Indian Economy and Economic Concepts

Poverty measurement methods

Poverty measurement in India rests on a poverty line, the minimum level of consumption expenditure needed to meet basic needs, and on counting the population whose spending falls below that line. Early estimates relied on calorie norms, and the Lakdawala approach set poverty lines at the state level. The Tendulkar Committee of 2009 changed the method by estimating poverty from monthly per capita consumption expenditure (MPCE) computed on a Mixed Reference Period (MRP), in which recall periods for different items are mixed. Its poverty line was based on an all-India urban consumption basket applied to both rural and urban areas, so it no longer used calorie intake as the anchor.

The calorie norms traditionally used in India are 2400 kilocalories per person per day in rural areas and 2100 kilocalories per person per day in urban areas. A calorie-based poverty line is the expenditure needed to obtain these calories together with essential non-food requirements such as clothing, footwear, fuel and light, education and health.

Multidimensional measurement looks beyond money income. The National Multidimensional Poverty Index prepared by NITI Aayog uses 12 indicators in three equally weighted dimensions: health, education and standard of living. The education dimension has two indicators, years of schooling and school attendance. Under the nutrition indicator, a household is deprived if any member for whom data are available is undernourished, and an adult with a body mass index below 18.5\ \mathrm{kg/m^2} is classed as undernourished.

Money supply measures

Money supply is measured in layers, labelled M1 to M4, and each layer adds a further category of liquid assets. Narrow money, M1, equals currency held by the public plus demand deposits with banks plus other deposits held with the Reserve Bank of India. Banker's deposits with the Reserve Bank are excluded because banks hold them as reserves, and they are not money in the hands of the public. Time deposits are excluded from M1 because they are not payable on demand.

M2 adds savings deposits with post office savings banks to M1. Broad money, M3, adds time deposits with banks to M1, and M4 adds total deposits with post office savings organisations to M3. M3 is the most widely used measure in India and is the headline indicator of money supply published by the Reserve Bank.

The composition of money matters for the money multiplier. The money multiplier depends on the currency-deposit ratio. If people hold more cash and fewer bank deposits, less of each unit of reserve money returns to banks as deposits, so banks create less credit and the money multiplier falls. Total demand for money is not raised by this shift; only its form changes.

National income accounting concepts

National income accounts distinguish between nominal and real values. Nominal GDP values the output of each year at that year's current prices. Real GDP values the output of every year at the prices of a common base year, so that changes reflect quantity rather than price changes. Potential GDP is the real output the economy can produce when all its resources are fully employed. Real GDP per capita is obtained by dividing real GDP by population.

The GDP deflator is the ratio of nominal GDP to real GDP multiplied by 100, that is, \text{GDP deflator} = \frac{\text{Nominal GDP}}{\text{Real GDP}} \times 100. It uses the basket of goods and services produced in the current year, so the basket changes over time, and it is not an unchanging basket. The deflator measures the average change in prices, and the inflation rate is derived from it; real GDP is obtained by dividing nominal GDP by the deflator.

Under the expenditure method, GDP = C + I + G + (X - M), so imports are subtracted. Net factor income earned from abroad is added to GDP to obtain Gross National Product, not GDP itself. Purchases and sales of second-hand goods are excluded because they do not represent new production. Changes in inventories form part of gross domestic capital formation.

Demand curve and law of demand

The demand curve plots the quantity of a good demanded against its own price, holding other determinants constant. The law of demand states that, other things being equal, a fall in a good's own price raises the quantity demanded. A change in the good's own price therefore causes a movement along the existing demand curve.

Changes in other determinants shift the entire curve rather than causing a movement along it. These determinants include the prices of related goods, consumer income, tastes and preferences, and expectations. Prices of complementary goods and substitutes are examples of such shifters. A rise in the price of a complement lowers demand for the good, and a rise in the price of a substitute raises it.

