MMPC-003 Solved Assignment

1) Circular flow of income and expenditure; difference between three-sector and four-sector models

What “circular flow” means

The economy can be understood as a continuous cycle in which income is generated and then spent again. One side of the cycle is the real flow (factors of production and goods/services). The other side is the money flow (factor payments and spending). The size of this circular flow is closely linked with the level of national income and overall economic activity.

Two-sector flow (basic picture)

• Households supply factors of production (land, labour, capital, entrepreneurship) to firms.
• Firms pay factor incomes (rent, wages, interest, profit) to households. This becomes household income (Y).
• Firms produce goods and services that households buy. Household spending becomes firms’ revenue.
• Financial intermediaries (like banks) channel household savings to firms for investment. In everyday life, you can observe this when households keep deposits in banks and firms borrow for expansion or working capital.

Leakages and injections (why the flow expands or contracts)

• Leakages/withdrawals: parts of income that do not return immediately to spending (for example, savings). Higher leakages tend to reduce the flow in the short run.
• Injections/additions: spending that enters the circular flow (for example, investment financed through borrowing or past savings). Higher injections tend to increase the flow.

Three-sector model (households + firms + government)

In the three-sector model, the government becomes an additional sector that affects the flow mainly through taxes and government expenditure.

• Taxes collected from households and firms reduce disposable income and operate like a withdrawal from the flow.
• Government expenditure on goods/services and factor payments injects income back into the economy, raising demand and production.
• A practical way to see this: when the government spends on roads, health, or education, firms receive orders and households receive wages—both increase spending capacity.

Four-sector model (adds foreign sector to the three-sector model)

The four-sector model includes households, firms, government, and the foreign sector (rest of the world). Here, external transactions become important:

• Exports (X) bring income into the domestic economy (an injection).
• Imports (M) send domestic spending to foreign producers (a leakage).
• If X > M, the economy experiences a trade surplus; if M > X, it faces a trade deficit.

$$ Y = C + I + G + (X – M) $$

Key differences: three-sector vs four-sector

• Additional sector: The four-sector model explicitly includes the foreign sector; the three-sector model does not.
• Additional leakages/injections: In the four-sector model, imports are leakages and exports are injections, which can significantly change income and output.
• Policy relevance: The three-sector model highlights fiscal tools (tax-spend). The four-sector model additionally shows how exchange rates, trade policy, and global demand can expand or shrink domestic activity.

2) Working of the capital market with instruments and intermediaries

Meaning and purpose of the capital market

A capital market deals with long-term financial instruments (maturity of more than one year). Its practical role is to mobilise savings, support capital formation, and finance business expansion and industrial growth.

How the capital market works (step-by-step view)

• Step 1: Need for long-term funds – companies/government require funds for expansion, infrastructure, or technology upgrading.
• Step 2: Issue of securities – funds are raised by issuing instruments like shares or bonds.
• Step 3: Allocation and subscription – investors commit money based on expected return and risk.
• Step 4: Trading and price discovery – once issued, many securities trade in organised markets, creating liquidity and market-based pricing.

Two main segments: primary and secondary market

• Primary market (New Issue Market): where new securities are issued for the first time. When a company offers securities to the public for the first time, it is an Initial Public Offering (IPO). This is mainly for raising fresh capital.
• Secondary market (stock market): where already-issued securities are bought and sold (for example, via recognised stock exchanges such as BSE and NSE). This market provides liquidity—investors can exit without waiting for maturity.
• Auction market vs OTC: in an auction market, trading occurs via a stock exchange platform; in Over-the-Counter (OTC), trading can occur electronically without a central physical exchange floor.

Major instruments used in the capital market

• Shares: represent ownership in a company. Shareholders typically have voting rights and may receive dividend. Shares can be equity shares or preference shares.
• Bonds: debt instruments issued by governments, companies, or municipalities. Bondholders earn interest (fixed or variable) and do not gain ownership or voting rights like shareholders.
• Other commonly traded claims: instruments such as options and similar contracts may also trade in the secondary market as part of market deepening and risk management.

