meant for improving the goodwill of the business enterprises.
• Business expenses of the employees on tours and entertainment.
12. Final goods can be classified into two groups: Consumption Goods and Capital Goods.
(a) Consumption Goods:
(i) Meaning: Consumption goods are those which satisfy the wants of the consumers directly. For example, cars, television sets, bread, furniture, air-conditioners, etc.
(u) Categories of Consumption Goods:
• Durable goods: These goods have an expected life time of several years and of relatively high value. They are motor cars, refrigerators, television sets, washing machines, air-conditioners, kitchen equipments, computers, communication equipments etc.
• Semi-durable goods: These goods have an expected life time of use of one year or slightly more. They are not of relatively great value. Examples are clothing, furniture, electrical appliances like fans, electric irons, hot plates and crockery.
• Non-durable goods: Goods which can not be used again and again, i.e., they lose their identity in a single act of consumption are known as non-durable goods. These are foodgrains, milk and milk products, edible oils, beverages, vegetables, tobacco and other food articles.
• Services: Services are non-material goods which satisfy the human wants directly. They cannot be seen or touched, i.e., they are intangible in nature. These are medical care, transport and communications, education, domestic services rendered by hired servants, etc.
(b) Capital Goods:
(i) Capital goods are defined as all goods produced for use in future productive processes.
For example, all the durable goods like cars, trucks, refrigerators, buildings, aircrafts,
air-fields and submarines used to produce goods and are ready for sale in the market
are a part of capital goods.
(ii) Stocks of raw materials, semi-finished and finished goods lying with the producers at the end of an accounting year are also a part of capital goods.
(iii) Some more examples of capital goods are machinery, equipment, roads and bridges.
(iv) These goods require repair or replacement over time as their value depreciate over a period of time.
13. Differentiate between final goods and intermediate goods on the basis of end used classification of goods and services with example.

Words that Matter

1. Circular flow of income: It refers to flow of money income or the flow of goods and services across different sectors of the economy in a circular form.
2. Money flow (nominal flow): Money flow refers to the flow of factor income, as rent, interest, profit and wages from the producing sector to the household sector as monetary rewards for their factor services.
3. Real flow or physical flow: Real flow of income implies the flow of factor services from the household sector to the producing sector and corresponding flow of goods and services from the producing sector to the household sector.
4. Factor income: Income earned by factor of production by rendering their productive services in the production process is known as Factor Income.
5. Transfer income: Income received without rendering any productive services is known as Transfer Income.
6. Current transfers: Transfers made from the current income of the payer and added to the current income of the recipient (who receive) for consumption expenditure are called current transfers.
7. Capital transfers: Capital transfers are defined as transfers in cash and in kind for the purpose of investment to recipient made out of the wealth or saving of a donor.
8. Final goods: These are those which are used for:
(a) Personal consumption (like bread purchased by consumer household), or
(b) Investment or capital formation (like building, machinery purchased by a firm)
9. Intermediate goods: These are those, which are used for:
(a) Further processing (like sugar used for making sweets), or
(b) Resale in the same year (If car purchased by a car dealer for resale).
10. Consumption goods: Consumption goods are those goods which satisfy the wants of consumers directly.
11. Capital goods: Capital goods are defined as all goods produced for use in future
productive processes.

Chapter 12 Consumer Protection class 12 Notes Business Studies

• As a result of this, consumers may be exposed to risks due to unsafe products- that is, he may be cheated, may have to pay a higher price etc.
• Thus; there is a need to provide adequate protection to consumers again
Importance of Consumer Protection
(from Consumer’s point of view)
1. Consumers Ignorance: Majority of consumers are not aware of their rights and reliefs available to them as a result of which they are exploited. In order to save consumers from exploitation, consumer protection is needed.
2. Unorganized Consumers: In India consumers are still unorganized and there is lack of consumer organizations also, thus consumer protection is required.
3. Widespread Exploitation of Consumers: Consumers are exploited on large scale by means of various unfair trade practices and consumer protection is required to protect them from exploitation.
From the point of
1. Long term Business Interest: It is always in the interest of the business to keep its customer satisfied. Global competition could be won only after satisfying customers. Satisfied customers lead to repeat sales and help in increasing customer base of business.
2. Moral Justification: It is the moral duty of any business to take care of consumer interest & avoid any form of their exploitation & unfair trade practices like defective & unsafe products, adulteration, false and misleading advertising, hoardings, black marketing etc.
3. Business uses Resources of Society: Every business uses the resources of the society and thus it is their responsibility to work in the interest of the society.
4. Social Responsibility: A business has social responsibilities towards various groups like owners, workers, government, customers etc. Thus, customers should be provided qualitative goods at reasonable prices.
5. Government Intervention: If a business engages in any form of unfair trade practices then government takes action against it, which adversely affects its goodwill.
CONSUMER PROTECTION ACT, 1986 (CPA, 1986)
1. Set up to protect and promote consumer interests thro a speedy and inexpensive redressal of grievances.
2. Recognizes consumer rights
Redressal agencies– set up a three-tier agency to address consumer grievances.
Scope of the act-
It is applicable to all types of undertaking:
• Large and small scale
• Private, public and co-operative sector
• Manufacturer or trader
• Firms supplying goods as well as services
Meaning of Consumer
1. Any person who buys any goods for a consideration. It includes any user of such goods with the approval of the buyer. But it does not include a person who obtains goods for resale or any commercial purpose.
2. Any person who avails any services for a consideration. It includes any beneficiary of such services but it does not include a person who avails such service for any commercial purpose.
Rights of a Consumer
Consumer Protection Act, 1986 has provided six rights to the consumers, which are as follows:
1. Right to Safety: Consumer has the right to be protected against products, & services which are hazardous to health & life (should use ISI marked electronic device.
2. Right to be Informed: Consumer has right to have complete information about the product before buying it.

3. Right to choose: Consumer has a right to choose any product out of the available products as per his own decision making.

4. Right to be heard: Consumer has the right to file a complaint to be heard in case of dissatisfaction with goods or services (use of grievance cell)
5. Right to Seek Redressal: Consumer has the right to get relief in case the product or service falls short of his expectations or is dangerous. He may be provided with replacement/removal of defect or compensation for any loss. Various redressal forums are set up by the Govt. at National and State level.
6. Right to consumer education: Consumer has the right to acquire knowledge nd to be well informed throughout life. He should be made aware of his rights and reliefs available to him in case of the product or service falls short of his exceptions. The Govt. of India has included consumer education in the school curriculum & is making use of media to make consumers aware of their rights.
Responsibilities/Duties of a Consumer
Consumer Responsibilities:
1. Ask for a cash memo
• On purchase of goods or services. This would serve as a proof of the purchase made.
2. Be aware
• About various goods and services available in the market so that an intelligent and wise choice can be made.
3. Buy only standardized goods
• As they provide quality assurance. Thus, look for ISI mark on electrical goods, FPO mark on food products, Hallmark on jewelry etc.
4. Follow manufacturer‘s instructions
• Learn about the risks associated with products and services, and use the products safely.
5. Read labels carefully
• So as to have information about prices, net weight, manufacturing and expiry dates, etc.
6. Assert yourself
• To ensure that you get a fair deal.
7. Be honest in your dealings.
• Choose only from legal goods and services and discourage unscrupulous practices like blackmarketing, hoarding etc.
8. File a complaint in an appropriate consumer forum
• In case of a shortcoming in the quality of goods purchased or services availed. Do not fail to take an action even when the amount involved is small.
9. Form consumer societies
• Which would play an active part in educating consumers and safeguarding their interests.
10. Respect the environment.
• Avoid waste, littering and contributing to pollution.


