Learn Economics

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I'm starting this thread so that everyone can learn more about economics, economic terms etc. Basic knowledge is necessary for making simple decisions of investment etc in future. Discussions are also welcome :) So here everyone can post dou...
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You can DO/KNOW anything, but not everything!!
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@saurav4489: I would like to introduce you and all with four new terms:

1) CRR: Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with the RBI. If the central bank decides to increase the CRR, the available amount with the banks comes down. The RBI uses the CRR to drain out excessive money from the system

2) Repo Rate: The rate at which the RBI lends money to commercial banks is called repo rate. It is an instrument of monetary policy. Whenever banks have any shortage of funds they can borrow from the RBI.

3) Reverse Repo Rate: The rate at which the RBI borrows money from commercial banks. Banks are always happy to lend money to the RBI since their money are in safe hands with a good interest

4) Liquidity: The degree to which an asset or security can be bought or sold in the market without affecting the asset's price. Liquidity is characterized by a high level of trading activity. Assets that can be easily bought or sold are known as liquid assets. It is safer to invest in liquid assets.

Now we look at your problem:

It is an obvious conclusion that when there is more money to invest, more will be the growth.
As derived above, When there is more money in market price tends to rise and hence, causes inflation.

So, there should be an equilibrium between the inflation and the the money that we invest in market. This is regulated by RBI. See how.

When RBI increases the Repo Rate, overall cost of the funds increases. So, this will keep a check in demands for funds. When demand slows, price will obviously go down (see the price vs demand curve) and equilibrium point in Price vs Quantity curve goes down. That results in easing the inflation.

For instance, if the availability of funds is scarce, and banks are not able to borrow at repo rate, they may have to increase the deposits rates upwards to attract depositors.

Since march 2010, repo rate has gone up from 4.25% to 8%. This clears the picture that with a rise in repo rate, we can slow down the inflation.

Now, depositors would like to deposit more, as repo rate is high. So, money would not come to market and there will be less to invest. As a result growth will be stalled.

Similar is the case with reverse repo rate. You can draw the conclusion by simply using the logic high interest rates equals low inflation, low interest rates = high inflation.

Rest @Brooklyn bhai has cleared, if still you have any query, then let me know :)
~~ Don't Hate, Educate. ~~
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@vijay_chandola said:
I see a great example of this with cell phone usage, as I have cousins of varying ages. The one who goes to school just uses SMS and gives missed calls, the one in college doesn't mind calling you, but you have to call her back if you want to have a long conversation, and Mr. Mittal can dedicate at least one cell phone tower to the one who has started earning.The eldest one has gone through the stage of SMS and short calls, and as her income rose, so did her consumption. Your consumption / demand will generally increase with your income levels.Now think of a situation where you open up a newspaper and read that the government is sorry for all its misdeeds, corruption, and general incompetence, and has decided to credit everyone's savings account with Rs. 1 crores, and if you don't have a savings account then a minister will come to your house and give you the cash personally.After you recover from the mild heart attack this news causes you – you will think that you have become rich, and will start spending like crazy. If you used an air conditioner for just the night – you will now want to use it all the time.Your demand for a lot of things will increase since you have this extra money now, and you are rich.So, let's get back to our earlier example, and say that instead of demanding 30 units at Re. 1 – you will now demand 50 units at Re. 1 and instead of demanding only 1oo unit at Rs. 2 – you will now demand 120 units at Rs. 2.~ All the figures are taken from : www.onemint.com
Heheh love this example....felt like i am back to college...
{We are what we repeatedly do. Excellence, therefore, is not an act but a habit.}
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@saurav4489 said:
Awesome post@vijay_chandolaI have two questions:1. India is currently facing the issue of creating a balance between inflation and growth, because when RBI tries to reduce inflation it indirectly also affects growth. I would like to have someone explain this interlinking in simplest terms possible. 2. Which are the factors that affect the currency of the country? What determines its increase and decrease?
Ans2:

This is very complex question to be answered in a single post that requires the understanding of lot dynamics.

But to make basic idea for it. For an open economy like ours both our countries internal factors and external factor effect it.
Why do we fall??? So that we can learn to pick ourselves up again.
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@saurav4489 said:
Awesome post@vijay_chandolaI have two questions:1. India is currently facing the issue of creating a balance between inflation and growth, because when RBI tries to reduce inflation it indirectly also affects growth. I would like to have someone explain this interlinking in simplest terms possible. 2. Which are the factors that affect the currency of the country? What determines its increase and decrease?
Ans1 :

Lets look at a simple scenario. Inflation is caused because people have more money to spend/ To explain look at macroeconomics of it all. Say for eg income of every person in India increases by 10K pm right now. This means more disposable income in everyone hands. But now supply of goods hasnt increased proportionally hence price of say a simple item such as milk rises.

If you are wondering why price of milk has risen read my above post explaining inflation.
Now what does RBI do to decrease this flow of disposable income in people's hand. It does lets say following:

1) Increase Rate of Interest on Fixed Deposit for 1 year from 5% to 10%.

2) Increases income tax for that month from 2% to 7%.

So you heck why dont i save the extra money. Now what does this do controls money supply hence regulate inflation.

But how this effect growth. Its simple if you want something more , it will be produced more beyond a point.

