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MATERIAL

XII Economics

Study Material, HOTS and VBQ

Supporting Material

Class-XII

Economics

6 XII – Economics

Supporting Material

EconomicsDesign of Sample Question Paper for March, 2013

Examination

Time : 3 hours Maximum Marks : 100

The weightage to marks over different dimensions of the question paper shall beas under.

Part A : WEIGHTAGE TO CURRENT/SUBJECT UNITS

S.No. Content Unit Mark

Part A : Introductory Micro Economics

1. Introduction 4

2. Consumer Behaviour and Demand 18

3. Producer Behaviour and Supply 18

4. Forms of Market and Price Determination 10

5. Simple applications of Tools of demand and supply curves

Total 50

Part B : INTRODUCTORY MACRO ECONOMICS

1. National Income and Related Aggregates 15

2. Money and Banking 8

3. Determination of Income and Employment 12

4. Government Budget and the Economy 8

5. Balance of payments 7

Total 50

Grand Total 100

7 XII – Economics

Weightage to Forms of Questions

S. Forms of Questions Marks for each No. of TotalNo. question question Mark

1. Very short answer type (VSA) 1 10 10

2. Short answer type (SAI) 3 10 30

3. Short answer type (SAII) 4 6 24

4. Long answer type (LA) 6 6 36

Total 32 100

C. No. of Sections

The questions paper will have two section A and B.

D. Scheme of Option

There will be no overall choice. However, there is internal choice in onequestion of 3 marks and one question of 4 marks and one question of 6marks in each section.

E. Weightage to forms of Questions

S.No. Estimated Difficulty PercentageLevel of Questions

1. Easy 30%

2. Average 50%

3. Difficult 20%

F. Typology of Questions

In order to asses different abilities related to the subject, the question paperis likely to include open-ended questions and numerical questions.

8 XII – Economics

CONTENTS

S. No. Chapter Page

1. Introduction 9 – 12

2. Consumer’s Behaviour & Theory of Demand 13 – 25

3. Production Behaviour and Supply 26 – 40

4. Forms of Market and Price Determination 41 – 47

5. Simple Application of Toos of Demand and Supply Curve 48 – 49

6. National Income 50 – 71

7. Money and Banking 72 – 77

8. Determinations of Income & Employment 78 – 90

9. Government Budget and the Economy 91 – 96

10. Balance of Payment 97 – 1105

Question Papers 106 – 116

Exam. Oriented Questions with Answers 117 – 154

9 XII – Economics

UNIT 1

INTRODUCTION

POINTS TO REMEMBER

q Study of Economics is divided into two branches

(a) Micro economics (b) Macro economics

q Micro economics studies the behaviour of individual economic units.

q Macro economics studies the behaviour of the economy as a whole.

q Economy is an Economic Organisation which provides sources to earnlivelihood.

q Economic problem is the problem of allocation of limited resources availablein the economy.

q Cause of economic problems are :

(a) Unlimited Human Wants (b) Limited Economic Resources

(c) Alternative uses of Resources.

q Central Problems of an Economy

Allocation of Resources

What to produce? How to produce? For whom to produce?

q For the selection of an opportunity, the sacrifice of next best alternative useis called opportunity cost.

q Production possibility frontier (PPF) shows different combinations of a setof two goods which can be produced with given resources and productiontechnology.

10 XII – Economics

q Production possibility curve PPC

(a) Slopes downward from left to right because if production of one goodis to increase then production of other good has to be sacrificed.

(b) Concave to the origin because of increasing marginal opportunity costor (MRT)

q Rightward shift of PPC indicates increase in resources and improvement intechnology.

q Leftward shift of PPC indicats decrease in resources and degradation intechnology.

q Marginal Rate of Transformation (MRT) is the ratio of number of units of agood sacrificed to increase one more unit of the other good.

q MRT can also called Marginal opportunity cost. It is defined as the additionalcost in terms of number of units of a good sacrificed to increase an additionalunit of the other good.

VERY SHORT ANSWER TYPE QUESTIONS (1 MARK)

1. With the help of an example, define micro economics.

2. Define macro economics with the help of an example.

3. Define opportunity cost.

4. Why does an economic problem arise?

5. Write two characteristics of resources.

6. What do you mean by scarcity?

7. What do you mean by marginal opportunity cost?

8. What do you mean by an economy?

HOTS

9. What is meant by economising the use of resources?

10. What do you mean by alternative uses of resources?

11. What will be the shape of PPF when MRT is constant?

12. Unemployment in India is a subject matter of Microeconomics orMarcoeconomics, give reason.


SHORT ANSWER TYPE QUESTIONS (3/4 MARKS)

1. Distinguish between microeconomics and macroeconomics. Give example.

2. Why does an economic problem arise? Explain the problem of 'How toProduce'?

3. Explain the problem of 'What to Produce' with the help of an example.

4. ‘For whom to produce’ is a central problem of an economy. Explain.

5. Why is a production possibility curve concave? Explain.

6. Define opportunity cost with the help of an example, how does it differ frommarginal opportunity cost?

7. What is ‘Marginal Rate of Transformation’? Explain with the help of anexample.

HOTS

8. What is PP Frontier? Explain it with the help of an imaginary schedule anddiagram.

9. Show the following situation with PPF

(a) Fuller utilisation of resources (b) Growth of resources.

(c) Under utilisation of resources.

10. “An economy always produces on, but not inside a PPC”. Defend or refute.

11. A lot of people die and many factories were destroyed because of a severeearthquake in a country. How will it affect the country’s PPC?

12. Calculate MOC from the following table. What will be the shape of PPC andwhy.

Combinations Green Chilly (Units) Sugar (Units)

A 100 0

B 95 1

C 85 2

D 70 3

E 50 4

F 25 5


ANSWER OF VERY SHORT TYPE QUESTIONS

1. Micro Economics is that branch of economics in which economic problemsare studied at individual level e.g. the behaviour of consumer, firms, etc.

2. Macro economics is that branch of economics which studies the economyas a whole and its aggregates e.g. National income, the level of employment.

3. For the selection of an opportunity, the sacrifice of next best alternative useis called opportunity cost.

4. An economic problem arises due to scarcity of resources having alternativeuses in relation to unlimited wants.

5. Resources are scarce (limited) and they have alternative uses.

6. Scarcity refers to a situation in which demand is more than supply.

7. Marginal rate of transformation (MRT) is the ratio of one good sacrificed toincrease one more unit of the other good.

8. An economy is an economic organisation which provides sources to earnlivelihood.

9. Economising the resources means that resources are to be used in amanner such that maximum output is realised per unit of output. It alsomeans optimum utilisation of resources.

10. Alternate use of resources mean, more than one uses to which a resourcecan be put.

11. Shape of PPF will be a straight line sloping down ward.

12. Unemployment in India is a subject matter of macroeconomics because itrelates to economy as whole.

HINTS [3 MARKS QUESTIONS]

12. Combinations MOC

A –

B 5

C 10

D 15

E 20

F 25


UNIT 2

CONSUMER'S BEHAVIOUR &THEORY OF DEMAND

POINTS TO REMEMBER

q Consumer : is an economic agent who consumes final goods and services.

q Total utility : It is the sum of satisfaction from consumption of all the unitsof a commodity at a given time.

q Marginal Utility : It is a net increase in total utility by consuming anadditional unit of a commodity.

q Law of Diminishing Marginal Utility : As consumer consumes more andmore units of commodity. The Marginal utility derived from the last eachsuccessive units goes on declining.

q Consumer’s Bundle : It is a quantitative combination of two goods whichcan be purchased by a consumer from his given income.

q Budget set : It is a quantitative combination of those bundles which aconsumer can purchase from his given income at prevailing market prices.

q Consumer Budget : It states the real income or purchasing power of theconsumer from which he can purchase the certain quantitative bundles oftwo goods at given price.

q Budget Line : Shows those combinations of two goods which a consumercan buy from limited income on same curve.

q Monotonic Preferences : Consumer’s preferences are called monotonicwhen between any two bundles, one bundle has more of one good and noless of other good.

q Change in Budget Line : There can be parallel shift (leftwards orrightwards) due to change in income of the consumer.


q Marginal Rate of Substitution (MRS) : It is the rate at which a consumeris willing to substitute good X for good y.

Good MRS = Good

xy

q Indifference Curve : is a curve showing different combination of twogoods, each combinations offering the same level of satisfaction to theconsumer.

q Properties of Indifference curve :

1. Indifference curves are negatively sloped.

2. Indifference curves are convex to the point of origin.

3. Indifference curves never touch or interesect each other.

4. Higher Indifference curve represents higher level of satisfaction.

q Consumer’s Equilibrium : Consumer is in equilibrium when he getsmaximum satisfaction from his limited income.

Condition of Consumer’s Equilibrium

(a) In terms of utility :

(i) In case of one good → MUx = Px

where MUx → Marginal utility of good X

Px → Price of Good X

(ii) In case of two goods

MUMU = = MUP P

yxm

x y

(b) In terms of Indifference curve : There should be

(i) Decreasing MRS (Marginal Rate of substitution).

(ii)PMRS =P

xxy

y

Px → Price of good x

Py → Price of good y

(iii) Budget line should be tangent to indifference curve.


q Demand : It is that quantity which a consumer purchases or is willing to buyat given price.

q Market Demand : It is the sum of total quantity purchased by all theconsumers at given price in the market.

q Demand Function : It is the functional relationship between the demandof a good and factors affecting demand.

q Change in Demand : When demand changes due to change in any oneof its determinants other than the price.

q Change in Quantity Demanded : When demand changes due to changein its own price.

q Price Elasticity of Demand : It measure the degree of responsiveness ofdemand to change in price of the commodity.


Percentage Method

( ) 1 0 0d

1 0 0

QE = or Ed =

PQ Q PP

Q P P Q−∆ × − ×

∆ −

dE Elasticity of Demand→

Q Change in quantity∆ →

d

P Change in PriceP Intitial PriceQ Initial QuantityOr

Percentage Change in QuantityE =

Percentage Change in Price

∆ →→→

q Total Expenditure Method : It measures price elasticity of demand on thebasis of change in total expenditure incurred on the commodity by ahousehold as a result of change in its price.

q There are three conditions :

1. If the Total Expenditure on the commodity changes inversely with theprice change, the demand is relatively elastic (ed > 1)

2. If the total expenditure on the commodity remains the same as beforeand after change in price, then demand is said to be unitary elastic(ed = 1)

3. It the total expenditure on the commodity increases with an increasein its price and decreases with a decrease in the price, then demandis relatively inelastic (ed < 1)

q Geometric Method : Elasticity of demand at any point is measured bydividing the length of lower segment of the demand curve with the lengthof upper segment of demand curve at that point.

Lower segment of the demand curveEd =

Upper segment of the demand curve


Diagram to show Geometric or point method :

Elasticity of demand at given point

Lower part of the demand curveEd =

Upper part of the demand curve

D is mid point of the demand curve

Degree of Price Elasticity of Demand


q Factors affecting Price elasticity of Demand

(a) Behaviour of the consumer

(b) Nature of the commodity

(c) Possibility of postponement of consumption.

(d) Proportion of income to be spent on the commodity

(e) Number of close substitutes

(f) Alternative uses of commodity

(g) Income of the consumer


1. What is meant by utility?

2. How is Total utility derived from marginal utilities?

3. What is Law of Diminishing Marginal Utility?

4. What will be the behaviour of total utility when marginal utility is zero?

5. State condition of consumer's equilibrium in respect of one good.

6. Define consumers equilibrium.

7. What is meant by Marginal Rate of Substitution (MRS).

8. What is meant by budget set.

9. Define Indifference curve Map.

10. How is budget line defined?

11. Why does higher indifference curve give more satisfaction?

12. What is the impact of diminishing marginal rate of substitution on the slopeof indifference curve?

13. Define monotonic preference.

14. How is market demand schedule derived with the help of individual demandschedules?

15. Define normal good.

16. How does availability of substitute good affect the elasticity of demand?

17. Demand of good ‘X’ falls due to increase in the income of the consumerwhat type of good ‘X’ is?

18. What will be the impact on demand of the good due to increase in price of


the substitute good?

19. A rise in price of a good results in a decrease in expenditure of it. Is itsdemand elastic or inelastic?

20. What is meant by market demand?

21. Define demand schedule.

22. What cause an upward movement along a demand curve?

23. If the number of consumers increase, in which direction will the demandcurve shift?

24. A straight line demand curve is given. What will be elasticity of demand onthe mid point of this curve.

25. If the slope of a demand curve is parallel to X-axis, what will be the elasticityof demand?

26. Why is demand of water inelastic?

27. Define price elasticity of demand.

H.O.T.S.

28. Why does total utility increases at diminishing rate due to continuous increasein consumption?

29. Due to decrease in price of pen why does the demand of ink increase?

30. What will be the behaviour of total utility when marginal utility curve liesbelow X-axis?

31. When is demand inelastic?

32. Give two examples of normal goods & inferior goods.

SHORT ANSWER TYPE QUESTIONS (3-4 MARKS)

1. Explain the law of diminishing marginal utility with the help of a utility schedule.

2. Explain consumers equilibrium with utility approach in case of single good.

3. What do you mean by budget line? What are the reasons of change inbudget line?

4. Explain the relationship between total utility and marginal utility with the helpof schedule.

Or


What changes will take place in total utility when –

(a) Marginal utility curve remains above X–axis

(b) Marginal utility curve touches X–axis

(c) Marginal utility curve lies below X–axis.

5. State three features of indifference curve.

6. Why does two indifference curves not intersect each other?

7. Under what situations there will be parallel shift in budget line?

8. Explain the effect of a rise in the prices of ‘related goods’ on the demandfor a good X.

9. Why does demand of a normal good increases due to increase in consumer’sincome?

10. State elasticity of demand of followings :

(a) Luxurious goods

(b) Goods of alternate use

(c) Necessity goods.

11. Distinguish between expansion of demand and increase in demand with thehelp of diagram.

12. Measure Price Elasticity of Demand on the following points of a straight linedemand curve :

(a) Centre point of the demand curve.

(b) Demand curve intercepting y-axis

(c) Demand curve intercepting x-axis.

13. Distinguish between change in demand and change in quantity demanded.

14. What will be the effect of following on elasticity of demand.

(a) time factor (b) nature of the product.

15. What will be the slope of demand curve under following situations.

(a) Perfectly elastic demand

(b) Perfectly inelastic demand

(c) Unit elastic demand.

16. State the factors of rightward shift of demand curve. Explain any one.


17. State the factors of leftward shift of demand curve. Explain any one.

18. How does ‘a proportion of income spent on a good’ affect elasticity ofdemand.

19. What will be elasticity of demand if

(a) Total expenditure increases due to increase in price.

(b) Total expenditure increases due to fall in price.

20. When price of a good is Rs. 7 per unit a consumer buys 12 units. Whenprice falls to Rs. 6 per unit he spends Rs. 72 on the good. Calculate priceelasticity of demand by using the percentage method. comment on thelikely shape of demand curve based on this measure of elasticity.

21. A consumer buys 10 units of a good at a price of Rs. 9 per unit. At priceof Rs. 10 per unit he buys 9 units. What is price elasticity of demand? Useexpenditure approach Comment on the likely shape of demand curve onthe basis of this measure of elasticity.

22. A consumer buys 20 units of a good at a price of Rs. 5 per unit. He inincurs an expenditure of Rs. 120 when he buys 24 units. Calculate priceelasticity of demand of the percentage method. Comment on the likelyshape of demand curve based on this information.

23. When the price of a commodity falls by Rs. 2 per unit, its quantity demandedincreases by 10 units. Its price elasticity of demand is (–) 1. Calculate itsquantity demanded at the price before change which was Rs. 10 per unit.

24. The price elasticity of demand of a commodity is –0.5. At a price of Rs. 20per unit, total expenditure on it is Rs. 2,000. Its price is reduced by 10percent. Calculate its demand at the reduced price.

H.O.T.S.

25. State four determinants of price elasticity of demand.

26. Fill in the gaps in the following equations :

(i)

?MU =

Q∆∆

(ii)

? = MUΣ

(iii)

n nMU = TU – ?

(iv)

D

q Pe =

? Q∆ ×


27. Differentiate between :

(i) Normal goods and Inferior goods

(ii) Complementary goods and substitute goods.

28. Why should the budget line be tangent to the indifference curve at thepoint of consumer’s equilibrium.

29. Why does consumer stop consumption in case where marginal utility is lessthan price of a good?

30. What is budget line? Why is it negatively stoped?

31. A consumer consumes only two goods x & y. state & explain the conditionsof consumer’s equiiprium with the help of utility analysis.

32. Explain the conditions determining how many units of a good the consumerwill buy at a given price.

33. Difine marginal rate of substitution. Explain why is an indifference curveconvex?

LONG QUESTIONS (6 MARKS)

1. Explain the conditions of consumer’s equilibrium with the help of theindifference curve analysis. Represent the same in a diagram.

2. Explain the determination of consumers equilibrium with the help of aschedule in case of two commodities by using utility approach.

3. Why does demand curve slope downward?

4. Explain the determinants of price elasticity of demand.

5. With the help of diagrams, explain the effect of following changes on thedemand of a commodity.

(a) A fall in the income of its buyer.

(b) A rise in price of complementary good.

6. What are the conditions of consumer’s equilibrium under the indifferencecurve approach? What changes will take place if the conditions are notfulfilled to reach equilibrium?

7. Explain the three properties of indifference curve.


H.O.T.S.

8. With the help of numerical example measure price elasticity of demand inthe following conditions by total expenditure method :

(i) Demand falls when price is constant.

(ii) Price falls while demand is constant.

9. Whether the following statements are true or false? Give reasons.

(i) Two indifference curves never intersects each other.

(ii) Income effect of inferior good is positive.

(iii) Change in quantity demanded is the explanations of law of demand.

10. Explain the concept of marginal rate of substitution (MRS) by giving anexample. What happens to MRS when consumer moves downwards alongthe indifference curve? Give reasons for your answer.

11. Following statements are true or false give reasons :

(i) Increase in number of consumers shifts the demand curve rightward.

(ii) The demand of a commodity becomes elastic if its substitute good isavailable in the market.

(iii) The price elasticity of demand is equal to unity at a point situated inthe middle of a straight line demand curve.

ANSWERS

VERY SHORT ANSWER TYPE QUESTIONS

1. Utility is the power of goods to satisfy human wants.

2. Total utility is derived by summing up the marginal utilities TU = ΣMU.

3. Law of diminishing marginal utility states that as more and more units of acommodity are consumed marginal utility derived from every additional unitmust decline.

4. Total utility will be maximum.

5. MUX = Px

6. Consumers equilibrium refers to a situations in which a consumer getsmaximum satisfaction from his given income and market price.


7. MRS is the rate of sacrifice of one good to get an additional unit of othergood.

8. The set of bundles available to the consumer with his given income atprevailing market price is called the budget set.

9. A family of indifference curve indicating different levels of satisfaction calledindifference map.

10. Budget line is a line showing all different possible combinations of twogoods which a consumer can buy with his given income and the price ofboth goods.

11. Higher difference curve shows a higher level of satisfactions. It shows thevarious combinations of excess quantity of both goods than lower indifferencecurve.

12. Indifference curve become convex towards the origin.

13. Consumer’s preferences are called monotonic when between any twobundles, one bundle has more of one good and no less of other good.

14. By summations of individual schedules.

15. Normal goods are those goods, the demand for which increases as incomeof the buyer rise. There in positive relation between income and demandof these goods.

16. The demand of a good becomes elastic if its substitute good is availablein the market.

17. Good ‘X’ is an inferior good.

18. The demand of the good will increase.

19. Elastic.

20. Market demand is the sum of total demand of all the consumers in themarket at a particular time and at a given price.

21. Demand schedule is a tabular representation which represent differentquantities of the commodity demanded at different prices.

22. Increase in price while other factors are constant.

23. Rightward.

24. Equal to unit.

25. Perfectly elastic.

26. Because water is a necessity good.


27. The price elasticity of demand is the degree of responsiveness of quantitydemanded of a commodity to the change in its price.

H.O.T.S. (ANSWERS)

28. As more and more units of commodity are consumed, marginal utility derivedfrom each successive unit tends to diminish so total utility increases atdiminishing rate up.

29. These are complementary goods.

30. Total utility start to decline.

31. When percentage change in quantity demanded is less than percentagechange in price, the demand is said to be inelastic.

32. Normal goods – Rice, Wheat

Inferior goods – coarse grain, coarse cloth.


UNIT 3

PRODUCTION BEHAVIOUR ANDSUPPLY

POINTS TO REMEMBER

q Total production refers to the sum total of production done by using all unitsof variable factors over a given period of time.

q Average production is the per unit output of variable factor (labour) employed.

AP =

TPvariable input

q Marginal product is addition to total product resulting from employing oneadditional unit of variable input.

q Returns to a factor : In a short period when additional units of variablefactors are employed with given fixed factors, then returns to a factoroperates. Returns to a factor shows the changes in total products, marginalproduct which arises due to change in ratio between fixed and variablefactor. They are as follows :

(A) Increasing returns to a factor : In the initial stage as more andmore units of variable factor are employed with fixed factor total physicalproduction increases at increasing rate.

(B) Diminishing returns to a factor : As more and more units of variablefactors are employed with fixed factors, then total product increases atdiminishing rate.

(C) Negative returns to a factor : This is the last stage of returns to afactor. As more and more units of variable factors are employed withgiven fixed factors, total production starts decreasing and marginalproduct becomes negative.

Relation between Total, Average and Marginal Product

1. So long as marginal product rises, total product increases at increasingrate.


2. Marginal product starts falling but remains positive, total product risesat diminishing rate in this stage.

3. When marginal product becomes negative, then total product startsfalling in this stage.

4. So long as average production is less than marginal product, averageproduction increases Marginal product intersects average product atthe point where average product is maximum. After this average productstarts falling and is more than marginal product in this stage.

q Cost : Cost is the sum of direct (explicit cost) and indirect cost (implicitcost).

q Those monetary payments, which are incurred by producers for paymentthose of factor and non-factor inputs which are not owned by produces arecalled Direct Cost.

q Implicit cost is the cost of self owned resources of the production used inproduction process.

q Total cost is the sum of total fixed cost and total variable cost.

TC = TFC + TVC or TC = AC X Q

q Total fixed cost remains constant at all levels of output. It is not zero evenat zero output level. Therefore, TFC curve is parallel to OX-axis.

TFC = TC – TVC or TFC = AFC × Q

q Total variable cost is the cost which vary with the quantity of output produced.It is zero at zero level of output. TVC curve is parallel to TC curve.

TVC = TC – TFC or TVC = AVC × Q

q Average cost is per unit of total cost. It is the sum of average fixed cost andaverage variable cost.

AC =

TCQ

or AC = AFC + AVC


q Average fixed cost is per unit of total fixed cost.

AFC =

TFCQ

or AFC = AC – AVC

q Per unit of total variable cost is called average variable cost.

AVC =

TVCQ

or AVC = AC – AFC

q Net increase in cost for producing one additional unit is called marginalcost.

MCn = TVCn – TVCn–1 or MC =

TVCQ

∆∆

Relation Between Short-Term Costs

q Total cost curve and total variable cost curve remains parallel to eachother. The vertical distance between these two curves is equal to total fixedcost.

q TFC curve remains parallel to X aixs and TVC curve remains parallel to TCcurve.

q With increase in level of output, the vertical distance between AFC curveand AC curve goes on increasing. On contrary the vertical distance betweenAC curve and AVC curve goes on decreasing but these two curves neverintersect because average fixed cost is never zero.

q Marginal cost curve intersects average cost curve and average variablecost curve at their minimum point. After the point of intersection with increasein output, AC curve and AVC curve starts rising.

q MC curve remains under the AC and AVC curve before inter section pointbut after inter section point AC and AVC curve remains under the MC curve.

q Average cost and average variable cost falls till they are more than marginalcost. When these two costs are less than marginal cost, in that situationboth (AC and AVC) rise.

q Money received from the sale of product is called revenue.

q Total revenue is the amount received from the sale of given units of acommodity over a particular period of time.

TR = AR × Q or TR= ΣMR


q Per unit revenue received from the sale of given units of a commodity iscalled average revenue. Average revenue is equal to price.

AR = TRQ or

P QQ×

= P = Price.

q Marginal revenue is net addition to total revenue when one additional unitof output is sold.

MR = TRQ

∆∆

q Behaviour of TR, AR and MR when per unit price remains constant or firmcan sell additional quantity of a good at same price

(a) Average revenue and marginal revenue remains constant at all levelsof output and AR and MR curves are parallel to ox-axis.

(b) Total revenue increases at constant rate and TR curve is positivelysloped straight line passing through the origin.

q Behaviour of TR, AR and MR when price falls with additional unit of outputsold or there is monopoly or monopolistic competition in the market

(a) Average revenue and marginal revenue curves have negative slope.MR curve lies below AR curve.

(b) Marginal revenue falls, twice the rate of average revenue.

(c) So long as marginal revenue is positive, total revenue increases. Whenmarginal revenue is zero, total revenue is maximum and when marginalrevenue becomes negative, TR starts falling.

q Concept of Producer’s Equilibrium : If refers the stage where producergetting maximum profit.

(A) MR and MC Approach : Conditions of producers equilibrium according tothis approach are :

(a) Equality between MR and MC

(b) MC curve should cut the MR curve from below at the point of equilibrium.

Or

MC should be more than MR after the equilibrium point, with increase inoutput.

q Supply : Refers to the amount of the commodity that a firm or seller iswilling to offer or to sell in a given period of time at various prices.


q Individual Supply : Refers to quantity of a commodity that an individualfirm is willing and able to offer for sale at each possible price during a givenperiod of time.

q Stock : Refers to the total quantity of a particular commodity available withthe firm at a particular point of time.

q Supply Schedule : Refers to a tabular presentation which shows variousquantities of a commodity that a producer is willing to supply at differentprices, during a given period of time.

Supply curve : Refers to the graphical representation of supply schedulewhich represents various quantities of a commodity that a producer iswilling to supply at different prices during given period of time.

q Law of Supply : States the direct relationship between price and quantitysupplied, keeping other factors constant.

Exceptions to Law of Supply

1. Future Expectation

2. Agricultural goods

3. Perishable goods

4. Rare goods

5. Backward countries.

q Price Elasticity of Supply : Refer to the degree of responsiveness ofsupply of a commodity with reference to a change in price of such commodity.It is always positive due to direct relationship between price and quantitysupplied.

Price Elasticity of Supply (Es) = Percentage change in quantity supplied

Percentage change in price

q Methods for measuring price elasticity of supply :

1. Percentage Method 2. Geometric Method

q Degrees of Elasticity of Supply :

(a) If the tangent to the supply curve passes through the point of origin,Es at that point is equal to unity.

(b) If the tangent intersects the x-axis, Es at that point is less than unity

(c) if tangent intersects the y-axis Es at that point will be greater thanunity.


Very Short Answer Type Questions (1 Mark)

1. Define production function.

2. Define marginal product.

3. What will be the behavior of total product when marginal product of variableinput is falling but is positive?

4. What is the relation between average and marginal product when averageproduct is falling?

5. Define average production.

6. What do you mean by fixed factors of production? Give example.

7. By which behaviour of marginal product will total product be maximum


8. How does fall in total product affects marginal product?

9. What do you mean by cost?

10. Define explicit costs.

11. Which cost curve is parallel to ox-axis? Why?

12. What do you mean by implicit costs?

13. Define marginal cost.

14. Why does the difference between average total cost and average variablecost falls with increase in output?

15. Define Revenue.

16. At what rate average and marginal revenue falls, with fall in per unit priceof a good?

17. What will be the behaviour of Average revenue when total revenue increasesat constant rate?

18. What do you mean by marginal revenue?

19. What will be the behaviour of total revenue when marginal revenue is zero?

20. Why does average cost curve and averages variable cost curve neverintersect each other?

21. What do you mean by producer’s equilibrium?

22. State any two conditions of producers equilibrium according to marginalrevenue and marginal cost approach.

23. Define supply.

24. What do you mean by individual supply schedule?

25. Define Market Supply

26. Name two determinants of supply.

27. What is meant by change in supply?

28. What type of change in price is the cause of upward movement along asupply curve?

29. What effect does an increase is tax rates have on supply of a commodity?

30. What causes a downward movement along a supply curve?

31. What is meant by leftward shift of supply curve?

32. How does a decrease in price of input effect supply curve of the commodity?


33. Why does a supply curve have a positive slope?

34. What is meant by elasticity of supply?

35. What is the price elasticity of supply, if supply curve is parallel to y-axis.

36. When does the elasticity of supply of commodity called equal to unity?

37. When does the producer increase the supply of a good at given price, givetwo reasons.

38. What causes an extension in supply?

39. If the price of a commodity falls by 10% and, consequently, the quantitysupplied decreases by 20%. What will be its price elasticity of supply?

H.O.T.S.

40. Why is total variable cost curve parallel to total cost curve?

41. Why does average fixed cost fall with increase in output?

42. Why is total fixed cost curve parallel to ox-axis.

43. Under which situation will MR fall when an additional quantity of a good issold?

44. What behaviour of per unit price will cause the equality of average andmarginal revenue.

45. Give one differences between law of supply and price elasticity of supply.

46. What is the price elasticity of supply associated when the supply curvepassing through to intersect to x-axis?

47. Why does a producer moves downward along a supply curve due todecrease in price of commodity?

48. What is the price elasticity of supply associated with when a supply curvepasses through the origin at 40° angle?

49. When does the supply curve shift rightward while price remains constant.

50. What effect does an increase in price of competitive good have on thesupply of a commodity?

51. How does the imposition of a tax affect the supply curve of a firm?



1. Why does the law of diminishing returns apply?

2. How does total product behave with change in marginal product?

3. Briefly explain the causes of increasing returns to a factor with the help ofmarginal product.

4. Explain the likely behaviour of total product. When only the unit of a variablefactor is increased to increase the output. Use numeric example.

5. Distinguish between total fixed cost and total variable cost.

6. Explain with the help of a diagram the relationship between Average cost,Average variable cost and Marginal cost.

7. Why is short run average cost curve ‘U’ shaped?

8. Explain diagrammatically the relationship between Average cost, Averagevariable cost and Average fixed cost.

9. What changes will take place in total revenue when

(a) Marginal revenue is falling but remains positive.

(b) Marginal revenue is zero.

(c) Marginal revenue is negative.

10. Define marginal revenue. Explain the relationship between average andmarginal revenue when price is constant at all levels of output.

11. How does marginal revenue effect total revenue when price decreases toincrease sale. Use Schedule.

12. What do you mean by producers equilibrium? State the conditions ofproducer’s equilibrium with Marginal Revenue and Marginal Cost Curves.

13. Explain producer’s equilibrium with the help of a numerical example usingmarginal revenue and marginal cost approach.

14. Draw in a single diagram the average revenue and marginal revenue curvesof a firm which can sell any quantity of the good at a given price. Explain.