Key intermediaries (who makes the market function smoothly)

• Stock brokers: connect investors to stock exchanges, execute trades, maintain records, and often guide investors on basic strategies (registered and regulated).
• Portfolio managers: manage investors’ portfolios either discretionarily (independently) or non-discretionarily (as per client directions).
• Other market facilitators: entities involved in issuing, distributing, and servicing securities (for example, underwriting/issue support and post-issue processes) help reduce friction and improve trust.

Regulation: why SEBI matters

In India, the capital market is regulated by SEBI. The central focus is investor protection, orderly development of markets, and prevention of unfair practices (for example, manipulation and insider trading). In real-world terms, this is why disclosure rules, registration norms, and surveillance exist—so that small investors can participate with greater confidence.

3) Insurance-sector reforms and universal social security for the underprivileged

Why insurance reforms were necessary

A major gap in India’s financial development has been that a large section of the population, especially low-income and informal workers, remained outside formal insurance coverage. Without insurance, households often rely on expensive or exploitative informal borrowing during illness, accidents, or death of an earning member—directly threatening social security.

Social security focus through major schemes (2015)

To strengthen universal social security, key schemes were introduced with simple enrolment and low premiums, largely routed through bank accounts (which improves access and transparency).

(i) Pradhan Mantri Suraksha Bima Yojana (PMSBY)

• Coverage: accidental death and disability protection (including full and partial disability categories).
• Eligibility: available to bank account holders in a broad working-age range.
• Affordability and access: premium is small and collected via auto-debit, which is practical for households that cannot manage large annual payments at once.

(ii) Pradhan Mantri Jeevan Jyoti Bima Yojana (PMJJBY)

• Coverage: renewable one-year term life cover with a fixed sum assured.
• Delivery: offered through life insurers (including LIC and others), with premium auto-debited from bank accounts.
• Why it helps: for many low-income families, even basic life cover protects dependents from a sudden income shock.

(iii) Atal Pension Yojana (APY)

• Target group: especially useful for unorganised-sector workers (for example, domestic workers, gardeners, daily-wage earners) who typically do not have formal retirement benefits.
• Benefit structure: provides a defined monthly pension level after a certain age, based on contribution and duration.
• Family protection: includes provisions for spouse/nominee benefits in case of death, which is crucial for vulnerable households.

How these reforms strengthen “universal” coverage in practice

• Low entry barriers: small premiums and bank-based auto-debit reduce procedural complexity.
• Risk protection at household level: accident, life, and pension coverage together address major vulnerabilities—health shocks, accidental loss, and old-age insecurity.
• Linkage with financial inclusion: as more households use formal bank accounts, insurance becomes easier to deliver at scale.

Practical limitations and what improves outcomes

• Awareness gap: many eligible households remain unaware of benefits/claims process; local-language counselling at banks helps.
• Claim assistance: simplified documentation support at the branch level reduces dropouts in claim settlement.
• Continuity: maintaining account activity and ensuring timely auto-debit is important so that coverage does not lapse.

4) Absolute advantage vs comparative advantage

Core idea

Both theories explain why countries trade and specialise, but they use different criteria for deciding who should produce what.

Absolute advantage (efficiency in direct production)

• A country has an absolute advantage in producing a good when it can produce that good using fewer units of input (for example, fewer labour hours) than another country.
• So, if the labour requirement for producing one unit of a good is lower in one country, that country is absolutely better at producing it.

Comparative advantage (efficiency in opportunity cost)

• Comparative advantage looks at opportunity cost, i.e., what must be given up to produce one more unit of a good.
• A country has a comparative advantage in the good for which its opportunity cost is lower than the other country’s.
• This is the key insight: even if one country is more efficient in producing everything, trade can still benefit both sides because opportunity costs differ.

