Devaluation of Money

Devaluation of Money

Devaluation refers to a decline in the value of a currency in relation to another, usually brought about by the actions of a central bank or monetary authority. Devaluation is sometimes used more generally to describe any significant drop in a currency's international exchange rate, although usually a decline caused by market forces with no government intervention is termed depreciation. Devaluations are most often associated with developing countries that don't allow their currency prices to float freely on the open market.

There are essentially two main classes of devaluations: planned policies and reactions to market events. Planned devaluations are brought about almost exclusively by government decisions to deliberately reduce the relative value of a currency, usually intended as a means to some improvement in the country's trading position. Market-driven devaluation, by contrast, is often the formal recognition by a government, frequently during a monetary crisis, that the value of its currency relative to major world currencies—especially the dollar—has already depreciated through trading in the foreign exchange markets. The primary alternative to a decision to devalue a currency in response to market forces is an organized government attempt, either unilaterally or multilaterally, to prop up a sagging currency through coordinated market intervention. Some devaluation scenarios may involve a mix of both deliberate and reactive stimuli; however, both kinds of devaluations are controversial undertakings, and some observers assert that they do not always lead to the intended effects.

Exchange Rate Basics

If we define an exchange rate of, for example, the U.S. dollar in terms of the British pound as e = dollars/pounds, where e is the exchange rate, then this specifies the number of dollars exchanged for each pound. If e rises from 1.50 to 1.75, it means that the price of the currency in the numerator, dollars in this case, has depreciated relative to the denominator currency, here British pounds, and indicates that approximately 17 percent more of the numerator currency is required to buy each unit of the denominator currency. Conversely, in this scenario the denominator currency is said to have been revalued or appreciated by approximately 13 percent.

The Role of Foreign Exchange Markets

Foreign exchange (FX) markets serve as the principal rate-setting mechanism for the exchange of currencies. In theory, they allow supply and demand to dictate the relative value of world currencies. In practice, they are also a medium for investment (including speculation and hedging) and an efficient means for obtaining or disposing of foreign currencies. As such, foreign exchange markets can give rise to significant rate fluctuations and can create conditions leading to a devaluation.

Most of the major world currencies are influenced by the FX markets, even if they are not completely free from government controls. As in other financial markets, trading in currencies is based on myriad considerations, including rumors and outside analysts' assessments of countries' economic health. When enough currency traders believe the outlook for a particular country is grim, they may cause a sharp depreciation in the international exchange rate for that country by unloading units of its currency onto the market. While such depreciation is not identical to devaluation, it may provoke devaluation depending on the monetary policies of the target nation. If a country imposes currency controls, such as pricing bands that specify a minimum and maximum value at which the currency may trade, it will be forced to choose between either (1) defending the controls by buying units of its own currency (or selling foreign currencies) on the FX market, or (2) lowering the controls—the latter being a devaluation. Often a country's initial reaction is to defend the currency at some arbitrary

level, but if the downward pressure on the markets persists, the country may deplete its reserves in a matter of weeks or months and either require assistance from other countries or accept devaluation as the alternative.

Factors Contributing To Devaluation Policies

Currency devaluation usually comes about when some determination is made that the domestic currency is overvalued relative to major world currencies. It may be used as a policy tool to relieve an unfavorable balance of trade or simply to stimulate fledgling export industries. Such policies assume that devaluation will make the country's exports more attractive abroad and imports from other countries less attractive at home, but in reality other factors may diminish these effects, making a planned devaluation a risky undertaking. Even if conditions at home are suitable for the ideal devaluation scenario, one country's devaluation may trigger a cycle of competitive devaluations by other countries and thereby undermine the initial country's strategy.

At the same time, developing countries in particular are periodically faced with a currency crisis in which they may need to consider devaluation. This can occur when chronic trade deficits, government budget deficits, or other internal weaknesses cause slack demand for a nation's currency, as was the case during the Asian financial crisis of the late 1990s. Although a variety of circumstances fomented this crisis, one of the most profound was a sell-off in the FX markets which led to sharp depreciations in several Asian currencies.

Technically, the biggest cause of devaluations is the existence of rate controls and other government exchange rate policies. If these did not exist, there would of course still be currency depreciations, but never an organized (even if reluctant) effort to allow a currency's value to fall. However, in the interests of stability, nearly all nations practice some form of rate intervention from time to time, whether by occasional targeted transactions on the open market or by a strict regime of price controls. The currencies most vulnerable to devaluation, hence, are those belonging to nations with uncertain economic prospects and with active rate control/support policies.

Still, the attraction of devaluation as a policy is its ease of implementation, and it can be seen as a panacea for an errant small economy with a trade deficit. In the estimation of some government officials, a devaluation is easier for a population to swallow than the harsh structural changes, e.g., voluntary cutbacks in demand for imported goods, that are otherwise necessary to ameliorate current account deficits and promote growth of output.

