FINAL TERM COURSE

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Chapter # 5. concepts of National income
National Income (NI)
National Income is also known as National Income at factor cost. National income at
factor cost means the sum of all incomes earned by resources suppliers for their
contribution of land, labor, capital and organizational ability which go into the years net
production. Hence, the sum of the income received by factors of production in the form
of rent, wages, interest and profit is called National Income. Symbolically,
NI=NNP+Subsidies-Taxes
Gross Domestic Product (GDP) The most important concept of national income is Gross
Domestic Product. Gross domestic product is the money value of all final goods and
services produced within the domestic territory of a country during a year.
Gross National Product (GNP) Gross National Product is the total market value of all
final goods and services produced annually in a country plus net factor income from
abroad. Thus, GNP is the total measure of the flow of goods and services at market value
resulting from current production during a year in a country including net factor income
from abroad.
Net National Product (NNP)
Net National Product is the market value of all final goods and services after allowing for
depreciation. It is also called National Income at market price. When charges for
depreciation are deducted from the gross national product, we get it. Thus,

NNP=GNP-Depreciation.
Personal Income (PI)
Personal Income i s the total money income received by individuals and households of a
country from all possible sources before direct taxes.
Disposable Income (DI)
The income left after the payment of direct taxes from personal income is called
Disposable Income. Disposable income means actual income which can be spent on
consumption by individuals and families. Thus, it can be expressed as:

DI=PI-Taxes
Per Capita Income (PCI)
Per Capita Income of a country is derived by dividing the national income of the country
by the total population of a country. Thus,
PCI=Total National Income/Total National Population

Chapter # 6. Money
Meaning of Money :
Money is a concept which we all understand but which is difficult to define in exact
terms.
Money is anything serving as a medium of exchange. Most definitions of money take
‘functions of money’ as their starting point. ‘Money is that which money does.’
According to Prof. Walker, ‘Money is as money does.’
This means that the term money should be used to include anything which performs the
functions of money, viz., medium of exchange, measure of value, unit of account, etc.
Since general acceptability is the fundamental characteristic of money, therefore, money
may be defined as ‘anything which is generally acceptable by the people in exchange of
goods and services or in repayment of debts.’
Functions of Money
In general terms, the main function of money in an economic system is “to facilitate the
exchange of goods and services and help in carrying out trade smoothly.” Its basic
characteristic is general acceptability. Functions of money are reflected in the following
well- known couplet:
“Money is a matter of functions A medium, a measure, a standard, a store.”
Thus conventionally money performs the following four main functions, each of which
overcomes one or the other difficulty of barter. Medium of exchange and measure of
value are primary functions because they are of prime Importance whereas standard of
deferred payment and store of value are called secondary functions because they are
derived from primary functions.
1. Money as the Medium of Exchange:
Money came into use to remove the inconveniences of barter as money has separated the
act of purchase from sale. Medium of exchange is the basic or primary function of
money. People exchange goods and services through the medium of money. Money acts
as a medium of exchange or as a medium of payments. Money by itself has no utility
(except perhaps to the miser). It is only an intermediary.
The use of money facilitates exchange, exchange promotes specialization Increases
productivity and efficiency A good monetary system is, therefore, of immense utility to
human society. Money is also called a bearer of options or generalized purchasing power
because it provides freedom of choice to buy things he wants most from those who offer
best bargain.
2. Money as a Unit of Account or Measure of Value:
Money serves as a unit of account or a measure of value. Money is the measuring rod,
i.e., it is the units in terms of which the values of other goods and services are measured
in money terms and expressed accordingly Different goods produced in the country are
measured in different units like cloth m metres, milk in litres and sugar in kilograms.
Without a common unit, exchange of goods becomes very difficult Values of all goods
and services can be expressed easily in a single unit called money Again without a
measure of value, there can be no pricing process. Without a pricing process organised
marketing and production is not possible. Thus, the use of money as a measure of value is
the basis of specialised production.
The measuring rod of money is also indispensable to all forms of economic planning.
Consumers compare the values of alternative purchases m terms of money Producers also
compare the values of alternative purchases m terms of money. Producers compare the
relative costliness of the factors of production in terms of money and also plan their
output on the basis of the money yield. It is, therefore, highly important that the value of
money should be stable.
3. Money as the Standard of Deferred Payments:
Deferred payments are payments which are made some time in the future. Debts are
usually expressed in terms of the money of account. Loans are taken and repaid in terms
of money.
The use of money as the standard of deferred or delayed payments immensely simplifies
borrowing and lending operations because money generally maintains a constant value
through time. Thus, money facilitates the formation of capital markets and the work of
financial intermediaries like Stock Exchange, Investment Trust and Banks. Money is the
link which connects the values of today with those of the future.
4. Money as a Store of Value:
Wealth can be stored in terms of money for future. It serves as a store value of goods in
liquid form. By spending it, we can get any commodity in future. Keynes places great
emphasis on this function of money. Holding money is equivalent to keeping a reserve of
liquid assets because it can be easily converted into other things.
People therefore normally wish to keep a part of their wealth in the form of money
because savings in terms of goods is very difficult. This desire is known as liquidity
preference. Clearly money is the best form of store of value. Wheat or any other product
which will command a value cannot be stored for a long period.
Another Function ‘Liquidity of Money’ is added these days. Money is perfectly liquid.
Liquidity means convertibility into cash. Thus, the ability to convert an asset into money
quickly and without loss of value is called liquidity of asset. Modern economists are
laying stress on liquidity of money.
Since, by definition, money is the most generally accepted commodity, it is also the most
liquid of all resources. Possession of money enables one to get hold of almost any
commodity in any place and money never locks a buyer. It is this peculiarity which
distinguishes money from all other commodities. A preference for liquidity is preference
for money.
Money, thus, acts as common medium of exchange, a common measure of value, as
standard of deferred payments and a store of value.

