KENDRIYA VIDYALAYA SANGATHAN LUCKNOW REGION I.I. T CAMPUS KANPUR-208016
STUDY MATERIAL-XII ECONOMICS 2009-2010 PATRON
Shri. M.S. Chauhan Assistant Commissioner (LR)
ADVISOR Shri. S.K.Trivedi Principal, KVIIT Kanpur Co-ordinator Mrs. T.Z. Naqvi Vice Principal, KVIIT Kanpur Resource Persons
1). Mrs. Reeta Tripathi (PGT Economics)
KV IIT Kanpur
2). Dr. Rajkumari (PGT Economics)
KV No. 3, Chakeri
3). Mr. Nanhelal (PGT Economics)
KV No. 2, Chakeri
4). Mrs. Meera Dubey (PGT Economics)
KV, Kanpur Cantt
PREFACE
From the Coordinator’s desk........................................
‘We are delivering the ‘BEST’ because we are focussed.’ The words of our honourable Assistant Commissioner Shri. M.S.Chauhan has motivated us with the commitment to give the best to our students. Out endeavour is to bring out new and best edition of study material incorporating the valuable suggestion of the teachers and the difficult areas faced by the students. The language is simple and comprehensive even for slow learners. The material has been prepared as per the latest CBSE syllabus. This subject’s teachers are advised to make the thorough use of the study material so that the students are proficient enough to score better percentile in the final. Valuable suggestions are always welcome.
CLASS – XII Syllabus and Unit Wise Weightage Units
Marks
Part A: Introductory Micro economics
1. Introduction 2. Consumer Equilibrium and Demand 3. Producer behaviour and supply 4. Different forms of Market and Price Determination Total:
Part B: Introductory Macro Economics
04 18 18 10 50
Marks
1. National Income and related Aggregate: 15 Basic concepts and measurements 2. Determination of Income and 12 Employment 3. Money and banking 08 4. Government Budget and the Economy 08 5. Foreign Exchange Rate & Balance of 07 Payments Total: 50
Micro Economics Unit – 1 Introduction Marks – 4 Basic concepts of the lesson –
Economics : Economics is a social science. It is concerned with the study of individual and social choice in situations of scarcity.
Economy : Economy is the sum total of all economic activities.
Economizing Resources : Economizing resources means making best possible use of available resources. The need for economizing resources arises due to scarcity of resources.
Economic Problem : The problem of choice making is called economic problem. Main causes for the emergence of economic problem are : a) Unlimited wants b) Limited resources c) Alternatives uses of resources Central problem of an economy : Central problems arise due to scarcity of resources in relation to demand for them. Three Central problems of an economy are : a) What to produce ? b) How to produce ? c) For whom to produce ? These three problem are generally grouped under one head ‘Allocation of Resources’
Production possibility Curve : It is a curve which shows various alternative production possibilities of two goods with given resources and techniques of production.
Assumption of PPC :
1. Only two goods are produced 2. All resources are fully employed 3. No charge in technology Characteristics of PPC 1. It is downward shopping from left tonight 2. It is concave to the origin. Opportunity Cost : Is in the value of next best activity. OR the cost of foreone alternatives.
Branches of Econimics : 1. Micro Economics 2. Macro Economics (The terms micro and macro were first used by Prof. Ragner Frisch in 1933) Microeconomics deals with small parts of the economy. Macroeconomics deals with the functioning of economics system as a whole.
Positive and Normative Economics : Positive economics deals with what is or how an economic problem facing a society is actually solved. Normative economics deals with what ought to be or how an economic facing a society should be solved. Market economy and planned economy. Market economy is a political economic system based on private property and private ownership Planned economy is controlled economy which is run by central authority with the motive of promoting public welfare. VERY SHORT ANSWER TYPE QUESTIONS (1 Mark)
Q. 1 : Define microeconomics. A. Microeconomics in that branch of economics which deals with the behaviour of individual unit of the economy.
Q. 2 : What do you mean by scarcity. A. Scarcity means resources available are less than their deamand.
Q. 3 : Write two examples of microeconomic variable. a) Supply of a commodity
b) Demand of a commodity
Q. 4 : Price determination of a commodity is a subject matter of micro or macroeconomics A. Price determination of accommodity is a subject matter of micro economics.
Q. 5 : Why is the study of the problem of unemployment in India considered a macro economic is variable ? A. The study of the problem of unemployment in considered a macroeconomic study because this problem is concerned with the Indian economy as a whole.
Q. 6 : Name any two central problems of an economy. A. The two central problem are. I. What to produce ? II. How to produce ?
Q. 7 : Why does the problem of choice arise ? A. Scarcity of resources having alternative uses gives rise to the problem of choice.
Q. 8 : Stat any two characterstics of economic resources. A.
(I) Economic resources are limited (II) Economic resources are capable of alternative uses.
Q. 9 : What is the meaning of the central problem how to produce’ A. Central problem of how to produce relates to the selection of technique of production of goods.
Q. 11 : Why is production possibility curve concave to origin ? A. PPC in concave to origin became of increasing marginal opportunities cost.
Q. 12 : Why does PPC moves downwards from left to right ? A. PPC moves downwards from left to right become more of one good can be obtained only by giving up the production of other good given the resources of the economy.
Q. 13 : What does rightward shift of PPC indicate ? A. Growth of resources
Q. 14 : Define opportunity cost. A. Opportunity cost is defined as the cost of alternative opportunity sacrificed. It in the value of next best alternative.
Q. 15 : Define marginal opportunity cost. A. Marginal opportunity cost in the amount of other good to be sacrificed in order to produce an addition UNIT of the good in question.
Q. 16 : What is marginal rate of transformation ? A. it is the ratio of unit of one good sacrificed to produce one more unit of the other good.
MRT = Units of one good sacrificed/ Additional units of other good produced.
Short answer Type Questions (3/4 marks)
Q. 1 : distinguish between microeconomics and maroeconomics. Ans Micro economics
Macro economics
1) The word micro is derived from the 1) The word macro is derived from the greek work ‘MIKROS’ which means greek work ‘MAKROS’which means small. large.
2) It studies the behavior of individual 2) It studies the economy as a whole. units of the economy. 3) It is alsobe called the price theory
3) It is known as the income and employment theory.
4) It deals with the problem of 4) It deals with the problem of fuller allocation of resources. utilization of resources.
Q. 2 : What is an economic problem ? How does it arise ? Ans : An economicproblem is basically the problem of choice which arises because of scarcity of resources. Human wants are unlimited but resource to satisfy them are limited. In such a situation, every individual and society have to make a choice as to which wants should be satisfied by making use of scarce resources which have alternative uses. Thus, economic problem is basically a problem of choice.
