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1. ECONOMY-It is a system which provides people with the means to work and earn to live.
2. SCARCITY-Scarcity means that resource are limited in relation to demand for them.3. OPPORTUNITY COST-It is the value of a factor in its next best alternative use.4. PRODUCTION POSSIBILITY CURVE-PPC repersents various combinations of two
goods that can be produced with the available technologies and given resource, assuming all resource are fully and efficiently utilised.
5. MARGINAL OPPORTUNITY COST-It refers to the rate at which producer sacrifice units of one good for an additional unit of another good.
6. MICRO ECONOMICS-It is the study of individual units of an economy e.g. a household, a firm
7. MACRO ECONOMICS-It is the study of aggregate units of an economy or study of as a whole e.g. all industries in the economy
ECONOMIC PROBLEM-Economic problem arise because the available resources are scarce in relation to the unlimited human wants for good and services
1. ROTATION OF PPC-It takes place when there is change in resource or technology for one commodity only.
2. SHIFT OF PPC-Shift in PPC occurs when there is change in resource or technology for both the goods.
3. WHAT TO PRODUCE-It is a problem of selection of different goods and there quantites with the available resources.
4. HOW TO PRODUCE-It is the problem of choice of techniques like- Labour intensive or capital intensive.
5. FOR WHOM TO PRODUCE-It is the problem of distribution of goods and services produced.
6. NORMATIVE ECONOMICS- It is the part of economics that express value or normative judgements about economic fairness or what the outcomes of economy.
Normative economics concerns “What ought to be” in economic matters.
7. POSITIVE ECONOMICS-: It is the branch of economics that concerns the description and explanation of economic phenomena. It focuses on the facts and cause-and –effect behavioral relationship.
Positive economics concerns the “ What is.” in economic matters
Q.Unemployment is reduced due to the measures taken by government like ‘Education for all’. Explain its effect on the PPC of Indian Economy and Why?
(or)Analyse the effect of ‘SarvaShikshaAbhiyan’on the PPC of a country.
Ans:-An Account of the effective measures taken by the government Like Education for all unemployment will get reduced in the economy because with Education and employment the production potential of the economy is bound to improve and increase, so if the economy was producing inside the PPC at point G because of unemployment now it will start producing on PPC because of productive and efficient use of Resources. In the long run if the same trend continues there can be growth.
FREQUENTLY ASKED QUESTIONS (CBSE EXAM)
1. Define Microeconomics.Ans-It is the study of individual units of an economy e.g. a household, a firm
2. Why does an economic problem arise?Ans-Economic problem arise because the available resource are scare in relation to the unlimeted wants for good and services.
3. What are the central problems of an economy?Ans-(i) What to produce (ii) How to produce (iii) For whom to produce
4. Define opportunity cost.Ans-It is the value of a factor in its next best alternative use.
5. Define marginal opportunity cost.Ans- It refers to the rate at which producer sacrifice units of one good for an additional unit of another good.
6. Distinguish between ‘micro’ and’ macro’ economics.Ans-MICRO ECONOMICS-It is the study of individual units of an economy e.g. a household, a firmMACRO ECONOMICS-It is the study of aggregate units of an economy or study of as a whole e.g. all industries in the economy
7. Explain the problem, of what to produce, how to produce and for whom to produce.Ans-WHAT TO PRODUCE-It is a problem of selection of different goods and their quantites with the available resources.HOW TO PRODUCE-It is the problem of choice of technique. Labour intensive or capital intensive to produce goods and services.FOR WHOM TO PRODUCE-It is the problem of distribution of goods and services producesd.
U-II 16 marks
DEMAND:-It is defined as the quantity of a good a person is willing to buy at a given price at a given point of timeLAW OF DEMAND:- Other things remains constant, the quantity demanded of a commodity falls with rise in price, and vice versa.NORMAL GOODS :- Normal goods are those goods which are positively. That means their demand increases with increase in income.and vice versa.INFERIOR GOODS :- Are those goods with are negatively related to income i.e. their demand falls with rise in incomeand vice versa.SUBSTITUTE GOODS :- Substitute goods are those goods which are used in place of the other eg. Tea and coffee.COMPLEMENTARY GOODS :- Are those goods which are used together eg. Car & petrol.DEMAND FUNCTION :- It explains relationship between demand of a commodity and its determinants.Dx = f(Px,Pa,Pb ………….Pn,income, taste, fashion etc.)
1. Give the formula calculating slope of Budget Line?
Slope of Budget Line is equal to the prices of the two commodities, i.e., Px/Py.
2. What is the slope of indifference Curve?
Slope of indifference curve is equal to MRS, i.e., Marginal Rate of Substitution
3. Explain why is the budget line downward sloping?
Because with given money income if a consumer buys more of one good, he has to buy
less of the other good.
4. Why is the indifference Curve convex to the origin?
Indifference curve is convex to the origin due to diminishing marginal rate of substitution.
5. Given the market price of a commodity how does a consumer decide as to how many units of that good buy? Explain
Ans. The consumer will decide when MUx/Px=Mum which is basedon law of diminishing marginal utility.
6 A consumer consumes only two goods X and Y. At a consumption level of these two goods, he finds that the ratio of marginal utility of price in case of X is higher than in case of Y. Explain the reaction of the consumer.
Ans. - The consumer will increase the consumption of good-X and will decrease the consumption of good-Y (Explain)
CBSE QUESTIONS
Q 1. Why does the demand curve slope downward? 3/4 Ans. The demand curve slopes downward because of:-
i) Law of diminishing marginal utility : According to this law, as a consumer in a given time, increases the consumption of a thing, the utility from each successive unit goes on diminishing A Consumer gets maximum satisfaction. When the price of a commodity is equal he its marginal utility. As more units are bought, their marginal utility diminishes. Thus, a consumer will buy more units of a commodity, with fall in its price.
ii) ii)Income effect : Change in the price of a commodity causes a change in the real income of the consumer. With fall in price, real income increases. The increased real income is used to buy more units of the commodity.
iii) iii)Substitution effect : When the price of community X falls it becomes cheaper in relation to commodity. Accordingly, X is substituted for the commodity. A consumer in order to get more satisfaction, will boy more units of the commodity whose price has fallen in relation to the commodity.
iv) iv)Uses of commodity : If a commodity has diverse uses, with the fall in the price of product consumer will buy more.
Q 2.Distinguish between ‘decrease in demand’ and decrease in quantity demanded. 3/4Ans :Decrease in demand is caused by factors other than price of the commodity like fall in income of consumer, decrease in price of substitute goods, a rise in the price of complementary goods or unfavorable change in consumer’s taste and preferences .In case of decrease in demand there is a shift of demand curve towards left [figure 1] decrease in quantity demanded is caused by a rise in the price of the commodity, other things being equal. In case of decrease in quantity demanded, there is an upward movement along the same demand curve. [figure2]
Q3. How is equilibrium achieved with the help of indifference curve approach ? 6
Ans: Meaning of consumer’s equilibrium.Maximum satisfaction that a consumer achieves with given money income and prices of the commodities. Under indifference approach in order to maximize satisfaction, consumer with his given income (budget) will try to achieve to highest possible level of indifference curve.
Set of indifference curves IC1, IC2, IC3 shows consumer’s scale of preferences between different combinations of good X and good Y.LM is the budget line facing the consumer with given money income and prices of good X and good Y. it is sure that consumer’s equilibrium will lie on some point on LM.Consumer’s equilibrium will be achieved where budget line(LM) is tangent to highest possible indifference curve (IC2). In other words where slope of indifference curve = slope of budget line. MRSxy = Px/Py
Two conditions essential for consumer’s equilibrium are as follows: Budget line must be tangent to indifference curve. Indifference curve must be convex to the origin at the point of tangency.Consumer will not achieve following situations:- He will not choose point P and R on budget line LM because they will be on a lower indifference curve IC1. Choosing point Q puts him on a higher indifference curve. i.e. IC2He cannot move on IC3 as it is beyond his money income, I.e. he cannot afford to buy any combination of good X and good Y on IC3.Q4.A firm earns revenue of Rs 50 when the market price of a good is \Rs 10. The market price increase to Rs 15 and the firm now earns a revenue of Rs.150. What is the price elasticity 3/4 supply?
ANS.
Price (Rs) TR (Rs) Supply (Units)10 50 50/10=515 150 150/15=10
ep= ∆q/∆p.p/q= 5/5.10/5 = 2Thus ep>1Q5. Define budget line. Explain its rotation and shift. 3/4
Ans.Budget line represents the different combination of commodities that a consumer can buy by spending all his money income with the given price of commodities.Rotation due to change in price of commodity and shift due to change in income.(use diagram to show rotation and shift)Q6.What do you mean by inferior goods in economics? whether law of demand applicable in case of inferior goods? 3/4
Ans.With increase in income, demand of these goods decreases.it may or may not be applicable
Q7.Explain substitute goods & complementary goods with suitable example & diagram.