Competing Views on Devaluation

According to the orthodox theory of international trade found in most textbooks, a planned devaluation is not necessary and is, in fact, disruptive since it interferes with free market forces. In theory, any trade deficit in a relatively open market system will automatically be translated into a decline in the affected country's price levels (via the outflow of money that is assumed to reduce prices and, in turn, depreciate the country's real exchange rate). This, according to the theory, would make that country's goods more competitive, expand its exports, and lead it toward trade balance. A similar process is envisioned for trade surpluses. A controversy arises, however, because it is highly questionable that this process actually plays out in reality. The prolonged study of the effects of devaluation has produced results that are theoretically indeterminate and empirically unconfirmed.

Though its validity is still debated, the theoretical J curve (see Figure 1) supports the argument that a devaluation can indeed have positive effects, albeit not immediately. Indeed, devaluation is expected to worsen the trade balance in the short term—possibly causing a contraction in output and

employment—before improving the overall balance. One explanation for this phenomenon is that changes in unit demand often move more slowly than price corrections, causing an immediate decrease in export revenues (due to lower prices) without an initial increase in units to offset it. Another hypothesized influence is known as the Marshall-Lerner condition, which states that the sum of price elasticities (the responsiveness of demand to a change in prices) of imports and exports must be greater than 1.0 if the depreciation is to induce a shift to greater export revenues, and hence, an improvement in the trade balance. Some empirical evidence supports the J curve and suggests that despite its negative effects in the short run, devaluation can lead to improved trade balances.

Figure 1 J Curve: Theoretical Shift in Balance

of Trade Following Devaluation

Some have argued that devaluation policies can lead to other more subtle repercussions in the international trading system. Other factors being equal, an improvement in country's trade balance means a decrease in the trade balance somewhere else in the world, since the sum of all world trade balances must equal zero. By logic of this argument, an improvement in one country's trade balance must be gained at the expense of its trading partners' trade balances. This is why devaluation is often referred to as a "beggar-thy-neighbor" policy.

Conclusion

The effects of devaluation can be complex and far-reaching. In theory, a weaker currency means that exports from the affected country will be cheaper relative to prices in other countries, and that imports will be more costly. These conditions may provide a boost to an economy that has undergone devaluation, but typically there are negative consequences as well, both internally and externally. And depending on the nature of a country's trading structure, the benefits may never materialize at all.

For large international corporations, devaluations often translate into lost revenue and decreased profitability in the affected country (assuming the company isn't based there), as companies usually can't raise their prices enough in competitive markets to make up for the losses stemming from the lower exchange rate. Moreover, since devaluations frequently coincide with broader economic turmoil such as inflation, instability in the financial markets, and recession, spending is likely to be tight in countries whose currencies have been devalued, further eroding sales. On the other hand, for companies with substantial export-oriented operations in countries whose currencies have been devalued, the business may be able to enjoy some cost advantages in its labor and materials, enhancing its competitive position abroad.

Value of Money (Determination of the Value)

Quantity Theory of Money The concept of the quantity theory of money (QTM) began in the 16th century. As gold and silver inflows from the Americas into Europe were being minted into coins, there was a resulting rise in inflation. This led economist Henry Thornton in 1802 to assume that more money equals more inflation and that an increase in money supply does not necessarily mean an increase in economic output. Here we look at the assumptions and calculations underlying the QTM, as well as its relationship to monetarism and ways the theory has been challenged.

QTM in a Nutshell

The quantity theory of money states that there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold. According to QTM, if the amount of money in an economy doubles, price levels also double, causing inflation (the percentage rate at which the level of prices is rising in an economy). The consumer therefore pays twice as much for the same amount of the good or service.

Another way to understand this theory is to recognize that money is like any other commodity: increases in its supply decrease marginal value (the buying capacity of one unit of currency). So an increase in money supply causes prices to rise (inflation) as they compensate for the decrease in money’s marginal value.

The Theory’s Calculations

In its simplest form, the theory is expressed as:

MV = PT (the Fisher Equation)

Each variable denotes the following:

M = Money Supply V = Velocity of Circulation (the number of times money changes hands) P = Average Price Level T = Volume of Transactions of Goods and Services

The original theory was considered orthodox among 17th century classical economists and was overhauled by 20th-century economists Irving Fisher, who formulated the above equation, and Milton Friedman.

It is built on the principle of "equation of exchange":

Amount of Money x Velocity of Circulation = Total Spending

Thus if an economy has US$3, and those $3 were spent five times in a month, total spending for the month would be $15.

QTM Assumptions

QTM adds assumptions to the logic of the equation of exchange. In its most basic form, the theory assumes that V (velocity of circulation) and T (volume of transactions) are constant in the short term. These assumptions, however, have been criticized, particularly the assumption that V is constant. The arguments point out that the velocity of circulation depends on consumer and business spending impulses, which cannot be constant.

The theory also assumes that the quantity of money, which is determined by outside forces, is the main influence of economic activity in a society. A change in money supply results in changes in price levels and/or a change in supply of goods and services. It is primarily these changes in money stock that cause a change in spending. And the velocity of circulation depends not on the amount of money available or on the current price level but on changes in price levels.

Finally, the number of transactions (T) is determined by labor, capital, natural resources (i.e. the factors of production), knowledge and organization. The theory assumes an economy in equilibrium and at full employment.