Q. 3 : What is production possibility curve? Draw a production possibility curve and show the following situations ? i) Fulles utilization of resources. ii) Under utilization of resources. iii) growth of resources. Ans : It is a curve which shows alternative combinations of two goods which can be reproduced with the given resource and technology of the economy. The three situations are shown below: Y (1)
A
P
Fuller utilasation of Resources
O
Wheat
C
Cloth
P
under utilisation of resources
P
B
Wheat
Y
X
O
Y
P1
Growth of resources
P Wheat
K
Cloth
P
X
O
P1 Cloth
P
X
Q. 4 : Define production possibility curve ? Draw a production possibility curve with the help of hypothetical schedule? Ans : For definition of PPC refer Q. No – 3 Production possibility schedule Production possibility
Cloth meters
in
thousand Wheat quintals
A
O
15
B
1
14
C
2
12
D
3
09
E
4
05
F
5
0
in
thousand
Q. 5 : Explain briefly the central problems of an economy.
Ans (a) What to produce – An economy has millions of commodities to produce but it cannot produce all of them because of shortage of resources. Therefore it has to decide whether to produce capital goods or consumer goods or it may have to decide whether to produce capital goods or consumer goods or to may have to decide whether to produce luxury goods or common goods and so on and at the same time quantity has also to be decided. (b) How to produce – The problem of how to produce means what technique of production should be employed to produce a good. Labour intensive and capital intensive technique are the two techniques of production. In labour intensive technique more labour and less capital is used, while in capital intensive technique more capital and less labour is used. The problem is to decide which technique should be used (c) For whom to produce – For whom to produce is the problem of distribution of the goods and services produced. What goods should be consumed and by whom depends upon how national income is distributed among people/factor-owners.
Q. 6 : Distinguish between positive economics and normative economics ? Ans :
Positive economics 1. It deals with what is or how an economic problem facing a society is actually solved. 2. It is based on cause and effect of facts. 3. It deals with actual or realistic situation. 4. It can be verified with actual data
Normative economics 1. It deals with what ought to be or how an economic problem should be solved. 2. It is based on ethics 3. It deals with idealistic situation 4. It cannot be verified with actual data.
Q. 7 : Distinguish between planned economy and market economy ? Ans : Planned Economy 1. A economy which is controlled by central authority with the objective of achieving definite targets. 2. Main objective of such an economy is to maximize welfare public. 3. Planned economy is made operative by some central authority who makes different projects and plans for the
Market Economy 1. Such an economy is controlled by capitalist who aims at maximizing profits. 2. Main objective of such an economy is to earn wealth and become as rich as possible. 3. Capitalist runs it through price mechanism by manipulating market force- demand and supply.
development of an economy.
Higher order thinking (Hots) Question Q. 1 : Why economic problem of power shortage arise in India ? A. Because demand for electric power in greater than its supply. A. 2 : Is software industry a microeconomic study ? A. Yes, because it is a study of an individual industry. Q. 3 : How production possibility curve is affected When there is improvement in technique of protection of a good ? A. When there is an improvement is technique of production of one commodity, we can produce Its more quantity with the given resources by which PPC rotates towards right. It means production of another good whose technique of production remains constant, will remain unchanged. As shown in the adjoining diagram we can produce BB1 additional quantity of X good with an improvement in its technique.
Unit II Consumer Equilibrium And demand Marks 18 Basic concepts of the lesson.
Utility : Want satisfying capacity of the commodity is called utility. Utility has two concepts – (1) Total utility :- It means the total satisfaction derived from consumption of given amount of a particular good. Or TU is the sum total of MU i.e. TU = ∑ MU
(2) Marginal utility : It is the addition made to total utility from the consumption of additional unit of the commodity. MU = TUn - TUn – 1
Consumer equilibrium : Consumer equilibrium is a situation when a consumer gets maximum satisfaction from his consumption and he has no tendency to change. Condition of consumer equilibrium. (a) When he uses single commodity (b) When he uses two commodity -
MU x Pr ice of x MU of a Rupee
MU y MU x Px Py
Law of diminishing marginal utility : The Law of diminishing marginal utility states that as consumer consumes more and more units of a commodity, marginal utility derived from successive units/additional units Goes on falling.
Indifference curve : It is a locus of different combinations of two goods that yield equal satisfaction to the consumer on all the points.
Properties of indifference curve : I. II. III. IV.
IC is convex to the origin It slopes downwords from left to right. Two indifference curves never intersects each other Higher indifference curve gives higher satisfaction.
Indifference map : Combination of two or more indifference curves is called indifference map.
Demand : Demand means the quality of a commodity which a consumer is willing to purchase at a given price in a given period of time. Individual demand and market demand : The quantity of a commodity that on individual demands at a particular price in a given period of time in known as individual demand. On the other hand the total quantity of commodity that all the consumers buy at a particular price in a given period of time is called market demand
Demand Schedule : Tabular statement showing different quantities of a commodity demanded at different prices is called demand schedule..
Price Rs
Demand - (KG
1
3
2
1
3
2
Demand curve : Graphical representation of demand schedule is called demand curve. Y
3 Priu
2 1
o
x Demand 1
2
3
Demand function : Functional relationship between demand for a commodity and its determinants is called demand function.
Law of Demand “Other things remaining the same demand expands with fall in price and demand contracts with rise in price.
Elasticity of Demand :
Price elasticity of demand is measured as percentage change in quantity demanded divided by percentage charge in price.
Ed = % change in Quantity demanded/ % change in price.
Mthods used for measuring elasticity of demand : I. II. III.
Percentage method Total expenditure method Geometric method
Very Short Answer Type Questions
(1 Marks)
Q. 1 : What is TU When MU in Zero ? A. TU is maximum Q. 2 : What is budget line A. A budget line consists of all bundles which cost exactly equal to the consumer’s income.
Q. 3 : What is budget set ? A. Budget set is the collection of all bundles that the consumer can buy with her income at the prevailing market prices.
Q. 4 : Define substitute goods. A : Goods which can be used in place of each other are called substitute goods. Ex. Tea & Coffee.
Q. 5 : What do you mean by complementary goods. A. Goods which can be used together are called complementary goods. Example : Car & petrol.
Q. 6 : What is normal good ? A. Goods whose income effect is positive are called normal goods.
Q. 7 : Define inferior goods. A. Goods whose income effect in negative are known as inferior goods
Q. 8 : What is elastic demand ?
A. When percentage change in quantity demanded in greater than percentage change in price, it is called elastic demand.
Q. 9 : If two demand curves intersect each other, which will have more elasticity ? A. The flatter curve will be more elastic.
Q. 10 : Define contraction of demand. A. Other things remaining the same with rise in price fall in demand is known as contraction of demand.
Short answer type question (3/4 marks)
Q. 1 : Explain relationship between TV & MV. A (1) Total utility increases till marginal utility is above zero. (2) T. U is maximum when MU is zero (3) T.U declines when MU becomes negative. TU
Utility MU
X
Quantity
Q. 2 : Explain consumers equilibrium with the help of indifference curve technique. A. According to indifference curve approach a consumer will be in equilibrium when the following two condition are fulfilled : (1) Budget line should be tangent to indifference curve i.e. MRSxy =
Px Py
(2) Indifference curve should be convex to the poiint of origin at equilibrium point. In can be shown with the help of the following diagram.
Y Consumer equilbirum ICTouches the budget line
Y Good
A E
IC 2 IC 1 IC 0
O
B
In the adjoini point where b fulfilled. Budg the highest p curve.
x
X Good
Q. 3 : Why demand curve slopes downward from left to right ? Or Why does law of demand operates ; A. Demand curve moves downwards from left to right because of the following. 1. Law of diminishing marginal utility 2. Income effect 3. substitution effect
Q. 4 : Distinguish between change in demand and change in quantity demanded. A. Change in demand refers to the shift of demand curve due to change in other factors price remaining the same. When demand curve shifts right hand side it is called increase in demand and when demand curve shifts left hand side it is called decrease in demand. Change in Quantity demanded refers to movement along a given demand curve due to change in price alone other factors remaining the same. When movement is downwards it is termed as expansion of demand and when movement is upwards it is called contraction of demand
Q. 5 : What causes rightward shift of demand curve ? A. Demand curve shifts to RHS when there is increase in demand due to : (1) Increase in income of the counsumer. (2) Favourable change in Taste and preference of the consumer. (3) Increase in price of substitute goods.