THE SALIENT FEATURES AND PROVISIONS OF CONSUMER PROTECTION ACT,1986
Who Can File A Complaint Under CPA, 1986
A complaint before the appropriate consumer forum can be made by:
1. Any consumer.
2. Any registered consumer association.
3. The central or state government.
4. One or more consumers on behalf of numerous consumers having same interest.
5. A legal heir or representative of a deceased consumer.
Complaints can be filed and compensation claimed w.r.t:
• Fraudulent practices by traders and manufacturers
• Defective goods
• Deficiency in services in connection with 9 services such as banking, transportation, insurance, supply of electricity and gas, house construction, medical service
REDRESSAL AGENCIES UNDER CONSUMER PROTECT ACT, 1986
For the redressal of consumer grievances the act provides a three–tier machinery as:

1. DISTRICT FORUM
District forum are set up in each district by the state concerned. The important features are:
(a) It consists of a President and two members, one of whom should be a woman, duly appointed by State Govt.
(b) It can receive consumer complaints of not more than Rs. 20 lakhs value.
(c) On receiving the complaint, the district forum shall refer the complaint to the opposite party concerned and send the sample of goods for testing in a laboratory.
(d) The district forum after being satisfied that goods are defective or there is some unfair trade practice can issue an order to opposite party directing him to either replace or return the price or pay compensation. In case the aggrieved party is not satisfied with the order of district forum. He can appeal before state forum within 30 days of passing an order.
2. STATE COMMISSION
It is set up in each state by the govt. concerned. The salient features are:
(a) Each commission consists of a president and it least 2 members appointed by state Govt.
(b) Complaints of at least Rs. 20 lakhs but not more than 1 crore can be filed with state commission.
(c) On receiving the complaint, the state commission can also refer the complaint to opposite party and send the goods for testing in laboratory.
(d) The state commission after being satisfied can order to opposite party to either replace or repay or pay compensation. In case the aggrieved party is not satisfied, they can appeal before national commission within 30 days of passing an order.
3. NATIONAL COMMISSION
It is setup by Central Govt. The provisions of act are:
(a) It consists of a President and at least 4 members appointed by Central Govt.
(b) All complaints are pertaining to goods and services of value more than Rs. 1 crore can be filed with national commission.
(c) On receiving the complaint, the national commission can also refer it to opposite party and send goods for testing.
(d) The National Commission has the power to issue orders for replace mentor removal and to pay the compensation for loss.
REMEDIES AVAILABLE TO CONSUMERS
• Remove defect in goods and deficiency in services.
• Replace defective goods with one with no defects
• Refund price paid
• Pay a reasonable amount of compensation for any loss or injury suffered.
• Pay punitive damages in appropriate circumstances.
• Discontinue unfair/restrictive trade practice
• Not to offer hazardous goods and services for sale
• Withdraw hazardous goods from sale
• Cease manufacturing hazardous goods
• Pay an amount to consumer welfare fund/ person (not less than 5%) to be utilized in the prescribed manner
• Issue corrective advertisement to neutralize the effect of misleading ads.
• Pay adequate costs to parties.
CONSUMER AWARENESS
Some important consumer organization and NGO’s engaged in protecting consumer interests are:
1. Consumer coordination council, Delhi.
2. Voluntary organization in Interest of Consumer Education, Delhi.
3. Mumbai Grahak Panchayat, Mumbai.
4. Consumer Association, Kolkata.
5. Consumer Unity and Trust Society Jaipur.
Role of Consumer organizations and NGO’s
1. Educating the general public about consumer rights by organizing training programmes, seminars and workshops.
2. Publishing periodical & other publications to educate consumers.
3. Providing legal assistance to consumers by providing legal advice etc.
4. Producing films or cassettes on food adulteration, misuse of drugs etc.
5. Filing complaints in appropriate consumer courts on behalf of consumers.
6. Encouraging consumers to take on action against unfair trade practices.
7. Taking an initiative in filing cases in consumer courts on behalf of consumers.
Ways and Means of Consumer Protection
1. Self Regulation by Business:
• It is in the long-term interest of businesses to serve the customers well.
• Socially responsible firms follow ethical standards and practices in dealing with their customers.
• Many firms have set up their customer service and grievance cells to redress the problems and grievances of their consumers.
2. Business Associations:
• Examples of associations of trade, commerce and business – Federation of Indian Chambers of Commerce of India (FICCI) and Confederation of Indian Industries (CII)
• They have laid down their code of conduct which lay down for their members the guidelines in their dealings with the customers.
3. Consumer Awareness:
• A consumer, who is well informed about his rights and the reliefs available to him, would be in a position to raise his voice against any unfair trade practices or unscrupulous exploitation. • This enables them to understand their responsibilities and to safeguard their interests.
4. Consumer Organizations’:
• Force business firms to avoid malpractices and exploitation of consumers.
5. Government:
• The most important of these regulations is the Consumer Protection Act, 1986. The Act provides for three-tier machinery at the district, state and national levels for redressal of consumer grievances.