Essentially, the theory’s assumptions imply that the value of money is determined by the amount of money available in an economy. An increase in money supply results in a decrease in the value of money because an increase in money supply causes a rise in inflation. As inflation rises, the purchasing power, or the value of money, decreases. It therefore will cost more to buy the same quantity of goods or services.

Money Supply, Inflation and Monetarism

As QTM says that quantity of money determines the value of money, it forms the cornerstone of monetarism.

Monetarists say that a rapid increase in money supply leads to a rapid increase in inflation. Money growth that surpasses the growth of economic output results in inflation as there is too much money behind too little production of goods and services. In order to curb inflation, money growth must fall below growth in economic output.

This premise leads to how monetary policy is administered. Monetarists believe that money supply should be kept within an acceptable bandwidth so that levels of inflation can be controlled. Thus, for the near term, most monetarists agree that an increase in money supply can offer a quick-fix boost to a staggering economy in need of increased production. In the long term, however, the effects of monetary policy are still blurry.

Less orthodox monetarists, on the other hand, hold that an expanded money supply will not have any effect on real economic activity (production, employment levels, spending and so forth). But for most monetarists any anti-inflationary policy will stem from the basic concept that there

should be a gradual reduction in the money supply. Monetarists believe that instead of governments continually adjusting economic policies (i.e. government spending and taxes), it is better to let non-inflationary policies (i.e. gradual reduction of money supply) lead an economy to full employment.

QTM Re-Experienced

John Maynard Keynes challenged the theory in the 1930s, saying that increases in money supply lead to a decrease in the velocity of circulation and that real income, the flow of money to the factors of production, increased. Therefore, velocity could change in response to changes in money supply. It was conceded by many economists after him that Keynes’ idea was accurate.

QTM, as it is rooted in monetarism, was very popular in the 1980s among some major economies such as the United States and Great Britain under Ronald Reagan and Margaret Thatcher respectively. At the time, leaders tried to apply the principles of the theory to economies where money growth targets were set. However, as time went on, many accepted that strict adherence to a controlled money supply was not necessarily the cure-all for economic malaise.

Money Market

The money market is a subsection of the fixed income market. We generally think of the term fixed income as being synonymous to bonds. In reality, a bond is just one type of fixed income security. The difference between the money market and the bond market is that the money market specializes in very short-term debt securities (debt that matures in less than one year). Money market investments are also called cash investments because of their short maturities. Money market securities are essentially IOUs issued by governments, financial institutions and large corporations. These instruments are very liquid and considered extraordinarily safe. Because they are extremely conservative, money market securities offer significantly lower returns than most other securities. One of the main differences between the money market and the stock market is that most money market securities trade in very high denominations. This limits access for the individual investor. Furthermore, the money market is a dealer market, which means that firms buy and sell securities in their own accounts, at their own risk. Compare this to the stock market where a broker receives commission to acts as an agent, while the investor takes the risk of holding the stock. Another characteristic of a dealer market is the lack of a central trading floor or exchange. Deals are transacted over the phone or through electronic systems. The easiest way for us to gain access to the money market is with money market mutual funds, or sometimes through a money market bank account. These accounts and funds pool together the assets of thousands of investors in order to buy the money market securities on their behalf. However, some money market instruments, like Treasury bills, may be purchased directly.

Failing that, they can be acquired through other large financial institutions with direct access to these markets. There are several different instruments in the money market, offering different returns and different risks.

Capital Market

Capital Market is one of the significant aspects of every financial market. Hence it is necessary to study its correct meaning. Broadly speaking the capital market is a market for financial assets which have a long or indefinite maturity. Unlike money market instruments the capital market instruments become mature for the period above one year. It is an institutional arrangement to borrow and lend money for a longer period of time. It consists of financial institutions like IDBI, ICICI, UTI, LIC, etc. These institutions play the role of lenders in the capital market. Business units and corporate are the borrowers in the capital market. Capital market involves various instruments which can be used for financial transactions. Capital market provides long term debt and equity finance for the government and the corporate sector. Capital market can be classified into primary and secondary markets. The primary market is a market for new shares, where as in the secondary market the existing securities are traded. Capital market institutions provide rupee loans, foreign exchange loans, consultancy services and underwriting.

International Monetary Systems

International monetary system, rules and procedures by which different national currencies are exchanged for each other in world trade. Such a system is necessary to define a common standard of value for the world's currencies. IMF The International Monetary Fund (IMF) is an organization of 188 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world. IMF performs the following functions.

(i) Providing short terms credit to member countries for meeting temporary difficulties due to adverse balance of payments.

(ii) Reconciling conflicting claims of member countries.

(iii) Providing a reservoir of currencies of member-countries and enabling members to borrow on another's currency.

(iv) Promoting orderly adjustment of exchange rates.

(v) Advising member countries on economic, monetary and technical matters.

Resources:

IMF is a pool of central bank reserves and national currencies that are available to member countries under specified conditions.

The capital of the IMF consists of the aggregate of the quotas allotted to the member countries member can pay its quota in its national currency.

The IMF utilizes its gold holdings to acquire dollars and other currencies for its operations.

