Foundation Course

Study Material

Paper 4

Business Economics
(Relevant for May, 2025 and
onward Examinations)

BOARD OF STUDIES
THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

© The Institute of Chartered Accountants of India

 1.ii
ii

This Study Material has been prepared by the faculty of the Board of Studies. The objective
of the Study Material is to provide teaching material to the students to enable them to
obtain knowledge in the subject. In case students need any clarifications or have any
suggestions for further improvement of the material contained herein, they may write to the
Joint Director, Board of Studies.

All care has been taken to provide interpretations and discussions in a manner useful for the
students. However, the Study Material has not been specifically discussed by the Council of
the Institute or any of its Committees and the views expressed herein may not be taken to
necessarily represent the views of the Council or any of its Committees.

Permission of the Institute is essential for reproduction of any portion of this material.

© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system,
or transmitted, in any form, or by any means, electronic, mechanical, photocopying, recording,
or otherwise, without prior permission, in writing, from the publisher.

Basic draft of this publication was prepared by CA. (Dr.) Rashmi Goel.

Edition : August, 2024

Committee/Department : Board of Studies

E-mail : [email protected]

Website : www.icai.org

Price : ` /-

ISBN No. : 978-81-19472-33-8

Published by : The Publication & CDS Directorate on behalf of

The Institute of Chartered Accountants of India
ICAI Bhawan, Post Box No. 7100,
Indraprastha Marg, New Delhi – 110002 (India)

Printed by :

© The Institute of Chartered Accountants of India

 iii

BEFORE WE BEGIN

The contents of the study material for Foundation have been designed and developed by
the Board of Studies, ICAI with an objective to synchronize the syllabus with the
International Education Standards (IESs) of IFAC (International Federation of Accountants) to
instill and enhance the necessary pre-requisites for becoming a well-rounded, competent and
globally competitive Accounting Professional.

The requirements of “IES 1 Entry Level Requirements” have been kept in mind while
developing the different chapters of study material.
This study material also lays emphasis on National Education Policy 2020 (NEP 2020) initiatives
like conceptual clarity rather than rote learning and new pedagogical and curriculum
restructuring based on the use of technology while teaching.
The traditional role of a chartered accountant was restricted to accounting and auditing, has
undergone a sea change. Presently, there has been a marked shift towards strategic decision
making and entrepreneurial roles that add value beyond traditional financial reporting. The
primary factors responsible for the change are the increasing business complexities on
account of a plethora of laws, borderless economies consequent to giant leap in e-commerce,
emergence of financial instruments, emphasis on corporate social responsibility, significant
developments in information technology, to name a few. Towards this end, the scheme of
education and training is being continuously reviewed so that it is in sync with the requisites
of the dynamic global business environment. The competence requirements are being
continuously reviewed to enable aspiring chartered accountants to acquire the requisite
professional competence to take on new roles.
Economics deals with problems and questions that affect almost all kinds of individuals in
their capacities as consumers and producers. Therefore, economic literacy is essential for each
and every individual. Business Economics, which has been introduced at the Foundation level
of the Revised CA course, has been developed keeping in mind the fact that CAs now a days
have to take up the role of not merely an accountant or auditor, but a business solution
provider. Business Economics which integrates economic theory with business practice will
help them in the process of business decision making.
The learning outcomes at the beginning of each unit orient the learners to focus on key
concepts. The end of the chapter summary is intended to recapitulate what has been covered
in the units. The sample questions appended at the end of each chapter, help students to

© The Institute of Chartered Accountants of India

.iv iv

practice what they have learned in the chapter /unit. The glossary at the end of the book
intends to provide a quick review of the major concepts to the learners.

