business economics presentation

8/12/2019 Business Economics Presentation

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Chapter 6: MeasuringNational Output and

National Income


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Outline

I. The concept of Gross Domestic Product (GDP)

II. Calculating GDP

1. The expenditure approach

2. The Income approachIII. Nominal GDP V.S. Real GDP

IV. Limitations of the GDP


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National Income

and Product Accounts National income and p rodu ct accounts

are data collected and published by thegovernment describing the variouscomponents of national income and output in

the economy.

The U.S. Department of Commerce isresponsible for producing and maintainingthe National Income and Product Accounts

that keep track of GDP.


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I. The Concept of Gross Domestic

Product

Gross domest ic product (GDP)isthe total market value of all final goodsand services produced within a givenperiod by factors of production locatedwithin a country.


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Final Goods and Services

The term f inal goods and serv icesinGDP refers to goods and servicesproduced for final use.

Intermediate goodsare goodsproduced by one firm for use in furtherprocessing by another firm.


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Value Added

Value addedis the difference between thevalue of goods as they leave a stage ofproduction and the cost of the goods as they

entered that stage.


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Value Added

Value Added in the Production of a Gallon of Gasoline

(Hypothetical Numbers)

STAGE OF PRODUCTION VALUE OF SALES VALUE ADDED

(1) Oil drilling $ .50 $ .50

(2) Refining .65 .15

(3) Shipping .80 .15

(4) Retail sale 1.00 .20

Total value added $ 1.00


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Exclusions of Used Goods

and Paper Transactions

GDP ignores all transactions in whichmoney or goods change hands but inwhich no new goods and services areproduced.


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Exclusion of Output Produced Abroad

by Domestically Owned Factors of Production

GDP is the value of output produced byfactors of production located w ithin acount ry. Output produced by a countrys

citizens, regardless of where the output isproduced, is measured by gros s nationalp rodu ct (GNP).


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II. Calculating GDP

GDP can be computed in two ways:

The expenditu re approach: A method ofcomputing GDP that measures the total

amount spent on all final goods during agiven period.

The income app roach: A method ofcomputing GDP that measures the

incomewages, rents, interest, andprofitsreceived by all factors ofproduction in producing final goods.


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II. Calculating GDP

1. The Expenditure Approach

Expenditure categories:

Personal consumpt ion expend i tures (C)

household spending on consumer goods.

Gross pr ivate domest ic

investment (I)spending by firmsand households on new capital:plant, equipment, inventory, and newresidential structures.


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II. Calculating GDP


Government consumpt ion and gros s

investment (G)

Expenditure categories:

Net exports (EX IM)netspending by the rest of the world, orexports (EX) minus imports (IM)


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II. Calculating GDP


The expenditure approach calculates GDP byadding together the four components ofspending. In equation form:

GDP C I G EX IM ( )


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Personal Consumption

Expenditures

Personal consumption expenditures(C) are expenditures by consumers

on the following: Durable goods

Nondurable goods

Services


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Gross Private Domestic Investment

Investmentrefers to the purchase of newcapital.

Total investment by the private sector is

called gros s p r ivate domest ic investment.It includes the purchase of new housing,plants, equipment, and inventory by theprivate sector:


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Nonresident ia l investment

Residential investment

Change in inventor ies


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Remember that GDP is not the market valueof total sales during a periodit is the marketvalue of total production.

The relationship between total production andtotal sales is:

GDP = final sales + change in business inventories


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Gross Investment

versus Net Investment Gross investmentis the total value of all newly

produced capital goods (plant, equipment, housing,and inventory) produced in a given period.

Depreciationis the amount by which an assetsvalue falls in a given period.

Net investmentequals gross investment minusdepreciation.

capitalend of period= capitalbeginning of period+ net investment


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Government Consumption

and Gross Investment

Government consumpt ion

and gross investment (G)counts expenditures by federal,

state, and local governmentsfor final goods and services.


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Net Exports

Net exports (EX IM)is the differencebetween exports and imports. The figure canbe positive or negative.

