Professional Documents
Culture Documents
P.I. = IAPS + Net current transfers from rest of world + Net current transfer from govt. + Interest on public dept + NFIA.
(ii) Personal Income : It is the sum of earned income and transfer income received by households from all sources
within and outside the country. It shows the purchasing power of the households.
(iii) Personal Disposable Income : It is that part of personal income which is avaibale to the households for disposal.
P.D.I. = Personal Income Direct Taxes Misc Exp. of govt. administrative department.
(iv) National Disposable Income : It is the sum of earned and unearned incomes received by the residents of a
country.
NDI = National Product + Net Current Transfers from rest of the world
or
= C + S.
(v)
(vi)
Closed Economy : It is the one which does not have economic relations with rest of the world. There are no experts/
imports of goods and services.
Open Economy : An open economy is the one which has economic relations with rest of the world. It exports goods and
services to rest of the world
Real National Income and Nominal National Income : National Income at current prices also known as Nominal
income. When the goods and services produced in an year are valued at market prices prevailing in the year of their
production.
National Income at constant prices also known as Real National Income. When goods and services produced in
a year are valued at fixed prices i.e. value of base year.
GNP Deflater : It is used to measure the average level of prices of all goods and services that makes up GNP deflater.
P1 Nominal GNP
GNP deflater 100 100
P0 Real GNP
Green GNP : It is defined as GNP which should help to attain a sustainable use of natural environment and equitable
distribution of benefits of development.
Question :
1. GDP is considered as an index of welfare of the people.
Do you agree with the statement. Explain :
Ans : No, welfare includes economic and non-economic welfare but GDP only takes economic welfare :
(a) Distribution of GDP : An increase in GDP may not lead to increase in total welfare. If its distribution results in
concentration of income in hands of very few industrialists.
(b) Non-Monitary Transactions : The non-market/monitary transactions like services of housewife, leisure time activities
etc. Is not taken in calculating GDP.
(c) Externalities : Negative externalities occur such as smoke of factory pollutes the air, industrial waste occurs air
pollution etc. should not be included in GDP.
(d) Rate of Population Growth : It is the rate of population growth which is higher then the rate of growth of real GDP.
2. National Income at Current Prices and Constant Prices : (Nominal NI and Real NI)
National income can be measured in terms of money in two waysat current prices and at constant prices.
(a) National inocme at current prices : If goods and services produced in a year are valued at current prices,
i.e. prices prevailing in that particular year, we get national income at current prices. Current price refer to the prices
prevailing in the year in which goods and services are produced. For example, when goods and services produced
during the year 2009-2010 are valued in prices of the same year, i.e., 2009-2010, it will be called national income at current
prices for the year 2009-2010.
(b) National Income at Constant Prices : If goods and services produced in a year are valued at fixed prices,
i.e., prices of the base year, we get national income at constant prices. Constant prices refer to the prices prevailing in
the base year. A base year is a carefully chosen year which is a normal year free from price fluctuations. (In India now
2004-2005 is treated as base year.) For instance, if goods and services produced during the year 2008-2009 are valued
at the prices of the base year (i.e., 2004-2005), it will be called national income at constant prices for the year 2008-2009.
(c) Capital Formation (Investment) : Capital formation is the net addition to the capital stock of an economy during a given
period. Increase in production leads to increase in consumption or capital formation or both. If whole of production is
consumed, there will be no capital formation and production, capacity will start decreasing.
(ii) Capital goods : Goods which are bought for producing other goods but not for meeting immediate needs of the
consumer are called capital goods. In fact, all goods that are produced for use in future for productive processes are
called capital goods. E.g., tools, implements, machinery, plants, tractors, buildings, transformers, etc. Such goods are
used for generating income by production units.
6. Domestic (Economic) Territory of a Country : Economic territory is the geographical territory administered by a
government within which persons, goods and capital circulate freely.
What domestic (economic) territory includes :
(i) Territory lying within the political frontiers of a country. It includes territorial waters also.
(ii) Ships and aircrafts owned and operated by the residents between two or more countries. For instance, Indian ships
moving between UK and Pakistan regularly or passangers planes operated by Air India between Russia and Japan are
parts of domestic territory of India.
(iii) Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents of a country in the internal
waters or engaged in extraction in areas where the country has exclusive rights of operation. For example, fishing boats
operated by Indian fishermen in the internal waters of the Indian Ocean will be considered as a part of domestic territory
of India.
(iv) Embassies, consulates and military establishments of the country located abroad. To illustrate, Indian embassies in
Russia, America and other countries will form parts of domestic territory of India. Similarly, embassies of other countries
like Japan, Russia, America in India are parts of domestic territories of their own countries and not of India.
What domestic territory does not include :
(i) Territorial enclaves (like embassies) used/administered by foreign governments.
(ii) International organisations which are physically located within goegraphical boundaries of a country. Their offices
form part of international territory.
7. Resident (Normal Resident) of a Country : National income has also been defined as Sum total of factor incomes earned by
the normal residents of a country during a year.
A resident is said to be a person (or institution) who ordinarily resides in a country and whose centre of economic interest
lies in that country. He is called a normal resident since he normally lives in the country of his economic interest. The period
of stay should be at least one year or more. Following points need to be noted.
(i) Normal residents cover both individuals and institutions.
(ii) Normal residents include both citizens and non-citizens, i.e., foreigners who reside in a country for more than a year and
have economic interest in that country.
(iii) International bodies like World Bank, World Health Organisation or International Monetary Fund are not considered
residents of the country in which these organisations operate but are treated as residents of international territory.
However, the staff of these bodies are treated as normal residents of the country in which the international body
operates. For example, international body like World Health Organisation located in India is not normal resident of India
but Americans working in its office for more than a year will be treated as normal residents of India.
(iv) Local employees working in fogiren embassies located in their country are treated as normal residents.
For example, Indians working in US embassy located in India are residents of India.
(v) Workers from across the border who cross border in the morning to work in the other country (like Indians who work
in Nepal) and return in the evening are not residents of the country where they work.
For example, normal residents of India include (i) Citizens (and institutions) of India, (ii) Citizens of other countries (i.e., non-
citizens) who normally reside in India for more than a year and whose centre of economic interest lies in India. (iii) Citnzens
of India working in (a) international bodies like I.M.F., (b) foreign bodies like banks, enterprises operating in India and (c)
foreign empassies located in India.
8. Investment (gross and net) : Investment means addition to the stock of capital goods such as buildings, equipment or
inventory that adds to the future productive capacity of the economy.
Gross Investment : That part of total final output which comprises capital goods constitutes gross investment of an
economy. It is addition to the capital which also includes replacement cost for the wear and tear that capital stock undergoes
over a period of fime. When investment is expressed as gross investment. It includes depreciation.
Depreciation : Depreciation or fall in value due to normal wear and tear is called consumption of fixed capital.
Net Investment : By deducting depreciation from gross investment, we get net investment. Symbolically:
Net investment = Gross investment Depreciation
Note- The new addition to the capital stock in the econmy is measured by net investment (and not by gross investment).
9. Per Capita Income : Per capita is the average per capita national income. It is income per head of population.
National Income
Per Capita Income =
Mid year Population
Factors of Production :
(i) Land : It refers to all natural resources which are free gifts of nature. Land, therefore, includes all gifts of nature available
to mankindboth on the surface and under the surface e.g., soil rivers, waters, forests, mountains, mines, deserts,
seas, climate, rains, air, sun, etc.
(ii) Labour : Human efforts done with the aim of earning income is known as labour. Thus, labour is a physical or mental
effort of human being in the process of production. The compensation given to labourers in return for their productive
work is called wages (or compensation of employees).
(iii) Capital : All man-made goods which are used for further production of wealth, are included in capital. Thus, it is man-
made material source of production. Alternatively, as capital. It is the produced means of production. Examples are
machines, trucks, factories, etc. An increase in the capital of the economy means an increase in the productive capacity
of the economy. Logically and chronologically, capital is derived from land and labour and has, therefore, been named
as stored-up labour.
(iv) Entrepreneur : An entrepreneur is a person who organises the other factors and undertakes the risks and uncertainities
involved in the production. He hires the other three factors,organises and coordinates them so as to earn be called an
entrepreneur. An entrepreneur acts as a boss and decides how the business shall run. He decides in proportion factors
should be combined. What and where he will produce and by what method.. Thus, entrepreneurship is a trait or quality
owned by the entrepreneur.
Some economists are of the opinion that basically there are only two factors of productionland and labour. Capital,
they say, is appropriated from gifts of nature by human primary and entrepreneur is only a special variety of labour.
Land and labour are, therefore, primary factors whereas capital and entrepreneur are secondary factors.
The following statements further clarify it.
Net product = Gross Product Depreciation
Net value added = Gross value added Depreciation
Net domestic capital formation= Gross domestic capital formation Depreciation
Capital Loss : Fall in value of fixed capital due to natural calamities (like earthquakes, floods, fires) and unforeseen
factors like war, thefts, etc. is called capital loss (and not depreciation). Provision of funds made by an enterprise for
replacement of worn out fixed capital over its expected life is called Depreciation Provision. Funds thus accumulated
over lifetime of the asset are used to replace the worn out assets with a new asset.
Significance of Net Indirect Taxes : (To differentiate between MP and FC) : Net Indirect Tax is the difference between the
indirect tax and subsidy. To find out Market Prices (MP), indirect taxes are added and subsidies are subtracted from Factor
Cost (FC) as explained above. Symbolically :
Market Price = Factor Cost + Indirect taxes Subsidies
= Factor Cost + Net indirect taxes
In short, MP includes net indirect tax whereas FC does not. Thus, FC becomes MP when net indirect taxes are added to FC.
In the absence of indirect taxes and subsidies. MP and FC are the same.
NFIA = Factor income earned from abroad by residents Factor income of non-residents in domestic territory
Components of net factor income from abroad : Following are its three main components:
(i) Net compensation of employees.
(ii) Net income from property and entrepreneurship (rent, interest, profit).
(iii) Net retained earning of resident companies abroad.
Net factor income from abroad = Net compensation of employees + Net income from property and entrepreneurship
+ Net retained earnings of resident companies abroad.
(ii) Value added : It refers to the addition of value to the raw material (intermediate goods) by a firm by virtue of its
productive activities.
Value added = Value of output Intermediate consumption
(iii) Distinction between Value of output and value added : The difference between value of output and value added is
intermediate consumption which is included in value of output but excluded from value added. Intermediate
consumption means expenditure incurred on secondary inputs like raw material, power, etc. by a producing unit.
Following steps are taken to derive net value added at FC from value of output.
In short, by substracting intermediate consumption, depreciation and net indirect taxes from value of output, we get
NVA at FC.
13. Factor Payments vs Transfer Payments : (or Factor Income vs Transfer Income)
(i) Factor Payment : Payment made to a factor of production in return for rendering productive (or factor) service is called
factor payment (or factor income). Examples are rent, wages, interest and profit. Income of land is rent,
of labour wages, of capital interest and of enterprise is profit.