 Chapter 11 Marketing class 12 Notes Business Studies

MEANING OF SOME IMPORTANT TERMS:
• Needs = basic human requirements. Essential items necessary or fundamental to human existence.
• Wants= desire for a particular product. Tend to be “satisfier specific”.
• Demand- willingness to buy is backed by purchasing power
• Utility – want satisfying power of a product.
• What can be marketed:
• A product =
• bundle of utility not confined to physical products but can refer to other things of value such as services, ideas, place. It refers to anything that satisfies a need or want.
• may be tangible or intangible(i.e. goods and services)
• even people can be marketed
• Customers= people or organizations that seek satisfaction of their wants.
• “Marketers‟ =
• Anyone taking a more active role in the process of exchange is called a marketer. Normally it is the seller. But in certain situations, it may also be the buyer. This may be in the situation of rare supply.
• Sellers as marketer are the deliverers or providers of satisfaction. They makes available products or services and offers them to customers with an intention of satisfying customer needs and wants. They can be divided into:
• Goods marketers (such as Hindustan Lever)
• Services marketers (such as Indian Airlines)
• Others marketing experiences (such as Walt Disney) or places (like tourist destinations).
• Marketing activities =activities carried on by the marketers to facilitate exchange of goods and services between the producers and the users of such products.
• Market is:
• Place where buyers and sellers meet and conduct buying and selling activities. It does not necessarily mean a geographical place(e.g. conduct of business thro telephone, mail or internet)
• The other ways in which this term is being used is in the context of a product market (cotton market, gold or share market), geographic market (national and international market), type of buyers (consumer market and industrial market) and the quantity of goods transacted (retail market and wholesale market).
• In the modern marketing sense, it refers to a set of actual or potential buyers of a product or service i.e. all customers who share a particular need or want and are able to buy the product (also referred to as target markets)
Important Features of Marketing
1. Needs and wants: Satisfaction of the needs and wants of individuals and organizations.
2. Creating a market offering: Complete offer for a product of service.
3. Customer value: greatest benefit or value for the money.
4. Exchange mechanism: Exchange of products/services for money/for something of value to them.
Meaning and concept of Marketing Management
Marketing management means management of the marketing functions. It is the process of organizing, directing and controlling the activities related to marketing of goods and services to satisfy customers’ needs & achieve organizational goals.
The process of Marketing involves:
i. Choosing a target market
ii. Getting, keeping as well as growing the customer
• that is, ensure that the target customers purchase the firm‘s product, ensure that they keep their customers satisfied with the products and attract new customers so that the firm can grow.
iii. Create, develop and communicate superior values to the customers.
Functions of Marketing/Marketing activities
Gathering And Analyzing Market Information:
• systematic investigation of facts
• SWOT analysis
• Necessary to identify needs
• Decisions can be wrt. Identifying customer needs and wants, identifying buying motives, choice of a brand name, packaging and media used for promotion.
• Data is available both from primary as well as secondary sources.
Marketing planning :
• Aim = to develop a complete marketing plan so that the marketing objectives can be achieved.
• It also must specify the action programs .
• E.g if a marketer aims at enhancing his market share in the country in the next three years, then his marketing plan should include various important aspects like plan for increasing level of production, promotion of products etc.
Product designing and development:
• Involves decisions regarding the product to be manufactured and it‘s attributes such as its quality considerations, packaging, models and variations to be introduced etc..
• Done by anticipating customer needs and developing new products or improving existing products to satisfy these needs.
Standardization and grading:
• Standardization = Process of setting certain standards for a product on the basis of its desired qualities. E.g. ISI mark for electrical goods.
• Grading = Division of products into classes made up of units possessing similar features such as for agricultural products
Packaging and labeling:
• Packaging‘ refers to designing a package (that is a wrapper or a container) for a product.
• Packaging protects the products from damage , risks of spoilage, breakage and leakage. It also makes buying convenient for customers and serves as a promotional tool.
• Labeling = designing a label to be put on the package. It may vary from a simple tag to complex graphics.
Branding
• Whether to sell the product in its generic name or in a Brand name.
• Helps in differentiation, builds customer loyalty and promote its sale.
• Decision = whether each product will have a separate brand name or the same brand name to be used for all products.
Concepts & Philosophies of Marketing
1. PRODUCTION CONCEPT = In the earlier days of the industrial revolution, the number of producers were limited, → limited supply of industrial products → not able to match demand . So, anyone who was able to produce goods could easily find buyers for the same.
2. PRODUCT CONCEPT= With passage of time, the supply improved→ customers started looking for products that were superior in performance, quality and features.
3. SELLING CONCEPT= increase in scale of production→ competition among the sellers → Product quality and availability alone did not ensure survival as a large number of firms were now selling products of similar quality.
4. MARKETING CONCEPT : Implies that a firm can achieve its goals by identifying needs of the customer and satisfying them better than the competitors. Customer satisfaction is the precondition for realizing the firm’s goal and objectives,
5. SOCIAL MARKETING CONCEPT : Under this concept customer satisfaction is supplemented by social welfare. Some products bring harmful effect on environment so these should not be supplied. It pays attention to the social, ethical and ecological aspects of marketing. Raman, Joginder, John, Iqbal and Shreya are friends. They are operating different business. Each one has his/her own concept regarding operating their business. Raman believes in producing products at a large scale. Thereby decreasing the average cost of the products and selling it’s at a reasonable price.
Meaning and Concept of Marketing and Selling
Marketing is a wide term. It refers to a large set of activities of which selling is just one part. A marketer before making the sale does a lot of other activities such as planning the type, design of the product, the price and selecting the distribution outlets at which the same would be available.
Selling: refers to the sale of goods or service through publicity, promotion and salesmanship. The title of the product is transferred from seller to buyer. The entire focus in selling is to covert the product into cash.
Difference between Selling & Marketing

Basis	Selling	Marketing
Scope	It is only a part of process of marketing.	It is a wide term consisting of a number of activities such aside notification, customers needs etc.
Focus	Transfer of the title from seller to consumer.	Achieving maximum satisfaction of customers needs and wants.
Pre-dominance	Product is given quantity.	Customer is treated as the king.
Aim	Profits through sales volume.	Profits through customer satisfaction.
Emphasis	Bending the customer according to the product.	To develop the products as per the customer needs.

Marketing Mix
There are a large number of factors that affect marketing decisions. They can be classified as:
• Non-controllable factors and Controllable factors:
To be successful, a firm needs to take sound decisions wrt controllable factors while keeping the environmental factors in mind.
To develop marketing tools, marketing managers use the above mentioned controllable factors and the set of marketing tools that a firm uses to pursue its marketing objectives in the target market is described as Marketing Mix. Success of a market offer will depend upon how well these ingredients are mixed to create superior value for customers and simultaneously achieve their sales and profit objective. Thus, an ideal marketing mix would need:
• Producing satisfying products • Offered to buyers at a reasonable price
• Conveniently available • About which communication is offered
Marketing mix refers to ingredients or the tools or the variables which the marketeer mixes in order to interact with a particular market.
11.8.1 Elements of Marketing Mix
The four main elements of marketing mix as classified by MCcarthy are:
A. Product
B. Price
C. Place/Physical Distribution
D. Promotion
These elements are more popularly known 4 P’s of the marketing.

Elements/4 Ps of Marketing Mix
1. Product Mix: All the features of the product or service to be offered for sale.

2. Price Mix: Value (Money) in lieu of product/service received by seller from a buyer.

3. Promotion Mix: Informing the customers about the products and persuading them to buy the same.

4. Place Mix: Physical distribution: Various decisions regarding distribution of products.
• Channels of distribution: Whether wholesalers, retailers are to be used or not.
• Physical movement of the products from producer to consumers.
• Storage, transportation, managing inventory (stock) etc.
i) Branding:
The process used to create a distinct identity of a product. It is the process of using a name, term, symbol or design individually or in some combination to identify a product.
Brand : Name, term, sign, design or some combination of the above used to identify the products of the seller and to differentiate them from those of competitors.
Qualities of a Good Brand Name
1. Short, easy to pronounce, spell and remember(Rin, Vim, Ponds)
2. Suggest product benefits and quality (Genteel, Boost)
3. Distinctive (Zodiac, Safari)
4. adaptable to packing or labeling requirements, to different advertising media and to different languages.
5. Versatile to accommodate new products(Maggi)
6. Capable of being registered and protected legally
7. Have staying power(should not get outdated easily.
Advantages of Branding-
Advantages to the marketers:
1. Enables product differentiation:.
• Distinguishes the firms products from that of its competitors, thus secures and controls its markets.
2. Helps in advertising and display programmes:
• Without a brand, the advertiser can only create an awareness about the generic product and not be sure of the sale of his brand.
3. Differential pricing:
• As when customers like and become used to a brand, the

Chapter 10 Financial Markets class 12 Notes Business Studies

Introduction
Financial Intermediation = process of allocating funds from saving surplus units (E.g. households) to saving deficit units (e.g. industries, government etc).
• Alternatives = Banks or Financial markets
Financial Markets are the institutional arrangements by which savings generated in the economy are channelised into avenues of investment by industry, business and the government. It is a market for the creation and exchange of financial assets.