15. Complete the following table :

Output Total Cost Average Variable Cost Marginal Cost(Units) (Rs.) (Rs.) (Rs.)

1 90 – 302 – 27 273 – – –4 180 30 –


16. Given below is the cost schedule of a firm. Its average fixed cost is Rs. 20when it produces 3 units.

Output (units) 1 2 3

Average variable cost (Rs.) 30 28 32

Calculate its marginal cost and average total cost at each given level ofoutput.


Output Average Variable Cost Total Cost Marginal Cost(Units) (Rs.) (Rs.) (Rs.)

1 – 60 202 18 – –3 – – 184 20 120 –5 22 – –

18. Define market supply. Explain its two determinants.

19. Distinguish between ‘Change in Supply’ and change in quantity supplied.

20. Explain briefly two causes of a rightward shift of supply curve.

21. Differentiate between contraction in supply and decrease in supply.

22. How does change in price of inputs affect the supply of a good.

23. What is meant by elasticity of supply? What will be the price elasticity underfollowing conditions :

(a) Percentage change in quantity is greater than percentage change inprice.

(b) Supply remain constant due to increase or decrease in price of thegood.

24. A seller of potatoes sells 80 quintals a day when the price of potatoes isRs. 4 per kg. The price elasticity of supply of potatoes is known to be 2.How much quantity of potatoes will the seller supply when the price risesto Rs. 5 per kg.

25. The coefficient of elasticity of supply of a commodity is 3. A seller supplies20 units of the commodity. How much quantity of this commodity will theseller supply. When price rises by Rs. 2 per unit?

26. The ratio of elasticity of supply of commodities A and B is 1 : 1.5. 20percent fall in price of A results in a 40 percent fall in its supply. Calculate


the percentage increase in supply of B if its price rises from Rs. 10 per unitto Rs. 11 per unit.

27. How does change in price of related goods affect the supply of given good.

H.O.T.S.

1. State the causes by which marginal product of a variable factor changefrom increasing return to diminishing return.

2. What would be the shape of average revenue curve when total revenue ispositively sloped straight line passing through origin. Explain with the helpof schedule and diagram.

3. What is a supply schedule? Explain how does change in technology ofproducing a good affect the supply of that good.

4. Following statements are true or false. Give reasons :

(a) At the stage of producer’s equilibrium, marginal cost will be decreasing.

(b) AR curve always remain above MR curve.

5. Whether following statements are true or false. Give reasons.

(a) Marginal revenue falls twice the rate at which average revenue falls.

(b) Average cost starts increasing when rising portion of marginal costintersects.

6. Following statements are true or false. Give reasons :

(a) Diminishing returns to a factor is applicable only when average productstarts falling.

(b) AC and AVC curves do not intersect each other

7. Distinguish between leftward shift to supply curve and downward movementalong a supply curve.

8. “The change in quantity supplied is explanation of law of supply”. Explain.

9. Either following statements are true or false. Give reasons.

(a) There is inverse impact of change in tax rates on the supply of givengood.

(b) Future expectation to increase in price increases the market supply ofa commodity.

10. Explain the geometric method of measuring price elasticity of supply withthe help of diagram.


LONG ANSWER TYPE QUESTIONS (6 MARKS)

1. Explain diagrammatically the effect on total output when units of one factoris increased and all other inputs are held constant.

2. Complete the following table

Output Total Cost Average Fired Average Variable Marginal(Units) (Rs.) Cost Cost Cost

0 36

1 – – – 18

2 – – – 14

3 – – 16 –

4 – – – 24

3. What is producer’s equilibrium? Explain the conditions of producer’sequilibrium through the ‘marginal cost and marginal revenue’ approach.Use diagram.

4. State whether true or false. Give reasons.

(a) Total product is the area under the marginal product curve.

(b) When marginal product falls, average product always falls.

(c) For the first unit of output MC = AVC.

5. State whether True or False. Give reasons.

(a) When marginal revenue is constant and not equal to zero, then totalrevenue will also be constant.

(b) As soon as marginal cost rises, average variable cost also starts rising.

(c) Total product always increases whether there is increasing returns orDiminishing return to a factor.

6. State whether the following statements are true or false. Give reasons foryour answer.

(a) When total revenue is constant average revenue will also be constant.

(b) Average variable cost can fall even when marginal cost is rising.

(c) When marginal product falls, average product will also fall.


ANSWERS

1 MARK QUESTIONS

1. Diminishing return to a facter

2. Marginal product is net addition to total product when one additional unitof variable factor is used.

3. Total product increases at diminishing rate.

4. MP falls but it falls at faster rate than AP

5. AP is a per unit output of a variable factor.

6. These factors of production which cannot be varied in short period e.g.machine, land.

7. When marginal product of a factor is zero, then total product will be maximum.

8. When total product falls, marginal product becomes negative.

9. Cost is the sum of explicit and implicit cost.

10. Those monetary payments by producer on factor and non factor paymentsis called explicit cost. Which are not owned by himself.

11. Total fixed cost because TFC remain constant at all level of output.

12. Implicit cost is the cost of self owned resources of producer.

13. Marginal cost is the net addition to total cost when one additional unit ofoutput is produced.

14. It is because average fixed cost goes on falling with increase in output.

15. Revenue is the amount received from sale of output.

16. Marginal revenue falls twice the rate of average revenue.

17. Average revenue remains constant.

18. Marginal revenue is net additions to total revenue by sale of one additionalunit of output.

19. Total revenue will be maximum.

20. Because AFC can never be zero at any level of output.

21. Producer’s equilibrium is a situation where he gets maximum profit.

22. 1. MR = MC

2. Rising portion of Marginal cost curve intersects marginal revenue curve.


25. Supply refers to the amount of the commodity that a firm or seller is willingto offer for sale in a given period of time at various prices.

26. Individual supply schedule is a tabular representation showing variousquantities of a commodity which a firm is ready to sell at different pricesduring a given period of time.

27. It referes the sum of tatal quantity supplied by all the firms in a market.

28. 1. Number of firms

2. Change in technology

29. Change in supply refers to increase or decrease in supply of a commoditydue to change in factors other than price like technology, price of inputs,Goal of producer, Number of firms etc.

30. Due to increase in price.

31. As a result of increase in tax rates production cost increase, so the profitmargin of producer will fall and producer will decrease the supply.

32. Decrease in price.

33. Due to change in other factors the supply of a commodity falls at sameprice than supply curve shifted to leftward.

34. As a result of decrease in price of input production cost falls then producersprofit margin will increase so producer will increase the supply of commodity.

35. Because of positive relation between price and supply.

36. Price Elasticity of Supply (Es) is a measure of degree of response of supplyfor a good to change in its price.

37. Perfectly elastic.

38. When percentage change in price is equal to percentage change in supply.

39. Due to change in other factor like improvement in technology, decrease inprice of inputs.

40. Increase in price of a commodity.

41.% change in quantity 20%

Es = 2% change in price 10%

= =


H.O.T.S.

42. Total cost is the sum of total fixed cost and total variable cost. TFC remainsconstant at all levels of output.

42. AFC can be calculated from TFC. Which remains constant at all level ofoutput.

43. TFC remains constant at all levels of output.

44. When per unit price falls by selling an additional unit of a good.

45. Per unit price remains constant.

46. Law of supply reflects the direction of change in supply where as priceelasticity of supply measures the magnitude of change in supply.

47. Inelastic.

48. Because profit margin of firm (producer) decreases.

49. Equal to unity elastic.

50. When the supply of commodity increases due to change in other factors.

51. Supply of the commodity will fall.

52. The supply curve will shift to the left side.


UNIT 4

FORMS OF MARKET & PRICEDETERMINATION

POINTS TO REMEMBER

q Market implies a system with the help of which the buyers and seller of acommodity or service come to contact with each other and complete the actof sale and purchase.

q Perfect competition is that type of market in which there are very largenumber of sellers, sell homogenous goods at constant price without anycompetition to consumer who have perfect knowledge about the market.

q Under perfect competition, price remains constant therefore, average andmarginal revenue curves also remain constant and parallel to ox-axis.


q Under perfect competition price is determined by an industry (a group ofproducers and consumers) with the forces of demand and supply. Noindividual firm or buyer can influence the price or supply of the product. Soindustry is price maker and firm is price taker.

MONOPOLY MARKET

q Monopoly is that type of market where there is a single seller, selling aproduct which does not have close substitutes.

q Under monopoly, due to absence of free entry and exit, firm earn abnormalprofit in the long run.

q Under monopoly, monopolist himself determines price of the productaccording to the elasticity of demand as he has full control over the supplyof the product.

q Under monopoly elasticity of demand for the good is less than one, therefore,demand curve has steeper slope. (Ed < 1).

q Under monopoly, average revenue and marginal revenue has negativeslope, as per unit price falls with increase in output sold.

q A monopolist may charge different price from different buyers for the samegood it is called price discrimination.

MONOPOLISTIC COMPETITION

q Monopolistic competition is that type of market in which there are largenumber of firms, sell differentiated product to the consumers who haveimperfect knowledge about the product and there is tough competitionbetween firms.

q Under monopolistic competition due to lack of control over supply each firmdetermines the price of their product, keeping in view the price level set byother firms.

q Under monopolistic competition elasticity of demand for the product is greaterthan one therefore demand curve (AR curve) has flatter slope.

q Each firm has to incur selling costs (expanditure on advertisement etc.) topromote its sales. This is because, there is a large number of close substituteavailable in the market.


OLIGOPOLY

q Oligopoly is the form of market in which there are few sellers. All the firmsproduce a certain amount of output of total market supply.

q All the firms under oligopoly produce homogenous or differentiated product.

q Under oligopoly entry of firms is not restricted but difficult.

q Under oligopoly demand curve is undefined.

q All the firms are interdependent in respect of price determination underoligopoly market.

q On the basis of production, oligopoly can be categorised in two categories.

(i) Collusive oligopoly is that form of oligopoly in which all the firmsdetermine price and quantity of output on the basis of cooperativebehaviour.

(ii) Non-collusive oligopoly is that form of oligopoly is which all the firmsdetermine the price and quantity of output according to the action andreaction of the firms.


q Equilibrium Price : Which corresponds to the equality between marketdemand and market supply of a commodity.

q Equilibraium quantity which corresponds to the equilibrium price in themarket.

q Market equilibrium is a state in which market demand is equal to marketsupply. There is no excess demand and excess supply in the market.


1. Define market.

2. What do you mean by homogenous product?

3. How is price determined under perfect competition?

4. What is the common feature shared by perfect and monopolistic competition?

5. If the firms are earning abnormal profits, how will the number of firms in theindustry change?

6. Define the monopoly market.

7. Under which market there is no difference between firm and industry?

8. What is normal profit?

9. Under which form of market the firm is price taker.

10. What is cartel?

11. What is the relationship between AR curve and demand curve in a monopolymarket?

12. What do you mean by price discrimination?

13. Define oligopoly.

14. Define equilibrium price.

15. When does the situation of excess supply arise?

16. What will be the effect on equilibrium price when increase in demand ismore than increase in supply?

17. Under what situation does the equilibrium price remains unaffected whenthere is simultaneous increase in demand and supply.

H.O.T.S.

18. What is the relation between average revenue curve and demand curveunder monopolistic competition?



1. Why is firm under perfect competition a price taker and under monopolisticcompetition is price maker. Explain?

2. How is the demand curve under monopolistic competition different fromdemand curve of a firm under perfect competition?

3. Why is a firm under perfect competition a price taker? Explain.

4. Explain three features of perfect competition.

5. Explain the implication of large number of seller feature of perfectcompetition.

6. What will happen if the price prevailing in the market is above the equilibriumprice.

7. Distinguish between monopoly and oligopoly.

8. Explain the concept of excess demand with the help of diagram.

9. Differentiate between ‘Collusive and non-collusive oligopoly.

10. Explain the determination of equilibrium price under perfect competition withthe help of schedule.

11. Explain why is the equitibrium price determined only at the output level atwhich market demand and market supply are equal.

H.O.T.S.

12. MR = AR in perfect competition but MR < AR in monopoly and monopolisticcompetition why?

13. In which condition decrease in demand can not change the price ofcommodity?

14. Explain how firms are interdependent in an oligopoly market.

15. In which competition the availability of close substitutes is present? Howdoes it effect the price?

16. Explain the implication of ‘freedom of entry and exit to the firms’ underperfect competition.



1. Explain the characteristics of monopolistic competition.

2. Market for a good is in equilibrium. There is simultaneous increase both indemand and supply of the good. Explain its effect on market price.

3. Explain the term market equilibrium. Explain the series of changes that willtake place if market price is higher than the equilibrium price.

4. How will a fall in the price of tea affect the equilibrium price of coffee.Explain the chain of effects.

5. Explain the following features of perfect competition.

(i) Large number of firms or Sellers and Buyers

(ii) Homogeneous Product.

6. Explain features of Oligopoly.

7. Explain how change in price of a substitute commodity would affect marketequilibrium of the commodity X.

8. With the help of a diagram explain the effect of “decrease” in demand ofa commodity on its equilibrium price and quantity.

9. There is simultaneous decrease in demand and supply of a commodity,when it result in

(i) no change in equilibrium price

(ii) a fall in equilibrium price.

ANSWERS

1 MARK QUESTIONS

1. Market is a system with the help of it the buyers and seller of a commodityor service come to contact with each other.

2. It means product produced by different firms is identical in all respect likequality, colour, size, weight etc. such products are perfect substitutes.

3. Price is determined by an industry by the forces of demand and supply.

4. (i) Free entry and exit of firms

(ii) Perfect mobility of factors.


5. The number of firms in the industry will increase.

6. It is a form of market under which there is a single seller, selling a productwhich does not have close substitutes.

7. Monopoly.

8. It is the minimum profit which a firm must get to stay in business.

9. Perfect competition.

10. A cartel is a group of firms which jointly set ‘output and price’ policy of itsproduct in such a way so as to reap benefits of monopoly.

11. Both AR curve and demand curve are the same in a monopoly market.

12. Price discrimination is a policy under which a seller sells a similar productat different prices to different buyers.

13. Oligopoly is a market structure where there are few firms competing fortheir homogenous or differentiated products.

14. It is the price at which demand = supply.

15. When market price is more than equilibrium price and market supply ismore than market demand.

16. When increase in demand is more than increase in supply, equilibrium pricewill increase.

17. When increase demand is equal to increase in supply the equilibrium pricewill remain same.

H.O.T.S.

18. Both AR and MR curves have negative slope


UNIT 5

SIMPLE APPLICATION OF TOOLSOF DEMAND AND SUPPLY CURVE

POINTS TO REMEMBER

q With the help of curves, these variables can be studied, which representpositive or negative relation.

q Variables are of two types (i) dependent variables (ii) independent variables.Generally independent variables are represented on OY-axis, where asdependent variables are represented on OX-axis.

q While plotting curves, value on OX-axis or OY-axis should be according toreasonable proportion.

q Relationship between variables can be understood easily through curvesbecause their effect is long lasting on our minds.

q In Economics demand and supply curves are used to express following :

1. Data relating to demand and supply.

2. To determine equilibrium in various economic activities.

3. To show the effect of change in demand and supply on equilibrium andmarket price.

4. For graphic representation of different categories of elasticity of demandand supply.

5. Determination of floor price and price ceiling in situation of excessdemand and excess supply.

q Govt. determines maximum and minimum price ceiling with the help ofdemand and supply.

q Govt. determines tax rate in accordance with elasticity of demand andsupply.


q Demand and supply curve explain equilibrium under following situations :

1. Rate of interest (Demand for money and supply for money)

2. Wage rate

3. Price determination of factors of production.

4. Determination of foreign exchange rate.

5. Determination of tax.

6. Saving of consumer.


UNIT 6

NATIONAL INCOME

POINTS TO REMEMBER

q Good : In economics a good is defined as any physical object, natural orman-made, that could command a price in the market.

q Consumption Goods : Those goods which satisfy human wants directly.

q Capital Goods : Those final goods which help in production. These goodsare used for generating income.

q Final Goods are those goods which are used either for final consumptionor for investment.

q Intermediate Goods refers to those goods and services which are usedfor further production or for resale. These goods do not fulfil needs ofmankind directly.

q Investment : Addition made to the stock of capital during a period is calledinvestment. It is also called capital formation.

q Depreciation : is expected fall in value of fixed capital goods due tonormal wear and tear and obsolescence.

q Gross Investment : Total addition of capital goods to the existing stock ofcapital during a time period at market price.

q Net Investment : is a measure of net availability of new capital or newaddition to capital stock in an economy.

Net Investment = Gross investment – Depreciation.

q Stocks : Variables whose magnitude is measured at a particular point oftime are called stock variables.

q Flows : Variables whose magnitude is measured over a period of time arecalled flow variable.


q Economic Territory : Economic (or domestic) Territory is the geographicalterritory administrated by a Government within which persons, goods, andcapital circulate freely.

q Scope of Economic Territory :

(a) Political frontiers including territorial waters and airspace.

(b) Embassies, consulates, military bases etc. located abroad.

(c) Ships and aircraft operated by the residents between two or morecountries.

(d) Fishing vessels, oil and natural gas rigs operated by residents in theinternational waters.

q Normal Resident of a country : is a person or an institution who ordinarilyresides in a country and whose centre of economic interest lies in thatcountry.

NATIONAL INCOME AGGREGATES

Domestic Aggregates

q Gross domestic Product at Market Price (GDPMP) is the market valueof all the final goods and services produced by all producing units locatedin the domestic territory of a country during a financial year.

q Net Domestic Product at Market Price (NDPMP) : NDPMP = GDPMP –Depreciation (consumption of Fixed capital)

q Domestic Income : (NDPFC) : It is the factor income accruing to ownersof factors of production for suppling factor services with in domestic territoryduring an accounting year.

NATIONAL AGGREGATES

q Gross National Product at Market Price (GNPMP) is the market value ofall the final goods and services produced by all producing units (in thedomestic territory and abroad) of a country during a financial year. GDPMP+ NFIA = GNPMP

q National Income (NNPFC) : is a measure of factor earnings of the residentsof a country both from economic (Domestic) territory and from abroadduring an accounting year.


NNPFC = NDPFC + NFIA = National Income.

q National Income at Current Prices (Nominal National Income) : It isthe money value of all final goods and services valued at current pricesproduced by normal residents of a country over a particular period of time.

q Real National Income or National Income at Constant Prices : It isalso called as real income. It is the money value of all final goods andservices valued at constant prices produced by normal residents of a country.

q Value of Output : Market value of all goods and services produced by anenterprise during an accounting year.

q Value added : It is the difference between value of output of a firm andvalue of inputs bought from the other firms during a particular period oftime.

q Double Counting : Counting the value of a commodity more than oncewhile estimating national income is called double counting.

q Ways to solve the problem of double counting.

(a) By taking the value of only final goods.

(b) By taking value added.

q National Disposable Income (NDI) : It is defined as net national productat Market price (NNPMP) plus net current transfer from rest of the world. NDI= NNPMP + Net current transfers from rest of the world.


OR

= National income + net indirect tax + net current transfers from the rest ofthe world.

q Gross National Disposable Income (Gross NDI)

= GNPMP + Net current Transfers from rest of the world.

q Net National Disposable Income (Net NDI)

= NNPMP + Net current Transfers from rest of the world.

OR

= Gross NDI – Depreciation.

q Concept of Value Added of One Sector or One Firm

1. Value output = Sales + Net Stock.

2. Gross Value added at market prices (GVAMP) = Value of output –Intermediate consumption

3. Net value added at market price (NVAMP) = GVAMP – Depreciation.

4. Net value added at factor cost (NVAFC) = NVAMP – Net indirect tax.

Note: By adding up NVAFC of all the sectors, we get NDPFC or Domestic Income.




5. When will be NDPMP be less than NDPFC?

6. State the meaning of consumption of fixed capital?

7. State the meaning of injection in income flow, with the help of an example.

8. What do you mean by leakage in income flow?

9. State whether the following are stock or flow :(i) Losses (ii) Capital(iii) Production (iv) Wealth

10. Define ‘Nominal GNP’

11. What do you mean by ‘Real GNP’?

12. Define stock variable.

13. Define capital goods.

H.O.T.S.

1. Which of the two NVAFC and NVAMP is equal to sum of factor income.

2. Why is money received from sale of shares is not included in domesticfactor income.

3. What aggregate do we get, when we add up the net value added of allproducing sectors of an economy?

4. How value added method solve the problem of double counting?

5. What is per capita real GDP.

6. Complete the following aggregates.

(i) National Income = Domestic income .......................

(ii) Personal Income = Private income .......................

(iii) Net value added at FC = Gross output .......................

SHORT ANSWER TYPE QUESTIONS (3 MARKS)

1. Distinguish between real and nominal gross domestic product.

2. Explain the basis of classifying goods into intermediate and final goods.Give suitable examples.


3. Distinguish between consumer goods and capital goods. Which of theseare final goods?

4. Explain how distribution of G.D.P. is its limitation as a measure of economicwelfare.

5. Explain the meaning of “Domestic Territory of a country”.

6. Distinguish between ‘factor income’ and ‘transfer income’.

7. Classify the following into stock and flow :

(i) Population of India (ii) Exports

(iii) Investment (iv) Expenditure on food by household.

(v) National Capital (vi) Deposits in saving account of bank.

8. Explain how distribution of Gross domestic product is a limitation in takingdomestic product as an Index of welfare.

9. How can externalities be a limitation of using gross domestic product as anindex of welfare.

10. Giving reasons, classify the following into intermediate and final goods :

(i) Machines purchased by a dealer of machines.

(ii) A car purchased by a house hold.

11. Distinguish between stock and flows. Give an example of each.

12. What is meant by a normal resident? State which of the followings aretreated as normal resident of India.

(i) An American working in the office of WHO located in India.

(ii) Indian working in U.S.A. embassy located in India.

13. Which of the following is factor income from abroad for an Indian residentand why?

(a) Interest income received by Indian resident on the bonds of companiesoperating in USA.

(b) Remittances by Indians settled abroad to their families in India.

q Giving reason explain how should the following be treated in estimatingnational income:

(i) Expenditure on fertilizers by a farmer

(ii) Purchase of tractor by a farmer.


H.O.T.S.

14. Explain why subsidies are added to and indirect taxes deducted fromdomestic product at market price to arrive at domestic product at factorcost.

15. Giving reasons, explain how are the following treated in estimating nationalIncome by the income method.

(a) Interest on a car loan paid by an individual

(b) Interest on a car loan paid by a Govt. owned company.

16. Why do we include the imputed value of goods but not services whileestimating production for self consumption?

17. Define operating surplus, write its components.

18. Distinguish between domestic product and national product. When candomestic product be more than National Product.

LONG ANSWER QUESTIONS (6 MARKS)

1. How will you treat the following while estimating national income of India.

(a) Dividend received by an Indian from his investment in shares of aforeign company.

(b) Money received by a family in India from relatives working abroad.

(c) Interest received on loan given to a friend for purchasing a car.

2. How will you treat the following while estimating national income of India?Give reason for your answer?

(a) Dividend received by a foreigner from investment in shares of anIndian Company.


(c) Interest received on loan given to a Friend for purchasing a car.

3. Explain the problem of double counting in estimating national income, withthe help of an example. Also explain two alternative ways of avoiding theproblem.


4. Distinguish between real gross domestic product and nominal gross domesticproduct. Can gross domestic product be used as an index of welfare of thepeople? Give two reasons.

5. How will you treat the following in estimating national income of India? Givereasons for your answer.

(a) Value of bonus shares received by share holders of a company.

(b) Fees received from students.

(c) Interest received on loan given to a foreign company in India.

6. Explain the steps of measuring national income by income method.

7. Giving reasons, categories following into transfer payment or factor payments.

(a) Financial help gives to flood victims

(b) Old age pension.

(c) Imputed rent.

8. Calculate private income :

Rs. (Crore)

(i) National interest 10

(ii) Personal disposable income 150

(iii) Corporate Profit Tax 25

(iv) Personal Taxes 50

(v) Retained earnings of private corporations 05

[Ans. : Rs. 230 crores]

10. Giving reasons explain whether the following are included in domestic productof India.

(i) Profit earned by a branch of foreign bank in India.

(ii) Payment of salaries to its staff by an embassy located in New Delhi.

(iii) Interest received by an Indian resident from firms abroad.


11. How will you treat the following while estimating national income. Give reasonsfor your answer.

(i) Capital gain on sale of house.

(ii) Prize won is lottery.

(iii) Interest on public debt.

12. While estimating national income. How will you treat the following. Givereason for your answer.

(i) Imputed rent of occupied house.

(ii) Interest received on debentures.

(iii) Financial help received by Flood victims.

NUMERICALS FOR PRACTICE

1. Calculate (i) gross domestic product at factor cost and (ii) net nationaldisposable income : 6

Rs. (in Crores)

(i) Net indirect tax 130

(ii) Government final consumption expenditure 100

(iii) Profit 90

(iv) Net domestic capital formation 120

(v) Change in stocks (–) 10

(vi) Private final consumption expenditure 500

(vii) Net imports 20

(viii) Net current transfers to abroad 10

(ix) Net factor income to abroad 30

(x) Gross domestic capital formation 160

2. From the following data calculate GNP at FC by (a) Income method


(b) Expenditure method.

Rs. (Crore)

(i) Net domestic capital formation 500

(ii) Compensation of employees 1850

(iii) Consumption of fixed capital 100

(iv) Govt. final consumption expenditure 1100

(v) PVT. final consumption expenditure 2600

(vi) Rent400

(vii) Dividend 200

(viii) Interest 500

(ix) Net Exports (—) 100

(x) Profits 1100

(xi) NFIA (—) 50

(xi) Net Indirect taxes 250

[Ans. : Rs. 3900 Crore]

3. There are only two producing sectors A and B in an economy. Calculate:

(a) Gross value added at market price by each sector

(b) National income.Rs. (Crore)

(i) Net factor income from Abroad. 20

(ii) Sales by A 1000

(iii) Sales by B 2000

(iv) Change in stock of B (–) 200

(v) Closing stock of A 50

(vi) Opening stock of A 100

(vii) Consumption of fixed capital by A and B 180

(viii) Indirect taxes paid by A and B 120

(ix) Purchase of raw material by A 500

(x) Purchase of raw material by B 600

(xi) Exports by B 70

[Ans. : Rs. 1370 Crore]


4. From the following data, calculate(a) Gross Domestic Product at Factor Cost (GDPFC) and(b) Factor income to abroad.

Rs. (Crore)

(i) Gross Domestic Capital formation 600

(ii) Interest 200

(iii) Gross national product at market price 2800

(iv) Rent300

(v) Compensation of employees 1600

(vi) Profit 400

(vii) Dividends 150

(viii) Factor income from abroad. 50

(ix) Change in stock 100

(x) Net indirect taxes 240

(xi) Net fixed capital formation 400

(xii) Net Export (–) 30

[Ans. : (a) GDPFC = 2600 Crores (b) FIPA = 90 Crores]

5. Calculate net national product at factor cost and gross national disposableincome from the following :

Rs. (Crore)

(i) Net current transfers to Row 10

(ii) Savings of non-departmental enterprises 60

(iii) Net indirect tax. 90

(iv) Income from property and entrepreneurship to the Govt.administrative departments 80

(v) Consumption of fixed capital 70

(vi) Personal Tax 100

(vii) Corporation tax 40

(viii) National debt interest 30

(ix) Current transfer payments by Govt. 50

(x) Retained Earnings of PVT. Corporate 10

(xi) Personal disposable income. 1100

[Ans. : (a) NNPFC = Rs. 1320 Crores (b) GNDI = 1470 Crores]


6. Calculate (a) Gross domestic product at market price (GDPMP) (b) Factorincome from abroad.

Rs. (Crore)

(i) Profit 500

(ii) Export 40

(iii) Compensation of Employees 1500

(iv) Net current transfer from Row 2800

(v) Rent90

(vi) Interest 300

(vii) Factor income to abroad 400

(viii) Net indirect tax 120

(ix) Gross fixed capital formation 250

(x) Net domestic capital formation 650

(xi) Gross fixed capital formation 700

(xii) Change in stock 50

[Ans. : GDPMP = 3050 Crores (b) FIRA = 120 Crores]

7. From the following data calculate (a) GDPMP and (b) Factor income fromabroad.

Rs. (Crore)

(i) Gross national product at factor cost 6150

(ii) Net export (–) 50

(iii) Compensation of Employees 3000

(iv) Rent800

(v) Interest 900

(vi) Profit 1300

(vii) Net Indirect tax 300

(viii) Net domestic capital formation 800

(ix) Gross fixed capital formation 850

(x) Change in stock 50

(xi) Dividend 300

(xi) Factor income to abroad. 80

[Ans. : GDPMP = 6400 Crores; FIFA = 130 Crores]


8. Calculate ‘Net National Disposable Income’ and ‘Personal Income’ from thefollowing data.

Rs. (Crore)

(i) Personal tax 212

(ii) Net national product at factor cost 2500

(iii) Net indirect tax 180

(iv) Domestic product accruing to Govt. 500

(v) Retained earnings of PVT. Corporations 80

(vi) NFIA23

(vii) National debt interest 100

(viii) Net current transfer from abroad 20

(ix) Corporation tax 70

(x) Current transfer from Government 30

[Ans. : NNDI = 2700 Crore; P.I. = 2000 Crore]

9. Find out (a) national income and (b) net national disposable income :

Rs. (Crore)

(i) Factor income from abroad 15

(ii) Private final consumption expenditure 600

(iii) Consumption of Fixed capital 50

(iv) Government final consumption expenditure 200

(v) Net current transfers to abroad (–) 5

(vi) Net domestic fixed capital formation 110

(vii) Net factor income to abroad 10

(viii) Net imports (–) 20

(ix) Net indirect tax 70

(x) Change in stocks (–) 10

[Ans. : N.I. - 840 Crore NNDI - 915 Crore]


10. From the following data show that net value added at factor cost (NVAFC)is equal to the sum of factor incomes.

Rs. (Crore)

(i) Purchase of raw material and other input fromthe domestic market 600

(ii) Increase in stock 200(iii) Domestic sales 1800(iv) Import of raw material 100(v) Exports 200(vi) Depreciation of fixed capital 75(vii) Salaries and wages 600(viii) Interest payments 450(ix) Rent75(x) Dividends 150(xi) Undistributed profits. 80(xi) Corporate profit tax 20(xii) Indirect tax 50

[Ans. : 1375 Crores]

11. From the following data calculate (a) Private income (b) Personal income(c) Personal disposable income.

Rs. (Crore)

(i) Income from property and entrepreneurship accruingto the Govt. administrative Dept. 100

(ii) Saving of non-departmental enterprises 80(iii) Factor income from NDP occurring to Private sector 500(iv) Corporation tax 30(v) Saving of Pvt. corporate sector 65(vi) Direct taxes paid by house hold 20(vii) Current transfers from Govt. Administrative departments 10(viii) Current transfer from Row 20(ix) Factor income from abroad 5(x) Operating surplus 150(xi) Factor income to abroad 15

[Ans. : (a) 520 Crore (b) 425 Crore (c) 405 Crore]


ANSWERS

1 Mark Questions

1. Net Export means the difference between export and imports.

Net export = Export – Imports

2. Current transfers are those transfers which are paid from current incomeand are added in current income of recipient.

3. Normal resident of a country is that person or institution whose centre ofeconomic interest lies in that country.

4. Economic territory means that geographical territory administrated by aGovt. within which persons, goods and capital circulates freely.