(4) Rise in price of complementary goods.
Q. 6 : State factors affecting market demand. A. Factors affecting market demand are : 1. Price of the commodity 2. Price of related commodities 3. Income of consumers 4. Taste and preference of consumer 5. Number of household in the market 6. Distribution of income.
Q. 7 : State assumptions of the law of demand. A. (1) There should be no change in the income of the consumer. 2. Tastes and preferences of the consumer should remain constant. 3. Prices of related goods should not change. 4. Consumers do not expect any change in price in future.
Q. 8 : Explain percentage method of measuring elastic of demand. A. According to this method elasticity of demand is measured by taking ratio of percentage change in quantity demanded to percentage change in price of the commodity
Ed = % change in quantity demanded/ % change in price
Example : When due price of a good falls by 10 % its quantity demanded rises from 40 units to 50 units calculate price elasticity of demand.
Solution : ed = % change in Quantity demanded/ % change in price.
Q 10 x 100 x 100 25 % Q 40 2.5 Ans = 10 % 10 % 10 %
Q. 9 : Explain total expenditure method of measuring elasticity of demand.
A. According to this method elasticity of demand is measured by comparing total expenditure on the commodity before and after the change in price. It in estimated as follows: 1. If fall in price leads to increase in total expenditure and vice-vevra, Ed > 1 2. If fall in price reduces total expenditure and vice versa, Ed < 1 3. If fall or rise in price has no effect on total expenditure, Ed = 1
Q. 10 : Draw diagrams showing (a) Increase in demand
(b) decrease in demand
(c) Expansion of demand (d) Contraction of demand A. Y
Y D
l
D
D
Increase indemand
(a)
D
I
Increase indemand
(b)
Price
P
P D O
y
I
Price O
x
Demand
y
d
p
e
(c)
Expansion of demand eI
pI
Q
DI x
Demand
d
pI
eI
(d)
x QI Qunaitity Demanded
Contraction of demand e
p d
price o
D
D
d
price o
QI
x Q Qunaitity Demanded
Q. 11 : Explain point method or Gemotric method of measuring elasticity of demand. A. This method measures elasticity of demand at any point ofn a straight line demand curve using the following formula : Ed = Lower segment of the demand curve/ upper segment of the demand curve
It can be shown with the help of following diagram –
Y A
Here AB in the demand curve. P is middle point of the line where Fd = 1 At other points also ed can be estimated using the formula.
AB , O
ed =
RB ed >1 , AR
R
PB ed =1 , AP
Price P
SB ed <1 , AS S
o ed = 0, AB
O
x
B Quantity demanded
Q. 12 : A consumer buys 80 units of good at a price of Rs. 4 per unit. When the price falls he buys 100 units. If price elasticity of demand is (-)1, find out the new price .. Ans : Given Ed = (-) 1,
Q = 80,
Q1 = 100,
P1 = ?
P=4
∆ Q = Q1 - Q = 100 – 80 = 20 Ed = (-) (-) 1 =
Q P x P Q 20 4 x P 80
(-) 80 ∆P = 80 ∆P = - 1 i.e. price of good has fallen. New Price (P1) = P - ∆P = 4–1=3 Ans : Rs 3 New Price. Long Answer type question (6 marks) Q. 1 : Briefly describe degrees of elasticity of demand : (1) Perfectly elastic demand : When demand changes to any extent without any change in price. It is called perfectly elastic demand.
Y D P Ed = Price
O Q Demand
Q
X
(2) perfectly in elastic demand – when change in price of a commodity has no effect on its demand it is called perfectly inelastic demand.
D
Y I
P
Ed = 0 Price
P
O Q
X
Demand
(3) Unit elastic demand : When % change in Quantity demanded is equal to % change in price it is called unit elastic demand.
D
Y
Q = P Ed = 1
P Price
I
P
D
O Q
X
Q
Demand
(4) More than unit elastic demand : When % change is quantity demanded is great than the % change in price of the commodity it is called more than unit elastic demand.
Y D
D>
P
Ed >1 Price
P P D
O Q Demand
Q
X
(5) Less than unit elastic demand : When % change in quantity demanded is less than the % change in price it is called less than unit elastic demand.
Y
D Q< P
P
Ed <1
Price I
P
D O Q
QI
X
Demand
Q. 2 : explain factors affecting elasticity of demand. And : factors affecting elasticity of demand are as under : (1) Availability of close substitutes :- Demand for accomodity having many substitutes in more elastic while commodities having no substitutes have inelastic demand. (2) price level : Demand is more elastic for the high priced good like car, V.C.R etc and vice versa. (3) Income of the consumer : Elasticity of demand is less in case of having very high income. But elasticity of demand in high in the case of having low income. (4) Total expenditure on the commodity : Demand for a commodity is more elastic if proportion of income spent on that commodity is high and vice versa. (5) Habits if consumers are habituated for the commodity the demand will be usually inelastic. Demand will not be affected by change in price. (6) Postponement – if the demand for a commodity can be postponed then elasticity of demand will be more and vice versa.
Q. 3 : Explain the three factors other than the price of a commodity that affect its demand. Ans : Factors other then the price of a commodity that affect its demand are :(1) Income of the consumers : There is a direct relationship between the income of the consumers and the demand for it. Generally, higher the income, higher the quantity demanded and lower the income, lower the quantity demanded. But in case of inferior goods, there is inverse relationship between the income of the consumer and his demand for inferior goods.
(2) Price of other commodities : The prices of related goods also affect the market demand for a commodity. In case of substitute goods, demand for a commodity falls with a fall in price of other commodity. In case of complementary goods demand for a commodity rises with a fall in the price of other commodities. (3) Taste and preference : Taste and preferences of the consumes also affect the market demand for a commodity. If a consumers has developed a taste (a liking) for the commodity, the demand will increase and if he has no taste or preference for a product, the demand will increase.
Q. 4 : Explain with the help of diagrams the effect of the following changes on the demand of a commodity : (1) A fall in the price of substitute good. (2) A favourable change in the taste of the buyer.
And (i) The demand of a commodity and price of its substitute goods are directly related to each other. When the price of substitute good falls, its demand rises and the demand of the commodity falls and as a result the demand curve of the commodity shifts to the left. The diagram shows the effect. In the diagram DD is demand curve of X (tea). With fall in price of substitute good coffee demand for tea falls from OQ to OQ, at the same price OP. The demand curve shifts left ward to D1D1 Y D
I
D
Price of tea
Price of Coffee = Rs 100/Kg
P Price of coffee Rs 50/Kh
I
D
O Q
I
Q
D X
Demand for tea
2) The demand of a commodity and taste of the Demand for coffee buyers are directly related to each other. When there is favourable change in the taste of the buyer, the demand of the commodity rises and as a result the demand curve of the commodity shifts to the right. The diagram shows the effect : In the diagram demand for X is shown by DD curve with a favorable change in the taste of the buyer, the demand for the commodity rises from OQ to OQ at the price OP. The demand curve shifts right wards to D1D1
Y
I
D
Price of x
D
P
I
D
D
O Q
Q
X
I
Demand for x
Q. 5 : Distinguish between an inferior good and. A normal good. Explain the effect of change in income on each giving suitable examples. A. Those goods which have direct price –demand relationship or inverse income – demand relationship are known as inferior goods. For example in case of the price of unripened bananas falls real income of the consumer increases. It induces him to buy less of unripened bananas and buy more of good quality bananas. Those goods which have inverse price- demand relationship or direct income demand relation ship are known as normal goods. For example in case the price of milk falls, real income of the consumer increases. Thus he is induced to demand more quantity of milk.
