Planning For It!

Understand our economy: For Laymen

 

 

Why can’t there be enough money around for everyone so that everything becomes simple and affordable to everyone.

 

Let’s assume a real life situation.

 

Many of you travel by flights once in a month or maybe more than that. How much money do you need to book a seat? Let’s say Rs. 5000. Everyone from your group has Rs. 5000. You go to the airline and queue up to buy tickets. However, the plane consists of limited seats. As the demand goes up the price is also raised.

 

You still have money with you but are not able to buy tickets.

 

Therefore, you see, if there is unlimited money, prices will keep increasing as there are limited goods and services. What would happen to people with less money?

 

Unlimited money gives rise to unlimited problems. Balance between supply of money and goods is studied under ‘Economics’.

 

 

ECONOMY

 

Economy is the study of satisfying unlimited wants with limited resources. In simple terms we can say – ‘Economics is the study of making choices’.

 

We have limited money and have unlimited needs such as food, clothes, education, recreation activities, accommodation etc. While spending the limited money we all have to prioritize our needs.

 

Now you know what economics is. Let us expand knowledge on this subject.

 

What is Money?                             

 

Money is not just a piece of paper; it’s a medium of exchange. Suppose you have a pair of shoes and need a shirt. Without the paper money, you’ll need to first find a person who needs pair of shoes and is ready to exchange shirt for that. You can imagine how difficult that would be.

 

To avoid this kind of complexities money is used as a mode of exchange. Our lives are a lot easier, with the existence of money.

 

Note that money is not the same thing as wealth. We cannot make ourselves richer by simply printing more money.

 

INFLATION

When too much money chases too few goods, the prices of goods increase. Consequently, cost of living goes high. This is called ‘Inflation’.

In the beginning of the article, we had seen the example of movie tickets. Demand was high and seats were limited, resultantly prices went up. Now assume that the theater had 100 seats and only 50 people were ready to buy the tickets. Seller then would decrease the price to fill up the spaces.

 

These scenarios are inflation and deflation, respectively, though in the real world inflation and deflation are changes in the average price of all goods and services, not just one.

 

Inflation and the Money Supply

We can also have inflation and deflation by changing the amount of money in the system. If the government decides to print a lot of money, then rupees will become plentiful relative to goods. Thus, inflation is caused by the amount of money rising relative to the amount of goods and services, and deflation is caused by the amount of money falling relative to the amount of goods. Inflation is caused by a combination of four factors:

  1. The supply of money goes up.
  2. The supply of other goods goes down.
  3. Demand for money goes down.
  4. Demand for other goods goes up.

GROSS DOMESTIC PRODUCT

 

The gross domestic product (GDP) is one of the primary indicators used to measure the health of a country's economy.

 

The GDP is a measure of all of the services and goods produced in a country over a specific period, classically a year. The GDP considers the market value of goods and services to arrive at a number, which is used to judge the growth rate of the economy.

 

Real GDP is the gross domestic product adjusted for inflation

Nominal GDP is the gross domestic product without taking into account inflation.



GDP growth rate

Change in GDP from one year to the next is called the GDP growth rate.

The real GDP growth rate is a much more useful measure of economic growth than the nominal rate.

If a country’s GDP is growing at a nominal rate of 5% but inflation is running at 4%, only 1% of the growth is due to improved economic output. The rest is just because prices of goods and services went up.


The GDP shows how well a particular country is doing economically.

One drawback of GDP however is that it can only measure what the government has measured. Nothing traded without the government knowing will be included in the GDP, which can be significant in some countries.



ECONOMIC POLICIES

 

You must be wondering what the government does when problems like inflation or deflation arise. Whenever such problems are faced by the economy, the government takes certain actions through RBI such as change in interest rates. The RBI cannot stop the changes in price completely, but it can ensure that they do not move up or down rapidly. It maintains the price stability by controlling the money available to people. It controls the money by either providing more money or taking away excess money from the banks.

 

There are two policies, which are used to control the economy –

 

  • Monetary Policy
  • Fiscal Policy

 

Monetary Policy – Monetary policy is the process a government, central bank, or monetary authority of a country uses to control:

(i)                 the supply of money,

(ii)               availability of money, and

(iii)              cost of money or rate of interest

 

to attain a set of objectives oriented towards the growth and stability of the economy.

 

Fiscal Policy –

The second tool available to government is fiscal policy. The term fiscal policy refers to the expenditure a government undertakes to provide goods and services and to the way in which the government finances these expenditures.

 

ECONOMIC CYCLES

 

You have learnt about GDP. When production is rising at a high rate it’s called economic boom. In such a phase output increases, employers need more people to work for them, resultantly wages paid also goes higher. Government tax revenues will be rising quickly. Company profits and investment increase, and existing resources are utilized increasingly.

 

Then economy reaches a phase when, resources reach a limit and production cannot go up anymore. More employment means more spending and demand causes inflation. Factories reduce their production and start laying off workers.

 

More unemployment means even lesser consumption and prices start declining.

 

Then again, economy comes in a phase of recovery. This is a complete cycle. RBI plays a vital role in running the economy.

 

RBI’s policies affect nearly every aspect of your life even though you don’t realize it.

Hope from now on, you’ll be able to understand one of most critical part of our lives in a meaningful manner J

 

About the Author:

Sapna Tiwari is a CERTIFIED FINANCIAL PLANNER and masters in Financial Management with over half a decade’s experience in the field of personal finance. The views expressed are personal. She can be reached at sapna3031@gmail.com

Published Mar 06 2013




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