5. When subsidies are more than indirect taxes.

6. It decreases in the value of fixed capital due to normal wear and tear andforeseen obsolescence.

7. ‘Injection’ is that economic concept, which add to flow of income and goodse.g., investment, Exports.

8. “Leakage” is that economic concept, which has negative impact on flow ofincome.

9. (i) Flow (ii) Stock (iii) Flow (iv) Stock

10. It is the gross money value of National Product of current year valued atcurrent prices.

11. It is the gross money value of National product of current year valued atbase year price.

12. A variable whose value is measured at a point of time.

13. Goods used is producing other goods are called capital goods.

H.O.T.S.

1. NVAFC

2. It is the financial transactions and does not have any impact on production.

3. NDP.


4. By deducting intermediate consumption from value of output, the problemof double counting can be solved.

5. When per capita income is measured from real GDP (measured at constantprice) is called per capita real GDP.

6. (i) National income = Domestic Income + Net factor income from abroad.

(ii) Personal income = Private income – Corporate tax – Undistributedprofit.

(iii) Net value added at FC = Gross Output – Intermediate Consumption –Depreciation – Net Indirect Tax

HINTS

3-4 Marks Questions

7. (a) Stock (b) Flow

(c) Flow (d) Stock

(e) Stock (f) Stock

10. (a) Intermediate good because it is for resale

(b) final good because purchased by ultimate consumer.

15. (a) Not include as paid for consumption expd.

(b) Included as paid for production expd.

NUMERICAL QUESTIONS (6 MARKS)

1. (i) GDPFC :

VI + II – VII + X – I

500 + 100 – 20 + 160 – 130

760 – 150 = 610

(ii) NNDI

610 – (160 – 120) – 30 + 130 – 10

740 – 80 = 660


2. GNPFC

(a) Income Method :

= (ii) + (vi) + (viii) + (x) + (xi)

NNPFC = 1850 + 400 + 500 + 1100 + (– 50)

= 3800

GNPFC = 3800 + 100 = 3900 Crores

(b) Expd. Method = (i) + (iii) + (iv) + (v) + (ix) + (xi) – (xii)

500 + 100 + 1100 + 2600 + (– 100) + (– 50) – 250

= 3900 Crore

3. GVAMP of Sector A

1000 – 50 – 500 = 450

GVAMP of Sector B

2000 – 200 – 600 = 1200

Total 450 + 1200 = 1650

NNPFC = 1650 – 150 – 120 + 20 = 1370 Crores

4. GDPFC :

NDPFC = (v) + (ii) + (iv) + (vi)

= 1600 + 200 + 300 + 400

= 2500

GDPFC = NDPFC +CFC

CFC = GDCF – NDCF (NFCF + ∆S)

= 600 – (400 + 100) = 100

GDPFC = 2500 + 100 = 2600 Crore.

FIPA

GNPMP = GDPFC + NFIA + NIT

2800 = 2600 + NFIA + 240


NFIA = – 40

NFIA = FIFA – FIPA

– 40 = 50 – FIPA

FIPA = 50 + 40 = 90 Crores

5. NNPFC = (xi) + (vi) + (vii) + (x) – (viii) – (ix) + (i) + (ii) + (iv)

= 1100 +100 + 40 + 10 – 30 – 50 + 10 + 60 + 80

= 1320 Crores

GNDI = NNPFC + (iii) + (v) – (i)

= 1320 + 90 +70 – 10

= 1470 Crores

6. (a) GDPMP :

NDPFC = (iii) + (v) + (vi) + (vii)

= 1500 + 500 + 300 + 400

= 2700 Crores

GDPMP = NDPFC + CFC + NIT

CFC = (GFCF + S) – 650

= (700 + 50) – 650

= 100

NIT = 250

GDPMP = 2700 + 100 + 250

= 3050

(b) FIFA

GNPFC = GDPMP + NFIA – NIT

2800 = 3050 + NFIA – 250

NFIA = 0



0 = FIFA – 120

FIFA = 120 Crores

7. GDPMP :

NDPFC = (iii) + (iv) + (v) + (vi)

= 3000 + 800 +900 + 1300 = 6000

GDPMP = NDPFC + CFC + NIT

CFC = GDCF – NDCF

= (GFCF + s) – NDCF

= (850 + 50) – 800

= 100

NIT = 300

GDPMP = 6000 + 100 + 300 = 6400 Crores

FIFA :

GNPFC = GDPMP + NFIA – NIT

6150 = 6400 + NFIA – 300

NFIA = 50


50 = FIFA – 80

FIFA = 130

8. NNDI = (ii) + (iii) + (viii)

= 2500+ 180 + 20

= 2700

Pr. I = (ii) – (iv) + (vii) + (viii) + (x) – (ix) – (v)

= 2500 – 500 + 100 + 20 + 30 – 70 – 80

= 2000 Crores


9. N.I. = (ii) + (iv) + (vi + x) – (viii) – (ix) – (vii)

= 600 + 200 + 110 + (– 10) – (–20) – 70 – 10

= 930 – 90

= 840 Crores

NNDI = N.I + ix – v

= 840 + 70 – (–5)

= 915 Crore

10. NVAFC = (ii) + (iii) + (v) – (i) – (iv) – (vi) – (xiii)

= 200 +1800 + 200 – 600 – 100 – 75 – 50

= 1375 Crores

Sum of factor income = (vii) + (viii) + (ix) + (x) + (xi) + (xii)

= 600 + 450 + 75 + 150 + 80 + 20

= 1375

11. (a) PVT Income – Rs. 520 Crore

(b) P.I. – Rs. 425 Crore

(c) P.D.I. = Rs. 405 Crore


UNIT 7

MONEY AND BANKING

POINTS TO REMEMBER

q Money : Money may be defined as anything which is generally acceptableas a medium of exchange and does the function of ‘unit of account’ andmeasures of value.

q Barter Exchange : It is a system of exchange in which transactions aremade by exchange of goods.

q Difficulties involved in the Barter Exchange

1. Absence of a common unit.

2. The lack of double coincidence of wants

3. Lacks of any satisfactory units to engage in contracts involving futurepayments.

4. Does not provide for any method of storing generalised purchasingpower.

5. Lack of divisibility.

q Supply of Money : Total stock of money with the public at a given pointof time.

q Commercial Banks : Commercial Banks is a financial institution who acceptsdeposits from the general public and provide loans facilities.

q Central Banks : The central Bank is the apex institution of monetary andbanking system of country.



5. Custodian of foreign exchange.

6. Controller of money supply and credit.

MONEY CREATION CREDIT CREATION BYCOMMERCIAL BANKS

K =

1�

K = Credit Multiplier

R = Cash reserve ratio


1. Define money.

2. What is meant by M.

3. What is meant by the term money supply?

4. What is bank rate?

5. State two primary functions of money.

6. What is meant by credit creation?

7. What is credit multiplier?

8. Write two functions of central banks.

9. What is cash reserve ratio (CRR)?

10. What is statutory liquidity ratio (SLR)?

11. What is demand deposits by banks?

12. State two monetary measures of credit control by central bank.

13. What are various money stock measures?

H.O.T.S.

14. What is margin requirement of loans.



1. Explain the function of money as ‘Unit of value’.

2. How does money solve the problem of double coincidence of wants?

3. Explain ‘ Store of value’ function of money.

4. What are open market operations? What is their effect on availability ofcredit?

5. Explain the ‘lender of last resort’ function of central bank.

6. Distinguish between SLR and CRR. Explain the Role of SLR and CRR incredit control.

7. How does changes in Bank rate affect money creation by commercial Bank?Explain.

8. State the role of central Bank as a banker of the Government.

9. State any four functions of money.

10. Explain the ‘Standard of deferred payment’.

11. How central bank is controller of credit?

12. Explain how does followings helps to control the credit creation.

(i) Open market operation

(ii) Margin requirement of loans

H.O.T.S.

13. What is meant by statutory liquidity ratio (SLR). State the effect of rise inrate of SLR on creation of credit.

14. Explain ‘currency authority’ and ‘controller of credit’ functions of centralbank.

15. Explain effect of increase in bank rate on credit creation by commercialbanks.



1. Define Central Bank. What are the functions of Central Bank?

2. Explain any four functions of money.

3. How does a central bank influence credit creation by commercial banksthrough ‘open market operation’ explain.

4. Explain the process of credit creation or money creation by commercialbanks with the help of numerical example.

ANSWERS

1 MARK QUESTIONS

1. Any thing which is generally acceptable by the people as medium of exchange,measure of value, standard of deferred payment and performs the functionof store of value.

2. M1 = currency held with public + demand deposit in banks + other depositin RBI.

3. Total stock of money which are held by the public at a particular point oftime in an Economy.

4. Rate at which central bank lends to the commercial bank.

5. 1. Medium of Exchange

2. Measure of value

6. Credit creation means power to expand demand deposits of CommercialBanks.

7. Credit multiplier measures, number of times deposits are multiplied as credit.

Credit multiplier =

1LRR

8. (i) Currency Authority

(ii) Controller of money and credit


9. Commercial Banks are required under law to keep a certain percentage oftheir total deposit in the central banks in the form of cash reserves. Thisis called CRR.

10. Every Commercial Bank is required to keep a fixed percentage (ratio) of itsassets in liquid form, called SLR.

11. Demand deposits are deposits which can be withdrawn from bank at anytime by the account holder.

12. (i) Bank Rate policy.

(ii) Open market operation

13. Following four measures of money stock are used.

M1 = C + DD + OD

M2 = M1 + Saving deposit in Post Office Saving banks.

M3 = M1 + Net time deposit of banks

M4 = M3 + Total deposits with post office saving organisation (except NSC).

HOTS

14. Marginal requirement of loan means the difference in percentage betweenthe amount of the loan and market value of the security offered by theborrower against the loan.

HINTS

3-4 MARKS QUESTIONS

11. Quantitative measures and qualitative measures of monetary policy.

13. Increase in SLR reduces credit availability.


UNIT 8

DETERMINATIONS OF INCOME &EMPLOYMENT

POINTS TO REMEMBER

q Aggregate demand refers to total demand for goods and services in theeconomy. AD represents the total expenditure on goods and services in aneconomy.

q Main components of Aggregate demand are :

(i) Household consumption expenditure (C).

(ii) Investment expenditure (I).

(iii) Govt. consumption expenditure (G).

(iv) Net export (X – M).

In two sector economy AD = C + I.

q Aggregate supply is the total supply of goods and services in the economy.It is also the value of total output available is an economy during a givenperiod of time.

AS = C + S

q Aggregate supply represents the national income of the country.

AS = Y (National Income)

q Consumption function shows functional relationship between consumptionand Income.

C = F(Y)

where C = Consumption

Y = National Income

F = Functional relationship.


q Consumption function (propensity to consume) is of two types.

(a) Average propensity to consume (APC)

(b) Marginal propensity to consume (MPC)

q Average propensity to Consume (APC) : Average propensity to consumerefers to the ratio of consumption expenditure to the corresponding level ofincome.

APC =

Consumption(C)Income(Y)

Important Points about APC

(i) APC is more than 1 : as long as consumption is more than nationalincome before the break-even point, APC > 1.

(ii) APC = 1, at the break-even point, consumption is equal to nationalincome.

(iii) APC is less than 1 : beyond the break-even point. Consumption isless than national income.

(iv) APC falls with increase in income.

(v) APC can never be zero : because even at zero level of nationalincome, there is autonomous consumption.

q Marginal Propensity to Consume (MPC) : Marginal propensity to consumerefers to the ratio of change in consumption expenditure to change in totalincome.

MPC = Change in consumption C

Change in Income Y�

�

Important Points about MPC

(1) Value of MPC varies between O and 1 : If the entire additional income isconsumed, then ∆C = ∆Y, making MPC = 1. However, if entire additionalincome is saved, then ∆C = 0, making MPC = 0

q Saving function refers to the functional relationship between saving andnational income.

S = f (y)

where S = saving

Y = National Income

F = Functional relationship.


q Saving function (Propensity to Save) is of two types.

(i) Average Propensity to Save (APS)

(ii) Marginal propensity to Save (MPS)

q Average Propensity to Save (APS) : Average propensity to save refers tothe ratio of savings to the corresponding level of income.

APS = Savings(S)Income(Y)

q Important Point about APS

(1) APS can never be 1 or more than 1 : As saving can never be equalto or more than income.

(2) APS can be zero : At break even point C = Y, hence S = 0

(3) APS can be negative or less than 1 : At income levels which arelower than the break-even point, APS can be negative as there will bedissavings in the economy.

(4) APS rises with increase in income.

q Marginal Propensity to Save (MPS) : Marginal propensity to save refersto the ratio of change in savings to change in total income.

MPS =

Change in Savings CChange in Income Y

�

�

q MPS varies between 0 and 1

(i) MPS = 1 if the entire additional income is saved. In such a case,∆S = ∆Y.

(ii) MPS = 0 If the entire additional income is consumed. In such a case,∆S = 0

q Relationship between APC and APS

The sum of APC and APS is equal to one. It can be proved as under weknow :

Y = C + S

Dividing both sides by Y, we get

Y C S = = Y Y Y


CAPC =

Y1 = APC + APS S

APS = Y

�

APC + APS = 1

because income is either used for consumption or for saving.

q Relationship between MPC and MPS

The sum of MPC and MPS is equal to one. It can be proved as under :

We know

∆Y = ∆C + ∆S

Dividing both sides by ∆Y, we get

Y C S= +

Y Y Y∆ ∆ ∆∆ ∆ ∆

1 = MPC + MPS C S= MPC, = MPS

Y Y∆ ∆

∆ ∆ �

MPC + MPS = 1 because total increment in income is either used forconsumption or for saving.

q Investment refers to the expenditure incurred on creation of new capitalassets.

q The investment expenditure is classified under two heads :

(i) Induced investment (ii) Autonomous investment.

q Induced Investment : Induced investment refers to the investment whichdepends on the profit expectations and is directly influenced by incomelevel.

q Autonomous Investment : Autonomous investment refers to the investmentwhich is not affected by changes in the Level of income and is not inducedsolely by profit motive.

q Marginal Efficiency of Investment (MEI) : MEI refers to the expectedrate of return from an additional investment.

q Ex-Ante Savings : Ex-ante saving refers to amount of savings whichhousehold intended to save at different levels of income in the economy.


q Ex-Ante Investment : Ex-ante investments refers to amount of investmentwhich firm plan to invest at different level of income in the economy.

q Ex-Post Saving : Ex-post savings refer to the actual or realised savingsin an economy during a financial year.

q Ex-Post Investment : Ex-post investment refers to the actual or realisedinvestment in an economy during a financial year.

q Equilibrium level of income is determined only at the point where AD = ASor S = I. But it cannot always be at full employment level also as it can beat less than full employment.

q Full employment is a situation when all those who are able and willing towork at prevailing wage rate, get the opportunity to work.

q Voluntary unemployment is a situation where person is able to work but notwilling to work at prevailing wage rate.

q Involuntary unemployment is a situation where worker is able to willing towork at current wage rate but does not get work.

q Under employment is a situation where AD is less than required AS at fullemployment level.

q Investment multiplier (K) is the ratio of increase in income (∆Y) due tochange in investment ∆I.

YK =

I1 1

K = or K = 1–MPC MPS

∆∆

q Excess demand refers to the situations when aggregate demand is in excessof aggregate supply corresponding to full employment.

q Deficient demand refers to a situation when aggregate demand is short ofaggregate supply corresponding to full employment.

q Inflationary gap is the gap by which actual aggregate demand exceeds thelevel of aggregate demand required to establish full employment. It measuresthe amount of excess of aggregate demand.

q Deflationary gap is the gap by which actual aggregate demand is less thanthe level of aggregate demand required to establish full employment. Itmeasures the amount of deficiency of aggregate demand.


1 MARK QUESTIONS

1. Define aggregate demand.

2. Define aggregate supply.

3. What is meant by Ex-Post investment?

4. What is meant by average propensity to consume?

5. Define marginal propensity to consume.

6. What is autonomous consumption?

7. What is Ex-ante aggregate demand?

8. Can the value of APC be greater than one?

9. Can APC be ever zero?

10. What is the relationship between APC and APS?

11. If APS is 0.6, how much will be the APC?

12. What is meant by Ex-ante saving?

13. If MPC and MPS are equal, what is the value of the multiplier?

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

15. What can be the maximum value of multiplier?

16. Can average propensity to consume be negative?

17. What do you mean by investment multiplier?

18. What will be the impact of increase in cash reserve ratio on the aggregatedemand?

19. What is investment?

20. Why can the value of marginal propensity to consume not be greater thanone?

H.O.T.S.

21. What is the impact of deficient demand on production and employment?

22. Define inflationary gap.

23. Under which situation is consumption function represented by a straightline.


24. What is the impact of continuous increase in income on average propensityto consume?

25. How much additional income will be generated in an economy with additionalinvestment of Rs. 100 crore, when MPC = 1/2?


1. Define aggregate demand. State its components.

2. Distinguish between average propensity to consume and marginal propensityto consume with the help of numerical examples.

3. Savings and investment are always equal discuss.

4. What is meant by investment multiplier? Explain the relationship betweenMPC and K?

5. State briefly the effect of excess demand on output, employment and price.

6. Explain the concept of inflationary gap with the help of a diagram?

7. Explain the situation of deficient demand in an economy with the help of adiagram.

8. State briefly any three measures to control excess demand in an economy.

q Find consumption expenditure if – autonomous consumption = Rs. 100marginal propensity to consume = 0.70 national income = Rs. 1000

9. What is monetary policy? Explain the role of (i) Bank rate and (ii) Marginrequirements in influencing the availability of credit in an economy.

10. Give the meaning of excess demand? Explain any two fiscal measures tocurrent excess demand.

11. What is fiscal policy? What possible fiscal measures can be taken withrespect to deficient demand in an economy?

12. What do you mean by full employment equilibrium? Explain with the help ofdiagram.

13. Explain with the help of diagram the concept of under-employmentequilibrium.

14. Distinguish between induced investment and autonomous investment?

15. Explain the concept of consumption function.

16. Briefly explain the relationship between MPC and MPS.


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

(i) When marginal propensity to consume is zero, the value of investmentmultiplier will also be zero.

(ii) Value of average propensity to save can never be less than zero.

18. If national income is 50 crore and saving Rs. 5 crore, find out APC. Whenincome rises to Rs. 60 crore and saving to Rs. 9 crore. What will be theAPC and MPS.

19. An economy is in equilibrium. Its national income is Rs. 5000 and autonomousconsumption expenditure is Rs. 500. What is the total consumptionexpenditure if MPC is 0.7?


Level of Income Savings MPC APC APS

0 – (80) – – –

100 – 0.7 – –

200 – 0.7 – –

300 – 0.7 – –

400 – 0.7 – –

21. Given marginal propensity to save equal to 0.25, what will be the increasein national income if investment increases by Rs. 125 crore. Calculatemultiplier.

22. Find out equilibrium level of income, when S = –40 + 0.25 Y and investmentis Rs. 60.

23. Can an economy be is equilibrium when there is unemployment in theeconomy? Explain.

24. How does change in bank rate controls the situations of excess and deficientdemand?

25. Briefly explain with the help of diagram the relationship between savingsand income?


H.O.T.S.

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

27. What happens if AD > AS prior to the full employment level of output?

28. Find saving function when consumption function is given as :

C = 100 + 0.6Y.

29. In a two sector economy, the saving function is given as :S = –10 + 0.2Y

and investment function is expressed asI = –3 + 0.1Y.

Calculate the equilibrium level of income?

30. State whether the following statement are true or false. Give reasons foryour answer

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

(b) The value of average propensity to save can never be greater than 1.

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

(i) When marginal propensity to consume is zero, the value of investmentmultiplier will also be zero.

(ii) Value of average propensity to save can never be less than zero.

32. Find national income from the following : autonomous consumption = Rs.100 marginal propensity to consume = 0.80 investment = Rs. 50


1. Why must aggregate demand be equal to aggregate supply at the equilibriumlevel of income and output? Explain with the help of a diagram?

2. Explain the equilibrium level of income with the help of saving and investmentcurves. If saving exceed planned investment, what changes will bring aboutthe equality between them?

3. Explain the working of multiplier with the help of a numerical example.

4. When planned investment is more than planned savings, what will be itsimpact on income and employment. Explain with the help of diagram.


5. What do you mean by Fiscal Policy? How it helps in controlling excessdemand?

6. Can there be equilibrium in case of underemployment. Explain with the helpof a diagram?

7. How quantitative and qualitative instruments of Govt. monetary policy controlsdeficient demand?

8. Distinguish between inflationary gap and deflationary gap. Show deflationarygap on a diagram. Can this gap exist at equilibrium level of income? Explain.

9. In an economy S = –50 + 0.5Y is the saving function (where S = saving andY = national income) and investment expenditure is 7000. Calculate.

(i) Equilibrium level of national income

(ii) Consumption expenditure at equilibrium level of national income.

10. C = 100 + 0.75y is a consumption function where C = consumptionexpenditure and Y = national income and investment expenditure is 800.On the basis of this information calculate.

(i) Equilibrium level of national income.

(ii) Saving at equilibrium level of national income.

11. Given below is the consumption function in an economy.

C = 100 + 0.5Y

with the help of a numerical example show that in this economy, as incomeincrease APC will decrease.

HOTS (6 MARKS QUESTIONS)

12. Draw on a diagram a straight line saving line curve for an economy. Fromit derive the consumption curve, explaining the method of derivation. Showa point on the consumption curve at which APC is equal to 1.

13. How increase in investment will effect income level of an economy? Explainwith the help of an example and diagram.

14. Briefly explain the concept of under employment equilibrium with the helpof diagram. How increase in investment helps in achieving, full employmentequilibrium?

15. What is ‘deficient demand’ in macroeconomics? Explain the role of openmarket operations in correcting it.


16. Explain the step taken in derivation of the saving curve from the consumptioncurve use. Use diagram.

ANSWERS

1 MARK QUESTIONS

1. Aggregate demand refers to total demand for goods & services in aneconomy, measured in terms of total expenditure.

2. Aggregate supply is the money value of the final goods and services ornational product produced in an economy during one year.

3. Ex-post investment refers to the actual or realised investment in an economyduring a financial year.

4. Average propensity to consume is the ratios of consumption expenditure toincome.

APC = CY

5. Marginal propensity to consume is the ratio of change in consumption tochange in income.

MPS =

CY

∆∆

6. Autonomous consumption refers to minimum level of consumption, evenwhen income is zero.

7. Estimated demand of goods and service in an economy during a financialyear.

8. Yes, the value of APC > 1 before the break-even point is attained.

9. APC can never be equal to zero as consumption can never be zero at anylevel of income.

10. The sum of APC and APS is equal to one.

APC + APS = 1

11. APC = 1 – APS = 1 – 0.6 = 0.4

12. Exante-saving refers to amount of saving which household intended tosave at different level of income in an economy.


13. We know that

MPS + MPC = 1

MPS + MPC = 1 Give that MPS = MPC

MPS =

12

1 1K = =

MPS 1/2

K = 2

14. The minimum value of K = 1, when MPC = O

15. The maximum value of k = ∞ when MPC = 1

16. No, because consumption can never be zero even at zero level of income.

17. Investment multiplier measures the ratio of change in investment and changein income.

18. Aggregate demand will fall.

19. Investment is an addition to capital stock. It is also called capital formation.

20. It is because change in consumption cannot be greater than change inincome.

21. Production and employment will decrease due to shortage of aggregatedemand.

22. Inflationary gap refers the situation under which AD is excess than requiredAS at full employment equilibrium.

23. When marginal propensity to consume remains constant.

24. APC falls with continuous increase in income.

25.

1 1 1K = = = = 2

11 – MPC 0.51–2

and ∆Y = K . ∆I

= 2 x 100

= 200 Crore.


HINTS

3-4 MARKS QUESTIONS

18. (i) 200 Crore (ii) 400 Crore

19. (i) ∆I = 7000 Crore. (ii) ∆C = 6300 Crore.

20. APC = –, 1.5, 1.1, 0.96, 0.9APS = –, (–), .5, (–) 0.1, .033, .1S = –80, –50, –20, 10, 40

21. K = 4

∆Y = 4 x 125

= 500 Crore.

22. Rs. 400

29. Rs. 70

6 MARKS QUESTIONS

9. (i) National income (Y) = 14100

(ii) Consumption expenditure (C) = 7100

10. (i) Equilibrium National Income (Y) = 3600

(ii) Saving = 800


UNIT 9

GOVERNMENT BUDGET AND THEECONOMY

POINTS TO REMEMBER

q Budget is a financial statement showing the expected receipt and expenditureof Govt. for the coming fiscal or financial year.

q Main objectives of budget are :

(i) Reallocation of resources. (ii) Redistribution of income and wealth

(iii) Economic stability (iv) Management of public enterprises.

q There are two components of budget :

(a) Revenue budget (b) Capital budget

q Revenue Budget consists of revenue receipts of Govt. and expenditure metfrom such revenue.

q Capital budget consists of capital receipts and capital expenditure.


q Revenue Receipts :

(i) Neither creates liabilities for Govt.

(ii) Nor causes any reduction in assets.

q Capital Receipts :

(i) It creates liabilities or (ii) It reduces assets.

q Revenue Expenditure :

(i) Neither creates assets (ii) Nor reduces liabilities

q Capital Expenditure :

(i) It creates assets (ii) It reduces liabilities.

q Revenue Deficit : Total revenue expenditure > Total revenue receipts

q Revenue deficit when total revenue expenditure excess total revenuereceipts.

q Implications of Revenue Deficit are :

(i) It leads to repayment burden in future without investment.

(ii) It shows wasteful expenditures of Govt. on administration.

(iii) It increase the burden of taxes.

q Fiscal Deficit : Total expenditures > Total Receipts excluding borrowing.

q Fiscal deficit : When total expenditure exceeds total receipts excludingborrowing.

q Implications of Fiscal Deficits are :

(i) It leads to inflationary pressure.

(ii) A country has to face debt trap.

(iii) It reduces future growth and development.


q Primary Deficit : Fiscal deficit – Interest payments.

q Primary Deficit : By deducting Interest payment from fiscal deficit we getprimary deficit.

q Budgetary Deficit : Total Expenditure > Total Receipts.

q Budgetary Deficit : Total expenditure exceeds total receipts.


1. Define Budget.

2. What is meant by non-tax receipts?

3. What are revenue receipts?

4. What are capital receipts?

5. Give two examples of non-tax revenue receipts.

6. What are the two sources of capital receipts?

7. Define revenue deficit.

8. Define fiscal deficit.

9. Why is repayment of loan a capital expenditure?

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

11. What is a balanced budget.

12. Define capital expenditure.

13. In a Govt. Budget primary deficit is Rs. 25,000 Cr. and interest paymentsare Rs. 15,000 Cr. How much is the fiscal deficit?

14. Define a Tax.

15. What is Direct Tax

16. Define Primary Deficity

H.O.T.S.

17. What are Budget Receipts?

18. In a Govt. Budget, revenue deficit is Rs. 8,00,000 Cr. and borrowings areRs. 50,000 Cr. How much is the fiscal deficit?

19. What is disinvestment?

20. What does zero primary deficit mean?



1. Explain the allocation of resources objective of Govt. budget.

2. What is the difference between revenue budget and capital budget?

3. What is meant by revenue receipts? Explain the components of revenuereceipts of the Govt.

4. Distinguish between direct tax and indirect tax.

5. What do you mean by capital receipts? What are the main components ofthe capital receipts?

6. Give the meaning of revenue deficit and fiscal deficit. What problems canthe fiscal deficit create?

7. What is fiscal deficit? What are its implications?

8. Distinguish between revenue expenditure and capital expenditure with anexample of each.

9. Explain the “redistribution of income” objective of Govt. budget.

10. Explain the ‘Economic stability’ objective of Govt. budget.

HOTS (3-4 MARKS)

11. Under which situations deficit budget is beneficial for the economy.

12. Are fiscal deficits necessarily inflationary? Give reasons in support of yourview.

13. Discuss the issue of deficit reduction.

14. How can surplus budget be used during inflation.

15. Giving reasons, classify the following as direct and indirect taxes.

(i) Entertainment tax (ii) Corporation tax

(iii) Excise tax (iv) Capital gains tax.


16. From the following data about a government budget find (a) revenue deficit,

(b) fiscal deficit and (c) primary deficit.

(Rs. arab)

(i) Plan capital expenditure 120

(ii) Revenue expenditure 100

(iii) Non-plan capital expenditure 80

(iv) Revenue receipts 70

(v) Capital receipts net of borrowing 140

(vi) Interest payments 30

17. Distinguish between :

(i) Capital expenditure and Revenue expenditure

(ii) Fiscal deficit and Primary deficit.

18. Why the fiscal Deficit equal to borrowings.

ANSWERS

1 MARK QUESTIONS

1. Budget is a financial statement showing the estimated receipts and estimatedexpenditure of the Govt. for coming fiscal year.

2. All the revenue receipt of Govt. other than tax receipts.

3. Revenue receipts are those receipts which neither creates liabilities forGovt. nor cause any reduction in assets.

4. Capital receipts are those receipts which either creates a liability or leadsto reduction in assets.

5. Interest, Fee.

6. Borrowings, Recovery of loans.

7. When total revenue expenditure exceeds total revenue receipts.

8. When total expenditure exceeds total receipts excluding borrowing.


9. As it leads to reduction in liability.

10. As it leads to reduction in assets.

11. Balanced budget is that when estimated receipts are equal to estimatedexpenditure.

12. Capital expenditure is that which creates assets and which reduces liabilities.

13. Fiscal Deficit = Primary Deficit + Interest Payment

= 25,000 + 15,000

= 40,000 Crore.

14. Tax is a legally compulsory payment imposed by Govt.

15. It refer the tax whose primary and final burdon borne by the person onwhom it is imposed.

16. It is the difference of fiscal deficit and interest paid.

17. Estimated money receipt received by the Govt. from different sources infiscal year are called budgetary receipts.

18. Rs. 50,000 Crore.

19. Disinvestment refers to withdrawal of existing investment.

20. Zero primary deficit means that interest commitment on earlier loans havecompelled the Govt. to borrow.

HINTS

3-4 MARKS QUESTIONS

15. (i) Indirect tax

(ii) Direct tax

(iii) Indirect tax

(iv) Direct tax


UNIT 10

BALANCE OF PAYMENT

POINTS TO REMEMBER


q Balance of trade is the net difference of Import and export of all visibleitems between the normal residents of a country and rest of the world.

q Autonomous items are those items of balance of payment which are relatedto such transaction as are determined by the motive of profit maximisationand not to maintain equilibrium in balance of payments. These items aregenerally called ‘Above the Line items’ in balance of payment.

q Accommodating item refers to transactions that take place because of otheractivity in Balance of Payment. These transactions are meant to restore theBalance of Payment identity. These items are generally called ‘Below theLine items’.

q Foreign exchange rate refers to the rate at which one unit of currency ofa country can be exchanged for the number of units of currency of anothercountry.