Q. 6 : Show the construction of individual and market demand schedule and curve when there are two households in the market. Ans. Construction of individual and market demand schedule and curve Let there be two households A and B in the market for wheat. By aggregating or summing their individual demands, market demand is obtained as shown in the table below : Individual and market demand schedule
Price Rs per Kg
Individual demand Market Schedule for wheat KG schedule per month QA
demand
QB QA
2
4
5
9
4
3
4
7
6
2
3
5
+
QB
8
1
2
3
Derivation of market demand curve :-
Demand curve of consumer A
8
8
8
4 DA
2 O 1
2
3
4
6
Price
6
Price
Price
6
Market demand curve
Demand curve of consumer B
4 2
x
DA O 1
2
3
4 5
x
4
Dm
2 O
x 1
2
3
4 5
6
7
8 9
Individual demand curve & market demand curve DA & DB are individual demand curves Dm is the market demand curve. It is the horizontal summation of DA & DB curves. Higher order thinking (HOT) questions. Q. 1 : Define marginal rate of substitution. A. It is defined as the amount of good Y the consumer is willing to give up to consume an additional unit of good X while leaving total utility unchanged.
Q. 2 : What do you meant by monotomic preferences ? A. A consumers preferences are monatomic if and only if between any two bundles, the consumer prefers the bundle which has more of at least one of the goods and no less of the other good as compared to the other bundle.
Q. 3 : When price of a good rises from Rs. 5 per unit to Rs. 6 per unit , its demand falls from 20 units to 10 units. Compare expenditure on the good to determine whether demand is elastic or inelastic. Ans : Given P=5
Q = 20
P1 = 6
Q1 = 10
Initial expenditure = P x Q = 5 x 20 = Rs 100
Later expenditure = P1 x Q1 = 6 x 10 = Rs 60 As price rises from Rs 5 to Rs 6 per unit, expenditure falls from Rs 100 to Rs. 60 Price and expenditure are moving opposite direction meaning that price elasticity of demand is elastic.
Q. 4 : At a given market price of good a consumer buys 120 units. When price falls by 50 percent he buts 150 units. Calculate price elasticity of demand. Ans : Given, % fall in price = 50 Q = 120 units Q1 = 150 units ∆Q = Q1 – Q = 150 – 120 = 30 units
ED = % change in Qty demanded/ % change in price. Percentage change in quantity demand =
Change in Quantity x 100 Original Quantity
=
30 x 100 25 % 120
ED =
25 % 1 0.5 50 % 2
Q. 5 : What is the relation between good X and Good Y in each case if with fall in the price of X demand for good Y (i) rises and (ii) falls ? give reason. Ans (i) If with fall in price off X (say sugar) demand for good Y (say, tea) rises. Then goods X and Y are complements. (ii) If with fall in price of X (say tean) demand for good Y (say, coffee) falls, then X and Y are substitutions.
Q.6 : Explain consumer equilibrium in case of two commodities. Ans : When a consumer uses two goods he will be in equilibrium when he spends his income in such a way that the ratio of the marginal utility of the two goods and their Prices is equal. i.e.
MUX MUY PX PY
It can be explained with the help of following table –
Suppose a consumer has Rs. 30 only & he spends it on two goods X & y The price of x is Rs 4 per unit & the price of Y is Rs 2 per unit MU schedule of the two goods will be as under.
Units
MUx
Mux/Px
MUY
MUY/Py
1
80
80/4 = 20
40
40/2 = 20
2
72
72/ 4 = 18
38
38/2 = 19
3
64
64/4 = 16
36
36/2 = 18
4
56
56/4 = 14
34
34/ 2 = 17
5
48
48/4 = 12
32
32/ 2 = 16
6
40
40/4 = 10
30
30/2 = 15
7
32
32/4 = 8
28
28 / 2 = 14
8
24
24/4 = 6
26
26/ 2 = 13
9
16
16/ 4 = 4
24
24/ 2 = 12
10
8
8/ 4 = 2
22
22 / 2 = 11
It is clear from the table that in order to have maximum utility the consumer will purchase 4 units of x & 7 units of y because this combination of two goods satisfies the condition.
MUX 56 14 At 4 units of Px 4
MUY 28 14 At 7 units of y Py 2
=
MUX MUy Px Py
Q. 7 : Explain three main causes of downward sloping demand curve. Ans : Following are three main causes responsible for the downward sloping nature of demand curve.
1) Law of Diminishing Marginal Utility - The law of demand is based upon the law of diminishing marginal utility. We know that marginal utility curve has a negative slope. Therefore, the demand curve being based upon marginal utility curve being based upon marginal utility curve also has a negative slope.
2) Income effect – A change in the price of a commodity affects consumers real income. When price falls, real income of the consumer increases This will induce him to buy more of this commodity. This is called income effect.
3) Change in the Number of Consumers – When the price of a commodity falls its consumption spreads to more. & more consumers. Therefore, the number of its consumes expands and its demand increases. Similarly when price increases, the commodity gets out of the reach of some consumers. Hence its demand falls. Q. 8 : What causes decreases indemand ? A. (1) Fall in the income of the consumer. (2) Fall in the price of substitute good (3) Rise in the price of complementary good. (4) Unfavorable change in the taste and preference of the consumer. Q. 9 : A new steelplant comes up in jharkhand. People who were previously unemployed in the area are now employed. How will this affect the demand for colour TV and Black & White TV in the reason. Ans : The demand for colour TV will increase and demand for Black & White TV will decrease.
Q10. Give the equation of budget line. Ans: P1X1 + P2X2 = M
Q11. Explain why the budget line is downward sloping? Ans: Budget line is downward sloping because if a consumer wants to buy more of one good, he has to buy less of the other good, given money income
Q12. Suppose the price elasticity of demand for a good is -0.2. How will the expenditure on the good be effected if there is 10% increase in the price of the good. Ans: Given ed = -0.2. Since ed is less than one, it is a case of inelastic demand. If there is 10% increase in the price of the good, there will be less than 10% fall in quantity demanded. Result will be rise in expenditure.