(ii) Transfer Payment : Payment received without any good or service provided in return is called transfer payment
(or transfer income). Transfer income is a receipt concept as compared to factor income which is an earning concept.
Such payments for which no productive services are rendered are known as transfer payments.
Income Method
1. Income Method, Steps and Precautions :Net domestic income is the income generated in the form of wages, rent, interest
and profit in the domestic territory of a country by all producers (normal residents and non-residents) in an accounting
year.
(a) Method : The Income Method measures national income from the side of payments made to the primary factors of
production in the form of rent, wages, interest and profit for their productive services in an accounting year.
(i) Identify enterprises which employ factors of production (land, labour, capital and enterprise).
(ii) Classify factor payments into various categories like rent, wages, interest, profit and mixed income (or classify
factor payments into compensation of employees, mixed income and operating surplus).
(iii) Estimate amount of factor payments made by each enterprise.
(iv) Sum up all factor payments made within domestic territory to get Domestic Income (NDP at FC).
(v) Estimate net factor income from abroad which is added to Domestic Income to derive National Income.
Note : Compensation to injured worker, employers contribution to social security schemes, TA relating to business
promotion, amount of loan, etc. not included in compensation of employees.
Royalty, is amount a receivable by a landlord for granting leasing rights of sub-soil assets (deposits of coal, iron,
natural gas, etc.) and for use of patents, copyrights, etc., is also included in the rent.
3. Interest : Interest is the price for the funds borrowed. It is the amount that the debtor becomes liable to pay to the creditor
over a given period of time.
Nationanl disposable income = NNP at MP + Net current transfers from rest of the world
= National income + net indirect taxes + net current transfer
from rest of the world
Gross NDI = GNP at MP + Net current transfers from ROW
Net NDI = NNP at MP + Net current transfers from ROW
= Gross NDI Depreciation
Expenditure Method :
(a) Method : Expenditure measures final expenditure on Gross Domestic Product at market price (GDP at MP) during a
period of account. Since all domestically produced goods and services are purchased for final use either by consumers
for consumption or by producers for investment, therefore, we take sum of final expenditure on consumption and
investment. This sum equals GDP at MP. Final expenditure is the expenditure made on purchase of domestically
produced goods and services for final use, i.e., for consumption and investment. By adding up all the items of final
consumption expenditure and final investment expenditure within the domestic economy, we get the aggregate called
GDP at MP. By subtracting depreciation and net indirect taxes from GDP at MP and adding to it net factor income from
abroad, we get NNP at FC or national income. Thus, under expenditure method, national income is measured at the
point of actual expenditure.
Mind, income generated by factors of production in the production process is spent by them on final goods.
Final use of a commodity is either for consumption or for investment and expenditure on them is called Final
Consumption Expenditure and Final Investment Expenditure, respectively. By adding up all the items of final
consumption expenditure and final investment expenditure within the domestic economy, we get the aggregate called
GDP at MP.
(b) Steps Involved : Expenditure method involves the following steps:
(i) Identification of economic units incurring final expenditure, e.g., household (or consuming) sector, firm
(or producing) sector and government sector.
(ii) Classification of final aggregate expenditure into following components:
1. Private final consumption expenditure.
2. Government final consumption expenditure.
3. Gross fixed capital formation.
4. Change in stocks.
5. Net exports.
(iii) Measurement of final expenditure on the above components. Sum total of the above five items gives us the value
of GDP at MP. By deducting depreciation and net indirect taxes from GDP at MP, we get NDP at FC.
(iv) Estimation of net factor income from abroad which is added to NDP at FC (Domestic Income) to obtain NNP at FC
(National Income).
(c) Precautions : The following precautions need to be taken for correct estimation of national income by expenditure
method. Alternatively, following items of expenditure should not be included.
(i) To avoid double counting, expenditure on all intermediate goods and service is excluded. For example, purchase of
vegetables by a restaurant, expenses on electricity by a factory, etc., are not included as they are for intermediate
consumption.
(ii) Government expenditure on all transfer payments such as scholarships, unemployment allowance, old-age
pension, etc. is excluded because no productive service is rendered by the recipients in exchange.
(iii) Expenditure on purchase of secondhand goods is excluded from national income because this type of expenditure
is not on currently produced goods.
(iv) Expenditure on purchase of old shares/bonds or new shares/bonds, etc. is excluded because it is not payment for
goods or services currently produced. It shows mere transfer of property from one person to another. Likewise,
gifts from abroad which bring transfer payment are not included.
(v) Imputed expenditure on own account output (e.g., owner occupying his house, self-consumed output by a farmer)
should be included.
Product Market : It is a market where goods and services are sold and purchased.
Factor Market : It is a market where factor of production are sold and purchased.
Important Terms
Private Income : Private income refers to the income which accrues to the private sector from all sources whether
received or not. it is the sum of factor income and transfer incomes received by private sector. It also includes net factor
income from abroad. The main constituents of private income are as follows :
1. Income from domestic product accuring to private sector.
2. Net factor income from abroad.
Private Income : Income from domestic product accruing to Private Sector + Current Transfer Income form Government
+ Net Current Transfers from Rest of the World + Interest on National Debt + Net Factor Income from abroad.
Personal Income : The sum of total income actually received by the households or individuals from all sources is called
personal income. It includes transfer as well as factor incomes.
OR
Personal Income : National Income Income from Domestic Product Accruing to Public Sector Corporation
Personal disposable income (PDI) : PDI is the part of income which may be spent or consumed by the households.
This income can be spent by households according to their desire.
OR
Questions :
1. When is the national income larger than domestic factor income ?
Ans : When NFIA is positive.
2. 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 ?
3. 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.
4. Why is the study of the problem of unemployment in India considered a macroeconomic study ?
Ans : The problem of unemployment in India is an economic issue at level of economy as a whole, hence considered as
macroeconomic study.
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 tincome 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.
7. All capital goods are producer goods, but all producer goods are not capital goods : Explain ?
Ans : Producer goods are all those goods which are used in the process of production. These goods may be raw material
or plant and machinery. Goods used as raw material are not durable goods because these goods can not be used in the
process of production again. So it is true that all capital goods are producer goods, but all producer goods are not capital
goods.
Ans : These are those goods which have crossed the boundary line of production and are ready for use by their final users.
Ans : Machine purchased by a household is a final goods. Machine purchased by a firm is a final goods when it is used
by the producer in the process of production but a machine purchased by one firm from the other for purchase of resale
is an intermediate goods.
10. Are the following included in the estimation of National Income of India ?
(i) Profit earned by a foreign company/bank in India.
(ii) Money received from sale of shares.
(iii) Salary paid to Americans working in Indian embassy in America.
(iv) Salary paid to Indians working in Indian embassy in America.
(v) Remittances from abroad.
Ans :
(i) No, as it is a factor income paid abroad (it is earned by non-residents).
(ii) No, it is only a transfer of paper claims.
(iii) No, this factor income belongs to non-residents.
(iv) Yes, as it is a factor income paid to normal resident of India.
(v) No, it is only a transfer payments.
(vi) No, it is only a transfer payments. No commodity is sent or services rendered return for this.
11. Are the following included in the estimation of National Income a country ? Give reason.
(i) Services rendered by family members to each other.
(ii) Wheat growth by a farmer but used entirely for familys consumption.
(iii) Expenditure government on providing free education.
(iv) Payment of fees to a lowyer 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 player 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 to 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 be included in NI because it is a wind fall 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.
12. Are the following included in the estimation of National Income a country ?
(i) Indirect Tax (Sale tax/Excise duty).
(ii) Salary received by the workers under NREGA.
(iii) Income Tax.
(iv) Corporation Tax.
Ans :
(i) It is not included in NI because it does not add in the flow of goods and services.
(ii) It is a included in NI because it is a factor income.
(iii) 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.
(iv) 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.
13. Whether school/examination fee paid by students is included in national income not ?
Ans : It is included in national income as these are payments for the services rendered.
14. Whether purchase of those by the tenant of the house is included in national income or not ?
Ans : It is not included as it does not add to national product.
15. Whether expenditure on providing meals to the beggars is included in national income or not ?
Ans : It is not included as it is a transfer payment.
17. Whether increase in price of stock lying with a trader is included in national income or not ?
Ans : It will not be included in national income as there is no corresponding increase in output.
18. Whether value of interest foregone on loans provided by employer to employee is included in national income or not ?
Ans : It is included as it is a part of compensation of employees.
21. Interest on national debt does not produce goods and services. It is only interest on borrowing.
22. Whether remittances by a NRI to his family in India are included in national income ?
Ans : It is not included as it is a transfer payment.
25. Whether mineral wealth will be included which has been extracted in that particular year.
Ans : That part of mineral wealth will be included which has been extracted in that paticular year.
26. Whether interest received by a household from a commercial bank is included in national income ?
Ans : Households both receive and pay interest. We include in national income only the net interest, that is the differences
between interest amount paid and the interest income received by households.
27. Whether commission received by a dealer of old car is included in national income or not ?
Ans : It is included as it is a productive service.
29. Whether payment of bus fare by a traveller is included in national income or not ?
Ans : It is included as it is a part of private final consumption expenditure.
30.(a) Can national income at constant prices be greater than national income at current prices ?
Ans : Yes national income at constant prices can be more than national income measured at current price under the
following two cases :
(a) When current year price index is low as compared to base year price index and output of goods and services
remains unchanged.
(b) When current output is less than the base year output, price index remaining the same.
1. From the hypothetical figures given below about an economy, calculate NDPFC.
(` in Crore)
(i) Private income 10,000
(ii) Income form domestic product accruing to govt. sector 925
(iii) Transfer payments 125
(iv) Net income from abroad () 200
(v) Net indirect taxes 250
Ans. NDPFC = (i) (iii) (ii) (iv)
= 10,000 125 + 925 (200) = 11,000
2. From the following data about an economy, estimate : (a) Personal Disposable Income (b) Private Income and (c)
National income.
(` in Crore)
(i) Personal income 1,225
(ii) Savings of private corporate sector 12
(iii) Corporate tax 23
(iv) Current transfers from government adm. Deptt. 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 enterprises 20
(viii) Net indirect taxes 195
(ix) Direct taxes paid by the households 25
Ans. (a) Personal disposable income = (i) (ix)
= 1,225 25 = 1,200 crore
(b) Private Income = Personal Income + (ii) + (iii)
= 1,225 + 12 + 23 = 1,260 crore
(c) National Income = Private Income (iv) (v) + (vi) + (vii)
= 1,260 30 25 25 20 = 1,250 crore
3. From the following data estimate : (i) Personal Income (ii) Private Income and (iii) Personal Disposable Income from Set
I and III. Also calculate : (i) National Income (ii) Personal Income (iii) Private Income from Set II.