Ans Substitute goods are refers than goods when Px increases, Dy will also increase for example Coca Cola Pepsi 1½ Complementary goods are those goods when Px Increases Dy will decrease for example car& Petrol 1 ½
Q8.The quantity demanded of a commodity falls by 5 units, when its price rises by Rs.1per unit. Its price elasticity of demand is (-1.5). Calculate the price before change. If at this price quantity demanded was 60 units. Ans ep= ∆q/∆p.p/q (1)
3 marks for calculationThe price before change = Rs 18
Q9.What is meant by price elasticity of demand? Explain any one method of measuring price elasticity of demand.
Ans :It is the degree of responsiveness of change in quantity demanded to change in price of a commodity. (1)
Any onemethod (3)
Q10.Explain total expenditure method of measuring elasticity of demand 3/4
Ans: In total expenditure method we compare direction of change in price and total expenditure to determine elasticity of demand. (1)
Here three situations are possible. (1×3=3)When price and total expenditure change in same direction Ed<1.When price and total expenditure change in opposite direction Ed>2.When total expenditure doesn't change with change in price Ed=1
Q12.What would be the elasticity of the commodity given .Give reason to justify your answer? 3(a)electricity(b)salt(c)a certain brand of shoes
commodity elasticity
reason
electricity elastic Multiuse commodity
salt inelastic Essential commodity
A certain brand of shoes
elastic Luxury commodity
Q13.Calculate the price elasticity of demand for a commodity when its price rises from Rs40 to Rs50 and its demand falls by 20%.Ans: Ed=percentage change in demand =20/25=0.8 Percentage change in priceQ A consumer consumes only two goods X and Y. At a consumption level of these two goods, he finds that the ratio of marginal utility of price in case of X is higher than in case of Y. Explain the reaction of the consumer.
Ans.- The consumer will increase the consumption of good-X and will decrease the consumption of good-YTOTAL PRODUCT- Total quantity of goods produced by a firm / industry during a given period of time with given number of inputs.
We derive TP by summing up MPTP = ∑MP
Average product = output per unit of variable input.
APP = TPP / units of variable factor
Average product is also known as average physical product.
MARGINAL PRODUCT (MP): refers to addition made to the total product, when one more unit of variable factor is employed.
MPn = TPn– TPn-1
MP = ∆TP / ∆n
STATEMENT OF LAW OF VARIABLE PROPORTION (SHORT RUN PRODUCTION FUNCTION)/ (RETURNS TO FACTOR) In short period, when only one variable factor is increased, keeping other factor inputs constant, the total Physical product (TPP) initially increases at an increasing rate, MPP increases, then TPP increases at a decreasing rate, MPP falls but remains positive and finally TPP decreases, MPP becomes negative. MPP initially increase then falls but remains positive then 3rd phase becomes negative.
EXPLICIT COST: Actual payment made on hired factors of production. For example wages paid to the hired labourers, rent paid for hired accommodation, cost of raw material etc.
IMPLICIT COST: Cost incurred on the self - owned factors of production.
For example, interest on owners capital, rent of own building, salary for the services of entrepreneur etc.
OPPORTUNITY COST : is the cost of next best alternative foregone / sacrificed.
FIXED COST (TFC) : are the cost which are incurred on the fixed factors of production.
These costs remain fixed whatever may be the scale of output. These costs are present even when the output is zero. These costs are present in short run but disappear in the long run.
TOTAL VARIABLE COST: TVC or variable cost – are those costs which vary directly with the variation in the output. These costs are incurred on the variable factors of production.
TOTAL COST : is the total expenditure incurred on the factors and non-factor inputs in the production of goods and services.
It is obtained by summing TFC and TVC at various levels of output.
AVERAGE COST : are the “cost per unit” of output produced.AVERAGE FIXEDCOST is the per unit fixed cost of production.
AFC = TFC / Q or output
AFC declines with every increase in output. It’s a rectangular hyperbola. It goes very close to x axis but never touches the x axis as TFC can never be zero.
AVERAGE VARIABLE COST is the cost per unit of the variable cost of production.
AVC = TVC / output.
AVC falls with every increase in output initially. Once the optimum level of output is reached AVC starts rising.
MARGINAL COST : refers to the addition made to total cost when an additional unit of output is produced.
REVENUE : - Money received by a firm from the sale of a given output in the market.
TOTAL REVENUE : Total sale receipts or receipts from the sale of given output.TR = Quantity sold × Price (or) output sold × price
AVERAGE REVENUE : Revenue or Receipt received per unit of output sold.
o AR = TR / Output sold
o AR and price are the same.o TR = Quantity sold × price or output sold × priceo AR = (output / quantity × price) / Output/ quantityo AR= price
AR and demand curve are the same. Shows the various quantities demanded at various prices.
MARGINAL REVENUE : Additional revenue earned by the seller by selling an additional unit of output.
MRn = TR n - TR n-1
MR n = ∆ TR n / ∆ QTR = ∑ M
PRODUCER’S EQUILIBRIUM - It is that situation in which a producer is getting maximum amount of profits.
There are two different approaches to study producer’s equilibrium situation: -
TR AND TC APPROACH- Producer is in equilibrium when difference between TR and TC is maximum
MC AND MR APPROACH- According to this approach the producer will be in equilibrium when the following conditions are satisfied.i. MC should be rising i.e. MC curve should intersect MR curve from below. MC>MR after
the equilibrium pointii. MC = MR
BREAK-EVEN POINT - It is that point where TR = TC or AR=AC. Firm will be earning normal profit.
VERY SHORT ANSWER QUESTIONS:1. What change will take place in marginal product, when total product increases at
diminishing rate?1
Ans: Marginal Product decreases2. What is MR?
1Ans: it is additional revenue by selling one additional unit of commodity.
3. What difference you find between fixed and variable costs?1
Ans Fixed cost do not vary with the level of output whereas variable cost vary with the level of outputSHORT ANSWER QUESTIONS:
4. Bring out the relationship between AC & MC? 3
Ans: As level of output increases-i) AC and MC falls and MC lies below ACii) MC reaches its minimum and then increases
5. State whether the following statement are true or false. Give reason for your answer. 3
(a) When total revenue is constant average revenue will also be constant.
Ans. (a) False because when TR is constant, AR will fall as output increases
6. Complete the following table;-4
Price (Rs.) Output (units) TR MR10 1 - -9 2 - -8 3 - -7 4 - -
Ans.
Price (Rs.) Output (units) TR MR10 1 10 109 2 18 88 3 24 67 4 28 4
7. What change will take place in marginal revenue when: 4Total revenue increase at increasing rate?Total revenue increases at a diminishing rate?Ans.(i) when total revenue increases at an increases rate, marginal revenue should be
increasing.When total revenue increases at a diminishing rate, marginal revenue should be
diminishing.
8. . Explain the relation between average revenue and marginal revenue of a firm in a perfect competitivemarket
4
Ans. Under perfect competition MR=AR Both are same because price is constant.
Fig.
AR=MR
9. What change in total revenue will result in (i) a decrease in marginal revenue, and (ii) increase in marginal revenue?
6
Ans. (i) with a decrease in marginal revenue, total revenue should increase at diminishing rate.
(ii) With an increase in marginal revenue, total revenue should increase at increasing rate.
10. When price of a commodity rises from Rs. 4 per unit to Rs.5 per unit, total revenue increases from Rs.600 to Rs. 900. Calculate its price elasticity of supply.
6
Es= ∆QS/QS/∆P/P = 30/150 x 4/1=4/5=0.8
11. Explain the behaviour of Total Product and Marginal Product when only one factor input is increased? 6
Ans: If more and more units of a variable factor are employed with fixed factors TPP increases at an increasing rate in the beginning then increases at a diminishing rate and finally starts falling.Inthe first phase MPP increases then falls but remains positive then becomes zero and negative.
0 X
Y
MR/AR
Ans: Price TR QS 4 600 150 5 900 180
TP P
MPP
/TPP
Units of variable factor
Phase I :TPP increases at an increasing rate up to OQ1 level of out put
Phase II: TPP increases at a diminishing rate till it reaches its maximum point (N). MPP is falling but remains positive
When TPP is maximum MPP is zero.
Phase III :TPP starts declining MPP become negative
12. Explain producer’s equilibrium with the help of MR and MC Approach6
MPP
X
X
O
Y
1st
2nd
3rd
MULTIDISCIPLNARY/HOTS
Giving reasons, state whether the following statements are true or false :
1. When there are diminishing returns to a factor, total product always decreases.
Ans :- False, When there is diminishing returns to a factor, TPP increases at a decreasing rate.