MEASUREMENT OF NATIONAL INCOME
1. There are three angles of looking at national income : (i) Value added, (ii) Income distribution and (iii) Final expenditure. 2. Accordingly, there are three methods of measurement of national income namely (i) Value added method (ii) Expenditure method. 3. Under all these methods, the first common step in the measurement of national income of a country is to classify its producing enterprises into three industrial sectors : (i) Primary sector, (ii) Secondary sector and (iii) Expenditure method. 4. Primary sector includes all units which produce goods and services by exploiting natural resources, agriculture, forestry and logging. Fishing, mining and quarrying are its sub-sectors. 5. Secondary sector includes all those units which produce commodities by transferring one type of commodity into another type of commodity. Manufacturing (registered and unregistered), construction, electricity, gas and water supply, etc. are its sub-sectors. 6. Tertiary sector includes those units which produce services like educational, medical, transport, banking, insurance, public administration and other services. 7. Value added method or production method is that method which measures the national income by estimating the value added at factor cost by each producing unit in the domestic territory of the country in an accounting year increased by the net factor income received from abroad. In this method, national income is measured at the production stage. 8. The main steps involved in the measurement of national income by value added method are: (i) Classify the producing enterprises into industrial sectors like primary, secondary and tertiary sectors. (ii) Estimate the net value added at factor cost, (NVAFC) by each producing enterprise by taking the following substeps : (a) Estimate the value of output by adding sales and change in stock (closing stock – opening stock). (b) Estimate the value of intermediate consumption (i.e., cost of raw material) and deduct the same from the value of output to arrive at gross value added at market price (GVAMP). (c) Deduct Depreciation (D) and net indirect taxes (NIT) to the gross value added at market price to obtain net value added at factor price. Symbolically, NVAFC = Value of output – IC – D – NIT. (iii) Take the sum of net value added at factor cost by all the producing enterprises to arrive at net domestic product at factor cost (NDPFC), i.e., NDPFC = ∑NVAFC. (iv) Add net factor income received from abroad to the Net Domestic Product at factor cost (NDPFC) to obtain Net National Product at factor cost (NNPFC) which is the national income. 9. Precautions to be undertaken under value added method are : (i) Avoid double counting of production. Instead of taking the value of output, take only the value added by each production unit. (ii) The output which is produced for self consumption and whose values can be estimated, must be included. (iii) The sale and purchase of second hand goods should not be included in the current production because the value of those goods has already been included earlier. (iv) The value of services rendered in the sales (i.e., commission earned on account of sale and purchase of second hand goods) must be counted because these services are freshly produced. (v) The value of intermediate consumption is not included.
10. Income Method is that method which measures national income from the side of payments made in the form of wages, rent, interest and profits to factors of production for their productive services in an accounting year increased by the net factor received from abroad. In this method, national income is measured at the stage when factor incomes are paid out by the producing enterprises to the factors of production. 11. The main steps involved in measuring national income through income method are : (i) Classify the producing enterprises into industrial sectors like primary, secondary and tertiary. (ii) Estimate the following factor income paid out by the production units in each sector : (a) Compensation of employees (wages and salaries + employers’ contribution towards social security schemes). (b) Rent and Royalty, Interests and Profits. (c) Mixed Income of self-employed units. (iii) Take the sum of factor incomes by all the industrial sectors to arrive at the net domestic product at factor cost (NDPFC) which is called domestic income. (iv) Add net factor income from abroad to the net domestic product at factor cost to arrive at the net national product at factor cost (NNPFC) which is the national income. 12. Precautions to be taken under income method are : (i) While estimating compensation of employees, all benefits accruing to the employees whether in cash or in kind must be included. It should not include only cash payments to the employees. (ii) In estimating interest, the interests on only those loans should be included which are taken for production. The interest on loans taken to meet consumption expenditure is a non-factor income and so it is not included in national income. (iii) Transfer incomes should not be included. (iv) Gifts, donations, charities, taxes, fines, lotteries, etc., are not factor incomes. These should not be included in estimating national income. 13. Expenditure Method is that method which measures the final expenditure on gross domestic product at market price during an accounting year. This total final expenditure is equal to gross domestic product at market price. In this method, national income is measured at the point of expenditure. 14. The main steps involved in measuring national income through expenditure method are as follows : (i) Classify the economic units incurring final expenditure into distant groups like household, government, firms etc. (ii) Estimate the following expenditure on final products by all economic units : (a) Private final consumption expenditure (PFCE). (b) Government final consumption expenditure (GFCE). (c) Gross domestic capital formation (GDFC).
Gross domestic fixed capital formation. Change in stock = (Closing stock – Opening stock).
(d) Exports – Imports (X – M). The sum total of all the above expenditure on final products of all the sectors of the economy gives us gross domestic product at market price (GDPMP).
(iii) Deduct depreciation (D), net indirect taxes (NIT) to the gross domestic product at market price to get net domestic product at factor cost (NDPFC). NDPFC = GDPMP – D – NIT. (iv) Add net factor income from abroad (NFIA) to the net domestic product at factor cost (NDPFC) to obtain net national product at factor cost (NNPFC) which is the national income.
NNPFC = NDPFC + NFIA = National Income. 15. Precautions to be undertaken under expenditure method are :
(i) Avoid double counting of expenditure by not including expenditure on intermediate products. Only the expenditure on final products is included. (ii) Expenditure on gifts, donations, taxes, scholarships, etc. is not expenditure on final products. These are transfer expenditures and should not be included in the final expenditure. Expenditure on purchase of second hand goods should not be included as the expenditure on these has been included when bought for the first time.
REAL AND NOMINAL NATIONAL INCOME
Real National Income : It is defined as the value of current output at some base year prices.
Nominal National Income : It is defined as the value of current output at current year prices.
GNP Deflator = (Nominal GNP / Real GNP) * 100.
Green GNP is defined as the GNP which would help to attain a sustainable use of natural environment and equitable distribution of benefits of development.
GDP AND WELFARE GDP is not a precise Index of Welfare, because it ignores (i) distribution of income, (ii) composition of GDP, (iii) non-monetary transactions, and (iv) the impact of (positive and negative) externalities.
HOTS
Q-1) How would you find whether a particular expenditure is an expenditure on intermediate goods or on final goods? Q-2) All producer goods are not capital goods. Why? Q-3) Write any three points on the significance of the net capital formation. Q-4) Distinguish between depreciation and depreciation reserve fund. Q-5) Distinguish between consumption of fixed capital and capital loss. Q-6) What is current replacement cost? Q-7) Are the following Stocks or Flows? (i) (ii) (iii) (iv) (v) (vi) (vii)
Investment, Monetary Expenditure, A Hundred Rupee Note, A family’s Consumption of Sugar, Services of a Tutor, Production of Cement, Machinery of a Sugar Mill.
Q-8) Money flows are opposite to real flows. How? Q-9) Why is the flow of income and product called a ‘circular’ flow? Q-10) Production is identical with the income in an economy. How? Q-11) What are the two basic components of personal disposable income? Q-12) How do you distinguish between old age pensions and retirement pensions in the context of estimation of national income?
Q-13) Operating surplus does not arise in1) subsistence sector and 2) general government sector of the economy. Why? Q-14) What causes change in inventory stock? Q-15) Export receipts are not a part of net factor income from abroad. Why? Q-16) State the two principal differences between national income at current prices and national income at constant prices.
Money and Banking
BARTER EXCHANGE Barter Exchange refers to the direct exchange of commodity for commodity. Problems of Barter Exchange :
1. 2. 3. 4. 5.
Lack of double coincidence of wants. Lack of divisibility. Difficulty in storing wealth. Absence of common measure of value. Lack of standard of deferred payments.
MEANING AND FUNCTIONS OF MONEY Money is something which has general acceptability as a means of exchange and/or as a measure and store of value.
Functions of Money :
1) Primary Functions 2) Secondary Functions 3) Contingent Functions
I. Primary Functions : (i) Medium of Exchange (ii) Measure of Value
II. Secondary Functions : (i) Store of Value (ii) Standard of Deferred Payments (iii) Transfer of Value
III. Contingent Functions : (i) (ii) (iii) (iv) (v) (vi)
Basis of Credit Basis of Distribution of Income Equalization of Marginal utilities and Productivities Guarantor of Solvency Best Utilization of Resources Liquidity
DEFINITIONS OF MONEY I. Legal Definition : Money is what the law says it is. Money has legal tender power. (i) Legal Tender Money : Currency, which is also called Fiat money, is legal tender money. Fiat Money refers to money by order/authority of the government. It includes notes and coins. (ii) Non-legal Tender Money : It is optional and voluntary money which is generally accepted as money on the basis of trust that their issues commends e.g., cheques, drafts, bills of exchange etc. It is also called Fiduciary Money. Fiduciary Money refers to money backed up by trust between the payer and the payee.