(` in crore)
Set I Set III Set II
(i) National Income 2,500 1300
(ii) Corporate profit tax 25 15 10
(iii) National debt interest 30 10 10
(iv) Direct personal taxes 75 40
(v) Saving of private corporate sector 50 25 15
(vi) Income from property and entrepreneurship
accruing to government adm. Departments 75 35 25
(vii) Current transfers from
Government adm. Departments 70 30 25
(viii) Savings of non-departmental public enterprises 10 5 5
(ix) Current transfer from rest of the world 30 15 10
(` in crore)
Set I Set III Set II
(i) Mixed Income of self - employed 280 560 850
(ii) Compensation of employees 240 490 730
(iii) Net Factor Income from rest of the world ()5 ()10 () 10
(iv) Imports 60 110 170
(v) Exports 50 100 140
(vi) Government final consumption expenditure 75 150 220
11. Calculate GNP at MP by (a) Expenditure Method and (b) Income Method from the following data:
(` in crore)
(i) Net capital formation 200
(ii) Private final consumption expenditure 1,000
(iii) Operating surplus 360
(iv) Wages and salaries 900
(v) Rent 100
(vi) Govt. final consumption expenditure 300
(vii) Consumption of fixed capital 50
(viii) Net indirect taxes 200
(ix) Net Factor Income from abroad ()10
(x) Employers contribution to S.S. Scheme 50
(xi) Net exports 10
Ans. (a) GNP at MP (Exp. Method)
= 200 + 1,000 + 300 + 50 + ( 10) + 10 = 1,550 crore
(b) GDP at MP (Income Method)
= 360 + 900 + 50 + 200 + (10) + 50 = 1,500 crore
12. Calculate National Income by (a) Income Method and (b) Expenditure Method.
(` in crore)
Set I Set II Set III
(i) Wages and Salaries 500 500 500
(ii) Govt. final consumption expenditure 120 120 120
(iii) Royalty 20 20 20
(iv) Interest 40 40 40
(v) Household final consumption expenditure 600 600 600
(vi) Change in stocks 10 10 10
(vii) Indirect taxes 100 100 100
(viii) Rent 50 50 50
(ix) Final consumption expenditure of private
non-profit institutions serving household 30 30 30
(x) Net Domestic Fixed Capital formation 60 60 60
(xi) Profit after tax 100 100 100
(xii) Corporate tax 20 20 20
(xiii) Net export () 20 () 20 () 20
(xiv) Subsidies 30 30 30
(xv) Net Factor Income from abroad () 5 5 () 10
Ans. (a) National Income (NNP at FC) by Income method:
(Set I) = 500 + 20 + 40 + 50 + 100 + 20 + (5) = 725 crore
(Set II) = 500 + 20 + 40 + 50 + 100 + 20 (+5) = 735 crore
(Set III) = 500 + 20 + 40 + 50 + 100 + 20 ( 10) = 720 crore
(b) National Income by Expenditure Method:
(Set I) = 120 + 600 + 10 + 100 + 30 + (20) + 30 + ( 5)
= 725 crore
(Set II) = 120 + 600 + 10 100 + 30 + 60 + ( 20) + 30 + 5
= 735 crore
(Set III) = 120 + 600 + 10 100 + 30 + 60 + (20) + 30 + ( 10)
= 720 crore
13. From the following data, calculate GNP at MP by (a) Income Method and (b) Expenditure Method.
(` in crore)
(i) Govt. final consumption expenditure 250
(ii) Change in stocks 65
(iii) Net Domestic Capital formation 150
(iv) Interest 90
(v) Profits 210
(vi) Corporate tax 50
(vii) Rent 100
(viii) Factor Income from abroad 20
(ix) Indirect taxes 55
(x) Factor Income to abroad 40
(xi) Exports 60
(xii) Subsidies 25
(xiii) Imports 80
(xiv) Consumption of fixed capital 20
(xv) Private final consumption expenditure 500
(xvi) Compensation of employees 450
(xvii) Value of rent free accommodation to employees 40
Ans. (a) GNP at MP (by Income Method)
= 90 + 210 + 100 + 20 + 55 40 25 + 20 + 450
= 880 crore
(b) GNP at MP (by Exp. Method)
= 250 + 150 + 20 40 + 60 80 + 20 + 500
= 880 crore
14. From the following data, calculate GDP at FC by (a) Expenditure Method (b) Income Method.
(` in crore)
(i) Personal consumption expenditure 700
(ii) Wages and Salries 700
(iii) Employers contribution S.S. Schemes 100
(iv) Gross business fixed investment 60
(v) Profits 100
(vi) Gross residential construction investment 60
(vii) Govt. purchase of goods and services 200
(viii) Gross public investment 40
(ix) Rent 50
(x) Inventory investment 20
(xi) Exports 40
(xii) Interest 50
(xiii) Imports 20
(xiv) Net Factor Income from abroad () 10
(xv) Mixed income 100
(xvi) Depreciation 20
(xvii) Subsidies 10
(xviii) Indirect taxes 20
Ans. (a) GDP at FC (by Exp. Method)
= 700 + (60 + 60 + 40 + 20) + 200 + 40 (40 20) + (10 20)
= 1,090 crore
(b) GDP at FC (by Income Method)
= 700 + 100 + 50 + 50 + 100 + 20
= 1,020 crore
15. From the following data, calculate National Income (NNP at FC) by (a) Income Method and (b) Expenditure Method.
(` in crore)
Set I Set II Set III
(i) Compensation of employees 1,200 600 500
(ii) Net Factor Income from abroad () 20 () 10 () 10
(iii) Net indirect taxes 120 60 165
(iv) Profit 800 400 220
(v) Private final consumption expenditure 2,000 1,000 900
(vi) Net Domestic Capital formation 770 385 200
(vii) Consumption of Fixed Capital 130 65
(viii) Rent 400 200 90
(ix) Interest 620 310 100
(x) Mixed income of self employed 700 350 400
(xi) Net exports () 30 ()15 ()25
(xii) Govt. final consumption expenditure 1,100 550 400
(xiii) Net current transfers from ROW 50
Ans. (a) (Income Method) NI = DI + NFIA
(Set I) = 1,200 20 + 800 + 400 + 620 + 700
= 3,700 crore
(Set II) = 600 10 + 400 + 200 + 310 + 350
= 1,850 crore
(Set III) = 500 10 + 220 + 90 + 100 + 400
= 1,300 crore
(b) (Exp. Method) NNFC = GDP at MP NIT Dep. + NFIA
(Set I) = 2,000 + 1,100 + 770 30 120 20
= 3,700 crore
(Set II) = 1,000 + 550 + 385 15 60 10
= 1, 850 crore
(Set III) = 900 + 400 + 200 25 165 10
= 1,3000 crore
16. From the following data, calculate National Income by (a) Income method and (b) Expenditure method.
(` in crore)
(i) Interest 150
(ii) Rent 250
(iii) Government final consumption expenditure 600
(iv) Private final consumption expenditure 1200
(v) Profit 640
(vi) Compensation of employees 1000
(vii) Net factor income from abroad 30
(viii) Net indirect taxes 60
(ix) Net exports () 40
(x) Consumption of fixed capital 50
(xi) Net domestic capital formation 340
Ans. (a) National Income (Income method) = 150 + 250 + 640 + 1000 30
= 2010 crore
(b) GDP at MP = 600 + 1200 + ( 40) + (50 + 340) = 2150
National income (NNP at FC) = GDP at MP (x) + (vii) (viii)
= 2150 50 + ( 30) 60 = 2010 crore
17. Calculate (a) GDP at MP and (b) Factor income from abroad from the following data
(` in Crore)
(i) Profit 500
(ii) Exports 40
(iii) Compensation of employees 1,500
(iv) GNP at FC 2,8000
(v) Net current transfer from rest of the world 90
(vi) Rent 300
(vii) Interest 400
(viii) Factor income to abroad 120
(ix) Net indirect taxes 250
(x) Net domestic capital formation 650
(xi) Gross fixed capital 700
(xii) Change in stock 50
Ans. NDP at FC (Domestic income)
= 500 + 1500 + 300 + 400 = 2700
Deprecation = (xi) + (xii) (x) = 700 + 50 650 = 100
(i) GDP at MP = NDP at FC + Depreciation + NIT
= 2700 + 100 + 250
= 3050 crore
(ii) NFIA = NNP at FC NDP at FC
= (2800 100) 2700 = 0
Factor income from abroad = NFIA + Factor income to abroad
= 0 + 120
= 120 crore
18. What are various money stock measures?
Ans. Following four measures of money stock are used
(i) M1 = C + DD + OD
(ii) M2 = M1 + Saving deposits in post office saving banks.
(iii) M3 = M1 + Net time deposits of banks.
(iv) M4 = M1 + Total deposits with post office saving organisation.
19. What is High Powered Money?
Ans. The total liability of monetary authority of the country (RBI in India) is called High Powered Money or monetary base.
20. What is Reserve Deposit Ratio (RDR) ?
Ans. It is ratio of total deposits which commercial banks keep as reserve.
21. Define liquidity trap.
Ans. It is situation of very low rate of interest where people are ready to hold whatever stock of money is supplied expecting
interest rate to rise in future and bond prices to fall.
22. What is credit money?
Ans. It refers to that money whose value as money (i.e., face value) is more than intrinsic value, i.e., commodity value of the
material money is made of e.g., cheques, drafts, notes, etc.
23. What is meant by demand for money?
Ans. Demand for money is the demand for liquidity, i.e., demand for cahs.
24. Which institution performs the function of clearing house in commercial banking system?
Ans. Central Bank, i.e., RBI in India.
25. Name the institution which acts as custodian of nations foreign exchange reserve.
Ans. In India it is RBI.
26. Distinguish between narrow money and broad money.
Ans. Narrow money consists of currency notes and coin (C) and demand deposits (DD) held by public in commercial banks.
Symbolically
M = C + DD
This definition is based on its medium of exchange function. As against it, broad money consists of narrow money + time
deposits (TD) held by commercial banks and Post Office saving organisations.
M = C + DD + TD. This definition is based on store of value function.
27. Why are financial institution like UTI, LIC not considered bank?
Ans. Because such financial institutions do not accept chequable deposits.
28. Why are Post Office savings banks not treated as bank?
Ans. Because they do not perform banks essential function of lending.
29. What are least (i) Repo Rate (ii) Reverse Repo Rate and Cash Reserve Ratio (CRR) in India?
Ans. Since 2009 in India (i) Repo Rate is 4.75% (Repo rate is the rate at which RBI lends short-term funds to banks) , (ii)
Reverse Repo Rate is 4% (Reverse Repo Rate is the rate at which banks part their surplus funds with RBI), and (iii) CRR
is 5.75% w.e.f. February 1, 2010 (CRR is the proportion of money which banks have to keep mandatorily with RBI at nil
rate of interest).
30. In an economy investment increases by Rs. 10 crore. As a result, income increases by Rs. 50 crore. What is the value of
multiplier?