Functions of Financial Market
1.Mobilization of savings and channelising them into the most productive uses:
• Facilitates transfer of savings from the savers to the investors.
• Financial markets help people to invest their savings in various financial instruments and earn income and capital appreciation.
• Facilitate mobilization of savings of people and their channelisation into the most productive uses.
2. Facilitate Price Discovery:
• Price of anything depends upon the demand and supply factors.
• Demand and supply of financial assets and securities in financial markets help in deciding the prices of various financial securities; where business firms represent the demand and the households represent the supply.
3. Provide liquidity to financial assets:
• Financial markets provide liquidity to financial instruments by providing a ready market for the sale and purchase of financial assets.
• Whenever the investors want, they can invest their savings into long term investments and whenever they want, they can sell the investments/ instruments and convert them into cash.
4. Reduce the cost of transactions:
• By providing valuable information to buyers and sellers of financial assets, it helps to saves time, effort and money that would have been spent by them to find each other.
• Also investors can buy/sell securities through brokers who charge a nominal commission for their services. This way financial markets facilitate transactions at a very low cost.
Types of Financial Markets

Money Market
Market for financial securities with maturity period of less than one year.
• Mkt for low risk, unsecured and short term debt instruments that are highly liquid are traded everyday.
• No plysical location bye conducted over the telephone and the internet.
• Helps to:
o raise short term funds
o Temporary deployment of funds .
The main instruments of money market are as follows:
l. Treasure Bills: They are issued by the RBI on behalf of the Central Government to meet its short-term requirement of funds. They are issued at a price which is lower than their face value and arc repaid at par. They are available for a minimum amount of Rs.25000 and in multiples thereof. They are also known as Zero Coupon Bonds. They are negotiable instruments i.e. they are freely transferable.
2. Commercial Paper: It is a short term unsecured promissory note issued by large credit worthy companies to raise short term funds at lower rates of interest than market rates. They are negotiable instruments transferable by endorsement and delivery with a fixed maturity period of 15 days to one year.
3. Call Money: It is short term finance repayable on demand, with a maturity period of one day to 15 days, used for interbank transactions. Call Money is a method by which banks borrow from each other to be able to maintain the cash reserve ratio as per RBI. The interest rate paid on call money loans is known as the call rate.
4. Certificate of Deposit: It is an unsecured instrument issued in bearer form by Commercial Banks & Financial Institutions. They can be issued to individuals. Corporations and companies for raising money for a short period ranging from 91 days to one year.
5. Commercial Bill: It is a bill of exchange used to finance the working capital requirements of business firms. A seller of the goods draws the bill on the buyer when goods are sold on credit. When the bill is accepted by the buyer it becomes marketable instrument and is called a trade bill. These bills can be discounted with a bank if the seller needs funds before the bill maturity.
Capital Market
Facilities and institutional arrangements through which long term securities are raised and invested- both debt and equity.
• Nature of Capital Markets:
a. Important component of Financial markets b. Two segments(primary and secondary) c. 2 forms(organized and unorganized) d. long term securities e. Satisfies long term requirements of funds f. Performs trade-off functions g. Creates dispersion in business ownership h. Helps in capital formation i. Creates liquidity
• Features Of Capital Market Instruments:
a. Provide long term funds
b. Lesser outlay required as unit value of instruments is low
c. Duration more than 1 year
d. Liquidity
e. Lower safety
f. Higher expected returns as compared to short term securities
The capital market can be divided into two parts:
1. Primary Market
2. Secondary Market
Primary Market
• New issues markets
• Transfers investible funds from savers to entrepreneurs.
• Funds used for setting up new projects, expansion, diversification, modernization of existing projects, mergers and take overs etc.
Methods of Floatation of New Issues in Primary Market
1. Offer through Prospectus: It involves inviting subscription from the public through issue of prospectus. A prospectus makes a direct appeal to investors to raise capital through an advertisement in newspapers and magazines.
2. Offer for Sale: Under this method, securities are offered for sale through intermediaries like issuing houses or stock brokers. The company sells securities to intermediary/broker at an agreed price and the broker resells them to investors at a higher price.
3. Private Placements: It refers to the process in which securities are allotted to institutional investor and some selected individuals.
4. Rights Issue: It refers to the issue in which new shares are offered to the existing shareholders in proportion to the number of shares they already possess.
5. e-IPOs: It is a method of issuing securities through an on-line system of stock exchange. A company proposing to issue capital to the public through the on-line system of the stock exchange has to enter into an agreement with the stock exchange. This is called an e-initial public offer. SEBI’s registered brokers have to be appointed for the purpose of accepting applications and placing orders with the company.
Secondary Market
1.Refers to a market where existing securities are bought and sold.
2.The company is not involved in the transaction at all. It is between two investors. Features of Secondary market are: 1) Creates liquidity 2) Fixed location 3) Comes after primary market 4) Encourages new investment
Difference between Primary Market and Secondary Market

Basis	Primary Market	Secondary Market
Securities	Only new securities are traded	Existing securities are traded
Price of Securities	Prices of securities are determined by the management of the company.	Prices are determined by the forces by the demand and supply of the securities.
Purchase and Sale	Securities are sold to investors directly by the company or through intermediary.	Investors exchange ownership of securities.
Place of Market	There is no fixed geographical location.	Located at specified places.
Medium	Only buying of securities takes place.	Both buying and selling of securities can take place.

Stock Exchange/Share Market
A Stock Exchange is an institution which provides a platform for buying and selling of existing securities. It facilitates the exchange of a security i.e. share, debenture etc. into money and vice versa. Following are some of the important functions of a Stock Exchange:
a. Gives liquidity and marketability to existing securities
b. Pricing of securities(dd and ss)
c. Safety of transactions(membership = regulated + dealings well defined)
d. Contributes to economic growth (ensures that savings are channelized to most productive investment avenues)
e. Spreading of equity cult(ensures wider share ownership)
f. Provides scope for speculation (in a restricted and controlled environment)
Trading Procedure on a Stock Exchange
1. Selection of Broker: in order to trade on a Stock Exchange first a broker is selected who should be a member of stock exchange as they can only trade on the stock exchange.
2. Placing the order: After selecting a broker, the investors specify the type and number of securities they want to buy or sell.
3. Executing the order: The broker will buy or sell the securities as per the instructions of the investor.
4. Settlement: Transactions on a stock exchange may be carried out on either cash basis or carry over basis (i.e. badla). The time period for which the transactions are carried forward is referred to as accounts which vary from a fortnight to a month. All transactions made during one account are to be settled by payment for purchases and by delivery of share certificates, which is a proof of ownership of securities by an individual. Earlier trading on a stock exchange took place through a public outcry or auction system which is now replaced by an online screen based electronic trading system. Moreover, to eliminate, the problems of theft, forgery, transfer, delays etc. an electronic book entry from a holding and transferring securities has been introduced, which is called process of de materialisation of securities.
Difference between Capital and Money Market

Basis	Capital Market	Money Market
Participants	Financial Institutions, Banks, Corporate Entities, foreign investors and individuals.	RBI, Banks Institutions and finance companies.
Instruments traded	Equity shares, bonds preferences and debentures, call money etc.	Treasury Bills, Trade Bills commercial paper
Investment Outlay	Does not necessarily require a huge financial outlay.	Entails huge sum of money as the instruments are quite expensive.
Duration	Deals in medium and long term securities having a maturity period of one year.	Deals in short term funds having a maturity period upto one year.
Liquidity	Securities are less liquid as money market securities.	Money markets instruments are highly liquid
Expected	High return	Low return
Safety	Capital Market Instruments are riskier both with respect to return and repayment.	Money market instruments are generally much safer with a minimum risk of default.