Expor ts (EX)

Impo rts (IM)


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Components of GDP, 1999:

The Expenditure ApproachComponents of GDP, 2002: The Expenditure Approach

BILLIONS OF

DOLLARS

PERCENTAGE

OF GDP

Personal co nsum pt ion expenditures (C) 7303.7 69.9

Durable goods 871.9 8.3

Nondurable goods 2115.0 20.2

Services 4316.8 41.3

Gross private domest ic inv estment ( l) 1543.2 14.8

Nonresidential 1117.4 10.7

Residential 471.9 4.5

Change in business inventories 3.9 0

Government cons ump t ion and gros s investment (G) 1972.9 18.9

Federal 693.7 6.6

State and local 1279.2 12.2

Net exports (EX IM) 423.6 4.1

Exports (EX) 1014.9 9.8

Imports (IM) 1438.5 13.8

Total gross dom est ic produ ct (GDP) 10446.2 100.0

Note: Numbers may not add exactly because of rounding.

Source: U.S. Department of Commerce, Bureau of Economic Analysis.


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II. Calculating GDP

The Income Approach

Nat ional incomeis the total income earnedby the factors of production owned by acountrys citizens.

The income app roachto GDPbreaks downGDPinto four components:

GDP= national income+ depreciation+ (indirecttaxessubsidies) + net factor payments to the restof the world + other


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II. Calculating GDP

The Income Approach

Components of GDP, 2002: The Income Approach

BILLIONS OF

DOLLARS

PERCENTAG

E

OF GDP

National income 8,199.9 80.3Compensation of employees 6,010.0 58.9

Proprietors income 943.5 7.3

Corporate profits 748.9 7.3

Net interest 554.8 5.4

Rental income 142.7 1.4Depreciation 1,351.3 13.2

Indirect taxes minus subsidies 739.4 7.2

Net factor payments to the rest of theworld

11.1 0.1

Other96.1

0.9

Gross domestic roduct 10 205.6 100.0


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From GDP to Disposable Personal

Income

GDP, GNP, NNP, National Income, Personal Income, and Disposable Personal

Income, 2002

DOLLARS

(BILLIONS)

GDP10,205.6

Plus: receipts of factor income from the rest of the world + 342.1

Less: payments of factor income to the rest of the world 353.2

Equals: GNP 10,194.5Less: depreciation 1,351.3

Equals: net national product (NNP) 8,843.2

Less: indirect taxes minus subsidies plus other

643.3Equals: national income 8,199.9Less: corporate profits minus dividends 332.6

Less: social insurance payments 731.2

Plus: personal interest income received from the government andconsumers

+ 439.1

Plus: transfer payments to persons +1,148.7

Equals: personal income 8,723.9


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From GDP to Disposable Personal

Income

Net nat ional productequals gross nationalproduct minus depreciation; a nations total

product minus what is required to maintain

the value of its capital stock. Personal incomeis the income received by

households after paying social insurancetaxes but before paying personal income

taxes.


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Disposable Personal

Income and Personal Saving

Disposable Personal Income and Personal Saving, 2002

DOLLARS

(BILLION

S)

Disposable personal income 7,417.7

Less:

Personal consumption expenditures 7063.5

Interest paid by consumers to business 204.3

Personal transfer payments to foreigners 31.3

Equals: personal saving 118.6

Personal savings as a percentage of disposable personal

income:

1.6%

Source: See Table 18.2.


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Disposable Personal Income and

Personal Saving

The personal saving rateis the percentageof disposable personal income that is saved.

If the personal saving rate is low, households

are spending a large amount relative to theirincomes; if it is high, households arespending cautiously.


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III. Nominal Versus Real GDP

Nom inal GDPis GDP measured in currentdol lars, or the current prices we pay forthings. Nominal GDP includes all the

components of GDP valued at their currentprices.

When a variable is measured in currentdollars, it is described in nominal terms.


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Calculating Real GDP

A weightis the importance attached to anitem within a group of items.

A base yearis the year chosen for the

weights in a fixed-weight procedure.A f ixed-weigh t pro cedureuses weights from

a given base year.