Y (Change in income) 50
Ans. K 5
I (Change in investment) 10
31. Calculate : Change in Income when MPC = 0.8 and Change in Investment = Rs. 1.000.
1 1 1 1
Ans. K(Multiplier) 5
1 MPC 1 0.8 0.2 1
5
Change in Income = Change in investment K
= 1,000 5 = 5,000
32. MPC in economy is 0.8. If investment is increased by Rs. 5 crore, how much would be the increase in income?
1 1 1 1
Ans. K 5
1 MPC 1 0.8 0.2 1/ 5
Increase in income = Change in investment K
= 5 5 = 25 crore
33. If in an economy MPC is 0.8 and investment is increased by Rs. 1,000 crore, calculate total increase in income.
1 1 1
Ans. K 5
1 MPC 1 0.8 0.2
1 1
(a) K or 4
1 MPC 1 MPC
or 4 4 MPC = 1
or 4 MPC = 3
MPC = 3/4 = 0.75 (Also, MPS = 1 0.75 = 0.25)
(b) Change in saving S = Y MPC
= 1000 0.25 = 250 crore
(c) C = Y MPC
= 1000 0.75 = 750 crore
Y 1000
(d) Value of multiplier (K) = 4
l 250
40. In an economy 75% of increase in income is spent on consumption. Investment is increased by Rs. 1000 crore. Calculate.
(a) Total increase in income (b) Total increase in consumption expenditure.
75 3 3 1
Ans. MPC MPS 1
100 4 4 4
1 1
K 4
MPS 1/ 4
Y Y
(a) K or 4 or Y = 4 1000 = 4000
I 1000
Increase in income = 4000 crore
(b) Increase in consumption expenditure, i.e., C
C = Y I
= 4000 1000 = 3000 crore
41. In an economy C = 500 + 0.9Y and I = 1000 (where C = consumption. Y= Income, I = Investment). Calculate the
following:
(i) Equilibrium level of income (ii) Consumption expenditure at equilibrium level of income.
Ans. (i) For equilibrium Y = C + I
\Y = 500 + 0.9Y + 1.000 (Substituting values of C and I)
Y 0.9Y = 1,500
0.1Y = 1,500
1
or Y = 1,500
10
Y = 15,000 (Equilibrium level of income)
(ii) Y=C+I
15,000 = C + 1,000
C = 15,000 1,000
= 14,000
Consumption expenditure at equilibrium level of income = 14,000
42. Given consumption function C = 100 + 0.75Y (where C = consumption expenditure and Y = Nation income) and
investment expenditure Rs. 1,000. Calculate the following.
(i) Equilibrium level of national income,
(ii) consumption expenditure at equilibrium level of national income.
Ans. (i) For equilibrium Y = C + I (i.e., AS = AD)
Y = 100 + 0.75Y + 1,000 (Given C = 100 + 0.75Y)
Y 0.75Y = 1,100
or 0.25Y = 1,100
100
Y 1,100 4, 400 (Equilibrium level of income)
25
(ii) C = 100 + 0.75Y (Given)
=100 + 0.75 4,400
= 100 + 3/4 4,400 = 3,400 (Consumption expenditure)
43. From the following information about an economy, calculate (i) its equilibrium level of national income and (ii) savings
at equilibrium level of national income. Consumption function C = 200 + 0.9Y (where C = consumption expenditure and
Y = National income). Investment expenditure I = 3,000.
Ans. (i) For equilibrium Y=C+I
Y = (200 + 0.9Y) + 3,000
Y 0.9Y = 3,200
or 0.1Y = 3,200
10
Y = 3,200 = 32,000 (National income)
1
(ii) C = 200 + 0.9Y (Given)
= 200 + 0.9Y (Y = 32,000 proved)
9
= 200 + 32,000
10
= 200 + 28,800 = 29,000
Saving = Y (National income) C (Consumption)
= 32,000 29,000 = 3,000
44. Define marginal propensity to save (MPS).
Ans. The ratio of change in saving (S) to change in income (Y) is called MPS.
Symbolically : MPS = S/Y
45. What is multiplier?
Ans. Investment multiplier (K) is the ratio of increased income (Y) due to an increase in investment (I). Symbolically : K =
Y / I.
46. What is deficient demand?
Ans. When aggregate demand is for a level of output that is less than full employment level of output, it is said to be
deficient demand.
47. What is excess demand?
Ans. When aggregate demand is for a level of output that is more than full employment level of output, then it is known as
excess demand.
48. How does the introduction of government sector affect the economy?
Ans. It impacts the level of aggregate demand through government expenditure and taxes. For example, an increase in
government expenditure increases the level of aggregate demand whereas increase in taxes causes a fall in aggregate
demand.
49. What is the basic difference between two expressions ex-ante and ex-post?
Ans. Ex-ante expression indicates variable before the beginning of even but ex-post expression indicates variable after the end
of the event.
50. Can consumption exceed income? If yes, what is the saving then?
Ans. Yes, consumption can exceed income when income is zero or less than subsistence consumption level. Then there is
negative saving.
52. Given autonomous consumption ( C ) = 500 crore, MPC (b) = 0.8, write equation of consumption function and determine
value of consumption when income (Y) = Rs. 3,000 crore.
Ans. Equation of consumption is C = C + bY, where C represents consumption function, C autonomous consumption, b
represents MPC and Y is level of income. By substituting values in the equation, we get.
C = 500 + 0.8 (3000)
= 500 + 2400 = Rs. 29,00 crore
53. How is equilibrium level of output determined under short run fixed price?
Ans. Under short run fixed price, equilibrium level of output is determined by level of exante aggregate demand. (It is assumed
that suppliers are willing to supply whatever amount of goods consumers will demand at the fixed price).
54. Define (a) Fiscal deficit (b) Budget deficit
(c) Revenue deficit and (d) Primary deficit.
Ans. (a) Fiscal deficit is defined as excess of total expenditure of government over sum of its revenue receipts and non-
debt capital receipts during a fiscal year.
(b) Budget deficit refers to the excess of total budgetary expenditure over total budgetary receipts (both revenue
receipts and capital receipts) of the government.
(c) Revenue deficit refers to the excess of governments revenue expenditure over its revenue receipts.
55. How can a deficit be financed?
Ans. A deficit may be financed:
(i) by printing new currency, i.e., monetary expansion and
(ii) by borrowing from internal source (i.e., public) and external source (i.e., foreign governments, World Bank)
56. Give two examples of debt creating capital receipts.
Ans. Net borrowing by government at home, borrowing from abroad.
57. Give two examples of non-debt capital receipts.
Ans. Recovery of loan, sale proceeds of public enterprises (i.e., disinvestment).
58. Why are borrowings by government capital receipts?
Ans. Because these create liability of government for repayment of loan.
59. Why is repayment of loan a capital expenditure?
Ans. Because it reduces governments liability.
60. Why are subsidies treated as revenue expenditure?
Ans. Because these neither result in creation on assets nor reduce governments liability.
61. Can there be a fiscal deficit in a government budget without a revenue deficit? Give reasons.
Ans. Yes (i) When revenue budget is balanced but capital budget shows a deficit or (ii) when there is surplus in revenue budget
but deficit in capital budget is higher than surplus in revenue budget.
62. State three items each of (a) debt creating capital receipts and (b) Non-debt creating capital receipts.
Ans. (a) (i) Borrowing at home,(ii) Borrowing from abroad, and (iii) Loans from RBI are debt creating capital receipts.
(b) (i) Recovery of loans, (ii) Proceeds from sale of Public sector units, and (iii) Paratial sale government shares in a
company.
63. State three implications of fiscal deficit.
Ans. (i) Fiscal deficit, i.e., borrowing creates problems of not only payment of interest but also of repayment of
loans.
(ii) High fiscal deficit generally leads to wasteful and unnecessary expenditure by the government.
(iii) Payment of interest increases revenue expenditure leading to higher revenue deficit which, in turn, may lead
to more borrowing. This may compel the government to borrow more to finance even interest payment creating
vicious circle and debt-trap.
64. What are (a) spot and (b) Forward markets in foreign exchange?
Ans. (a) If the operation is of daily nature, it is called spot market or current market and the exchange rate that
prevails in the spot market is called spot rate.
(b) A market for foreign exchange for future delivery is known as forward market. Here foreign exchange is
bought and sold for delivery at a future date.
65. Define (a) NEER, (b) REER and (c) RER
Ans. (a) NEER is the measure of average relative strength of a given currency without eliminating the effect of price
change.
(b) REER is an effective exchange rate base on real exchange rates instead of nominal rates.
(c) Real Exchange Rate (RER) is the exchange rate that is based on constant prices to eliminate the effect of price
changes.
66. What is meant by balance of trade (BOT)?
Ans. BOT is the difference between money value of exports and imports of material goods.
67. When is there deficit in BOT?
Ans. When value of exports is less than value of imports, then BOT is called in deficit.
68. State various forms of capital account transactions.
Ans. (i) Private transactions,
(ii) Official transactions,
(iii) Direct investment and
(iv) Portfolio investment.
69. What does BOP account of a country record?
Ans. BOP account of a country records all transactions in goods, service and assets between residents of a country and rest
of the world.
70. Which two transactions determine BOT?
Ans. Export of goods and import of goods determine balance of trade.
71. Why are autonomous items called above the line items?
Ans. Because they are recorded in BOP account as first items before calculating deficit and surplus. In fact, deficit or surplus
occurs due to autonomous items.
72. Describe the causes for disequilibrium in BOP.
Ans. 1. Large imports due to large-scale development expenditure.
2. High domestic prices,
3. New sources of supply and new substitutes.
4. Political instability,
5. Changes in taste, fashion and preference.
73 State two merits and two demerits of flexible exchange rate system.
Ans. (a) merits are :
(i) Deficit or surplus is automatically corrected.
(ii) It frees the government from problem of BOP.
(b) Demerits are :
75. Why does a rise in foreign exchange rate cause a rise in its supply?
Ans. A rise in foreign exchange rate makes home countrys (say, Indias) goods cheaper to foreigners. As a result, demand for
Indian goods increases leading to increase in Indias exports. This brings a greater supply of foreign exchange. Thus,
there is direct relation between price (rate) of foreign exchange and supply of foreign exchange. (Mind, there is inverse
relation between price of foreign exchange and demand for foreign exchange.)
For Example : When a weaver gives cloth to the farmer in return for getting wheat from the farmer, this is called barter
exchange.
(b) Problem of Storing Wealth : It is difficult to store value in the absence of money, the individuals have to store wealth
in the form of goods like horses, shoes, wheat etc, it is very expensive to store goods in this form for a long time.
(c) Lack of common measure of value : In the barter system, there is lack of common measure of value. One goods value
for one person is different from that goods value for other. The rate of exchange will be arbitrarily fixed.
(d) Lack of Standard of Deferred Payments : Another drawback of this is that it lacks a standard of future payments.
So, credit transactions cannot take place smoothly under barter trading. Both parties run the risk that the value of
goods to be repaid may decrease or increase in future.