Depository Services and DEMAT Accounts: Keeping in the mind the difficulties to transfer of shares in physical form, SEBI has developed a new system in which trading in shares is made compulsory in electronic form Depository services system and D-Mat Account are very basis of this system.
Depository Services: Just like a bank keeps money in safe custody for customers, a depository also is like a bank and keeps securities(e.g. shares, debentures, bonds, mutual funds etc.) in electronic form on behalf of the investor. In the depository a securities account can be opened, all shares can be deposited, they can be withdrawn/ sold at any time and instruction to deliver or receive shares on behalf of the investor can be given. At present there are two depositories in India: NSDL. (National Securities Depository Ltd.) and CDSL (Central Depository Services Ltd.). which are known as “Depository Participants”. (DPs)
Services provided by Depository
Dematerialisation (usually known as demat) is converting physical certificates to electronic form. Rematerialisation, known as remat, is reverse of demat, i.e getting physical certificates from the electronic securities.
Transfer of securities, change of beneficial ownership.
_ Settlement of trades done on exchange connected to the Depository. Now a days on-line paper-less trading in shares of the company is compulsory in India. Depository services is the name of that mechanism. In this system transfer of ownership in shares take place by means of book entry without the physical delivery of shares. When an investor wants to deal in shares of any company he has to open a Demat account. There
are four players who participate in this system.
1. The Depository: A depository is an institution which holds the shares of an investor in electronic form. There are two depository institutions in India these are NSDL and CDSL.
2. The Depository Participant: He opens the account of Investor and maintains securities records.
3. The Investor: He is a person who wants to deal in shares whose name is recorded
4. The Issuing Company: That organization which issues the securities. This issuing company sends a list of the shareholders to the depositories.
Benefits of Depository Services
• Sale and Purchase of shares and stocks of any company on any stock Exchange.
• Saves time.
• Lower transaction costs
• Ease in trading.
• Transparency in transactions.
• No counterfeiting of security certificate
• Physical presence of investor is not required in stock exchange.
• Risk of mutilation and loss of security certificate is eliminated.
Demat Account
Demat (Dematerialized) account refers to an account which an Indian citizen must open with the depository participant (banks, stockbrokers) to trade in listed securities in electronic form. The securities are held in the electronic form by a depository.
Benefits of Demat Account
1. Reduces paper work.
2. Elimination of problems on transfer of shares such as loss, theft and delay.
3. Exemption of stamp duty when transfer of shares.
4. The concept of odd lot stand abolished.
5. Increase liquidity through speedy settlement.
6. Attract foreign investors and promoting foreign investment.
7. A single demat account can hold investments in both equity and debt instruments.
8. Traders can work from anywhere.
9. Automatic credit into demat account for shares arising out of bonus/split/consolidation % merger.
10. Immediate transfers of securities.
11. Change in address recorded with a DP gets registered with all companies in which investor holds securities eliminating the need to correspond with each of them.
Opening of Demat Account
A Demat account is opened on the same lines as that of a bank account. Prescribed account opening forms available with the DP, need to be filled in. Standard agreement is to be signed by the client and the DP, which details the rights and obligation of both parties. Along with the form, the client is required to attach photograph, attested copies of residence proof and proof of identity need to be submitted.
Securities and Exchange Board of India (SEBI)
SEBI was established by Government of India on 12 April 1988 as an interim administrative body to promote orderly and healthy growth of securities market and for investor protection. It was given a statutory status on 30 January1992 through an ordinance which was later replaced by an Act of Parliament known as the SEBI Act, 1992. It seeks to protect the interest of investors in new and second hand securities.
Objectives of SEBI
1. To regulate stock exchange and the securities market to promote their orderly functioning.
2. To protect the rights and interests of investors and to guide & educate them.
3. To prevent trade mal practices such as internal trading.
4. To regulate and develop a code of conduct and fair practices by intermediaries like brokers, merchant bankers etc.
Functions of SEBI
1. Protective Functions :a) Prohibit fraudulent & unfair trade practices in secondary market (e.g. Price rigging & misleading statement) .b) Prohibit insider trading. c) Educate investors Promote fair practice & code of conduct in securities market
2.Development Functions : a) Promotes training of intermediaries of the securities market . b) Investor education c) Promotion of fair practices code of conduct of all SRO‘s. d) Conducting research & publish information useful to all market participants
3. Regulation Functions :
a) Registration of brokers and sub brokers & other players in the mkt.
b) Registration of collective investment schemes & mutual funds.
c) Regulation of stock bankers & portfolio exchanges & merchant bankers.

Business Studies Class 12 Revision Notes Chapter 9 Financial Management

Points to Remember

1. Business Finance Money required for carrying out business activities is called Business Finance.

2. Financial Management It refers to efficient acquisition of finance, efficient utilisation of finance and efficient distributing and disposal of surplus for smooth working of company.
According to Howard and Upton, “Financial management involves the application of general management principles to a particular financial operation.

3. Role of Financial Management
(i) Size and composition of fixed assets
(ii) Amount and composition of current assets
(iii) The amount of long term and short financing
(iv) Fixing debt equity ratio in capital
(v) All items in Profit and Loss account

5. Objectives of Financial Management

6. Financial Decisions
The financial functions relate to three major decisions which every finance manager has to take
(i) Investment decision
(ii) Financing decision
(iii) Dividend decision
7. Investment Decision (Capital Budgeting Decision)
This decision relates to careful selection of assets in which funds will be invested by the firms.
Factors affecting investment/capital budgeting decisions are
(i) Cash flow of the project (ii) Return on investment
(iii) Risk involved (iv) Investment criteria
8. Financing Decision This relates to composition of various securities in the capital structure of the company. Mainly sources of finance can be divided in to two categories
(i) Owners fund
(ii) Borrowed fund
Factors affecting financing decisions are
(i) Cost (ii) Risk
(iii) Cash flow position (iv) Control consideration (v) Floatation cost (vi) Fixed operating cost
(vii) State of capital market
9. Dividend Decision This relates to distribution of profit earned. The major alternatives are to retain the earnings or to distribute to the shareholders.
Factors affecting dividend decisions are
(i) Earning
(ii) Stability of earning
(iii) Cash flow position
(iv) Growth opportunities
(v) Stability of dividend
(vi) Preference of shareholders
(vii) Taxation policy
(viii) Access to capital market consideration
(ix) Legal restrictions
(x) Contractual constraints
(xi) Stock market reaction
10. Financial Planning It means deciding in advance how much to spend, on what to spend according to the funds at your disposal.
11. Objectives of Financial Planning
(i) To ensure availability of funds whenever these are required,
(ii) To see that firm does not raise resources unnecessarily.
12. Importance of Financial Planning
(i) It facilitates collection of optimum funds.
(ii) It helps in fixing the most appropriate capital structure.
(iii) Helps in investing finance in right projects.
(iv) Helps in operational activities.
(v) Base for financial control.
(vi) Helps in proper utilisation of finance.
(vii) Helps in avoiding business shocks and surprises.
(viii) Link between investment and financing decisions.
(ix) Helps in co-ordination.
(x) It links present with future.
13. Capital Structure Capital structure means the proportion of dept and equity used for financing the operations of business.