2. TPP increases only when MPP increases.
Ans :- False, TPP also increases when MPP decreases but remains positive.
3. Increase in TPP always indicates that there are increasing returns to a factor.
Ans :- False, TPP increases even when there are diminishing returns to a factor.
4. When there are diminishing returns to a factor marginal and total products always fall.
Ans: - False,Only MPP falls, not TPP. In case of diminishing returns to a factor, TPP increase at diminishing rate.
5. Why AFC curve never touches ‘x’ axis though it lies very close to x axis?Ans :- Because TFC can never be zero.
Ans: Producer’s equilibrium refers to the situation of that level of output which gives the producer maximum profit and he has no incentive to increase or decrease the level of output.
Condition:
i) MC=MR
ii) MC should cut MR from below.
iii) After Equilibrium output MC>MR
iv) MC should be rising.
6. Why AVC and AFC always lie below AC?Ans:- AC is the summation of AVC & AFC so AC always lies above AVC & AFC.
7. Why TVC curve start from origin?Ans:- TVC is zero at zero level of output.
8. When TVC is zero at zero level of output, what happens to TFC or Why TFC is not zero at zero level of output?
Ans:- Fixed cost are to be incurred even at zero level of output
9. Can MR be negative or zero.
Ans:- Yes, MR can be zero or negative.
10. If all units are sold at same price how will it affect AR and MR?
Ans:- AR and MR will be equal at levels of output.
11. What is price line?
Ans:- Price line is the same as AR line and is horizontal to X-axis in perfect competition.
12. Can TR be a horizontal Straight line?
Ans:- Yes, when MR is zero.
13. What happens to TR when a) MR is increasing, b) decreasing but remains positive andc)
MR is negative?
Ans:- a) TR increases at an increasing rate.
b) TR increases at a diminishing rate.
c) TR decreases.
14. Why AR is more elastic in monopolistic competition than monopoly?
Ans:- Monopolistic competition market has close substitutes. Monopoly market does not have
close substitutes.
UNIT IV: FORMS OF MARKET AND PRICE DETERMINATION MARKS 12
Market: It refers to a situation in which large number of buyers&sellers interact with each other.Perfect Competition Market: It refers to such a market structure where there are large numbers of buyers and sellers and firm sell a homogenous product at uniform price.
2. Homogeneous product - The product sold in the market is homogeneous or identical in allrespect i.e. shape, size, colour, composition, etc.
Monopoly – It’s a market situation where there is a single seller of a commodity which has no close substitutes. 4. Price discrimination-When a monopolist charge different prices from different buyers for the same product is called price discrimination. It’s a distinct feature of monopoly market. E.g. railways charge different fare for senior citizens, children and others for same journey.
Monopolistic Competition- It refers to such a market structure where there are large number of buyers and sellers and the firms produce & sell differentiated product which has many close substitute available. Oligopoly is a market structure in which there are a few large sellers of a commodity, which sell homogenous and differentiated products.If in an oligopoly market, the firms produce homogeneous products, it is called perfect oligopoly.If the firms produce differentiated products, it is called imperfect oligopoly.Collusive oligopoly is one in which the firms cooperate with each other in deciding price and output.Non Collusive oligopoly is one in which firms compete with each other.
Very Short answer questions
1. Define market.
It is a real or imaginary place where goods and services are purchased and sold by buyers and sellers respectively and payment is made in return for it.
2. What do you mean by perfect competition?
It is a market in which there are large number of buyers and sellers, selling homogenous goods. There is free entry into and exit from the market and firm is price taker and industry is price maker.
3. In which market the number of sellers are least?
Monopoly
4. Why the demand curve in monopolistic competition is more elastic?
It is because of the availability more substitutes.
5. in which market form, firm is the price-maker
a- Perfect Competition b- Oligopoly c- Monopoly d- Monopolistic competition
Ans:- c
6. In which of the following market form demand curve is indeterminate?
a- oligopoly b- Monopoly c- perfect competition d- monopolistic competition
Ans:- A
7. Explain the meaning of collusive oligopoly.
Collusive oligopoly – In this type of oligopoly firms decide price of goods through mutual cooperation with each other by forming groups or cartels.
SHORT ANSWER QUESTIONS (Three marks OR Four marks Questions)
8. Explain the implication of large number of buyers and sellersfeature of perfect competition.
Implications (i) As there are large number of buyers and sellers an individual buyer or seller cannot influence market supply or price.
9. Explain the implication of free entry and exit of firms a feature of perfect competition.
Suppose an industry enjoy abnormal profit then many firms are attracted towards the industry and they will enter the industry, then the margin of profit of firm’s decreases and in the long run the existing firms will get normal profit.
Hence in the long run firms will earn normal profits.
10. Differentiate perfect competition and monopolistic competition.
Perfect competition Monopolistic competition1 .Large number of buyers and sellers. 1. There are large number of buyers & sellers
with differentiated products. 2. Firm is price taker and industry is price maker.
2. Firm is the price makerpartially .
3. Average Revenue (AR) curve is perfectly elastic & horizontal.
3. Average Revenue (AR) curve is downward sloping & Relatively elastic.
4. There is no Selling cost 4. Selling costs are high.
11. How are the Equilibrium price and Equilibrium Quantity changes with the change in the following situations?
A – If demand and supply increases at an equal rate
B – If demand increases where supply is perfectly inelastic
ANS (A) The price at which quantity demanded and quantity supplied are equal is known as equilibrium price and the quantity at this point is called equilibrium quantity. When both demand
and supply increases in the market, then both the demand and supply will shift to the right at equal rate and will intersect at a point. Thereby the equilibrium price will remain at the same
(B) In this case demand curve will be downward sloping one but the supply curve which is perfectly inelastic will be vertical to Y-axis. The downward sloping demand curve and vertical shaped supply curve intersect at point E which is the equilibrium point. When demand increases with supply being perfectly inelastic, then thedemand curve will shift to the right and will intersect the vertical shaped supply curve at a point say E1. Thereby the equilibrium price will go up &equilibrium quantity will remain at the same level.
12. How is Equilibrium Price determined under perfect market?Price of the commodity is determined in market by the forces of demand and
supply. At the price, where quantity supplied& demanded are equal, equilibrium price is determined. This can be explained by the following illustration
Price of Quantity QuantityApple Demanded Supplied
(in numbers) (In numbers)1 50 10 Qd>QsExcess demand 240 203 30 30 Qd = Qs
4 20 405 10 50 Qd< Qs Excess supply
The price of apple is determined on the basis of demand and supply of apple in market. At the price of Rs 3/- the quantity demanded for apple is equal to quantity supplied of apple (i.e.) 30 Below Rs 3/-, the quantity demanded is more than the quantity supplied. Above example at price more than Rs 3/-, the quantity demanded is less than the quantity supplied (excess supply). Therefore, the equilibrium price is Rs 3/-. At this price the quantity demanded is equal to quantity supplied. We can explain the equilibrium price with help of the following diagram
At point E, the quantity demanded for apple is equal to quantity supplied of apple. So the equilibrium price of apple is Rs 3/- if price of apple is Rs 4/- the demanded for apple is less than supplied of apple. If price of apple is Rs 2/- the quantity demanded is more than quantity supplied (i.e.) Excess demand.
13. Demand and Supply equation for a product are given below: (3)Yd =100-PYs =70+2PDetermine equilibrium price and quantity.
Ans. Under equilibrium:Yd = Ys100-P = 70+2P30 = 3PP = Rs. 10Putting the value of P in the equationYd =100-10 = 90 unitsYs =70+2(10) = 90 unitsTherefore, equilibrium quantity = 90units
14. What are the reasons which give emergence to the monopoly market?Ans- The main reasons are as under)Patent Rights- Patent rights are the authority given by the government to a particularFirm to produce a particular product for a specific time period.ii) Formation of Cartel- Cartel refers to a collective decision taken by a group of firms toAvoid outside competition and securing monopoly right.iii) Government licensing- Government provides the license to a particular firm to producea particular commodity exclusively15. Why is demand curve facing a monopolistic competition firm likely to be more elastic?Ans- In monopolistic competition market the demand curve of a firm is likely to be moreElastic, the reason behind this is that all the firm in the industry produce close substitute ofeach other. If close substitute of any good is available in the market then elasticity ofdemand is very high because whenever there is a hike in price the consumer will shift to itssubstitutes. That is why a firm‘s demand curve under monopolistic competition is more elastic.16. Explain the effect of Maximum price-ceiling on the market of a good.(use diagram)Ans:-
Maximum price-ceiling refers to imposition of upper limit on the price of a goods by the
Government. For example in the diagram OP is price ceiling, while equilibrium price is op1. At
this price, the producer are willing to supply only PA or OQ1 while consumer demand PB or OQ
Q2. The effect of the selling that shortage equal to AB or Q1Q2 is created which may further led
to black marketing
UNIT 5 NATIONAL INCOME AND RELATED AGGREGATESBASIC CONCEPT MARKS 15
NATIONAL INCOME: - It is the sum total of factor incomes earned by normal residents of a country during the period of one accounting year.