II. Functional Definition : Money can be defined as anything that is generally accepted as a medium of exchange and at the same time acts as a measure of value, store of value and standard of deferred payments.
III. Narrow vs. Broad Definition : Narrow definition of money is based upon its medium of exchange function, while in Broad definition of money scope of money is extended to include store of value function in addition to medium of exchange function.
CLASSIFICATION OF MONEY I. Full Bodied Money : It is money whose value as a commodity for non-monetary purposes is equal to its value as money e.g., gold coins, silver coins etc.
II. Representative Full Bodied Money : It has no value as a commodity but it represents in circulation an amount of money with a commodity value equal to the value of money e.g., paper money.
III. Credit Money : Credit Money is money whose value as money is more than the commodity value of the material form in which the money is made e.g., token coins, representative token money, circulatory promissory notes issued by the central bank and deposits at bank.
MONEY SUPPLY Meaning : It refers to the stock of money held by the public at a point of time in an economy. Measures of Money Supply :
M1=C + DD + OD where C = Currency held by public, DD = Net demand deposits of the bank, OD = Other Deposits held with the RBI
M2 = M1 + Savings of the people with post offices M3 = M1 + Net time deposits with the commercial banks
M4 = M3 + Savings with the post offices (other than in the form of N.S.Cs)
M1 is the most liquid, narrow and least comprehensive measure. M3 is the most commonly used measure of money supply. M4 is the least broad and most comprehensive measure.
BANKING
Bank : Bank is defined as an institution which receives funds from the public and gives loans and advances to those who need them. Commercial Bank : It is an institution that accepts deposits from the general public and extends loans to household, government and firms with a view to earn profit.
Functions of a commercial Bank :
I. Primary Functions (i) Accepting deposits – Fixed Deposits, Current Deposits, Savings deposits, Recurring Deposits etc. (ii) Advancing loans – Cash credit, Term/Demand loans, Overdraft, Discounting of Bills of Exchange etc. (iii) Credit Creation – Credit multiplier = 1/CRR
II. Secondary Functions (i) Agency functions – Transfer of funds, collection of funds, payments of various items like taxes and insurance, purchase and sale of securities, collection of dividends. letters of reference, acts as Trustee and Executer of property etc on behalf of their customers. (ii) General utility services – Locker facilities, traveler’s cheques, gift cheques, purchase and sale of foreign exchange etc.
Central Bank : It is an apex institution that controls and regulates the banking and monetary system of the country. It is the sole agency of note issue in a country. It serves as a banker to the banks and government and controls the supply of money in the country.
Functions of a Central Bank :
1. 2. 3. 4. 5. 6. 7.
Currency Authority Banker to the Government Banker’s Bank and supervisor Lander of last resort Custodian of foreign exchange reserves Controller of money supply and credit Clearing house function
Difference between a Central Bank and a Commercial Bank :
1. The Central Bank is an apex bank while a Commercial Bank functions under the control of the Central Bank. 2. A Central Bank is a government institution but a Commercial Bank may be a government or a private institution. 3. The Central Bank focuses on social welfare while a Commercial Bank focuses on profit maximization. 4. A Central Bank does not directly deals with the public while a Commercial Bank does. 5. A Central Bank has a monopoly of note issue while a Commercial Bank does not have any such power. 6. A Central Bank controls credit in a country while a Commercial Bank creates a credit. 7. There is only one Central Bank in a country while Commercial Banks may be in any number.
Credit control by the Central Bank :
1. Quantitative measures : (i) Bank rate – It is the rate at which the Central Bank lends funds to banks against approved securities or eligible bills of exchange. During inflation by increasing the bank rate, the flow of credit reduces and on the other hand during deflation Central Bank reduces the bank rate to increase the flow of credit. (ii) Open Market Operations – It refers to the sale and the purchase of government securities in the open market by the Central Bank. By selling the securities it withdraws cash balance from the economy and vice versa. (iii) Cash Reserve Ratio – It refers to the minimum percentage of net deposits of the banks which they are required to keep the Central Bank. When the flow of credit is to be increased the CRR is reduced and vice versa. (iv) Statutory Liquidity Ratio – Every bank is required to maintain a fixed percentage of its assets in the form of cash or other liquid assets, called SLR. For reducing the flow of credit the Central Bank increases the SLR and vice versa.
2. Quantitative measures : (i) (ii) (iii) (iv)
Margin Requirement Selective Credit Control Moral Suasion Direct Action
UNIT – 8 DETERMINATION OF INCOME & EMPLOYMENT Aggregate demand, aggregate supply and related concepts Concepts of Aggregate demand :- AD refers to desired expenditure (planned expenditure) on the purchase of domestically produced good and services during an accounting year. Components of AD: 1. C (Private consumption expenditure) – private consumption expenditure is determined by the level of personal disposable income in the economy. 2. I (Private investment expenditure):- investment implies increase in the stock of capital goods it is market rate of interest which determine private investment expenditure. 3. G (Government expenditure):- It is
include both consumption expenditure &
investment expenditure of Government. It is autonomous investment. 4.X-M (Net Exports):- Exports – imports AD= C+I+G+X-M Or AD=C+I AD Schedule :- AD Schedule is a table showing combined behaviour of C and I corresponding to different level of Y in the economy. Concepts & component of AS:- AS refer to flow of goods and services as planned by the producers during and an accounting year. Y=C+S C and S are two component of AS AS line happens to be a 45o line this because of obvious identities between Y on the X-axis and C+S on Y axis Consumption function and propensity to consume: Consumption function is the relationship between consumption and income C=f(Y) Fundamental psychological law : 1. consumption expenditure increase with the increase income 2. minimum level of consumption incurred even when income (Y)=0 3. consumption does not increase at the rate at which income increase. Break even points Where C=Y Propensity to consume:- it refers
to the schedule which shows the level of
consumption at different levels of income in an economy.
1. Average propensity to consume (APC):- it is the ratio of consumption expenditure to any particular level of income APC=C/Y 2. Marginal propensity to consume (MPC):- it is ratio of a change in consumption to a change in income MPC= C/ Y Saving function and propensity to save : saving - it is the excess income over and above consumption during an accounting year S=Y-C
Saving function refers to the relation between S and Y S=f(Y) Propensity to save :- a schedule showing amounts that will be saved at different levels of income 1. Average propensity to save (APS):- it is ratio of saving to income APS =S/Y 2. Marginal propensity to save (MPS):- it is ratio of change in saving to a change in income MPS=S/Y APC+APS =1 MPC+MPS=1 Concept Of Full Employment :- full employment is situation in which everyone who wants to work is working except for those who are frictionally and structurally unemployed. Voluntary Unemployment :- It refer to the situation when a person unemployed because he is not willing to work at the existing wage rate, even when work is available. Involuntary Unemployment :- it is situation in which people are able to work and willing to work at existing rate of wages but do not get work. Important Questions: 1. Give Meaning of aggregate demand 2. Name the principal of component of aggregate demand. 3. What is aggregate supply ? What are its components? 4. Distinguish between average propensity to consume and marginal propensity to consume. 5. Distinguish between average propensity to save and marginal propensity to save. (tipswrite definitions also) 6. What is consumption function? Illustrate its behaviour using a suitable diagram and table. 7. What is production function? Illustrate its behaviour using a suitable diagram and table. 8. Define following 1- Full employment 2- Voluntary unemployment 3- involuntary unemployment 4- Break even point. Determination of Equilibrium Level Income and Employment Equilibrium level of income is that level of income where aggregate demand equals aggregate supply of output or (Level of planned saving equals planned investment.