Input prices are costs faced by producers. They shift the supply curve, not the demand curve, so they do not directly affect the quantity consumers demand at a given price. Under a horizontal, fully elastic supply curve, the equilibrium price is fixed. A leftward shift of demand then reduces the equilibrium quantity while the price stays the same.

Human development approaches

The Human Development Index combines three dimensions: a long and healthy life measured by life expectancy at birth, knowledge measured by expected and mean years of schooling, and a decent standard of living measured by GNI per capita at purchasing power parity. Progress in each component is tracked separately in the UNDP Human Development Reports. In the 2020 report, gains for India are recorded in life expectancy at birth and in GNI per capita.

The UNDP human development approach rests on four pillars: productivity, equity, sustainability and empowerment. Equity refers to fair access to opportunities, sustainability to preserving opportunities for future generations, and productivity to human capabilities that raise output. Security is not one of the four pillars, although it is closely related to human development.

Gross National Happiness is a development philosophy that emphasises sustainable development, cultural preservation, environmental conservation and good governance rather than income alone. Bhutan is the only country to have officially adopted Gross National Happiness as the measure of its national progress.

Market structures

Monopolistic competition has many sellers, free entry and exit, and differentiated products. Each firm faces a downward-sloping demand curve and sets its own price. Branded soaps are a standard example, because brands are close but distinct substitutes and advertising and packaging create product differentiation. The defining features are product differentiation and a large number of buyers and sellers, while barriers to entry are absent. Homogeneous products are a feature of perfect competition, not of monopolistic competition.

Market structures differ in how efficient their output is. A perfectly competitive firm produces where price equals marginal cost, which is the socially optimal level of output. A monopoly firm restricts output below the socially efficient level, where price exceeds marginal cost, and this causes a deadweight loss. An oligopoly firm is interdependent, so it must anticipate the reactions of rival firms when it takes decisions.

GST coverage and exclusions

The Goods and Services Tax subsumed most indirect taxes levied by the Centre and the states, including central excise duty, service tax, state value added tax and entertainment tax. Goods such as cosmetics, jewellery and medical grade oxygen are taxable under GST at different rates, and examples include a standard rate for cosmetics, a reduced rate for medical grade oxygen and a concessional rate for jewellery.

Some items were deliberately kept outside GST. Alcoholic liquor for human consumption and a set of petroleum products, including motor spirit (petrol), are excluded. Taxes on these items continue under separate levies, such as central excise and state value added tax on petroleum products.

Basic customs duty on imports was kept outside GST and continues alongside the integrated tax on imports. Among the taxes listed in the question, taxes on petroleum and petroleum products remain outside the GST regime. Specific GST rates are fixed for certain goods, and they must be memorised accurately. Precious metals such as gold and silver attract a rate of 3 per cent, while unworked diamonds attract 0.25 per cent.

Monetary and fiscal policy effects

Contractionary monetary policy, such as a rise in the policy rate or an open market sale of securities, raises interest rates. Expansionary fiscal policy, which raises government borrowing and spending, also pushes interest rates upward. When contractionary monetary policy and expansionary fiscal policy are combined, the interest rate rises unambiguously. A higher domestic interest rate attracts foreign capital inflows, which increase demand for the domestic currency and cause it to appreciate. Expansionary monetary policy lowers interest rates, so combining it with either fiscal stance does not give an unambiguous rise.

To control inflation, the government and central bank must reduce money supply and aggregate demand. Raising interest rates on savings and fixed deposits encourages saving and reduces spending and borrowing. By contrast, higher non-planned government expenditure raises aggregate demand, export subsidies boost domestic demand, and a cut in the cash reserve ratio releases funds for bank lending. All three add to inflationary pressure.

Open market operations change money supply directly. When the central bank buys Treasury Bills or foreign exchange from the public, it injects money into circulation. When it sells Treasury Bills or foreign exchange to the public, it absorbs money and contracts the money supply.