(iii) Debt Service Coverage Ratio (DSCR)
(iv) Return on investment
(v) Cost of debt
(vi) Tax rate
(vii) Cost of equity (viii) Floatation cost
(ix) Risk consideration
(x) Flexibility
(xi) Control
(xii) Regulatory framework (xiii) Stock market condition (xiv) Capital structure of other companies

16. Fixed Capital Fixed Capital involves allocation of firm’s |
capital to long term assets or projects.
17. Importance or Scope of Capital Budgeting Decision
(i) Long term growth (ii) Large amount of funds involved
(iii) Risk involved (iv) Irreversible decision
18. Factors Affecting Requirement of Fixed Capital
(i) Nature of business (ii) Scale of operation
(iii) Technique of production (iv) Technology upgradation (v) Growth prospects (vi) Diversification
(vii) Availability of finance and leasing facility
(viii) Level of collaboration/joint ventures

19. Working Capital
Working Capital refers to excess of Current assets over Current liabilities.
There are two types of working capital
(i) Gross working capital (ii) Net working capital

20. Operating Cycle

(ix) Operating efficiency
(x) Availability of raw materials
(xi) Level of competition
(xii) Inflation
(xiii) Growth prospects

Chapter 8 Controlling class 12 Notes Business Studies

Meaning & Definition: Controlling involves comparison of actual performance with the planned performance. If there is any difference or deviation, then finding the reasons for such difference and taking corrective measures or action to stop those reasons so that they don‘t re-occur in future and that organizational objectives are fulfilled efficiently.
Importance of Controlling
1. Controlling helps in achieving organizational goals: The controlling function measures progress towards the organizational goals and brings to light/indicates corrective action.
2. For Evaluating/Judging accuracy of standards: A good control system enables management to verify whether the standards set are accurate or not by careful check on the changes taking place in the organizational environment.
3. Making efficient use of resources: By the process of control, a manager seeks to reduce wastage of resources.
4. Improves employees motivation: A good control system ensures that employees know well in advance what they are expected to do & also the standard of performance. It thus motivates & helps them to give better performance.
5. Facilitating Coordination in action: In controlling each department and employee is governed by predetermined standards which are well coordinated with one another. Control provides unity of direction.
6. Ensuring order and discipline: Controlling creates an atmosphere of order and discipline in the organization by keeping a close check on the activities of its employees.
Nature of Controlling/Features of Controlling
1. Goal oriented: Controlling is directed towards accomplishment of organizational goals in the best possible manner.
2. Pervasive: Controlling is an essential function of every manager and exercised at all levels of management.
3. Continuous: It is not an activity to be pursued in the end only; it has to be done on a continous basis.
4. Controlling is looking back: Controlling involves measurement of actual performance and its comparison with the desired performance. It is the process of checking and verification.
5. Controlling is forward looking: It is related to future because it seeks to improve future results on the basis of experience gained in the past.
6. Depends on planning: It pre supposes existence of planning because without planning no control is possible.
7. Action oriented*: Control has no meaning if no corrective action is taken; So timely action should be taken to prevent deviations.
8. Primary Function of Management* – controlling is performed at all levels and in all types of organizations.
9. Brings back management cycle back to planning:* Control should not be viewed as the last function. In fact it links back to planning. Controlling involves
• Comparing actual performance with standards • Finding out deviations • Taking corrective action so that they don‘t repeat in future These are the guidelines when future planning is done. Thus controlling not only completes one cycle of management process and also helps to improve planning in the next cycle.

Relationship between Planning and Controlling
Planning and controlling are interrelated and in fact reinforce each other in the sense that-
1. Planning is pre-requisite for controlling. Plans provide the standard for controlling. Thus, without planning, controlling is blind. If the standards are not set in advance managers have nothing to control.
2. Planning is meaningless without controlling. It is fruitful when control is exercised. It discovers deviations and initiates corrective measures.
3. Effectiveness of planning can be measured with the help of controlling.
4. Planning is looking ahead and controlling is looking back: Planning is a future oriented function as it involves looking in advance and making policies for the maximum utilization of resources in future that is why it is considered as forward looking function. In controlling we look back to the performance which is already achieved by the employees and compare it with plans. If there are deviations in actual and standard performance or output then controlling functions makes sure that in future actual performance matches with the planned performances. Therefore, controlling is also a forward looking function. Thus, planning & controlling cannot be separated. The two are supplementary function which support each other for successful execution of both the function. Planning makes controlling effective whereas controlling improves future planning.
Controlling Process
1. Setting Performance Standards: Standards are the criteria against which actual performance would be measured. Thus standards become basis for comparison and the manager insists on following of standards.
2. Measurement of Actual Performance: Performance should be measured in an objective and reliable manner which includes personal observation, sample checking. Performance should be measured in same terms in which standards have been established, this will facilitate comparison.
3. Comparing Actual Performance with Standard: This step involves comparison of actual performance with the standard. Such comparison will reveal the deviation between actual and desired performance. If the performance matches the standards it may be assumed that everything is under control.
4. Analysing Deviations: The deviations from the standards are assessed and analysed to identify the causes of deviations.
5. Taking Corrective Action: The final step in the controlling process is taking corrective action. No corrective action is required when the deviation are within the acceptable limits. But where significant deviations occur corrective action is taken.
Limitations of Controlling
1. Difficulty in setting quantitative standards:
Control system loses its effectiveness when standards of performance cannot be defined in quantitative terms. This makes comparison with standards a difficult task.
e.g areas like human behaviour, employee morale, job satisfaction cannot be measured quantitatively.
2. Little control on external factors:
An enterprise cannot control external factors like government policies, technological changes, competition. etc.
3. Resistance from employees:
Control is resisted by the employees as they feel that their freedom is restricted. E.g employees may resist and go against the use of cameras to observe them minutely.
4. Costly:
Control involves a lot of expenditure, time and effort. A small enterprise cannot afford to install an expensive control system.
Managers must ensure that the cost of installing and operating a control system should not exceed the benefits derived from it.

 Chapter 7 Directing class 12 Notes Business Studies

Meaning:
Directing means giving instructions, guiding, counseling, motivating and leading the staff in an organization in doing work to achieve Organizational goals. Directing is a key managerial function to be performed by the manager along with planning, organizing, staffing and controlling. From top executive to supervisor performs the function of directing and it takes place accordingly wherever superior – subordinate relations exist.Directing is a continuous process initiated at top level and flows to the bottom through organizational hierarchy.
Direction has got following characteristics:
1. Pervasive Function- Directing is required at all levels of organization. Every manager provides guidance and inspiration to his subordinates.
2. Continuous Activity- Direction is a continuous activity as it continuous throughout the life of organization.
3. Human Factor- Directing function is related to subordinates and therefore it is related to human factor. Since human factor is complex and behaviour is unpredictable, direction function becomes important.
4. Creative Activity- Direction function helps in converting plans into performance. Without this function, people become inactive and physical resources are meaningless.
5. Executive Function- Direction function is carried out by all managers and executives at all levels throughout the working of an enterprise, a subordinate receives instructions from his superior only.
6. Delegate Function- Direction is supposed to be a function dealing with human beings. Human behaviour is unpredictable by nature and conditioning the people’s behaviour towards the goals of the enterprise is what the executive does in this function. Therefore, it is termed as having delicacy in it to tackle human behaviour.
Importance
1. Initiates Action: It helps to initiate action by the people in the organization towards attainment of desired objectives. The employees start working only when they get instructions and directions from their superiors. It is the directing function which starts actual work to convert plans into results.
2. Integrates Employee’s Efforts: All the activities of the organization are interrelated so it is necessary to coordinate all the activities. It integrates the activities of subordinates by supervision, guidance and counselling.
3. Means of motivation: It motivates the subordinates to work efficiently and to contribute their maximum efforts towards the achievement of organizational goals.
4. Facilitates change: Employees often resist changes due to fear of adverse effects on their employment and promotion. Directing facilitates adjustment in the organization to cope with changes in the environment.
5. Stability and balance in the organization: Managers while performing directing function instruct, guide, supervise and inspire their subordinates in a manner that they are able to strike a balance between individual and organizational interests.
Principles of Effective Direction:
Effective direction leads to greater contribution of subordinates to organization goals. The directing function of management can be effective only when certain well accepted principles are followed.
The following are the basic principles of effective direction:
1. Harmony of Objectives:
It is an essential function of management to make the people realize the objectives of the group and direct their efforts towards the achievement of their objectives. The interest of the group must always prevail over individual interest. The principle implies harmony of personal interest and common interest..
2. Unity of Command:
This principle states that one person should receive orders from only one superior, in other words, one person should be accountable to only one boss. If one person is under more than one boss then there can be contradictory orders and the subordinate fails to understand whose order to be followed. In the absence of unity of command, the authority is undermined, discipline weakened, loyalty divided and confusion and delays are caused.
3. Unity of Direction:
To have effective direction, there should be one head and one plan for a group of activities having the same objectives. In other words, each group of activities having the same objectives must have one plan of action and must be under the control of one supervisor.
4. Direct Supervision:
The directing function of management becomes more effective if the superior maintains direct personal contact with his subordinates. Direct supervision infuses a sense of participation among subordinates that encourages them to put in their best to achieve the organizational goals and develop an effective system of feed-back of information.
5. Participative or Democratic Management:
The function of directing becomes more effective if participative or democratic style of management is followed. According to this principle, the superior must act according to the mutual consent and the decisions reached after consulting the subordinates. It provides necessary motivation to the workers by ensuring their participation and acceptance of work methods.
6. Effective Communication:
To have effective direction, it is very essential to have an effective communication system which provides for free flow of ideas, information, suggestions, complaints and grievances.
7. Follow-up:
In order to make direction effective, a manager has to continuously direct, guide, motivate and lead his subordinates. A manager has not only to issue orders and instructions but also to follow-up the performance so as to ensure that work is being performed as desired. He should intelligently oversee his subordinates at work and correct them whenever they go wrong.