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Calculating Real GDP

A Three-Good Economy

(1) (2) (3) (4) (5) (6) (7) (8)

GDP IN GDP IN GDP IN GDP IN

YEAR 1 YEAR 2 YEAR 1 YEAR 2

IN IN IN IN

PRODUCTION PRICE PER UNIT YEAR 1 YEAR 1 YEAR 2 YEAR 2YEAR

1

YEAR 2 YEAR

1

YEAR

2

PRICES PRICES PRICES PRICES

Q1 Q2 P1 P2 P1x Q1 P1x Q2 P2x Q1 P2X Q2

GoodA 6 11 $.50 $ .40 $3.00 $5.50 $2.40 $4.40

Good B 7 4 .30 1.00 2.10 1.20 7.00 4.00

Good C 10 12 .70 .90 7.00 8.40 9.00 10.80

Total $12.10 $15.10 $18.40 $19.20

NominalGDP

in year 1

NominalGDP

in year 2


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Calculating the GDP Deflator

The GDP deflator is one measure of theoverall price level. The GDP deflator iscomputed by the Bureau of Economic

Analysis (BEA). Overall price increases can be sensitive to

the choice of the base year. For this reason,using fixed-price weights to compute real

GDP has some problems.


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The Problems of Fixed Weights

1. Structural changes in the economy.2. Supply shifts, which cause large

decreases in price and largeincreases in quantity supplied.

3. The substitution effect of priceincreases.

The use of fixed price weights toestimate real GDP leads to problemsbecause it ignores:


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IV. Limitations of the GDP

GDP and Social Welfare

Society is better off when crime decreases,however, a decrease in crime is not reflectedin GDP.

An increase in leisure is an increase in socialwelfare, but not counted in GDP.

Nonmarket and household activities are notcounted in GDP even though they amount toreal production.


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GDP and Social Welfare

GDP accounting rules do not adjust forproduction that pollutes the environment.

GDP has nothing to say about the distribution

of output. Redistributive income policieshave no direct impact on GDP.

GDP is neutral to the kinds of goods aneconomy produces.


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The Underground Economy

The underground economyis thepart of an economy in whichtransactions take place and in which

income is generated that is unreportedand therefore not counted in GDP.


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Gross National Income per Capita

To make comparisons of GNP between countries,currency exchange rates must be taken into account.

Gross National Incom e (GNI)is a measure used tomake international comparisons of output. GNI is

GNP converted into dollars using an average ofcurrency exchange rates over several years adjustedfor rates of inflation.

GNI divided by population equals gross national

income per capita.


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Gross National Income per Capita

Per Capita Gross National Income for Selected Countries,

2002

COUNTRY U.S. DOLLARS COUNTRY U.S. DOLLARS

Switzerland 36,970 Portugal 10,670Japan 35,990 South Korea 9,400Norway 35,530 Argentina 6,860United States 34,870 Mexico 5,540Denmark 31,090 Czech

Republic5,270

Ireland 28,880 Brazil 3,060Sweden 25,400 South Africa 2,900

United Kingdom 24,230 Turkey 2,540Netherlands 24,040 Colombia 1,910

Austria 23,940 Jordan 1,750Finland 23,840 Romania 1,710Germany 23,700 Philippines 1,050Belgium 23,340 China 890France 22,640 Indonesia 680

Canada 21,340 India 460


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Review Terms and Concepts

base year

change in business inventories

compensation of employees

corporate profits

current dollars

depreciation

disposable personal income, or after-taxincome

durable goodsexpenditure approach

final goods and services

fixed-weight procedure

government consumption and grossinvestment (G)

gross domestic product (GDP)

gross investment

gross national income (GNI)

gross national product (GNP)

gross private domestic investment (I)

income approach

indirect taxesintermediate goods

national income

national income and product accounts


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Review Terms and Concepts

personal saving

personal saving rate

proprietors income

rental income

residential investment

services

subsidies

underground economy

value added

weight

net exports (EXIM)

net factor payments to the rest of theworld

net interest

net investment

net national product (NNP)

nominal GDP

nondurable goods

nonresidential investmentpersonal consumption expenditures (C)

personal income

Difficulties of Measurement of
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Difficulties of Measurement of

National income
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1. Lack of statistical data :-

In the less developing countries, theaccurate figures about the various sectorsof economy are not available due to this

we are unable to estimate the real nationalincome of the country.