Money : Anything which is generally acceptable by the people in exchange of goods and service or in repayment of
debts.
Features :
(i) Medium of Exchange : Money is a thing that acts as medium of exchange for the sale and purchase of of goods and
services.
(ii) Measure of Value : The value of all goods and service is expressed in terms of money, which is known as price, so
we can say that it is measure of value.
(iii) It is the most liquid form of assets.
(iv) Money possesses general acceptability.
(v) Money is a means and not an end in itself.
Functions of Money :
(i) Medium of Exchange : As money as the quality of general acceptability, therefore, all the exchanges in an
economy takes place in terms of money.
(ii) Measure in Value : The second function of money is that it acts as common measure of value. All the value of
goods and services can be measured and expressed in terms of money. It provides a basis for keeping accounts,
estimating national income, calculating profit and loss, costing etc.
(iii) Store of Value : Storing wealth has become easy with the introduction of money. It is a source of further
investment money can be stored easily as it remains stable as compared to other commodities. It does not need
much space.
(iv) Standard of Deferred Payments : These are those payments which are made in future. When we borrow money
from somebody, we have to return both the principal as well as interest amount but it was difficult in barter system
but with the introduction of money, money performs this function most effectively.
Fiduciary Money : It refers to money backed up by trust between the payer and the payee. Cheques are fiduciary
money as these are accepted as a means of payment on the basis of trust.
Statutory Liduidity Ratio : Every bank is required to maintain a fixed percentage of its assets in the form of cash or
other liquid assets called SLR.
Question : Money acts as a yardstick of standard measure of value to which all other things can be compared. Explain :
Answer : Money service as a measure of value in terms of unit of account. Measurement of value was the main difficulty
of the barter system. 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 service can be expressed in terms of money.
This function of money also enables the trading firms to acertain their costs, reveness, profits and losses.
(ii) Open Market Operations : The central bank buys and sells government securities in the open market. When the
central bank wants to contract credit it sells government securities which are sold by commercial banks and
households. It will increase the money of commercial bank and households by which credit creation will be
increased.
(iii) Cash Reserve Ratio : They are required under law to keep with central bank a minimum percentage of their
deposits as cash reserves. This is called CRR When central bank wants to reduces the flow of money, they can
increase the CRR by which there will be less amount remain with the commercial bank. On the other bank,
when central bank wants to increase the flow of money, they can decrease the CRR by which there will be more
amount remain with the commercial bank. It will increase credit creation.
Qualitative :
(i) Margin Requirements : It refers to the difference between the current value of the security offered for loans and
the value of loans granted.
(ii) Moral Suasion : It means persuasion, request and appeal by the central bank to the member banks to expand or
contract credit, as the situation demands. For eg., the central banks may request the commercial bank not to grant
loans for speculative purposes.
(iii) Rationing of Credit : It is another method of selective credit control. Under this, the reserve bank fixed credit
quota for member banks. If the member banks seek more loans than their fixed quota, they will have to pay high
interest.
Central Bank : It is an apex institution of the monetary and banking structure of the country. It regulates the entire
banking system of the country.
Functions :
(i) Bank of Note issue : It has the sole monopoly to issue currency notes. It has an issue department which is solely
responsible for the issue of notes and coins.
(ii) Banker to the Government : It manager accounts of the government banks across all in the country. It keeps
some cash balances of the commercial bank as a compulsory deposit.
(iii) Bankers Bank : Central bank is the bank of all the banks which operates in the country. It keeps some cash
balance of the commercial bank as a compulsory deposit.
(iv) Lender of Last Resort : If a commercial bank fails to get financial accomodation from anywhere, can go to central
bank. It can give advance loans to such a bank.
(v) Custodian of Foreign Exchange reserves : It also functions as the custodian of all the foreign exchange
reserves key currencies such as US-dollars.
(vi) Controller of Credit : The central bank establishes stability not only in the internal price level, but also in the
foreign exchange rates. It helps in economic growth and smooth functioning of the economy.
Functions of Commercial Bank :
(i) Internet Banking : It facilitates the account holder to operate his account through internet by using his personal
computer.
(ii) ATM Facilities : The ATM machines are being provided by the bank. These machines can be used by the account
holder within the country.
(iii) Credit Cards : Commercial banks issue credit cards to their customers. The card holders can purchase goods and
services from various shops without making cash payments. The card issuing banks make payments immediately
to the sellers but receive the amount from the buyer after 30 to 45 days.
Functions of Money :
(i) Medium of Exchange : Money acts as a means of payments for exchange of goods and services. Goods and
services are exchanged for money when people sell things. Money is exchanged for goods and services when
people buy things. Therefore money reduces trading cost.
(ii) Unit of Value : Monetary unit is a unit in which the values of goods and services are expressed. The value of each
good or service can be expressed in terms of price i.e. the number of monetary units. For eg. If a notebook is worth
Rs.10 and a pen is worth Rs.5 then the note book is worth of 2 pens.
(iii) Store of Value : Money is a best form of reserve. The holders of money are the holders of generalised purchasing
power. It can be spent over a period of time. For eg., Money can be stored in the form of deposits in bank, purchase
of wants and shares, purchase of fixed assets etc. it can be liquified when required.
(iv) Standard of Deferred Payments : The money can be used for making future payments. It helps in borrowings,
lendings and formulating capital market. For eg., The situation of future payments are pensions, principle and
interest on debt, salaries etc. Here once an agreement is made to pay a certain amount of money then the value
remains fixed as the value of money remains fixed.
Money Supply : It can be defined as total amount of money is the economy held by public at a given point of time.
(ii) Demand Deposit by Commercial Bank : It is known as bank money. Banks demand deposit are referred to as
money supply because they are transferable by cheques in the settlement of debts. Bank is agreed to pay money
on demand at any time.
Credit Creation : It is the most important function of commercial banks. Credit plays an important role in the monetary
business system. It adds to the money supply in the economy.
Generally people open their current accounts in the commercial banks and can meet its obligations. But when credit is
granted by the bank, the bank do not give the cash money to the borrowers, they open a loan amount of the borrowers and
the money is transferred to the loan account. In this may bank create credit by advancing loans.
Example :
(a) Suppose banks has total deposit of Rs.1000 [primary deposit]. The bank can analyse that the whole of money is
not demanded at one time. But sum amount of money can be withdrawn anytime.
(b) So, 20% of the deposit that is 200 will be kept as reserve by the bank and the remaining will be given as a loan.
(c) Then remaining amount i.e. 800, will be transferred to the loan account of the borrowers.
(d) Then again 20% of 800 i.e. 160 will be kept as reserve and the remaining will be given as loan.
(e) So, at the end of this process with the primary deposit i.e. 1000, the bank can create the total deposit of 5000.
1
Credit Creation = Primary deposit
CRR
100
1000 = Rs.5000.
20
Features of a Budget :
(i) It is a statement of expected revenue and proposed expenditure.
Public Expenditure : It refers to the expenditure incurred by the government for the satisfaction of collective needs of
the people.
Capital Expenditure
(a) Revenue Expenditure : It is the expenditure incurred for the normal running of the government departments and
provision for various services. It includes expenditure like expenditure on civil administration, public health etc.
It neither creates assets for the government nor reduction in the libilities. It is of recurring nor reduction in the
liabilities. It is of recurring type. It is called non-development expenditure.
(b) Capital Expenditure : It refers to expenditure which leads to creation of assets or reduces liabilities. It is a
non-reducing type of expenditure. It is called development expenditure. Expenditure on acquisition of assets, land
and building etc.
Types of Taxes :
(i) Direct and Indirect Taxes (ii) Proportional, progressive and regressive
Proportional Tax : Taxes in which the tax rate remains constant whatever size of the tax base may be.
Progressive Tax : Taxes in which the rate of tax increases are called progressive taxes. In India income tax is a progressive
tax.
Regressive Tax : When the rate of tax decreases as the tax base increases the tax are called regressive tax.
(a) Revenue Deficit : It refers to the excess of revenue expenditure over revenue receipts.
Recenue deficit = Total revenue expenditure Total revenue receipts
(b) Fiscal Deficit : It refers to the excess of total expenditure both on revenue and capital accounts over revenue
receipts and only non-borrouring type of capital receipts.
Fiscal Deficit : Total budget expenditure Revenue Receipts non-debt Capital receipts
Balanced Budget : A budget is said to be balance when revenue and expenditure are equal.
Unbalanced Budget : If expenditure exceeds revenue, the budget will be unbalanced. The unbalanced may be due to
an excess of expenditure over revenue, this budget is called deficit budget or may be due to an excess of revenue over
expenditure, this budget is called surplus budget.
Components of Budget :
(i) Budget receipts (ii) Budget Expenditure
(i) Budget Receipt : It refer to the estimated money receipts of a government from all sources during a fiscal year.
Budget receipts can be of two types : revenue receipts and capital receipts.
(a) Revenue Receipts : These are those receipts of the government which neither create any liability for the
government nor cause any reduction in the assets of the government. For example : tax is a revenue receipts
as it does not create any liability for the government.
(b) Capital Receipts : These are those receipts of the government which either creates any liability for the
government or cause any reduction in the assets of the government. These include items of non-routine
nature.
1mark Questions :
1. Why is tax-treated as revenue receipts ?
Ans: Because tax neither create a liability for the government nor reduces assets of the govt.
3. Classify the borrourings and recovery of loans into revenue and capital receipts of govt. budget ? Give reason.
Ans: Borrouring on capital receipts because the government is under obligation to return the amount along with
interest so it creates liability of the govt. Recovery of loans is also a capital receipt because these reduce assets
of the govt.
5. What will be the value of fiscal deficit if primary deficit is Rs.53000 crores and intt. on borrourings is
Rs.5000 crores ?
Ans: Fiscal defifit = Primary deficit + Interest Payment
= 53000 + 5000
= 58000 crores
(b) Non Developmental : It refers to expenditure incurred on essential general services of the government. It helps in
smooth functioning of an economy. It does not adds to flow of good and services.
(c) Planned : It is that public expenditure which represents current development and investment that arise due to plan
proposal. For eg., infrastructure development.
(d) Non-Planned : It refers to expenditure provided in the budget for routine functionining of the government. For eg.,
expenditure on emergency needs, subsidies, pensions etc.
(ii) By borrouring from internal sources (public) through issuing bonds and shares and external sources (IBRD, IMF).
Implication :
(a) It measures the amount of borrourings required by the govt. and extent of govt. dependance on others to meet its
budget expenditure.
(b) Govt. borrours from RBI i.e. deficit financing which leads to increase in circulation of money and causes inflation.
(c) Indebatness : govt. borrourings from rest of the world which increases the dependance on other countries and effect
the growth and development. This increases the financial burden on future generation to pay loans and interest
amount.
(d) Debt Trap : As the govt. expanditure increases, its liability in future to repayloan with interest also increases.
The increase in interest amount leads to increase in revenue expenditure. Increase in revenue expenditure leads to
increase in revenue deficit. The gap between revenue receipt is met by borrourings.
