Role of Money Market and Capital Market in India
Role of Money Market in India
- Short-term requirements of borrowers: Money market provides reasonable access for meeting the short-term financial needs of the borrowers at realistic prices.
- Liquidity Management: Money market is a dynamic market. It facilitates better management of liquidity and money in the economy by the monetary authorities. This, in turn, leads to economic stability and development of the country.
- Portfolio Management: Money market deals with different types of financial instruments that are designed to suit the risk and return preferences of the investors. This enables the investors to hold a portfolio of different financial assets which in turn, helps in minimizing risk and maximizing returns.
- Equilibrating mechanism: Through rational allocation of resources and mobilization of savings into investment channels, money market helps to establish equilibrium between the demand for and supply of short-term funds.
- Financial requirements of the Governments to fulfill its short term financial requirements on the basis of Treasury Bills.
- Implementation of Monetary policy: Monetary policy is implemented by the central bank. It aims at managing the quantity of money in order to meet the requirements of different sectors of the economy and to increase the pace of economic growth. A well-developed money market ensures successful implementation of the monetary policy. It guides the central bank in developing an appropriate interest policy.
- Economizes the use of cash: Money market deals with various financial instruments that are close substitutes of money and not actual money. Thus, it economizes the use of cash.
- Growth of Commerce, Industry and Trade: Money market facilitates discounting bills of exchange to local and international traders who are in urgent need of short-term funds. It also provides working capital for agriculture and small scale industries.
Role of Capital Market in India
- Mobilizes long term savings: There is an increasing demand for investment funds by industrial organizations and the government. But the availability of financial resources is insufficient to meet this growing demand. Capital market helps to mobilize long term savings from various section of the population through the sale of securities.
- Provides equity capital: Capital market provides equity capital or share capital to entrepreneurs which could be used to purchase assets as well as fund business operations.
- Operational efficiency: Capital market helps to achieve operational efficiency by lowering the transaction costs, simplifying transaction procedures, lowering settlement timings in purchase and sale of stocks.
- Quick valuation: Capital market helps to determine a fair and quick value of both equity (shares) and debt (bonds, debentures) instruments.
- Integration: Capital market leads to integration among real and financial sectors, equity and debt instruments, government and private sector, domestic and external funds etc.
Law of Diminishing Marginal Utility
Introduction
This law was first proposed by Prof. Gossen but was discussed in detail by Prof. Alfred Marshall in his book ‘Principles of Economics’ published in 1890. The law of diminishing marginal utility is universal in character. It is based on the common consumer behaviour that utility derived diminishes with the reduction in the intensity of a want.
Statement of the Law
According to Prof. Alfred Marshall, “Other things remaining constant, the additional benefit which a person derives from a given increase in his stock of a thing, diminishes with every increase in the stock that he already has.” In other words, marginal utility that any consumer derives from successive units of a particular commodity goes on diminishing as his or her total consumption of that commodity increases. In short, the more of a thing you have, the less you want to have more of it.
Assumptions
- Rationality: Consumer is assumed to be rational. It means that his behaviour is normal and he tries to maximize his satisfaction.
- Cardinal measurement: The law assumes that utility can be cardinally or numerically measured. Hence, mathematical operations are easily possible to know and compare the utility derived from each unit of a commodity.
- Homogeneity: All units of a commodity consumed are exactly homogeneous or identical in size, shape, colour, taste etc.
- Continuity: All units of commodity are consumed in quick succession without any lapse of time.
- Reasonability: All the units of a commodity consumed are of reasonable size. They are neither too big nor too small.
- Constancy: All the related factors like income, tastes, habits, choices, likes, dislikes of a consumer should remain constant. Marginal utility of money is also assumed to be constant.
- Divisibility: The law assumes that the commodity consumed by the consumer is divisible so that it can be acquired in small quantities.
Exceptions to the Law of Diminishing Marginal Utility
- Hobbies: In certain hobbies like collection of various stamps and coins, rare paintings, music, reading etc., the law does not hold true because every additional increase in the stock gives more pleasure. This increases marginal utility. However, this violates the assumption of homogeneity and continuity.
- Miser: In the case of a miser, every additional rupee gives him more and more satisfaction. Marginal utility of money tends to increase with an increase in his stock of money. However, this situation ignores the assumption of rationality.
- Addictions: It is observed in case of a drunkard that the level of intoxication increases with every additional unit of liquor consumed. So MU received by drunkard may increase. Actually it is only an illusion. This condition is similar to almost all addictions. However, this violates the assumption of rationality.
- Power: This is an exception to the law because when a person acquires power, his lust for power increases. He desires to have more and more of it. However, this again violates the rationality assumption.