Types of Money
Commodity Money
Commodity money is the simplest and most likely also the oldest type of money. It builds
on scarce natural resources that act as a medium of exchange, store of value, and unit of
account. Commodity money is closely related to (and originates from) a barter system,
where goods and services are directly exchanged for other goods and services.
Commodity money facilitates this process, because it acts as a generally accepted
medium of exchange. The important thing to note about commodity money is that its
value is defined by the intrinsic value of the commodity itself. In other words, the
commodity itself becomes the money. Examples of commodity money include gold
coins, beads, shells, spices, etc.
Fiat Money
Fiat money gets its value from a government order (i.e. fiat). That means, the government
declares fiat money to be legal tender, which requires all people and firms within the
country to accept it as a means of payment. If they fail to do so, they may be fined or
even put in prison. Unlike commodity money, fiat money is not backed by any physical
commodity. By definition, its intrinsic value is significantly lower than its face value.
Hence, the value of fiat money is derived from the relationship between supply and
demand. In fact, most modern economies are based on a fiat money system. Examples of
fiat money include coins and bills.
Fiduciary Money
Fiduciary money depends for its value on the confidence that it will be generally accepted
as a medium of exchange. Unlike fiat money, it is not declared legal tender by
the government, which means people are not required by law to accept it as a means of
payment. Instead, the issuer of fiduciary money promises to exchange it back for a
commodity or fiat money if requested by the bearer. As long as people are confident that
this promise will not be broken, they can use fiduciary money just like regular fiat or
commodity money. Examples of fiduciary money include cheques, bank notes, or drafts.
Commercial Bank Money
Commercial bank money can be described as claims against financial institutions that can
be used to purchase goods or services. It represents the portion of a currency that is made
of debt generated by commercial banks. More specifically, commercial bank money is
created through what we call fractional reserve banking. Fractional reserve
banking describes a process where commercial banks give out loans worth more than the
value of the actual currency they hold. At this point just note that in essence, commercial
bank money is debt generated by commercial banks that can be exchanged for “real”
money or to buy goods and services.
Evolution of Money
Some of the major stages through which money has evolved are as follows: (i)
Commodity Money (ii) Metallic Money (iii) Paper Money (iv) Credit Money (v) Plastic
Money.
Money has evolved through different stages according to the time, place and
circumstances.
(i) Commodity Money:
In the earliest period of human civilization, any commodity that was generally demanded
and chosen by common consent was used as money.
Goods like furs, skins, salt, rice, wheat, utensils, weapons etc. were commonly used as
money. Such exchange of goods for goods was known as ‘Barter Exchange’
(ii) Metallic Money:
With progress of human civilization, commodity money changed into metallic money.
Metals like gold, silver, copper, etc. were used as they could be easily handled and their
quantity can be easily ascertained. It was the main form of money throughout the major
portion of recorded history.
(iii) Paper Money:
It was found inconvenient as well as dangerous to carry gold and silver coins from place
to place. So, invention of paper money marked a very important stage in the development
of money. Paper money is regulated and controlled by Central bank of the country (RBI
in India). At present, a very large part of money consists mainly of currency notes or
paper money issued by the central bank.
(iv) Credit Money:
Emergence of credit money took place almost side by side with that of paper money.
People keep a part of their cash as deposits with banks, which they can withdraw at their
convenience through cheques. The cheque (known as credit money or bank money),
itself, is not money, but it performs the same functions as money.
(v) Plastic Money:
The latest type of money is plastic money in the form of Credit cards and Debit cards.
They aim at removing the need for carrying cash to make transactions.