Types of unemployment

Structural unemployment arises when the skills, occupations or locations of job seekers do not match the vacancies on offer. It is a long-term mismatch and typically results from technological change or from a lasting shift in demand for particular products. A mismatch between the regional or occupational pattern of vacancies and the pattern of worker availability is a textbook case of structural unemployment.

Cyclical unemployment rises during a downturn because of a deficiency of aggregate demand and falls when the economy recovers. Frictional unemployment is short-term joblessness while a worker searches for or moves between jobs. Disguised unemployment means that surplus workers appear to be employed but add nothing to output, as is often seen in agriculture.

Government budget deficits

The fiscal deficit is the excess of the government's total expenditure over its total receipts, excluding borrowings. It is written as \text{Fiscal deficit} = \text{Total expenditure} - (\text{Total receipts} - \text{Borrowings}), and it shows the total amount the government must borrow to finance its spending. The primary deficit equals the fiscal deficit minus interest payments, so it shows the borrowing needed for current expenditure apart from interest obligations. The current deficit concerns only the revenue account, that is, revenue expenditure in excess of revenue receipts.

Deficit financing means covering a budget gap by borrowing or by creating money. The idea is closely associated with John Maynard Keynes, who argued that government spending financed by a deficit can raise aggregate demand and help an economy recover from depression.

Exchange rate systems

An exchange rate states the value of one currency in terms of another. Under a fixed exchange rate system, the rate is set by government decision and maintained by government or central bank intervention in the foreign exchange market. Under a floating system, the rate is determined by market demand and supply, although authorities may intervene occasionally.

The Bretton Woods System pegged currencies to the US dollar, which was convertible to gold at a fixed price, so exchange rates were fixed rather than floated. Under the classical gold standard, currencies were fixed in terms of their gold content.

Devaluation or depreciation of a currency makes domestic goods cheaper for foreign buyers, so exports tend to rise. Foreign goods become dearer in domestic currency, so imports tend to fall. Higher prices of imported goods and inputs raise the domestic price level, so devaluation tends to increase domestic inflation.

Loan terms and interest rates

Collateral is an asset that a borrower pledges to guarantee repayment of a loan. If the borrower defaults, the lender may take possession of the collateral to recover the amount owed. Other instruments in banking are different: a cheque is a payment instrument, a guarantee card certifies cheque payments, and a bond is a debt security issued by a borrower.

The nominal interest rate is the percentage by which the money repaid exceeds the principal borrowed, measured in money terms without adjusting for inflation. The real interest rate adjusts the nominal rate for inflation, so it is approximately the nominal rate minus the inflation rate. The bank rate is the rate at which the central bank lends to commercial banks, and the terms of credit are the conditions attached to a loan.

Indian tax administration and e-governance

India's direct and indirect taxes are administered by the Central Board of Direct Taxes and the Central Board of Indirect Taxes and Customs, and both rely heavily on electronic filing, online payment and digital appeal systems, a model usually called e-governance. Within this framework, the Income Tax Appellate Tribunal (ITAT) is the appellate forum for income tax disputes, and its e-Dwar portal allows taxpayers and authorised representatives to lodge appeals and related papers electronically. Learners should note that such a name denotes a government digital service, not a publication, a monument or a heritage site.

The Goods and Services Tax is the other key topic. The Constitution (One Hundred and First Amendment) Act, 2016 introduced GST and gave both Parliament and the State legislatures the power to make laws on it. In 2017 Parliament enacted the Central Goods and Services Tax Act, which levies central GST on intra-state supplies, the Integrated Goods and Services Tax Act, which covers inter-state supplies, and the Goods and Services Tax (Compensation to States) Act, which provides compensation to States for revenue loss. Each State, however, enacts its own State Goods and Services Tax Act through its legislature, so a State GST Act is not a parliamentary enactment and must be kept apart from the central set of 2017 laws.