SYSTEM OF EXCHANGE RATE

Fixed exchange rate Flexible exchange rate.

q The epitome of the fixed exchange rate system was the gold standard inwhich each participant country committed itself to convert freely its currencyinto gold at a Fixed Price.

q Merit of Fixed Exchange Rate

(i) Stability in exchange rate

(ii) Promotes capital movement and international trade.

(iii) No scope for speculation.

q Demerits of Fixed Exchange Rate

(i) Need to hold foreign exchange reserves.

(ii) No automatic adjustment in the ‘Balance of payments.’

(iii) Enhance dependence on external sources.

q In a system of flexible exchange rate (also known as floating exchangerates), the exchange rate is determined by the forces of market demandand supply of foreign exchange.


q The demand of foreign exchange have inverse relation with flexible exchangerate. If flexible exchange rate rise the demand of foreign exchange falls.Vice versa.

q Sources of Demand for Foreign Exchange

(a) To purchase goods and services from the rest of world.

(b) To purchase financial assets (i.e., to invest in bonds and equity shares)in a foreign country.

(c) To invest directly in shops, factories, buildings in foreign countries.

(d) To send gifts and grants to abroad.

(e) To speculate on the value of foreign currency.

(f) To undertake foreign tours.

q The supply of foreign exchange have positive relation with foreign exchangerate. If foreign exchange rate rise the supply of foreign exchange rate alsorise and vice versa.

q Sources of Supply of Foreign Exchange

(i) Direct purchase by foreigners in domestic market.

(ii) Direct investment by foreigners in domestic market.

(iii) Remittances by non-residents living abroad.

(iv) Flow of foreign exchange due to speculative purchases by N.R.I.

(v) Exports of goods and services.

q Merits of Flexible Exchange Rate

(i) No need to hold foreign exchange reserves

(ii) Leads to automatic adjustment in the ‘balance of payments’.

(iii) To increase the efficiency in the economy by achieving optimumresources allocation.

(iv) To remove obstacles in the transfer of capital and trade.

q Demerits of Flexible Exchange Rate

(i) Fluctuations in foreign exchange rate.

(ii) Encourages speculation.

(iii) Discourages international trade and investment.


q In currency depreciation, there is a fall in the value of domestic currencyin term of foreign currency. In currency appreciation, there is a rise in thevalue of domestic currency in term of foreign currency.

q In currency appreciation, there is a rise in the value of domestic currencyin terms of foreign currency.

q Equilibrium flexible exchange rate is determined at a level where demandfor and supply of foreign exchange are equal to each other.

q Managed floating system is a system in which the central bank allows theexchange rate to be determined by market forces but intervenes at timesto influence the rate.


1. What is meant by balance of trade?

2. Define balance of payment.

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

4. The balance of trade shows a deficit of Rs. 300 crs. and the value ofexports is Rs. 500 crs. What is the value of imports?

5. List two items included in the balance of trade account.

6. List two items of the capital accounts of balance of payment.

7. Give meaning of managed floating exchange rate.

8. What is meant by invisible items?

9. What is meant by unilateral transfer?

10. What is meant by Autonomous transactions?

11. Write the name of those economic transactions which are made by thegovernment to make equilibrium in balance of payment.

12. What do you mean by Fixed Exchange Rate?

13. Define Flexible Exchange rate?

14. State two merits of Flexible Exchange Rate.

15. State two demerits of Flexible Exchange Rate.

16. State two merits of fixed exchange rate.


17. State two demerits of fixed exchange rate.

18. What is the slope of demand curve of foreign exchange?

19. What is the slope of supply curve of Foreign Exchange?

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

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

22. Define Devaluation of Domestic Currency.

23. What is meant by Depreciation of Domestic Currency?

24. What is meant by Appreciation of Domestic Currency?

HOTS (1 MARK)

26. In which circumstances, the devaluation of currency will be in favour ofeconomy?

27. In which circumstances the appreciation of currency will be non favourablefor the economy?

28. Under which circumstances, the purchasing power of foreign currencyincreases in comparison to domestic currency?

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

30. Does BOP always remain balanced?


1. Write any three points of difference between BOT and BOP.

2. Distinguish between current account and capital account of BOP.

3. How can deficit in BOP be financed?

4. What are the components of the current account of the balance of paymentaccount.

5. Give difference between the autonomous and accommodating items includedin BOP.

6. Distinguish between autonomous and accommodating transaction in thebalance of payment account. Give an example each.


7. Give three reasons why people desire to have foreign exchange.

8. Give any three/four sources of supply of foreign exchange.

9. Explain the relationship between foreign exchange rate and demand for it.

10. Explain the relationship between foreign exchange rate and supply of foreignexchange.

11. Explain the terms ‘appreciation and depreciation of currency.’

12. Explain the merit and demerits of fixed exchange rate.

13. Explain the merits and demerits of flexible exchange rate.

14. How is flexible exchange rate determined in a free market economy? Explainwith the help of diagram.

15. Higher the foreign exchange rate, lower the demand fore foreign exchange.Explain why?

16. Lower the foreign exchange rate, higher the demand for foreign exchange.Explain why?

17. Explain the impact of Devaluation of domestic currency on the export andimports of an economy.

18. Give the meaning of fixed flexible and managed floating exchange rate.

19. Why the demand for foreign exchange falls when the foreign exchange raterise explain with the help of an example.

6 MARKS QUESTIONS

1. Explain the distinction between Autonomous and Accommodating transactionsin balance of payments. Also explain the concept of balance of payments‘defict’ in this context.

2. What is balance of payments accounts? Name three components each ofits current account and capital account.

3. How is balance of trade different from balance of payments? State the itemsnot included in balance of trade.


HOTS

20. What is the impact of appreciation of currency on the demand for foreignexchange?

21. What is the impact of appreciation of currency on the supply of foreignexchange?

22. What is the impact of depreciation of currency on the demand for foreignexchange?

23. What is the impact of depreciation of currency on the supply of foreignexchange?

24. Distinguish between devaluation and depreciation of domestic currency.

25. Giving reasons state whether the following statements are true or false :

(i) Excess of foreign exchange receipts over foreign exchange paymentson account of accommodating transactions equals deficit in the balanceof payments.

(ii) Export and import of machines are recorded in capital account of thebalance of payments account.

ANSWERS

1 MARK QUESTIONS

1. It is the difference between monetary value of exports and imports of materialgoods or visible items.

2. A balance of payment is a statement of double entry system of all economictransactions between residents of a country and the residents of foreigncountries during a given period of time.

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

4. 800 Crores.

5. Visible items Watch, Petrol, Electronic item.

6. (i) Direct Foreign Investment

(ii) Loans


7. Exchange rate influenced by the intervention of the central bank in theforeign exchange market.

8. Invisible items are all those type of services which are exported and imported.

9. These refers to one sided transfers from one country to other. These arenot trading transactions.

10. Autonomous transactions refer to international economic transactions inthe current and capital account that are undertaken for profit.

11. Accommodating items.

12. Fixed exchange rate is the rate which is officially fixed in terms of Gold orany other currency by the govt. or adjusted only frequently.

13. Flexible exchange rate is determined by demand for and supply of a givencurrency in foreign exchange market.

14. (i) No need to hold foreign exchange reserve.

(ii) Optimum resource allocation.

15. (i) Fluctuations in foreign exchange rate.

(ii) Encourages speculation.

16. (i) Stability in Exchange rate.

(ii) No scope for speculation.

17. (i) Need to hold foreign exchange reserves.

(ii) No automatic adjustment in the ‘Balance of Payments.’

18. Negative slope.

19. Positive slope.

20. Exports will increase because Indian goods have become cheaper forforeigners.

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

23. Devaluations means to reduce parity rate of its currency with respect ofgold or any other currency by the Government.

24. When the value of domestic currency reduce with respect to other currencyby the demand and supply forces of foreign exchange in a free exchangemarket.


25. Appreciation of currency refer when the value of foreign currency reducewith respect to domestic currency. It occurs in a free exchange market bythe forces of demand and supply of currency.

1 MARK HOTS QUESTIONS

26. When economy adopt the policy of Export Promotions.

27. When we adopt the policy of Import Substitution.

28. Capital account records capital transfer such as loans and investmentbetween one country and the rest of the world which causes a change inthe asset or liability status of the residents of a country or its government.

29. With the help of international loans.

30. Always in equilibruim in the sense of accounting.


SAMPLE QUESTION PAPER – SET I

ECONOMICS

Time : 3 Hours Maximum Marks : 100

General Instructions :

(i) All questions in both the sections are compulsory.

(ii) Marks for questions are indicated against each.

(iii) Question Nos. 1–5 and 17–21 are very short-answer questions carrying 1mark each. They are required to be answered in one sentence each.

(iv) Question Nos. 6-10 and 22-26 are short-answer questions carrying 3 markseach.

(v) Question Nos. 11-13 and 27-29 are also short-answer questions carrying4 marks each. Answer to them should not normally exceed 70 words each.

(vi) Question Nos. 14-16 and 30-32 are long-answer questions carrying 6 markseach. Answer to them should not normally exceed 100 words each.

(vii) Answer should be brief and to the point and the above word limit beadhered to as far as possible.

SECTION – A

1. Give one example each of microeconomics and macroeconomics.

2. When is the demand of a commodity said to be inelastic?

3. Define production function.

4. What causes a downward movement along a supply curve?

5. Define monopoly.

6. Why does an economic problem arise? Explain.

OR

Explain the problem of ‘What to produce’.

7. Distinguish between a normal good and an inferior good. Give example ineach case.


8. How is the price elasticity of demand of a commodity affected by the numberof its substitutes? Explain.

9. Explain the effect of rise in input prices on supply of a commodity.

10. Why is a firm under perfect compititon a price-taker? Explain.

11. Define marginal cost. State the relation between marginal cost and averagecost.

OR

Define revenue. State the relation between marginal revenue and averagerevenue.

12. Commodities X and Y have equal price elasticity of supply. The supply ofX rises from 400 units to 500 units due to a 20 percent rise in its price.Calculate the percentage fall in supply of Y if its price falls by 8 percent.

13. Explain the meaning and the conditions of producer’s equilibrium (undermarginal revenue & marginal cost approach)

14. Explain the conditions of consumer’s equilibrium in case of (i) singlecommodity and (ii) two commodities. Use utility approach.

15. Giving reasons, state whether the following statement are true or false:

(i) When there are diminishing returns to a factor, total product alwaysdecreases.

(ii) Total product will increase only when marginal product increases.

(iii) When marginal revenue is zero, average revenue will be constant.

16. Explain the implications of the following features of perfect competition.

(i) Homogeneous products

(ii) Freedom of entry and exit to firms.

OR

Market for a good is in equilibrium. Suppose supply decreases. Givingreasons,explain its effect on equilibrium price and quantity. Use diagram.


SECTION – B

17. Why is repayment of loan a capital expenditure?

18. Define bank rate.

19. Give meaning of foreign exchange.

20. Define involuntary unemployment.


22. State three objectives of a governement budget.

OR

Give meanings of revenue deficit, fiscal deficit and primary deficit.

23. Explain the circular flow of income.

24. Where is inverse relation between foreign exchange rate and demand forforeign exchange. Why? Explain.

25. List the items of the current amount of balance of payments account. Alsodefine ‘balance of trade’.

26. Explain “bankers’ bank and supervisor” function of central bank.

27. Distinguish between.

(i) Revenue receipts and capital receipts

(ii) Direct tax and indirect tax

28. There is increase in investment of Rs. 100 Crore in an economy. Marginalpropensity to consume is 1. What can you say about total increase inincome? Calculate.

29. Explain process of credit creation by commercial bank.

OR

State the four function of money. Explain anyone of them.

30. Explain the concept of ‘excess demand’ in macroeconomics. Also explainthe role of open market operation in correcting it.

OR

Explain the concept of ‘deficient demand’ in macroeconomics. Also explainthe role of Bank Rate in correcting it.


31. How will you treat the following while estimating domestic factor income ofIndia? Give reasons for your answer.

(i) Remittances from non-resident Indians to their families in India.

(ii) Rent paid by the embassy of Japan in India to a resident Indian.

(iii) Profits earned by branches of foreign bank in India.

32. There are only two producing sectors A and B in on economy. Calculate :

(I) Gross value added at market price by each sector.

(II) National Income (Rs. Crore)

(i) Net factor income from abroad 20

(ii) Sales by A 1000

(iii) Sales by B 2000

(iv) Change in stock of B (–) 200

(v) Closing stock of A 50

(vi) Opening stock of A 100

(vii) Consumption of fixed capital by A & B 180

(viii) Indirect taxes paid by A & B 120

(ix) Purchases of raw materials etc. by A 500

(x) Purchases of raw materials etc. by B 600

(xi) Exports by B 70


SET – II SECTION – A

1. How does change in technology affect the possibilities of production.

2. Give meaning of change in quantity supplied.

3. Define implicit cost.

4. Why the demand of the commodity which have alternative uses, is moreelastic?

5. What is meant by market equilibrium?

6. Giving example distinguish between total fixced cost and total variable cost.

OR

Explain the relation between average fixed cost, average variable cost andaverage total cost.

7. When the price of a commodity falls by Rs. 4 per unit its quantity demandedrise by 20 units. Its price elasticity of demand is (–1). Calculate. its quantitydemanded at the price before change which was Rs. 20 per unit.

8. Why is the demand curve of a firm indeterminate in a oligopoly market?

9. How is a production possibility curve affected when resaurces are inefficientlyemployed in an economy? Explain.

10. Explain the relation of total revenue and marginal revenue, when a firm cansold more units of a good by lowering the price.

11. Explain the geometric method of measuring price elasticity of demand.

12. Explain how a fall in price of the related good affects the demand for thegiven good. Give example.

13. Explain any two causes of rightward shift of supply curve.

OR

What is a supply schedule? Explain how does change in technology ofproducing a good affect the supply of that good.

14. Giving reason, explain the behaviour of total product under the law ofvariable proporation. Use numerical example.


15. Explain the conditions of consumers equilibrium in case of two goods. Useindifference curve approach.

16. Market for a good is in equilibrium. Explain the chain effects of increase insupply of the good on the equilibrium us diagram.

OR

Distinguish between monopoly and monoplistic competition on the basis offollowing features.

(i) Price determination

(ii) Entry and exit of a firm in the market

(iii) Elasticity of demand of the good.

Section – B

17. Define demand deposits.

18. What is meant by autonomous transactions in the balance of payments?

19. What is capital goods?

20. Define nominal GDP.

21. What is statutory liquidity ratio?

22. Define the capital account of balance of payment.

23. Explain the relation of marginal propensity to consume and multiplier.

24. An economy is in equilibrium its national income is Rs. 10,000 andautonomous consumption expenditure is Rs. 1,000. What is the totalconsumption expenditure if marginal propensity to consume is 0.7?

25. Why does the supply fo foreign currency fall when its price falls? Explain.

OR

Why does the demand of foreign currency fall when its price rises? Explain.

26. Explain how is the unequal distribution a limitation of taking gross domesticproduct as an index of welfare.

27. What is meant by fiscal deficit in goverernment budget. State the implicationsof fiscal deficit.

ORExplain the “price stability” objective of a government budget.


28. Giving reason categorise the following as revenue expenditure and capitalexpenditure.

(i) Free supply of book by the government to students studying in schools.

(ii) Expenditure by the government for the establishment of printing press.

29. Giving reason explain the treatment assigned to the following while estimatingnational income.

(i) Contribution by employers to provident fund.

(ii) Petrol expenditure provided by the company to employee.

30. Explain the role of the following in correcting excess demand in an economy

(i) Government Tax

(ii) Cash Reserve RatioOR

Explain the role of the following in correcting deficient demand in an economy.

(i) Open market operations.

(ii) Margin requirement

31. How do commercial bank creats money? Explain with the help of numericexample.

32. From the following information calculate.

(A) Gross domestic product at factor cost

(B) Net National disposable income (Rs. Crore)

(i) Net indirect tax 260

(ii) Government final consumption expenditure 200

(iii) Profits 180

(iv) Net domestic capital formation 240

(v) Change in stocks (–) 20

(vi) Private final consumption expenditure 1,000

(vii) Net imports 40

(viii) Net current transfer to abroad 20

(ix) Net factor income to abroad 60

(x) Gross domestic capital formation 320


SET-IIISECTION – A

1. Define microeconomics. 1

2. What is the behaviour of average fixed cost as output increases 1

3. What is Individual demand ? 1

4. What is a price maker firm? 1

5. What is the behaviour of average revenue in perfect competitionmarket? 1

6. Explain the properties of production possibility curve.

7. Give the relation between marginal cost and average variable cost with thehelp of diagram.

8. Explain the implication of large number of sellers in a perfectly competitivemarket.

ORExplain the features of an oligopoly market. 3

9. What are implicit and explicit cost exlain with the help of examples.

10. Explain condition of consumer’s equilibrium in case of single good.

11. Define an indifference map. Explain why an indifference curve to the rightshows higher utility level. 4

12. When price of a good is Rs. 7 per unit, a consumer buys 12 units. Whenprice falls to Rs. 6 per unit he spends Rs. 72 on the good. Calculate priceelasticity of demand by using the percentage method. Comment on thelikely shape of demand curve based on this measure of elasticity. 4

13. Explain how changes in prices of other products influence the supply of agiven product

OR

What does the law of variable proportions show ? State the behaviour oftotal product according to this law. When more of variable inputs areemployed. 4

14. Explain the conditions of producer’s equilibrium in terms of marginal costand marginal revenue? Use a schedule. 6


15. Explain how do the following influence demand for a good.

(i) Rise in prices of the related goods

(ii) Fall in income of the consumer. 6

16. Define equilibrium price. Show the effect of an increase in supply of acommodity on its equilibrium price, demand remaining unchanged. 6

OR

Market for a good is in equilibrium. There is simultaneous ‘decrease’ bothin demand and supply of the good. Explain its effect on market price.


SECTION – B

17. Define ‘flow’ variable. 1

18. What are intermediate goods? 1

19. What are demand deposits? 1

20. Define indirect tax. 1

21. Give the meaning of managed floating exchange rate. 1

22. Calculate net value added at factor cost :

(i) Output sold (units) = 200

(ii) Price per unit of output (Rs.) = 10

(iii) Closing stock (Rs.) = 100

(iv) Opening stock (Rs.) = 150

(v) Consumption of fixed capital (Rs.) = 600

(vi) Import duty (Rs.) = 400

(vii) Intermediate cost (Rs.) = 10,000

(viii) Subsidy (Rs.) = 500

(Ans : Rs. 9450)

23. Distinguish between revenue expenditure and capital expenditure in agovernment budget. Give examples. 3

OR

Explain the ‘Price Stability” objective of a government budget. 3

24. Explain the ‘Banker to the Government’ function of the Central Bank. 3

25. Distinguish between consumption function equation and saving functionequation. 3

26. Find ‘investment’ from the following auto nomous consumption = Rs. 100

National Income = Rs. 500

Marginal propensity to consume = 0.75

(Ans. Rs. 25)


27. Giving reason explain how should the following be treated in estimatingnational income:

(i) Interest paid by banks on deposits by individuals.

(ii) National debt interest. 4

28. Explain any two functions of money. 4

OR

Explain the components of legal reserve ratio. 4

29. Explain ‘revenue deficit’ in a Government budget. What does it indicate? 4

30. Explain the concept of “excess demand” in macroeconomics. Also explainthe role of Bank Rate in correcting it. 6

OR

Explain the concept of “deficient demand” in macroeconomics. Also explainthe role of “open market operation” in correcting it. 6

31. What is balance of payments account? name three components each of itscurrent account and capital account. 6

32. Find out (a) Gross national product at market price and (b) Net currenttransfers from abroad. (4+2) = 6

(Rs. Crore)

(i) Net Indirect Tax 35


(iii) Net national disposable income 750

(iv) Closing stock 10

(v) Govt. final consumption expenditure 150

(vi) Net domestic fixed capital formation 100

(vii) Net factor income to abroad (–) 15

(viii) Net imports 20

(ix) Opening stock 10

(x) Consumption of fixed capital 50

(a) 795 crore (b) Rs. 5 crore


EXAM. ORIENTED QUESTIONS WITH ANSWERS

UNIT 1

INTRODUCTION

3 -4 MARKS QUESTIONS

Q.1 Why is a production possibilities curve concave? Explain.

Ans. The production possibility curve being concave means that MRTincreases as we move downward along the curve. MRT increasesbecause it is assumed that no resource is equally efficient in productionof all goods. As resources are transferred from one good to another,less & less efficient resources have to be employed. This raises costand raises MRT.

Q. 2 Explain properties of a production possibilities curve.

Ans. There are two properties of a production possibilities curve.

1 Downward sloping : It is because as more quantity of one goodis produced some quantity of the other good must be sacrificed.

2. Concave to the origin : It is because the marginal rate oftransformation increases as more of one good is produced.

Q. 3 Explain the problem of ‘what to produce’.

Ans. An economy can produce different possible combinations of goods &services with given reasources. The problem is that, out of thesedifferent combinations, which combination is produced. If production ofone good increases then less resources will be available for othergoods.

Q. 4 What is ‘Merginal Rate of transformation’? Explain with the help of anexample.

Ans. MRT is the rate at which the units of one good have to be sacrificedto produce one more unit of the other good in a two goods economy.


Suppose an economy produces only two goods X and Y. Furthersuppose that by employing these resources fully and officiently, theeconomy produces 1X + 10Y. If the economy decides to produce 2X,it has to cut down production of Y by 2 units. Then 2Y is the opportunitycost of producing 1X. Then 2Y:1X is the MRT.

Q. 5 Explain the problem ‘How to produce’.

Ans. Broadly, there are two techniques of production.

(i) Labour intensive Technique : Under this technique, productiondepends more on the use of labour.

(ii) Capital Intensive Technique : Under this technique, productiondepends more on the use of machines (called capital) efficienttechnique of production is that which uses minimum possibleinputs for a given amount of output. So that, cost per unit ofoutput is minimised.


CONSUMER BEHAVIOUR AND DEMAND

UNIT 2

3 - 4 MARKS QUESTIONS

Q.1 Distinguish between ‘increase in demand’ and ‘increase in quantitydemanded’ of a commodity.

Ans. When demand increases at given price then it is called ‘increase indemand’. On the other hand, when demand increases by decrease inthe price of a commodity then it is called increase in quantity demand.

Q. 2 Given price of a good, how does a consumer decide as to how muchof that good to buy?

Ans. Consumer purchases upto the point where marginal utility is equal tothe price (MU=P). So long as marginal utility is greater than price, hekeeps on purchasing. As he makes purchases MU falls and at aparticular quantity of the good MU becomes equal to price. Consumerpurchases upto this point.

Q. 3 A consumer consumers only two goods X and Y. State & explain theconditions of consumer’s equilibrium with the help of utility analysis.

Ans. There are two conditions of consumer equilibrium :

(i)X Y

X Y

MU MU =

P P

OR

X X

Y Y

MU P =

MU P

Explanation :

If,

X Y

X Y

MU MU

P P

the consumer is not in equilibrium because he

can raise his total utility by buying less of Y and more of X.


Similarly if X Y

X Y

MU MU

P P the consumer is not in equilibrium as

he can raise his total utility by buying less of X and more of Y.

(ii) MU falls as consumption increases : If MU does not fall asconsumption increases the consumer will end up buying onlygood which is unrealistic or consumer will never reach theequilibrium position.

Q. 4 Explain how the demand for a good is affected by the price of its relatedgoods. Give examples.

Ans. Related goods are either substitutes or complementary

Substitutes Goods : When price of a substitude falls, it becomescheaper than the given good. So the consumer substitutes it for givengood will decrease.

Similarly, a rise in the price of substitute will result in increase in thedemand for given good.

For example Tea and Coffee.

Complementary Goods : When the price of a complementary goodfalls its demand rises and the demand for the given good will increase.

Similarly when price of complementary good increases, then demandfor given good decreases.

For example : – Car & Petrol.

Q. 5 Distinguish between normal goods and inferior goods. Give examplealso.

Ans. Normal Goods : These are the goods the demand for which increasesas income of the buyer rises. There is a positive relationship betweenincome and demand or income effect is positive.

Example ; Rice, Wheat

Inferior Goods : These are the goods the demand for whichdecreases as income of buyer rises. Thus, there is negativerelationship between income and demand or income effect is negative.

Example : coarse grain, coarse cloth.


Q. 6 Explain any four factors that affect price elasticity of demand.

Ans. 1. Nature of Commodity : Necessories like Salt, Kerosene oil etc.have inelastic demand and luxuries have elastic demand.

2. Availability of substitutes : Demand for goods which have closesubstitudes is relatively more elastic and goods without closesubstitutes have less elastic demand.

3. Different uses : Commodities that can be put to different useshave elastic demand for instance electricity has different uses.

4. Habit of the consumer : Goods to which consumers becomehabitual will have inelastic demand.

Examples – Liquor and Cigarette.

Q. 7 Explain relationship between total utility and marginal utility with the helpof a schedule.

Ans. Quantity (Units) Total utility Marginal utility0 0 –

1 8 8

2 14 6

3 18 4

4 20 2

5 20 0

6 18 – 2

(1) As long as MU is positive, TU increases.

(2) When marginal utility is equal to zero then total utility is maximum.

(3) When marginal util[ity is negative; Total utility starts diminishing.

Q. 8 Define marginal utility. State the law of diminishing merginal utility.

Ans. Marginal Utility : It is addition more to the total utility as consumptionis increased by one more unit of the commodity.

Law of Diminishing Merginal utility : It states that as consumerconsumes more and more units of a commodity, the utility derived fromeach successive unit goes on decreasing. According to this law TUincreases at decreasing rate and MU decreases.


6 MARKS QUESTIONS

Q.1 Explain the three properties of indifference curves.

Ans. Three properties of indifference curves are as follow.

1. Slopes downward from left to right : To consume more of onegood the consumer must give up some quantity of the other goodso that total utility remains the same.

2. Convex towards the origin : MRS declines continuously dueto the operation of the law of diminishing marginal utility.

3. Higher indifference curves represents higher utility :Higher indifference curve represent large bundle of goods. Whichmeans more utility because of monotoric preference.

Q. 2 Explain the conditions of consumer’s equilibrium using indifferencecurve analysis. Use diagram.

Ans. There are two conditions for consumer’s equilibrium.

(i) MRS = X

Y

PP

(ii) MRS is continuously falling.ExplanationSuppose there are two goods X and Y. the first condition of

consumer’s equilibrium is MRS =

X

Y

PP

If MRS

X

Y

PP

. It means consumer values X more than what market

values & willing to give more price than market price he willpurchase more of X this cause fall in MRS and it will continue

upto that when MRS = X

Y

PP

If MRS

X

Y

PP

. It means consumer values X less than what market

values. Consumer is willing to give less price as market price &


he will purchase less of X, by this MRS will increase and it will

continue till MRS = X

Y

PP

(ii) Unless the MRS is continuously falling the equality between the

MRS and

X

Y

PP

will not be achieved.

Consumer is in equilibrium at point E.


PRODUCER BEHAVOUR AND SUPPLY

UNIT III


Q. 1 Explain the likely behaviour of total product under the stage ofincreasing return to a factor with the help of numerical example.

Ans. Increasing return to a factor is the first phase of the Law of return toa factor. When more and more units of a variable factor is combinedwith fixed factor up to a certain level total physical product increaseswith increasing rate.

Machine Units of labour Total physical product

1 1 10

1 2 24

1 3 42

Q. 2 With the help of example distinguish between total fixed cost and totalvariable cost.

Ans. Total fixed cost Total variable cost

1. Fixed cost remains constant 1. variable cost changes with theat each level of output ie change in quantity. It increaseit do not change with or decrease as the outputchange in quantity. change.

2. It can not be zero when 2. it is zero when output is zerooutput is zero.

3. Its curve is parallel to 3. Its curve is parallel to theX-aixs curve of total cost.

4. Example :- Rent, wages 4. Example :- cost of raw material,of permanent staff. wages of casual labour.


Q. 3 Draw average cost, average variable cost and marginal cost curves ona single diagram and explain their relations.

Ans.

Relation of AC, AVC and MC

1. MC interects to AC and AVC at their minimum level

2. AC and AVC decreases before the interection by MC, but remaingreater than MC.

3. AC and AVC starts to increase after the itersection by MC, andbecomes less than MC.

4. As output increases, AC and AVC tends to be closer but thedifference between AC and AVC can naver be zero.

Q. 4 Draw average cost, average variable cost and average fixed costcurves on a single diagram and explain their relation.

1. AC is the vertical summation of AVC and AFC

2. The difference between AC and AVC falls as output increases but


the difference of AC and AFC increases.

3. As output increases AC and AVC tends to be closer but theircurves do not interect each other because AFC always remainsmore than zero.

Q.5 Explain the relation between average revenue and marginal revenuewhen a firm can sell an additional unit or a good by lowering the price.

Ans. 1. AR and MR both decreases.

2. MR decrease at the rate of twice than AR.

3. MR become zero and negative but AR can never be zero.

Q. 6 Distingush between change in quantity supplied and change in supply.

Ans. Change in quantity supplied change in supply

1. It refers the change in 1. It refer’s the change in supplysupply due to change in due to the change in theprice of the good determinents of supply other

than price

2. Determinents of supply 2. Price of the good remainsother than price remains unchanged.unchanged

3. Law of supply apply 3. Law of supply does not apply.

4. There is upward and 4. supply curve shifted to leftwarddownward movement along or rightward under thiswith supply curve in this condition.situation.

Q. 7 Explain how does change in price of input affect the supply of a good.

Ans. Increase in price of input :

increase in price of input is cause of a decrease in the supply of agood because the production cost of a good will increase due toincrease in price of input. It will reduced the profit. So producer willdecrease the supply of the good.

Decrease in price of Input :

Decrease in price of input is a cause of increase in supply becausewhen the price of input decrease the production cost of a good alsoalso decreases. Decrease in cost increases the profit margin. Itmotivate to producer to increase the supply of the good.


Q. 8 Explain how changes in prices of other products influence the supplyof a given product.

Ans. The supply of a good is inversly influenced with the change in priceof other product which can explain as fallows.A. Rise in price of other product :–

When there is rise in the price of other product the productionof these product become more profitable due to unchanged costin comparison of the production of given produce. As a result theproducer will produce more quantity of other product so thesupply of given good will decrease.