Operations:

The IMF has shown great interest in the economic development of under development countries. It has made a steady progress towards the establishment of a multilateral system of payment in respect of current transactions.

It has simplified the multiple exchange system. The IMF has promoted exchange rate stability and expansion of world trade.

It has provided an excellent forum for the discussion and solution of economic, fiscal and financial problems having an international impact.

The IMF has granted undue credit to some countries. Its insistence on devaluation in some cases proved ill advised. It has followed a week policy in the fixation of exchange rate.

It has been charged as being partial to developed countries and not helping adequately the under developed countries.

Working Capital

January 23, 2013 Answers, B.Com. Part 2, Bachelor of Commerce, Banking and Finance

Working Capital

Q.2. What do you mean by working capital. State its importance in business?

Introduction

Adequacy of working capital rises the credit standing of the concern. Such a concern can buy goods on better terms and reduce the cost of production on account of receipt of cash discounts.

A concern is sure to fail, if there is no adequate supply of materials or cash. Nowadays production is carried on in anticipation of demand. There is a time between the point of supply of raw material and the ultimate realization of the sale proceeds of finished products. A large amount of working capital is required to keep the business moving continuously. Many new businesses are floated very well in the beginning but are unable to run properly usually because of inadequacy of working capital.

Kinds of Working Capital

Working capital a short term finance is of two types:

1. Initial Working CapitalIt is the amount required to meet all current expenses the early development of business. This period may vary in different types of business according to their nature.

2. Regular Working CapitalIt is the amount required after the business has been established as a going concern. The regular capital consists of two parts(a) Fixed(b) Variable

(a). Fixed Working Capital is the minimum amount of working capital required to carry on normal business operations. Every business has to maintain a minimum inventory of raw materials work in process, finished goods, etc. It always requires short term finance for making certain regular payments such as purchases, salaries, wages and rent etc.

(b). Variable Working Capital part of working capital is also known as seasonal or special working capital. It is the additional amount required during busy seasons on emergencies or under certain abnormal conditions such as in cases of rising prices, strikes and lock-out etc.

Factors Governing Short-Term Or Working Capital

1. Nature of BusinessIt is an important feature of determining the amount of working capital. Trading concerns requires large amount of working capital since their investment in current assets such as bills and book debts, etc., is more than that in fixed assets. Manufacturing units engaged in producing producer’s goods require lesser proportion of working capital. Public utilities like transport, electricity corporations, etc., need relatively little amount of working capital.

2. Size of BusinessSmall size business needs relatively large amount of working capital than a larger business.

3. Conversion of Working CapitalThe speed with which working capital changes its form also affects the amount of working capital needed. If cash is converted into inventory into bills and books debts and bills into cash within a short time, the business can be managed with a small amount of working capital.

4. TurnoverWhere there is a rapid turnover, it is possible to carry on business with comparatively limited amount of working capital.

5. Terms of TradeA concern which makes purchases in on credit and sells for cash only, requires a smaller amount of working capital.

6. Cash FlowWhen inflow of cash is greater than its outflow, a smaller amount of working capital is required.

7. Seasonal VariationsIf the demand and/or supply are seasonal and widely fluctuate, more working capital is needed.

8. Absence of CoordinationThe absence of coordination in the policies of production and distribution of goods may result in higher demand for working capital.

9. Transport FacilitiesIf means of transport facilities and communication available are not adequate and satisfactory the business concern is faced to maintain a large amount of stock of goods. This needs higher amount of working capital.

Adverse Balance of Payments

January 29, 2013 Answers, Banking, HSC Part-2 ( XII ), Intermediate

Adverse Balance of Payments

Q.30. Explain in detail that how are adverse balance of payments can be corrected?

METHODS OF CORRECTING AN ADVERSE BALANCE OF PAYMENTS

Following are same of the methods adopted for correcting and adverse balance of payments.

Improving the balance of trade through import restrictions & measures of export promotionsSince balance of payments becomes adverse because of excess imports over exports, so a country having such a problem must try to check imports either by total prohibition or by levying import duties so by a quota system. Another method may be import substitution i.e. trying to produce in the country what it currently imports. Exports can be stimulated by measures of export promotion granting subsidies or other concessions to industrialists and exports.

Depreciation of the currencyIf a country depreciates its currency it proves very helpful in increasing the exports of goods. The value of the home currency fall relatively to foreign currency hence the foreigners are able to buy move goods with the same amount of their own currency or for the same amount of goods they have to pay less in terms of their own currency than before.

DevaluationA country can turn the balance of payments in its favour by devaluating her currency. In this case also the devalued currency will become cheaper in terms of the foreign currency and the foreigners will be able to buy move goods by paying the same amount of their own currency. The effect is the same as in the case of depreciation.

DeflationDeflation means construction of currency. If currency is contracted then according to the quantity theory of money the value of the currency will rise or the prices will fall. When prices fall the country becomes a good country to buy in and not a good country to sell into Exports will also thus increase and imports will be checked and hence the balance of trade will become favourable.