Economic curves and indicators

Economists use standard curves to show how two economic variables move together, and each curve is associated with a particular relationship. The Lorenz curve plots the cumulative share of population against the cumulative share of income or wealth, so the further it bows away from the line of perfect equality, the greater the inequality in distribution. The Phillips curve shows the inverse relationship between inflation and unemployment in the short run. The Engel curve shows that the share of income spent on food falls as household income rises, a pattern known as Engel's law. The Laffer curve relates the tax rate to the tax revenue collected; revenue rises at low rates and falls beyond a certain rate because economic activity is discouraged.

Indicators of the financial cycle, meaning the expansion and contraction of credit and asset prices, are tracked most often by the credit-to-GDP ratio. Analysts pay particular attention to the gap between this ratio and its long-run trend, which the Bank for International Settlements uses to signal the build-up of financial imbalances. Tax-to-GDP, fiscal deficit-to-GDP and household consumption-to-GDP ratios describe revenue capacity, fiscal stance or the composition of demand, and they are not the primary financial-cycle indicators.

Factors of production

The classical factors of production are land, labour, capital and entrepreneurship, and they are combined to produce goods and services. Capital is commonly divided into physical capital and human capital. Physical capital comprises the man-made inputs used in production, such as tools, machines, buildings, raw materials and the money needed at each stage of production. Human capital, by contrast, is the knowledge, skills and health embodied in workers.

The funds a firm keeps in hand to meet input costs at each stage of production are called working capital, whereas durable assets used over many production cycles form fixed capital.

Land requirements differ sharply across sectors. Agriculture depends heavily on land, whereas non-farming activities such as manufacturing, trade and services are carried out in factories, offices and workshops. These activities therefore need comparatively little land and rely more on labour, capital and raw materials.

Foreign direct investment

Foreign direct investment (FDI) is investment by a resident of one country in an enterprise in another country, made with a lasting interest and a degree of management influence. The International Monetary Fund treats a voting stake of 10 per cent or more as the threshold for this kind of influence. Setting up a new company, institution or plant in India, such as a foreign-owned educational institution, is therefore FDI, because it is a long-term productive commitment that gives the investor control over the activity.

Purchases of listed shares that do not confer management control are classified as foreign portfolio investment rather than FDI, and this distinction is central to the concept. Government policy sets sectoral caps on FDI. In Union Budget 2025 the cap for the insurance sector was raised from 74 per cent to 100 per cent. Telecom has long allowed 100 per cent FDI under the automatic route, while defence is open up to 74 per cent under the automatic route.

Microfinance and NBFCs

Microfinance refers to the provision of very small loans, savings and insurance services to low-income households that lack access to ordinary bank credit. Loans are usually short-term and often unsecured, meaning they are granted without collateral. They are commonly delivered through joint-liability groups or self-help groups. Microfinance institutions normally set an upper limit on household income for eligibility and cap the size of each loan, and borrowers are expected to accept the agreed rate of interest stated in the loan contract.

Non-Banking Financial Companies (NBFCs) are companies that lend, invest and deal in securities but do not hold a banking licence. Because they are not banks, they cannot accept demand deposits and cannot issue cheques drawn on themselves. Their deposits are also not covered by the deposit insurance scheme of the Deposit Insurance and Credit Guarantee Corporation (DICGC). Lending and advances, however, form the core business of NBFCs, so they are fully entitled to give loans.

Inflation and deflation

Inflation is a sustained rise in the general price level, and deflation is a sustained fall in that level. Deflation is usually linked to a contraction of money supply or aggregate demand, and it can discourage spending because consumers expect prices to keep falling. A sustained decrease in the general price level is therefore called deflation.

Several related terms are often confused with it:

• Devaluation — a deliberate official reduction in the value of a currency relative to foreign currencies. Example: a government lowers the official peg of its currency.
• Recession — a decline in real output, which is a measure of activity and not of the price level.
• Disinflation — a slowdown in the rate of inflation while prices still rise.
• Reflation — a deliberate expansion of money and spending to lift prices after a deflationary phase.
• Shrinkflation — a company reducing the quantity or size of a product while keeping its price unchanged. Example: a 400 g pack is sold at the old price but now contains 350 g.