2. Lack of staff :-There is a shortage of trained staff whichmay collect the statistics about the national

product.

3. Public co-operation :-

Public is also not ready to provide thecorrect figures about the income due to thefear of income tax.

4. No account :-Some people do not keep any properaccount about their business income, sotheir income is not included in the nationalincome.


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5. Difficulty in assessment :-Some goods and services value can not beassessed easily. For example the value ofdifferent Cows and Sheep's is very difficult.

6. Problem of double counting :-While computing the national income thereis always a danger of double counting. Ifthe care is not taken the national income isover estimated.

7. Unpaid services :-In national income only those services areincluded for which the payment is made.The unpaid services are excluded.

8. Assessment of depreciation :-The assessment of depreciation allowance,repair and replacement charges is a verydifficult job.

A landlord receives Rs. 1000 monthly arent of his house This rent will be included


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rent of his house. This rent will be includedin the national income. If this house ispurchased by the tenant. Now Rs.1000 willnot be paid by the tenant. So now Rs. 1000income of the tenanthas increased. Now

the controversial issue is that it should beincluded in the national income or not.

10. Transfer earnings :-

The transfer earnings like pensions areexcluded from the national income and itfeels problem.

11. Foreign payments :-We include only net foreign balance, if weinclude all the sources from which foreignpayment is received, it will be moredifficult.

12. Direct exchange :-

In the less developing areas peopleexchange the commodities with the

commodities and do not use the money. Sothe value of these goods can not be
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Chapter- 2

Macro Economic Framework

Cl i l h f d


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Classical theory of Income and

Employment The basic contention of classical economists was that if wages and prices were

flexible, a competitive market economy would always operate at full

employment. That is, economic forces would always be generated so as to

ensure that the demand for labour was always equal to its supply.

In the classical model the equilibrium levels of income and employment were

supposed to be determined largely in the labour market. At lower wage ratemore workers will be employed. That is why the demand curve for labour is

downward sloping. The supply curve of labour is upward sloping because the

higher the wage rate, the greater the supply of labour.


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The classical economists believed that aggregate demand wouldalways be sufficient to absorb the full capacity output Qo. In otherwords, they denied the possibility of under spending or overproduction.This belief has its root in Says Law.

(a) Says Law:According to Says Law supply creates its own demand,

i.e., the very act of producing goods and services generates an amountof income equal to the value of the goods produced. Says Law can beeasily understood under barter system where people produced (supply)goods to demand other equivalent goods. So, demand must be thesame as supply. Says Law is equally applicable in a modern economy.

The circular flow of income model suggests this sort of relationship. For

instance, the income created from producing goods would be justsufficient to demand the goods produced.

(b) Saving-Investment Equality:There is a serious omission in SaysLaw. If the recipients of income in this simple model save a portion oftheir income, consumption expenditure will fall short of total output andsupply would no longer create its own demand. Consequently there

would be unsold goods, falling prices, reduction of production,


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c) Saving-Investment Equality in the Money Market:The classicaleconomists also argued that capitalism contained a very special marketthemoney marketwhich would ensure saving investment equality and thus wouldguarantee full employment. According to them the rate of interest wasdetermined by the demand for and supply of capital. The demand for capital isinvestment and its supply is saving. The equilibrium rate of interest is

determined by the saving-investment equality. Any imbalance between savingand investment would be corrected by the rate of interest. If saving exceedsinvestment, the rate of interest will fall. This will stimulate investment and theprocess will continue until the equality is restored. The converse is also true.

(d) Price Flexibility:The classical economists further believed that even if therate of interest fails to equate saving and investment, any resulting decline intotal spending would be neutralized by proportionate decline in the price level.That is, Rs 100 will buy two shirts at Rs 50, but Rs 50 will also buy two shirts ifthe price falls to Rs 25. Therefore, if households saves more than firms wouldinvest, the resulting fall in spending would not lead to decline in real output, realincome and the level of employment provided product prices also fall in thesame proportion.