Chapter # 7. Inflation
1. Meaning of Inflation:
Inflation may be defined as ‘a sustained upward trend in the general level of prices’ and
not the price of only one or two goods. G. Ackley defined inflation as ‘a persistent and
appreciable rise in the general level or average of prices’. In other words, inflation is a
state of rising prices, but not high prices.
It is not high prices but rising price level that constitute inflation. It constitutes, thus, an
overall increase in price level. It can, thus, be viewed as the devaluing of the worth of
money. In other words, inflation reduces the purchasing power of money. A unit of
money now buys less. Inflation can also be seen as a recurring phenomenon.
It is to be pointed out here that inflation is a state of disequilibrium when there occurs a
sustained rise in price level. It is inflation if the prices of most goods go up. Such rate of
increases in prices may be both slow and rapid. However, it is difficult to detect whether
there is an upward trend in prices and whether this trend is sustained. That is why
inflation is difficult to define in an unambiguous sense.
The simplest definition of Inflation is “a rise in the general level of prices”. By the term
general, we mean if the price of one good has gone up it is not inflation, it is inflation
only if the prices of most goods have gone up. The opposite of inflation is deflation
which means a fall in the general level of prices.
Types of Inflation
1. Demand Pull Inflation: Inflation arises when there is an increase in the supply of
money but there is no corresponding increase in the supply of goods useful to the
community.
Accumulation of more money than before raises the purchasing power of people and
stimulates the demand for goods but the supply of the latter being limited, the necessary
consequence will be the inflation of the price level. Demand Pull Inflation thus means, in
plain words, too much money chasing too few goods.
2. Cost Push Inflation: When the prices of goods increases because of an increase in the
cost of production, it is known as cost push inflation. Cost-push inflation is one of two
main types of inflation within an economy. It refers to rising costs of production (usually
in the form of wages) contributing to increasing pricing pressure. One of the signs of
possible cost-push inflation can be seen in rising commodity prices, as commodities like
oil and metals are major production inputs.
Causes of inflation in Pakistan:
a. Population explosion: Our population is rising at a very fast that is 3%. On other
hand the rate of growth of GNP is not very high that is 5.4%. Thus increase in national
output is insufficient to solve the problem of scarcity of goods. Since independence, our
population has increase four times.
b. Political instability: A country’s economy depends upon political stability. Political
instability discourages investment and encourages speculation. Under such
circumstances, the industrialist and businessman feel unsecure and cannot make good
plans. The government also cannot adopt affective measures to control rise in prices.
c. Imported inflation: A very important cause of inflation in Pakistan is the existence
of inflation in other countries. Since 1970’s most countries are experiencing inflation.
The result in the Pakistan has to import machinery, raw material and other goods at
higher prices.
d. Nationalization: Due to nationalization of industrial in 1992, people were
discouraged to make investment in industrial. Moreover in Pakistan the nationalization
industrial sector did not perform well. They becomes centers of insufficient production,
high prices and poor quality goods were result.
e. Wages increases: The increase in wages of workers has also contributed to inflation.
Increase in wages result in higher cost of production of goods. So their price rises.
f. Climatic factors: Pakistan economies heavily depend upon agriculture but due to
weather condition many crops fall short of target, thus pushing up prices. For example
cotton production remain stagnant and below target during previous years. Wheat
production has also not kept pace with rising demand.
g. Oil crises: The oil prices in 1973 created by a large quantity of inflation throughout
the world. Import of oil is a high Burden on our foreign exchange reserves. At present 25
percent of our exports are used to pay for oil. From time to time, oil exporting countries
increase price of oil, which raises transport cost.
h. Artificial scarcity of goods: Frequent artificial scarcity of essential items is created
(cement, ghee, oil, sugar, etc) and huge profits are charged. Similarly through smuggling,
large quantity of essential goods is sent to Afghanistan and India.
i. Printing more money:
If the Central Bank prints more money, you would expect to see a rise in inflation. This is
because the money supply plays an important role in determining prices. If there is more
money chasing the same amount of goods, then prices will rise. Hyperinflation is usually
caused by an extreme increase in the money supply.
J. Interest rate:
There is a general tendency for interest rates and the rate of inflation to have an inverse
relationship. The Federal Reserve is responsible for implementing the country's monetary
policy, including setting the federal funds rate which influences the interest rates banks
charge borrowers.
In general, when interest rates are low, the economy grows and inflation increases.
Conversely, when interest rates are high, the economy slows and inflation decreases.
Control mechanism of Inflation
It is the main objective of every government to take proper measures to control inflation.
The main measures which are used to control inflation are:
1. Monetary policy.
2. Fiscal policy.
3. Direct measures and other measures.
1. Monetary policy:
Monetary policy is a policy that influences, the economy through changes in money
supply and available credit. Monetary policy is adopted by central bank of country. The
various monitory measures which are used to control inflation are grouped under heads.
a. Qualitative control.
b. Quantitative control.
2. Fiscal policy: Fiscal policy is the deliberate change in either government spending or
taxes to simulate or slow down the economy. It is the budgetary policy of government
relating to taxes, public expenses, public borrowing and deficit financing. Fiscal policy is
based upon demand management examples, raising or lowering the level of aggregate
demand by controlling various expenses, government expenses, consumption expenses.
3. Direct measures: It means the step of government like rationing of goods and
freezing of prices and wages. The government can also increase voluntary savings of
people by giving them various incentives.
Other measure:
a. Increase in output: The most effective method to control inflation is to increase the
supply of goods. For this purpose, industrial and agricultural out put should be increased.
However, Pakistan performance in this regard in unsatisfactory.
 b. Control of smuggling: All steps should be adopted to check these evils through
publicity as well as punishment. Large quantity of wheat, ghee, and other essential
commodities being smuggled to Afghanistan should be control.
c. Industrial peace: Industrial peace should be control to maintain the supply of goods
and avoid the danger of scarcity. The disturbance such as what happened at Karachi
during the post years? Should be control.

