How does government infrastructure projects boost GDP ?

Let us take very simple case.

let us assume govt. has to construct a road for public utility.

Cost of a road project is Rs 100.

Expenditure of govt. will be income of somebody . Let us assume that somebody is person A.

Person A saves 20% and spends 80% of his income. This means person A saves Rs 20 and spends Rs. 80.

Here is the interesting part now.

Expenditure of person A will be income of , let us assume, person B.

Person B also saves 20% and spends 80% of his income. This means he saves Rs. 16 and spends Rs. 64.

Expenditure of person B will be income of person C so on and so forth.

As we know that all the expenditure happened in this case will be counted in GDP of a country.

So GDP= 100+0.8 x 100+0.8 x 0.8 x 100 + ...

This is a geometric series and hence total GDP = 100/0.2= 500


So if govt spends 100 Rs on a project  then GDP increases to 500 Rs.

This called a multiplier effect in economics. In this particular case multiplier is 5.

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Why onion prices are so high in current time ( Supply side Inflation)?

How does inflation occur from supply side?

Price of any good or service depends on supply and demand of that good or service.

If supply of any good or service increase then price will decrease and vice a versa.

Following factors of production create inflation from supply side.

• Industrial disputes between labor and management

            If there is a dispute between labor and management then strike will occur. this reduces the               output of a company. Hence supply of produce will go down and hence inflation will occur.

• Shortage of factors of production:

           Man : why an engineer gets more salary than a worker?

 Because more workers are available to do less skillful job than engineers are . So shortage of   skilled labor creates dives up the salaries. 

          Machine: Why govt. gives subsidy to farmer to buy tractor? 

   Because if farmer uses tractor he will produce more crop. So supply of farm produce will increase and inflation can be controlled. So Lack of machine will give rise to inflation.

          Money: Why government banks such as SIDBI gives loan to farmers at very less interest rates? or why  Modi govt. has created a new bank, MUDRA? 

 Without money nobody will be able to buy machines or hire men to produce goods and services. MUDRA bank provides loans to small vendors such as small fruit vendor. A small fruit vendor uses his small cart to sell his fruits. Imagine if he buys a small 3 wheeler. So he can bring   his perishable items to market very easily. So he can sell more fruits in market increasing supply and reducing inflation.

        Material: Why price of gold is more than price of steel?

  As availability of gold is less than the availability of steel, supply of gold is less in the market. Due to this price of gold is very high or we can say that the price is inflated. This is supply side inflation. 

                          

                                                 

• Natural calamities:

          Why El-Nino was so much in News few days back?

 El-Nino is a climatic situation in which Australia and India will face shortage of monsoon. The monsoon shortage affect India's agricultural produce. This will give rise to the inflation of food prices. Thats why India in the recent past was facing inflation of daily food items. Inflation level was around 10%. 

• Black marketing creating artificial shortage:

          Why onion prices were so high in the recent time?

          Middle men or traders create artificial shortage due to which supply of onion in the market goes down and onion prices sky-rocket. 

          

why does share price of a company fluctuate in share market?

let's take a simple example.
let us assume a country called RICE-LAND.
everyone in this country eats only rice. Some farmers produce only rice.
In economics, price of any good depends on supply and demand.

Now, lets assume meteorological department of country predicts that there is not going to be enough monsoon this year. So people in this country will face food shortage in coming time. So people will go in market and purchase extra rice than they need . Thus they create extra demand and food price will shoot up.

Similarly, if meteorological dept. says that there is going to be enough monsoon  then rice price is going to be stable or will slightly go down. Because there will be enough rice in the market and people won't think that there is going to be a shortage in the near future.

Same phenomenon occurs in the share market. If people feel that due to certain market conditions company is going to make huge profit in the future then they start buying that share. Thus the demand of the share increases. And hence the price also increases.

 

Why RBI can not print money all the time & distribute to poor?

Here is a good example.

Let’s assume a country called RICE-LAND where everybody eats rice.

Cost of rice is Rs1/kg.

RICE-LAND produces 100 kg rice each year. Cost of production is Rs.100

What if the government decides to print money &  give its money to poor to eradicate poverty?

Because people get money, they will go and buy rice in the market.

So demand of rice will increase.

So the people who earn money by hard work won’t have enough rice to eat and price of rice will increase.

This explains how printing money will give rise to inflation.

Now what should the government do in this case?

Government in this case will actually give subsidy to farmers. Let us assume subsidy of Rs.10 to buy tractor.

Due to farm mechanization farmer will be able to produce extra 10 kg rice or more than that.

Now cost of production of rice is Rs.110 and crop produced is 110 Kg.

So still you got cost of per kg rice Rs. 1/Kg.

And economic activity in the country increased which we call as GDP.

This gives a pretty good example how subsidies increase the GDP of country and why RBI cant print huge amount of money and distribute.

How depreciation of currency can create problem for a company?

How depreciation of currency can create problem for a company



Due to globalization, multinational companies raise their loans in foreign currencies. So depreciation of currency will create problems to pay the loan.

 e.g. Let us assume company X in India has taken loan from some bank in USA in dollars. At the time of taking loan exchange rate was Rs.50 per dollar.

Due to certain macroeconomic instabilities, let us assume indian currency depreciated. Now the exchange rate is Rs. 60 per dollar.

So company has to pay more money now. 

So devaluation of currency brings potential ruin to companies that have borrowed in foreign currency.