There are ten chapters in Business Economics namely, Introduction to Business Economics,
Theory of Demand and Supply, Theory of Production and Cost, Price Determination in
Different Markets, Business Cycles, Determination of National Income, Public Finance, The
Money Market, International Trade, and Indian Economy. An attempt has been made to make
this study material as self-contained as possible. The economic concepts have been explained
in a clear, thorough way, using various applications to illustrate the use of theory and to
reinforce students’ understanding of it. Care has been taken to explain the principles and
concepts in a lucid and easy language with the help of diagrams, pictures, tables, and
illustrations so as to enable students to understand concepts properly and relate theory to
real world situation.
The learners are requested to keep themselves updated on the wide-ranging changes that
occur in the economic arena in view of the lack of feasibility of instantly incorporating them
in the study material. Your valuable suggestions to improve the contents and /or use of
pedagogical devices would be appreciated.

Happy Reading and Best Wishes!

© The Institute of Chartered Accountants of India

 v

SYLLABUS
PAPER – 4: BUSINESS ECONOMICS (100 MARKS)

Objective:
To develop an understanding of the concepts and theories of Economics and to acquire the
ability for addressing application-oriented issues.
Contents:
1. Introduction to Business Economics
Meaning and scope of Business Economics
Basic Problems of an Economy and Role of Price Mechanism.
2. Theory of Demand and Supply

Meaning and Determinants of Demand, Law of Demand and Elasticity of Demand –

Price, Income and Cross Elasticity
Theory of Consumer’s Behaviour –Indifference Curve approach
Meaning and Determinants of Supply, Law of Supply and Elasticity of Supply, Market
Equilibrium and Social Efficiency.
3. Theory of Production and Cost

Meaning and Factors of Production, Short Run and Long Run

Law of Production – The Law of Variable Proportions and Laws of Returns to Scale,
Producer’s Equilibrium
Concepts of Costs – Short-run and long-run costs, Average and Marginal Costs, Total,
Fixed and Variable Costs
4. Price Determination in Different Markets

Market Structures: Perfect Competition, Monopoly and Monopolistic Competition.

Using Game Theory to study Oligopoly.
Price Determination in these Markets
Price- Output Determination under different Market Forms

© The Institute of Chartered Accountants of India

.vi vi

5. Determination of National Income

a. Macro Economic Aggregates and Measurement of National Income
b. Determination of National Income: Keynes’ Two Sector Basic Model, Three
Sectors and Four Sectors Models
6. Business Cycles

♦ Meaning
♦ Phases
♦ Features

♦ Causes behind these Cycles

7. Public Finance
a. Fiscal functions: An Overview, Centre and State Finance

b Market Failure/ Government intervention to correct market failure.

c. Process of budget making: Sources of Revenue, Expenditure Management, and
Management of Public Debt.

d. Fiscal Policy
8. Money Market
a. Concept of Money Demand
b. Important theories of Demand for Money
c. Concept of Money Supply, Cryptocurrency and other new terminology
d. Monetary Policy

9. International Trade
a. Theories of International Trade including theories of intra-industry trade by
Krugman.

b. Trade Policy – The Instruments of Trade Policy

c. Trade Negotiations
d. Exchange Rates and its economic effects
e. International Capital Movements: Foreign Direct Investment
10. Indian Economy (Before 1950- Chanakya and Nand Vansh, OECD Paper (1950-1991),
Basic knowledge 1991 Onwards