Linking the idea to the standard condition (labour-requirement form)

$$ \frac{a_{LC}}{a_{LW}} < \frac{a^{*}_{LC}}{a^{*}_{LW}} \quad \text{and/or} \quad \frac{a_{LC}}{a^{*}_{LC}} < \frac{a_{LW}}{a^{*}_{LW}} $$

A simple numeric illustration (student-friendly)

• Absolute advantage: Home uses fewer hours for both goods (2 < 3 and 4 < 6), so Home has absolute advantage in both.
• Comparative advantage: Home’s opportunity cost of 1 cloth is 2/4 = 0.5 wheat; Foreign’s is 3/6 = 0.5 wheat. If we adjust the numbers slightly (as commonly happens in real data), opportunity costs differ and then each country specialises where it gives up less of the other good.
• Practical takeaway: real-world trade is driven less by “who is best at everything” and more by “who sacrifices less by specialising,” which is why trade can expand total output and consumption possibilities.

Difference in one line

• Absolute advantage = lower input requirement for a good.
• Comparative advantage = lower opportunity cost of a good.

5) Short notes

(a) Corporate Social Responsibility (CSR)

Meaning: CSR is a management approach in which companies integrate social and environmental concerns into business operations and stakeholder interactions. It is commonly linked with the triple-bottom-line idea—balancing economic, environmental, and social goals rather than focusing only on profit.

Why it matters: CSR builds long-term trust with stakeholders (employees, customers, communities), improves sustainability, and can reduce business risk (for example, reputational risk from unsafe practices).

CSR in India (regulatory highlight): Under Section 135 of the Companies Act, 2013, certain large companies must form a CSR Committee and ensure CSR spending/disclosure. The framework also expects companies to spend about 2% of average net profits (preceding years) on eligible CSR activities, with preference often given to local areas of operation. Implementation can be direct or through credible non-profit partners, and routine business activities are not counted as CSR.

(b) Banking structure in India

Apex level: The Reserve Bank of India (RBI) is the regulator of the banking system and supervises monetary policy and banking stability.

Main classification: Banks are broadly classified into scheduled banks (included in the Second Schedule of the RBI Act) and others, with scheduled banks forming the core institutional structure.

• Scheduled commercial banks: include public sector banks (including SBI and nationalised banks), private sector banks (old and new), foreign banks, and Regional Rural Banks (RRBs).
• Scheduled cooperative banks: include cooperative institutions that operate on cooperative principles and serve local/regional credit needs.

Functional shift: Modern banks are not limited to deposits and lending; they also support payments, remittances, ATM and electronic transfers, foreign exchange services, and various financial products that connect savers with borrowers more efficiently.

(c) Atmanirbhar Bharat Abhiyan

Meaning and objective: Atmanirbhar Bharat Abhiyan is a national initiative aimed at strengthening domestic capability, reducing excessive external dependence, and supporting recovery and resilience—especially after the COVID-19 shock. A major economic package (about Rs. 20 lakh crore, around 10% of GDP) was announced to support businesses, workers, migrants, and vulnerable sections, along with structural reforms.

Five pillars (conceptual framework)

• Economy: aiming for a “quantum jump” rather than incremental change.
• Infrastructure: as the identity of modern India.
• System: technology-driven and not bound to outdated processes.
• Demography: leveraging India’s population strength as an energy source.
• Demand: strengthening demand and supply chains as a growth engine.

Illustrative measures (how it works on the ground)

• MSME support: credit guarantees such as the Emergency Credit Line Guarantee Scheme (ECLGS) to provide liquidity support via banks/NBFCs.
• Job creation and sector push: later announcements (for example, Atmanirbhar Bharat 3.0) included measures oriented to employment generation and production incentives (PLI) for priority sectors, along with targeted relief in housing and infrastructure-related activity.

Practical interpretation: for students, the simplest way to explain the programme is that it combines relief (immediate support), reform (policy changes), and rebuild (capacity creation) so that domestic enterprises can compete better while protecting vulnerable households.