(i) Supervision- implies overseeing the work of subordinates by their superiors. It is the act of watching & directing work & workers.
(ii) Motivation- means inspiring, stimulating or encouraging the sub-ordinates with zeal to work. Positive, negative, monetary, non-monetary incentives may be used for this purpose.
(iii) Leadership- may be defined as a process by which manager guides and influences the work of subordinates in desired direction.
(iv) Communications- is the process of passing information, experience, opinion etc from one person to another. It is a bridge of understanding.
1. Supervision, as an element of directing:
 process of guiding the efforts of employees and other resources to accomplish desired objectives.
 Overseeing people at work
 Involves instructing, observing, monitoring and guiding employees.
Carried out at all levels but more important at the lower levels therefore the term ‘Supervisor’is used at the operativeslevel of management
I. Importance of Supervision/Role of a Supervisor/Functions
1. Link between workers and management because the supervisor explains management policies to workers and brings workers problems to the notice of the management.
2. Ensures issuing Instructions: To make sure that the instructions are communicated to each and every employee.
3. Facilities Control: Control means match between actual and planned output. It ensures checking on the methods in use and progress of work according to planned schedule.
4. Maintenance of discipline: The strict supervision and guidance of supervisor encourages the employees and workers to be more disciplined in the activities.
Under the guidance of superior the workers follow a fixed or strict timetable and execute the plans in right directions.
5. Feedback: The supervisors are directly dealing with the subordinates. As a result, feedback in the form of suggestions, grievances keep coming to the management. It improves quality management decisions and revision of plans & policies.
6. Improved Motivation: A supervisor with good leadership qualities can build up high morale among workers. The relationship with the supervisor is a very good incentive to improve the motivation level of the employees while guiding the employees, the supervisors encourage the subordinates to perform to their best capacities.
7. Optimum utilization of resources: All the activities are under the observation of supervisor so less wastage and optimum utilization of resources is possible.
II. Motivation
Meaning:
i. Incitement or inducement to act/move.
ii. Process of stimulating people to action to accomplish desired goals.
• Three key terms = motive, motivation, motivators
 Motive :inner state that energizes, activates and directs behaviour towards goals.
Arises out of unsatisfied needs = causes restlessness.
 Motivation : Process of stimulating people to action + Depend on satisfying needs of people.
 Motivators: Technique used to motivate people.Egs. = pay, bonus, promotion, recognition etc.
Features
1. Psychological Phenomenon: Motivation is an internal feeling which means it cannot be forced on employees. The internal feeling such as need, desire, aspiration etc. influence human behaviour to behave in a particular manner.
2. Goal Directed Behaviour: It induces people to behave in such a manner so that they can achieve their goals. A motivated person works towards the achievement of desired goals.
3. Motivation can be either positive or Negative: Positive motivation means inspiring people to work better and appreciating a work that is well done e.g., pay increase promotion recognition. Negative motivation means forcing people to work by threatening or punishing them. e.g., issue of memo, demotion, stopping increments etc.
4.Complex Process: It is a complex and difficult process. Individuals differ in their needs and wants and moreover human needs change from time to time.
5. Continuous Process: Human needs are unlimited and so they keep on changing continuously, satisfaction of one need gives rise to another. As soon as one need is satisfied another need arises. So managers have to continuously perform the function of motivation.
Maslow‟s Hierarchy Of Needs:
Maslow‘s need hierarchy is considered to be fundamental to the understanding of motivation and plays an important role in motivation.
• People have a wide range of needs like physiological needs, social needs, safety needs, esteem needs and self actualisation needs which motivate them to work.
• The manager must understand the needs and wants of people in order to motivate them and improve their performance levels.
• For the satisfaction of these needs, managers must offer different incentives (monetary and non-monetary).

NEED	Examples Of Need (Individual Example)	Management Can Satisfy This Need By (Organizational Example)
1. Basic Physiological Needs	Most basic in the hierarchy and corresponds to primary needs. Hunger, thirst, shelter, sleep.	Offer monetary incentives e.g. Good salary/wages and comfortable working conditions
2. Safety/Security Needs	Security and protection from physical and emotional harm, stability of Income etc.	Offer job security, pension, insurance etc
3. Affiliation/Belonging Needs	Refer to affection, sense of belongingness, acceptance and friendship	The firm can encourage team building and permit the workers to opportunity to interact socially and so develop cordial relations with colleagues
4. Esteem Needs	Include factors such as self-respect, autonomy status, recognition and attention	Recognize good performance, provide opportunity for employees to feel a sense of accomplishment, provide important job titles etc
5. Self Actualisation Needs	The drive to become what one is capable of becoming. These needs include growth, self-fulfillment and achievement of goals.	Offer the freedom to take decisions, providing them with opportunity to learn things, encouraging creativity, leading to achievement of goals etc.

Financial and Non-Financial Incentives: Incentive means all measures which are used to motivate people to improve performance.

Financial incentives = directly in money form or measurable in monetary terms.  1. Pay and allowance 2. Productivity linked incentive schemes 3. Bonus 4. Profit sharing 5. Co-partnership/Stock options 6. Retirement benefits 7. Perquisites

Non-financial incentives= main emphasis is to provide psychological and emotional satisfaction. Not measurable in monetary terms.  1. Status2. Organizational climate 3. Career advancement opportunities 4. Job enrichment 5. Employee recognition programmes 6. Job security 7. Employee participation 8. Employee empowerment