© The Institute of Chartered Accountants of India

 vii

CONTENTS
Pages
Chapter 1 – Nature & Scope of Business Economics ............................................ 1.1 – 1.36
Unit 1: Introduction ..........................................................................................................1.1
1.0 Introduction ..................................................................................................................................... 1.2
1.1 Definitions of Business Economics ............................................................................................ 1.7
1.2 Nature of Business Economics.................................................................................................... 1.8
1.3 Scope of Business Economics ................................................................................................... 1.11
1.4 Difference between Economics & Business Economics..................................................... 1.13
Summary ......................................................................................................................................... 1.14
Unit 2: Basic Problems of an Economics & Role of Price Mechanism ......................... 1.16
2.0 Basic Problems of an Economy ................................................................................................ 1.16
2.1. Capitalist Economy ...................................................................................................................... 1.18
2.2 Socialist Economy ....................................................................................................................... 1.22
2.3 The Mixed Economy .................................................................................................................... 1.25
Summary ......................................................................................................................................... 1.27
Test Your Knowledge .................................................................................................................. 2.27
Chapter 2 – Theory of Demand and Supply .......................................................... 2.1-2.117
Unit 1: Law of Demand and Elasticity of Demand ...........................................................2.1
1.0 Meaning of Demand ..................................................................................................................... 2.3
1.1 What Determines Demand .......................................................................................................... 2.4
1.2 The Demand Function ................................................................................................................... 2.9
1.3 Law of Demand .............................................................................................................................. 2.10
1.4 Expansion and Contraction of Demand ................................................................................. 2.18
1.5 Elasticity of Demand .................................................................................................................... 2.22
1.6 Income Elasticity of Demand .................................................................................................... 2.38
1.7 Cross- Price Elasticity of Demand ............................................................................................ 2.42
1.8 Advertisement Elasticity ............................................................................................................. 2.46
Summary ......................................................................................................................................... 2.47

© The Institute of Chartered Accountants of India

.viii viii

Unit 2: Theory of Consumer Behaviour ........................................................................ 2.50

2.0 Nature of Human Wants ............................................................................................................ 2.50
2.1. Classification of Wants………………………………………………………………………………………………2.51
2.2 Relationship between TU & MU............................................................................................... 2.52
2.3 Law of Diminishing Marginal Utility ........................................................................................ 2.53
2.4 Consumer Surplus ........................................................................................................................ 2.54
2.5 Indifference Curve Analysis ....................................................................................................... 2.59
Summary ......................................................................................................................................... 2.72
Unit 3: Supply ................................................................................................................ 2.74
3.0 Introduction ................................................................................................................................... 2.74
3.1. Determinants of Supply .............................................................................................................. 2.75
3.2 Law of Supply ................................................................................................................................ 2.77
3.3 Movements on Supply Curve- increase or decrease in the quantity supplied ........... 2.79
3.4 Shifts in Supply Curve – increase or decrease in supply .................................................. 2.79
3.5 Elasticity of Supply ....................................................................................................................... 2.80
3.6 Equilibrium Price .......................................................................................................................... 2.87
Summary ......................................................................................................................................... 2.89

Test Your Knowledge .................................................................................................................. 2.90

Chapter 3 – Theory of Production and Cost ........................................................... 3.1-3.72
Unit 1: Theory of Production ...........................................................................................3.1
1.0 Meaning of Production................................................................................................................. 3.2
1.1 Factors of Production .................................................................................................................. 3.5
1.2 Production Function .................................................................................................................... 3.20

1.3 Production Optimisation ............................................................................................................ 3.29

Summary ......................................................................................................................................... 3.32
Unit 2: Theory of Cost .................................................................................................. 3.35
2.0 Cost Concepts ............................................................................................................................... 3.35
2.1. Cost Function ................................................................................................................................ 3.39

© The Institute of Chartered Accountants of India

 ix

2.2 Short Run Total Costs ................................................................................................................. 3.39

2.3 Long Run Average Cost Curve .................................................................................................. 3.45
2.4 Economies & Diseconomies of Scale ...................................................................................... 3.48
Summary ......................................................................................................................................... 3.52
Test Your Knowledge .................................................................................................................. 3.54
Chapter 4 – Price Determination in Different Markets .......................................... 4.1-4.86
Unit 1: Meaning and Types of Markets............................................................................4.1
1.0 Meaning of Market ........................................................................................................................ 4.2
1.1 Types of Market Structures ......................................................................................................... 4.6
1.2 Concepts of Total Revenue, Average Revenue and Marginal Revenue ......................... 4.8
Summary ......................................................................................................................................... 4.14
Unit 2: Determination of Prices ................................................................................... 4.16
2.0 Introduction ................................................................................................................................... 4.16
2.1. Determination of Prices – A General View ............................................................................ 4.17
2.2 Changes in Demand and Supply .............................................................................................. 4.19
2.3 Simultaneous Changes in Demand and Supply……………………………………………………….4.21
Summary ......................................................................................................................................... 4.25