Revenue Deficit with its Implication : It refers to excess of total revenue expanditure of the government over its
total revenue receipts.
Implication :
(a) It indicates the dissavings on government account because the government has to make the uncovered gap by
drawing capital receipts i.e. either through borrourings or disinvestment.
(b) Revenue deficit results in government liabilities and decrease in government assets and therefore increases the
repayment burden in future.
Foreign Exchange Rate : The rate at which one currency can be converted into another currency. Suppose 1 US dollar can
be obtained by paying INR 50, then the foreign exchange rate is 1 US dollar = 50 INR ,
1 pound = 70 INR.
Types of Exchange Rates : The conversion rate between two currencies is decided by :
(i) Government (ii) Market
(a) Fixed Exchanged Rate : If the government decides the conversion rate, it is called fixed exchanged rates. Such a rate
does not vary with changes in demand and supply of foreign currency. Only government has the power to change it.
(b) Floating Exchange Rate : If the market forces determined the conversion rate, it is called floating exchange rate,
this rate varies with changes in demand and supply of foreign currencies. There is a well organised foreign exchange
market in a country having floating exchange rate.
(c) Managed Flating Rate : This system of exchange rate have emerged recently. This is essentially a floating rate, it is
called managed because the centralbank tries to influence the rate by entering the market as a bulk buyer or seller.
When the central bank finds floating rate too high, its start selling foreign exchange from it reserves to bring down the
rate.
When it finds the rate too low it starts buying to raise the rate. This kind of floating is also called dirty floating rate.
(ii) Source of Supply in Exchange Rate : The supply of US dollars in India comes from those who earn these dollars by
selling goods and services to the countries to make payments in US dollars. There are many sources of supply of
foreign exchange :
From exporting goods goods and services.
From transfer payments in the form of gifts, remittances.
From income receipts.
From investments in financial and physical assets from rest of the world.
From borrouring money and receiving re-payements from foreign currencies.
Demand curve is normally downward sloping at price OP0, demand for foreign exchange is (PO), at lower price OP1, demand
is (F1) which is higher. At higher price (P2), demand is lower (F2).
Relation betwen Supply and Price : There is a direct relationship between price of exchange and supply of that foreign
exchange. The higher the price, the higher is the supply, the lower the price, the lower will be supply.
The supply curve is normally upward sloping at price PO, supply for foreign exchange is F0, at lower price P1, supply is
F1 i.e. lower. At higher price P2 supply is F2 is higher.
Determination for Foreign Exchange Rate : Like the price of a good foreign exchange is also determined by the
forces of demand and supply of foreign exchange. There are organised foreign exchange markets in every country where
buyers and sellers meet and bargain.
The price that prevails at a particular point of time is the equilibrium exchange rate. This equilibrium occurs at that rate at
which the quantity demanded by a foreign currency equals the quantity supplied of that currency.
The price of foreign exchange is determined at the intersection of demand and supply curves relating to foreign exchange.
OP is the market demand and OF is the demand and supply of foreign exchange at this rate.
Appreciation of Currency : It means rise in the external value of a currency. If today 1 dollar can be exchange at Rs.45
and after one month, 1 dollar is exchanged at Rs.40 then we can say that there is appreciation in the value of an Indian
currency.
Depreciation of Currency : It means falls in the external value of a currency. If today 1 dollar can be exchanged at
Rs.45 and after one month, 1 dollar is exchanged at Rs.50 then we can say that there is depreciation in the value of
Indian currency.
Balance : Means the difference between the sum of credits and sum of debits.
A deficit in BOP occurs when during the year autonmous inflow of foreign exchange.
Questions :
1. Why is supply curve a positive sloped curve ?
Ans : As rate of exchange increases the demand for US $ also increases and vice versa. It is become as rate increases the
home countrys goods become more cheaper for the foreigners and supply is more for US $.
As the rate increases from Rs.46 to Rs.47, then the supply of US $ also increases from 8 to 10 units, Here units the increases
in exchange rate, the rupee value is depreciating.
5.
6.
Aggregate Demand :
It is defined as the total demand for final goods and services planned to be purchased by all sectors of economy at a given
level of income in a period of time.
Components :
AD = Consumption + Investment
These components can be understood in four parts :
(a) Private consumption demand (b) Government demand for goods and services
(a) Private Consumption Demand : It means planned demand for final consumer goods and services by
households during a period of time. It is influenced by the disposable income of the households. From the income
the consumer consumes and the rest he saves.
(b) Govt. Demand for Goods and Services : It means planned consumption expenditure of general government
on providing free services to the people and on capital formation during a period. Eg. services of law and order,
defence, education, health, sanitation, roads, flyovers, railways etc.
(c) Private Investment Demand : It means planned expenditure on making addition to capital goods by private
producers during a period of time. For eg. expenditure on fixed assets and inventeries. Investment is categorised
into two parts :
(i) Induced (ii) Autonomous
(d) Demand for Net Exports : It means the planned net foreign demand for the goods and services produced in the
country during a period. Generally net export demand is a small proportion. Therefore, the Keynes has ignored this
component.
Aggregate Supply : Total value of final goods and services produced in the given period of time.
Component :
National Income = Consumption + Savings
The value of this output is equal to the cost planned to be incurred on producing this output which the producer expects
to recover during this period. The cost includes the payments to the factors of production i.e. rent, wages, interest, profit.
Rent + Wages + Intt. + Profit = NNPFC ignoring NFIA
Schedule :
Schedule :
Behaviour of MPC :
MPC changes between 0 to 1
0<b<1
(i) When income is zero consumption is positive. Therefore, MPC can never be zero.
(ii) When income increases, consumption also increases but at a slower rate.
Therefore, MPC can never be 1 or greater than it.
S = y C by
S = y C by
S = C y by
S = C y 1 by
when income is zero.
For eg., If the national income of the country increases from 1000 crores to 1200 crores and the consumption increases from
800 crores to 900 crores.
100
Then, MPC 0.5
200
Therefore, a rupee change income causes 0.5 rupee change in consumption.
Average Propensity to Consume : It is the ratio of consumption to income i.e. the proportion of income spend on
consumption.
C
APC
y
For eg., If nationalincome of the country is 1000 crores and the consumption is 800 crores.
800
APC 0.8
1000
Therefore, the economy 80% of its income.
S C y 1 by
whereas S = Savings function
C = Dissaving
(1 b) = Rate of change in saving in respect to
y = level of income
Questions :
1. Can APC can greater than 1 or equal to 1 or less than 1 Yes or No. Prove the statement.
Ans :
APC is greater than 1 before the break even point (point B) where consumption is greater than income.
3. APS is negative, APS is equal to 0, is positive but less than 1. Give reasons.
S
Ans : APS can be negative when saving is negative, APS
y
When it is before break even point.
Eg. y C S
80
100 180 80 APS = 0.8
100
APS can be zero when saving is zero, at break even point
Eg. y C S
0
500 500 0 APS = 0
500
APS can be less than 1 but positive because saving is positive beyond break even point.
Eg. y C S
20
600 530 20 APS = 0.3
600
4. APS can never be greater than 1. Prove.
Ans : APS can never be greater than 1 because APC + APS = 1.
APS can never be zero or negative and therefore APS can never be greater than 1.
The line (C + I) i.e. aggregate demand and the 45line depicts the equilibrium level of national income. The 45 line enables
us the identify the equilibrium because here planned planned output (A.S.).
Important Terms :
(a) Exante Saving Investment : In an economy what we plan to save during a particular period, it is known as
planned saving whereas what we plan to invest during a particular period, it is known as planned investment.
(b) Expost Saving and Investment : In an economy what we actually save is export or realised saving and what are
actually invest is called export investment or realised investment.
Actual Investment = Planned Investment + Unplanned Investment
(c) Full Employment : It means maximum efficient utilisation of the economics available resources i.e. every able
body who is willing to work in the current wage rate is employed.
(d) Voluntary Unemployment : It refers to the population which prefer not to work at the prevailing wage rate.
They are not the part of labour force.
(e) Involuntary Unemployment : It refers to a situation in which all able person who are willing at work at current
wage rate cannot get work. According to kenes it is due deficiency of aggregate demand. It is due to wage price
rigidity and constant marginal physical product.
Case 1 : S < I
The economy is at a level of output less than M i.e. point P. At this level of income, the saving function lies below the
investment schedule. At this level of income households are saving an amount less than firms plan to invest. The effect
of this is reduction in inventories. The firm will increase the production, employment. The economy returns to equilibrium
output level M. Here planned saving is equal to planned investment.
Case 2 : S > I
The economy is at a level of output greater than M i.e. point N. The saving function lies above the investment schedule.
At this level of income the households are saving more then the firms plan to invest. The effect of this will lead to
unplanned increase in inventories. The firm will reduce the production, employment. The economy returns to equilibrium
output level M. Here planned saving is equal to planned investment.
Multiplier : It is a measure of change in national income as a result of initial change in investment.
y
k
I
Multiplier shows that a change in investment i.e. by I, income increases by a greater income i.e., y.
For eg., If an increase in investment is Rs.100 crores which causes an increase in income of Rs.300 crores then the
multiplier is
y 300
k 3times
I 100
Relationship between Multiplier and MPC
(i) The value of multiplier is determined by MPC. Higher the MPC, greater is the size of multiplier. Lower the MPC,
smaller is the size of multiplier.
1
k
1 MPC
(ii) Expenditure of one individual is the income of other. When investment increases, income of the people also
increases. They spend a part of the increased income on consumption and the rest they save.
(iii) How much of their income, the people would spend on consumption will depend on MPC.
(iv) If MPC is more, it will generate income for another.
(v) Therefore, increase in investment does not cause increase in income in the same same proportion rather increase
in income is more than initial increase in investment.
(vi) The factor by which the income increase depends upon MPC. Therefore, higher than MPC, higher is the value of
multiplier.
Short Run fixed Price Analysis : Exante demand for final goods : In an economy without a government and foreign
trade, exante aggregate demand (planned aggregate demand) for final goods i.e. the sum total of exante consumption
expenditure and exante investment expenditure on final goods. AD = C + I.
It is measured by summing up the consumption f (x) and constant investment (autonomous investment)
AD = C + I
AD C by I
In case of exante investment expenditure, the assume constant price (rate of interest) over a short period of time to
determine level of aggregate demand
At equilibrium AS = AD
Income = AD
= C by I
C = Autonomous consumption
I = Autonomous investment
Deficient Demand : It can be when aggregate demand falls hort of aggregate output at full employment level.
Deflationery Gap : It is the difference between actual aggregate demand and required aggregate demand at full
employment level. It is negative for our economy.
Excess Demand : Where AD > AS, at full employment level, it is known as excess demand.
Q* = Output level
FG = Inflationery gap
Point F = Full employment equilibrium
Point E = Over employment equilibrium
(i) At output Q*, the economy is at full employment level. At point F is full employment equilibrium.