AD = AS approach –according to Keynes the equilibrium level of income and employment is determined at a point where aggregate demand to is = to aggregate supply. AS
Point of Equilibrium
Aggregate Demand
AD=AS
AD E
AD < AS
450
AD < AS
O
X L
M
N
Income & Employment
In the Figure AD and AS are interest at point E which indicate point of equilibrium where OM is the equilibrium level of income = employment = output
a) if AD < AS- Stock of goods will start rising due to poor sales producers cut down employment and output till AS = AD b) if AD > AS – there will be increase in income and productions. Effective Demand :- Aggregate demand at the point of equilibrium is called and effective demand because it becomes effective in determination of national income and Employments.
Planned Saving (ex-ante Saving) :- The saving which are planned to be made by all the household in the economy during a period
Planned investment (Ex-ante investment) :- The investment which is planned or desired to be made by the firms in the economy during the period. Actual Saving (Ex-post Saving) :- it is the actual Amount of savings that took place, measured after the trade . Actual investment (Ex-post investment):- it is the actual investment that took place, measured after the track. Marginal efficiency of investment:- it refers to expected rate of return from marginal unit of investment . There is inverse relationship between volume of investment and MEI
Multiplier and its Mechanism The Concept of Multiplier Investment multiplier or output multiplier refers to the factor by which output/income increases, because of increase in investment. It is measured as the ratio between increases in output/income and increases in investment. K=Y/ I Relationship between multiplier and MPC:There is the direct relationship between multiplier and MPC. Higher the value of MPC, higher the multiplier and vice versa. K= 1/1-MPC = 1/MPS Multiplier the process :-
Change
Change
Change
in investment
In
in
income
Consumpt ion
I
Y
C
Change In Income
Y
Important questions:1. Investment multiplier 2. Give a formula of multiplier 3. Explain the relationship MPC and investment multiplier 4. Define following (a) Planned investment (b) Actual investment (c)
Planned Saving
(d) Actual saving (e) MEI 5. Explain determination of equilibrium level of income using saving- investment approach. Use Diagram and table. a. Explain determination of equilibrium level of income using aggregate demand and aggregate supple approach. Use Diagram and table.
Problems of Deficient Demand and Excess Demand
Deficient Demand :- Deficient demand is a situation when AD< AS (corresponding to full employment level). Deflationary gap :- Deflationary gap is equal to the difference between AD-at full employment’ and AD-at underemployment. Causes of Deflationary Gap:- (i) Reduction in private consumption expenditure, (ii) Reduction in investment expenditure (iii) reduction in government expenditure, (iv) Decline in exports, (v) rise in imports, (vi) Increase in tax burden. Consequences of deficient Demand causes Deflation underemployment:-
when AD
fails to catch up with As of full employment, all goods and services produced in the economy cannot be sold Accordingly, profits start shrinking. This discourages investment and lowers of income/employment in the economy. The economy is caught in a law level equilibrium trap where low AD causes low output, and low output/income causes low AD. Excess Demand:-
Excess demand is a situation when AD> AS (corresponding to full
employment level). Inflationary Gap : Inflationary gap is equal to the difference between AD-beyond full employment and AD-at full employment. Causes of Inflationary Gap:- Causes of inflationary gap are just opposite to the (above stated) causes of deflationary gap. These related to a rise various components of AD, a rise that continues to occur even when resources are fully utilized. Consequences of Excess Demand Excess Demand causes inflation:
Because excess
demand is that level of AD which surpasses AS (at full employment level0, It must cause inflation. Output cannot be increased once full employment is reached Hence, AD beyond that level would only cause pressure of demand on the existing supply, implying inflation. The economy is caught in a wage-price spiral where wages catch prices and prices catch wages. Combating Excess and Deficient Demand:- Measure of combating excess and deficient demand, include: (i) fiscal measure, and (ii) monetary measure. Fiscal measure relate to fiscal policy, and monetary measure related to monetary policy of the government. Fiscal policy : It refers to the revenue and expending policy (or budgetary policy) of the government to combat the situations of excess and deficient demand. Components of fiscal policy and the way these are used :(i)
Government Expenditure: Increased to combat deficient demand, and decreased to combat excess demand.
(ii)
Taxes: Tax burden is lowered to combat deficient and raised to combat deficient demand.
(iii)
Public Borrowing: Increased to combat excess demand, and decreased to combat deficient demand. Deficient Financing: Increases to combat deficient demand, and decreased to combat excess demand. Monetary policy: it refers to that policy of the government which combats excess and deficient demand by regulating the cost of credit and availability of credit in the economy.
Components of Monetary Policy and the way these are used:I. Bank rate: increased to combat excess demand, and decreased to combat deficient demand. II. Open Market Operations: The Central bank sells securities to combat excess demand and buys securities to combat deficient demand. III. CRR: Raised to combat excess demand, and lowered to combat deficient demand. IV. SLR: Raised to combat excess demand, and lowered to combat deficient demand. V. Margin Requirement: Raised to combat excess demand, and lowered to combat deficient demand. VI. Moral Suasion: Banks are convinced and pressurized to pursue cheap money policy to combat deficient demand, and dear money po0licy to combat excess demand. VII. Rationing: Introduced to combat excess demand, and withdrawn (if already existing) to combat deficient demand.
Important Questions 1. What is Deficient Demand ? 2. Define Deflationary gap. 3. What is meant by Excess Demand? 4. Define Inflationary gap. 5. What is Fiscal Policy. How is it used to correct excess & deficient demand? 6. What do you mean by Monetary Policy? How is it used to correct and Excess and Deficient demand? 7. Explain Inflationary & Deflationary gap with the help of Diagram.
Unit - 9 Government Budget and The Economy
Concepts of Govt. Budget – Government Budget is the statement of estimates of the govt. receipts and govt. expenditure during the period of the financial year. Objectives of Government Budget (i)
Redistribution of Income and Wealth
(ii) Reallocation of Resources (iii) Economic Stability (iv) Managing Public Enterprises Components of Budget (i) Budget Receipts – Budget receipts refer to estimated money receipts of the government from all sources during the fiscal year.
(ii) Budget Expenditures – Budget expenditures refers to estimated expenditure of the government on its development and non development programmes or on its plan and non plans programmes during the fiscal year.
Components of Budget Receipts (i) Revenue Receipts –
Revenue receipts of the government are those money receipts which do not either create a liability or lead to reduction in assets.
Classification of Revenue Receipts Constituents of Revenue Receipts
Tax Receipts
Non Tax Receipts
Income Tax
Fines & Penalties
Corporation Tax
Escheat
Estate Duty
Special Assessment
Gift Tax
Fees, License and Permits
Customs Duty Excise Duty Sales Tax
Income from Public Enterprises Gifts and Grants
Tax Receipts – A Tax is a compulsory payment made by an individual, household or a firm to the government without reference to anything in return.
Types of Taxes (i)
Progressive and Regressive Taxes
(ii)
Ad Valorem and Specific Taxes
(iii) Direct and Indirect Taxes
Direct Tax – A Direct tax is really paid by the person on whom it is legally imposed. Eg:Income Tax Indirect Tax – Indirect Tax is imposed on one person but paid by some other person. Eg:- Sales Tax
(ii) Capital Receipts –
Capital Receipts are those monetary receipts which either create liability for the government or cause reduction in the assets of the government.