FACTOR INCOME: - It refers to the income received by various factors of production in lieu of their productive services in the process of production.
TRANSFER INCOME /UNILATERAL PAYMENTS: - It refers to the incomes received by their recipients without rendering any productive service.
NET FACTOR INCOME FROM ABROAD (NFIA) : - This is the difference between income earn from abroad for rendering factor services by the normal residents of a country to the rest of the world and the income paid for the factor services rendered by non residents in the domestic territory of a country.
NORMAL RESIDENTS :- He is said to be one who ordinarily resides in the country concerned and whose centre of economic interest lies in that country.
CONSUMPTION GOODS/ CONSUMER GOODS: -It refer to those goods which are directly used for the satisfaction of humanwants.
DURABLE GOODS: - It refers to those goods which can be used for several years and have relatively high value.
SEMI DURABLE GOODS: - It refers to those goods which can be used for a period of one year or slightly more.
NON DURABLE/ PERISHABLE GOODS: - It refers to those goods which are used of in a single act of consumption.
CAPITAL GOODS: - It refers to those goods fixed assets which are used in the process of production of other goods.
INTERMEDIATE GOODS: - It refers to those goods which are used as inputs in the production of others goods.
FINAL GOODS: - It refer to those goods which are ready for consumption and need no further processing. The goods which have crossed production boundary.
STOCK: - It refers to the quantity of a variable which is measured at a particular point of time.
FLOW: - It refers to the quantity of a variable which is measured over a period of time.
INVESTMENT: - It is a process of capital formation.
FIXED INVESTMENT: - It refers to the stock of fixed assets of the producer during an accounting year.
INVENTORY INVESTMENT: - Change in inventory or stock during the year is called inventory investment.
GROSS INVESTMENT: - Expenditure on the purchase of fixed assets as well as expenditure on the inventory stock during the year.
DEPRECIATION: - Loss of value of fixed assets in use on account of normal wear and tear.
INJECTIONS: - These are the amount of money added to the flow of income in an economy which increases national income.
LEAKAGES: - It refer to the amount of money withdrawn from the flow of income .
GDPmp: - It is the total value of the all final goods and services by all the enterprises within the domestic territory of a country in a particular year.
GDPfc:- It is total value of all final goods and services produced in a country in a particular year excluding NIT.
GNPmp: - It is defined as the total value of all final goods and services produced in a country in a particular year and net factor income from abroad.
GNPfc: - It is defined as the total value of all final goods and services produced in a country in a particular year and net factor income from abroad excluding NIT
NNPfc : - It is the sum total of factor incomes earned by normal residents of a country during the period of one accounting year.
NNPmp:- It refers to market value of a final goods and services produced during the year inclusive of net factor income from abroad but exclusive of depreciation.
REAL GDP :- It refers to the market value of all the final goods and services produced within the domestic territory of a country during a financial year as estimated using the base year prices .
NOMINAL GDP :- It refers to market value of all the final goods and services produced within the domestic territory of a country during a financial year using the current year prices
GNP DEFLATOR = Nominal GNP/Real GNP * 100.
PRIVATE INCOME: - It is the total income from all sources (factor income as well as current transfer) that accrues to private sector during the period of one year.
PERSONAL INCOME = Private income – corporation tax – retained earnings or corporate savings.
PERSONAL DISPOSABLE INCOME = Personal income – direct personal taxes – miscellaneous receipts of the government.
GROSS NATIONAL DISPOSABLE INCOME = GNPmp + net current transfer from rest of the world.
NET NATIONAL DISPOSABLE INCOME = NNPmp + net current transfer from rest of the world.
INCOME METHOD:NDPfc= compensation of an employee’s + operating surplus+ mixed income of self-employed.
EXPENDITURE METHOD: GDPmp = private final consumption expenditure + govt, final consumption exp. +gross fixed capital formation + change in stock + net export.
NDPmp = private final consumption expenditure + govt, final consumption exp. +net fixed capital formation + change in stock + net export.
VALUE ADDED METHOD
GVAmp / GDPmp= value of output – value of intermediate consumption
= sales +change in stock – value of intermediate consumption
HOT QUESTIONS:1. Normal residents of India working in an American company in England add to
(A)Domestic product of india (b) domestic product of England (c) National product of England (d) None of these.Ans - b
2. National product at current prices is higher than the national product at constant price during the period of (i) risingprices (ii) fallingprices (iii) constantprices (iv) a&b
Ans - a3. Why is transfer income not included in national income ?( 1)Ans – because it is not connected with any productive activity antheire is no value addition.4. Calculates sales from the following data. ( 3 )Particulars Rs. In lakhs(i)output sold 800(ii)price per unit 20(iii)excise 1600Iv)import duty 400 (v)change in stock -500(vi)depreciation 1000(vii)intermediate cost 8000Ans – NVAmp = (i)X (II)+(V)-(VII)-(VI)
= 800 X 20+(-500)-8000-1000=6500
5.If nominal income is 1000 and price index is 200 calculate real income. (3)ANS. Real income = nominal income/ price index X 100
1000/200 X 100 = 5006. The value of nominal GNPof an economy was 2500 cr in the particular year .the value of GNP of that country during the same year at the base year price was 3000cr . calculate the value of GNPdeflator. Has the price level risen between the base year and the current year? (3)ANS –GNP deflator = Nominal GNP / Real GNP X 100
= 2500 /3000 X 100= 0.83
(B) No, price level has reduce by 17% between the base year and the current year.7.Differentiate between stock and flow concept. (4)Ans- STOCK FLOWI It means an economic variable measured at a particular point of time
(i)it means an economy variable measured over a period of time.
(ii)It has no time dimension (ii)It has time dimension like per hour, per day, per month, per year
(iii)it is a static concept. (iii)It is a dynamic concept.
Example wealth, inventory Example -Investment, change in inventory
8. Explain the problem of double counting with the help of an example. (4)Ans – The problem of double counting arises when value of an intermediate good is also include along with the value of final goods .exampleOutput wheat flour breadValue of output 500 700 1000Value of input 0 wheat=500 flour=700Value added 500 200 300Total value added in three stages is = 500+200+300 = 1000(value of final output , bread)But if we add total value of the output instead of value added it will be 500+700+1000= 2200 9. calculate (a)NDP FC (B) Personal income on the following data. (6)Particulars Rs in crores
(i) Private final consumption expenditure 700(ii) Savings of non departmental enterprises 20(iii) Net domestic fixed capital formation 100(iv) Undistributed profit 5(v) Change in stock 10(vi) Corporation tax 35(vii) Net export 40(viii) Income from property and entrepreneurship accruing
to the govt.adm department30
(ix) National debt interest 40(x) Govt. final consumption expenditure 150(xi) Current transfer from govt. 25(xii) Net factor income from abroad -10(xiii) Net current transfer from rest of the world 10(xiv) Net indict tax 60(xv) Personal taxes 35
Ans–(i) NDPfc = i+x+iii+v+vii-xiv = 700+150+100+10+40-60 = 940
(b)PI =NDPfc – ii-viii+xii+xiii+ix+xi – vi – iv = 940-20-30-10+10+40+25-35-5 = 915
10.Is GDP an indicator of welfare? Explain it. (6)Ans – No , GDP is a not indicator of an economy welfare because
(i)it gives no indication of the composition of output (II)gives no indication of the distribution of resources(iii) It does not take into account the level of on unemployment(iv)It does not take into account ecological degradation
11.How will you treat the following while estimating national income of India? Give reasons for your answer. (6)(i)Salaries received by indian residents working in Russian embassy in India.Ans – yes , it is because salaries received by India residents.(ii)Profits earned by an Indian bank from its branches abroadAns – yes , because it comes under NFIA(iii)Entertainment tax received by the govt.