d. Control of money supply: Volume of credit and money supply should be control.
This can be done if tight monetary policy is followed. Decrease in money supply means
less purchasing power with the people.
e. No deficit financing: The development expenses should meet through taxation,
savings. Excessive issue of currency should not be used to meet budget deficit.
f. Population control: Measure should be adopted to decrease the rate of population
growth. The campaign of population planning has already started showing some success.
g. Simple living: Luxurious life style should be discouraged and simple living should be
adopted. The political leaders should themselves adopt simple living and provide an
example for others.

Chapter # 8. Public Finance

Public Finance Public finance is a study of income and expenditure or receipt and
payment of government. It deals the income raised through revenue and expenditure
spend on the activities of the community and the terms ‘finance’ is money resource i.e.
coins. But public is collected name for individual within an administrative territory and
finance. On the other hand, it refers to income and expenditure. Thus public finance in
this manner can be said the science of the income and expenditure of the government.

Different economists have defined public finance differently. Some of the definitions are
given below.
According to prof. Dalton “public finance is one of those subjects that lie on the border
lie between economics and politics. It is concerned with income and expenditure of
public authorities and with the mutual adjustment of one another. The principal of public
finance are the general principles, which may be laid down with regard to these matters.

According to Adam Smith “public finance is an investigation into the nature and
principles of the state revenue and expenditure”

To sum up, public finance is the subject, which studies the income and expenditure of the
government. In simpler manner, public finance embodies the study of collection of
revenue and expenditure in the public interest for the welfare of the country.
Government revenue
Government revenue is money received by a government. It is an important tool of the
fiscal policy of the government and is the opposite factor of government spending.
Revenues earned by the government are received from sources such as taxes levied on the
incomes and wealth accumulation of individuals and corporations and on the goods and
services produced, exports and imports, non-taxable sources such as government-owned
corporations incomes, central bank revenue and capital receipts in the form of external
loans and debts from international financial institutions.
Public expenditure
Public expenditure refers to Government expenditure i.e. Government spending. It is
incurred by Central, State and Local governments of a country. Public expenditure can be
defined as, "The expenditure incurred by public authorities like central, state and local
governments to satisfy the collective social wants of the people is known as public
expenditure."
Throughout the 19th Century, most governments followed laissez faire economic policies
& their functions were only restricted to defending aggression & maintaining law &
order. The size of pubic expenditure was very small. But now the expenditure of
governments all over has significantly increased. In the early 20th Century, John
Maynard Keynes advocated the role of public expenditure in determination of level of
income and its distribution. In developing countries, public expenditure policy not only
accelerates economic growth & promotes employment opportunities but also plays a
useful role in reducing poverty and inequalities in income distribution.
Tax
Government earns revenue through plenty of ways like interests ,dividends, trading
profits etc and tax is one of the primary tool of revenue. Some one rightly describes tax
as;
“A fine is a tax for doing something wrong whilst tax is a fine for doing something right.”
Direct Tax:
A direct tax is the money paid directly to the imposing authority which most of the time
is the government or the municipal authority. These are the form of taxes which is
directly paid to the central and state government by the people levied. The burden of
paying direct tax cannot be shifted to another person as the name suggests it, it is to be
directly paid to the central or state govt.Examples of direct taxes include the income tax,
the corporate taxes, property taxes, and gift taxes.
Indirect Tax:
An indirect financial charge that is collected by an intermediary from the ultimate bearer
of the cost. The intermediary files a tax return later and submits the collected amount to
the imposing authority or government. Unlike direct tax, the burden of the tax can be
shifted onto others, or consumers specifically on the goods and services they are availing
them. Indirect taxes are paid to the government within chain which includes the
consumers and retailers. Some of the examples of indirect taxes include the value-added
tax, the central tax, customs duty, service tax, and securities transaction tax among others.