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(e) Wage Flexibility: The classical economists also believed that a decline inproduct demand would lead to a fall in the demand for labour resulting inunemployment. However, the wage rate would also fall and competition amongunemployed workers would force them to accept lower wages rather thanremain unemployed. The process will continue until the wage rate falls enoughto clear the labour market. So a new lower equilibrium wage rate will be

established. Thus, involuntary unemployment was logical impossibility in theclassical model.

K i h f &


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Keynesian theory of output &

Employment

Keynes theory of output and employment isoften called a monetary theory ofemployment. Outline the relations of

monetary factors in the relationship betweensavings and investment. What role does aprice mechanism play in determining the eq.between savings & investment?


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Keynes said, the consumption of the nation will also affect their income. Heformulated his analysis for the closed economy with no government, but thetheory could be extended.

So all income is either spent or saved. Y=C+S, whereas the income of thenation will be the investment expenditure + consumption. Y=C+I, it follows thatthe country is in equilibrium if S=I, but this is just stating an identity. In practice

the time lags are involved and C+S comes from the previous time period,whereas C+I forms the income for the next period.

It is the nature of people not to spend all their extra income, the proportion spentis the Marginal Propensity to Consume. At very low levels of income peopleactually dis save (live from previous stocks or borrow).


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So Keynes suggested in the case when full employment level was above Y1government intervention to increase I and ultimately C+I, so the level of nationalincome would rise. Friedeman called early Keynesians fiscalists. But the generaltheory does not mention fiscal policy, Keynes only mentions monetary policy.

Keynes took over the quantity theorists assumption about Ms=exogenous. Thedemand for money is Md=kPY according to the Cambridge approach. Keynes

accepted that but told this is not the complete picture. The Md should alsoinclude interest rate. So Md could be split to 3:

1. transactionary - like monetarists defined it, it is interest inelastic anddepends on how often one is paid the wage.

2. precautionary - for rainy days, much the same as 1.


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3. asset demand for money - liquidity preference L(r). This is interest elastic.So Keynes reformulated the Cambridge formulae: Md=kPY + L(r). Liquiditypreference showed the difference between how many bonds or money you liketo hold. If you have higher liquidity preference you hold more money. Amount ofmoney does not matter, aggregate demand can be anything with given amountof money, the velocity of circulation can be whatever, if people do not want to

spend, then extra money will be held in accounts.


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Central Bank & its functions

The central bank generally performs the following functions:

1. Bank of Note Issue:

The central bank has the sole monopoly of note issue in almost every country.

The currency notes printed and issued by the central bank become unlimited

legal tender throughout the country.

In the words of De Kock, "The privilege of note-issue was almost everywhereassociated with the origin and development of central banks."

However, the monopoly of central bank to issue the currency notes may be

partial in certain countries. For example, in India, one rupee notes are issued

by the Ministry of Finance and all other notes are issued by the Reserve Bank

of India.

The main advantages of giving the monopoly right of note issue to the central

bank are given below:

(i) It brings uniformity in the monetary system of note issue and note circulation.

(ii) The central bank can exercise better control over the money supply in the

country. It increases public confidence in the monetary system of the country.


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(iii) Monetary management of the paper currency becomes

easier. Being the supreme bank of the country, the central

bank has full information about the monetary requirements

of the economy and, therefore, can change the quantity of

currency accordingly.(iv) It enables the central bank to exercise control over the

creation of credit by the commercial banks.

(v) The central bank also earns profit from the issue of paper

currency.(vi) Granting of monopoly right of note issue to the central

bank avoids the political interference in the matter of note

issue.