Exchange ControlUnder a system of exchange control, all exporters are asked to surrender their claims or foreign currencies to the central bank which pays in return the home currency, which the exporters really want. This available foreign exchange is rationed by the central bank among the licenced importers. Thus imports are restricted to the foreign exchange available. There is no danger of more goods being imported than exported.

Balance of Payment


Balance of Payment

Q.29. Write a detailed note on Balance of Payments.

BALANCE OF PAYMENTS

Each nation periodically publishes a set of statistics that summarize for a given period all economic transactions between its residents and the outside world. This statistical statement is referred to as balance of payments. The accounts show how a nation has financed its internation activities during the reporting period. They also show that what changes have taken place in the nations financial claims and obligations with the rest of the world.

STANDARD PRESENTATIONThe IMF has significantly worked with success to standardize the system and the form of presentation.

B.O.P – DOUBLE ENTRY ACCOUNTThe B.O.P used double entry accounting. Transactions are recorded as credits of the yield receipts from or claims against foreign owners. Credits are received for example by exports of merchandise, sale of securities overseas and rendering services to foreigners. Similarly, debits are recorded of transactions cause payments to foreigners e.g. importing goods, tourist expenses abroad, purchase of foreign bonds.

B.O.P – CURRENT ACCOUNTThe Current Account uncludes merchandise trade in good and International Services are termed as Invisible trade. There are four basic service components. Tourism, Investment, Private Sector, Services such as royalties, rent, consulting and engineering fees etc and Government services such as diplomatic and buildings and membership fees in international organizations.

B.O.P – CAPITAL ACCOUNTThe capital account has a long term and a short term sector. The long term amount shows the inflow and outflow of capital commitments which have a maturity longer than a year. Short term capital movement frequently have a maturity date from 30-90 days. Long term capital items generally include loans to and from other governments, financial support for development. Projects abroad and export financing. Short term capital include paying for international services, selling accounts etc

Balance of Trade


Balance of Trade

Q.28. Define Balance of Trade

BALANCE OF TRADE

Balance of trade refers to the difference in the value of imports and exports of commodities only i.e. visible items only. Movements of goods between countries is known as visible trade because the movement is open and can be verified by the custom officials with respect to balance of trade the following terminologies are important.

Balanced Balance of TradeIf during a given years exports and imports of the country are equal the balance of trade is said to be Balanced.

Favourable Balance of TradeIf the value of exports exceeds the value of imports the country is said to experience an export surplus or favourable balance of trade.

Un-Favourable Balance of TradeIf the value of imports exceeds the value of its exports the country is said to have a deficit or an adverse balance of trade.

Rate of Exchange


Rate of Exchange

Q.23(A). Define the term rate of exchange.

Q.23(B). Explain how the rate of exchange is determined?

RATE OF EXCHANGE

The rate at which the currency or monetary unit of one country can be exchanged with the monetary unit of other country is called the rate of exchange. In other words, the rate at which a unit of one country exchanges for the currency of another is the rate of exchange between them. It may be used to denote the system whereby the trading nations pay off their debts.

Determination of Rate of ExchangeThe rate of exchange is determined under the following under the following money systems as:

Under Gold StandardIf two currencies are on gold standard and if their currencies are expressed in terms of gold i.e. a certain weight of gold then the rate of exchange is determined by reference to the gold contents of the two currencies. Suppose Pakistan and United States are on gold standard the rupee being equal to 10 grams of gold and dollar consisting of 50 grams of gold. The rate of exchange between the two countries will be1 Rupee = 10/50 = 1/5 $ or 0.20 cents1 Dollar = 50/10 = 5 Rupees.Thus the rate of exchange is determined in a direct manner by comparison between the gold contents of the two countries. This rate of exchange is also known as Mint Par of Exchange. The actual rate in the foreign exchange market will be slightly different from the mint par to allow for certain expenses. However the actual rate of exchange between currencies will not depart much from the mint par and will move between the two points of export and import of gold. These points are called Gold Points.

Under Paper Currency MethodThis phenomenon of exchange rates determination is also called Purchasing Power Parity

Theory. No country in the world is rich enough to have a free gold standard. All countries nowadays have paper currencies. According to this theory the rate of exchange between two countries depend upon the relative purchasing powers of their respective currencies. Such will be the rate which will equate the two purchasing powers.For example if a certain assortment of goods can be purchased for ₤ 1 in Britain and a Similar assortment of goods with Rs. 16 in Pakistan then the purchasing power of ₤ 1 is equal to the purchasing power of Rs. 16. Thus the rate of exchange according to purchasing power parity theory will be₤ 1 = Rs.16

Fluctuation in Rate of Exchange


Fluctuation in Rate of Exchange

Q.24. What are the causes of fluctuation in the rate of exchange of a country?

The rate of exchange fluctuates in the market due to interplay of demand and supply of currency of a particular country. This is the result of some of the following transactions.

BALANCE OF TRADEThe main reason for fluctuations in the rate of exchange of the currency is the value of imports and exports of a country. If the value of imports exceeds the value of exports the rate of exchange will lend downwards and vice versa.