(ii) Suppose the AD increases at full employment level i.e. point from F to G. The economy will face inflationary
pressure.
(iii) The rise in price will lead to rise in national income.
(iv) This increase in national income is due to rise in price i.e. increase in nominal national income and not due to
increase in quantity produced i.e. real national income.
(v) The rise in national income will lead to new equilibrium position i.e. point E known as over employment
equilibrium.
(a) Quantitative :
(i) Bank Rate : It is the rate at which the Central Bank leads to the commercial bank. To check depression,
the central bank reduces the bank rate. It enables the commercial bank to take more loan from it and in
turn give more loans to the producer at a low rate of interest. It increase the investment demand and
therefore, aggregate demand which eliminates the deflationery gap.
(ii) Open Market operations : It refers to buying and selling of the securities by the Central Bank. Central
Bank purchases govt. bonds and securities from commercial bank by payment in cash, which increases
the cash stock with commercial bank. It increases the lending capacity and therefore increases the
investment and aggregate demand.
(iii) Legal Reserves : There are two types of legal reserves : CRR and SLR
CRR : It is the minimum percentage of deposits kept by the commercial banks with the central bank.
In deficient demand, it is reduced.
SLR : It is the minimum percentage of deposits to be kept by the commercial bank with itself is called SLR.
The SLR is reduced to correct the problem of deficient demand.
(b) Quantitative :
(i) Margin requirements : It refers to the difference between the current value of the security offered for
loans and the value of loan granted. In case of deficient demand the central bank reduces the margin.
Thereby increasing investment demand and finally aggregate demand.
(ii) Moral Suasion : The central bank appeals to the commercial bank to encourage lending to the selected
sector to expand credit.
2. Fiscal Policy : It is a budgetary policy of the govt. related to revenue expenditure of the govt. to correct the problem
of deficient demand.
(i) Govt. Expenditure : Deficient demand can be corrected by increasing the level of govt. expenditure by an
amount equal to deflationery gap. The expenditure is either consumption or investment expenditure.
(ii) Deficit Financing : It is increased to increase the purchased power in the economy.
(iii) Taxes : The taxes are decreased in case of deficient demand. The govt. adopts progressive taxation policy i.e.
higher the income higher than taxes. The MPC of the rich people is lower as compared to the poor.
Money Multiplier : New deposits in banks leads to creation of more deposits by banks. Total deposits is many times the
initial deposits. The multiple by deposits can increase due to an initial deposit in called money/deposit multiplier.
The value of money multiplier is determined by LRR.
1
Deposit multiplier =
LRR
20
It suppose LRR = 20%, deposit = 0.2
100
1 1 1 10
Multilier = 5
LRR 0.2 0.2 2
10
Working :
1. New deposits of Rs.1000 is made in Bank. LRR = 20%. The bank keeps 20% deposits as cash, so Rs.200 as kept as cash
reserve and bank lends the remaining amount of Rs.800.
2. Lending means that bank create deposits of Rs.800 in the name of the borrouers. This is the first round creation and
is equal to 80% of the initial deposit.
3. Borrouer withdraw the entire amount of loan and spend the same on goods and services.
4. The seller of the goods and services receives Rs.800 of revenue and deposit the same in their respective bank.
5. The bank gets new deposits and keep the 20% and lend the remaining amount of Rs.640. This is the second round
increase. It is 80% of previous round increase.
Legal Reserve Ratio : It is that fraction of deposits with the commercial bank which is legally compulsory for the
banks to keep in the form of cash. Eg.: A bank has a deposit of 100 lakhs and the LRR = 20%, it means bank must hold
Rs.20 lakh as cash.
The bank do not keep the entire deposit in the form of cash as by doing so, it will not earn any profit.
The banks keeps only a fraction of deposits as cash and use the remaining for giving loans.
At any point of time, the bank has to meet the withdrawl demand of the depositor failing which a legal violation
of contract arises between depositor and bank.
It is because from experience it is found that not only depositor withdraw money at the same time and that they
withdraw any fraction of deposits.
At the same time, they continue to make new deposits. Therefore, there is no need for banks to keep the entire
amount as cash, they banks can easily meet the daily withdrawl of the depositors.
8. The sum total of all deposits will ultimately be Rs.5000 i.e. 5 times the initial deposits.
Supply :
(i) Currency with public
(ii) Demand deposits with commercial banks currency is created by central bank of country because it has sole rights of
using notes. This currency is called high powered money. Demand deposits are created by commercial banks and are
called bank money.
17. If a product price increases, a familys spending on the product has to increase. Comment
Ans. The answer depends upon two factors, namely, (i) Elasticity of demand, and (ii) Availability of substitute. If demand for
the product whose price has increased is inelastic and the product has no substitute, a familys spending will increase. On
the other hand, if demand is elastic or the products substitutes are available, a familys spending need to increase.
18. What is meant by cross price effect? Give two examples.
Ans. It is the effect of change in price of one product on quantity demanded of other product. For example, when price of petrol
rises, demand for cards falls. When price of coffee rises, demand for tea rises. Cross price effect happens in case of related
goods.
19. If price of good x rises and it leads to an increase in demand for good y, how are the two goods related?
Ans. The two goods are complementary to each other.
20 Will the total expenditure change in the opposite direction or same direction of price change if % change in quantity is (i)
greater than (ii) less than % change in price of the commodity?
Ans. (i) Total expenditure will change in the opposite direction of price change if % change in quantity > % change in price and
(ii) in the same direction of price change if % change in quantity < % change in price.
21. What will you say about MPP of a factor when TPP is falling?
Ans. MPP is negative ().
22. What will you say about MPP of a factor when TPP is rising at diminishing rate?
Ans. MPP is falling but remains positive.
23. When MPP is falling and is positive, at what rate TPP is changing?
Ans. TPP is rising at a diminishing rate.
24. When APP falls, what is the relation between MPP and APP?
Ans. MPP is less than APP.
25. What happens to TPP when MPP of the variable input is negative ()?
Ans. TPP falls when MPP is negative.
26. When APP rises, what is the relation between MPP and APP?
Ans. MPP is greater than APP.
27. When APP is maximum, what is the relation between MPP and APP?
Ans. MPP is equal to APP.
28. What does division of labour mean?
Ans. it refers to allocation of tasks (work) among workers according to their specialisation.
29. What are volume discounts?
Ans. It is discount (deduction) on price when a large quantity is purchased.
30. The following table gives MPP of factor. It is also known that TPP at zero level of employment is zero. Determine its TPP
and schedules.
Level of employment 1 2 3 4 5 6
MPP 20 22 18 16 14 6
Ans. TPP 20, 42, 60, 76, 90, 96; APP 20, 21, 20, 19, 18, 16
31. The following table gives APP of a factor. It is also known that the TPP at zero level of employment is zero. Determine
TPP and APP schedules.
Level of employment 1 2 3 4 5 6
APP 50 48 45 42 39 35
Ans. TPP 50, 96, 135, 168, 195, 210;APP 50, 46, 39, 33, 27, 15
32. Do ATC and AVC curves intersect? Give reasons.
Ans. ATC curve and AVC curve do not intersect each other because the difference between ATC and AVC is AFC which is
always positive.
33. Why is MC curve in short run U-shaped?
Ans. MC curve in short run is U-shaped due to operation of law of returns (i.e., law of variable proportion). As output is
increased, MC first falls, reaches its minimum and then rises due to operation of increasing, constant and diminishing
returns in production.
34. Increasing and decreasing returns to scale respectively imply downward and upward slopping portion of long run average
cost (LAC) curve. Comment
Ans. The above statement which reflects U-shape of LAC curve is defended. U-shape is the result of operation of returns to
scale according to which a firm experiences increasing returns to scale (i.e., diminishing cost) in the beginning, followed
by constant returns and then by diminishing returns to scale (i.e., increasing cost). This makes the LAC curve first sloping
downward and then upward.
35. Why is AC curve U-shaped in the ling run?
Ans. LAC curve is U-shaped because of operation of law of returns to scale.
36. What change will take place in AC if MC is rising?
Ans. AC will also rise because rising MC will pull AC up.
37. Why is AC curve U-shaped in the short run.
Ans. SAC curve is U-shaped because of operation law of returns to a variable proportion.
41. From the following data for a firm, find (i) AFC, (ii) AVC and (iii) MC.
Output (units) 0 1 2
Total Cost (Rs) 75 95 110
Ans. Output TC FC VC AFC AVC MC
0 75 75 ___ ___ ___ ___
1 95 75 20 75.0 20.0 20
2 110 75 35 37.5 17.5 15
42. Given that total fixed cost is Rs 60, complete the following table.
Output (units) AVC (Rs) TC (Rs) MC (Rs)
1 20
2 15
3 20
Ans. Output AVC TVC TFC TC MC
1 20 20 60 80 20
2 15 30 60 90 10
3 20 60 60 120 30
43. The table given below shows the total cost of a firm at different levels of output. Calculate MC and AVC at each level of
output.
Output (units) 0 1 2 3 4
Total Cost (Rs) 100 160 212 280 356
Ans. Output TC MC TVC AVC
0 100 ___ ___ ___
1 160 60 60 60
2 212 52 112 56
3 280 68 180 60
4 356 76 256 64
44. TFC of firm is Rs 12. Given below is its MC schedule. Calculate TC and AVC from each given level of output.
Output (units) 1 2 3 4 5 6
MC (Rs) 9 7 2 4 8 12
Ans. Output TFC MC TVC AVC TC
1 12 9 9 9 21
2 12 7 16 8 28
3 12 2 18 6 30
4 12 4 22 5.5 34
5 12 8 30 6 42
6 12 12 42 7 54
45. Calculate MC and TC from the following cost schedule of a firm whose total fixed costs are Rs 15.
Output (units) 1 2 3 4
Total Variable Cost (Rs) 10 19 29 49
Ans. Output(Units) TVC(Rs) FC (Rs) TC (Rs) MC (Rs)
1 10 15 25 10
2 19 15 34 9
3 29 15 44 10
4 40 15 55 11
Ans.
Output Price TR TC Profit MR MC
1 24 24 26 2 24
2 24 48 50 2 24 24
3 24 72 72 0 24 22
4 24 96 92 4 24 20
5 24 120 115 5 24 23
6 24 144 139 5 24 24
7 24 168 165 3 24 26
At output level of 6 units, producer is in equilibrium because at this level producer gets maximum profile (i.e., `. 5) after
which profit falls as more is produced (TR and TC approach). According to MR and MC approach also, at level of 6 units
MR = MC and after this MC becomes greater than MR.
54. Given below is a cost and revenue schedule of a producer. At what level of output the producer is in equilibrium. Give
reasons for your answer.
58. Due to improvement of technology, marginal costs of production televisions have gone down. How will it affect the
supply curve of television?
Ans. The supply curve will shift to the right.
59. What effect does a cost saving technical progress have on supply curve of product?
Ans. The supply curve shifts to the left. (As profit falls due to rise in cost.)