For eg. I produce 10 packets of milk per day and sell at Rs 10 per packet. I see demand rise, but i dont increase my supply accordingly, the price rises till say Rs 15 per packet. After that equilibrium is reached.

But if i produced 12 packets per day i could charge Rs 14 per packet hence earn more overall
thus this means more development.

So RBI by aiming to decrease inflation restricts growth.

Always remember. Inflation is akin Friction, neccesarry evil in a limited amount



Why do we fall??? So that we can learn to pick ourselves up again.
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Awesome post @vijay_chandola :)


I have two questions:

1. India is currently facing the issue of creating a balance between inflation and growth, because when RBI tries to reduce inflation it indirectly also affects growth. I would like to have someone explain this interlinking in simplest terms possible.

2. Which are the factors that affect the currency of the country? What determines its increase and decrease?
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@vijay_chandola: Since you've explained a very good concept in a simplest manner. Also elaborate on Demand and Supply Curves basics n then on Different type of Goods such as normal goods, Giffen Goods, luxury goods.
Why do we fall??? So that we can learn to pick ourselves up again.
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Why do we fall??? So that we can learn to pick ourselves up again.
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Why can't a country print money and become rich?



A lot of people have this misconception that a country's currency is backed by the gold it holds. But, this is simply not true – any country can print as much money as they want, and they don't need to have any gold to back their currency.

In fact, in recessionary times – countries do resort to printing money, or what is known as Quantitative Easing, – a term that became popular just after the recession.

But, that measure is only for extreme situations, and is also considered dangerous because printing money causes inflation in an economy, and if you print too much money you can get hyper – inflation also.

So, how does printing money cause inflation?
Demand and Price

Let's take a simplified example to understand this. First, think of how demand of a product is related to its price.
That's fairly easy to do right? A lot more iPads will sell at Rs. 5,000 than they will at 25,000.
If you were to draw a graph that shows the relationship between demand and price of a product it would generally look like this.



In this example – at 1 rupee you demand 100 units of a commodity, but at Rs. 2 you demand just 30.

You can get fancy and call this a downward sloping demand curve.

Supply and Price

On the other hand a lot more suppliers will be willing to get into a business if the end product sells at a higher rate. I remember quite a few years ago, a lot of households started planting vanilla in Kerala because vanilla rates had shot up.

So, supply will be high at higher prices, and that curve would look something like this.



In this example – you want to supply just 50 units at Rs. 1.20, but when the price shoots up to Rs. 2.15 – you are willing to supply as much as 120 units.

Feel free to tell your friends that supply curves are upwards sloping.

How is the price finally fixed?
The price of any product is largely determined by its demand and supply, and when you super impose the price curve and demand curve – the intersection is called the equilibrium price, and it is generally believed that prices will move towards this point and stabilize here.

In our example this will look something like this.



What will happen if the government prints money and hands it out to its citizens?

What happens when your income rises? – Your consumption or demand of certain things also rises with your income.

I see a great example of this with cell phone usage, as I have cousins of varying ages. The one who goes to school just uses SMS and gives missed calls, the one in college doesn't mind calling you, but you have to call her back if you want to have a long conversation, and Mr. Mittal can dedicate at least one cell phone tower to the one who has started earning.

The eldest one has gone through the stage of SMS and short calls, and as her income rose, so did her consumption. Your consumption / demand will generally increase with your income levels.

Now think of a situation where you open up a newspaper and read that the government is sorry for all its misdeeds, corruption, and general incompetence, and has decided to credit everyone's savings account with Rs. 1 crores, and if you don't have a savings account then a minister will come to your house and give you the cash personally.

After you recover from the mild heart attack this news causes you – you will think that you have become rich, and will start spending like crazy. If you used an air conditioner for just the night – you will now want to use it all the time.

Your demand for a lot of things will increase since you have this extra money now, and you are rich.

So, let's get back to our earlier example, and say that instead of demanding 30 units at Re. 1 – you will now demand 50 units at Re. 1 and instead of demanding only 1oo unit at Rs. 2 – you will now demand 120 units at Rs. 2.

This will have the impact of shifting the demand curve to the right, and pushing the price of the commodity upwards.

If you were to graph this – it would look something like this.



The green star indicates the price which will be fixed due to the new realities of increased notional wealth, and people demanding more because their wealth has been increased.

Think of times when the stock market is booming – people have this “wealth effect” where they feel that they are richer and start spending more, and as a result prices rise as well. Just printing money will also do the same thing.

What I have done here is take an example that's used with respect to increased incomes, but in this case the increased income is nothing but a handout from the government which has printed more cash. This is a theoretical way to understand the consequence of printing money, and you can see a real example of this with Zimbabwe.

At one point you could a buy a 100 billion dollar Zimbabwe bank note for 15 US Dollars at E-bay, but even that was really expensive because if you were actually in Zimbabwe you could buy just 3 eggs with it!

So, printing money is not the way to become rich – becoming competitive – producing cheaper goods, and facilitating exports are.

If your people can buy onions at 5 bucks a kg instead of 50, they are richer by the amount they save and this can be used elsewhere, but if you credit everyone's account with more money – they will just end up driving the price of onions higher, and that won't do them any good.
As always, feel free to weigh in on the question, and be sure to point out any mistakes that you see.

~ All the figures are taken from : http://www.onemint.com

~~ Don't Hate, Educate. ~~
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