Unit 3: Price Output Determination under Different Market Forms ........................... 4.27
3.0 Perfect Competition .................................................................................................................... 4.28
3.1. Monopoly ....................................................................................................................................... 4.39
3.2 Imperfect Competition- Monopolistic Competition ......................................................... 4.51
3.3 Oligopoly ........................................................................................................................................ 4.56
Summary ......................................................................................................................................... 4.62

Test Your Knowledge .................................................................................................................. 4.65

Chapter 5 – Business Cycles .................................................................................... 5.1-5.21
5.0 Introduction ..................................................................................................................................... 5.2
5.1 Phase of Business Cycle................................................................................................................ 5.3
5.2 Features of Business Cycle ........................................................................................................... 5.9

© The Institute of Chartered Accountants of India

.x x

5.3 Causes of Business Cycles .......................................................................................................... 5.10

5.4 Relevance of Business Cycles in Business Decision Making ............................................. 5.13
Summary ......................................................................................................................................... 5.14
Test Your Knowledge .................................................................................................................. 5.16
Chapter 6 – Determination of National Income .................................................... 6.1-6.72
Unit 1: National Income Accounting. ............................................................. ……………….6.1

1.1 National Income Accounting ................................................................................................................... 6.2

1.2 Usefulness and Significance of National Income Estimates ......................................... ............... 6.2

1.3 Different Concepts of National Income ............................................................................................... 6.3

1.4 Measurement of National Income in India .......................................................................................6.15

1.5 The System of Regional Accounts in India .......................................................................................6.26

1.6 GDP & Welfare ............................................................................................................................................6.27

1.7 Limitations and Challenges of National Income Computation .................................................6.28

Summary ........................................................................................................................................................6.29

Test Your Knowledge .................................................................................................................. 6.30

Unit 2: The Keynesian Theory of Determination of National Income ............................. 6.34

2.1 Introduction ..................................................................................................................................................6.35

2.2. Circular Flow in a Simple Two-Sector Model ...................................................................................6.36

2.2. Basic Concepts & Functions ...................................................................................................................6.38

2.4 The Two-Sector Model of National Income Determination.......................................................6.43

2.5 The Investment Multiplier .......................................................................................................................6.50

2.6 Determination of Equilibrium Income: Three Sector Model ..................................................... 6.54

2.7 Determination of Equilibrium Income: Four Sector Model ........................................................6.62

2.8 Conclusion.....................................................................................................................................................6.68

Summary ....................................................................................................................................................... 6.68

Test Your Knowledge .................................................................................................................. 6.70

© The Institute of Chartered Accountants of India

 xi

Chapter 7 – Public Finance ...................................................................................... 7.1-7.91

Unit 1: Fiscal Functions: An Overview, Centre and State Finance ...................................7.1
1.1 Introduction .................................................................................................................................................... 7.2
1.2 The Role of Government in an Economic System ............................................................................ 7.3
1.3 The Allocation Function ............................................................................................................................. 7.5
1.4 The Redistribution Function ..................................................................................................................... 7.8
1.5 Stabilization Function ................................................................................................................................. 7.9
Summary ........................................................................................................................................................7.15
Test Your Knowledge .................................................................................................................. 7.18
Unit 2: Market Failure/ Government intervention to correct Market Failure ............. 7.23
2.1 Introduction .................................................................................................................................... 7.23
2.2 The Concept of Market Failure ................................................................................................... 7.24
2.3 Why Do Markets Fail..................................................................................................................... 7.24
2.4 Public Goods .................................................................................................................................. 7.27
2.5 Incomplete Information ............................................................................................................... 7.29
2.6 Government Intervention to Minimize Market Power ....................................................... 7.32
2.7 Government Intervention to Correct Externalities .............................................................. 7.33

