Payment of tax directly by a individual or a firm is direct tax; it depends on income, wealth and properties of the direct tax payer.
Ex:
Income Tax
Stamp Tax
Indirect Tax
The taxes that is not imposed only an the tax payer is called indirect tax.
Ex:
Taxes on goods and services
Business turn over tax
Tax charging Types
Proportional tax
Progressive tax
Regressive tax
Macro – economic Objectives
Full employment
Economic growth
Price stability
Favourable balance of payment
Sustainable development
Variable factors of Macro economy
Functions of the economy are determined by the level of variable factors of macro economy and the time taken.
There is a number of macro – economic variables in an economy.
Production
Rate of employment
Price level
Consumption
The level of macro – economic variable factors and how they change with time are determined by internal & external factors.
When macro – economic variable factors do not change in a positive manner the economy will not function well.
Macro economic Problems
The problems arising as a result of the economic activities in the entire economy are called macro economic problems.
Ex:
Unemployment
Increase in inflation
Declining foreign exchange rates
These problems can be solved by bringing macro economic variable factors to a favourable position.
Macro economic Management
Managing the economy towards achieving macro economic objectives is known as macro economic management.
Macro economic Policies
All the activities of macro – economic management are known as macro economic policies.
Ex:
Monetary policy
Fiscal policy
International trade policy
Government role in a Market economy
Allocation/distribution of resources efficiently
Distribution of income and wealth fairly/equally
Formulation of rules and regulations and good governance
Stabilization of macro – economic policies
Achieving economic development and sustainable development
Provision of infrastructural facilities
Actions taken by government to minimize inefficiency in the Market economy
Production of public & welfare goods
Prevention of imperfect competition
Greater focus on the prevention of externalities like environmental pollution
Ensuring the ownership of public resources
Actions taken by government to Ensure equity
Redistribution of income and wealth
Limitations on assimilation of wealth
Land reforms
Infrastructure facilities provides by Government
Provision of physical Infrastructure facilities.
Ex:
Main roads
Highways
Bridges
Airports
Buildings
Provision of institutional infrastructure facilities.
Ex:
Legal structure
Courts
Regulatory institutions
Government Failure
When the government intervenes the market economic system it is unable to achieve expected results and it increases the ineficiency in the economy, due to its inherent weaknesses. It is called government failure.
Government intervention to control market failure causes government failures.
Externalities are the non compensated benefits or losses borne by an external party that is not participating in an economic activity.
Externalities arise from consumption as well as production.
Externalities of Production
Benefits or losses borne by an external party due to a production activity is identified as externalities of production.
Positive Externalities of Production
The research focused new technology
Beautiful parks and gardens
Negative Externalities of Production
Industrial activities that burn fossil fuels
Industrial activities that deplete the ozone layer
Externalities of Consumption
Benefits or losses born to an external party due to a consumption activity is identified as externalities of consumption.
Social costs and social benefits are based on external costs and benefits.
Private costs + External costs = Social costs
Private benefits + External benefits = Social benefits
Only private costs and private benefits are taken into account in a market economy.
The decisions taken on the production and consumption of goods and services are not optimum decisions as externalities are not taken into consideration.
This situation is illustrated by the following graph:
According to graph the equilibrium point (optimum point) is at point “A” where MSC is equal to MPB. Equilibrium (optimum) quantity produced and consumed is Q0.
But when the social benefits are taken into account optimum equilibrium point is at point “B” where MSC is equal to MSB. Q1 is the equilibrium production and consumption point.
When there is a positive externality of consumption, optimum consumption exceeds optimum market consumption when social benefits are less.
According to graph optimum market production is at “A” where MC is equal to MSB. Q0 is the equilibrium and optimum level of production.
When Social benefits are considered, optimum production is at “B” where MSC = MSB Q1 is the equilibrium and optimum production point.
When there is a positive externality of production and social benefits are taken into account, optimum production exceeds the optimum market production.
Following steps can be taken to prevent ill effects caused by externalities:
Compensation
Internalization
Rationing
Charging license fees
Fines
Imposing regulations
Failure of the Market system
Failure of the free market system means that the market mechanism is unable to allocate scarce resources for social benefit.
Factors cause Market failure
Externalities
Imperfect competition
Imperfect information
Non provision of public goods
Inefficiency in the provision of quasi public goods
Provision of demerit goods
The institutions or organizational processes which facilitiate the exchange of monetary assets are known as monetary market.
Monetary market can be divided as money market and Capital market.
Liquidity of credit instruments and maturity period are used to distinguish between money market and capital market.