FOREIGN INVESTMENTForeign capital investment in a country necessities the payment of dividends or interest to the investing countries. If the capital absorbing country is not in a position to pay such claims in foreign currency, the rate of exchange of that country will definitely fall down.

SERVICE CHARGESFreight and Insurance expenses also fluctuates the rate of exchange of a country. If the importing country does not have her own shipping companies the transportation charges are to be paid to foreign ships. So the insurance premium in case is to be paid to foreign companies. This creates a demand of foreign currency and if the supply is limited the rate of exchange will fall

Objectives Of Exchange Control


Objectives Of Exchange Control

Q.25. Identify the objectives of exchanges control?

OBJECTIVES OF EXCHANGE CONTROL

The following are some of the objectives of exchange control.

To restore EquilibriumThe chief objective of exchange control is to restore equilibrium in its balance of payments. If a country finds that its balance of trade has been persistently unfavourable then it must do something set it right. The balance of payment must ultimately be made to balance.

To Protest Home IndustriesAnother objective of exchange control is to protect the home industry from unfettered competition from abroad if the people at home are more interested in purchasing foreign goods it will ultimately discourage the local producers to produce more. It will directly affect the National Income and the domestic Gross Product of the country.

To Conserve Foreign ReservesTo conserve foreign reserve is another major objective of exchange control. Every Country needs foreign exchange in order to maintain its stability monetarily in the present age. Also the countries need foreign exchange to make payments for their imports and to pay back their debts obligation. For this a country must have foreign currencies on their hand. If there is a deficiency of the foreign exchange it is going to affect its liquidity position internationally and its credit rating.

Foreign Exchange


Foreign Exchange

Q.26. How does a country controls its foreign exchange?

METHODS OF EXCHANGE CONTROLPaul Einzig is his book exchange controls has mentioned as many as 41 different methods of exchange control. They can be categorized as1. Direct Method2. Indirect MethodThey are discussed here as under.

1. DIRECT METHODThe direct method are further classified as:Intervention

For an effective control of foreign exchange rates and the foreign exchange market the government usually have a central authority i.e. the Central Bank that has the complete power to control and regulate the foreign exchange market. Under this method any body who either wants to purchase or sell foreign exchange he has to deal with the central bank. All the selling and purchasing transactions of foreign exchange is controlled by the central bank which helps it to adjust demand and supply of foreign exchange according to the need of the country.

RestrictionExchange restriction is another powerful weapon of exchange control. It refers to the policy by which the government restricts the supply of its currencies coming into the exchange market. It is achieved either by one of the following methods.i. By centralizing all trading in foreign exchange with central bank of the country.ii. To prevent the exchange of national currency against foreign currency with the permission of the government.iii. By making all foreign exchange transactions through the agency of the government.

Exchange Clearing AgreementUnder this method the countries engaged in trade pay to their respective central bank the amounts payable to their respective foreign creditors. The central banks they use the money in off setting the corresponding claims after fixing the value of the foreign currencies by common agreement. The basic principle is to offset international payments so that they have not to be settled through the medium of the foreign exchange market.

2. INDIRECT METHODSThe most commonly used direct method or tool of exchange control is the use of tariff duties and quotes and other quantative restrictions on the volume of international trade. By imposing tariff and quotes the demand for the foreign currency falls down in the case of restricting the imports.

Rate of InterestAnother method of indirect exchange is the rate interest. The rate of exchange is the result of demand and supply of each other currencies arising out of trade and capital movement. A high rate of interest in a country attracts short term capital from other countries that leads to a exchange rate for the currency in terms of other currencies goes up.

ECONOMICS

Monopoly

Monopoly

Monopoly is that market from in which the single producer controls the whole supply of a single commodity that has no close substitutes.

Two points must be noted in regard to the definition. First there must be an individual owner it seller if. There will be monopoly. That single producer may be individual owner or group of partners or a joint stock company or any other combination of producers of the state. Hence there must be a sole producer or seller in the market if it is to be called monopoly.

Secondly, the commodity produced by the producer must have no close substitutes. Competing if he is to be called a monopolist this ensures that there must no rival of the monopolist. By the absence of closer substitutes we mean that there are no other firms producing similar products or product varying only slightly from that of the monopolist.

The above two conditions ensure that the monopolist can set the price of his product and can pursue an independent price policy.

“POWER TO INFLUENCE PRICE IS THE VERY ESSENCE OF MONOPOLY.”

Market Price

January 28, 2013 Answers, HSC Part-1 ( XI ), Intermediate, Principles of Economics

Market Price

Market Price

Market price is the actual price that prevails in the market at any particular time. It never remains constant. It changes from day to day and even from moment to moment. It can change at any time at any moment.

Determination of Market Price

Market price is determined by the relative forces of demand and supply. The demand depends upon the satisfaction, which a consumer drives from the consumption of the commodity. Supply on the other hand depends upon the cost of production of the commodity. The consumer tries to achieve more and more satisfaction least possible expenditure. He does not pay more than the marginal utility of the commodity to him the seller on the other hand tries to maximize his profit by changing as much as he can. He will never accept the price which is less than the marginal cost of production of the commodity and thus marginal utility and marginal cost pf production are the two limits the maximum and the minimum and price is determined between these two limits, so we can say that,

“The price is determined at point where the amounts demanded and offered for sale are equal.”