B. Fall in the price of other product :–When there is fall in the price of other product the productionof these product become less profitable due to unchanged costin comparison of the production of given product. As a resultproducer will produce less quantity of other product so the factorsof production shifted for the production of given good. It causean increase in supply of given good.

Q. 9 Explain how technological advancement influence the supply of a givenproduct.

Ans. Technological advancement brings a positive impact in the supply ofa given product. It reduces per unit cost and increase the productivityof given factors of production. Due to these reasons production ofgiven product becomes more profitable.

Q. 1 Explain the law of variable proporation with the help of diagram/schedule.

ORWhat is the likely behaviour of total product/marginal product when onlyone input is increased for increasing production? Use diagram/schedule.

Ans. Law of variable proportion state the inpact of change in unit of avariable factor on the physical output. When more and more unit ofa variable factor combined with fixed factor physical product passesthough following phases.

Behaviour of TP(i) TP increases at an increasing rate(ii) TP increases at diminishing rate(iii) TP falls


Behaviour of MP

(i) MP increases and becomes maximum.

(ii) MP decreases and becomes zero.

(iii) MP becomes negative.

Machine unit of labour TPP MPP1 1 3 31 2 7 41 3 12 51 4 16 41 5 19 31 6 21 21 7 22 11 8 22 01 9 21 – 1


First Phase :–

TPP increases with increasing rate upto A point. MPP also increase andbecomes maximum of point C.

Second Phase :–

TPP increases with diminishing rate and it is maximum on point B. MPPstart to decline and becomes zero at D point.

Third Phase :–

TPP starts to decline and MPP becomes negative.

– Important instruction for giving the answer of above question.

– Do not use diagram for the explaination of this question if it isinstructed to use schedule and do not use schedule if theexplaination of this question asked with the help of diagram.

– Do not explain the behaviour of marginal product with the helpof schedule and diagram. If there is instruction to explain only thebehaviour of total product.

– Do not explain the behaviour of total product with help ofschedule and diagram if there is instruction to explain only thebehaviour of marginal product.

Q. 2 What is producer’s equilibrium? Explain the conditions of produce’sequilibrium through the ‘marginal cast and marginal revenue’ approach.use diagram/schedule.

Ans. Producer’s equilibrium refer’s the stage under which with the help ofgiven factor’s of production producer attain that level of production ofwhich he is getting maximum profit. The conditions of producer’sequilibrium through the marginal cost and marginal revenue approachare as follows.

1. Marginal cost should be equal to marginal revenue.

2. With the increase in output after equilibrium marginal cost shouldbe greater than marginal revenue.


Output MR MC1 4 52 4 43 4 34 4 45 4 5

OR

Output MR MC1 10 52 8 43 6 34 4 45 2 5


Explanation of conditions :–

(i) So long as MC is less than MR, it is profitable for the producerto go on producing more because it adds to its profits. He stopsproducing more when MC becomes equal to MR.

(ii) When MC is greater than MR after equilibrium if means the profitwill decline if producer will produce more units of the good.

Important instruction for giving the answer of the above question

– Use only one schedule/diagram given as above for theexplaination.

– Do not use diagram for the explaination of this question if it isinstructed to use schedule and do not use schedule if theexplaination of this question is asked with the help of diagram.


FORMS OF MARKET AND PRICE DETERMINATION

UNIT IV


Q.1 Explain the implication of large number of buyers in a perfectlycompetetive market.

Ans. The implication is that no single buyer is in a position to influence themarket price on its own because an individual buyer’s purchase formsa negligible proportion of the total purchase of the good in the market.

Q. 2 Explain why are firms mutually interdependent in an oligopoly market.

Ans. Firms are mutually interdependent because an individual firms takesdecision about price and output after considering the possible reactionsby the rival firms.

Q. 3 Explain the inplication of ‘freedom of entry and exit to the firms’ underperfect competition.

Ans. The firms enter the industry when they firnd that the existing firms areearning super normal profits. Their entry raises output of the industry,brings down the market price and thus reduce profits. The entrycontinues till profits are reduced to normal (or zero) The firms startleaving the industry when they are facing losses. This reduces outputof the industry, raises market price and reduces losses. The exitcontinues till the losses are wiped out.

Q. 4 Explain the implication of ‘perfect knowledge about market’ underperfect competition.

Ans. Perfect knowledge means that both buyers and sellers are fullyinformed about the market price. Therefore no firm is in a position tocharge a different price and no buyer will pay a higher price. As a resulta uniform price prevails in the market.

Q. 5 Why is the demand curve more elastic under monopolistic competitionthan under monopoly.


Ans. The elasticity of demand is high when the product has close substitutesand that elasticity of demand tends to be low when the product doesnot have close substitutes as we know in monopolistic competition thereis large number of close substitutes while in monopoly there is no closesubstitutes hence the demand curve under monopolistic competition ismore elastic than under monopoly.

Q. 6 Why is a firm under perfect competition a price taken while undermonopoly a price maker? Explain in brief.

Ans. A firm under perfect competition a price taker by the following reasons:

1. Number of firms : The number of firms under perfectcompetition is so large that no individual firm by changing sale,can cause any meaningful change in the total market supply.Hence, market price remains unaffected.

2. Homogenuous product : All firms in a perfectly competitiveindustry produce homogeneous product. Hence, price remainssame.

3. Perfect knwledge : All the buyers and sellers have perfectknowledge about market price so no firm charge a different pricethan market price. Hence a uniform price prevails in the market.

A firm under monopoly a price maker by the following reasons :

1. A monopolist is a single seller of the product in the market. Henceit has full control over supply

2. There are no close substitutes of the monopoly product, hencethe demand is less elastic or ‘inelastic.

3. There are legal, technical and natural barriers to the entry of newfirms so that there is no fear of increase in market supply.

Q. 7 Differentiate between price discrimination and product differentiation.

Ans. Price discrimination : Price discrimination is a situation when amonopolist charges different price from different buyers of the sameproduct. This is generally done to maximise profits.

Product Differentiation : Product differentitation is a situation whendifferent producers under monopolistic competition, try to differentiatetheir product in terms of its shape, size, packaging, trade mark or brandname. This is done to attract buyers from the rival firms in the market.


Q. 8 Distinguish between perfect competition and monopoly.

Ans. Perfect competition Monopoly

1. Large numer of buyers 1. One seller & largeand sellers no. of buyers.

2. Products are 2. There is no close substituteshomogeneous of goods.

3. Free entry & exit 3. Barriers to entry

4. There is no control 4. There is full control overover price market price.

Q. 9 Differentiate between monopoly & monopolistic competition.

Ans. Monopoly Monopolistic competition

1. Single seller & large 1. Large number of buyersno. of buyers. and sellers.

2. No. close substitutes 2. There is productof products. differentiation.

3. Barriers to entry 3. Free entry and exit.

4. Selling cost is zero. 4. Heavy selling costs areincurred.

Q. 10 What is oligopoly? State its main properties/features.

Ans. Oligopoly : It is a form of the market in which there are a few big sellersof a commodity and a large number of buyers. There is a high degreeof interdependence among the sellers regarding their price & outputpolicy.

Following are some principal features of oligopoly :

1. A few firms

2. High degree of interdependence.

3. Non-price competition.

4. Entry barriers.

5. Formation of cartels.


6 MARKS QUESTIONS

Q.1 Distinguish between collusive and non-collusive oligopoly. Explain howthe oligopoly firms are interdependent in taking price and outputdecisions.

Ans. Collusive oligopoly is one in which the firms cooperate with each otherin deciding price and output where as, non-collusive oligopoly is onein which the firms compete with each other.

The firms are interdependent because each firm takes intoconsideration the likely reactions of its rival firms when deciding itsoutput and price policy.

It makes a firm dependent on other firms. The firm may have toreconsider the change in the light of the likely reactions.

Q. 2 Market for a good is in equilibrium. There is an ‘increase’ in demandfor this good. Explain the chain of effects of this change. Use diagram.

– Increase in demand shifts the demand curve from D1 to D2 tothe right leading to excess demand E1 F at the given price OP1.

– Since the consumers will not be able to buy all they want to buyat this price, there will be competition among buyers leading rise


in price.

– As price rises, demand starts falling (along D2) and supply startsrising (along S) as shows by arrows in the diagram.

– This change continue till D and S are equal at E2.

– The quantity rises to OQ and price to OP2.

Q. 3 Market for a good is in equilibrium. There is simultaneous ‘decrease’both in demand and supply of the good. Explain its effect on marketprice.

Ans. There are three possibilities :

1. If the relative (percentage) decrease in demand is greater thanthe decrease in supply, price will fall. The price will fall becauseof excess supply in the market.

2. If the relative (percentage) decrease in demand is less than thedecrease in supply price will rise.

The price will rise because of excess demand in the market.

3. If the relative (percentage) decrease in demand is equal to thedecrease in supply price will remain unchanged

The price will remain unchanged because there is neither excessdemand nor excess supply in the market.

Q.4 Explain why the equilibrium price of commodity is determined at thatlevel of output at which its demand equals its supply.

Ans. Suppose demand is greater than supply. Since the buyers will not beable to buy all what they want, there will be competition among thebuyers. It will have on upward influence on the price. As a reasultdemand will start falling and supply rising. It will go on till demand isequal to supply again.

It demand is less than supply. Since the sellers will not able to sell allwhat they want, there will be competition among the sellers. It will havea downward influence on the price. As a reasult demand will start risingand supply falling. It will go on till demand is equal to supply again.

Hence, the equilibrium price of a commodity is determined at that levelof output at which its demand equals its supply.


UNIT VI


NATIONAL INCOME AND RELATED AGGREGATES

1 Mark Questions with Answer

1. Define stock variable.

Ans. A variable whose value is measured at a point of time.

2. Define capital goods.

Ans. Goods used is producing other goods are called capital goods.

3. What is nominal gross domestic product ?

Ans. When GDP of a given year is estimated on the basis of price of thesame year, it is called nominal GDP.

4. Define flow variables.

Ans. Any variable whose magnitude is measured over a period of time iscalled a glow variable.

5. Define ‘real’ gross domestic product.

Ans. When GDP of a given year is estimated on the basis of base yearprices it is called real gross domestic product.

6. Define capital formation.

Ans. Increase in the stock of capital in the given period is called capitalformation


3/4 Marks Questions with Answers

1. Calculate gross value added of factor cost :

(i) Units of output gold (units) 1000

(ii) Price per unit of output (Rs.) 30

(iii) Depreciation (Rs.) 1000

(iv) Intermediate cost (Rs.) 12000

(v) Closing stock (Rs.) 3000

(vi) Opening stockf (Rs.) 2000

(vii) Exise (Rs.) 2500

(viii) Sales Tax 3500

Ans. GVAFC = (ixii) + v – vi – iv – vii – viii

= (1000X30) + 3000 – 2000 – 12000 – 2500 – 35000 = Rs. 13000

2. Calculate Net Value added at factor cost :

(i) Consumption of Fixed capital (Rs.) 600

(ii) Import duty (Rs.) 400

(iii) Output sold (units) 2000

(iv) Price per unit of output (Rs.) 10

(v) Net change in stock (Rs.) (–) 50

(vi) Intermediate cost (Rs.) 10000

(vii) Subsidy (Rs.) 500

Ans. NVA FC = (iii x iv) + v – vi – ii + vii – i

= (2000x10) + (–50) – 10000 – 400 + 500 – 600

= Rs. 9450

3. Find Net Value added at market price :

(i) Output sold (units) 800

(ii) Price per unit of output (Rs.) 20

(iii) Excise (Rs.) 1600


(iv) Import duty (Rs.) 400

(v) Net change in stock (Rs.) (–) 500

(vi) Defniciation (Rs.) 1000

(vii) Intermediate cost (Rs.) 8000

Ans. NVAmp = (i x ii) + v – vii – vi

= (800x20) + (–500) – 8000 – 1000

= Rs. 6500

4. Giving reasons classify the following into intermediate products andfinal products

(i) Furniture purchased by a school.

(ii) Chalk, duster, etc, purchsed by a school.

Ans. (i) It is final product because it is purchased for final investment.

(ii) These are intermediate products because these are taken to beused up completely during the same year.

5. Giving reasons, explain the treatment assigned to the following whichestimating national income.

(i) Family members working free on the farm owned by the family.

(ii) Payment of interest on borrowings by general government.

Ans. (i) Imputed salaries of these members will be included in nationalincome.

(ii) It will not be included in national income because it is non-factorpayment as general government borrows only for consumptionpurpose.

6. Giving reasons, explain the treatment assigned to the following whichestimating national income.

(i) Payment of income tax by a firm

(ii) Festival gifts to employes.

Ans. (i) Not included, as it is transfer payment from firm to government.

(ii) Not included, as it is transfer payment.


7. Explain the basis of classifying goods into intermediate and final goods.Give suitable examples.

Ans. Goods which are purchased by a production unit from other productionunits and meant for resale or for usingup completely during the sameyear are called intermediate goods for example : raw material.

Goods which are purchased for consumption and investment are calledfinal goods for example : Purchase of machinery for instalation infactory.

8. Giving reason classify the following into intermediate and final goods.

(i) Machine purchased by a dealer of machine.

(ii) A car purchased by a house hold.

Ans. (i) It is an intermediate good because it is meant for resale in themarket.

(ii) It is a final good because it is meant for final consumption.

9. How will you treat the following in estimating rational income of India?Give reasons for your answer.

(i) Value of bonus shares received by shareholders of a company.

(ii) Interest received on loan given to a foreign company in India.

Ans. (i) It is not included in national income because it is the return offinancial capital and not of the goods & services.

(ii) It is included in the national income as interest is a factor incomeand a part of domestic income.

6 Mark Questions

1. How will you treat the following which estimating national income ofIndia? Give reasons.

(a) Divident received by an Indian from his investment in shares ofa foreign company.


(c) Interest received on loans given to a friend for purchasing a car.

(d) Dividend received by a foreigner from investment in shares of anIndian company.

(e) Profit earned by a branch of an Indian bank in Canada.


(f) Scholarship given to Indian students studying in India by a foreigncompany.

(g) Fees received from students.

(h) Profits earned by branch of a foreign bank.

(i) Interest paid by an individual on a loan taken to buy a car.

(j) Expenditure on machines for installation in a factory.

(k) Profit earned by a branch of foreign bank in India.

(l) Payment of salaries to its staff by an embassy located in NewDelhi.

(m) Interest received by an Indian resident from firms abroad.

(n) Salaries received by Indians working in branches of foreign banksin India

(o) Profits earned by an Indian bank from its branches abroad.

(p) Rent paid by embassy of Japan in India to an Indian resident.

(q) Imputed rent of self occupied house

(r) Interest received on debentures

(s) Financial help received for flood victims.

2. How will you treat the following which estimating domestic factor incomeof India? Give reasons.

(i) Remittances from non-resident Indian to their families in India

(ii) Rent paid by the embassy of Japan in India to a resident Indian.

(iii) Profit earned by branches of foreign bank in India.

(iv) Payment of salaries to its staff by embassay located in India.

(v) Interest received by an Indian resident from firms abroad.

3. Are the following part of a country’s net domestic product at marketprice? Explain

(a) Net indirect tax

(b) Net export

(c) NFIA

(d) Consumption of fixed capital


Ans. (a) It is factor income from abroad so will be included in nationalincome.

(b) It is transfer receipts, so it is not included in national income.

(c) Not included in national income, because it is a non-factor receiptas loan is not used for production for consumption

(d) Included as it is a factor income to abroad.

(e) It is a part of NFIA and will be included in national income.

(f) It is transfer receipts, so it is not included in national income.

(g) It is included in national income becuase it is a part of the privatefinal consumption expenditure of the house hold.

(h) Included in national income because it is part of domestic factorincome of India.

(i) Not included because it is a non-factor income as loan is not usedfor production but for onsumption.

(j) Included because it results in flow of income throught productiveactivities

(k) Included, because it is a part of domestic product of India.

(l) Not included because it is not a part of domestic product of India

(m) Included as it is the part of NFIA.

(n) Included because it is earned in domestic territory of India.

(o) Included because it is aprt of NFIA

(p) Included as it is paid to an Indian resident out side the domesticterritory of a country. It will be included in NFIA.

(q) Included as a part of rent as it is payment to self for housingservices.

(r) Included because it is a factor earning

(s) Not included as it is a transfer payment.

Ans. 2 (i) Not included as it is a transfer payment

(ii) Not included because Japanese embassy in India does not fallwith in the domestic territory of India.


(iii) Included because it falls with in the domestic territory of India

(iv) Not included as an embassy located in India is not fall with in thedomestic territory of India

(v) Not included in domestic product but it is the part of NFIA.

Ans. 3 (a) Yes, because market price = factor cost + Net Indirect tax

(b) Yes, because NDPMP includes net exports

(c) No, because domestic means it excludes NFIA

(d) No, net means consumption of fixed capital is excluded.


MONEY AND BANKING

UNIT VII


Q.1 Explain the significance of the ‘Store of Value’ function of money.OR

State the importance of the ‘Store of Value function of money.

Ans. People save a part of their earnings for use in future. But in what form?Money fulfills this need of the people. Money as a store of value meansthat money is an asset and can be stored for use in future one canhold one’s earnings until the time one wants to spend it. This is thestore of value function of Money.

Q.2 Explain the ‘Unit of Account’ function of money?

Ans. The ‘Unit of Account’ function of money is also called the ‘measure ofvalue’ function. Money as a unit of account means a standard unit forquoting prices. It makes money a powerful medium of comparing pricesof goods and serives.

Q.3 Explain the ‘Medium of Exchange’ function of money?

Ans. Money as a medium of exchange means money as a means of paymentfor exchange of goods and services. Goods and services areexchanged for money when people sell things. Money is exchanged forgoods and services when people buy things. The medium of exchangefunction of money solves the problem of double coincidence of wantsinherent in the barter system of trade.

Q.4 Explain the “Lender of Last Resort’ function of the central bank.

Ans. Central bank also lends money directly to commercial banks. Insteadof rediscounting, central bank given loans against the bill of exchangepromissory notes, treasury bills, government securities, etc. The directlending to commercial bank is referred to as the ‘lender of the lastresort’ function of central bank.


Q.5 Explain the “Government’s Bank” function of a central bank.

Ans. A central bank conducts the banking account of governmentdepartments. It performs the same banking functions for thegovernment as commercial bank performs for its customers. It acceptstheir deposits and undertakes inter-bank transfers. It also gives loansto the government. A central bank also provides various services asagent of the government. It manages public debt. It also gives adviceto the government regarding money market, capital market, governmentloans and economic policy matters.

6 - Marks Questions with Answers

Q.1 What do you mean by credit/money creation? Explain the process ofmoeny creation by the commercial banks with the help of a numericalexample.

Ans. Money creation is a process in which a commercial bank creates totaldeposits many times the initial deposits.

The capacity of commercial bank to create depends on two factors:

1. Amount of initial fresh deposit

2. Legal reserve ratio LRR

Money multiplier =

1LRR

Money Creation = Initial Deposit ×Money multiplier

The Working :

Suppose (i) Initial Deposit = Rs. 1000 (ii) LRR = 20%

As required, the bank keeps 20% ie Rs. 200 as cash reserve and lendthe remaining Rs. 800. Those who borrow use the money for makingpayments. As assumed those who receive these payments put themoney back into their bank accounts. This creates a fresh deposit ofRs. 800. The bank again keep 20% ie Rs. 160 and lend Rs. 640. Inthis way the money goes on multiplying leading to total money creationof Rs. 5000.

Money creation = Initial Deposit ×

1LRR

= 1000 ×

10 .2


UNIT VIII

DETERMINATION OF INCOMEAND EMPLOYMENT

1 - Mark Questions with Answers

1. Give the meaning of ex-ante savings.

Ans. : Ex-ante savings are the planned savings or expected savings

2. Give the meaning of deflationary Gap.

Ans. It is the gap between excess of aggregate supply over aggregate demandat full employment level.

3. What is Ex-ante aggregate demand?

Ans. It is planned or desired aggregate demand.

4. Give the meaning of Inflationary Gap.

Ans. It refers to the amount by which the actual aggregate demand exceedsthe level of aggregate demand required to establish the full employmentequilibruim.

5. What is meant by ex-ante investment?

Ans. : It is planned or desired investment during a particular period.


Ans. Aggregte demand is defined as the money value of total goods andservices demanded by an economy during a given period.

7. What is propensity to consume?

Ans. Which shows the level of consumption at different levels of income inan economy.

8. Define marginal propensity to consume.


Ans. It is defined as measure of the rate at which aggregate consumptionexpenditure Changes as national income changes.

MPC= C/Y

9. What is involuntry unemployment?

Ans . When people who are willing to work at the giving wage rate do not getwork.

10. What is meant by excess demand in macro economics?

Ans. In macro economics, when aggregate demand is more than aggregatesupply at full employment level, then there is excess demand.

11. 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 investmentmultiplier

12. Give the meaning of aggregate supply?

Ans. Aggregate supply is the money value of total supply of goods and servicesavailable for purchase by an economy during a given period.

13. Can the value of APS be negative?

Ans. Yes, when there are dissavings.

14. Write the relation ship between MPS and multiplier?

Ans. K=1/1-MPC = 1/MPS or inverse relationship between MPS and the sizeof the mulitiplier

3/4 - Marks Questions with Answers

1. In an economy the MPC is 0.75. Investment expenditure in the economyincrease by Rs.75 crore. Calculate total increase in national income.

Ans. : K=∆Y/∆I = 1/1-MPC

∆Y= ∆Ix1/1-MPC

= 75x1/1-0.75

= 300 Crore

2. 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

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

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

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

(3) When MPC>MPS, the value of investment multiplier will be greaterthan 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 qreater 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 greaterthan 0.8

or

(4) True, since MPS = ∆S/∆Y if ∆S = 0 than MPS can at the most bezero.

(5) True because K = 1/1-MPC = 1/1-0=1

(6) True, because APC + APS = 1

4. Explain the distinction between voluntary and involuntry employment.

Ans. Voluntary unemployment is that part of the working force not willing toengage itself is gainful occupation. Involuntary unemployment is thatpart of labour force which is willing and able to work at the prevailingwage rate but is out of work.

5. 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 onconsumption, higher will be value of investment multiplier. Higher theproportion of increased income spend on consumption, higher will bevalue of investment multipler.

6 - Marks Questions

1. Explain the role of the following in correcting deficient demand in anEconomy.

(1) Open market operation

(2) Bank rate

Ans : (1) Open market operation refer to the sale and purchase of securitiesby the Central Bank incase of deficient demand when AD fallingshort of AS at full employment, the Central Bank buys securitiesin the open market and makes payment to the sellers. The moneyflows out of the central bank and reaches the commercial bankas deposits. This raises the lending capacity of the banks, peoplecan borrow more. This will raise AD.

(2) Incase of deficient demand central bank decrease the bank ratewhich the central bank charges on the loan given to commercialbank. This forces the commercial banks to reduce lending rate.Since borrowing become cheaper and people borrow more.Arises.

2. Explain the role of the following in correcting 'Excess demand in anEconomy'

(1) Bank Rate

(2) Open market

Ans : (1) To Correct excess demand central bank can rise the bank rate.This forces commercial bank to increase lending rates. Thisreduces demand for borrowing by the public for investment andconsumption. Aggregate demand falls.

(2) When there is excess demand Central Bank sells securities. Thisleads to flow of money out of the commerical banks to the centralbank when people make payment by cheques. This reducesdeposits with the banks leading to decline in their lending capacity.Borrowing decline. AD declines.


3. Explain the role of following in correcting the deflationary gap in aneconomy.

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 economicactivities in the economy like, building of roads, bridges, canal etc.This will raise the level of exployment. It will in turn increase theincome and the purchasing power. Thus aggregate demand willrise.

2) During deficient demand, central bank reduces the CRR. The resultof reducing CRR will be seen in the surplus cash reserves withthe banks which can be offered for credit. The bank’s credit bankreduces SLR, this will have expansionary effect on the creditposition of the banks leading to increase in thier leading capacityborrowing increases & AD increases.

4. Explain the role of margin requirements for correcting the deflationarygap.

Ans. : Deflationary gap refers to a situation when at full employment level ofincome AD falls short of AS. It is called deficient demand.

Margin requirements refers to the margin on the security provided bythe borrower. When margin is lower, the borrowing capacity of the barroveris higher. When central bank lowers the margin the borrowing capacityof the borrowers increase. This raise AD.

5. 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 expd.

Ans. : MPC = 75% = 75/100 =3/4

MPS = 1-3/4 = 1/4 K=4

(1) ∆Y = ∆I x K= 1000 x 4= 4000 Crore


(2) ∆Y = ∆C + ∆I

∆C = ∆Y - ∆I

= 4000-1000

= Rs. 3000 Crore

6. In an economy the equilibruim level of income is Rs.1200 Crore.

MPC : MPS = 3:1

∆I = ?

Ans. New equilibruim income = Rs. 20000 Crore

=20000-12000=8000 Crore

K= 1/MPS = 1/0.25 = 4

∆I = ∆Y/K = 8000/4

= Rs.2000 Crore


GOVT. BUDGET AND THE ECONOMY

UNIT IX

Q.1 Explain the ‘redistribution of income’ objective of a government budget.OR

Explain how the government budget can help in a fair distribution ofincome in the economy.

Ans. Budgetary policies are useful medium to reduce inequalities of incomefor the fair distribution of income. government can use tax policy andpublic expenditure as a tool. govt can reduce the disposable incomeand wealth of Rich by imposing heavy tax and can spend more onproviding free services to the poor. It raise the disposable incomewelfare of the poor.

Q. 2 Explain the “Reallocation of resources” objective of a governmentbudget.

Ans. Through its Budgetary policy the government directs the allocation ofresources in a manner such that there is a balance between the goalor of profit maximisation and social welfare. Government can providesubsidy and reduction in tax rate to motivate investment into areaswhere private sector initiative is not coming. Production of goods whichare injurious to social life is discouraged through heavy taxation.

Q. 3 Distingush between revenue receipts and capital receipts with the helpof example.

Ans. Revenue receipts Capital Receipts

1. These receipts do not 1. These receipts create liabilitycreate any liability for for the govt.the govt.

2. These receipts do not 2. These receipts cause acause any reduction in reduction in assets of the govt.assets

3. Example :– Tax receipts 3. Example:– Loan by govt.disinvestment.


Q. 4 Distingush between revenue expenditure and capital expenditurewith the help of example.

Ans. Revenue Expenditure Capital Expenditure

1. These expenditure do 1. These expenditure are causesnot cause increase in increase in govt. assetsgovt. assets

2. These expenditure do not 2. These expenditure are causescause any reduction in reduction in govt. liabilitygovt. liability

3. Example:– transfer payment 3. Example:– Repayment of loanby govt. by govt.

Q. 5 Distingush between direct and indirect tax

Ans. Direct Tax Indirect Tax

1. Direct tax is a tax whose 1. The liability to pay andliability to pay and incidence incidence of indirect tax dolie on the same person not lie on the same person

2. Its incidence can not be 2. Its incidence can be shiftedshifted to some other to some other personperson

3. Example :– income tax 3. Production tax

Q. 6 What is meant by fiscal deficit. Write its implications.

Ans. Fiscal deficit is equal to excess of total expenditure over the sum ofrevenue receipts and capital receipts excluding borrowings. ie. Fiscaldeficit means borrowing of the government.

Fiscal Deficit :– Total expenditure – Total receipts net of borrowings

Implication of Fiscal deficit

1. It increase the supply of money in the economy

2. it increase financial burden for future generation.

3. it is cause of inflation.


UNIT X

BALANCE OF PAYMENT

1. Define foreign exchange rate.

Ans. : Foreign exchange rate is the price of a foreign currency in terms ofdemestic currency

2. What is foreign exchange?

Ans. Any currency other than the domestic currency.

3. What is balance of payment Accounts?

Ans. : It is a systematic record of all economic transactions between theresidents of a country and the rest of the world in a given period (oneyear) of time

4. State two sources of supply of foreign exchange.

Ans. : Exports and foreign tourism.

5. State two sources of demand of foreign exchange.

Ans. : Import of goods & services and to get education in abroad.

6. What does a deficit in balance of trade indicate.

Ans. Deficit in balance of trade indicates that the imports of good are qreaterthan the exports.

7. What is fixed exchange rate?

Ans. When rate of exchange is fixed by the Government in an economy.

8. Define flexible exchange rate

Ans. : The rate of exchange in terms of other currencies are determind bymarket forces of demand and supply.

9. Define managed floating exchange rate.


Ans. It is a system in which the central bank or Government allow theexchange rate to determined by market forces but they take decisionsto intervene whenever they feel it appropriate.

10. State the components of capital account of balance of payment.

Ans. 1. Borrowing and lending to and from abroad.

2. Investment to and from abroad.

3. Change in foreign exchange reserves

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

Ans. : Exports of goods and imports of goods determines BOT. When the valueof exports of goods is greater than the value of imports of goods.

12. What are the components of current account of the BOP account?

Ans. (1) Exports and imports of goods

(2) Exports and imports of services

(3) Unilateral transfers

13. Explain the meaning of deficit in BOP

Ans. When autonomous foreign exchange payments exceeds autonomousforeign exchange receipts, the difference is called balance of paymentsdeficit.

14. Distinguish between devaluation and depriciation of domestic currency

Ans. When Government or authorities reduce the price of domestic currencyin terms of all foreign currencies is called devaluation.

The fall in market price of domestic currency (due to demand supply inthe market) in terms of a foreign currency is called depreciation.

15. When price of a foreign currency rises its supply also rises. explainwhy?

Ans. If exchange rate increases, this will make domestic country's goodscheaper to foreigners. The demand for our exports will rise. It impliesmore supply of foreign exchange.

HOTS (Higher Order Thinking skills)

1

1. An agriculturist increased his capital and labourby 20% in the cultivation of his land. But he foundthat the amount of production raised increased by15% only. (He had actually not employed any im-proved technology.) Point out which law does ac-count for the phenomenon?The Law of Diminishing Returns

2. �Increasing and decreasing returns to scale respec-tively imply downward and upward sloping por-tion of the long run average cost curve�. Defendor refute.Like the short run average cost curve, the long runaverage cost curve (LAC) and marginal cost curves(LMC) are �U� shaped. The LMC curve cuts the LACcurve at its minimum point. The reason behind the�U� shape of LAC is the pattern of the returns to scale.Increasing returns to scale means that if output is in-creased at a given rate (say 10%), inputs need to beincreased only by less than proportionately (say 7%).This implies that average cost must fall as output ex-pands. Similarly decreasing returns to scale imply thatthe average cost must rise with output. Finally, if re-turns to scale are constant, the average cost is con-stant independent of output.Increasing returns to scale Þ LAC decreases with

(IRS) outputConstant returns to scale Þ LAC does not change

(CRS) with output

Decreasing returns to scale Þ LAC increases with

(DRS) output

In the diagram, LAC curve is �U� shaped. This meansthat as output is increased starting from a smalllevel,there are increasing returns to scale (in the out-

put range 0 to q0). Therefore LAC falls in the initialstage of production. In other words, the downwardsloping portion of LAC curve represents increasingreturns to scale. LAC remains constant at output levelq0. LAC increases at output levels higher than q0. Sowe can say that the upward sloping portion of LACcurve shows decreasing returns to scale.