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2. Banker, Agent and Adviser to the Government:

The central bank functions as a banker, agent and financial adviser to the

government,

(a) As a banker to government, the central bank performs the same functions

for the government as a commercial bank performs for its customers. It

maintains the accounts of the central as well as state government; it receivesdeposits from government; it makes short-term advances to the government; it

collects cheques and drafts deposited in the government account; it provides

foreign exchange resources to the government for repaying external debt or

purchasing foreign goods or making other payments,

(b) As an Agent to the government, the central bank collects taxes and other

payments on behalf of the government. It raises loans from the public and thusmanages public debt. It also represents the government in the international

financial institutions and conferences,

(c) As a financial adviser to the lent, the central bank gives advise to the

government on economic, monetary, financial and fiscal ^natters such as

deficit financing, devaluation, trade policy, foreign exchange policy, etc.


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3. Bankers' Bank:

The central bank acts as the bankers' bank in three capacities:

(a) custodian of the cash preserves of the commercial banks;

(b) as the lender of the last resort; and (c) as clearing agent. In this

way, the central bank acts as a friend, philosopher and guide to thecommercial banks

As a custodian of the cash reserves of the commercial banks the central

bank maintains the cash reserves of the commercial banks. Every

commercial bank has to keep a certain percentage of its cash balances

as deposits with the central banks. These cash reserves can be utilisedby the commercial banks in times of emergency.


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4. Lender of Last Resort:

As the supreme bank of the country and the bankers' bank, the central

bank acts as the lender of the last resort. In other words, in case the

commercial banks are not able to meet their financial requirementsfrom other sources, they can, as a last resort, approach the central bank

for financial accommodation. The central bank provides financial

accommodation to the commercial banks by rediscounting their

eligible securities and exchange bills.

The main advantages of the central bank's functioning as thelender of the last resort are :

(i) It increases the elasticity and liquidity of the whole credit structure

of the economy.

(ii) It enables the commercial banks to carry on their activities even

with their limited cash reserves. (iii) It provides financial help to the commercial banks in times of

emergency.

(iv) It enables the central bank to exercise its control over banking

system of the country.


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5. Clearing Agent:

As the custodian of the cash reserves of the commercial banks, the

central bank acts as the clearing house for these banks. Since all banks

have their accounts with the central bank, the central bank can easily

settle the claims of various banks against each other with least use of

cash. The clearing house function of the central bank has the followingadvantages:

(i) It economies the use of cash by banks while settling their claims

and counter-claims.

(i) It reduces the withdrawals of cash and these enable the commercial

banks to create credit on a large scale.

(ii) It keeps the central bank fully informed about the liquidity position

of the commercial banks.


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Commercial Bank & its functions

The main functions of commercial banks are accepting deposits from

the public and advancing them loans.

However, besides these functions there are many other functions which

these banks perform. All these functions can be divided under the

following heads:

1. Accepting deposits

2. Giving loans

3. Overdraft

4. Discounting of Bills of Exchange

5. Investment of Funds 6. Agency Functions

7. Miscellaneous Functions


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1. Accepting Deposits:

The most important function of commercial banks is to acceptdeposits from the public. Various sections of society, accordingto their needs and economic condition, deposit their savingswith the banks.

For example, fixed and low income group people deposit theirsavings in small amounts from the points of view of security,income and saving promotion. On the other hand, traders andbusinessmen deposit their savings in the banks for theconvenience of payment.

Therefore, keeping the needs and interests of various sectionsof society, banks formulate various deposit schemes. Generally,there ire three types of deposits which are as follows:


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(i) Current Deposits:

The depositors of such deposits can withdraw and deposit money whenever

they desire. Since banks have to keep the deposited amount of such accounts

in cash always, they carry either no interest or very low rate of interest. These

deposits are called as Demand Deposits because these can be demanded or

withdrawn by the depositors at any time they want. Such deposit accounts are highly useful for traders and big business firms

because they have to make payments and accept payments many times in a

day.

(ii) Fixed Deposits:

These are the deposits which are deposited for a definite period of time. This

period is generally not less than one year and, therefore, these are called as

long term deposits. These deposits cannot be withdrawn before the expiry of

the stipulated time and, therefore, these are also called as time deposits.

These deposits generally carry a higher rate of interest because banks can use

these deposits for a definite time without having the fear of being withdrawn.