Trade Union


Trade Union

Trade Union

Modern industrialization has given rise to a great number of problems. As a result there has been a clash between the interests of labour and organization, the former claming high wages and latter high profits. Today labour has come to realize that they can improve their conditions of work only through collective bargaining with the employers. In the words of Sydney and Webb

“A trade union is a continuous association of wage earners for improving the conditions of their working lives”.

Functions of Trade Unions

Functions of Trade Unions

Trade unions perform a number of functions. Some of them are classified in these main groups viz:1. Militant Function2. Fraternal Functions3. Political Functions

1. Militant Function

The main function of a trade union is to fight for the basic rights and interests of its members. In doing this they offer the following benefits to the labour.

Job Security

For achieving this objective seniority rights of the workers, control over hiring of labour, grievance procedure for handling cases of discharge etc is used as devices.

Improving Conditions of Work

Trade unions put a pressure on the employers to provide workers with better conditions of work, sufficient recreation facilities, standardized hours of work etc.

Limitation of Output

If a given number of labours produce more than what they ought to be employed for, trade unions make sure for a standardization plan. Hence the output per worker is standardized.

2. Fraternal Function

Fraternal function consists of mutual help for the welfare of the workers. Under this content the trade unions perform the following functions.

Professional Training

Trade unions arrange for education and professional training opportunities training opportunities for their workers and also assist them in improving their efficiency and skill.

Source of Information

Trade unions serve as a source of information for the workers. The workers are guided and advised by the trade unions. Their leaders defuse information by organizing meetings of the workers.

Insurance Facilities

The trade unions also arrange for insurance facilities against risks, accidents etc. they make the workmen compensation act followed in this regard.

3. Political Functions

Many trade unions fight elections to the rights. In many countries strong; labour parties have grown up and in England especially there has been the government in the hands of labour party many times. The trade unions influence the labour party of the government and often clench some labour seats in the legislature.

Importance of Labour Unions

Importance of Labour Unions

Trade unions are of great significance for an economy because of the reason that they create congenial relation between the workers and the management and help a lot in developing mutual understanding among them. This brings industrial peace, which becomes an effective stimulation for the growth and expansion of industries in a country.

Trade unions help the employers by extending cooperation in settlement of labour disputes. In the absence of trade unions it becomes difficult if it is not possible for the employers to contract the individual workers and find out their views on certain issues related to the disputes. Trade unions also assist the employers in labour administration and control. The efficiency of workers is also improved through trade unions and as such, the employers are benefited.

Market


Market

Market

In ordinary language market means a place where things are bought and sold, but in Economics the market does not mean a particular place or bazar, it only means a commodity and a group of buyers and sellers of the same. Thus we speak of cotton market or share market etc. Same are willing to buy and others are willing to sell. The buyers and sellers can with one another by verbal, by letter, telephone, internet etc but place does not matter.

Classification of Market

Categories of market are:1. Perfect market2. Imperfect marketAgain categories are classified into:

Market on the Basis of Time

On the basis of time market could be classified into the following kinds:

1. Day–to-Day MarketThis type of market is concerned with goods that are perishable like milk, fish, vegetable, fruits etc. The price in this market is determined by the demand of the market. If the demand expands the period is short that the supply can’t be increased immediately at all, therefore the price will increase similarly if demand decrease the time is so short that the surplus supply can’t be stored due to the perishability of the goods, obviously the price will decrease.

2. Short Period MarketIt is the market when time allows supply to adjust with the demand of the market to the extent of available size of the firm or producing units. For example: If market demand is so goods per day and particular firm of the same goods could produce max: 100 units by using its full production capacity .If demand increases from 50 to 75 units the firm can supply utilising the unused capacity, but if demand becomes 120 it can’t be satisfied by existing production capacity because total size of firm is 100 units per day.

3. Long Period MarketWhen the period is so long that the supply can adjust with the demand of the market by changing the size of the firm. If the demand of the market increases immediately the prices will also increase. This increase of price will expand the margin of profits of the producers therefore the firm can increase the production through employing more labor, more machines , raw material

etc. By increasing supply reduces the increased prices and they come again on the previous point. Similarly if demand falls the price also decrease and producers curtail their production due to decrease in margin of profits. As consequence of curtail in production the depressed price goes up again on the previous point.

Market on the Basis of LocationMarkets can be classified on the basis of location.

1. Local MarketIf the goods are sold and purchased in a limited area is called local market. For example: If the goods produced in Karachi are sold in Landhi or Malir, it will be the example of local market. Local market generally is concerned with the perishable good like milk, fish, bricks etc.

2. National MarketThis is the kind of the market which covers the whole of the country. For example: the textiles of Karachi are sold in all the four provinces of Pakistan. Similarly sports goods produced in Sialkot are supplied in whole the country.

3. International MarketWhen the goods produced locally are sold in all the countries of the world is called International market. For example: the cars produced in Japan are sold in whole of the world. The buyers and sellers from all over the world compete with one another therefore prices are influenced by the world environment.