3. In the year 2006, all major domestic airlines inIndia reduced their air fares for certain sectors.Because they wanted to attract luxury class trainpassengers and to fill their vacancies. Most air-lines have an occupancy rate of between 50 to 60%.Discuss how marginal cost and average cost playan important role in the cost function of these air-lines.Marginal cost can be defined as the extra or addi-tional cost of producing one extra unit of output. Av-erage cost is the total cost divided by the total num-ber of units produced. Normally the occupancy ratein the airline industry is only 50 to 60 percent. Whenwe divide the total cost by the number of passengerstravelling, we can arrive at the average cost of flyinga plane. Here it includes the capital investment (fixedcost) as well as the salary, fuel, etc. (variable cost)involved in flying a plane. So the average cost is veryhigh since the occupancy rate is low.With the addition of more passengers, the marginalcost does not increase but the average cost comesdown. When the occupancy rate is low, discounts onair fares increase the occupancy rate, without addingany further cost of flying. As the occupancy rate in-creases, the average cost per passenger comes down.So even if the airlines give discounts, it does not in-crease the marginal cost.

4 Considering the rising demand for natural rub-ber, the Rubber Board encouraged farmers to usemore fertilizer for increasing rubber production.But the Farmer�s Forum warned the farmersabout the consequence of heavy doze fertiliza-tion. Make your stand in the context of the Lawof Diminishing Returns.The Rubber Board encouraged farmers to use morefertilizer to increase rubber production in tune withthe rising demand for the natural rubber. But thefarmer�s forum warned the farmers about the use ofheavy doze of fertilizers. The reason behind the warn-

LMC

Quantity of output

Co

st

LAC

q0

IRS DRS

CRS

0

Economics

2

ing is nothing but the Law of Diminishing Returns.Any production unit has a maximum capacity, whichcan be reached by changing the variable factors ofproduction. Thus an optimum combination will bereached. Beyond such combination returns will be-come constant and then gradually, start declining.Farmers should keep this in mind while using morefertilizer for increasing rubber production. If they goon increasing one factor of production and keep oth-ers constant, finally the rubber production will endup with losses.

1. Definition is the accurate description of an ideaor an object. Collect some important definitionsof the term �Money�.

¨ �Money is what money does� - Walker¨ �Anything which is commonly used and generally

accepted as a medium of exchange or as a standardof value�. � Kent

¨ �Money is the pivot around which economic scienceclusters... the major part of the subject matter of eco-nomics is concerned with the functioning and mal-functioning of money�. � Alfred Marshall.

¨ �Money is anything that is habitually and widely usedas a means of payments and is generally acceptablein the settlement of debts� � G.D.H. Cole

2. Without money no nation can go ahead towardseconomic development. Discuss the role of moneyin economic development.The role of money in promoting economic develop-ment is discussed below:1. Money stimulates productivity and economicgrowth.2. Money promotes investments.3. Money facilitates investments in high yielding as-sets.4. Creation of new credit or bank money exploitsidle resouces and unemployed human resources thatexists in developing economies.5. Funding on new investment or capital accumula-tion by creating more mony, causes rise to price in adeveloping economy. This increase in prices willforce people to reduce their present level of consump-tion. This leads to more savings.

3. The buying of securities by the Central Bank willhave an effect on the money supply. What hap-pens to the money supply?

Ans. Money supply increases.4. The Reserve Bank of India lends funds as a

�Lender of last resort� to a commercial bank, at aparticular interest rate. What this rate is knownas?Ans. Bank rate

5. The government adopted the most effective quan-titative method to control inflation in our economy.Which method?Ans. Cash Reserve Ratio

6. The Reserve Bank of India decides to print cur-rency notes worth Rs. 500 crore, additionally. Doesit require to increase its reserves in this respect? Ifnot, why?Ans.The Reserve Bank of India can print and issueany amount of notes by keeping a statutory minimumreserve, which is Rs. 200 crore. Therefore the reservesneed not be increased to print notes worth Rs. 500crore.

1. Price of a commodity under perfect competitionis determined by one of the following: Which?(a) Market forces (b) Firm (c) Buyer

Ans: Market forces2. Point out which type of market structure is the

exact opposite of perfect competition.Ans: Monopoly3. Examine the main features of perfect competition.

Perfect competition is an extreme form of marketwhich rarely exists in practice. It is a market situationin which there are a large number of buyers and sell-ers dealing with homogeneous products. The follow-ing are the features of perfect competition:

(1) Existence of large number of buyers and sellers:Under perfect competition, the number of buyers andsellers will be large. Each seller sells a very small pro-portion of the total quantity sold in the market. Be-cause of this reason, a single buyer or seller cannotinfluence the price of the commodity.

(2) Homogeneous product: The commodity bought andsold must be homogeneous or identical in all respectsie, in size, colour, shape, smell, packing, etc.

(3) Perfect mobility of goods and factors of produc-tion:Under perfect competition, there will be freedom of

1


3

movement for goods and factors of production. Goodscan be taken from one place to another and factors ofproduction can freely move between firms and indus-tries.

(4) Freedom of entry and exit: Freedom of entry andexit means that new firms can enter the industry andexisting firms can leave the industry freely.

(5) Perfect knowledge of market conditions: Underperfect competition, buyers and sellers will have com-plete knowledge about the availability of goods, theircosts, prices etc.

(6) Absence of transport cost: Absence of transportcosts is an important assumption of perfect competi-tion. If prices are to be uniform, we have to assumethat transport costs do not enter the price.

4. �Under perfect competition, the seller is a price-taker�. Explain.

Since there are large number of buyers and sellersunder perfect competition, a single seller or buyer can-not influence the price. The price is determined bythe market forces of demand and supply. The totaldemand for the product and the total supply of theproduct together determine the price. The implica-tion of product being homogeneous is that all firmshave to charge the same price for the product. If anyone producer happens to charge a price higher thanthe prevailing price, no one will demand from him.Product homogeneity and the existence of a large num-ber of firms together imply that each firm is very smallcompared to the whole market and no single firm caninfluence the market price. Each seller accepts theprevailing market price as determined by market de-mand and supply. Therefore, a firm under perfect com-petition is called a price-taker. It is illustrated in thefollowing diagram.

O

Output

M1

M

D

M2

P

Pri

ce

O

Output

D

D

EP

S

Q

S

In the diagram, equilibrium price determined by theforces of demand and supply is OP. A particular firmonly takes the price prevailing in the market. At theequilibrium price, a firm can sell any quantity of thecommodity. He has to only decide how much of thecommodity he should sell at the market price.

1. Find the odd one out and justify your answer.Bank rate/Open market operation/ Cash ReserveRatio/ TaxationTaxation : Except this, all others in the group aremonetary measures.

2. During inflation government should raise taxes.(True or false, justify your answer)True. To cut personal consumption expenditure therates of personal corporate and commodity taxesshould be raised.

3. Deficient demand leads to deflationery gap. (Saywhether True or False, justify your answer)Ans: True: Deficient demand gives rise to deflation-ary gap which causes the economy�s income, outputand employment to decline, thus pushing the economyinto an under employment equilibrium.

4. Mr. Tom found his salary doubled in the last twoyears. However he could purchase the very samequantity of goods evenafter his increased income.How will you explain this situation?When Mr. Tom�s salary doubled he could purchaseonly very same basket of goods. This shows that hehas not consumed anything additionally. Therefore,he might have saved the increased portion of the sal-ary. Saving is what is left over after consumption ex-penditure. Here, the ratio of change in consumptionto change in income is MPC (DC/DY)

1. Examine how an increase in input price affectthe equilibrium quantity exchanged in the prod-uct market?Prices of factors of production influence the supplyof commodities. If price of an input increases, thecost of production of a commodity using more of thatinput increases. Therefore the supply of the commod-ity will decrease. When the input price rises, the sup-ply curve shifts to the left. An increase in input price,therefore increases the equilibrium price and the equi-librium quantity falls. It is illustrated in the given fig-ure.

Economics

4

S

SD

D S1

S1

P

Q

P1

Q1

Pric

e

QuantityO X

Y

2. Show the determination of market equilibriumwith the help of demand and supply schedules anda diagram.

Equilibrium price is determined by the intersectionof demand and supply curves. The point at whichdemand curve and supply curve intersect with eachother is called equilibrium point. The following mar-ket demand and supply schedules illustrate the deter-mination of equilibrium price in a market.

Price of Quantity QuantityBananas (in Rs.) demanded supplied

18 10,000 1,000

19 8,000 2,000

20 7,000 4,000

21 6,000 6,000

22 5,000 7,500

23 4,500 8,500

3. Give one example of direct intervention and indi-rect intervention in the market mechanism.

In a free enterprise economy, price of a commodity isdetermined by the forces of demand and supply. Butin certain situations the government may interfere inprice fixation. There are some policies, eg. differentkinds of taxes and subsidies, that change the marketprice indirectly via shifting the demand and supplycurves. Sales taxes and excise taxes are common ex-amples. These are called indirect interventions.

There are other policies by which prices are fixed di-rectly by the government; these are called direct inter-ventions. Examples of direct intervention are pricecontrol on products and support price for commodi-ties. It is thought that if necessary items like sugar,

rice etc. were left to the play of free market entirely,poor people would not be able to afford them at themarket-clearing price. Hence, for a long time, the gov-ernment has adopted a system of price control throughration shops for such commodities. In terms of demandand supply curves, price control means fixing pricebelow the equilibrium price. This may lead to ration-ing system or blackmarketing.

Inorder to protect the interest of farmers the govern-ment fixes minimum price or support price for com-modities. It is fixed above the equilibrium price to in-sulate farmers from income fluctuations resulting fromprice variation in the free market.

4. �Equilibrium price may or may not change withshifts in both demand and supply curves�. Com-ment.The equilibrium price and quantity will change if thereare changes in demand and supply conditions. It ispossible that both demand and supply shifts occursimultaneously. It may be noted that when both de-mand and supply increase, the equilibrium quantitywill increase, and when they decrease, the equilib-rium quantity will decrease. But in both cases, thenew equilibrium price may rise, fall or remain at thesame level depending upon the relative change in de-mand and supply. The effect of change in both de-mand and supply is shown in the following diagram.

Pric

e>

P

S

Q1

S

P1

QO

D

D

>Quantity demanded

D1

D1

S1

S1


5

In the diagram, the rate of increase in demand is greaterthan the rate of increase in supply. Therefore, the newequilibrium quantity and equilibrium price will in-crease. The change in the equilibrium price dependsupon the relative changes in demand and supply. Afew instances are given below.(1) When increase in supply is equal to increase indemand, the equilibrium price will remain unaffected,while equilibrium quantity will increase.(2) When increase in supply is greater than increasein demand, the equilibrium price will fall while equi-librium quantity will increase.(3) When increase in supply is less than increase indemand, equilibrium price will rise, and quantity willrise.

5. Analyse the determination of equilibrium pricewith a diagram.In the market, there are two forces, viz. supply anddemand. Equilibrium refers to a market where quan-tity demanded is equal to quantity supplied. The equal-ity of demand and supply determines the equilibriumprice. Equilibrium price is the amount at which buy-ers want to buy and sellers want to sell. The amountis equal. Only at the equilibrium price, wishes of boththe buyers and sellers are satisfied.\ Equilibrium D = S

Surplus

S > D Excess SupplyD = S EquilibriumD > S Excess Demand

Quantity Demanded

Pric

e

Shortage

E

Diagrammatic Explanation: When price is P, demand

is equal to supply at point E. At this point E, both the

quantity demanded and quantity supplied are equal,

at Q. ie., Demand = Supply. This is the point of equi-

librium, E. At this point, there is no excess supply (D

< S) or excess demand (D > S) for the commodity.

Equilibrium price P is therefore called market clear-

ing price.

Here, price is an outside factor. So, when it changes,

equilibrium is disturbed. This leads to equilibrium

situations.

When price moves up to P1, there is lesser demand

and more supply. This leads to excess supply. When

price moves down to P2, demand is more than sup-

ply. This creates excess demand. These two condi-

tions are called disequlibrium states.

Marshall likened the forces of demand and supply to

the two blades of a scissors, moving in opposite di-

rections. Just as both the blades moves in the oppo-

site directions to cut a piece of paper, demand and

supply moving in opposite ways together and at the

same time, determine the equilibrium price.

6. Give one example of direct intervention and indi-

rect intervention in the market mechanism.

In a free enterprise economy, price of a commodity is

determined by the forces of demand and supply. But

in certain situations the government may interfere in

price fixation. There are some policies, eg. different

kinds of taxes and subsidies, that change the market

price indirectly via shifting the demand and supply

curves. Sales taxes and excise taxes are common ex-

amples. These are called indirect interventions.

There are other policies by which prices are fixed di-

rectly by the government; these are called direct in-

terventions. Examples of direct intervention are price

control on products and support price for commodi-

ties. It is thought that if necessary items like sugar,

rice etc. were left to the play of free market entirely,

poor people would not be able to afford them at the

market-clearing price. Hence, for a long time, the gov-

ernment has adopted a system of price control through

ration shops for such commodities. In terms of de-

Economics

6

mand and supply curves, price control means fixing

price below the equilibrium price. This may lead to

rationing system or blackmarketing.

In order to protect the interest of farmers the govern-

ment fixes minimum price or support price for com-

modities. It is fixed above the equilibrium price to

insulate farmers from income fluctuations resulting

from price variation in the free market.

7. Examine how an increase in the price of a substi-

tute good in consumption affect the equilibrium

price?

Equilibrium price is the price at which quantity de-

manded and supplied are exactly equal. When there

is a change in demand or supply condition, the equi-

librium price also will be changed. For eg. tea and

coffee are substitute goods. Suppose the price of cof-

fee rises for some reason. The demand curve for tea

will shift to the right due to increase in the price of

coffee. Thus, as the price of a substitute good in con-

sumption rises, the price of a given product rises and

its quantity exchanged increases.

1. Budget receipts can be classified into two. Men-

tion those two components and expalin them.

Budget receipts may be classified as revenue receipts

and capital receipts.

(a) Revenue receipts: Revenue receipts may be di-

vided into tax revenue and non-tax revenue. A tax is a

compulsory contribution from a person to the gov-

ernment to meet the expenses incurred in the com-

mon interest of all. Non-tax revenue consists of all

other revenue receipts such as commercial revenue

and administrative revenue.

(b) Capital Receipts: Capital receipts refer to all

money mobilised by the government that either cre-

ates a liability of repayment or involves a sale of an

asset. The main items of capital receipts are:

(i) Loans raised by the government for the public.

(ii) Borrowing by the government from the RBI

through sale of treasury bills.

(iii) Loans raised from foreign governments.

(iv) Recoveries of loans granted to State and Union

territory governments.

(v) Small savings and deposits in the public provi-

dent fund, etc.

2. � The budget is a tool for the government to imple-

ment its various policies.� Do you agree with this

statement? Explain.

The budget is an annual statement of the estimated

receipts and expenditures of the government over the

fiscal year which runs from April 1 to March 31. The

government has several policies it wishes to imple-

ment in the overall task of performing its functions.

Implementation of these policies requires expenditure

by the government and some source of funding for

that expenditure. The budget is a tool for the govern-

ment to implement its various policies. The objec-

tives pursued by the government through the budget

are the following.

1) Activities to secure a reallocation of resources:

The government has to reallocate resources in line

with social and economic considerations in case the

market fails to do so or does so inefficiently.

2) Redistributive Activities: The government redis-

tributes income and wealth to reduce inequalities by

expenditures on social security, subsidies, public

works etc.

3) Stabilising Activities: The government tries to pre-

vent business fluctuation and maintain economic sta-

bility ie, high level of employment and price stability.

4) Management of public enterprises.

Government undertakes commercial activities

through its public enterprises. The commercial activi-

ties are of the nature of natural monopolies, heavy

manufacturing etc. A natural monopoly is a situation


7

where there are economies of scale over a large range

of output; then one firm can produce at a lower aver-

age cost than more than one firm could. Eg. railway,

electricity etc. These usually come under state regu-

lation because if left unregulated, there will be a ten-

dency of the monopolist to curtail output in pursuit

of profit, thereby lowering social welfare.

1. A monopoly market structure may arise in vari-

ous ways. How will you justify this statement with

the help of examples?

In monopoly market structure there is only one seller.

This is defined in the context of a given geographi-

cal location or space. For example in India before

liberalisation in the power sector, the generation and

distribution of electricity were in the hands of State

Electricity Boards (SEBs). A monopoly market struc-

ture emerges because of any of the following reasons:

(a) The government gives licence to only one company

for producing a product or providing a service in a

given locality or space. For instance, till 2002, VSNL

had monopoly in India in providing international tele-

phone service.

(b) Big private companies engage in research and come

up with new products or new technology in produc-

ing an existing product. As a reward for their risk and

investment in research the government grants patent

rights. In other words, monopoly arises because of

granting patent certificate or what is called patent

rights.

(c) Sometimes, firms retain their individual identity but

they co-ordinate their outputs and pricing policy so

as to act as if it is a monopoly. This is called a cartel.

The OPEC (Organisation of Petroleum Exporting

Countries) in the 1970�s is an example of a cartel that

led to virtual monopoly in the world market for oil.

2. The concept of monopolistic competition was in-

troduced by Prof.Chamberlin. In what way you

can explain this market situation?

The concept of monopolistic competition was intro-

duced by Prof. Chamberlin. Monopolistic competi-

tion is a market situation in which both the monopoly

element and competitive element are present. In this

market situation, many producers produce goods

which are close substitutes and engage in acute com-

petition among themselves. The following are the fea-

tures of monopolistic competition:

(1) Large number of buyers and sellers: The number

of firms is fairly large though not very large as in per-

fect competition. For example, there is large number

of firms in the market for products like tooth pastes,

soaps, etc. The number of firms may vary from indus-

try to industry.

(2) Product differentiation: An important characteris-

tic of monopolistic competition is product differen-

tiation. Each firm produces a product which is differ-

entiated from the products of rival firms. Product dif-

ferentiation means differentiation of the product in

terms of colour, shape, sme[ll, packing, taste, brand

name etc. For example, toilet soaps like Pears, Rexona,

Hamam, Lifebuoy etc.

1. Disequilibrium in the BoP results in favourable

(Surplus) or unfavourable (Deficit) BoP. Examine

the causes responsible for unfavourable BoP and

mention the measures used to correct BoP deficit?

Causes responsible for unfavourable BoPs are mainly

the following.

1. More demand for consumption goods

During post-war period demand for goods increased

considerably. Due to demand of tea, oil seeds, and iron

ore within the country the exports of these goods went

down. Consequently unfavourable balance of trade

increased.

2. Imports of machinery and equipments

Since independence heavy import of machinery was

Economics

8

made for the replacement of obsolete machines. We

also had to import more machines to satisfy our de-

sire for rapid industrialisation. The imports of ma-

chines made our balance of payment unfavourable.

3. Imports of war equipments

The Indo-China and Indo-Pak war forced us to im-

port war equipments to defend our country.

4. Setting up of embassies

After independence we had to incur heavy expendi-

ture in setting up embassies and high commissions

abroad. It also contributed to our unfavourable bal-

ance of payments.

5. Increase in foreign competition

Our major exports were jute, tea and textiles. But

these days we have tough competition from

Bangladesh in exports of jute. Sri Lanka and Indone-

sia are our rivals in the exports of tea. We have also

tough competition from Korea and China in the ex-

ports of cloth. All these competitions have reduced

our exports in these commodities leading to balance

of payment deficit.

6. Hike in the petrol prices

The price of petrol which was 2 dollar per barrel in

1973 has now increased to 36 dollar per barrel. The

continuous rise in the consumption of petrol and its

regular hike in price has increased balance of pay-

ment deficit.

7. Eruption of gulf war

In 1990-91 there was a Gulf war between Iraq and

several Western Countries. It increased the price of

petrol, on one hand and on the other hand stopped

the remittances by Indians working in Gulf area like

Kuwait, Iraq etc. This worsend the situation further

and increased our balance of payment deficit.

8. Disintegration of USSR.

We have very large amount of foreign trade with

USSR. Disintegration fatally affected our foreign

trade.

9. Payment of interest on foreign trade

We had borrowed substantial loan from abroad. Its

repayment together with interest thereon mounted very

fast. Interest on these loans approximated to Rs.

70,970 crores in 1997-98. It has also resulted in the

balance of payment deficit.

10. Slow growth of exports

Our exports has not been increasing as fast as the im-

ports are increasing. The trade deficit is still widen-

ing. This has also resulted in the balance of payment

deficit.

The measures used to correct BoP deficit are:

1. Increase in production

2. Promotion of exports

3. Favourable bilateral trade agreements

4. Reduction in imports

5. Deflation

6. Encouragement to foreign investment

7. Devaluation of Indian currency

8. Foreign assistance

9. Import substitution

2. The term trade is commonly understood to mean

exchange of goods wares or mechandise among

people. How will you distinguish between inter-

nal trade and international trade?

Trade implies an exchange of goods and services be-

tween two individuals or groups of individuals. An

exchange of goods and services between two indi-

viduals living in the same locality or in two different

regions of the same country is internal trade. It is trade

with in the same country. International trade is an

exchange of goods and services between two indi-

viduals or groups of individuals living in two differ-

ent countries. It is trade between two nations.

1

UNIT I

INTRODUCTION

QUESTIONS BASED ON HOTS WITH MODEL ANSWERS

VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each)

Q.1. Why is there a need for economizing of resources?

Ans. Because resources are limited.

Q.2. Why does economic problem arise?

Ans. It arises mainly because of scarcity of resources.

Q.3. Why is PPC downward sloping from left to right?

Ans. Because in situation of full employment of resources, production of one good

can be increased only with less of other good.

Q.4. What does a rightward shift of PPC indicate?

Ans. The rightward shift of PPC indicates growth of resources or technological

progress.

Q.5. What does a point below PPC indicate?

Ans. It shows inefficient/under-utilization of resources.

Q.6. What does slope of PPC show?

Ans. Negative slope of PPC shows that in order to produce more units of one good,

some units of the other good must be sacrificed.

Q.7. When allocation of resources is considered as inefficient?

Ans. Allocation of resources is considered as inefficient when economy performs

below the PPC curve.

SHORT ANSWER TYPE QUESTIONS: (3/4 Marks Each)

Q.1. Does production take place only on the PP curve?

Ans. Yes and no, both. Yes, if the given resources are fully and efficiently utilized.

No, if the resources are underutilized or inefficiently utilized or both.

Refer to the above figure; on a point anywhere on the PPC the resources are fully

and efficiently employed. On point U, below the PPC or any other point but below

the PPC, the resources are either underutilized or inefficiently utilised or both. Any

point below the PP curve thus highlights the problem of unemployment and

inefficiency in the economy.

2

Q.-3 Massive unemployment will shift the PPC to the left. Defend or refute.

Ans.- Production is drawn on the basis that the given resources are fully as well

as efficiently utilized. Massive unemployment is a situation when resources are

not fully utilized. Or it is a situation of under employment. It would only mean

that the economy is not operating on the PPC but some-what inside the PPC.

Therefore PPC will not shift to leftward.

UNIT- II

CONSUMER‟S CHOICE AND DEMAND ANALYSIS


Q.-1 All points below the budget line shows the various possible bundles which

cost exactly equal to consumer‟s income. Is it right or wrong?

Ans.- Wrong.

Q.-2 If Ram is offered Ice Cream free of cost. How much Ice Cream will he

consume?

Ans.- Ram should consume Ice-Cream to that extent to which the marginal utility of

Ice-Cream becomes equal to zero

O

X

Wheat

PPC

Y

Clo

th

A

B

C

D

. U

3

Q.-3 What happens to the budget set if both the prices as well as the income

doubled?

Ans.- The budget set remains same.

Q.-4 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.

Q.-5 Does a fall in income have the same effect on the demand for the given

commodity?

Ans.- No, it will depend upon the nature of the good. If good is normal then its

demand will increase and if the good is inferior then its demand will decrease

Q.-6 There is train and bus service between New Delhi and Jaipur. Suppose

that the train fare between the two cities comes down. How will this affect

demand curve for bus travel between the two cities?

Ans.- As train and bus service are substitute to each-other, the demand curve for

bus service between the two cities will shift leftward to the initial demand curve

of bus service

Q.-7 Determine how the following changes (or shifts) will affect market

demand curve for a product.

(a) A new steel plant comes up in Jharkhand people who were previously

unemployed in the area are now employed. How will this affect the demand

for colour T.V. and Black and White T.V. in the region?

(b) In order to encourage tourism in Goa. The Government of India suggests

Indian Airlines to reduce air fare to Goa from the four major cities of

Chennai, Kolkata, Mumbai and New Delhi. If the Indian Airlines reduces

the fare to Goa, How will this affect the market demand curve for air

travel to Goa?

(c) There are train and bus services between New Delhi and Jaipur. Suppose

that the train fare between the two cities comes down. How will this affect

demand curve for bus travel between the two cities?

Ans: (a) There will be rightward shift in market demand curve for colour and Black

and White T.V. This is because of increase of income of the people due to

employment in the new steel plant.

4

(b) The demand for travel to Goa will expand in response to reduction in the air fare.

However, this will be reflected by a movement along the demand curve. There

will be no shifts in the demand curve.

(c) As train fare comes down the demand for bus travel will reduce. Demand curve

for the bus travel will shift to the left showing less demand at the same price.

Q 8. If a good can be used for many purposes, the demand for it will be elastic.

Why?

Ans: If a good can be used for many purposes , the demand for it will be more

elastic because with a decrease in its price it is put to several uses and with a

rise in its price it is withdrawn from its many existing uses. So that, there is a

considerable change in demand in response to some change in price.

Q 9. “If a product price increases, a family‟s spending on the product has to

increase.” Defend or refute.

Ans: When product price increases, expenditure on the commodity will not increase

in the situation when Ed>1 (elasticity of demand is greater than unity). It will

increase only in situation when Ed<1. In a situation when Ed=1. Expenditure

will remain constant, even when prices rise.

Q 10. Suppose there are 30 consumers for a good, having identical demand

function: d(p) =10-3P for any price less than or equal to 10/3 and d(p)=0

for any price greater than 10/3. Write the market demand function.

Ans: Market demand function is simply a horizontal summation of individual

demand functions. Since demand function for all the 30 consumers is identical,

we can write market demand simply as „individual demand function

multiplying by a factor of 30‟. Thus:

Individual demand function :

D(p)= 10-3P

Market demand function:

Md(p)=10 x 30 – 3 (30)P

= 300-90 P.

Q.11 How would you comment on the elasticity of demand when 8% decrease

in price of a commodity causes 2% increase in expenditure of the

commodity?

Ans: Elasticity of demand must be greater than unity (implying a situation of elastic

demand) when expenditure on the commodity responds inversely to any change

in price of the commodity.

5

Q12. A dentist was charging Rs.300 For a standard cleaning job and per

month it used to generate TR is equal to Rs. 30,000. She has since last month

increased the price of dental cleaning to Rs.350. As a result fewer customers are

now coming for dental cleaning, but the TR is now Rs. 33,250 .From this, what

can we conclude about the elasticity of demand for such a dental service?

Ans. PRICE TOTAL EXPENDITURE (Rs.)

300 30,000

350 33,250

When price increases, total expenditure also increases. So elasticity is less than 1.

Q. 13. The elasticity of demand for X is twice the elasticity of demand for Y.

Price of X falls by 5% and Price of Y rises by 5% . What will be the % change

in the quantity demanded of X and Y?

Ans. Suppose elasticity of demand for Y = 1 , and

elasticity of demand for X will be = 2

So, % decrease in qt. demanded of Y will be 5% , because price rises by

5%, and

% increase in qt. demanded of X will be 10% , because price falls by 5% .

Q.14 If prices of salt and cigarettes, both rises by 10% , will the qt. demanded

of both goods affected in an equal manner?

Ans. No, because the nature of the two goods is different. Salt , a necessary good,

will have constant consumption and marginal consumers will reduce the

consumption of cigarettes , which is non-essential.

Q 15. Given eD = - 0.02, and percentage increase in price = 20%, find change in

expenditure on the commodity.

6

Implying that expenditure on the commodity increses by 15.2% owing to increase

the commodity by 20% . Which is why ed is less than 1.

.

Q. 16 If Y

Y

X

X

P

MU

P

MU, then the consumer should buy more of commodity Y and

less of commodity X to reach the equilibrium position. Is it right or

wrong?

7

Ans.- Wrong. Because in that situation consumer should increase consumption of

good-X so that the ration of MUX to its price may become equal to the ratio of

MUY to its price.

Q. 17 Law of diminishing marginal utility will operate even if consumption

takes place in intervals. Defend or refute.

Ans.- No, the of diminishing marginal utility will operate even if consumption takes

place in intervals. Because it is based on the assumption that consumption is

taking place in continuation

Q. 18 What changes will take place in TU, when: (i) MU curv remain above the

X-axis, (ii) MU curve touches the X-axis, (iii) MU curve lies below the X-

axis.

Ans.- (i) TU increases at decreasing rate. (ii) TU becomes maximum. And (iii) TU

starts to decline

Q. 19 A good may be an inferior good for one consumer and normal for another

consumer. Defend or refute.

Ans.- Yes it is right. A good may be inferior for a higher income person and the

same good may be a superior good for a low income person

UNIT – III

PRODUCER BEHAVIOUR AND SUPPLY


Q.1. What happens to MPP when TPP increases at decreasing rate?

Ans. MPP falls but remains positive.

Q.2. As the variable input is increased by one unit, total output falls. What

would you say about of marginal productivity labour?

Ans. Marginal productivity of labour is negative.

Q.3. Why is MC curve in short run U-shaped?

Ans. MC Curve in short run is U-shaped due to operation of the law of returns to a

factor.

Q.4. Why does fixed cost not influence marginal cost?

Ans. Because marginal cost do not include fixed cost.

Q.5. When a seller sells his entire output at a fixed price, what will be the

shape of AR & MR curves?

Ans. Both AR & MR are equal and coincide with each other on a horizontal line.

8

Q.6. Show that average revenue equals price.

Ans. AR

TR

Q

PXQ

QP ice= = = = Pr

Q.7. What effect does a cost saving technical progress have on the supply

curve?

Ans. Supply curve will shift to the right.

Q.8. What effect does an increase in excise tax have on the supply curve?

Ans. Supply curve will shift to the left.

Q.9. What happens to TPP when marginal productivity of variable input is

negative?

Ans. TPP falls.

Q.10. When is TPP maximum in relation to MPP?

Ans. When MPP is zero.

Q.11. What happens to MPP when TPP is declining?

Ans. MPP declines and remains negative.

Q.12. How does fall in MPP affect TPP?