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iii) Saving Deposits:

In such deposits, money upto a certain limit can be deposited and with-

drawn once or twice in a week. On such deposits, the rate of interest is

very less. As is evident from the name of such deposits their main

objective is to mobilise small savings in the form of deposits. These

deposits are generally done by salaried people and the people whohave fixed and less income.


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2. Giving Loans:

The second important function of commercial banks is to advance loans to its

customers. Banks charge interest from the borrowers and this is the main

source of their income.

Banks advance loans not only on the basis of the deposits of the public rather

they also advance loans on the basis of depositing the money in the accountsof borrowers. In other words, they create loans out of deposits and deposits out

of loans. This is called as credit creation by commercial banks.

Modern banks give mostly secured loans for productive purposes. In other

words, at the time of advancing loans, they demand proper security or

collateral. Generally, the value of security or collateral is equal to the amount

of loan. This is done mainly with a view to recover the loan money by sellingthe security in the event of non-refund of the loan.

At limes, banks give loan on the basis of personal security also. Therefore,

such loans are called as unsecured loan. Banks generally give following types

of loans and advances:


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(i) Cash Credit:

In this type of credit scheme, banks advance loans to its customers on the basis

of bonds, inventories and other approved securities. Under this scheme, banks

enter into an agreement with its customers to which money can be withdrawn

many times during a year. Under this set up banks open accounts of their

customers and deposit the loan money. With this type of loan, credit is created. (iii) Demand loans:

These are such loans that can be recalled on demand by the banks. The entire

loan amount is paid in lump sum by crediting it to the loan account of the

borrower, and thus entire loan becomes chargeable to interest with immediate

effect.

(iv) Short-term loan:

These loans may be given as personal loans, loans to finance working capital

or as priority sector advances. These are made against some security and entire

loan amount is transferred to the loan account of the borrower.


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3. Over-Draft:

Banks advance loans to its customers upto a certain amount through over-

drafts, if there are no deposits in the current account. For this banks demand a

security from the customers and charge very high rate of interest.

4. Discounting of Bills of Exchange:

This is the most prevalent and important method of advancing loans to thetraders for short-term purposes. Under this system, banks advance loans to the

traders and business firms by discounting their bills. In this way, businessmen

get loans on the basis of their bills of exchange before the time of their

maturity.

5. Investment of Funds:

The banks invest their surplus funds in three types of securitiesGovernment

securities, other approved securities and other securities. Government

securities include both, central and state governments, such as treasury bills,

national savings certificate etc.

Other securities include securities of state associated bodies like electricity

boards, housing boards, debentures of Land Development Banks units of UTI,shares of Re ional Rural banks etc.


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6. Agency Functions:

Banks function in the form of agents and representatives of their customers.

Customers give their consent for performing such functions. The important

functions of these types are as follows:

(i) Banks collect cheques, drafts, bills of exchange and dividends of the shares

for their customers. (ii) Banks make payment for their clients and at times accept the bills of

exchange: of their customers for which payment is made at the fixed time.

(iii) Banks pay insurance premium of their customers. Besides this, they also

deposit loan installments, income-tax, interest etc. as per directions.

(iv) Banks purchase and sell securities, shares and debentures on behalf of

their customers.

(v) Banks arrange to send money from one place to another for the

convenience of their customers.


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7. Miscellaneous Functions:

Besides the functions mentioned above, banks perform many other functions

of general utility which are as follows:

(i) Banks make arrangement of lockers for the safe custody of valuable assets

of their customers such as gold, silver, legal documents etc.

(ii) Banks give reference for their customers. (iii) Banks collect necessary and useful statistics relating to trade and industry.

(iv) For facilitating foreign trade, banks undertake to sell and purchase foreign

exchange.

(v) Banks advise their clients relating to investment decisions as specialist

(vi) Bank does the under-writing of shares and debentures also. (vii) Banks issue letters of credit.

(viii) During natural calamities, banks are highly useful in mobilizing funds

and donations.

(ix) Banks provide loans for consumer durables like Car, Air-conditioner, and

business economics presentation

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