Market on the Basis of Nature of Goods

1. General MarketMarket is said to be general where not a specific but general goods are sold and purchased. For example: if cloth, pots, shoes, vegetable, fruit are sold at a time it will be called general market.

2. Specialised MarketIn this market special or specific goods are brought to sale in this kind of the market. For example: grains are sold in grain market similarly fruits are sold and purchased in fruit market. These markets provide facility to the buyers that they could purchase goods of their

Methods of Calculating National Income




To calculate national income the following three methods are generally used:

1. Net output Method or Production Method

For calculating national income under this method the net output or the production of various commodities is estimated and evaluated at the market prices. For this purpose we take two steps,Firstly we estimate the monetary value of the commodities that are produced internally .The production or output of different sections of the economy i.e. agricultural, manufacturing, trade, commerce, transport etc is analyzed after deducting the depreciation charges.Secondly; we consider the foreign business transactions that were performed during the financial year. In this regards in this regard we only consider the difference between exports and imports.These two aggregate are then summoned up to get the gross domestic product which in turn is deducted from the total revenue earned to arrive at national income. In very simple words the contribution, which each enterprise makes to total output, is equal to its total revenue minus what is paid out to other enterprises and the depreciation of equipment used in the process of production. The production method is the most direct method for calculating national income. It s equation can be written as:

NATIONAL INCOME = G.N.P – COST OF CAPITAL – DEPRECIATION – INDIRECT TAXES

2. Income Method

Under this method the various factors of production are classified in a few broad categories. The incomes of various and sectors are obtained from there financial statements. Under this method the national income is also estimated by summing up the income that arrives to the factors of production provided by the national residents. Thus the rate at which the national income is distributed among the various factors of production is estimated. This method of calculating national income is quite complex. Usually the undeveloped countries where most of the people are not directly covered by direct taxation. Equation wise the method can represent national income as:

NATIONAL INCOMER = RENTAL INCOME + WAGES + INTEREST + PROFIT

3. Expenditure or outlay Method

This method gives national income by adding up all public and private expenditures made on goods and services during a year. It is obtained by:

Personal consumption expenditure of goods and services. Gross domestic private investment. Government purchase of goods and services. Net Foreign investment.

It must however be recognized that it is the final expenditure only which must be counted and not the immediate expenditure.

Price Determines the Demand

Price Determines the Demand

The demand for the commodity is related to price. IT is always at a price. Prof. Beaham defines as under:

“The demand for anything at a given price is the amount of it which will be brought per unit of time at that price.”

Demand varies with price. It varies inversely with price. If the price rises the demand contracts and if the price falls the demand extends. This responsiveness depends on many factors the effective demand for necessaries generally do not change with price. In other words the effective demand for necessaries is inelastic. The may rise or fall but the effective demand for necessaries remain practically the same. The effective demand for comforts is elastic. In other words variation in for comforts is in perpotion to a change in price.

Principles of Economics

Economics is an influential introductory textbook by American economists Paul Samuelson and William Nordhaus. It was first published in 1948, and has appeared in nineteen different editions, the most recent in 2010. It was the best selling economics textbook for many decades and still remains popular, selling over 300,000 copies of each edition from 1961 through 1976. The book has been translated into forty-one languages and in total has sold over four million copies.

Principles of Economicso Concept o Origin of the word Economics o Early Definitions of Economics o Smith’s Definition of Economics o Marshal’s Definition of Economics o Robbins Definition of Economics o Comparison of Marshall’s and Robbins Definitions of Economics o Scope of Economics o Meaning of Land o Characteristics of Land o Definition o Capital and Wealth o Formation of Capital o Importance of Capital o Efficiency of Labour o Characteristics of Labour o Factors Determining Efficiency of Labour o Division of Labour o Mobility of Labour o Criticism

o Definition of Marginal Utility o Law for Equi-Marginal Utility o Introduction of Law of Demand o Demand Schedule o Demand Curve o Elasticity of Demand o Measurment of Elasticity o Malthusian Theory of Population o Propositions of The Theory o Economics of Scale o Laws of Returns o Importance o Price Determines the Demand o Monopoly o Market Price o Definition of National Income o Concepts of National Income o Methods of Calculating National Income o Difficulties Faced while Calculating National Income o Importance of National Income Computation in Modern Economic Analysis o Definition of Rent o Recardian Theory of Rent o Quasi Rent o Modern Theory of Rent o Wages and Its Forms o Why Interest is Paid? o Factors Determining Real Wages o Relative Wages o Causes of Differences o Interest, Gross Interest and Net Interest o Constituents of Gross Interest o Liquidity Preference Theory o Profit, Pure or Net Profit, Gross Profit o Constituents of Gross Profit o Different Theories of Profit o Trade Union o Functions of Trade Unions o Importance of Labour Unions o Definition of Money o Functions of Money o Types of Money o Value of Money o Quantity Theory of Money o Importance of Money o Dangers of Money

o Bi Metallism o Gresham’s Law o Defects of Barter System o How Money Removed The Difficulties of Barter o Gold Standards o Advantages of Gold Standard o Market

Devaluation of Money

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