60. If a farmer grows rice and wheat, how will an increase in price of wheat affect supply curve of rice?
Ans. The supply curve of rice will shift leftward. (Because producers will reduce supply of rice and instead increase production
of more profitable wheat.)
61. What is the price elasticity associated with a straight line supply curve passing through the origin?
Ans. Price elasticity of straight line supply curve passing through the origin is equal to one.
62. A new technique of production reduces the marginal cost of producing stainless steel. How will this affect the supply curve
of stainless steel utensils?
Ans. Supply curve of stainless steels utensils will shift rightward because fall in marginal cost means more profit margin with
induce producers to produce more.
63. Because of cyclone in a coastal are, the sea level covers a lot of rice fields. This reduces productivity of land. How will it
affect supply curve of rice of that region?
Ans. Supply curve of rice will shift to the left because fall in productivity of land caused by cyclone will result in fall in
production/ Supply of rice.
64. Can there be some fixed cost in the long run? If not, why?
Ans. No there cannot be fixed cost in the long run because there is no fixed factor/input in the long run.
65. At a particular level of output a producer finds that MC is greater than MR. What will he do to maximise his profit?
Ans. The producer will reduce his production to increase his output.
66. A perfectly competitive firm is price taker and industry the price maker. Comment.
Ans. Under perfect competition, price of a product is determined by equilibrium between demand and supply of the whole
industry. Since every firm has to accept the market price thus determined by the industry, therefore, a firm is said to be the
price taker and industry the price maker.
67. If the firms are earning abnormal profits, how will be the number of firms in the industry change?
Ans. The number of firms will increase in the industry because new firms will be attracted to avail of abnormal profits.
68 What is the relationship between break even price and MC at the long run competitive equilibrium?
Ans. Break-even price = MC at the long run competitive equilibrium.
69. Which point on the long run AC curve does a competitive firm produce in the long run equilibrium?
Ans. At the lowest (minimum) point on the long run average cost curve.
70. What are patent rights?
Ans. Paten right is an exclusive right (licence) granted to a company (or an individual) to produce a particular product or to use
a particular technology for claiming to be discoverer of that particular product or technology.
71. Why MR is less than AR for a monopoly firm?
Ans. Because it can sell more only by lowering the price of commodity. Decreasing price (AR) implies decreasing MR. As
result, MR from sale of successive units will be less than the price (AR).
Ans. In monopoly as out increases / decreases, price changes according to what consumers are willing to pay along demand
curve. So, market demand curve facing a monopoly firm is a constraint.
73. For a non-viable industry, where does the supply curve lie relative to demand curve.
Ans. The supply curve lies above demand curve.
74. How does an increase in the price of a substitution good in consumption affect the equilibrium price?
Ans. Equilibrium price will increase.
75. How does a cost saving technological process affect the market price and quantity exchange?
Ans. It will cause a rise in market price and a fall in the quantity exchanged.
76. What does the FAD theory of famines say?
Ans. When the available quantity of foodgrains falls leading to a rise in its price, the poor people can no longer afford to by
even minimum quantity of foodgrains for survival. This causes heavy starvation taking the shape of a famine.
77. Why does a surplus emerge in the case of support price?
Ans. Surplus emerges because supply exceeds demand due to support price which is always higher than equilibrium price.
78. What will be the impact on market price and quantity exchanged when:
(i) There is rightward shift in demand curve;
(ii) The demand curve is perfectly elastic and supply curve shifts out (rightward);
(iii) Both the demand and supply curves decrease in the same proportion?
Ans. (i) Equilibrium (market) price and quantity will increase presuming supply to be constant.
(ii) It will lead to decrease in price and increase in quantity transacted.
(iii) Equilibrium price will not be affected but quantity supplied and demanded will decrease in the same ratio.
79. Equilibrium price may or may not change with shifts in both demand and supply curves. Comment.
Ans. (i) Equilibrium price will not change if both the demand curve and supply curve shift in the same direction
(leftward or rightward) in the same proportion.
(ii) Equilibrium price will change if both the demand curve and supply curve shift in the same direction
(rightward or leftward) but in unequal proportion or if demand curve and supply curve shit in opposite
direction.
80. Why is MR less than AR in monopoly and monopolistic competition?
Ans. Because a firm can sell more only by lowering the price of its commodity.
80. What happens to equilibrium price and quantity when :
(i) increase in demand is equal to increase in supply.
(ii) decrease in demand is equal to increase in supply.
Ans. (i) Equilibrium price will not change but quantity supplied and demanded will increase in the same ratio.
(ii) There will be no change in equilibrium quantity but equilibrium price will fall.
81. Suppose the demand and supply curve of a commodity x in a perfectly competitive market are given by :
Qd = 700 P
Qs = 500 + 3P
Find the equilibrium price and the equilibrium
Ans. At equilibrium price Qd = Qs (Quantity demanded = Qty. supplied)
700 P = 500 + 3P
700 500 = 3P + P
4P = 200 or P = 50
So, equilibrium quantity = 700 P
= 700 50
1 1 1 1
Ans. K(Multiplier) 5
1 MPC 1 0.8 0.2 1
5
Change in Income = Change in investment K
= 1,000 5 = 5,000
97. MPC in economy is 0.8. If investment is increased by Rs. 5 crore, how much would be the increase in income?
1 1 1 1
Ans. K 5
1 MPC 1 0.8 0.2 1/ 5
Increase in income = Change in investment K
= 5 5 = 25 crore
98. If in an economy MPC is 0.8 and investment is increased by Rs. 1,000 crore, calculate total increase in income.
1 1 1
Ans. K 5
1 MPC 1 0.8 0.2
Total increase in income = Increase in investment K (multiplier)
= 1,000 5 = 5,000 crore
99. In an economy, MPC is 0.75. If investment expenditure is increased by Rs. 100 crore, calculate total increase in income
and consumption expenditure.
1 1 1 1
Ans. K 4
1 MPC 1 0.75 0.25 1/ 4
Total increase in income = Increase in investment K
= 500 4 = 2,000 crore
Total increase in consumption expenditure = 0.75 of 2,000 = 1,500 crore
100. In an economy, investment expenditure is increased by Rs. 400 crore and MPC is 0.8. Calculate total increase in income
and savings.
1 1 1 1
Ans. K 5
1 MPC 1 0.8 0.2 1/ 5
Total increase in income = 400 5 = 2,000 crore
Total increase in saving = 0.2 (= 1 0.8) of 2,000 = 400 crore
101. As a result of increase in investment by Rs. 20 crore, national income increases by 100 crore. Find out MPC.
Y 100
Ans. K 5
I 20
1 1
K or 5
1 MPC 1 MPC
or 5 MPC = 5 1 = 4
or MPC = 4/5 = 0.8
102. In an economy investment increase by Rs. 120 core. The value of multiplier is 4. Calculate MPC.
1 1
Ans. K or 4
1 MPC 1 MPC
4 4MPC = 1 or 4MPC = 4 1 = 3
MPC = 3/4 = 0.75
103. A Rs 200 crore increase in investment leads to a rise in national income by Rs. 1,000 crore. Find out marginal propensity
to consume (MPC).
1
or Y = 1,500
10
Y = 15,000 (Equilibrium level of income)
(ii) Y=C+I
15,000 = C + 1,000
C = 15,000 1,000
= 14,000
Consumption expenditure at equilibrium level of income = 14,000
107. Given consumption function C = 100 + 0.75Y (where C = consumption expenditure and Y = Nation income) and
investment expenditure Rs. 1,000. Calculate the following.
(i) Equilibrium level of national income,
(ii) consumption expenditure at equilibrium level of national income.
Ans. (i) For equilibrium Y = C + I (i.e., AS = AD)
Y = 100 + 0.75Y + 1,000 (Given C = 100 + 0.75Y)
Y 0.75Y = 1,100
or 0.25Y = 1,100
100
Y 1,100 4, 400 (Equilibrium level of income)
25
(ii) C = 100 + 0.75Y (Given)
=100 + 0.75 4,400
= 100 + 3/4 4,400 = 3,400 (Consumption expenditure)
108. From the following information about an economy, calculate (i) its equilibrium level of national income and (ii) savings at
equilibrium level of national income. Consumption function C = 200 + 0.9Y (where C = consumption expenditure and Y =
National income). Investment expenditure I = 3,000.
Ans. (i) For equilibrium Y=C+I
Y = (200 + 0.9Y) + 3,000
Y 0.9Y = 3,200
or 0.1Y = 3,200
10
Y = 3,200 = 32,000 (National income)
1
(ii) C = 200 + 0.9Y (Given)
= 200 + 0.9Y (Y = 32,000 proved)
9
= 200 + 32,000
10
= 200 + 28,800 = 29,000
Saving = Y (National income) C (Consumption)
= 32,000 29,000 = 3,000
109. Define marginal propensity to save (MPS).
Ans. The ratio of change in saving (S) to change in income (Y) is called MPS.
Symbolically : MPS = S/Y
110. What is multiplier?
Ans. Investment multiplier (K) is the ratio of increased income (Y) due to an increase in investment (I). Symbolically : K =
Y / I.
111. What is deficient demand?
Ans. When aggregate demand is for a level of output that is less than full employment level of output, it is said to be deficient
demand.
136. Why are autonomous items called above the line items?
Ans. Because they are recorded in BOP account as first items before calculating deficit and surplus. In fact, deficit or surplus
occurs due to autonomous items.
137. Describe the causes for disequilibrium in BOP.
Ans. 1. Large imports due to large-scale development expenditure.
2. High domestic prices,
3. New sources of supply and new substitutes.
4. Political instability,
5. Changes in taste, fashion and preference.
138. State two merits and two demerits of flexible exchange rate system.
Ans. (a) Merits are :
(i) Deficit or surplus is automatically corrected.
(ii) It frees the government from problem of BOP.
(b) Demerits are :
(i) It encourages speculations leading to fluctuations in exchange rate.
(ii) Wide fluctuations in exchange rate discourage investment and international trade.
139. State four source each of demand for foreign exchange and supply of foreign exchange.
Ans. (a) Sources of Demand are:
(i) To purchase goods and services from foreign countries.
(ii) To invest and purchase financial assets in a foreign country.
(iii) For sending gifts abroad and
(iv) To undertake foreign tours.
(b) Sources of Supply are :
(i) Direct foreign investment in the domestic territory,
(ii) When foreigners purchase home countrys goods and services,
(iii) Remittances by non-residents abroad and
(iv) When foreign tourists come to home country.
140. Why does a rise in foreign exchange rate cause a rise in its supply?
Ans. A rise in foreign exchange rate makes home countrys (say, Indias) goods cheaper to foreigners. As a result, demand for
Indian goods increases leading to increase in Indias exports. This brings a greater supply of foreign exchange. Thus, there
is direct relation between price (rate) of foreign exchange and supply of foreign exchange. (Mind, there is inverse relation
between price of foreign exchange and demand for foreign exchange.)