Ans – NO , because no tax is included
UNIT 6 MONEY AND BANKING 8 MarksBarter System: Barter system refers to directly exchange of goods known as barter system. It is also known as C-C economy.Money: Money is what money does. Or any commodity which refer to money which have,“Medium of exchange, Measuring unit and differed payment”.Primary function of Money:
• Medium of Exchange: It means that money acts as a medium for the sale and purchaseof goods and services.• Standard of Differed Payment: Differed payment refers to those payments which aremade some time in the future.Supply of Money:It refers to total stock of money held by the people of a country at a point of time.Measurement of Money Supply:• M1= C+DD+OD• M2= M1+DEPOSITS WITH POST OFFICE SAVING BANK ACCOUNT• M3= M1+NET TIME DEPOSIT WITH THE COMMERCIAL BANK• M4= M3+TOTAL DEPOSITS WITH POST OFFICESForms of Money:Narrow Money: If M1 or M2 measures are used, then it is known as Narrow Money.Broad Money: If M3 or M4 measures are used, then it is known as Broad Money.Fiat Money: It refers to money backed with the order of the government.Fiduciary Money: It refers to money backed with mutual trust between the payer and thepayee.Full Bodied Money: Money value = commodity valueCredit Money: Money value of coins and notes > Commodity value of coins and notes.High Powered Money: It consists of currency and cash reserves with banks.Money Multiplier Money multiplier or deposit multiplier measures the amount of money thatthe bank is able to create in the form of deposits with every unit of money it keeps as reserve.Money Multiplier = 1/LRRreserves of the commercialbanks with the central bank as a percentage of their total deposits.Statutory Liquidity Ratio (SLR): This refers to liquid assets of the commercial banks which theare required to maintain as a minimum percentage of their total deposits.Bank Rate: It is the rate at which the central bank gives credit to the commercial banks.Legal Reserve Ratio (LRR): It is legally compulsory for the banks to keep a certain minimum
fraction of these deposits as cash. The fraction is called the legal reserve ratio.
• Open Market Operation: its refers to the sale and purchase of securities in theopen market by the central bank. To increase money supply central bankPurchases the securities from the commercial banks and vice versa.• Margin Requirements: it refers to the difference between the current value ofthe security offered for loan and the value of loan granted.in order to increasemoney supply central bank reduce the margin requirement and vice versa.• Rationing of Credit: Rationing of credit refers to fixation of credit quotas fordifferent business activities.• Moral Suasion: Some times, the central banks makes the member banks agreethrough persuasion or pressure to follow its directives on the flow of credit.
One mark Questions:---
Q.1 Define barter system. Ans. Barter system refers to directly exchange of goods known as barter system. It is also known as C-C economy.Q.2 what were the difficulties in Barter System?Ans. These were the Following difficulties in barter system:• Problem of double coincidence of want.• Lack of measuring unit.• Lack of value store.
Q.3 Give the Primary function of Money?Ans. These are the primary function of money-• Medium of Exchange: It means that money acts as a medium for the sale and purchaseOf goods and services. Measure of value: money serves as a measured of value in termsof unit of account.Q.5 What do you mean by Supply of Money?Ans. It refers to total stock of money held by the people of a country at a point of time and demand deposits of Commercial bank. .Q.6 What are the components of money supply?Ans. M1,M2,M3,M4are different forms of money and they have also different components.• M1= C+DD+OD• M2= M1+deposits with post office saving bank account• M3= M1+net time deposit with the commercial bank
• M4= M3+total deposits with post officesQ.9 Define Fiat Money.Ans. It refers to money backed with the order of the government.Q.10 Define Fiduciary Money.Ans. It refers to money backed with mutual trust between the payer and the payee.
Q.13 Define High Powered Money.Ans. It consists of currency and cash reserves with banks.HM = Currency with the Public + Cash reserves with the banksQ.14 What do you mean by Liquidity?Ans. Liquidity of assets refers to its convertibility in to money/cash. Faster an asset can beconverted into cash, more liquid it is.Commercial Bank and the Central BankQ.1 Define Commercial Bank.Ans. Commercial Bank is an institute which accepts deposits and advances loans with the viewto earn profit.Q.3 What is Credit Multiplier?Ans. It indicates the maximum credit that the commercial banks can create with their additional cash reserve. Credit Multiplier = 1/CRRQ.5 what is the minimum value of money multiplier?Ans. The minimum value of money multiplier is 1.Q.6 Explain the process of Credit Creation by Commercial Bank.Ans. The deposits held by banks are used for giving loans. However banks cannot used theWhole of deposits for lending.It is legally compulsory for the banks to keep a certain minimum fraction of their deposits asResources. The friction is called legal reserve ratio (LRR) is fixed by the central bank.Example: suppose initial deposits in is bank are rupees 1000 and LRR is 20%It means, banks are required to keeps only Rs. 200 as cash reserves and free to lend Rs. 800.This 800 will again come in the bank as deposit. With new deposit of Rs.800, banks keep 20% as
Money Multiplier = 1/LRR= 1/0.2=5Total Deposit = Initial Deposit X Money Multiplier= 1000X5 = 5000Q.10 Define the Central Bank and explain its functions.Ans. Central Bank is the apex institution which controls, operates, regulates and directs theentire monetary system of the country.Functions of Central Bank:• Issuing of Notes: Central bank of a country has the exclusive right of issuing notes. Thisis called currency authority function of the central bank.• Banker to the Government: Central bank is a banker, agent and financial advisor to theGovernment; it manages accounts of the government.
• Bankers Bank: It is an apex bank of all banks in the country. It acts as a banker to all commercial banks by providing loans and other kinds of Assistance whenever they are in need. • CRR: The part of the deposits of commercial banks kept with the Central bank is called CRR.It is the important instruments for Central bank to control money supply inThe economy. During inflation it will be increased to decrease the money supply in the economy.& Vice versa. • SLR: The part of the deposits of commercial banks kept by themselves as liquid assets is called SLR.It is the important instruments for Central bank to control money supply inthe economy. During inflation it will be increased to decrease the money supply in the economy.& Vice versa. • Open Market Operation: its refers to the sale and purchase of securities in theopen market by the central bank. To increase money supply central bankpurchases the securities from the commercial banks and vice versa.• Qualitative Instruments:• Margin Requirements: it is refers to the difference between the current value ofthe security offered for loan and the value of loan granted.in order to increasemoney supply central bank reduce the margin requirement and vice versa.• Rationing of Credit: Rationing of credit refers to fixation of credit quotas fordifferent business activities.• Moral Suasion: Some times, the central banks makes the member banks agreethrough persuasion or pressure to follow its directives on the flow of credit.
Q.13 If total deposits created by commercial bank are rupees 12000 crores, LRR is 25%calculate initial deposit.Ans. Money Multiplier = 1/LRR = 1/.25 = 4Initial deposit = Total deposit/Money Multiplier= 12000/4 = 3000 crores.Q.14 If initial deposit is rupees 200 crores and total deposits is rupees 1600 crores, calculateLRR.Ans. Money Multiplier = Total deposit/Initial deposits= 1600/200 = 8Money Multiplier = 1/LRR8 = 1/LRRLRR = 1.25
UNIT 7 DETERMINATION OF INCOME, OUTPUT AND EMPLOYMENT MARKS 12
Autonomous consumption : The consumption which does not depend upon income. (Or) The amount of consumption expenditure when income is zero. C > 0. Even if income is
zero consumption cannot be zero. Consumption will take place from past savings for survival.
Autonomous Investments : It is Investment which is made irrespective of level of income. It is generally run by the government sector. It is income inelastic. The volume of autonomous investment is same at all level of income.
Determination of income, output and employment is the core of the subject matter of macroeconomics.AD and AS together determine the level of income, output and employment.Aggregate demand is the total demand of goods and service in the economy.
The main components of AD are-1. House hold consumption expenditure.2. Investment expenditure.3. Government consumption expenditure4. Net export.
Household consumption expenditure is the expenditure incurred by the household on the purchase of goods and services to satisfy their wants.
Investment expenditurerefers to the expenditure incurred by the private firms and government on the purchase of capital goods such as plant and equipment.
Government consumption expenditure refers to the expenditure incurred by the government on the purchase of goods and services.
Net export refers to the difference between export and import.AD=C+I+G+(X-M).In a two sector economy AD =C+I.
Aggregate supply is the sum total of consumption expenditure and saving.AS=C+S
PROPENSITY TO CONSUME AND PROPENSITY TO SAVE .
The relationship between consumption and income is called propensity to consume or consumption function.C=f(Y).Consumption function may be represented by an equation.
C=a+b(Y) C=consumption, a =consumption at zero level of income b=MPC (slope of the consumption curve) Y=income.
The consumption equation shows the level of consumption for various level of income.
Propensity to consume is of two types A) Average propensity to consume (APC)B) Marginal propensity to consume (MPC).
APC= ratio of total consumption to total income.
APC=C/Y. MPC=∆C/∆Y. Propensity to save indicates the tendency of the households to save at a given level of
income. It shows the relation between saving and income. Propensity to save is also of two types.