Monetary policy instruments

The Reserve Bank of India uses several instruments to influence liquidity and interest rates, including the repo rate, the reverse repo rate, the cash reserve ratio, the statutory liquidity ratio and open market operations. Under the liquidity adjustment facility (LAF), the policy rates form a corridor within which the overnight money rate moves. The standing deposit facility (SDF) lets banks park surplus liquidity with the central bank without providing government securities as collateral. The SDF was operationalised in April 2022 under the statutory framework created by an amendment to the RBI Act, and its rate replaced the fixed reverse repo rate as the floor of the LAF corridor.

Monetary transmission is the process by which changes in policy rates reach bank lending and deposit rates. It is tracked through bank-level rates such as the weighted average lending rate, the weighted average domestic term deposit rate and the one-year median marginal cost of funds based lending rate (MCLR). These indicators show how fully and how quickly policy changes pass through to borrowers and depositors. The SDF rate is an operating policy rate and does not itself measure transmission to lending and deposit rates.

MoSPI surveys and statistical agencies

The Ministry of Statistics and Programme Implementation (MoSPI) is the central nodal ministry for official statistics in India. It conducts a range of national surveys, including the Survey on Social Consumption (Health), the Comprehensive Modular Survey on Telecom and ICT skills, the Periodic Labour Force Survey (PLFS) and the Annual Survey of Unincorporated Enterprises. All of these surveys therefore fall under the ministry's responsibility.

The PLFS is the principal source of employment and unemployment statistics, and its reports are prepared by the National Statistical Office within MoSPI. The annual PLFS report for 2023-24 shows agriculture as the largest employing sector, with its share of total employment rising over the period since 2017-18. The share of women working in agriculture also increased, so sector shares and gender shares must be read separately.

Functions of money

Money is anything generally accepted as a means of payment, and it performs four classical functions:

• Medium of exchange — it serves as an intermediary in the exchange of goods and services, removing the need for barter. Example: a buyer pays cash to a shopkeeper for bread.
• Store of value — it keeps purchasing power over time.
• Unit of account — prices and values are expressed in terms of money.
• Standard of deferred payment — it is used to settle debts that are payable in the future.

Regulating consumption is not a function of money. The central bank may influence spending through monetary policy, but this is a policy outcome and not an inherent function of money.

Output gaps in GDP

Potential GDP is the level of real output an economy can produce when its resources are fully employed without generating accelerating inflation. The output gap is the difference between actual real GDP and potential GDP, and in percentage terms it is (Y - Y^{*})/Y^{*} multiplied by 100, where Y is actual real GDP and Y^{*} is potential GDP. When aggregate demand is insufficient, the equilibrium level of real GDP falls short of potential GDP, and the shortfall is called a recessionary gap, also known as a deflationary gap. A recessionary gap is associated with unemployment and idle productive capacity. The reverse case, in which equilibrium real GDP exceeds potential GDP, is an inflationary gap. Demand-side and supply-side inflation describe causes of rising prices and do not name the gap between equilibrium and potential output.

Stagflation

Stagflation is the situation in which an economy grows slowly or stagnates while the general price level rises rapidly, often together with high unemployment. It is distinct from stagnation alone, which lacks rapid inflation, from deflation, in which prices fall, and from recession, which is a decline in real output that need not involve rising prices.

Stagflation is difficult for policymakers because measures that curb inflation, such as tighter monetary policy, tend to deepen the slowdown, while measures that stimulate growth can add to inflationary pressure. Students should therefore recognise the combination of slow growth and rising prices as the defining feature of the term.

Crowding in effect

Crowding in refers to the rise in private investment that is induced by an increase in government spending. When the government spends more, national income and demand rise, and this improved outlook encourages private firms to invest more. Crowding in is therefore the positive counterpart of crowding out, in which higher government borrowing pushes up interest rates and reduces private investment.