Money market is the market in which transaction of money and shortterm monetary instruments are exchanged.
The main function of the money market is to co-ordinate borrowers and suppliers of short term credits.
The bills and securities with a maturity period of less than one year are called short term monetary instruments.
The instruments which are used in the money market are called credits, treasury bills, securities, domestic and foreign bills of exchange and repurchasing agreements of commercial papers.
The sub markets of the money market are as follows:
Inter bank call credit market
Primary and secondary treasury bills market
Local and foreign exchange market
Limited off shore banking market
The short term – loan market:
Commercial paper market
Re purchasing agreement market
Influencing the cost of debts and liquidity by changing interest rates and money supply is called monetary policy.
Quantitative and qualitative monetary instruments are the two main instruments used to operate the monetary policy.
Quantitative credit control instruments are the common methods of reducing the supply of loans. The volume of loans and the direction of the flow of the loans are controlled by the qualitative credit control instruments.
Quantitative monetary instruments are of three types such as Bank interest rate, statutory reserve ratio and open market operations.
Policy interest rates are:
Bank interest rate.
Repurchasing rate.
Reselling rate.
Among them repurchasing rate and reselling rate are used in the open market operations.
Qualitative credit control instruments are of various types:
Credit Ceilings
Collateral requirements for loans
Selective interest rates
Moral suasion
The independent body that was set-up to carry out the monetary policy of Sri Lanka is the Central Bank Of Sri Lanka.
The mission of the Central Bank is to maintain economic and price stability and the stability of the monetary system for sustainable economic development through policies, supervision, commitment and excellence.
Following are the dual objectives of the Central Bank:
To maintain economic and price stability
To maintain the stability of the monetary system.
Economic and price stability means maintenance of a low level of inflation.
Price Stability is important in order to:
Promote economic growth
Distribute resources efficiently
Minimize risks to producers, consumers and investors
Make economic planning successfully
Creating an effective monitoring framework and strong and protective payment and settlement system for depositors and investors are the infrastructure facilities needed to materialize stability of the monetary system.
Stability of monetary system is important for the following reasons:
To make financial institutions and market function effectively
To avoid balance of payment crises
To finalize the price of assets
To protect market liquidity
The process of regulating monetary instruments to influence the interest rate and money supply to reach the objectives of economic and price stability and the stability of monetary policy is monetary policy.
The targets of regulating the monetary policy can be shown as follows:
Operational target – Amount of high powered money
Intermediate target – Interest and money supply
Final Target – Stability of the monetary system
The special, very strong and prominent monetary institutions that act as financial intermediaries in the monetary system with profit motive are called commercial banks.
Services provided by Commercial banks
Accepting deposits
Providing loans
Long term loans
Short term loans
Services as an agent
Common Utility services
Assisting in foreign banking activities
Providing pawning services
Providing safe keeping services
Providing related services in foreign currency transactions
Objectives of Commercial bank
To maintain liquidity
To maintain profitability
Statutory reserve ratio
According to the regulations of the Central Bank, commercial banks must maintain a certain percentage of its deposits as a reserve. This ratio is known as the statutory reserve ratio.
The Central Bank changes this ratio from time to time.
Excess Reserves
The amount of reserves exceeding the statutory requirement is called excess reserves.
Excess reserve = Current money reserve – Statutory reserve.
Excess reserve is determined based on the following factors:
The demand for loans
Selection of commercial banks between liquidity and profitability
Monetary policies of the Central Bank
Deposit Multiplier
Deposit multiplier is the number of times of expansion of deposit or creation of credit with a demand deposit.
Deposit multiplier is equal to the reciprocal of statutory reserve ratio.
Liquidity – Profitability
When liquidity is maintained profitability decreases and when profitability is maintained, liquidity decreases.
Since there is a clash between the two objectives, mentioned above, assets should be maintained in a balanced manner.
Credit Creation
Generating more deposits than the existing deposits by lending the excess reserves of commercial banks is called Credit creation.
Since only one bank functions in a monopolistic banking system, credit creation is possible. But it is impossible for a single bank in a banking system to create money.
The credit creation of the commercial banking system is based on the following assumptions:
After making the initial deposit there is no inflow or outflow of money in the banking system
All the borrowers deposit their total amount of loans in another commercial bank
No bank maintains excess reserves
There are limitations to credit creation as follows:
If people prefer to retain money with them, excess reserves of commercial banks will decline
Credit creation decreases when banks prefer to maintain excess reserves
Decreasing the demand for loans
Classifies the financial system of Sri Lanka as below:
