Micro Economics

Chapter-1 (Introduction)

Q. -1 Explain the central problem “What to produce”. Or

State the problems relating to allocation of resources in an economy.

Ans. The problem of what to produce is related to allocation of resources this problem arises because of limitation of resources. It is the problem of deciding what goods and services should be produced and in what quantities. Ex. Consumer goods or capital goods.

Q. -2 Explain the problem of choice of technique? Ans. This problem is related Choosing the best possible technique or technology of

production. There are two techniques of production i.e. labour intensive and capital intensive technique. In labour intensive technique more labour and less capital is used. And in capital intensive technique more capital and less labour is used. This problem is raised due to availability of resources.

Q. -3 Explain the central problem distribution of income? Ans. For whom to produce deals with the distribution of income among the people income

distributed among them in the form of wages, interest and profit. The share of each factor is determined by its relative contribution in national income. Those factor who contribute more will get more and vice-versa It means deciding a careful allotment of available resources for producing desired goods and services.

Q. -4 Draw a PPC curve and show the following:- a) Growth of resources. b) Underutilization of resources. c) Fuller utilization of resources

Ans.

A) With economic growth i.e. growth of resources or advancement of technology the economy will be in a position to produce more of wheat as well as more of maize which will shift the PPC to the right. As shown in the above diagram the original PPC shifts to the right and PP becomes the new i.e. P’P’.

B) The point R lying below the PPC shows underutilization of resources since with the given resources economy can produce either MN more of maize or QT more of wheat with its given resources.

Economic Growth

Wheat

Maize

O

.

.

R

S

P

P

P1

P1

C) In the diagram PP is the production Possibility curve. The point “S” on PPC shows full employment of resources. By definition all point on PC show various combinations of two goods which the economy can produce by utilizing all its resources fully and efficiently.

Q. -5 What is the impact of education for all campaign (sarva Shiksha Abhiyan) on the PPC curve of the Indian Economy and Why?

Ans. Education for all promote education in the economy. Education will raise the efficiency by making a worker skilled and thus contributing more effectively. This development will increase the production potentially there by PPC shifting right word.

Q.6 Giving reasons, state whether the following statements are true or false. 1) If the economy operates inside PPC, it shows fuller utilization of resources. 2) Because of destruction caused by war, a country’s PPC will shift to the left. 3) A job guarantee scheme will lead to a rightward shift of PPC.

Ans. 1. False- If there is underutilization or in efficient utilization of resources the economy

will produce at any point inside the PPC. 2. True- due to decrease in resources PPC will shift to the left. 3. True- If given resources are fully and efficiently utilized.

Q.7 Giving reason comment on the shape of Production Possibilities Curve

based on the following schedule :

Good X Good Y

0 30

1 27

2 21

3 12

4 0

Ans. Good -X (Units) Good- Y (Units) MRT

0 30 -

1 27 3Y : 1X

2 21 6Y : 1X

3 12 9Y : 1X

4 0 12Y : 1X

Since MRT is increasing, the PPC is downwrd sloping concave to the origin.

Economic Growth

X

Y

O

P

P

P1

P1

Q.8 What I likely to be the impact of “Make in India” appeal to the foreign investors by the Prime Minister of India, on the production possibilities frontier of India? Explain.

OR What is likely to be the impact of efforts towards reducing unemployment on the production potential of the economy? Explain.

Ans. ‘Make in India’ appeal signifies invitation to foreign producers to produce in India. This will lead to increase in resources thus raising production potential of the country. As a result PP curve will shift upwards.(Diagram not required)

OR Reducing unemployment has no effect on the production potential of the country. It is because production potential is determined assuming full employment. Unemployment indicated that the country is operating below potential. Reducing unemployment simply helps in reaching potential.(Diagram not required)

Consumer Behaviour & Demand

Q. -9 Explain why marginal utility declines with consuming more units of commodity? Ans. Marginal utility of successive units because of the law of diminishing marginal utility.

Its states that as more and more units of a commodity are consumed by a consumer the marginal utility derived from each successive unit tends to diminish.

Q. - 10 Explain consumer’s equilibrium in single commodity case. OR

Given the market price of a good, how does a consumer decide as to how many units of that good to buy? Explain. (Hint: Explain consumer’s equilibrium in single commodity case.)

OR How does a consumer reach equilibrium position when he is buying only one commodity? Explain with the help of a marginal utility schedule.

Ans. Consumer’s equilibrium refers to a situation when a consumer maximizes his satisfaction, spending his given income across different goods and services at given price. In case of a single commodity, consumer attains equilibrium when:

(i) MUx/Px = MU of Money. Where, MUx is marginal utility of commodity-X and Px is price of commodity-X. It implies that in a state of equilibrium , rupee worth of satisfaction actually derived from the commodity should equal to rupee worth of satisfaction expected by the consumer (MUm)

(ii) Marginal utility of money remain constant. (iii) Law of diminishing utility holds good. Implying that marginal utility must

decline as more of a commodity is consumed. Q. - 11 Explain consumer’s equilibrium in two commodity case. Ans. Consumer consuming only two goods, say X and Y, will attain equilibrium when the

following conditions are satisfied: (i) Marginal utility per rupee (MUx/Px) must be same between both the goods

purchased by the consumer. Thus, MUx/Px = MUy/Py

(ii) Marginal utility of money remains constant. That is, MUx/Px or MUy/Py should be equal to MUm, which implies that utility per rupee obtained by the consumer from Good-X or Good-Y should be equal to marginal utility of money. Thus,

MUx/Px = MUy/Py = Mum

(iii) Law of diminishing marginal utility must hold good. Implying that marginal utility declines as more and more of a commodity is consumed.

Q. - 12 Why does Indifference curve slope downwards? Ans. In order to maintain the same level of satisfaction along a curve if consumers increase

consumption of commodity X then the consumption of commodity Y has to be reduced. Hence the IC are downward sloping

Q. - 13 How many chocolates, will a consumer buy, if they are available free of cost? Ans. As per law of diminishing marginal utility consumer consumes the units of a

commodity till he gets maximum satisfaction. Though the chocolates are free of cost a consumer will consume up to that unit which will give him minimum positive utility and he becomes fully satisfied.

Q. –14 Briefly explain the properties of indifference curve. Ans.

1. Indifference curve slopes downwards: As the units of consumption of one commodity is increased, the units of the

consumption of another commodity has to be decreased therefore indifference curve slopes downward.

2. Indifference curve is convex to the origin: Indifference curve is convex to the origin because of decreasing marginal rate of substitution. 3. Higher indifference curve gives more satisfaction: Higher indifference curve gives more satisfaction because any point on higher

indifference curve shows more units of at least any one commodity which gives more satisfaction.

4.Two Indifference curves never intersect each other: Each Indifference curve gives different satisfaction, if two curves intersect means at

intersection point both the curves will give equal satisfaction but it is not possible.

Q. –15 Explain consumer’s equilibrium through indifference curve approach. Ans. Consumer equilibrium is a state in which a consumer gets maximum satisfaction by

spending his income on particular commodities. As per Indifference curve approach consumer is in equilibrium where the slop of budget line and the slop of indifference curve equal to each other, where budget line is tangent to the indifference curve. Which is shown in the following diagram: Consumer’s Equilibrium

E

e

Y

X O

GOOD-Y

GOOD-X

IC1

e

IC2

e

IC3

e

A

B

. e

In the above diagram consumer’s equilibrium is at point ‘E’ where AB budget line is tangent to the IC2. Consumer will not be in equilibrium at any point on IC1 because this curve gives less satisfaction. Consumer will also not be in equilibrium at any point on IC3 because at this curve consumer cannot reach due to limitation of resources.

Q. –16 Consumer consumes only two goods X and Y, and is in equilibrium. Price of X rises, explain reaction of consumer with the help of utility analysis.

Ans. Now is if consumers finds Mux/Px < MUy/Py, he will reduce expenditure on X and Increase that on Y. So when Py falls demand for Y rises and he will buy more quantity of Y because Y becomes cheaper in relation to X. He will continue substituting Y for X till the point Mux/Px = MUy/Py.

Q. –17 A consumer consumes only two goods X and Y. At a consumption level of these two goods, he finds that marginal rate of substitution is higher than the ratio of the prices. Explain the reaction of the consumer.

Ans. MRSxy more than Px/Py, this means to get one more unit of commodity X consumer is willing to sacrifice more units of commodity Y than the market requires. It shows that consumer is willing to pay higher price of commodity-X, than the market requires. Consumer will now buy commodity-X and buy less of commodity-Y. This will bring down MRSxy till it becomes equal to Px/Py. MRSxy = Px/Py

Q. –18 Distinguish between extension of demand and increase in demand. Ans. EXTENSION OF DEMAND INCREASE OF DEMAND

i.)It is movement along with demand curve.

ii.)It happens due to decrease in price.

iii.)Other factor remains constant.

iv.)Downward movement of demand curve.

vi.) When demand increase due to decrease in

price is called extension

i.)It is a part of shift of the demand curve.

ii.) It happens due to change in other factors.

iii.)price remain constant

iv.)rightward shift of demand curve

vi.) When demand increases due to change in other factors is

known as increase in demand

Q. –19 Distinguish between contraction of demand and decrease in demand.

Ans. CONTRACTION OF DEMAND DECREASE IN DEMAND

It is a movement along with the demand curve.

ii.) It happens due to increase in price.

iii.) Other factors remains constant.

iv.) Upward movement of demand curve.

v.) when demand decreases due to increase in

price is called contraction.

it is a part of shift of demand curve.

ii.)It happens due to change in other factors.

iii.)Price remains constant.

iv.)Leftward movement of demand curve.

v.)When demand decreases due to change in other factors it is

called decrease in demand.

Q. –20 Draw demand curves showing price elasticity: (a) Greater than one (b) Infinity (c) Zero, (d) Less than one.

Ans. (a) Greater than one (b) Infinity

(c) Zero (d) Less than one

Q. – 21 From the following table calculate price elasticity of demand by the percentage method. Price of Good-X (Rs.) Total Expenditure (Rs.) (Per unit)

4 600 5 525

Ans. PRICE QUANTITY TOTAL EXPENDITURE

4

5

150

105

600

525

HERE,P1=5 P=4 P= P1-P=1

Q=150 UNITS Q1=105 UNITS; D=Q1-Q= (105-150)=45 UNITS

Ed= (-)

= (-) =1.2

Ed=1.2

Q. –22 Price elasticity of demand for a good is (-) 1. At a given price the consumer buys

60units of the good. How many units will the consumer buy if the price falls by 10%? Ans. (-) 1 implies negative relation, so if the price falls by 10% the consumer will buy

more. 60/100*10=6. New quantity = 66

Q. –23 A consumer buys 5 units of a good at a price of Rs 4 per unit. When the price falls to Rs

3 per unit he buys 10 units. Calculate price elasticity of demand. Ans.

P=4 ; P1=3; Q=5 Q1=10

Ed=

= 4

Ed=4

PRICE QUANTITY

4 5

3 10

Q. –24 A consumer buys 80 units of a good at a price of Rs. 5 per unit. Suppose price elasticity of demand is -2. At what price will he buy 64 units?

Ans.

PRICE QUANTITY

5 80

X 64

P=5; P1=X Q=80; Q1= 64 Ed=-2

Ed=

-2 =

-0.5 = x P1= 5+0.5 =5.5

Q. –25 Price of a good rises from Rs. 10 per unit to Rs. 11 per unit. As a result, quantity demanded of that good falls by 10%. Calculate its price elasticity of demand.

Ans. PRICE QUANTITY

10 ↓ 10%

11

= Ed=1

Q. –26 A consumer buys 50 units of a good at a price of Rs. 10 per unit. When price falls to Rs.

5 per unit he buys 100 units. Find price elasticity of demand by the ‘Total Expenditure method’.

Ans. PRICE QUANTITY EXPENDITURE

10 50 500

5 100 500

There is no relation between change in price and expenditure. so, Ed=1

Q. –27 Price of a commodity falls from Rs. 4 to Rs. 3 per unit. As a result total expenditure on

it rises from Rs. 200 to Rs. 300. Find out price elasticity of demand by percentage method.

Ans. PRICE QUANTITY EXPENDITURE

4 50 200

3 100 300

= = 4%

Chapter-3 (Production)

Q. –28 Explain the relationship between Total Physical Product (TPP) and Marginal Physical Product (MPP).

Ans. Relationship between TP and MP :- A.) When TP increases with increasing rate then MP increases. B.) When TP increases with decreasing rate then MP is increasing. C.) When TP becomes highest and constant then MP becomes 0

Q. –29 Explain the law of variable proportion with the help of total and marginal physical product.

OR Explain the effect on output when only one input is increased and all others are held constant.

OR Explain the “law of variable proportions” in terms of behaviour of total Product and marginal product.

Ans. LAW OF VARIABLE PROPORATION:- It states that as more and more of the variable factor is combined with fixed factor MP will initially rise, but a situation will come when MP of variable factor will start declining, it can be zero and even negative. With the increase in variable factor and other factors remaining constant TP and MP change as follows :- A.) When TP increases with increasing rate then MP increases. B.) When TP increases with decreasing rate then MP is increasing. C.) when TP becomes highest and constant then MP becomes 0 D.) When TP is decreasing then MP is negative.

Q.30

What are the different phases in the Law of Variable Proportions in terms of Marginal Product? Give reason behind each phase. Use diagram.

Ans. The Law of Variable Proportion shows the impact on output when units of variable factor are increased, keeping fixed factors constant in the short-run. The law state stat if more and moe units of a variable factor are employed with fixed factors, then Total Physical Product(TPP) increases at an increasing rate in the beginning then increases at a diminishing rate and finally starts falling or in other words, MPP initially increases, then falls an eventually becomes negative. The law can be explained wi the help of following schedule and diagram:

Land No. labourers

of

TPP APP MPP stages

1 1 1 1

0 1 2 3

0 2 6

12

0 2 3 4

- 2 4 6

Stage-I

1 1 1

4 5 6

16 18 18

4 3.6 3

4 2 0

Stage –II

1 1

7 8

14 8 2 1

(-)4 (-) 6

Stage - III

As per the above schedule and diagram, In Stage I, TPP tends to rise at an increasing rate. This corresponds to a situation of increasing returns to a factor. In stage II, TPP tends to rise at a diminishing rate. This corresponds to situation of diminishing returns to a factor In stage III, TPP starts declining. This is a situation of negative returns to a factor. Causes of increasing returns to a factor (i) Fuller utilization of the fixed factor: In the initial stages, fixed factors remains underutilized. Its fuller utilization is possible by adding additional units of the variable factor to total output and the MP of variable factor tends to increase. (ii) Increased efficiency of the variable factor: Additional application of the variable factor causes process based division of labour that raises efficiency of the factor. Causes of diminishing returns to factor are (i) Fixity of the factor: It is the principal cause behind the law of diminishing returns. As more and more units of the variable factor is combined with the fixed factor, the latter gets excessively utilized, leading to decrease in its productivity. (ii) Imperfect factor substitutability: Factors of production are imperfect substitutes of each other. E.g. more and more labour cannot be continuously used in place of additional capital Causes of S negative return to a factor are (i) Limitation of fixed factor: The fixed factor can be optimally used only up to a certain level. (ii) Decrease in efficiency of variable factor: As the variable factor is increased its efficiency tends to fall.

Q. –31 Explain the reasons for increasing returns to a factor. Ans. i. Greater application of the variable factor ensures fuller utilization of the fixed

factor. ii. Greater application of the variable factor facilitates better division of labour which

increases the marginal productivity of labour, and iii. Greater application of the variable factor improves coordination between the

factors which gives increasing returns to a factor. Q. –32 Explain the reasons for decreasing returns to a factor. Ans. i. Fixity of the factors: As more and more units of a variable factor are combined

with the fixed factor, the fixed factor gets over utilized. Hence, it gives diminishing returns.

ii. Factors are imperfect substitute of each other: factors of production are imperfect substitutes of each other, accordingly, fixed factor cannot be replaced by other factors.

iii. Poor coordination among different factors: The coordination among different factors is impaired as more and more of a variable factor is employed, other factors remaining constant so that marginal product of the variable factor declines.

Q. –33 Complete the following table: Units of labour 0 1 2 3 4 5 6 TPP 0 20 - - 88 - - MPP - - 22 - - 17 - APP 0 - - 22 - - 20

Ans. Units of labour 0 1 2 3 4 5 6 TPP 0 20 42 66 88 105 120 MPP 0 20 22 24 22 17 15 APP 0 20 21 22 22 21 20

Chapter-4 (Concepts of Cost & Revenue)

Q. –34 Differentiate between explicit cost and implicit cost. Give one example of each. Ans. Difference between Explicit cost and Implicit cost:

Explicit Cost Implicit Cost It is the cost which incurred on the factors of production hired from outside.

It is the cost of factors of production supplied by the owner himself.

In it actual money is paid to the owners of factors of production.

In it money is not paid actually because factors are owned by the producer.

Example: Wages paid to laborers hired from outside.

Example: No payment is made to the factors provided by producer himself.

Q. –35 Distinguish between fixed costs and variable costs. Give two examples of each. Ans. Difference between Fixed Cost and Variable Cost:

Fixed Cost Variable Cost 1. It is the cost incurred on fixed

factors of production. 2. This cost does not change with

the change in output. 3. It is also known as

‘supplementary’ cost 4. Example: Rent on land, Interest

on loan etc.

1. It is the cost incurred on variable factors of production.

2. This cost directly change with the change in output.

3. It is also known as ‘primary cost’. 4. Example: cost of raw material,

wages paid to casual labours etc.

Q. –36 Why the short run MC curve is ‘U’ shaped? Ans. U-shape of Marginal cost curve is explained with reference to the following facts:

(i) Initially, a firm may enjoy increasing returns to a factor. Accordingly, MP tends to rise and MC tends to fall.

(ii) Subsequently, there may be constant returns to a factor. This implies a situation of constant MP and constant MC.

(iii) Finally, a firm must face a situation of diminishing returns. MP starts declining and MC starts rising. Briefly, MC assumes U-shaped in accordance with the law of variable proportions.

Q. –37 Explain the relationship between marginal cost (MC) and average cost (AC). Ans. (i) Initially both MC and AC fall, MC falls faster than AC.

(ii) As MC falls faster than AC, minimum point of MC comes, and starts rising till AC falls to its minimum point.

(iii) MC equals AC when AC is minimum and constant. (iv) Afterwards both MC and AC rise, MC rises faster than AC. Y MC MC/AC AC 0 X OUTPUT

Q. –38 Explain producer’s equilibrium with the help of MR and MC approach under perfectly competitive market.

Ans. Producer is said to be in equilibrium when he maximizes his profits. According to marginal revenue and marginal cost approach, producer strikes his equilibrium when

the following conditions are satisfied: (i) MR = MC, and (ii) MC curve cuts MR curve from it’s below at the point of equilibrium. (iii) MC should be greater than MR after equilibrium.

In the above diagram producer is in equilibrium at point ‘E’ where OQ units of output are produced. At this point of equilibrium MR=MC and MC cuts MR from its below, where producer gets maximum profit. He will not produce less or more quantity than OQ, because he will not get maximum profit.

Q. –39 Why does AFC diminish with increase in production? Ans. In short run Total Fixed cost remain fixed, as output increase per unit fixed cost falls,

therefore AFC diminishes with increase in production. Q. –40 Explain the relationship between marginal revenue and total revenue under monopoly

market. Ans. The relationship between TR and MR under monopoly:

i. In monopoly market TR increases at diminishing rate because MR diminishes. ii. TR increases as long as MR is positive. iii. When TR is constant and maximum, MR is zero. iv. When MR becomes negative, TR falls.

Q. –41 What will be the effect of the following on marginal revenue when: (i) Total revenue increases at a decreasing rate. (ii) Total revenue increases at an increasing rate.

Ans. i. When total revenue increases at a decreasing rate, marginal revenue diminishes. ii. When total revenue increases at an increasing rate, marginal revenue increases.

Q. –42 Explain the relationship between Average revenue and Marginal revenue under monopoly with the help of diagram.

Ans. Relationship between AR and MR under monopoly.

O

P

Y

MC

E

Q X

Units of output

AR/MR AR=MR

O UNITS

X

AR

MR

AR/MR

Y

i. Under monopoly average revenue and marginal revenue curves are separate and downward sloping.

ii. MR diminishes faster than that of AR. iii. In case of a straight line downward sloping AR curve, slope of MR curve will be

twice the slope of AR curve. iv. Marginal revenue can be zero or negative but not the average revenue.

Q.43 Why will a producer not be in equilibrium if conditions of equilibrium are not met? Ans. The equilibrium conditions are : (i) MC = MR and (ii) MC > MR after equilibrium

Suppose MC = MR condition is not met. Let MC > MR. In this it will l be profitable for the firm to produce more or less depending upon the relative changes in MC and MR till MC = MR. Similarly, if MC < MR it will also be profitable to produce more till MC = MR. Now Suppose ‘MC > MR after equilibrium condition is not met’ and MC < MR after equilibrium. In this case the firm will not be in equilibrium, because it can increase its profits by producing more.

Chapter – 5 (Supply)

Q. –44 Explain briefly four factors which lead to an increase in supply of a commodity. Ans. The four factors which lead to an increase in supply of a commodity are:

(i) Decrease in price of related goods: When the price of substitute goods fall, supply of the commodity rises because fall in the price of substitute good discourage the producers to switch over to the production of original good. Therefore its supply increases.

(ii) Decrease in price of factor of production: When the price of factors of production decreases, the cost of production declines and at the same resources more units are produced and supplied in the market.

(iii)Increase in number of firms: When number of firms increases there is more supply in the market. (iv) Decrease in expected future price: If it is expected that in future the price is going to fall, at present the producers will

supply more to avoid the loss in future Q. –45 Explain briefly four factors which lead to decrease in supply of a commodity. Ans. The four factors which lead to a decrease in supply of a commodity are:

(i) Increase in price of related goods: When the price of substitute goods rise, supply of the commodity falls because rise in the price of substitute good encourage the producers to switch over to the production of substitute good. Therefore its supply decreases.

(ii) Increase in price of factor of production: When the price of factors of production increases, the cost of production rises and at the same resources fewer units are produced and supplied in the market.

(iii)Decrease in number of firms: When number of firms decreases there is less supply in the market. (iv) Increase in expected future price: If it is expected that in future the price is going to rise, at present the producers will

supply less to earn the profit in future. Q. –46 Explain with the help of diagrams the effect of the following on the supply of a

commodity: (i) An improvement in technology. (ii) A rise in price of inputs. (iii) Decrease in tax on the commodity. (iv) An increase in price of other goods.

Ans.

(i) With an improvement in technology, the supply of a commodity will increase and there

will be a forward shift in a supply curve.

S1 S2 Supply curve shift forward after the improvement in technology K

Price T S1 S2 Quantity (ii) With a rise in price of inputs, the supply of a commodity will decrease and there will be a backward shift in a supply curve. S2 S1 Supply curve shift backward after the rise in price of inputs. Price T

K

S2 S1 Quantity (iii) With decrease in tax on the commodity, the supply of a commodity will increase and there will be a forward shift in a supply curve. S1 S2 Supply curve shift forward after the decrease in tax on the commodity K Price T S1 S2 Quantity

O

Y

X

Y

O X

(iv) With a rise in price of other goods, the supply of a commodity will decrease and there will be a backward shift in a supply curve. S2 S1 Supply curve shift backward after the increase in price of other goods. Price T

K

S2 S1 Quantity

Q. –47 Distinguish between contraction of supply and decrease in supply.

Ans.

Contraction of Supply Decrease in Supply

1. Contraction of supply refers to decrease in quantity supplied of a commodity due to decrease in its price.

1. Decrease in supply refers to decrease in quantity supplied of a commodity at its existing price.

1. Contraction of supply occurs due to fall in own price of the commodity.

2. Decrease in supply occurs due to unfavourable change in factors other than own price of the commodity.

1. Diagrammatically, it implies a downward movement along the same supply curve.

3. Diagrammatically, it implies a leftward shift in supply curve.

Q. –48 Distinguish between extension of supply and increase in supply.

O

Y

X

O X

S

y

P

P

1

Q1 Q

Contraction of supply

S S1

S1 S

x o Q1 Q

P

Y Decrease in supply

Ans.

Extension of Supply Increase in Supply

1. Extension of supply refers to rise in quantity supplied of a commodity due to rise in its price.

1. Increase in supply refers to rise in quantity supplied of a commodity at its existing price.

2. Extension of supply occurs due to rise in own price of the commodity.

2. Increase in supply occurs due to favourable change in factors other than own price of the commodity.

3. Diagrammatically, it implies an upward movement along the same supply curve.

3. Diagrammatically, it implies a rightward shift of supply curve.

Q. –49 Draw the supply curves showing price elasticity of supply (i) equal to one, (ii) greater than one, (iii) less than one, (iv) equal to zero, (v) infinite.

Q.50 Examine the effect of a) Fall in the own price of good X, b) Rise in tax rate on good X on the Supply Curve. Use diagrams.

Ans.

y

O Q1 X

S

P

P1

Q

Extension of supply

Q

S S1

S1 S

x o Q1

P

Y Increase in supply

Chapter – 6 (Forms of Market)

Q. –51 Explain the features of perfect competition market. Ans. Features of perfect competition:

1. Large number of sellers and buyers: The share of each seller or firm is not significant, a firm’s supply does not affect the market supply. Similarly each buyer does not affect the price of the product.

2. Homogenous product: Product sold in the market are homogenous which ensures a uniform price for the products of all the firms in the industry.

3. Free entry and exit of firms: Buyers and sellers are free to enter or leave the market at any time they like. New firms induced by large profits can enter the industry whereas losses make inefficient firms to leave the industry.

4. Perfect knowledge about the market: The firms have all the knowledge about the product market and the input markets. Buyers also have perfect knowledge about the product market.

5. Perfect mobility: There is perfect mobility in the market both for goods and factors of production. There is no restriction on their movement. Goods can be sold at any place, similarly factors of production can freely move from one place to another or from one occupation to another.

6. Absence of transportation and selling cost: It is assumed that there is no transport cost for consumers who may buy from any firm and also there is no selling cost. Which ensures existence of a single uniform price of the product.

Q. –52 Explain the features of monopoly market. Ans. Features of monopoly market:

1. Single seller: There is only one seller or producer of a commodity in the market and has full control over the supply of the commodity therefore a firm is the price maker and not the price maker.

2. Absence of close substitute of product: The product sold by the monopolist has no close substitute, if substitute are

available but not identical products. 3. Difficult entry of a new firms:

The monopolist controls the situation in such a way that it becomes very difficult for a new firm to enter the monopoly market and compete with the monopolist by producing the same product.

4. Price discrimination: Price discrimination refers to the practice of charging different prices from different buyers at the same time for the same product.

5. Price maker: A monopoly firm has market power and is itself a price-maker. It can choose any price, it likes.

Q. –53 Explain the features of monopolistic competition market. Ans. Features of monopolistic competition market:

1. A large number of firms: The number of firms selling similar product is fairly large, but not very large as in perfect competition, as a result firms are in a position to influence the price of their product due to their brand names.

2. Product differentiation: In this market, producers can produce different products on the basis of brand, colour, shape etc., but that products should be a close substitute to each other.

3. Selling cost: It is the expenses which are incurred for promoting sales or inducing customers to buy a good of a particular brand

4. Free entry and exit of firms: New firms can enter the market, if found profitable. Similarly, inefficient firms already operating in the market are free to quit the market if they incur losses.

Q. –54 Explain ‘large number of buyers and sellers’ feature of perfect competition. Ans.

(i) Large number of sellers- The word ‘large number’ simply states that the number of sellers is large

enough to render a single seller’s hare in total market supply of the product is insignificant.

On single seller has no option but to sell what it produces at this market determined price. This position of an individual firm in the total market is referred to as price taker.

(ii) Large number of buyers- The word ‘large number’ simply states that the number of buyers is large

enough, that an individual buyer’s share in total market demand is insignificant, the buyers cannot influence the market price on his own by changing his demand.

This makes a single buyer also a price taker. Q.55 Explain the implications of the following in a perfectly competitive market:

(a) Large number of sellers (b) Homogeneous products.

Ans (a) Large number of sellers means that number of firms are large enough so that contribution to total output of the industry by any individual firm is negligible. So, single firm is in a position to influence the market price on its own by changing its own output. Thus, price remains unchanged. (b) Homogeneous products means that buyers treat products of all the firms as same in all respect as homogeneous product. As such no firm can charge a higher price because no buyer is willing to pay the same. Then market price remains the same for all the firms.

Q.56 Explain the implications of the following in an oligopoly market: (a) Barriers to entry of new firms (b) A few or a few big sellers

Ans. (a) The main implication of barriers to entry is that such barriers allow only a limited number of firms into oligopoly industries. Such barriers may be in the form of huge capital requirements, patent rights, availability of crucial raw material etc. (b) A few or few big sellers has the implication that each big seller contributes a fairly large share of total output. This gives an individual seller the power of influencing the market price by changing its own output.

Q. –57 Explain ‘product differentiation’ feature of monopolistic competition. Ans. One important feature of monopolistic competition is that the product produced and

sold by various firms (or sellers) are not identical but they are slightly different from each other. Products are differentiated from each other on the basis of brand name, shape, colour, packing etc. These differentiated products are close substitutes of each other and therefore, their price cannot be very much different from each other. Each firm enjoys some monopoly in its product and is in a position to fix its price.

Q. –58 Distinguish between collusive and non-collusive oligopoly. Ans.

Basis Collusive Oligopoly Non-Collusive Oligopoly

Meaning When in an oligopoly market, the firms cooperate with each other in determining prices and output both.

When in Oligopoly market, the firms compete with each other.

Profit Under collusive oligopoly, the firms would behave as a single monopoly (i.e. cartel) and aim at maximizing their collective profit rather than their individual profits.

Under Non-collusive oligopoly, each firm aims at maximizing its own profits and decides how much quantity to produce assuming that the other firms would not change their quantity supplied.

Aim All firms collude to form a cartel and fix output and price by themselves through output quotas and market price.

Each firm tries to increase its market share through competition.

Alternative name

Cooperative oligopoly Non-Cooperative oligopoly

Q. –59 Distinguish between perfect oligopoly and imperfect oligopoly. Ans.

Perfect Oligopoly Imperfect Oligopoly When the firms produce homogenous product is known as perfect oligopoly.

When the firms produce differentiated product is known as imperfect oligopoly.

For example: copper, iron, steel and aluminum act.

For example: toilet soap, cigarettes and soft drinks etc.

Q. –60 Why is the number of firms small in oligopoly? Explain. Ans. The number of firms is small in oligopoly because there are barriers which prevent the

entry of firms into the industry. Patents, large capital requirements, control over the important raw materials etc. prevent new firms from entering into the given industry. Only those firms that are able to cross these barriers, enter the industry.

Q. –61 Draw average revenue and marginal revenue curves of a monopoly firm, monopolistic competition firm and perfect competition firm.

Ans. Shapes of Average Revenue and Marginal Revenue curves:

Q. –62 How is the equilibrium price determined under perfect competition? Explain with the help of a diagram.

Ans.

Equilibrium price is determined when market demand and market supply are equal to each other. When demand curve and supply curve intersect each other, at that intersection point the price is determined is known as equilibrium price and at that point quantity of demand and supply are equal, is known as equilibrium quantity. In the above diagram at point ‘E’ demand curve and supply curve are intersecting to each other which is equilibrium point. At this point 0P equilibrium price is determined and 0Q equilibrium quantity is determined.

Y D S Price P E

0 X Q Quantity demanded and supplied

Q. –63 Explain with the help of a diagram, the effect of an increase in the supply of a commodity on its equilibrium price and quantity.

Ans. If market for a good is in equilibrium, due to increase in supply there will be excess supply in the market, it will affect the equilibrium price and quantity as shown in the following diagram.

Y S S1 P E Price P1 E1 O Q Q1 x Quantity Due to excess supply, competition among the producer will make the price fall. Due to fall in price there is downward movement along demand curve. So equilibrium price falls from OP to OP1 and equilibrium quantity rises from OQ to oQ1.

Q. –64 Explain with the help of a diagram, the effect of a decrease in the supply of a commodity on its equilibrium price and quantity.

Ans. If market for a good is in equilibrium, due to decrease in supply there will be less

supply in the market, it will affect the equilibrium price and quantity as shown in the following diagram.

Due to less supply, competition among the producer will make the price rise. Due to rise in price there is upward movement along demand curve. So equilibrium price rises from OP to OP1 and equilibrium quantity falls from OQ to oQ1.

Q. –65 Explain with the help of a diagram, the effect of an increase in the demand of a

commodity on its equilibrium price and quantity.

S1

S D1

E

P1

1 Price

Y

P S1

D

S

X O

Quantity

Q Q1

E1

D

Ans. If market for a good is in equilibrium, due to increase in demand there will be more demand in the market, it will affect the equilibrium price and quantity as shown in the following diagram.

Due to increased demand, competition among the consumers will make the price rise. Due to rise in price there is upward movement along supply curve. So equilibrium price rises from OP to OP1 and equilibrium quantity will rise from OQ to oQ1.

Q. –66 Explain with the help of a diagram, the effect of a decrease in the demand of a

commodity on its equilibrium price and quantity. Ans. If market for a good is in equilibrium, due to decrease in demand there will be less

demand in the market, it will affect the equilibrium price and quantity as shown in the following diagram.

Due to decreased demand, it makes the price to fall. Due to fall in price there is downward movement along supply curve. So equilibrium price falls from OP to OP1 and equilibrium quantity will fall from OQ to oQ1.

Q. –67 Explain the effect of simultaneous decrease in both demand and supply on equilibrium

price and quantity.

Ans. There are following three cases:

Quantity

S D1

P1

1

Y

E Price P

D

S

X O Q Q1

Quantity

D1

D1

D1 S

Y

P11

Price P

E1

D S

X O Q1 Q

D1

D1

E

Case I: When demand and supply both decrease by the same proportion: In this case equilibrium price remain constant but equilibrium quantity falls. In the above diagram DD demand curve and SS supply curve shifted to their leftward by the same proportion, as a result equilibrium price OP remain constant but equilibrium quantity decreased from OQ to OQ1. Case II: When decrease in demand is greater than decrease in supply: In this case equilibrium price and equilibrium quantity falls. In the above diagram, as decrease in demand is greater than decrease in supply, both the curves are shifted to their leftward. The equilibrium price falls from OP to OP1 and equilibrium quantity also falls from OQ to OQ1. Case III: When decrease in demand is less than decrease in supply: In this case equilibrium price rises and equilibrium quantity falls.

S D1

Y

E P Price

D

S

X

D1

D1

Q1 O

Q Quantity

S1

S1

E

1

D1

S

Y

E P

Price

D1

D

S D1

S1

E

1

S1

X O Q Q1

Quantity

P1

In the above diagram, as decrease in demand is less than decrease in supply, both the curves are shifted to their leftward. The equilibrium price rises from OP to OP1 but equilibrium quantity falls from OQ to OQ1.

Q. –68 Explain the effect of simultaneous increase in both demand and supply on equilibrium price and quantity.

Ans. There are following three cases: Case I: When demand and supply both increase by the same proportion: In this case equilibrium price remain constant but equilibrium quantity increases. In the above diagram DD demand curve and SS supply curve shifted to their rightward by the same proportion, as a result equilibrium price OP remain constant but equilibrium quantity increased from OQ to OQ1. Case II: When increase in demand is greater than increase in supply: In this case equilibrium price and equilibrium quantity rise.

D1

Y

S

E P Price

D1

S1

D

S1

S D1

X

P1

O Q Q1

Quantity

S D1

Y

E

P Price

D1

D S X

D1

S1

E

1

S1

Q1 O

Q Quantity

E1

In the above diagram, as decrease in demand is greater than decrease in supply, both the curves are shifted to their leftward. The equilibrium price falls from OP to OP1 and equilibrium quantity also falls from OQ to OQ1. Case III: When decrease in demand is less than decrease in supply: In this case equilibrium price rises and equilibrium quantity falls.

In the above diagram, as decrease in demand is less than decrease in supply, both the curves are shifted to their leftward. The equilibrium price rises from OP to OP1 but equilibrium quantity falls from OQ to OQ1.

Q. –69 If at a given price of a commodity, there is excess demand, how will the equilibrium price be reached? Explain with the help of a diagram.

Ans. When market price is below the equilibrium price, then at that given price, demand is greater than supply, which leads to excess demand. The equilibrium price will be reached as shown in the following diagram.

S D

1

Y

E

P Price

D1

S1

E

1

D1

D S S1 X

E1

O Q1 Q

Quantity

P1

D1

Y

S

E P Price

D1

S1

D

S1

S D1

X

P1

O Q Q1

Quantity

Due to excess demand of AB in the above diagram, competition among the buyers, will rise the price from P1 to P. As the law of supply it will rise supply from A to E and subsequently as per law of demand, the quantity demanded falls from B to E and equilibrium price OP will be reached.

Q.70 What is minimum price ceiling? Explain its implications? Ans. For certain goods and services, govt. sets minimum price. This minimum price is called

minimum price ceiling. This price is normally set at a level higher than the equilibrium price. This leads to excess supply. Since producers are not able to sell all them want to sell, they illegally sell the good or service below the minimum price.

Q.71 If the prevailing market price is above the equilibrium price explain its chain effects. Ans. If the prevailing market price is above the equilibrium price, there will be excess

supply. Producers are not able to sell all they want to sell, resulting in competition among the sellers. Price starts falling. As a result demand starts rising and supply stars falling. These changes continue till the equilibrium is reached.

Q.72 What is maximum price ceiling? Explain the effects of Maximum price ceiling Ans. Maximum price ceiling refers to the maximum price that the producers to aloud to

charge. Govt. resorts to such is ceiling when the equilibrium price an essential commodity is un usually high and beyond the rich of a common man. The govt. then intervenes specially in times of shortage of essential food items like wheat, sugar etc on account of bad weather. In this situation govt. impose price ceiling. It may lead black marketing which means illegally charging in higher price. Y E P a b Maximum price ceiling Price P0 O X Quantity OP is equilibrium price and govt. impose OP0 price ceiling.

Price

Y

D1

E

E

1 P

D

S

A B P1

S

X O Q

Quantity demanded and supplied

Macro Economics

National Income and Related Aggregates

1. Why is the study of the problem of unemployment in India considered a macro economic

study?

Ans. The problem of unemployment in India is an economic issue at level of economy as a

whole, hence considered as macroeconomic study.

2. State whether following is true or false. Give reason for your answer.

a) Capital formation is a flow

b) Bread is always a consumer good.

c) Nominal GDP can never be less that real GDP

d) Gross domestic capital formation is always greater than gross fixed capital

formation.

Ans. (a) True, because it is measured over a period of time.

(b) False, it depends upon the end use of bread. When it is purchased by a

household it is a consumer good. When purchased by restaurant for making

sandwich, it is an intermediate (producer) good.

(c) False. Nominal GDP can be less than the real GDP when the prices in the base

year is more than the current year.

(d) False, gross domestic capital formation can be less than gross fixed capital

formation if change in stock is negative.

3. Why are exports included in the estimation of domestic product by the

expenditure method? Can the gross domestic product be greater than the gross

national product? Explain

Ans. Expenditure method estimates expenditure on domestic product i.e., expenditure

on final goods and services produced within the economic territory of the

country. It includes expenditure by residents and non residents both. Exports

though purchased by non residents are produced within the economic territory and

therefore a part of domestic product.

Domestic product can be greater than national product, if the factor income paid

to the rest of the world is greater than the factor income received from the rest of

the world i.e, when net factor income received from abroad is negative.

4. Calculate Value Added at factor cost from the following.

Items Rs. Crores

Purchase of raw materials 30

Depreciation 12

Sales 200

Excise tax 20

Opening stock 15

Intermediate consumption 48

Closing stock 10

Ans. Sales + Δin stock = value of output

200 + (cl. St – op. st)

200 + (10 -15)

= 200 -5=195

Value of output – intermediate consumption

= value added at MP

195-48 = 147

V.A at FC = V.A at MP – Net indirect tax

147 – 20

127 crores

5. Calculate Net National Product at MP ITEMS Rs. crores

a. Private final Consumption expenditure 200

b. Net indirect taxes 20

c. Change in stocks (--)15

d. Net current transfers from abroad (--)10

e. Govt. final consumption expenditure 50

f. Consumption of fixed capital 15

g. Net domestic capital formation 30

h. Net factor income from abroad 5

i. Net imports 10

Ans. (a) + (e) + (g) + (-i) = NDP MP

200 + 50+ 30 -10

280 -10 = 270 crores

NNP MP = NDP MP + NFIFA

270 + 5 = 275

NNP MP + 275 crores

6. Calculate Gross Domestic Product at Market Price by

(a) Production Method and

(b) Income Method

ITEMS Rs. crores

a. Intermediate consumption by

i) Primary sector 500

ii) Secondary sector 400

iii) Tertiary sector 400

b. Value of output by

i) Primary sector 1000

ii) Secondary sector 900

iii) Tertiary sector 700

c. Rent 10

d. Compensation of employees 400

e. Mixed income 550

f. Operating surplus 300

h. Net factor income from abroad (--)20

i. Interest 5

j. Consumption of fixed capital 40

k. Net indirect taxes 10

7. GDP MP by production method

(b) (i) + (ii) + (iii) – a (i) + (ii) + ( iii) = value added

(1000+ 900 + 700) – (500 -400-400)

2600 – 1300 = 1300 crores Value added at MP (GDP MP)

Income method

Compensation of employees + operating surplus + mixed income = NDP FC

= 400 + 300 + 550 = 1250 crores

GDP MP = NDP FC + consumption of fixed capital + net In. tax

= 1250+ 40 + 10

GDP MP =1300

8. When is gross domestic product of an economy equal to gross national product?

Ans. When NFIA is zero

3. Will the following be included in gross domestic product / Domestic Income of India?

Give reasons for each answer.

(i) Consultation fee received by a doctor.

(ii) Purchase of new shares of a domestic firm.

(iii) Profits earned by a foreign bank from its branches in India.

(iv) Services charges paid to a dealer (broker) in exchange of second hand goods.

Ans. (i) Yes, It is a factor income. It is his salary. (ii) No, It is not included in GDP, because it

is a merely financial transaction which does not help directly in production. (iii) Yes, It is

a factor income in domestic territory. (iv) It is included because it is his factor income

(salary).

9. State whether the following is a stock or flow:

(a) Wealth,

(b) Cement production,

(c) Saving of a household, and

(d) Income of household.

Ans. Stock – (a) & (b), since these are variables measurable at a point of time. Flow – (c) & (d),

since these are variables measurable over period of time.

10. State whether the following is a stock or flow:

(a) National capital,

(b) Exports,

(c) Capital formation, and

(d) Expenditure on food by households.

Ans. Stock – (a), since national capital is a variable measurable at a point of time. Flow – (b),

(c) & (d), since these are variables measurable over period of time.

11. Are the following included in the estimation of National Income a country? Give reasons.

(i)Rent free house to an employee by an employer.

(ii) Purchases by foreign tourists.

(iii) Purchase of a truck to carry goods by a production unit.

(iv) Payment of wealth tax by a household.

Ans. (i) It should be included in NI because it is a part of the compensation of employees

(salary in kind). (ii) It is included in NI because it is a part of the final consumption

expenditure on domestic product. (iii) It should be included in NI because it is an addition

to the capital stock of the production unit. (iv) It should not be included in NI because it is

a compulsory transfer payment and paid from past savings of the tax payers.

12. Is net export a part of NFIA? Explain.

Ans. No, it is not.Net export, the difference between export and import (X- M), is a part of

expenditure on domestic product. While NFIA is the difference between income earned

from abroad by the normal residents of a country and income earned by non-residents in

the domestic territory of that country. It is not included in the domestic product rather it is

a component of NI. Therefore both are different concepts.

13. Why are exports included in the estimation of domestic product by the expenditure

method? Can gross domestic product be greater than gross national product? Explain.

Ans. Expenditure method estimates expenditure on domestic product, i.e. expenditure on final

goods and services produced within the economic territory of the country. It includes

expenditure by residents and non- residents both. Exports, though purchased by

nonresidents, are produced within the economic territory, and therefore, a part of domestic

product. Domestic product can be greater than national product if factor income paid to

the rest of the world is greater than the factor income received from the rest of the world is

i.e. when net-factor income received from abroad is negative.

14. Will the following be included National Income? Give reasons for each answer. (i) Free

Medical facility to employees by the employer.

(ii) Money received from sale of old house.

(iii) Government expenditure on street lighting.

(iv) Interest received by a household from a commercial bank.

(v) Receipts from sale of land.

(vi) Interest on public debt.

Ans. (i) Yes, as it is a supplementary income paid in kind and hence a part of compensation of

employees. (ii) No, as it has already been taken into account when the house was

constructed. (iii) Yes, It is a part of Government final consumption expenditure and it

adds to flow of services. (iv) Yes, as it is payment for use of capital. (v) No, as it does not

add to flow of goods & services. (vi) It should not be included in NI because public debt is

a loan taken on to meet consumption expenditure by the government

15. Are the following included in the estimation of National Income a country? Give reasons.

(i) Unemployment allowance under NREGA.

(ii) Indirect tax (Sale tax/excise duty).

(iii) Salary received by the workers under NREGA.

(iv) Income tax.

(v) Corporation tax.

(vi) Travelling expenses paid to salesman by the employer.

Ans. (i) It is transfer payment received by those persons who are not employed; therefore it

should not be included in NI. (ii) It is not included in NI because it does not add in the

flow of goods and services. (iii) It is included in NI because it is a factor income. (iv) It is

a part of compensation of an employee (income). While calculating NI by income method,

compensation of employees is to be included while doing so, income tax to be paid by

them should not be included separately. (v) It is a part of profit of corporate sector. While

calculating NI by income method, profit is to be included while doing so, Corporation tax

should not be included separately. (vi) Travel expenses incurred by employees for

business purpose which are reimbursed by the employers are excluded because these are a

part of intermediate consumption of the employers

16. Write the followings with ‘True’ or ‘False’ with reasons:

(i)Purchase of machinery is never considered as intermediate consumption.

(ii)Salaries to Indian employees working in Indian embassies abroad are a part of net

factor income of abroad.

(iii)Remittances by the NRIs are a part of our national income.

(iv)Export of goods is not a part of expenditure on the domestic production.

Ans: False, It purchase of machinery can be considered as intermediate consumption when it is

resold.

False, Salaries to Indian employees working in Indian embassies abroad are not a part of

net factor income of abroad because Indian embassy is a part of domestic territory of

India.

False, because remittances are transfer payments which are not included in national

income.

False, because goods of exports are produced within the domestic territory of the country

therefor Export of goods is a part of expenditure on the domestic production.

16. Sale of petrol and diesel cars is rising particularly in big cities. Analyse its impact on

gross domestic product and welfare.

Ans: Final sales of cars raises GDP, because final sales are final products. Cars provides

convenience in transportation but at the same time it cause traffic jams, air pollution and

noise pollution reducing the welfare of the people. Pollution has bad effect on the health

of the people.

17. Explain how ‘externalities’ are a limitation of the GDP as an indicator of welfare.

Ans: Externalities both positive and negative are limitations of GDP as an indicator of welfare

because GDP does not take them into account, taking an example of introduction of metro

rail, as the latest means of transport, reduced transport cost, travel time of its commuters

who have not directly contributed anything towards its cost. Expenditure on its

construction in included in GDP but not the positive externalities flowing from it. GDP

and positive externalities both increase welfare. Hence taking only GDP as an index of

welfare, under states welfare.

Similarly GDP also does not take into account negative externalities. Taking the example

of factories producing goods, they increase GDP on one hand and on the other hand

create pollution of air, noise, water which it turn harm people by creating pollution, in this

way GDP as an index of welfare over state welfare.

18. Explain the problem of double counting. How can it be avoided? Give two measures.

Ans. Production is a continuous process and in this process it is difficult to know the final

product. It gives rise to problem of double counting.

“Thus counting the value of a commodity more than one in the measurement of

national income is called double counting.”

This leads to over estimation of the value of goods and services produced.

Therefore to know the correct value of national income, we must avoid the problem of

double counting.

Problem of double counting can be avoided by:

(i) Including only the value of final goods and services in the national income.

(ii)Using value added method of calculating national income.

19. How will be the following treated while estimating GDP? Give reasons for your answer.

Compensation of employees to the residents of Japan working in Indian embassy in Japan.

Profit earned by a branch of foreign bank in India.

Rent received by an Indian resident from Russian embassy in India.

Profit earned by a branch of state bank of India in England.

Salaries received by Indian residents, working in American embassy in India.

Profit earned by an Indian company from its branch in Singapore.

Compensation of employees given to the residents of China working in Indian embassy in

China.

Financial help given to flood victims.

Salaries paid to non-resident Indians working in Indian embassy in America.

Ans. Compensation of employs to residence of japan working in Indian embassy in India is part

of a domestic territory of India hence included in domestic factor income of India.

Profits earned by a branch a foreign bank in India is a factor income paid abroad and

therefore a part of domestic factor income of India.

Rent received by an Indian resident from a Russian embassy in India is not a part of

domestic factor income of India.

Profit earned by a bank of SBI in England is not a part of domestic territory of India.

Salary received by Indian residents, working in American embassy in India is not a part of

domestic factor income of India.

Profit earned by an Indian company from its branch in Singapore is not a part of domestic

factor income of India because branch in Singapore is not a part of domestic territory of

India.

Compensation of employs given to residents of china working in Indian embassy in china

is not a part of domestic factor of India.

Financial help given to flood victims is a transfer payment and therefore not included in

domestic factor income of India.

Salary paid to nonresident Indians working in Indian embassy in America is a part of

domestic factor income of India because Indian embassy is a part of domestic territory of

India.

Determination of Income and Employment

20. What can be the minimum value of investment multiplier?

Ans. Investment multiplier K=1/1-mpc if mpc = 0 than K=1/1-0 = 1 which is minimum value

of investment multiplier

21. Can the value of APS be negative?

Ans. Yes, when there are dis savings

22. In an economy the MPC is 0.75. Investment expenditure in the economy increase by

Rs.75 crore. Calculate total increase in national income.

Ans. K=DY/DI = 1/1-MPC DY= DIx1/1-MPC = 75x1/1-0.75 = 300 Crore

23. An economy is in equilibrium. Its consumption function is C=300 +0.8Y. and investment

is 700 find national income.

Ans. C= 300+0.8 Y

Y = C+I Y = 300+0.8Y+700 =1250

24. In an economy 75% of the increase in income is spent on consumption. Investment

increased by Rs.1000 Crore. Calculate

(1) Total increase in income

(2) Total increase in consumption expenditure

Ans. MPC = 75% = 75/100 =3/4 MPS = 1-3/4 = 1/4 K=4 (1) DY = DI x K = 1000 x 4 = 4000

Crore (2) DY = DC + DI DC = DY - DI = 4000-1000 = Rs. 3000 Crore

25. In an economy the equilibrium level of income is Rs.1200 Crore. MPC : MPS= 3:1 DI= ?

Ans. New equilibrium income = Rs. 20000 Crore =20000-12000=8000 Crore K= 1/MPS =

1/0.25 = 4 DI = DY/K = 8000/4 = Rs.2000 Crore

26. Why can the value of MPC be not greater than 1?

Ans. It is because change in consumption can never be greater than change in income

27. Does an excess of AD over AS always imply a situation of inflationary gap?

Ans. No. Inflationary gap occurs only when AD>AS corresponding to full employment level of

employment.

28. What happens if AD>AS prior to full employment level of employment?

Ans. It is a state of disequilibrium in economics. When AD>AS , producers have to cater to

demand out of their existing stock of goods , implying that the desired level of stocks will

decrease. It implies greater production & therefore there is increase in AS .This process

continues till equilibrium is struck between AD and AS.

29. In poor countries like India , people spend a high percentage of their income so that APC

and MPC are high . Yet , value of multiplier is low . Why?

Ans. Working of the multiplier process is based on one fundamental assumption: that there

exists, excess capacity in the economy , so that whenever consumption expenditure rises

(implying increase in demand ) there is a corresponding increase in production (implying

increase in income ) . But poor countries like India, lack in production capacity.

Accordingly, whenever demand increases (in terms of increase in consumption ), there is

increasing pressure of demand on the existing output (implying inflation or rise in prices)

rather than the increase in output or income.

30. In what respect foreign trade will be useful in removing the adverse economic effects of

deficient demand?

Ans. Export increases the demand for goods and services produced in the domestic territory and

is helpful to reduce deficient demand.

31. What happens in an economy, when credit availability is restricted and credit is made

costlier?

Ans. Aggregate demands falls.

32. Giving reasons, state whether the following statements are true or false.

(1) When MPC is zero, the value of investment multiplier will also be zero.

(2) Value of APS can never be less than zero

(3) When MPC>MPS, the value of investment multiplier will be greater than 5. (4) The

value of MPS can never be negative

(5) When investment multiplier is 1, the value of MPC is zero.

(6) The value of APS can never be greater than 1.

Ans. (1) False because when MPC = 0 Value of investment multiplier is one K=1/1-MPC =

1/1-0 = 1

(2) False because APS is negative when there are dissavings

(3) True, if MPC is greater than 0.8 or false if MPC > 0.5 but not greater than 0.8.

(4) True, since MPS = DS/DY if DS = 0 than MPS can at the most be zero.

(5) True because K = 1/1-MPC = 1/1-0=1 (6) True, because APC + APS = 1

33. Explain the relationship between investment multiplier and MPC?

Ans. K=1/1-MPC, It shows direct relationship between MPC and the value of Multiplier.

Higher the proportion of increased income spend on consumption, higher will be value of

investment multiplier. Higher the proportion of increased income spend on consumption,

higher will be value of investment multiplier.

34. 3. Explain the role of following in correcting the deflationary gap in an economy. 1) Govt.

Expenditure 2) Legal Reserve Ratio

Ans. 1) In a situation of deflationary gap or deficient demand. The Govt. should raise its

expenditure i.e. there will be more economic activities in the economy like, building of

roads, bridges, canal etc. This will raise the level of employment. It will in turn increase

the income and the purchasing power. Thus aggregate demand will rise. 2) During

deficient demand, central bank reduces the CRR. The result of reducing CRR will be seen

in the surplus cash reserves with the banks which can be offered for credit. The bank’s

credit bank reduces SLR, this will have expansionary effect on the credit position of the

banks leading to increase in their leading capacity borrowing increases & AD increases.

35. Explain the role of margin requirements for correcting the deflationary gap.

Ans. Deflationary gap refers to a situation when at full employment level of income AD falls

short of AS. It is called deficient demand. Margin requirements refers to the margin on the

security provided by the borrower. When margin is lower, the borrowing capacity of the

barrow is higher. When central bank lowers the margin the borrowing capacity of the

borrowers increase. This raise AD.

36. In poor countries like India, people spend a high percentage of their income so that

APC and MPC are high. Yet, value of multiplier is low. Why?

Ans Working of the multiplier process is based on one fundamental assumption: that

there exists, excess capacity in the economy, so that whenever consumption expenditure

rises (implying increase in demand) there is a corresponding increase in production

(implying increase in income). But poor countries like India, lack in production

capacity. Accordingly, whenever demand increases (in terms of increase in

consumption expenditure), there is increasing pressure of demand on the existing output

(implying inflation or rise in prices) rather than the increase in output or income.

37. What is Investment Multiplier and How is measured?

Ans. The operation of multiplier can be understood with following example. Suppose

there is increase in investment of Rs.100 cr which results in construction of new

buildings. This will increase the income of builder, architect, labour by Rs.100cr.

Now with given MPC = 0.5 i.e half, they will together consume or spend Rs. 100

* 1/2 = Rs.50 cr on consumption goods.

The producers of these consumers’ goods will thus have an increase of Rs. 50 cr

and they will further spend half of their increased income on some other goods.

This process will go on with each round of consumption on goods decreasing, as

half of increased income will be spend and process will come to end when

additional consumption will falls to zero.

Thus total increase in income is 200 cr due to increase in investment of 100

cr.

38. What do you mean by the problem of excess demand? Explain with the help of a diagram

and also suggest any two measures to solve the problem.

OR

What do you mean by inflationary gap? Explain with the help of a diagram and also

suggest any two measures to remove the inflationary gap in an economy.

Ans. When actual aggregate

demand becomes higher

than the amount of

aggregate demand

required for full

employment it is called

excess demand. Or excess

demand occurs when the

actual aggregate demand

(AD) is greater than the

aggregate demand

required for full

employment (ADf). The

extent to which actual

aggregate demand become

higher than the aggregate

demand required for full

employment is referred as

inflationary gap. It the

following diagram

economy is in the state of

equilibrium at point Ef where actual aggregate demand is greater than the aggregate

demand required for full employment level of income. The gap (BEf) is known as

inflationary gap.

Measures to correct the problem of Excess demand :-

1. Fiscal Measures:-Measures related to taxation and public expenditure are normally

called fiscal measures. In this regard following measures can be adopted- (i) Government

may decrease the disposable income of households by increasing personal direct taxes and

it may cause a decrease in household’s final consumption expenditure. (ii) Government

Full Employment Equilibrium

AS

ADf

AD1 E1

Ef

O M1 Mf

AD

(&

AS

(C

+I)

Output

(AÉrÉ)

B

45o

Excess Demand or Inflationary Gap

may decrease its expenditure on final goods and services.

2. Monetary Measures:-Measures which are adopted to control money supply or credit

creation in a country are called monetary measures and the policy concerning monetary

control measures is termed as monetary policy. In this regard following measures can be

adopted- (i) Increase in the reserve ratio (ii) Increase in interest rates.

39. What do you mean by the problem of deficit demand? Explain with the help of a diagram

and also suggest any two measures to get rid of the problem.

OR

What do you mean by deflationary gap? Explain with the help of a diagram and also

suggest any two measures to remove the deflationary gap in an economy.

Ans. When actual aggregate

demand becomes lower

than the amount of

aggregate demand

required for full

employment it is called

deficient demand. Or

deficient demand occurs

when the actual aggregate

demand (AD1) is lower

than the aggregate

demand required for full

employment (ADf). The

extent to which actual

aggregate demand

become lower than the

aggregate demand

required for full

employment is referred as

deflationary gap. It the

following diagram economy is in the state of equilibrium at point Ef where actual

aggregate demand is lower than the aggregate demand required for full employment level

of income. The gap (BEf) is known as deflationary gap.

Measures to correct the problem of Deficient demand :-

1. Fiscal Measures:-Measures related to taxation and public expenditure are normally

called fiscal measures. In this regard following measures can be adopted- (i) Government

may increase the disposable income of households by reducing personal direct taxes and it

may cause an increase in household’s final consumption expenditure. (ii) Government

may increase its expenditure on final goods and services.

2. Monetary Measures:-Measures which are adopted to control money supply or credit

creation in a country are called monetary measures and the policy concerning monetary

control measures is termed as monetary policy. In this regard following measures can be

adopted- (i) Reduction in the reserve ratio (ii) Reduction in interest rates.

40. Explain using Saving-Investment approach the determination of equilibrium level of

output and income in an economy. What happens when the economy is not in equilibrium

and saving exceeds investment?

Full Employment Equilibrium

AS

ADf

AD1

E1

Ef

O M1 Mf

AD

& A

S

(C

+I)

Output

(AÉrÉ) (AÉrÉ)

B

45o

Deficient Demand or

Deflationary Gap

Ans. According to

Saving and

Investment

approach an

economy is in

equilibrium at a

level of income

where planned

savings equals to

planned

investment

(S=I). In the

diagram it is

clear that

planned saving

is equal to

planned

investment at

OMf level of income. Hence economy is in equilibrium at point Ef.

Suppose the level of income is greater than the equilibrium level of income and it

increases from OMf to OM1. In this situation saving function curve lies above the

investment function curve which means planned savings (E1M1) is greater than the

planned investment (BM1). It creates the situation of excess savings. Hence, there would

be unplanned or undesired increase in stock of inventories. Consequently, in order to

reduce the stock of unsold inventories firms reduce their output leading to unemployment.

Therefore, the output in the economy starts declining and ultimately it becomes equal to

the level of equilibrium income (OMf).

Money and Banking

41. Explain the credit creation function of commercial bank with the help of an example.

Ans. Credit creation is the process of expansion of credit through derivative deposits. It is done

by commercial bank with the motive of earning interest income.

Total Credit Creation = Primary Deposits X 1/LRR

Example-Suppose there is an initial deposit of Rs. 1000 and L.R.R. is 20% i.e., the banks

have to keep Rs. 200 and lend Rs. 800/-. All the transactions are routed through banks.

The borrower withdraws his Rs. 800/- for making payments which are routed through

banks in the form of deposits account. The Bank receives Rs. 800/- as deposit and keeps

20% of Rs.800/- i.e., Rs.160/- and lends Rs.640/- . Again the borrower uses this for

payment which flows back into the banks thereby increasing the flow of deposits.

Round Deposits (in Rs.) Loans (in Rs.) Cash Reserve

Ratio (20%)

Initial deposit 1000 800 200

First round 800 640 160

Second round 640 512 128

- - - -

- - - -

Total 5000 4000 1000

41. All the currency issued by the central bank is its monetary liability. How?

Ans: The Central Bank is obliged to back the currency with assets of equal value. These assets

Full Employment Equilibrium

Ef

O Mf

Savi

ng

Output or Income

(I) Investment

(S) Saving

M1

E1

B

usually consist of gold coin, gold bullion, foreign securities and the domestic

government’s local currency securities. The country’s Central government is usually

authorised to borrow money from the central bank. Government does this, by selling local

currency securities to the central bank. When the central bank acquires these securities, it

issues currency. Putting and withdrawing currency into and from circulation is also the job

of the central bank.

42. How does RBI control credit with ‘open market operations’?

Ans. Open market operation refers to purchase and sale of government securities in the open

market (public and commercial bank) by the central bank.

To control excess demand – government securities are sold by the central bank in the open

market. The central bank withdraws additional purchasing power. There will be

contraction of credit, less money will flow in the system. Purchasing power in the

economy reduces. Aggregate demand falls and excess demand stands corrected.

To control deficient demand – By purchasing the government securities, the central bank

injects additional purchasing power in the system which expand credit. More money

supply will flow in the system, purchasing power in the economy increase. Aggregate

demand rises and deficient demand is corrected.

Government Budget and the Economy

43. Why is repayment of loan a capital expenditure?

Ans. As it leads to reduction in liability.

44. Why recovery of loan is treated a capital receipt?

Ans. As it leads to reduction in assets.

45. In a Govt. Budget primary deficit is Rs. 25,000 Cr. and interest payments are Rs. 15,000

Cr. How much is the fiscal deficit?

Ans. Fiscal Deficit = Primary Deficit + Interest Payment = 25,000 + 15,000 = 40,000 Crore.

46. In a Govt. Budget, revenue deficit is Rs. 8,00,000 Cr. and borrowings are Rs. 50,000 Cr.

How much is the fiscal deficit?

Ans. Rs. 50,000 Crore.

47. What does zero primary deficit mean?

Ans. Zero primary deficit means that interest commitment on earlier loans have compelled the

Govt. to borrow.

48. Explain how the government budget can help in a fair distribution of income in the

economy.

Ans. Budgetary policies are useful medium to reduce inequalities of income for the fair

distribution of income. Government can use tax policy and public expenditure as a tool.

govt can reduce the disposable income and wealth of Rich by imposing heavy tax and can

spend more on providing free services to the poor. It raise the disposable income welfare

of the poor.

49. 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.

50. 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.

51. 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.

52. 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.

53. 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 37 spends sufficient money on social security schemes, economic

subsidies and public works etc.

54. What are the basis of classifying receipts into revenue receipts and capital receipts?

Ans. 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.

55. Why is tax treated as revenue receipt?

Ans. Because tax neither create a liability for the govt nor reduces assets of the govt.

56. 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

57. What will be the value of fiscal deficit if primary deficit is 53,000 crores and interest on

borrowings is Rs 5,000 crores?

Ans. Fiscal deficit=Primary deficit + Interest Payment = 53,000+5,000 = 58,000

58. State which budget expenditure does not result in creation of assets or reduction of

liability. Give examples also.

Ans. Revenue Expenditure does not result in creation of assets or reduction of liability. Such

expenditures are incurred for the normal running of government departments and

maintenance of services. For example: salaries, old age pensions, interest payments,

subsidies, grants etc.

59. What indicates zero primary deficit?

Ans. Zero primary deficits means that the government has to resort to borrowings only to make

interest payments.

60. What indicates revenue deficit?

Ans. Revenue deficits are defined as the excess of revenue receipts. Revenue Deficit = Revenue

Expenditure-Revenue Receipts Revenue deficit is a reflection of the government’s fiscal

policy. The implication of revenue deficit is that the government is borrowing to maintain

even its consumption expenditure. It shows that the country’s financial system is getting

destabilized.

61. Explain how taxes and government expenditure can be used to influence distribution of

income on the society.

Ans. Taxes and expenditure can be used to alter distribution of income. Government can

impose higher taxes on income of rich and goods and services consumed by them. The

money so connected can be spent on providing free goods and services to the poorer

section of the society. This will reduce disposable income of the rich and raise that of the

poor. This can alter distribution of income.

62. Government decides to raise its expenditure on producing public utilities. What will be

the impact of this on the public? Explain.

Ans. When government decides to raise its expenditure on public utilities like parks, street

lighting, roads etc., it reflects the value of social welfare. Everybody will benefit from

these public utilities, without any discriminating. This is a step towards welfare

maximization.

63. Explain the role of government budget in influencing the allocation of resources.

Ans. Government can influence allocation of resource for production of different goods and

services through its budget. When the government wants that more resources be used in

production of some goods, it provides incentive to the producers in the form of tax

concession and subsidies.

64. Categorize the following items into Direct tax and Indirect tax.

Corporation tax (b) Value Added Tax (c) Service tax (d) Wealth tax

Ans. Direct tax

Indirect Tax

Indirect Tax

Direct Tax

65. In a government budget, revenue deficit is Rs. 50,000 crores and borrowings are Rs.

75,000 crores. How much is the fiscal deficit?

Ans. Fiscal deficit = Total Estimated Expenditure –Total Estimated Receipts

= (Revenue Expenditure + capital Expenditure) –

(revenue receipts + capital receipts

excluding borrowings)

= Rs. 75,000 crores ( as fiscal deficit is equal to the

borrowings)

66 In a government budget, primary deficit is Rs. 10,000 crores and interest payment is Rs.

8,000 crores. How much is the fiscal deficit?

Ans. Fiscal deficit = primary Deficit + interest payments

= 10,000 + 8000 =Rs.18,000 crores

67. What are revenue receipts of government? Mention two sources of revenue of receipts.

Ans. Receipts which neither create a liability nor lead to reduction in assets are called Revenue

receipts. Two sources of revenue receipts are tax receipts and non-tax receipts.

68. Give reasons, categories the following in to the revenue receipts and capital receipts:

Recovery of loans.

Corporation tax.

Dividends on investments made by the government.

Sale of public sector undertakings (enterprises).

Ans. Recovery of loans: - Recovery of such as loans is a capital receipts as it reduces the assets

of the government.

Corporation Tax: - it is revenue receipts as it neither creates any liability nor reduces any

asset of the government.

Dividends and investment made by the government:-it is revenue receipts as it neither

creates any liability nor reduces any asset of the government.

Sale of public sector under takings (enterprises):- it is a capital receipt as it reduces assets

of the government.

Balance of Payments and Foreign Exchange Rate

69. When is there a deficit in the balance of trade.

Ans. When the value of imports is more than value of exports.

70. The balance of trade shows a deficit of Rs. 300 crs. and the value of exports is Rs. 500 crs.

What is the value of imports?

Ans. 800 Crores

71. Write the name of those economic transactions which are made by the government to

make equilibrium in balance of payment.

Ans. Accommodating items.

72. What will be the effect on exports, if foreign exchange rate increases?

Ans. Exports will increase because Indian goods have become cheaper for foreigners.

73. What will be the effect on imports if foreign exchange rate increases.

Ans. Import will decrease because foreign goods have become costlier for Indians.

74. In which circumstances, the devaluation of currency will be in favour of economy?

Ans. Appreciation of currency refer when the value of foreign currency reduce with respect to

domestic currency. It occurs in a free exchange market by the forces of demand and

supply of currency.

75. In which circumstances the appreciation of currency will be non favourable for the

economy?

Ans. When we adopt the policy of Import Substitution.

76. Under which circumstances, the purchasing power of foreign currency increases in

comparison to domestic currency?

Ans. Capital account records capital transfer such as loans and investment between one country

and the rest of the world which causes a change in the asset or liability status of the

residents of a country or its government.

77. With the help of which item BOP gets balanced?

Ans. With the help of international loans.

78. Does BOP always remain balanced?

Ans. Always in equilibrium in the sense of accounting.

79. Which transactions determine the balance of trade? When is balance of trade in surplus?

Ans. Exports of goods and imports of goods determines BOT. When the value of exports of

goods is greater than the value of imports of goods.

80. State which type of exchange rate has no official intervention in the foreign exchange

market? How it is determined?

Ans. Flexible exchange rate has no official intervention. It is determined by the interaction of

supply and demand in the foreign exchange market.

81. What will be the value of imports, if the net imports are Rs 160 crores and the value of

exports are Rs 400 crores.

Ans. Balance of Trade = Exports- Imports Imports= Exports – Balance of trade= 400-(-

160)=560 Or Imports= Exports + net imports = 400+160=560 Ans Rs 560 crores

82. If Balance of payment of a country is Rs (-) 100 crores and total payment are Rs 500

crores. Find out its total receipts.

Ans. Balance of Payment = Total receipts- Total payments Total receipts= Total Payment

+BOP =500 + (-100) =500-100=400 Ans Rs 400 crores

83. Balance of payments always balances. Discuss it.

Ans. Balance of payments is always balanced. A negative balance on the current account is

equated with positive balance in the capital account. The monetary authorities may

finance a deficit by depleting their reserves of foreign currencies or by borrowing from the

IMF etc. Hence BOP is always in balance.

84. Explain the relationship between foreign exchange rate and demand for foreign exchange.

Ans.

There is inverse relationship

between the demand for foreign

exchange and foreign exchange

rate. As foreign exchange

decreases, foreign goods &

services in terms of Rupees

becomes cheaper and hence

people purchases more of foreign

goods & services and therefore

demands for foreign exchange

increases. And vice-verse.

85. Explain the relationship between foreign exchange rate and supply for foreign exchange.

Ans. There is direct relationship

between the supply of foreign

exchange and foreign exchange

rate. As foreign exchange

increases, Indian goods &

services in terms of Dollar

becomes cheaper and hence

foreigners purchase more of

Indian goods & services and

therefore supply of foreign

exchange increases. And vice-

verse.

86 The balance of trade shows a deficit of Rs. 5000 crores and the value import of goods is

Rs. 9000 crores. What is the value of exports?

Ans. BOT = VOE – VOI

(-) 5000 = 4000 – VOI

5000 + 4000 = VOI

Rs. 9000 Crores = VOI

87. The balance of trade shows a deficit of Rs. 5,000 crores. Value of exports is Rs. 4,000

crores. Find out the value of imports.

Ans. BOT = VOE – VOI

(-) 5000 = VOE – 9000

(-) 5000 + 9000 = VOE

Rs. 4000 Crores = VOE Rs. 9000 Crores

88. ‘Devaluation and Depreciation of currency are one and the same thing’. Do you agree?

How do they affect the exports of a country?

Ans: Devaluation is the fall in the value of demotic currency in relating to foreign currency as

planned by the government in a situation when exchange rate is not determined by the

forces of demand and supply, but is fixed by the government of different countries.

Whereas, Depreciation is the fall in the value of domestic currency in relation to foreign

currency in a situation when exchange rate is determined by the forces of demand and

supply in the international money market.

As a general phenomenon, any depreciation/ devaluation of currency may result into

increase in exports of the goods and services from the country since it would increase the

global competitiveness of the goods.

89. When is there a deficit in the balance of trade.

D

D

O M

R

DD & SS of Dollar

Do

llar

Pri

ce in

ter

ms

of

Rs.

R1

M1

S

S

O M

R

DD & SS of Dollar

Do

llar

Pri

ce in

ter

ms

of

Rs.

R1

M1

Ans. When the value of imports is more than value of exports.

90. The balance of trade shows a deficit of Rs. 300 crs. and the value of exports is Rs. 500 crs.

What is the value of imports?

Ans 800 Crores

91. Write the name of those economic transactions which are made by the government to

make equilibrium in balance of payment.

Ans. Accommodating items.

92. What will be the effect on exports, if foreign exchange rate increases?

Ans. Exports will increase because Indian goods have become cheaper for foreigners.

93. What will be the effect on imports if foreign exchange rate increases.

Ans. Import will decrease because foreign goods have become costlier for Indians.

94. In which circumstances, the devaluation of currency will be in favour of economy?

Ans. Appreciation of currency refer when the value of foreign currency reduce with respect to

domestic currency. It occurs in a free exchange market by the forces of demand and

supply of currency.

95. In which circumstances the appreciation of currency will be non favourable for the

economy?

Ans. When we adopt the policy of Import Substitution.

96. Under which circumstances, the purchasing power of foreign currency increases in

comparison to domestic currency?

Ans. Capital account records capital transfer such as loans and investment between one country

and the rest of the world which causes a change in the asset or liability status of the

residents of a country or its government.

97. With the help of which item BOP gets balanced?

Ans. With the help of international loans.

98. Does BOP always remain balanced?

Ans. Always in equilibrium in the sense of accounting.

99. Which transactions determine the balance of trade? When is balance of trade in surplus?

Ans. Exports of goods and imports of goods determines BOT. When the value of exports of

goods is greater than the value of imports of goods.

100. State which type of exchange rate has no official intervention in the foreign exchange

market? How it is determined?

Ans. Flexible exchange rate has no official intervention. It is determined by the interaction of

supply and demand in the foreign exchange market.

101. State which of the following is a visible item and which is an invisible item in Balance of

payments. (a) Export of jute product (b) Software services exports.

Ans. (a) Export of jute product - Visible Item (b) Software services exports - Invisible Item

102. What will be the value of imports, if the net imports are Rs 160 crores and the value of

exports are Rs 400 crores.

Ans. Balance of Trade = Exports- Imports

Imports= Exports – Balance of trade= 400-(-160)=560 Or Imports= Exports + net imports

= 400+160=560

103. If Balance of payment of a country is Rs (-) 100 crores and total payment are Rs 500

crores. Find out its total receipts.

Ans. Balance of Payment = Total receipts- Total payments Total receipts= Total Payment

+BOP =500 + (-100) =500-100=400

104. Balance of payments always balances. Discuss it.

Ans. Balance of payments is always balanced. A negative balance on the current account is

equated with positive balance in the capital account. The monetary authorities may

finance a deficit by depleting their reserves of foreign currencies or by borrowing from the

IMF etc. Hence BOP is always in balance.