Average propensity to save (APC)Marginal propensity to save.(MPC)Average propensity to save is the ratio of saving to income
APS=S/Y.
Marginal propensity to save is the ratio of change in saving to change in income
MPS=∆S/∆Y.1. There is relationship between APC and APS.
APC+APS=1APC=1-APS.
2. There is relationship between MPC and MPS.MPC+MPS=11-MPC=MPS.
Meaning of involuntary unemployment and full employment.
Involuntary unemployment refers to a situation in which people are ready to work at prevailing wage rate, but do not find work.Full employment refers to a situation in which no one is unemployed i.e.…there is no involuntary unemployment.
Ex ante investment is the planned investment which the planner intends to invest at different level of income and employment in the economy.
Ex ante savings refers to the planned saving at different level of income in the economy.
Ex post investment refers to the realised or actual investment in an economy during the year. It is the total of planned investment and unplanned investment.
Ex post savings refers to the realised or actual savings in an economy during the year. It is the total of planned savings and unplanned savings.
Multiplier- In an economy an increase in investment leads to increase in national income which is three times more than the increase in investment (calculate marginal propensity to consume)
MULTIPLE CHOICE QUESTIONS(One mark)
1. The value of aggregate supply equals:(a) Domestic income (b) National in come (c )Private income (d) none of the above
2. Its value can be negative: (a) APS (b) MPS (c) APC (d) MPC
3. If MPC is given as 1, how much is MPS? (a) 1 (b) 0 (c) Infinity (d) None of the above 4. There is inverse relationship between multiplier and: (a) MPS (b) MPC (c) APC (d) APS 5. When MPS = zero, then K=
(a) 1 (b) 0 (c) ∞ (d) (-) 1 6. Full employment implies the absence of:
(a) Voluntary unemployment (b) Involuntary unemployment(c) Unemployment (d) None of the above
7. In a situation of inflationary gap at the full employment level of income:(a) AD>AS (b) AD=AS(c) AD<AS (d) None
8. Which of the following is a monetary measure to correct deficient demand?(a) Reduction in Government spending (b) Increase in Government spending(c) Lowering margin requirements (d) Reduction in tax rate
9 According to which economist, the economy can be in equilibrium at less than full employment level
(a) J.M. Keynes (b) Adam Smith(c) J.B. Say (d) None of the above
10. The amount of deposits kept by the commercial banks with the Central Bank:(a) CRR (b) SLR(c) LRR (d) RRR
1. Draw a hypothetical propensity to consume curve from it draw the propensity curve to save curve
6ANS . APC=C/Y APS=S/Y
Propensity to save curveIs drawn from propensity to consume curveWhen Y=C APC=1 Till that point APS is negative at point‘s’When y>c there is a positive saving
2. Explain the determination of income and employment with AD and AS. (Give schedule) 6
ANS AD= C+IAS=C+S AS=Y (refers to countries national income)The equilibrium level of income is determined at a point when AD=AS.
Y = c+s
Y > C
S=0
IncomeAPS=0
S
0
c
C/S
y
c
S
X
Equilibrium can be achieved at full employment and even at under employment situation.It may not be always at full employment condition in an economy.
Y c I AD=C+I AS=Y
0 50 100 150 0
100 100 100 200 100
200 150 100 250 200
300 200 100 300 300 AD=AS400 250 100 350 400
500 300 100 400 500
The above schedule shows equilibrium level of income is 300 where AD=AS 300=300.
2. Explain the equilibrium level of income, employment and output with saving and investment approach. What happens when savings exceeds investment?
6
Ans. Equilibrium is achieved when planned saving is equal to planned investment that is S=I.This can be seen with the help of schedule and a diagram.
INCOME CONSUMPTION SAVING INVESTMENT
Y C (S=Y-C) I
0 50 -50 100
100 100 0 100
200 150 50 100
300 200 100 100 S=I400 250 150 100
Saving
100 I
Y
X
The equilibrium level of income is s 300 core and at this point S (100) = I (100) the equilibrium may necessarily not be at the full employment level. When saving exceeds planned investment means people are consuming less and spending more as a result AD is less than AS.This will lead to accumulation of more goods with producer .this will make the businessmen to reduce production consequently, output, income & employment will be reduced till the equilibrium level of income.
3. Draw a straight line consumption curve. From it derive a saving curve explaining the process. Show on the diagram.
6
a) The level of income at which average propensity to consume equal to one.b) A level of income at which average propensity to save is negative.
ANS
consumption saving
CNegative savingA
o Y B Income/Output
Savings S
Saving
O B Negative savings Income/Output
300 IncomeS/I
-A
Ac is the consumption curve and OA is the consumption expenditure at zero level of income. Income minus consumption is saving.When income is 0, the economy’s consumption level is OA. The corresponding level of saving is -0A.So –a is the starting point of saving curve. At OB level of income consumption is equal to income, so saving are zero. so B is another point on saving curve .
Join A and B and extend this line to S, AS is the saving curve.a) The level of income at which APC is equal to one is OB.b) A level of income at which APS is negative OY.
4. If in an economy investment increases by Rs 1000 cores to Rs 1200 cores and as a result total income increases by 800 cores calculate capital MPS.
4Ans.∆ I=1200-1000=200∆Y=800∆K=∆Y/∆I=800/200=4K=1/MPS=4MPS=1/4=0.25MPS=0.25
5. IF in an economy the actual level of income is Rs 500crores whereas the full employment the level of income is RS 800 cores. The MPC=0.75 calculate the increase in investment required to achieve full employment income.
4ANS Actual income=Rs500 cores Full empl Income = Rs 800 cores ∆ y = 800 -500 = 300 coresMPC = 0.75 = 75 = 3
100 4K = 1 1 1 100 -------- ------------ = ---------- = --------- = 4 01-MPC 1 - 0.75 0.25 25
We know that ∆ y = K. ∆ I300 = 4 × 4 I∆ I = 75 crores
6. Calculation of APC and MPC given the level of Income and Consumption4
Income consumption APC = c/y MPC = ∆c/∆y0 4 - -10 12 1.20 0.8020 20 1.00 0.8030 28 0.93 0.8040 36 0.90 0.80
7. Suppose the consumption equals c= 40 + 0.75 y, Investment equals I = Rs 60 and Y= C + I. Find i) Equilibrium level of income ii) The level of consumption at equilibrium iii) level of saving at equilibrium
6
Ans: i) Y= C + I AS = ADSubstituting the value of c and I we getY = 40 + 0.75y + 60 Y= C+ I I=60(Y-0.75y)= 100(1-0.75)Y=1000.25Y =100Y=100/0.25Y=10000/25Y=400
Equilibrium level of income = Rs. 400 cr.ii)AS =AD
C= 40 + 0.75y Y = 400 C= 40 + 0.75(400) = 340C=340
iii) Y= C + S So S= Y-CS= 400 -340 = 60S= 60 crores
6. In a two sector economy, the saving and investment functions are:6
S= -10 + 0.2Y I = -3 + 0.1Y
What will be the equilibrium level of income?
Ans: Equilibrium level of income S= I
-10 + 0.2y = -3 + 0.1y
0.2y – 0.1y = -3 + 10
0.1y =7
y = 70
8. Explain the components of the equation C= 20 + 0.90 y and construct a schedule for consumption where income is Rs 200 , Rs 300 , Rs 350 and Rs 400.
69. ANS Components of equation c=20 + 0.90y explained in ¾ mark question number 1
The schedule for consumption is as follows
Y (Income) c=20 + 0.90y
200 200 c= 20 + 0.9 × 200
250 245 =20 + 180 = 200
300 290 c= 20 + 0.9 ×250
350 335 = 20 + 225 = 245
400 380 c= 20 + 0.9 × 300 = 290
C= 20 + 0.9 × 350 + 335
C= 20 + 0.9 × 400 = 380
8.The consumption function is C= 20 + 0.9y. The value of Income is given as 100,200, 300, 400 and 500. Find out the consumption schedule and draw the consumption curve.
6
ANS - The consumption schedule
Y (Income) C = 20 + 0.9 Y
0 C=20
100 C=20 + 0.9 (100) = 110
200 C=20 + 0.9 (200) = 200
300 C=20 + 0.9 (300) = 290
400 C=20 + 0.9 (400) = 380
500 C=20 + 0.9 (500) = 4
The consumption curve is shown as
C=f(Y)
10. How is equilibrium output of final goods determined under short run fixed price?6
ANS Under short run fixed price, equilibrium output and equilibrium demand at fixed price and constant rate of interest can be found with the help of following formulas
Y= ‾A ---------1 - bY = Value of equilibrium output__A = Total Autonomous consumptionb = MPC
__ __ __Thus, value of equilibrium output (y) depends on values of A (i.e, c + I) and bi.e AD = AS __ __Y= C + I + by __ __ __Y = A + by (A= C + I showing total autonomous expenditure)__Y – by = A Y (1-b) = ‾AY= ‾A-------- 1-b
MULTIDISCIPLINARY QUESTIONS
1. Can the value of APS be negative? If yes then when?Ans. The value of APS can be negative when the value of consumption exceeds the value of income. At low level of income saving is negative.