2.8 Government Intervention in The Case of Merit Goods...................................................... 7.37

2.9 Government Intervention in The Case of Demerit Goods ................................................ 7.38
2.10 Government Intervention in The Case of Public Goods .................................................... 7.39
2.11 Price Intervention: Non-Market Pricing ................................................................................. 7.39
2.12 Government Intervention for Correcting Information Failure ......................................... 7.40
2.13 Government Intervention for Equitable Distribution ......................................................... 7.40

Summary ......................................................................................................................................... 7.41

Test Your Knowledge .................................................................................................................. 7.45
Unit 3: The Process of Budget Making: Sources of Revenue, Expenditure
Management and Management of Public Debt ................................................ 7.51
3.1 Introduction ..................................................................................................................................................7.51
3.2. The Process of Budget Making .............................................................................................................7.52

© The Institute of Chartered Accountants of India

.xii xii

3.3 Sources of Revenue ...................................................................................................................................7.56

3.4 Public Expenditure Management .........................................................................................................7.57
3.5 Public Debt Management .......................................................................................................................7.59
Test Your Knowledge .................................................................................................................. 7.65
Unit 4: Fiscal Policy .................................................................................................................. 7.72
4.1 Introduction ..................................................................................................................................................7.72
4.2. Objectives of Fiscal Policy .......................................................................................................................7.73
4.3 Types of Fiscal Policy.................................................................................................................................7.74
4.4 The Instruments of Fiscal Policy ............................................................................................................7.76
Summary ........................................................................................................................................................7.83
Test Your Knowledge .................................................................................................................. 7.85
CHAPTER 8 – Money Market ................................................................................... 8.1-8.58
Unit 1: The Concept of Money Demand: Important Theories ............................................... 8.1
1.1 Introduction ...................................................................................................................................... 8.2
1.2 The Demand for Money ................................................................................................................ 8.4
1.3 Theories of Demand for Money ................................................................................................... 8.5
1.4 Post-Keynesian Developments in the Theory of Demand for Money ................................ 8.12

1.5 Conclusion ...................................................................................................................................... 8.15

Summary ......................................................................................................................................... 8.16
Test Your Knowledge .................................................................................................................. 8.18
Unit 2: The Concept of Money Supply ................................................................................... 8.22
2.1 Introduction ..................................................................................................................................................8.23
2.2 Rationale of Measuring Money Supply ..............................................................................................8.24

2.3 The Sources of Money Supply ...............................................................................................................8.25

2.4 Measurement of Money Supply ...........................................................................................................8.26
2.5 Determinants of Money Supply ............................................................................................................8.27

2.6 The Concept of Money Multiplier ........................................................................................................8.27

2.7 The Money Multiplier Approach to Supply of Money .................................................................8.29

© The Institute of Chartered Accountants of India

 xiii

2.8 Monetary Policy and Money Supply ...................................................................................................8.33

2.9 Effect of Government Expenditure on Money Supply ................................................................. 8.33
Summary ........................................................................................................................................................8.38
Test Your Knowledge .................................................................................................................. 8.40
Unit 3: Monetary Policy........................................................................................................... 8.44
3.1. Introduction ..................................................................................................................................................8.45
3.2 Monetary Policy Defined .........................................................................................................................8.45
3.3 The Monetary Policy Framework ..........................................................................................................8.45
3.4 The Organisational Structure for Monetary Policy Decisions ....................................................8.50
3.5 Conclusion.....................................................................................................................................................8.51
Summary ........................................................................................................................................................8.51
Test Your Knowledge .................................................................................................................. 8.54
Chapter 9 – International Trade ............................................................................. 9.1-9.88
Unit 1: Theories of International Trade ...........................................................................9.1

1.1 Introduction ...................................................................................................................................... 9.2