- Money: It is said that the MU of money never becomes zero. It increases when the stock of money increases. This is because money is a medium of exchange which is used to satisfy various wants. However, according to some economists, this law is applicable to money too.
Law of Demand
Introduction
The law of demand was introduced by Prof. Alfred Marshall in his book, ‘Principles of Economics’, which was published in 1890. The law explains the functional relationship between price and quantity demanded.
Statement of the Law
According to Prof. Alfred Marshall, “Other things being equal, higher the price of a commodity, smaller is the quantity demanded and lower the price of a commodity, larger is the quantity demanded.” In other words, other factors remaining constant, if the price of a commodity rises, demand for it falls and when price of a commodity falls demand for the commodity rises. Thus, there is an inverse relationship between price and quantity demanded.
Assumptions
- Constant level of income: If the law of demand is to find true operate then, consumers’ income should remain constant. If there is a rise in income, people may demand more at a given price.
- No change in size of population: It is assumed that the size of population remains unchanged. Any change in the size and composition of population of a country affects the total demand for the product.
- Prices of substitute goods remain constant: It is assumed that the prices of substitutes remain unchanged. Any change in the price of the substitute will affect the demand for the commodity.
- Prices of complementary goods remain constant: It is assumed that the prices of complementary goods remain unchanged because a change in the price of one good will affect the demand for the other.
- No expectations about future changes in prices: It is assumed that consumers do not expect any further change in price in the near future. If consumers expect a rise in prices in future, they may demand more in the present even at existing high price.
- No change in tastes, habits, preferences, fashions etc.: It is assumed that consumers’ tastes, habits, preferences, fashions etc. should remain unchanged. Any change in these factors will lead to a change in demand.
- No change in taxation policy: Taxation policy of the government has a great impact on demand for various goods and services. Therefore, it is assumed that there is no change in the policy of taxation declared by Government.
Exceptions to the Law of Demand
- Giffen’s paradox: Inferior goods or low quality goods are those goods whose demand does not rise even if their price falls. At times, demand decreases when the price of such commodities fall.
- Prestige goods: Expensive goods like diamond, gold etc. are status symbol. So rich people buy more of it, even when their prices are high.
- Speculation: The law of demand does not hold true when people expect prices to rise still further. In this case, although the prices have risen today, consumers will demand more in anticipation of further rise in price.
- Price illusion: Consumers have an illusion that high priced goods are of a better quality. Therefore, the demand for such goods tend to increase with a rise in their prices. For example, branded products which are expensive are demanded even at a high price.
- Ignorance: Sometimes, due to ignorance people buy more of a commodity at high price. This may happen when consumer is ignorant about the price of that commodity at other places.
- Habitual goods: Due to habit of consumption, certain goods like tea is purchased in required quantities even at a higher price.
Law of Supply
Introduction
The law of supply is also a fundamental principle of economic theory like law of demand. It was introduced by Prof. Alfred Marshall in his book, ‘Principles of Economics’ which was published in 1890. The law explains the functional relationship between price and quantity supplied.
Statement of the Law
“Other things being constant, higher the price of a commodity, more is the quantity supplied and lower the price of a commodity less is the quantity supplied” In simple words, other factors remaining constant, a rise in price results in a rise in the quantity supplied and vice-versa. Thus, there is a direct relationship between price and quantity supplied.
Assumptions of the law
- Constant cost of production: It is assumed that there is no change in the cost of production. A change in cost of production will affect the profits of the seller. Therefore less quantity will be supplied at the same price.
- Constant technique of production: It is also assumed that technique of production does not change. Improved technique of production may lead to an increase in production. This in turn may lead to an increase in the supply at the same price.
- No change in weather conditions: It is assumed that there is no change in the weather conditions. Natural calamities like floods, earthquakes etc. may decrease supply.
- No change in Government policy: It is also assumed that government policies like taxation policy, trade policy etc. remain unchanged.
- No change in transport cost: It is assumed that there is no change in the condition of transport facilities and transport cost. For example, better transport facility increases supply at the same price.
- Prices of other goods remain constant: Prices of other goods are assumed to remain constant. If they change, the law of supply may not hold true because producer may transfer resources to other products.
- No future expectations: The law also assumes that the sellers do not expect future changes in the price of the product.
Exception of law of supply
- Agricultural goods: The law of supply does not apply to agricultural goods as they are produced in a specific season and their production depends on weather conditions.
- Urgent need for cash: If the seller is in urgent need for hard cash, he may sell his product at which may even be below the market price.
- Perishable goods: In case of perishable goods, the supplier would offer to sell more quantities at lower prices to avoid losses. For example, vegetables, eggs etc.
- Rare goods: The supply of rare goods cannot be increased or decreased according to its demand. Even if the price rises, supply remains unchanged. For example, rare paintings, old coins, antique goods etc.