470
0500400300200100
300
200
20
110
380
290
Income
Cons
umpti
on
e.g.: if income is Rs 1000 and consumption expenditure is Rs 1200 Y=C+S S=Y-C1000-12000=-200APS=-200/1000=0.2 APS=S/Y.APS=-0.2.
2. Explain the components of equation c= ‾a + by.Ans. ‘a’ is called intercept and it represents the amount of consumption when there is a zero level of income i.e. autonomous consumption. The consumption is positive at zero level of income. The coefficient ‘b’ measures the slope of consumption. The slope gives the increase in consumption per unit increase in income. This is called as MPC. Consumption changes by ‘b’ for every one rupee change in income. Consumption changes in the same direction as income.
3. Derive the saving function from the consumption function c=‾a+by.Ans. Saving is equal to income minus consumption (y=c+s).The saving function relates to the level of savings to the level of income. It is derived from the consumption which is as follows:Y=C+SS=Y-Csince C=‾a+bY.therefore,S=Y-(a+bY)S= -a+(1-b)Y
4. Explain the components of S= -a+ (1-b) Y.Ans. The saving function is S= -a+ (1-b) Y.-a represents the intercept term and it represents the amount of savings done when there is zero level of income. The saving is negative at zero level of income because at zero level of income consumption (a) is positive. Negative saving is nothing but dissaving, this means that at zero level of income there is dissaving of amount –a.The coefficient (1-b) measures the slope of the saving function. The slope of the saving function gives the increase in savings per unit increase in the income. This is known as MPS. Since ‘b’, that is MPC is less than one, it follows that (1-b) i.e. MPS is positive. Saving is an increasing function of income.
5. Can the average propensity to consume be greater than one? Give the reason for your answer.Ans. APC can be greater than one when the consumption exceeds the income. At that level APS will be negative .when the APS is negative APC will be greater than one.
6. When can the APC be equal to one? Give reason for your answer.Ans. APC can be equal to one when APS =0, i.e when consumption = income.E.g: y=1000, c=1000.APC=C/Y 1000/1000=1APC=1APC+APS=11-APC=APS1-1=0
7. Explain the meaning of investment multiplier? What can be its minimum value and why?Ans. Defined as the ratio of change in the income to the change in the investment.K=∆Y/∆I.The value of the multiplier is determined by the MPC. It is directly related to MPC.K=1/1-mpc = 1/1-0 =1K=1Minimum value of K is when minimum value of MPC=0, the minimum value of K will be unit one.
UNIT 8: GOVERNMENT BUDGET AND THE ECONOMY
BASIC CONCEPTS (MARKS 8)
GOVERNMENT BUDGET: Government budget is the annual statement, showing item wise estimates of receipts and expenditure during a fiscal year.
COMPONENTS OF THE BUDGET: It has two components (a) Revenue budget (b) Capital Budget
TAX: A tax is a compulsory payment made to the government without reference toany benefit. SURPLUS BUDGET: A surplus budget is one where the estimated revenues are greater than the estimated receipts.
BALANCED BUDGET: A balanced budget is one where the estimated revenue equals the estimated expenditure. REVENUE RECEIPTS: Those receipts which neither create any liability nor causes any reduction in the assets of the government. Exp-taxes, fees etc. REVENUE EXPENDITURE: It refers to the expenditure which neither creates any assets nor causes reduction in any liability of the government. Ex-payment of salaries etc.
CAPITAL RECEIPTS : It includes those receipts which either create a liabilitity or cause a reduction in the assets of the government. Ex- borrowings, disinvestment etcCAPITAL EXPENDITURE : It refers to the expenditure which either creates an asset or causes a reduction in the liabilities of the government. Ex –construction of Metro, repayment of loans etc. REVENUE DEFICIT: It refers to excess of revenue expenditure over revenue receipts during the given fiscal year. FISCAL DEFICIT : Total expenditure - Total receipts excluding borrowings PRIMARY DEFICIT : It is the difference between fiscal deficit and interest payment
HOTS
Q. 1 Which type of revenue receipts are treated as legally compulsory payment imposed on
the people by the govt.? Give example also.
Ans. Taxes imposed on the people by the govt. such as income tax, sales tax.
Q.2 When the liability to pay a tax is on one person and the burden of tax falls on some
other person, state the type of tax?
Ans: These are indirect taxes such as sales tax.
Q.3 What happens to aggregate demand when the govt. budget is in deficit?
Ans: A deficit budget increases the aggregate demand because the deficit budget means that the
amount of expenditure is more than the amount of tax.
Q.4 Classify the borrowings and recovery of loans into revenue and capital receipts of govt.
budget. Give reason also.
Ans. Borrowings are capital receipts because the government is under obligation to return the
amount along with interest so it creates liability for the government. Recovery of loans are also
capital receipts because these reduce assets of the govt.
Q.5 How tax revenue is different from administrative revenue?
Ans: Tax revenue is the revenue that arises on account of taxes levied by the government. Taxes
are of two types: direct taxes and indirect taxes. Direct taxes are those taxes levied immediately
on the property and income of persons income tax, corporate tax, wealth tax whereas indirect
taxes are the taxes levied on the production and sale of goods like sales taxes, excise duty etc.
Administrative revenue is revenue that arises on account of the administrative function of the
government. It includes(a)Fees(college/school)(b) License fees paid to get permission to perform
a service (c) Fines and penalties etc.
Q.6 How government reallocates the resources and redistributes the income through
Budget?
Ans. 1. Reallocation of resources:-
In case, the market economy fails or does not achieve the desired social objectives, the
government has to interfere through budget and reallocate resources accordingly. Through its
budgetary policy, the government of a country directs the allocation of resources in a manner
such that there is a balance between the goals of profit maximization and social welfare.
Production of goods which are injurious to health is discouraged through heavy taxation. On the
other hand, production of ‘socially useful goods’ is encouraged through subsidies.
2. Redistribution of Income: -
Every economy strives to attain a society, where inequality of income and wealth
should be minimum. In order to achieve this objective through govt. budget the government
spends sufficient money on social security schemes, economic subsidies and public works etc.
Q.7 What are the basis of classifying receipts into revenue receipts and capital receipts?
Ans. It is classified on the basis of liability and creation of assets. Revenue receipts are those
which neither create a liability for the govt nor reduce the assets of govt such as income tax,
sales tax, fees, profits etc. Capital receipts are those which either create a liability for the govt or
reduce assets such as borrowings, disinvestment, recovery of loans etc.
Q.8 Why is tax treated as revenue receipt?
Ans. Because tax neither create a liability for the govt. nor reduces assets of the govt.
Q.9 Find out the value of total receipts of govt. Budget if budget deficit is Rs 2,000 crores and
the total expenditure is Rs 3,000 crores.
Ans:- Budget deficit =Total Expenditure- Total receipts
Total receipts= Total Expenditure- Budget deficit
= 3,000-2,000
= 1,000 Ans. Rs. 1,000 crores
VALUE BASED QUESTIONS
Q. Objectives of government budget includes higher taxes on richer section and spending more on providing services of education and health free to poorer section. Tell what would be impact on richer and poorer section and society as a whole?Ans. (a) Decrease disposable income of richer and increase those of poorer and thus help in bringing equality in the society.
Q. How can government encourage private sector to undertake certain production in public interest?Ans. By giving tax concession, through subsidies and undertaking projects through public and private partnership etc.
FAQsQ 1.How the government budget helps in reducing inequalities in income. Explain? (3) Ans. Government can reduce inequality of income by two ways- (1) Taxation: High rates of tax for rich people. (2)Subsidies: Reduce the prices of goods.
Q2. What is the difference between fiscal deficit and primary deficit? Explain the implication of revenue deficit. (4)
Ans... Difference between fiscal deficit and primary deficit-Fiscal deficit Primary deficit
1.It shows the total borrowing requirement of the government including interest payments.
It shows the total borrowing requirement of the government excluding interest payments.
2.It is difference total expenditure and total receipts excluding borrowings.
Fiscal deficit = TE – TR (Excluding borrowings)
It is difference between fiscal deficit and interest payment
Primary deficit = fiscal deficit – interest payment.