1.2 Important Theories of International Trade................................................................................. 9.4
Summary ........................................................................................................................................... 9.9
Test Your Knowledge .................................................................................................................. 9.11
Unit 2: The Instruments of Trade Policy ................................................................................ 9.14
2.1 Introduction ..................................................................................................................................................9.15
2.2. Tariffs...............................................................................................................................................................9.16
2.3 Non -Tariff Measures (NTMs) ................................................................................................................9.21
2.4 Export-Related Measures ........................................................................................................................9.26
Summary ........................................................................................................................................................9.27
Test Your Knowledge .................................................................................................................. 9.30
Unit 3: Trade Negotiations ..................................................................................................... 9.33
3.1 Introduction ..................................................................................................................................................9.33
3.2. Taxonomy of Regional Trade Agreements (RTAs) .........................................................................9.34

© The Institute of Chartered Accountants of India

.xiv xiv

3.3 The General Agreement on Tariffs and Trade (GATT) ..................................................................9.36

3.4 The Uruguay Round and the Establishment of WTO....................................................................9.37
3.5 The World Trade Organization (WTO)................................................................................................9.37
3.6 The Doha Round .........................................................................................................................................9.44
3.7 G 20 Economies: Facilitating Trade......................................................................................................9.44
Summary ........................................................................................................................................................9.45
Test Your Knowledge .................................................................................................................. 9.47
Unit 4: Exchange Rate and Its Economic Effects ................................................................... 9.50
4.1 Introduction ..................................................................................................................................................9.51
4.2 The Exchange Rate .....................................................................................................................................9.51
4.3 The Exchange Rate Regimes ..................................................................................................................9.51

4.4 Nominal Versus Real Exchange Rates.................................................................................................9.54

4.5 The Foreign Exchange Market ...............................................................................................................9.55
4.6 Determination of Nominal Exchange Rate .......................................................................................9.56
4.7 Changes in Exchange Rates ....................................................................................................................9.57
4.8 Devaluation Vs Depreciation..................................................................................................................9.59
4.9 Impacts of Exchange Rate Fluctuations on Domestic Economy...............................................9.60
Summary ........................................................................................................................................................9.64
Test Your Knowledge .................................................................................................................. 9.66
Unit 5: International Capital Movements .............................................................................. 9.70
5.1 Introduction ................................................................................................................................... 9.71
5.2 Types of Foreign Capital ........................................................................................................... 9.71
5.3 Foreign Direct Investment (FDI) ............................................................................................. 9.72
5.4 Foreign Portfolio Investment (FPI) ........................................................................................ 9.72
5.5 Reasons for Foreign Direct Investment ............................................................................... 9.74
5.6 Modes of Foreign Direct Investment (FDI) ......................................................................... 9.77

5.7 Benefits of Foreign Direct Investment ................................................................................. 9.78

5.8 Potential Problems Associated with Foreign Direct Investment ................................ 9.80

© The Institute of Chartered Accountants of India

 xv

5.9 Foreign Direct Investment in India (FDI) ........................................................................... 9.82

5.10 Overseas Direct Investment by Indian Companies .......................................................... 9.83
Summary ......................................................................................................................................... 9.85
Test Your Knowledge .................................................................................................................. 9.86
Chapter 10 – Indian Economy ............................................................................ 10.1-10.38
10.1 Status of Indian Economy: Pre Independence Period (1850-1947).........................................10.1
10.2 Indian Economy: Post Independence (1947-1991) ........................................................................10.4
10.3 The Era of Reforms.....................................................................................................................................10.7
10.4 The Economic Reforms of 1991 ............................................................................................................10.9
10.5 GDP Growth Rates Post 1991 Reforms ........................................................................................... 10.15
10.6 NITI Aayog: A Bold Step for Transforming India ......................................................................... 10.16
10.7 The current state of the Indian Economy: A brief overview .................................................... 10.18
10.8 Conclusion.................................................................................................................................................. 10.27
Summary .......................................................................................................................................10.27
Test Your Knowledge ................................................................................................................10.34
Glossary ........................................................................................................................ i – xxi

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India