III. Leadership
Leadership is the activity of influencing people to strive willingly for mutual objectives. Managers at all levels are expected to be the leaders of their subordinates. Leadership indicates the ability of an individual to maintain good interpersonal relations with followers and motivate them to contribute for achieving organizational objectives. It is a process of interaction between the leader and his followers. It helps in persuading employees to work cooperatively and enthusiastically towards common goals.
Importance of Leadership:
1. Makes people contribute positively:
• Influences behaviour and makes people contribute positively and produce good results.
2. Creates congenial work environment:
• Maintains personal relations, helps followers fulfil their needs+ provides confidence, support and encouragement.
3. Introduces change:
• Persuades, clarifies and inspires people to accept changes.
• So overcomes resistance to change with minimum discontent..
4. Handles conflict
• Does not allow adverse effects .
• Allows followers to express their feelings and disagreements and gives suitable clarifications.
5. Trains subordinates:
• Builds up successors and helps in smooth succession process.
Qualities Of A Good Leader:
1. Physical features – appearance, personality, heath and endurance inspires followers to work with the same tempo.
2. Knowledge – knowledge and competence to instruct and influence subordinates.
3. Integrity – the leader should be a role model regarding ethics, values, integrity and honesty.
4. Initiative – grab opportunities instead of waiting for them.
5. Communication – capacity to explain his ideas and also be a good listener, teacher, counselor and persuader.
6. Motivation skills – understand followers needs and devise suitable means to satisfy them. 7. Self-confidence – so that he can provide confidence to followers
8. Decisiveness – should be firm and not change opinions frequently
9. Social skills – sociable, friendly and maintain good relations with followers.
Styles of Leadership
Leadership styles refer to a leader’s behaviour. Behavioural pattern which the leader reflects in his role as a leader is often described as the style of leadership.
A Leadership style is the result of the leader’s philosophy, personality, experience and value system. It also depends upon the type of followers and the atmosphere revealing in the organization.
Different types of leadership style are:
1. Autocratic leadership
2. Participative leadership/Democratic
3. Free rein leadership/Laissez Faire
A leader may use all styles over a period of time but one style tends to predominate as his normal way of using power.
l. Autocratic or Authoritarian Leader
An autocratic leader gives orders and insists that they are obeyed. He determines the policies for the group without consulting them. He does not give information about future plans but simply tells the group what immediate steps they must take. Under this style, all decision making power is centralized in the leader. He does not give the subordinates any freedom to influence his decisions.
It is like “bossing people around.” This style should normally be used on rare occasion.

It is best applied to situations where there is little time for group decision making or where the leader is the most knowledgeable member of the group.
2. Democratic or Participative Leader
A democratic leader gives order only after consulting the group and works out the policies with the acceptance of the group.
He never asks people to do things without working out the long term plans on which they are working. He favours decision making by the group as shown in the diagram.
This improves the attitude of the employees towards their jobs and the organization thereby increasing their morale. Using this style is of mutual benefit – it allows them (subordinates) to become part of the team and helps leaders (seniors) to make better decisions.

When should Participative/democratic leadership be applied?
It works best in situations where group members are skilled and eager to share their knowledge.
It is also important to have plenty of time to allow people to contribute, develop a plan and then vote on the best course of action.
This style should NOT he used when:
In situations where roles are unclear or time is of the essence, democratic leadership can lead to communication failures and incomplete projects.
3. Laissez Faire or Free Rein Leader
A free rein leader gives complete freedom to the subordinates. Such a leader avoids use of power. He depends largely upon the group to establish its own goals and work out its own problems. Group members work themselves as per their own choice and competence. The leader exists as a contact man with the outsiders to bring information and the resources which the group requires for accomplishing the job. Note: This is also known as laissez faire which means no interference in the affairs of others. Frenchlaissezmeanstolet/allowfairmeanstodo.

Communication
It is transfer of information from the sender to the receiver with the information being understood by the receiver. Communication plays key role in the success of a manager. Directing abilities of manager mainly depend upon his communication skills. That is why organization always emphasizes on improving communication skills of managers as well as employees. Communication is important for the directing function because all other elements of directing become possible only when there is adequate communication.
Elements of Communication Process
1. Sender: Who conveys his thoughts or ideas.
2. Message: Ideas, feelings, suggestions, order etc.
3. Encoding: Converting the message into communication symbols such as words/pictures etc.
4. Media: Path/Channel through which encoded message is transmitted to receiver e.g., face to face, phone call, internet etc.
5. Decoding: Converting encoded symbols of the sender.
6. Receiver: Who receives communication of the sender.
7. Feedback: All those actions of receiver indicating that he has received and understood the message of the sender.
8. Noise: Some obstruction or hindrance to communication like poor telephone connection, inattentive receiver.
Importance of Communication
1. Facilitates Coordination: between interrelated departments and sections thus creating a unity of purpose and action.
2. Provides data necessary for decision makings: When information is effectively and efficiently communicated to management.
3. Increases managerial efficiency: Every individual in the organization is assigned a job or task. The employee must know clearly who has to report to whom, what part of total job they are expected to perform and what are their decisions. The clarity comes only with smooth flow of communication which keeps the organization at work with efficiency.
4. Promotes cooperation and Industrial Peace: The two-way communication promotes cooperation and mutual understanding between the management and workers and brings peace in the organization.
5. Establishes effective leadership: Effective communication helps to influence subordinates. while influencing, a leader should possess good communication skills.
If there is two-way information flow between the superior and subordinates then there will be positive reaction of employees.
Communication taking place within an organization may be broadly classified into two categories.

Formal communication  1.Official communication following the chain of command 2.Is concerned with official matters 3. May be written/oral but generally recorded and filed. 4.Directions =Vertical:Downward-superior to subordinates –sending notices, passing guidelines, asking them to complete assigned work.upward- subordinates to superior – application for leave, submission of reports.Horizontal- between departments – about schedule of product delivery, product design etc.5.Popular communication networks are:Single chain, Wheel, Circular, Free flow and Inverted V

Informal Communication:  1.Takes place outside the official channels – 2. May be work related or other matters – 3.Arises out of social interactions – 4.Grapevine:Origin and direction of flow is not easily locatedCuts across scalar chainSpread of rumors is possible as it is not easy to fix responsibilities –5.Types =single strand,gossip,probability network,clusters

Difference between Formal and Informal Communication

Basis	Formal Communication	Informal communication
1. Meaning	Follows the official chain of command.	Between individuals and groups are not officially recognized.
2. Channel	Through a definite path.	No definite path.
3. Speed	Slow: because all information has to pass through an established scalar chain.	Very fast-Cuts across all the official channels.
4. Nature	More rigid and cannot be modified.	Flexible and varies from individual to individual.
5. Expression	It is mostly expressed in the written form.	It mostly tends to be oral.

Barriers to Effective Communication
Semantic Barriers: Concerned with problems and obstructions in the process of encoding or decoding of message into words or impressions. Semantic barriers are as follows:
1. Badly expressed message: Sometimes intended meaning may not be conveyed

2. Words with different meanings confuses the receiver.
3. Faulty translations may transfer wrong messages.
4. Unclarified assumption: Different interpretations may result in confusion.
5. Technical Jargon: Technical words may not be understood by the workers.
Psychological/Emotional barriers
1. Premature evaluation- judgement before listening leads to misunderstanding.
2. Lack of attention/poor listening may disappoint the employees.

Organizational Barriers

 
Factors related to organization structure:
1. If organizational policy does not support free flow of information it creates problem.
2. Rules and regulations: Rigid rules and regulations may lead to red tapism and delay of action.
3. Status conscious managers may not allow subordinates to express their feelings freely.
4. Complexity in organization structure results in delay and distortion.
Personal Barriers: of superiors and subordinates.
1. Fear of challenge to authority may withhold or suppress a particular communication.
2. Lack of confidence of superior in his subordinates.
3. Unwillingness to communicate. e.g., fear of punishment/demotion.
4. Lack of proper incentives stops the subordinates to offer useful suggestions.
Improving Communication Effectiveness
1. Clarify the ideas before communication.
2. Communicate according to the needs of receiver.
3. Consult others before communicating.
4. Be aware of language, tone and content of message.
5. Ensure proper feedback. Feedback provides opportunity for suggestions and criticism.
6. Follow up communication helps to remove hurdles, misunderstanding of information given by managers to subordination.
7. Be a good listener.