Ans. TPP increases at decreasing rate.

Q.13. What effect does an increase in input price have on the supply curve?

Ans. The supply curve will shift towards left-hand side.

Q.14. Why does average cost fall as output rises?

Ans. AC falls due to operation of the law of increasing returns to a factor as output

rises.

Q15. Does fixed cost affect marginal cost? Give the answer with reason.

Ans. No, because fixed cost is not subject to change and it is not considered while

calculating MC.

Q.16. What would be the effect of increase in the output on the TFC?

Ans. There would not be any effect of increase in the output on the TFC, It will be

constant at different levels of production.

Q.17. If marginal revenue falls, will total revenue fall?

Ans. It may fall when MR falls and becomes negative. If MR falls but remains

positive then TR may increase with diminishing rate.

Q.18. What is the price elasticity of supply of a commodity whose straight line

supply curve passes through the origin forming an angle of 25º?

Ans. Price elasticity of supply will be equal to one when a straight line supply

curve passes through the origin; angle does not matter anything.

Q. 19. Can MC be equal to TVC?

Ans.- Yes MC may be equal to TVC at output level one.

9

Q. 20 Why does the minimum point of AC curve fall towards right of AVC

curve?

Ans.- Because AC is sum total of AVC and AFC.

Q.21. The two inversely S-shaped short run cost curves are parallel to each

other and maintain a constant distance of Rs. 50. What is indicated by Rs.

50? Also identify the two inversely S-shaped short run cost curves.

Ans.- Rs. 50 is TFC. And two inversely S-shaped cost curves are TVC and TC

respectively.

Q. 22. The equality of MC and MR is a condition necessary for equilibrium, but

it is not by itself sufficient to ensure the attainment of producer‟s

equilibrium. Comment.

Ans.- Yes. For consumers equilibrium it is also essential that after the equilibrium

level of production MC should be greater than MR. Other-wise there will be

an incentive to increase the output in order to maximize the profit.

Q. 23. Ram produces both Jeans and Shirts. How will an increase in the price of

Jeans affect the supply curve of Shirts?

Ans.- An increase in the price of Jeans will decrease the supply of Shirts, because

now it will be profitable to the producer to produce and sell more of Jeans

instead of Shirts, as it has become expensive.

Q. 24. Will a firm stop production at break-even point in short run? Why?

Ans.- No, firm will not stop the production at break-even point because that firm has

given best employment to its factors of production.


Q.1. Why is more of a commodity supplied only at a higher price?

Ans.- Because increase in production leads to decrease in returns to a factor. That in

turn leads to increase in cost. That is why more of a commodity supplied only

at a higher price

Q. 2. Suppose the functions of demand and supply curves of a commodity are

given by: qD = 100-p

qS = 60 + p for p≥ 15

= 0 for 0≤p<15

10

(i) What does p =15 indicate?

(ii) Find the equilibrium price and equilibrium quantity.

(iii) Whether the given commodity comes under the category of viable

industry.

(iv) Calculate market demand and supply at price of Rs. 25 and Rs. 10.

Show that at price of Rs. 25, there is excess supply and at price of Rs.

10, there is excess demand.

Ans.-

(i) P=15 indicates that the minimum average cost of the firm is Rs. 15 and

firm will not supply the commodity for any price less than Rs. 15

(ii) Equilibrium Price = Rs. 20 and equilibrium quantity = 80 units

(iii) Yes, the given commodity comes under the category of viable industry as

there is some price, at which supply and demand happens to coincide.

(iv) At price Rs. 25 market demand = 75 units and market supply = 85 units.

Therefore there will be excess supply of 10 units

And at price of Rs. 10 market demand = 90 units and market supply = 70

units. Therefore there will be excess demand of 20 units.

Q. 3. There are three different supply curves passing through the origin. A

curve makes an angel of 60o. Curve B makes an angel of 45

o and curve C

makes an angel of 30o. What will be the price elasticity of curve A, B and

C?

Ans.- Price elasticity of supply of good will be equal to one if supply curve is

passing through the origin point, irrespective of the angel made by it with the

origin.

Q. 4. Why should MC curve cut MR curve from below to achieve producer‟s

equilibrium?

Ans.- Because after equilibrium level of output, marginal cost should become

greater than the marginal revenue. Other-wise there will be an incentive to

increase the output in order to maximize the profit.

11

Q. 5. The gap between AC and AVC keeps on decreasing with rise in output,

but they never meet each other. Comment.

Ans.- Yes it is right statement. Because the gap between AC and AVC is equal to

AFC which goes on diminish as output increases. Since TFC is fixed at all

levels of output, AFC goes on diminish as output increases

Q. 6. If TVC=0, TC is also zero. Is it true or falls? Give reason for your answer.

Ans.- It is falls. Because in short TC = TFC + TVC. Therefore in short run TC will

be some-thing positive even if TVC=0. But in long run TC = TVC. Therefore

in long run TC will be zero if TVC=0.

Q. 7. Why increasing MP not sustainable?

Ans. Decrasing MP set in due to following reasons:-

1. Fixity of the factor: As more and more units of the variable factor continue

to be combined with the fixed factor, the later gets over-utilized.

2. Imperfect Substitution among Factor: Beyond a certain limit, factors of

production cannot be substitute for one another e.g. more and more of

labour cannot be continuously used in place of additional capital.

Q. 8. Why MC cuts AC at its minimum?

Ans. because (i) When MC < AC, AC falls.

(ii) When MC = AC, AC is minimum.

(iii) When MC > AC, AC rises.

(iv) MC falls & rises faster than AC.

(v) Both are obtained from TC.

ACTC

QMC

TC

Q= =,

12

Q. 9. How do changes in MR affect TR?

Ans. i) If MR increases, TR increases at increasing rate.

ii) If MR is constant, TR increases at constant rate.

ii) IF MR falls, TR increases at diminishing rate.

Q.10. What is MR? How is it related to AR?

Ans. MR refers to the change in TR due to sale of an additional unit.

Relation –

(i) If AR (Price) is constant, MR = AR

(ii) If AR (Price) falls, MR < AR.

(iii) If AR (Price) rises, MR > AR.

Q. 11. What will be the price elasticity of supply if the supply curve is a

positively sloped straight line?

Ans. Es = 1 if the curve starts from the origin point.

Es> 1 if the curve starts from the y-axis and

E<1 if the curve starts from the x-axis.

Q. 12. State the relation between marginal revenue and average revenue when a

firm:

(i) is able to sell more quantity of output at the same price.

(ii) is able to sell more quantity of output only by lowering the price.

Ans. Marginal revenue is the addition to total revenue from producing one more

unit of output.

13

(i) MR = AR at all levels of the output. (In case of perfect completion market)

(ii) MR will be less than AR at all levels of the output. (In case of monopoly

and monopolistic market)

LONG ANSWER TYPE QUESTIONS: (6 Marks Each)

Q. 1. In the following table, identify the different phases of the law of variable

proportions and explain them with the help of the table and a diagram.

Variable input

(units) 1 2 3 4 5 6 7 8

Total product

(units) 2 5 9 12 14 15 15 14

Ans. Law of Variable Proportion states that if we go on using more and more units

of a variable factor along with a fixed factor, the total output initially increases

at an increasing rate, after that it increases at diminishing rate and finally it

declines.

It can be explained through the following three stages:

Units of

labour

TPP MPP Stages of

Production

1 2 2

Stage I 2 5 3

3 9 4

4 12 3

Stage II 5 14 2

6 15 1

7 15 0 Stage III

8 14 –1

14

Stage 1:

• TPP increases at an increasing rate.

• MP increases and reaches at its maximum at the end of the stage.

• This is also called stage of increasing returns.

Stage 2:

• TPP increase but at diminishing rate.

• MPP starts decline but remains positive.

• This stage comes to an end when TPP is maximum and MPP is zero.

Stage 3:

• TP starts decline.

• MP becomes negative.

• This is also called stage of decreasing/negative returns.

TPP

MPP

X

Y

‟

Y

Labour

TPP

&

MPP

Stage I Stage III

Stage II

15

NUMERICAL PROBLEMS WITH SOLUTIONS: PRODUCTION:

Q. 1. Find out APP and MPP.

Labour 1 2 3 4 5 6 7

TPP 40 80 110 130 140 140 130

Ans. APP 40 40 36.67 32.5 28 23.33 18.57

MPP 40 40 30 20 10 0 -10

Q. 2. Find out the TPP and APP.

Labour 1 2 3 4 5 6 7

MPP 24 20 16 12 8 0 -8

Ans. TPP 24 44 60 72 80 80 72

APP 24 22 20 18 16 13.33 10.28

Q. 3. Calculate the APP and MPP.

Labour 0 1 2 3 4 5 6 7

TPP 0 5 12 20 30 35 40 42

Ans. APP 0 5 6 6.66 7.5 7 6.66 6

MPP - 5 7 8 10 5 5 2

Q. 4. The following table gives APP of a factor. It is also known

that (TPP) total product at O level of employment is O.

Determine its total product and marginal product.

Labour 1 2 3 4 5 6

APP 50 48 45 42 39 35

Ans. TPP 0 50 96 135 168 195 210

MPP - 50 46 39 33 27 15

16

COST:

Q. 1. Calculate the TVC, AFC,AVC, and MC.

Output 0 1 2 3 4 5 6

TC 60 80 100 111 116 130 150

Ans. TFC 60 60 60 60 60 60 60

TVC 0 20 40 51 56 70 90

AFC - 60 30 20 15 12 10

AVC - 20 20 17 14 14 15

MC - 20 20 11 5 14 20

Q. 2. Calculate TC and AVC.

Output 1 2 3 4 5 6

AFC 60 30 20 15 12 10

MC 32 30 28 30 35 43

Ans. TC 92 122 150 180 215 258

TFC 60 60 60 60 60 60

TVC 32 62 90 120 155 198

AVC 32 31 30 30 31 33

Q. 3 . Calculate MC and AC if fixed cost is 40.

Output 1 2 3 4 5 6

TVC 60 80 90 110 150 216

Ans. MC 60 20 10 20 40 66

TC 100 120 130 150 190 256

AC 100 60 43.33 37.5 38 42.67

Q.4

OUTPUT 1 2 3 4

AC 54 ------ ----- 33

AVC 30 24 ----- -----

MC 30 ----- 24 -----

ANS.

OUTPUT 1 2 3 4

AC 54 36 32 33

AVC 30 24 24 27

17

MC 30 18 24 36

REVENUE:

Q. 1. Find AR and MR.

Output 1 2 3 4 5 6 7

TR 10 24 33 40 40 36 28

Ans. AR 10 12 11 10 8 6 4

MR 10 14 9 7 0 -4 -8

Q. 2. Find out TR and MR.

Output 10 9 8

AR 6 7 8

Ans. TR 60 63 64

MR - 3 1

Q. 3. Complete the following table:

Output 1 2 3 4

Price - 9 - -

MR 10 - - 4

TR - - 24 -

Ans. Output 1 2 3 4

Price 10 9 8 7

MR 10 8 6 4

TR 10 18 24 28

Q. 4. Calculate TR and AR

Output 1 2 3 4

MR 10 8 0 -2

Ans. TR 10 18 18 16

AR 10 9 6 4

18

ELASTICITY OF SUPPLY:

Q.1. If price elasticity of supply of a commodity is 5. A producer

supplies 500 units of this product at a price of Rs. 5 per unit.

How much quantity of this product will be supplied, at the price

of Rs. 6 per unit?

Ans. es = 5

P Q

5 500 ∆q = x – 500

6 x ∆p = 1

p = 5

q = 500

e

q

px

p

q=

5

500

100=

-x

5 × 100 = x – 500

500 = x – 500

500 + 500 = x

x = 1000 (units)

Q.2. Due to a 10 per cent rise in the price of a commodity, its quantity

supplied rises from 400 units to 450 units. Calculate its price

elasticity of supply. Is the supply elastic?

Ans. P = 10% Change in quantity

% Change in quantity supplied = x 100

Original quantity

=

50

400100x

= 12.5%

es =

12 5

10

.

es =

125

100

19

es = 1.25 (Yes, its supply is elastic.)

Q.3. The quantity supplied of a commodity at a price of Rs. 8 per unit

is 400 units. Its price elasticity of supply is 2. Calculate the new

price at which its quantity supplied will be 600 units?

Ans. es = 2

p q ∆q = 200

8 400 ∆p = x - 8

x 600 p = 8

q = 400

e

q

px

p

q=

e

xx2

200

8

8

400=

-

2

4

8=

-x

2 (X - 8) = 4

2 x - 16 = 4

2 x = 4+16

2 x = 20

x = 10

Hence the new price is Rs. 10.

Q.4. When the price of a commodity rises from Rs.10 to Rs.12 per

unit, its quantity supplied rises by 100 units. If es = 2, Calculate

its quantity supplied at increased price.

Ans. es = 2

∆q = 100

∆p = 2

p = 10

e

q

px

p

q=

4q = 1000

q = 250 (original quantity)

100 10

2 = ____

x ____

2 q

20

Quantity supplied at increased price = 250 + 100 = 350 units

Q.5. If es = 3, A seller supplies 20 units of the commodity at a price of

Rs.8 per unit. How much quantity of the commodity will the

seller supply when price rises by Rs.2 per unit?

Ans. es = 3

q = 20

p = 8

∆p = 2

e

q

px

p

q=

8 ∆q = 120

∆q = 15

(change in quantity)

Quantity supplied at increased price = 20 + 15 = 35 units

UNIT-IV

FORMS OF MARKET AND PRICE DETERMINATION


Q. 1. What is the value of MR when demand curve is elastic?

Ans. MR is positive. Q. 2. In which market DD curve is indeterminate?

Ans.- Oligopoly Market.

Q 2. Who determines price under perfect competition?

Ans: Price under perfect competition is determined by the forces of market demand

and market supply in industry.

Q 3. How much loss can a firm bear?

Ans: A firm can bear losses upto its total fixed costs in short run.

Q 4. Explain the motivation behind granting patent rights.

Ans: Motivation behind granting patent rights are:

(A) To encourage research and development; and

(B) To encourage new discoveries and innovations.

∆q 8

3 = ____

x ____

2 20

21

SHORT ANSWER TYPE QUESTIONS: - (3 /4 Marks Each)

Q 1. Explain how the efficiency may increase if two firms merge?

Ans: When the two firms merge, their combined efficiency is expected to improve

owing to:

(A) Increase in the scale of output and the consequent economies of scale.

(B) Better division of labour and specialization; and

(C) Use of better technology, saving the cost of production.

Q 2. Why is the demand curve facing a monopolistically competitive firm likely

to be very elastic?

Ans: It is because the products produced by the monopolistically competitive firms

are close substitutes to each other. If products are close substitutes to each

other the elasticity of demand is high, which is what makes the firm‟s demand

curve(under monopolistic competition) very elastic.

Q 3. Why is the demand curve facing a firm perfectly elastic under perfect

competition but less than perfectly elastic under monopolistic

competition?

Ans. The demand curve under perfect competition is perfectly elastic. Perfectly

elastic demand curve means any quantity can be sold only at a given price.

Under perfect competition, the price of the product is determined by the

industry by the forces of demand and supply and the firm has no option but to

accept it. Uniform price prevails because all firms are selling a homogeneous

product. A firm cannot influence or alter the price. Implying that a firm can

sell any quantity at the given price. Therefore, the demand curve will be a

straight line parallel to the X-axis as shown in Fig. ; which is perfectly elastic,

showing Ed=infinity

The demand curve under monopolistic competition is less than perfectly

elastic. It means more can be sold only at lower price. Under monopolistic

competition, the seller sells a differentiated product, so he exercises partial

control over price. But he can sell more only by lowering the price; certainly

not at the existing price.

This is what makes the demand curve less than perfectly elastic.

Q 4. Which features of monopolistic competition are monopolist in nature?

Ans. (i) Product differentiation

(ii) Control over price

(iii) Downward sloping demand curve

22

Q 5. How does an increase in the price of a substitute good in consumption

affect the equilibrium price?

Ans: With increase in the price of the substitute good, the equilibrium price of the

concerned good will increase owing to shift in demand curve to the right.

Q 6. „Changes in both demand any supply of a commodity may or may not

affect its equilibrium price.‟ Explain.

Ans: If the demand and supply of a commodity change equally, and in the same

direction there will be no effect on its price. On the other hand, an unequal

change in demand and supply will affect equilibrium price. When demand

increases more than supply, equilibrium price will rise. On the other hand,

when supply increases more than demand, equilibrium price will fall.

Q 7. When will the equilibrium price of a commodity not change even if its

demand and supply both increase? Explain with the help of a diagram.

Ans. If both increases equally.

Q 8. A severe drought results in a drastic fall in the output of wheat. Analyze

how will it affect the market price of wheat?

Ans: As a result of severe drought, the output of wheat is reduced. It means the

supply of wheat in the market will reduce, causing a shift of supply curve to

the left. Accordingly, market price of wheat will increase.

23

Q 9. Suppose the demand for jeans increases. At the same time, because of an

increase in price of cotton, the supply of jeans decreases. How will it

affect the price and quantity sold of jeans?

Ans: Increase in market demand for jeans along with a decrease in the supply of

jeans should raise the price of jeans and the quantity sold will decline.

Q 10. China is a big manufacturer of technology of telephone instruments. It

has recently become a member of W.T.O., which means it can sell its

products in other member countries like India. Suppose that it does

export a large number of telephone instruments to India:

(A) How will it affect the price and quantity sold of telephone instruments

in India?

(B) Suppose that the demand for telephone instruments is relatively

elastic. How will it affect India‟s total expenditure on telephone

instruments?

Ans: (A) As a result of large export of telephone instruments by Chine to India, the

market supply of telephone instruments increases. It reduces the price of

telephone instruments while the quantity sold will increase.

(B) If the demand for telephone instruments is relatively elastic, reduction in

price should increase total expenditure on telephone instruments in India.

Q 11. Mrs. Ramgopal says that economists say inconsistent things: as price

falls, demand rises, but as demand rises, price rises. Defend or refute.

Ans: The statement of Mrs. Ramgopal that “as price falls, demand rises, but as

demand rises, price rises”, can be defended. The first part of the statement i.e.

as price falls demand rises is the general behavior of the consumer in the

market. This is simply a forward movement along a demand curve. Demand

changes due to change in the price of the commodity. But, there may also be

situation when increase in demand leads to increase in price. When the supply

of the commodity remains unchanged. And demand increases (due to factors

other than price such as increase in income of the consumer or change in taste

preference of the consumer.) The demand curve shifts upward and it raises the

market price. Fig. illustrates the two situations:

24

Q 12. Answer all the questions in terms of shifts in or movements along the

demand and supply curves.

(A) In 2001, the Supreme Court of India banned smoking in public

places. How is this likely to affect the average price of cigarettes and the

quantity sold?

(B) New discoveries of oil reduce the price of petrol and diesel. Consider

their effects on the market for new cars.

(C) New environmental regulations require the drug industry to use a

more environment friendly technology whose running cost are higher but

which discharges less chemicals than before. How would it affect the price

of drug?

Ans: (A) A ban on cigarette smoking in public places should cause a backward shift

in demand curve. Consequently average price of cigarettes should fall. Fall in

average price of cigarette should cause a fall in quantity sold.

(B) New discoveries of oil reducing the price of petrol/diesel should imply

increase in demand for cars (in terms of shift in demand curve to the right), as

cars and petrol/diesel are complementary goods.

(C) Due to the use of costlier (environment friendly) technology, supply curve

of drug will shift to the left, causing a rise in the price of drug.

Q 13. In a state of equilibrium, price greater than MC is ruled out for a

perfectly competitive firm. Show diagrammatically.

Ans: Fig illustrates how prices greater than MC is ruled out for a perfectly

competitive firm in a state of equilibrium. Equality between price (AR) and

MC is struck at point Q where all the conditions of equilibrium are satisfied.

OL is the equilibrium level of output. Suppose the firm decides to produce

25

OL1 output where AR(=L1Q1)>MC(=L1T1). As a consequence of shifting

from Q to Q1; loss of TR=Q1L1LQ, while the TC is saved to the tune of Q1TQ.

Evidently, reduction in TC (=Q1TQ) is only a part of reduction in

TR(=Q1L1LQ). Implying that the differential between TR and TC(= profit)

would reduce in case the firm shifts from Q to Q1 Profit is maximized only at

point Q where price = MC.

Q 14. In a state of equilibrium, price lesser than MC is ruled out for a perfectly

competitive firm. Show diagrammatically.(Question for practice)

Q 15. What is firm‟s supply curve in the short run, operating under perfect

competition?

Ans: It is MC curve of the firm starting from a point where MC=AVC (minimum).

In Figure, short period supply curve of the firm is MC curve starting from point Q

where AR= AVC (minimum).

Q.16 In which market situation, the influence of an individual seller is zero?

26

Ans. In the Perfectly Competitive market situation.

Q.17 How is a single buyer a price taker in perfect competition?

Ans. A single buyer‟s share in total market demand is so significant that the buyer

cannot influence the market price on his own by changing his demand.

Q.18 Normal profit means zero economic profit. Why?

Ans. Suppose the existing firms are earning above normal profits. Attracted by the

positive profits, the new firms enter the industry .The market supply increases

and the price comes down. New firms continue to enter and the price

continues to fall till economic profits are reduced to zero.

In case of losses, firms start leaving the industry, supply falls and prices

starts going up and all this continues till losses are wiped out. Remaining

firms in the industry then once again earn just normal profits / zero profit.

Q. 19. Why does there are few firms in oligopoly market?

Ans.- There are only few firms in oligopoly market because there are some

restrictions on the entry of firms in the market. Which are inter-dependence of

firms, big requirements of funds, great competition among the firms. The only

firms which can break these restrictions are able to enter the market.

Q. 20. Does a monopolist has full control over the price?

Ans. No, because price is determined by the forces of demand and supply . a

monopolist controls only the supply side and demand side remain

uncontrolled.

27

UNIT VI

NATIONAL INCOME AND RELATED AGGREGATES


Q.1. When is the national income less than domestic income?

Ans. When NFIA is negative.

Q.2. When is the national income larger than domestic factor income?

Ans. When NFIA is positive.

Q.3. What is the effect of an indirect tax and a subsidy, on the price of the

commodity?

Ans. The effect of an indirect tax on a commodity is to increase the price and the

effect of subsidy is to reduce the price in the market.

Q.4. Are the wages and salaries received by Indians working in American

Embassy in India a part of Domestic Product of India?

Ans. No, because American embassy is not a part of domestic territory of India.

Q.5. 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.

Q.6. When is gross domestic product of an economy equal to gross national

product?

Ans. When NFIA is zero.

Q.7 Name a product whose value is included in GDP but its consumption

reduce welfare?

Ans. Liquor.

Q.8 Why is interest paid by consumers not a factor payment?

Ans. Because consumer borrow money for consumption purpose.

Q.9 If compensation of employees in a firm constitutes 55 % of net value added

at factor cost of the firm , find the proportion of operating surplus.

Ans. 100 % - 55 % = 45 % ( assuming mixed income is Zero)


Q.1. 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.

28

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

(iii) 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) It is included because it is his factor income (salary).

Q.2. State whether the following is a stock or flow:

(a) Wealth, (b) Cement production, (c) Saving of a household, and (d) Income of

household.(e)profit

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

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

Q.3. 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.

Q.4. Are the following included in the estimation of National Income a

country? Give reasons.

(i) Bonus received by employees.

(ii) Government expenditure on defence.

(iii) Money sent by a worker working abroad to his family.

(iv) Profit earned by a branch of Indian Bank in London.

(V) Expenditure by government in providing free education.

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

employees (salary in cash).

(ii) It should be included in NI because defence service is considered final

service so far as it provides peaceful and secure environment to the citizens.

(iii) It is included in NI because it is a part of NFIA.

(iv) It is included in NI of India because it is a part of NFIA.

(v) yes , it is a part of government final consumption expenditure.



(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.

29

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.

Q.6. 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.

Q.7 Should we treat subsidy as transfer payment?

Ans. No, value addition has already accrued. In fact, subsidies tend to lower the

market value of the good produced .Accordingly, these are added to the

market price to make it equal to the factor cost . Subsidies are a part of NNP

FC which is why these are deducted from factor cost to equate it with market

price.

LONG ANSWER TYPE QUESTIONS: (6 Marks Each)

Q. 1. Will the following be included in gross domestic product / Domestic

Factor Income of India? Give reasons for each answer.

(i) interest free loan to bank employees from bank

(ii) Factor income from abroad.

(iii) Compensation of employees given to residents of china working in

Indian embassy in China.

(iv) Profit earned by a company in India, which is owned by a non-

resident.

Ans. (i) no, it is to be repayed.

(ii) No, because factor income is earned not within the domestic territory of a

country but from abroad.

(iii) Yes, because Indian embassy in China is a part of domestic territory of

India.

(iv) Yes, because the company within India‟s domestic territory earns profit.

30

Q.2. 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.(4+2)

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 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.

Q.3. Are the following included in the estimation of National Income of India?

Give reasons for each answer.

(i) profits earned by Dabur India in U.K.

(ii) Money received from sale of shares.

(iii) Salary paid to Americans working in Indian embassy in America.

(iv) payment of electricity bill by a factory

(v) direct purchases of government in a foreign country.

(vi) Remittances from aboard.

Ans. (i) Yes , it is a part of factor income earned from abroad.

(ii) No, it is only a transfer of paper claims.

(iii) No, this factor income belongs to non-residents.

(iv) No. it is intermediate consumption.

(v) Yes , it is government final consumption expenditure.

(vi) No, it is only a transfer payment. No commodity is sent or services

rendered return for this.

Q.4. Will the following be included National Income? Give reasons for each

answer.

(i) Services of owner occupied houses.

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

(iii) Purchase of second-hand machine from a domestic firm.

(iv) Consultancy fee paid to a foreign expert.

(v) Commission paid to agent for the sale and purchase of shares.

(vi) Dividend received on shares.

Ans. (i) Yes, Imputed rent of owner occupied houses will be included in NI.

(ii) No, because it is a financial transaction which does not help directly in

production.

(iii) No, because it is not related with current flow of goods and services.

(iv) No, as it is a factor income paid abroad (it is earned by non-residents).

(v) Yes, It is included in NI since it is paid for rendering productive services.

31

(vi) Yes, dividends are a part of corporate profit and therefore, include in NI.

Q.5. 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.



(i) Services rendered by family members to each other.

(ii) Wheat grown by a farmer but used entirely for family‟s consumption.

(iii) Expenditure government on providing free education.

(iv) Payment of fees to a lawyer engaged by a firm.

(v) Man of the match award to a player of the Indian cricket team.

(vi) Payment of the match fee to players of Indian cricket team.

Ans. (i) Services rendered by family members to each other should not be included

in NI because these are not rendered for the purpose of earning income.

(ii) Imputed value of self-consumed wheat grown by a farmer must be

included in NI, because it adds in the flow of goods.

(iii) It should be included in NI because the government expenditure on the

free services is considered as a part of government final consumption

expenditure.

(iv) Yes, as it is factor income against the service of lawyer.

(v) It should not be included in NI because it is a windfall gain and it does not

add in the flow of goods and services.

(vi) It should be included in NI of India because they render productive

services as professionals.

32



(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

NUMERICAL PROBLEMS WITH SOLUTIONS:

Q.1. Calculate private income, personal income, personal disposable income and

National disposable income from the following data:

(Rs. in Crores)

(i) National income 3000

(ii) Savings of private corporate sector 30

(iii) Corporate tax 80

(iv) Current transfer from government 60

(v) Income from property and entrepreneurship to government 150

(vi) Current transfers from rest of the world 50

(vii) Savings of non-departmental government sector 40

(Viii) Net indirect taxes 250

(ix) Direct taxes paid by household 100

(x) Net factor income from abroad (-) 10

33

Solution: -

Private income = (i) - (iv + vii) + (iv + vi)

= 3000 - (150 + 40) + (60 + 50)

= 2920 Crores.

Personal income = 2920 - (ii) - (iii)

= 2920-30-80

= Rs 2810 Crores.

Personal Disposable Income = 2810- (ix)

= 2810-100

= Rs 2710 Crores.

National Disposable Income = (i) + (vi) + (viii)

= 3000 + 50 + 250

=Rs 3300 Crores.

Q2. Calculate NI by income and expenditure method:

(Rs. in Crores)

(i) Subsidies 5


(iii) NFIA (-) 10

(iv) Indirect Tax 25

(v) Rent 5

(vi) Government final consumption expenditure 20

(vii) Net domestic fixed capital formation 30

(viii) Operating surplus 20

(ix) Wages 50

(x) Net export (-) 5

(xi) Addition to stock (-) 5

(xii) Social security contribution by employers 10

(xiii) Mixed income 40

Solution: -

Income method

NI= (ix) + (xii) + (viii) + (xiii) – (iii)

= 50 +10 + 20 + 40 -10

=Rs 110 Crores.

Expenditure method

NI = (ii) + (vi) + (vii) + (xi) + (x) - (iv) + (i) + (iii)

=100 + 20 + 30 + (-) 5 + (-) 5 – 25 + 5 +10

34

=Rs 110 Crores.

Q.3. Calculate the value added by Firm A and Firm B from the following data: -

(Rs. in Lakhs)

(i) Purchase by Firm A from the rest of the world 40

(ii) Sales by Firm B 100

(iii) Purchases by Firm A from Firm B 60

(iv) Sales by Firm A 120

(v) Exports by Firm A 40

(vi) Opening stock of Firm A 45

(vii) Closing stock of Firm A 30

(viii) Opening stock of Firm B 40

(ix) Closing stock of Firm B 30

(x) Purchases by Firm B from Firm A 60

Solution: -

Value Added by Firm A = (iv) + [(vii) – (vi)] – (i) – (iii)

= 120 + [30 – 45] – 40 – 60

= Rs 5 Lakhs.

Value Added by Firm B = (ii) + [(ix) – (viii)] - (x)

= 100 + [30 – 40] - 60

= Rs 30 Lakhs.

Q.4. Estimate (i) Personal Income, (ii) Private Income and (iii) Personal

Disposable Income with the help of the following data.

(Rs. in Crores)

(i) National income 1300

(ii) Corporate tax 15

(iii) Direct personal taxes 40

(iv) Savings of private corporate sector 25

(v) Income from property and entrepreneurship accruing to Government

Administrative Departments 35

(vi) Current transfer from government administrative departments 30

(vii) National Debt Interest 10

(viii) Savings of non departmental government enterprises 5

(ix) Current transfers from rest of the world 15

Solution: -

Private Income = (i) - (v) – (viii) + (vii) + (vi) + (ix)

= 1300 – 35 – 5 +10 + 30 + 15

= Rs. 1315 crores.

35

Personal Income = Private Income – (ii) – (iv)

= 1315 -15 -25

= Rs 1275 crores.

Personal Disposable Income = Personal Income – (iii)

= 1275 – 40

= Rs 1235 Crores.

Q.5. Estimate (i) Personal Disposable Income, (ii) Private Income and (iii)

National Income from the following data:

(Rs. in Crores)

(i) Personal income 1225

(ii) Saving of private corporate sector 12

(iii) Corporate tax 23

(iv) Current transfer from government administrative departments 30

(v) Current transfer from rest of the world 25

(vi) Income from property and entrepreneurship accruing to Government

Administrative Departments 25

(vii) Savings of non departmental government enterprises 20

(viii) Net indirect tax 195

(ix) Direct tax paid by the households 25

Solution: -

Personal Disposable Income = Personal income - Direct tax

= 1225 - 25

= 1200 Crores

Private Income = Personal income + Saving of private corporate sector + Corporate

tax

= 1225 +12 + 23

= 1260 Crores

National Income = Private Income – (iv) – (v) + (vi) + (vii)

= 1260 – 30 - 25 + 25 + 20

= 1260 Crores

36

Q.6. Estimate the following with the help of given data:

(i) GDPMP ,

(ii) Net Value Added at factor cost; and (iii) prove that it is equal to the income

generated.

(Rs. in Crores)

(i) Increase in the stock of unsold goods 1000

(ii) Sales 10,000

(iii) Net indirect tax 800

(iv) Purchase of raw materials from other firms 1650

(v) Purchase of fuel and power 850

(vi) Consumption of fixed capital 500

(vii) Rent 700

(viii) Wages and salaries 3500

(ix) Interest payment 1000

(x) Dividend 1500

(xi) Corporate gain tax 300

(xii) Undistributed profit 200

Solution: -

GDPMP = Sales + Increase in the stock - Purchase of raw materials - Purchase of fuel

and power.

= 10,000 + 1000 -1650 -850

= 11,000 -2500

= 8500 Crores.

Net Value Added at factor cost = Sales + Increase in the stock - Purchase of raw

materials –

Purchase of fuel and power - Consumption of fixed capital - Net

indirect tax.

= 10,000 + 1000 - 1650 - 850 - 500 – 800

= 11,000 – 3800

= 7200 Crores.

Income generated = Rent + Wages and salaries + Interest + Dividend + Corporate

gain tax + Undistributed profit.

= 700 + 3500 + 1000 + 1500 + 300 + 200

= 7200 Crores.

Hence it is proved that Net Value Added at factor cost = Income Generated

37

UNIT VII

DETERMINATION OF INCOME AND EMPLOYMENT


Q. 1 Can consumption exceed income? If yes, what is the saving then?

Ans. Yes, when income is zero or less than subsistence level of

consumption . Saving is –ve.

Q.2 How much new income will be generated in an economy with an

increase in investment by Rs. 200 and when two-third of rise in

income spent on consumption.

Ans. 600 Rs .

Q.3 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.

Q.4 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.

Q.5 What happens in an economy, when credit availability is restricted and

credit is made costlier?

Ans. Aggregate demands falls


Q.1 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

38

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.

Q.2 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.

Q.3 Show a point on the consumption curve at which APC= 1.

Ans. APC = C/Y =1 is possible if C=Y, i.e. Consumption is equal to Income.

Q.4 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.

39

.

Q.5 Calculate consumption expenditure at the income level of Rs.1000 crores,

if autonomous consumption is Rs. 80 crores. And 20% of additional income is

saved.

Ans. MPS = 0.2

SO , MPC =0.8

C=c + bY (c = autonomous consumption)

C= 80+ 0.8 * 1000=Rs. 880 crores.

Q.6 Find national income from the following:

Autonomous consumption : Rs. 100

MPC : 0.8

Investment : Rs. 50

Ans. Y = c + b Y+ I

= 100+0.8 Y +50

Y= Rs. 750

40

UNIT – VIII

MONEY AND BANKING


Q.1 Money acts as a yardstick of standard measure of value to which all other

things can be compared. Discuss it.

Ans. Money serves as a measure of value in terms of unit of account. Measurement

of value was the main difficulty of the barter system. Introduction of money has

removed this difficulty. It acts as a yardstick of standard measure of value to which

all other things can be compared.” Money measures the value of everything or the

prices of all goods and services can be expressed in terms of money. This function of

money also enables the trading firms to ascertain their costs, revenues, profits and

losses.

Q 2. The central bank acts as lender of last resort. How?

Ans. The central bank also acts as lender of last resort for the other banks of the

country. It means that if a commercial bank fails to get financial accommodation

from anywhere, it approaches the central bank as a last resort. Central bank advances

loan to such a bank against approved securities. As a lender of the last resort, central

bank exercises control over the entire banking system of the country.

Q 3. Central bank performs the function of a clearing house. How?

Ans. Every bank keeps cash reserves with the central bank. The claims of banks

against one another can be easily and conveniently settled by simple transfers from

and to their account. Supposing, Bank A receives a cheque of Rs 10,000 drawn on

Bank B and Bank B receives a cheque of Rs. 15000 drawn on Bank A. The most

convenient method of settling or clearing their mutual claims is that Bank A should

issue a cheque amounting to Rs 5000 in favour of Bank B, drawn on central Bank.

As a result of this transference, a sum of Rs 5000 will be debited to the account of

Bank A and credited to the account of B. There is not need of cash transactions

between the banks concerned. It facilitates cash transaction across the entire banking

system, it also reduces requirement of cash reserves of the commercial banks.

41

UNIT – IX

GOVT BUDGET AND THE ECONOMY


Q.1 What does low primary deficit indicate?

Ans. It implies that the government is borrowing largely to make interest payment

on previous loans.

Q.2. Why is sales tax treated as revenue receipt?

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

govt.

Q.3 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

Q.4. 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

Ans. Rs. 58,000 crores

42


Q.1 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.2 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.

43

Q.3 Identify the following as revenue receipts and capital receipts.

Give reason .

(i) Financial help from microsoft for the victims of flood affected

areas.

(ii) Sale of 40 % shares of publicc sector undertaking to a private

enterprise (iii) Profits of LIC

Ans. (i) & (iii) are revenue receipts because they neither create liability

nor reduce assets of the government..

(ii) is capital receipts as it reduce assets of the government.

Q.4 Identify the following as revenue expenditure and capital

expenditure. Give reason .

(i) grants given by central government to state government

(ii) 10% share purchase by the government in a private company.

(iii) Pension paid to retired government employees.

Ans. (i) & (iii) are revenue expenditure as it neither create assets

nor reduce liability of the government.

(ii) is capital expenditure as it increase assets of the government.

Q.5 How can surplus budget be used during inflation?

Ans. In case of surplus budget, government is taking more money from

the economy than injecting into it. It results in a fall in aggregate demand

which is considered good to check inflation.

Q.6 Give the relationship between revenue deficit and fiscal deficit.

Ans. Revenue deficit = revenue expenditure – revenue receipts

Fiscal deficit = revenue deficit + ( capital expenditure – non-debt

creating capital receipts)

So , revenue deficit is a part of fiscal deficit

44

UNIT – X

BALANCE OF PAYMENT

VERY SHORT ANSWER TYPE QUESTIONS: - (1 Marks Each)

Q.1 What is foreign exchange?

Ans. It is the amount of currency reserves of all countries other than the

domestic currency .

Q.2 What does a change from Rs. 52 = $ 1 to Rs. 56 = $ 1 indicate?

Ans. Indian rupee depreciate in terms of $.

Q.3 Why are autonomous items called „above the line ` items?

Ans. Because autonomous items are recorded in BOP as first items before

calculating surplus or deficit.

Q.4 Is import of machinery recorded in current account or capital

account?

Ans. Since import of machinery is import item , it is recorded in current

account.


Q.1 Why foreign currency/exchange is needed?

Ans. i) To purchase of goods and services from other countries.

ii) To send a gift abroad.

iii) To purchase financial assets in a particular country and

iv) To speculate on the value of foreign currencies.

Q.2. What are the factors responsible for inflow of foreign currency?

Ans. i) foreigners purchasing home country goods and services through exports.

ii) Foreigners investment in home country through joint ventures and through

financial market operation.

iii) Foreign currencies flow into the economy due to currency dealers and

speculators

Q.3 When exchange rate of foreign currency falls it‟s supply also falls. Explain

how?

45

Ans. When exchange rate falls, experts become less profitable hence supply of

foreign currency through exports falls.

Q.4 When exchange rate of foreign currency falls, its demand rises. Explain

how?

Ans. When exchange rate falls, imports become cheaper, demand for imports rises

and so rises the demand of foreign exchange to purchase more imports.

Q.5 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

Q.6. 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

Q.7. Find the primary deficit if fiscal deficit is Rs 15,000 crores and interest

payment is Rs 4,000 crores

Ans:- Primary deficit= Fiscal deficit- Interest Payment

=15,000-4,000

= 11,000 Ans. Rs. 11,000 crores

Q.8 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.

46

Q .9 Should a current account deficit be always a cause for alarm? Explain.

Ans. If the increase in current account deficit indicates rise in investment , then it

will increase future output , so it is not a cause of alarm but it is a cause of worry if

the increase in current account deficit reflects smaller savings or large budget deficit

because it indicates higher government or private consumption.

PART-I

MICRO ECONOMICS Note:- Q1 to Q7 carry the weightage of 1 marks each and from Q8 to Q20 carry the weightage of 3/4 marks each Ques1. In an underdeveloped economy why there is the need of efficient utilization of resources? Ques 2. A farmer is getting more profit in producing opium than in production of wheat. In the situation of famine which crop should be produced? Ques3. Why has the power crisis increased in India? Ques 4. According to law of demand by increasing the price of a good its demand decreases but in the case of petrol, its demand is increasing with increase in price why? Explain. Ques5. Inspite of having monopoly, Why the Indian Railway has not increased the fare for many years? Ques 6. The market price of sugar rises when its demand increases. How the supply of sugar can be changed so that price of sugar remain constant? Ques7. Although there are few (more than one) firms in oligopoly. Even these firms can enjoy monopoly power. How? Ques 8. How can the productivity of Human resources be increased? Ques 9. What efforts should be made in an economy for the continuous use of exhaustible natural resources in production? Ques 10. There are various sources of income a teacher has such as 1. He can earn Rs 40000 from teaching in school. 2. He can earn Rs 50000 by tuition/coaching 3. He earns Rs 60000 by writing help book guides. What is the opportunity cost of teaching in school? Why should he choose teaching profession? Ques 11- How is the law of diminishing marginal utility applied with regard to education/ knowledge?

Ques12- The demand of electricity is increasing but due to scarcity of resources its supply cannot be increased. Give any two measures how the demand of electricity can be decreased? Ques13. Even the price of petrol is very high but still its demand is very high. How can the demand of petrol be decreased? Ques 14. A manager of zoo wants to increase the revenue, which measure is more appropriate i. Increase the entry fee ii. Decrease the entry fee. Explain? Ques15. Even the contribution of plastic industry in GDP is more then why it is not considered an Index of social welfare? Ques16. Explain the effects on the market equilibrium by imposing ban on the sale of GUTKA in Delhi? Ques17. How can the tax policy of Govt be effective in controlling the supply of LIQUOR like harmful product? Ques 18. In a situation of fall in the sale of Ice-Cream, the Ice-Cream producer would like to reduce the production. What factors of production fixed or variable will be reduced by him? Explain with reasons. Ques 19. Availability of agricultural land (fixed factor) is limited in the world, but demand of food grain in continuously increasing, is it possible to increase the supply of food grains by continuously increasing variable factors like seeds, fertilizers etc. explain? Ques 20. The demand for cooking gas is not falling inspite of regular hike in the price of cooking gas. What will be the elasticity of demand for cooking gas. Explain giving suitable reasons in support of your answer.

PART-II

MACRO ECONOMICS Note:- Q1 to Q6 carry the weightage of 1 marks each and from Q7 to Q25 carry the weightage of 3/4 marks each Ques1. Why comparing the GDP of various nations might not tell you which nation is better off? Ques 2. Compensation to flood victims is a good social security measure by the Govt. But why it is not included in the estimation of national income? Ques3. GDP Calculation do not directly include the social costs of environmental damages for example global warming, acid rain. Do you think these costs should be included in GDP? Why or Why not? Ques4. Why did India devalue its currency in 1991? Ques5. Do you think that a rise in BPO services a good source of supply of foreign currency? Ques6. Suppose the present foreign exchange rate is 1$= Rs50 and if it falls to 1$=Rs60 should central bank intervene in the foreign exchange rate? Ques7. Why do non market economic activities like 1. Services of housewives 2. Voluntary services 3. Leisure time activities

help in the flow of goods and services of a country. But why these are not included in the estimation of national income? Ques 8. GDP growth rate in India for the last few years is more than 6% but still more than 28% of population is lying below poverty line. Explain any two factors responsible for it. Ques9. In the situation of inflation credit creation by commercial bank is beneficial for the bank but it explain its negative impact on economy? Ques10. In Indian market, money supply is the reason of rising price level. Explain any one measure of central bank to control money supply? Ques11. Why is the use of money more convenient for exchange than barter system. Explain? Ques 12. Suppose all the customers of a commercial bank demand for their deposits at the same time then how does central bank help to commercial bank in this situation. Ques 13. Why do all the compensation in form of money than toys more convenient to an employee working in toy manufacturing factory? Ques14. Excess money supply is necessary for rapid economic development but it creates inflationary situation. Write any two fiscal measures to control inflationary situation. Ques15. Saving provides economics security in future but why it is not good from the viewpoint of investment multiplier? Ques 16. Why do the consumption expenditure of involuntary unemployed worker not zero, even at zero level of income? Ques17. What impacts will be on economy when there is planned investment is less than planned saving? What steps should be taken by the govt to maintain equilibrium in the economy. Ques 18. Increase in money supply is an effective measure to control economic depression but it creates the burden of borrowing on economy. Explain any two measures by which economic depression can be controlled even in the situation of increase in money supply. Ques 19. In India unemployment is a major problem, if aggregate demand is equal to aggregate supply, can it be called a situation of equilibrium? Ques20. In India a majority of population is lying below poverty line due to inequality of ‘Income and Wealth’ . How can budget be helpful in solving this problem? Ques21. There has been consistent rise in prices of fruits and vegetables in Delhi for sometimes. Which measures of budget will you support to reduce the prices of these commodities? Ques22. Budget deficit creates disequilibrium in every economy but in developing countries like India, why does Govt depend on it?

Ques23. Classify following items into Revenue Expenditure and capital expenditure. Give reason for your answer. 1. Free Supply of Stationary to the students by the Govt. 2. Economic assistance given according to Ladli Scheme. 3. Expenditure on the construction of computer lab in school. 4. Expenditure on Mid Day Meal given to students by the Govt. Ques24. Should a current account deficit be a cause for alarm? Explain. Ques25. What impact will fall on the expenditure of an American citizen who comes to India for Medical treatment if foreign rate is increased?

SUGGESTED ANSWERS

PART-I

MICRO ECONOMICS Ans1- Developmental needs are more in under developed economy and these are fulfilled with our limited resources. Value- Critical Thinking Ans2- Production of Wheat because in the situation of famine, food grain like wheat is required more than opium Value- Social Welfare

Ans3- Because its demand is greater than supply Value- Awareness about efficient use of power Ans4- Now a days petrol has become a necessary good and its supply is limited. Value- - Critical Thinking Ans5- Indian Railway is a major public sector undertaking and its main motive is social welfare not the profit. Value- Social Welfare Ans6- The price of sugar remains constant when demand and supply increase in the same proportion. Value- problem Solving Ans7- Firms in oligopoly form cartel and in this way these firm can control over prices. Value- Critical Thinking Ans8 – The Productivity of Human Resource can be increased with the help of human capital formation by providing training and skill to available labour force. Value-creative Thinking Ans9 – There are the various efforts- 1. To increase use of renewable resources 2. To explore the substitutes of resources 3. To reduce the wastage of resources. 4. To spread awareness about the effectively and optimum use of natural resources. Value -Environmental Conservation Ans-10 - Opportunity cost of teaching is writing books. He should choose teaching profession because it provides maximum social welfare Value- Social Welfare Ans11- In this case the law of diminishing marginal utility will not apply because every effort to get education/ knowledge increases the utility. Value Analytic Ans 12- 1. Use the energy/ electricity saving devices. 2. Use alternative sources of electricity such as solar energy, wind energy etc Value -Environmental Conservation Ans13 - 1. By car pooling 2. By using public transport system 3. By using alternative and renewable resources of petrol such as solar energy. Value- Awareness for efficient use of resources Ans 14- By reducing the entry fee the number of visitors will increase and total revenue will increase, but if the entry fee is increased then number of visitors will decrease and total revenue will fall. Value- Problem solving

Ans 15- Because in the production of plastic product, a lot of harmful gases are released in the atmosphere. Value-Environment Conservation Ans 16- Due to the ban on the sale of GUTKA in Delhi, the supply of GUTKA will be reduced and the firms producing GUTKA will shift their factors of production in the production of other related goods. Consumer demand of GUTKA will reduce and hence in this way both the demand and supply of GUTKA will reduce Value-Social Health Conciousness Ans 17- The production of LIQUOR like harmful product will be less profitable to the producer due to increasing tax rate because the difference between the revenue and cost decreases and hence producer’s profit will decrease and the supply of liquid will be decreased. Value- Social Health Conciousness Ans 18- when sale of ice-cream decreases then profit of producer will fall by which he will try to control his cost of production but in short run he cannot change the cost of fixed factors therefore he will reduce the cost of variable factors. Value- Analytic Ans 19 -Availability of agricultural land is limited in the world, production of food grains may be increased by continuous increase in variable factors only upto a optimum combination with fixed factor. After that law of negative returns is applied. Value- Critical Thinking Ans 20 - The elasticity of demand for cooking gas will be inelastic because there will be no change in demand for cooking gas inspite of rise in price of cooking gas. Value- Critical Thinking

PART-II

MACRO ECONOMICS Ans 1- The well being of nation or standard of living of people is measured by per capita income (GDP/ Total Population) and distribution pattern of income not only by GDP Value- Critical Thinking Ans 2- Because this is a transfer payment Value- Implement of Knowledge Ans 3- Yes because people’s well being is affected by these environmental damages. No, it is very difficult to assess real damages in monetary terms. Value- Awareness about social cost of GDP

Ans 4-India devalued its currency in 1991 to increase the flow of foreign exchange reserve. Value- Analytic Ans 5- Yes, because it is a export of services and good source of foreign currency. Value- Critical Thinking Ans 6- Yes, Central Bank should intervene in order to safeguard the interest of the importers. Value- Creative Thinking Ans 7- They are not included in national income, because of non-availability of data and problem in measuring the proper monetary values of these services. Value- Implication of Knowledge Ans 8- There are two factors 1. Unequal distribution of GDP 2. Rise in price level Value- Social Awareness Ans 9- Money creation by commercial bank in the condition of rising prices increases money supply it creates the situation of excess demand and consequently again increases the price level. Ans 10- explain any one reason 1. Bank Rate 2. Cash Reserve Ratio (CRR) 3. Statutory Liquidity Ratio (SLR) Value- Thinking Ans 11- 1. Medium of Exchange 2. Store of Value 3. Standard of deferred payment Value- Empathy Ans 12- Explain the function of central bank as lender of the last resort. Value- Analytic Ans 13- There is lack of general acceptability in case of toys, while in the case of money there is general acceptability so he can purchase any goods and services with the help of money at any point of time and he does not face any problem of lack of double coincidence of wants. Value- Empathy Ans 14- Fiscal Measures 1. Increase in Tax rates 2. Reduce Public expenditure Value- Critical Thin king Ans 15- Money supply is reduced by increase in savings, which creates the situation of deficient demand in economy, consequently it reduces the functioning of investment multiplier. Value- Analytic

Ans 16- A worker has to incur some expenditure to fulfill his basic needs even at zero level of income. Value- Empathy Ans 17- If there is planned investment is less than planned saving this will create the situation of deficient demand in the economy and it will result increase in the inventory stock of unsold goods. In this situation of Govt. should take fiscal & monetary measures to increase aggregate demand. Value- Analytic Ans 18-1 . Decrease in Bank Rate 2. Decrease in statutory Liquidity Ratio (SLR) 3. Purchasing of Govt. Securities by the central bank Value- Critical Thinking Ans 19- No, because it is the situation of under-employment equilibrium. Value- Problem Solving Ans 20- In Indian budget progressive tax system can be a good measure to remove the inequality of ‘income and wealth’ and govt should provide social facilities like education, health & food grain to the poor at subsidized rate. Value- Problem Solving Ans 21- Prices of fruits and vegetables can be reduced by providing subsidies to the producer of fruits & Vegetables and govt. should also provide fruits and vegetables at subsidised rates to the consumers through public distribution system. Value- Problem Solving Ans 22- Per capita income in developing countries like India is comparatively low so the tax receipts of the Govt are not sufficient, but on the other hand govt has to incur heavy public expenditure for the development of economy so Govt is compelled on budget deficit. Value- Economic Awareness Ans23 - 1,2 &4 are revenue expenditure because it neither create assets nor cause reduction in assets. 3 is capital expenditure because it increase assets of the Govt. Value - Analytic Ans 24- No, if deficit in current account is offset by the capital account otherwise such deficit has to be met by following which is a cause for alarm. 1. Depleting Foreign Exchange reserves 2. Taking foreign Loans. Value- Analytic Ans 25- Expenditure on treatment will reduce because by the increasing foreign exchange rate, his purchasing power will increase. Value- Empathy

VALUE BASED QUESTION AND ANSWER

OF

ECONOMICS

FOR

CLASS XII

NOTE:-FROM THE ACADEMIC SESSION 2012-13 THE CBSE IS

INTRODUCING VALUE BASED QUESTION IN THE QUESTION

PAPER. ACCORDINGLY IN 2013 BOARD EXAMINATION 05(FIVE)

MARKS WILL BE VALUE BASED QUESTION.ONE OR TWO

QUESTIONS WILL BE OF ONE MARK AND ONE THREE MARK OR

ONE FOUR MARK QUESTION WILL BE ASKED IN THE QUESTION

PAPER.

SOME SAMPLE QUESTION IS GIVEN IN THE CBSE WEB

SITE.KEEPING THAT IN MIND SOME VALUE BASED QUESTIONS

HAS BEEN PREPARED FROM MICRO AND MACRO ECONOMICS.

THE SOURCE FOR THE SAME IS CBSE SITE, SOME REFERENCE

MATERIAL AND OWN EXPERIENCE IN THE FIELD OF ECONOMICS.

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MACRO ECONOMICS

Q1. Ms. Nidhi is interested in knowing the change in quantity produced by a farmer with

a fall in the price of the product. Which branch of economics would she study to

ascertain the change?

Ans .Micro Economics

Q2. Give an example to show that an item which is kept constant in micro economics is

considered a variable in macro economics.

Ans. National Income is kept constant in micro economics, but in macro economics, it is

considered as an important variable.

Q3. What is the rationale for not taking into account the value of intermediate goods in

the measure of Gross Domestic Product?

Ans. To avoid the problem of double counting.

Q4.Will the commission given to a broker for sale of an old house be included in national

income?

Ans. Yes, it will be included in national income as it is a payment for productive service

received.

Q5.Why leisure is not included in Gross National Product?

Ans. It is very difficult to measure the value of leisure.

Q6.State whether money supply is a stock variable or flow variable?

Ans. Money supply is a stock variable because it is expressed at particular point of time.

Q7.What will be the effect of a rise in the bank rate on money supply?

Ans. Money supply will reduce.

Q8.Can the value of Average Propensity to Consume be greater than one?

Ans. Yes, the value of APC can be more than 1.At low levels of income; consumption

tends to be more than income. So ,APC >1 before the break- even point is attained.

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Q9.Can Average Propensity to Consume be ever zero?

Ans. APC can never be equal to zero as consumption can never be zero at any level of

income.

Q10.What happens when the credit availability is restricted and credit made costlier?

Ans. Limited and costly credit leads to contraction of credit and it has a deflationary

impact on the economy.

Q11.Why is an entertainment tax, an indirect tax ?

Ans. The burden of entertainment tax can be shifted to other persons(ultimate

consumers).

Q12.The price of 1 US Dollar has fallen from Rs 50 to Rs48.Has the Indian currency

appreciated or depreciated?

Ans. Indian currency has appreciated.

Q13.Why are exports entered as positive items in the balance of payments accounts?

Ans. Exports lead to an inflow of foreign exchange in the country. Thus they are recorded

as positive (credit) items.

Q14.How is purchase of an asset in another country treated in the capital account?

Ans .Purchase of an asset in a foreign country appears as a negative (debit) item in the

capital account (as there is an outflow of foreign exchange).

Q15.Should a current account deficit be a cause for alarm? Explain.

Ans. Since deficit in current account is met by the surplus of capital account, it is not taken

as a cause for alarm.

Q16.How does real flow consist of factor flow and product flow?

Ans .Real flow consists of two kinds of flows:

(i)Factor flow :It is the flow of factor services from households to firms.

(ii)Product flow :It is the flow of goods and services from firm to households.

Q17. “All producer goods are not capital goods.”Comment.

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Ans. It must be noted that all goods used by producer (known as producer goods) are

not capital goods. Producer goods include ( i)Raw material;(ii)Fixed assets like plant

and machinery .The first type of producer goods (i.e. raw material, like

coal,wood,etc.),are not capital goods as they lose their identity in the production

process. They are single- use producer goods and cannot be repeatedly used in the

production process..So, it can be said that all capital goods are producer goods, but

all producer goods are not capital goods.

Q18.Why do we have different methods to measure the national income ?Why all the methods lead to same estimate ?

Ans. We have three different methods to measure the national income(value added method, income method and expenditure method )because production, income and expenditure are three different phases of circular flow of income. Use of particular method depends on the availability of reliable data.

All the three methods lead to same estimate because they are used to measure the

same physical output at three different phases.

Q19.The Reserve Bank of India aims to make the credit costly for the general public in order to reduce the availability of credit. What should be done ?

Ans. The Reserve Bank of India should increase the bank rate. An increase in the bank rate

increases the costs of borrowing from the central bank.It forces the commercial

banks to increase their lending rates, which discourages the borrowers from taking

loans.It makes the credit costly for the general public and reduces the availability of

credit.

Q20.If inflation is higher in country A than country B ,and the exchange rate between the

countries is fixed .What is likely to happen to the trade balance between the two

countries ?

Ans. In this situation, the exports from country B to country A will rise and it will lead to

surplus trade balance for country B.However , due to higher prices in country A ,its

imports will increase from country B and it will lead to deficit in trade balance for

country A.

MICRO ECONOMICS

Q1.Massive unemployment will shift the PPF to the left. Defend or refute.

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Ans. The given statement is refuted .Massive unemployment does not decrease

the capacity of economy to produce. So, there will be no shift of PPF.

However, economy will operate at some point inside the PPF, due to

unutilisation of human resources.

Q2.What is the opportunity cost of an input which has no alternative use?

Ans. The opportunity cost of such input is zero.

Q3.Utility is directly linked with the usefulness of a commodity. Is it true or

false?Give reason.

Ans. False. A commodity may not be useful, yet it may have utility for a particular

person. For example, chewing tobacco is harmful for health ,yet many

people derive high degree of utility from it.

Q4.In order to encourage tourism in Goa, Indian Airlines reduces the air fare to

Goa.How will it affect market demand curve for air travel to Goa ?

Ans. There will be a downward movement along the same market demand curve

for air travel to Goa. It happens because of decrease in the air fare.

Q5. At certain level of output ,the marginal cost of a firm is above its marginal

revenue .Can this be its equilibrium output ?

Ans.No,it can not be its equilibrium output because the marginal cost exceeds the

marginal revenue. The firm is running at a loss.

Q6. Trendz produces both jeans and shirts .How will an increase in the price of

jeans affect the supply curve of shirts ?

Ans. An increase in the price of jeans will make the production of jeans more

attractive . As a result ,Trendz will shift its resources from shirts to jeans.It

will shift the supply curve of shirts towards left.

Q7. A severe drought results in a drastic fall in the output of wheat. Analyze how

it will affect the market price of wheat.

Ans. Market price of wheat will increase(due to decrease in supply).

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Q8.What will be the effect on equilibrium price and equilibrium quantity of

telephone instruments ,if China exports a large number of telephone

instruments to India.

Ans. Equilibrium price will fall and equilibrium quantity will rise(due to increase in

supply).

Q9. ‘Both , microeconomics and macroeconomics have same degree of

aggregation’.Defend or refute.

Ans. The given statement is refuted.

●Micro economics involves limited degree of aggregation.For example,

market demand (micro concept)is derived by aggregating individual

demands of all the buyers in particular market.

●On the other hand , macro economics involves the highest degree of

aggregation. For example,aggregate demand(macro concept)is derived for

the entire economy. It means ,micro economics and macro economics

differ in degree of aggregation.

Q10.”Law of demand is a quantitative statement”. Comment.

Ans. Law of demand is only an indicative and not a quantitative statement. It

indicates only the direction, in which the demand will change with a change

in price. It says nothing about the magnitude of such a change. For example

price of Pepsi rises from Rs 10 to Rs 12 per bottle,then,as per law of

demand, we can say that the demand for Pepsi will fall. But the law does not

give the actual amount by which the demand for Pepsi will decline.

Q11. “MC can be calculated both from total cost and total variable cost and is not

affected by total fixed cost.”Discuss.

Ans. The given statement is correct.MC is not at all affected by total fixed cost

(TFC). MC is addition to TC or TVC when one more unit of output is

produced. As TFC remains same with increase in output ,MC is independent

of fixed cost and is affected just by change in variable costs.

Q12.Why AR curve under monopolistic competition is more elastic than AR curve

under monopoly?

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Ans. The AR curve under monopolistic competition is more elastic because there

exists close substitutes of the product sold by the monopolistic firm where

as under monopoly the AR curve is less elastic because there is non

availability of close substitutes of the product sold by the monopoly firm.

Q13.How does a firm under monopolistic competition exercise partial control

over price?

Ans. A monopolistic competitive firm enjoys partial control over price. It happens

because by incurring heavy selling costs, the firm is able to create a

differentiated image of its product in the minds of consumers. Products are

differentiated on the basis of brand ,size, color, shape,etc.Buyers are

attracted to buy a particular product even at a relatively higher price.

Q14.Why is number of firms small in an oligopoly market ?

Ans. The main reason for small number of firms under Oligopoly is the Barriers to

entry, which prevent entry of new firms into the industry. Patents,

requirement of large capital,control over crucial raw materials,etc,are some

some of the other reasons,which prevent new firms from entering into

industry.As a result ,there are few firms in an Oligopoly market.

Q15.”Demand and supply are like two blades of a pair of scissors”.Comment.

Ans. The given statement is correct.Both the blades of pair of scissors are equally

important to cut a piece of cloth.Similarly ,both demand and supply are

neede for determining price in the market.There is no use for demand for a

product if there is no supply for the product and supply is not needed if

there is no demand for the product. One of the two may play more active

role in price determination in the short run.But,,both are needed to

determine the price in the long run.

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