Implication of revenue deficit:- A revenue deficit indicates the inability of the government to meet the expenditure on
routine functioning of the economy. Q3. Define (i) Fiscal Deficit (ii) Budget deficit Revenue deficit (iv) Primary Deficit(4*1=4)Ans. Fiscal deficit Budget expenditure – Budget receipts
(When BE>BR) (Other than Barrowing )Budget deficit Budget expenditure - Budget receipts(When BE>BR) Revenue deficitRevenue expenditure - Revenue reaction (When RE>RR) Primary deficit - = Fiscal deficit – interest payment
Q4. Find the difference between revenue receipts and capital receipts. (3)Ans: Revenue receipts are the receipts which don't create liabilities to Govt. & do not cause
reduction in assets of Govt ex: - Tax & non tax receipt Capital Receipts: - are the receipts which create liabilities to Govt& cause reduction in Assets of
Govt.Ex-Disinvestment
Q5. Distinguish between direct taxes & indirect taxes with examples(3)ANS,.
Q6.Why are subsidies treated as revenue expenditure?(1)
ANS .Subsidies do not lead to increase in asset or decrease in liability of government.
Q7.Tax rates on higher income group have been increased. Which economic value does it reflect. Explain? (4)
ANS.1. It will increase social welfare. 2. There will be equal distribution of income. (1½×2=3)
Q8.Categories the following receipts into revenue receipts and capital receipts. Give reason for your answer. (4)
a. Receipt from sale of shares of a public sector undertaking.b. Borrowingsc. Profit of public sector undertakingd. Interest received on loan given to other counties.
ANS.(a)Capital receipts as it decreases assets of the government. (1)
Direct Taxes Indirect Taxes These are imposed on income & wealth of
person These taxes are imposed on goods &
service Burden of these tax can't be shifted to another person
Burden of these taxes can be shifted to another person Income Tax Sale Tax
(b)Borrowings – Capital receipts as it increases liability of the govt. (1)(c)Profit – Revenue receipt as it neither increases liability nor decreases assets of the govt.
(1)(d)Revenue receipt – neither decrease asset nor increase liability. (1)9.State the following statements as true or false and give reason:- (4)(1)Construction of dam is revenue expenditure.(2)Loan from the World Bank is a capital receipts.(3)Income from Interest is a capital receipt.(4)Expenditure on repayment of loans by the Government is capital expenditure.Ans. False-it is capital expenditure, it creates assets.True- borrowing creates liability.False-it is revenue receipt. Neither creates any liability. True- it reduces liability.
Q10. What do you mean by fiscal deficit? Explain its implications.(3/4)Ans. FD=TE-TR(other than borrowings).(1)1 mark for each.
UNIT 9 BALANCE OF PAYMENTS AND FOREIGN EXCHANGE RATES
(BASIC CONCEPTS) MARKS 7
1. Foreign Exchange Rate-: It is the rate at which currency of one country is converted into currency of another country.
2. Fixed Exchange Rate System -: It refers to the system in which the rate of exchange is fixed by the government. It remains unchanged for a certain time period.
3. Flexible Exchange Rate-: It is the rate which is determined by the market forces of demand and supply. It is also known as floating exchange rate.
4. Managed Floating -: It is a foreign exchange rate determined by market forces and central bank influences the exchange rate through intervention in the exchange market.
5. Demand for foreign exchange-:i) to make payments for import ii) To make investment in ROW
6. Supply of foreign exchange-: i) Receipts from export.ii) Foreign investment.
7. Depreciation of domestic currency -: Decrease in the value of domestic currency in terms of foreign currency by the demand and supply of foreign exchange.
8. Devaluation of domestic currency -: Decrease in the value of domestic currency in terms of foreign currency planned by the government not by the market forces.
9. Balance of Payments -: It is an accounting statement that provides a systematic record of all the economic transactions between residents and rest of the world.
10. Balance of trade -: It refers to the difference between exports and imports of goods or visible items.
11. Autonomous items -: These are those transactions of BOP which take place due to some economic motive for profit maximization.
12. Accommodating items-: These are those transaction of BOP which are undertaken to cover deficit or surplus of BOP.13. Appreciation of domestic currency-: Increase in the value of domestic currency in terms of foreign currency by the market forces of demand and supply of foreign exchange.
14.Current Account:- It records all the transactions relating to export and import of goods, services and unilateral transfers during a given period of time.
15. Capital Account: It records all those transactions which cause a change in the assets or liabilities of the residents of a country.
16. Components of Current Account:i)Export and import of goods. ii)Export and import of services. iii) Unilateral transfers to and from abroad.
17. Components of capital Account; i) Foreign direct investment. ii) Portfolio investment. iii)Borrowings and lending to and from abroad.
18. Deficit in Balance of payments:It refers to a situation when outflow of foreign exchange is more than its inflow.
19. Surplus in Balance of payments:It refers to a situation when inflow of foreign exchange is more than its outflow.
20.Credit side of BOP:All inflows of foreign exchange are recorded on the credit side of BOP.
21. Debit side:All outflows of foreign exchange are recorded on the credit side of BOP.
Questions and Answers (Value based and multidisciplinary questions)
Frequently Asked Questions (CBSE EXAM)
Q1. What is meant by balance of payments account? Ans- Balance of payments refers to the statement of accounts recording all economic transactions of a country with rest of the world in an accounting year.
Q2. What is meant by balance of trade? Ans-Balance of trade is defined as the difference between the value of imports and exports ofonly physical goods or visible items.
Q3. Distinguish between balance on trade account and balance on current account.
Ans-Balance on trade account includes only visible items of trade. It is defined as the differencebetween export of goods and imports of goods.
Balance of trade=export of visible items-import of visible items
Balance on current account includes transactions of visible items and invisible items.
Q4. Distinguish between autonomous and accommodating transactions of balance of payments account. Ans- Autonomous items are related to those transactions which are determined by consideration of
profit. Accommodating items are not determined by considerations of profit. These itemsare meant to restore BOP equilibrium.
Q5. Which transactions determine the balance of trade? When is balance of trade surplus? Ans- Export and import of goods or visible items determine the balance of trade. Visible items include all commodities of export and import. Balance of trade is the difference between the value of exports and the value of imports. Surplus in balance of trade occurswhen export of goods> import of goods.
Q6. Distinguish between current account and capital account of balance of payments account.Ans- Current account of BOP is that part of BOP which records items of:
a)Export and import of goods (visible)b)Export and import of services (invisibles) includes:
c)Non factor services d) Income(arising out of factor services) e) Unilateral transfers.
Capital account of BOP is that part of BOP which records items of:
a)Borrowing (external assistance and commercial borrowings)b)Investments (FDI as well as portfolio investment)c)NRI depositsd)Banking capital etc
Q7. Define foreign exchange rate. Ans.-The rate at which one currency exchanges for the other currency in the international money market is known as foreign exchange rate.
Q8. What is flexible exchange rate? Ans. - Flexible rate of exchange is that rate which is determined by the demand for and supply of different currencies in the foreign exchange market.
Q9. Why is foreign exchange demanded? Ans. - Foreign exchange is demanded for the following reasons:
i) Payment of international loans.ii) Gifts and grants for rest of the world.iii) Investment in rest of the world.iv) Direct purchase abroad as well as imports from rest of the world.
Q10. What are the sources of supply of foreign exchange? Ans.- The sources of supply of foreign exchange are
i) Purchase of domestic goods by the foreigners.
ii) Direct foreign investment as well as portfolio investment in home country.iii) Speculative purchases of foreign exchange.iv) Remittance by the non residents living in foreign countries.
Q. 11. Explain the concept of managed floating exchange rate. Ans.- It is a system in which exchange rate is determined by the forces of supply and demand in the international money market, but at times the central bank intervenes to place some influence on the exchange rate so that it remains within desired limits.
Q12.-When price of foreign currency falls, the demand for that foreign currency rises. Explain why? Ans.- When price of foreign currency falls, the demand for that foreign currency rises, because :
i) Indian players in the international market will now buy more of foreign currency because now it is available at a lower price. Thus the demand rises.
ii) Now, imports become cheaper than before. Accordingly imports tend to rise, implying a rise in the demand for foreign currency.
iii) Travelling abroad now becomes cheaper, accordingly demand for the foreign currency rises
Q.13. How is flexible rate of exchange determined? Ans.- Flexible exchange rate is determined by the forces of supply and demand in the international market. The theory of determination of rate of exchange is the demand and supply theory. According to this theory the rate of exchange of a country’s currency isdetermined by the demand for and supply of its currency. If the demand for foreign exchange rises its value will also rises and if the demand for foreign exchange falls its value will also fall. Similarly supply of foreign exchange also influences the exchange rate. Greater the supply, lower the exchange rate.