Classification of Capital Receipts Capital Receipts
Recovery of Loans
Borrowings and other liabilities
Disinvestment
Budget Expenditure – Budget Expenditure refers to estimated expenditure of the government on its development and non development programmes or on its plan and non plan programmes during the fiscal year.
Components of Budget Expenditures (i) Revenue Expenditure- Revenue expenditure refers to estimated expenditure of the government in a fiscal year which doesn’t either create assets or cause a reduction in liabilities.
Eg-
Interest Payment, Expenditure of Subsidies, Expenditure on defence.
(ii) Capital Expenditure -
Capital expenditure refers to the estimated expenditure of the government in a fiscal year which either creates assets or causes a reduction in liabilities.
Eg.-
Expenditure of Land & Building, Machinery and equipments, purchase of shares. Development Expenditure – It is directed towards development programmes of the country and which directly contributes to the flow of goods and services in the economy. Eg.- Expenditure on the expansion of public sector enterprises.
Non Development Expenditure – It is not directly related to development programmes of the country and which does not directly contributes to the flow of goods and services in the economy. Eg.- Expenditure on defence.
Plan Expenditure – It is incurred in accordance with planned development programmes of the country.
Non Plan Expenditure – It is not incurred in accordance with planned development programmes of the country. Eg.- Expenditure as a relief to the earthquake victims.
Balanced Budget –
Total Expenditure =
Total Receipts
Surplus Budget -
Total Expenditure <
Total Receipts
Deficit Budget -
Total Expenditure >
Total Receipts
Budget Deficit – Budget Deficit refers to a situation when budget expenditures of the government are greater than the budget receipts.
Three Types of Budget Deficit (i)
Revenue Deficit -
When Revenue Expenditure is more than the revenue receipts.
Implications – More people pay high taxation. Disinvestment and increase in the borrowings of the government.
(ii)
Fiscal Deficit
-
Fiscal deficit is in fact equal to the total borrowings and other liabilities of the government.
Fiscal Deficit
=
Total or Budget Expenditure (Revenue Expenditure + Capital
Expenditure)
–
Total
or
Budget
Receipts
other
borrowings (revenue receipts + capital receipts other than borrowings). Implications – Greater Fiscal deficit implies greater borrowings by the government. (i)
Causes Inflation
(ii)
Increases Foreign Dependance
(iii)
Accumulates Financial Burden for future generation
(iv)
Multiplies Borrowings which causes Debt-trap.
(iii)
Primary Deficit -
Primary deficit is the difference between fiscal deficit and interest payment.
Primary Deficit
=
Fiscal deficit – Interest Payment
Measures to Contain Budgetary Deficits (i)
Lowering Government Expenditures
(ii)
Raising Government Receipts through (a) Taxation (b) Disinvestment
Deficit Financing (i)
Monetary Expansion - This amounts to printing of currency notes to the extent of deficit.
(ii)
Borrowings from the Public
(iii)
Disinvestment
Important Questions 1. Define Government Budget. 2. Define Tax. 3. Differentiate between Revenue Receipts and Capital Receipts with suitable examples. 4. Distinguish between Revenue Expenditures and Capital Expenditures with examples. 5. Define Direct Taxes and give examples. 6. Define Indirect Taxes with examples. 7. Distinguish between Development and Non Developmental Expenditures. 8. State any three objectives of Govt. Budget. 9. What is Fiscal Deficit? What are its Implications. 10.What is Revenue Deficit and what are its implications. 11.How can the Deficit in Budget be financed.
National Income and Related Aggregates
MEANING OF MACROECONOMICS
1. Macro Economics is the study of aggregates or averages covering the entire economy such as national income, full employment, unemployment, aggregate consumption, aggregate savings and general price level. In other words, Macro Economics is the branch of Economics which is primarily concerned with the study of relationship between broad economic averages. Macro Economics deals with the aggregates of the economy. 2. Lord J.M.Keynes, an eminent economist has played an important role in the development of macro Economics. He is called, The Father of Modern Macro Economics. He wrote a book on Macro Economics named “General Theory of Employment, Interest and Money” published in 1936. 3. Macro Economics is alternatively called Theory of Income and Employment or simply income analysis. Under Macro Economics, we try to explain how the level of income and employment are determined in an economy and how unemployment can be removed. 4. The scope of Macro Economics includes the following topics : (i) Concept and measurement of national income. (ii) Determination of income and employment. (iii) Money and Banking. (iv) Government budget and the economy. (v) Determination of foreign exchange rate and balance of payments.
CIRCULAR FLOW OF INCOME
1. Circular flow of income forms the basis for measurement of Macro Economic activities. It helps to know the functioning of an economy. 2. Circular flow of income refers to continual circular movement of money and goods in an economy. 3. Circular flow of income may be of two types : (i) Real flow and (ii) Money flow. 4. Under real flow of income, household render factor services to the firms and the firms produce goods and services to pay further services. 5. Under money flow of income, all payments by the firms to the households for their factor services and by the households to the firms for the purchase of goods and services are made in terms of money. 6. Flow of goods and services between firms and households is real flow and flow of money between the firms and households is money flow. If we prepare a diagram, we shall find that real flow is clockwise whereas money flow is counterclockwise and vice-versa. 7. Circular flow of income is discussed under three different situations based on certain simplifying assumptions. (i) Circular flow of income in a two sector company. (ii) Circular flow of income in a three sector company. (iii) Circular flow of income in a four sector company. 8. The circular flow of income in a two sector economy (or simple economy) is presented in the form of a figure given :
Circular Flow of Income in a Simple Economy
CONCEPTS OF NATIONAL INCOME
1. National Income is used as a yardstick to measure the annual economic performance of the country. 2. National Income is defined as the sum total of factor income earned by the residents of a country during one year or it is the sum total of market value of final goods and services produced by the residents of a country during one year. 3. Broadly speaking, there are eight concepts of aggregates of national income, viz., GDPMP, GNPMP, NDPMP, NNPMP, GDPFC, GNPFC, NDPFC and NNPFC. 4. For a better understanding of these concepts or aggregates of national income, a knowledge of three fundamental terms is essential. (i) Depreciation (or Consumption of fixed capital). (ii) Net Indirect Taxes, and (iii) Net Factor Income from Abroad. 5. Depreciation (or consumption of fixed capital) refers to the loss of value of fixed assets due to its normal wear and tear. This concept is used to make distinction between gross and net. If we deduct depreciation from gross, we get net and if we add depreciation to net we get gross. 6. Net Indirect Tax (NET) is defined as the difference between indirect taxes (ID) and subsidies (S), i.e., NIT = IT – S. This concept is used to make distinction between market price and factor cost. If we deduct NIT from market price, we get factor cost and if we add NIT to factor cost, we get market price. 7. Net Factor Income from Abroad (NFIA) is defined as the difference between factor income received from abroad and the factor income paid abroad. This concept is used to make distinction between national and domestic. If we NFIA from national, we get domestic and if we add NFIA to domestic, we get national. 8. GDP at market price refers to the total market value of all the final goods and services produced within the domestic territory of a country in an accounting year, i.e., GDP = P*Q. 9. GNPMP = GDPMP + NFIA. 10. NDP = GDP – Depreciation. 11. NNP = NDP + NFIA. 12. NNP = GNP – Depreciation. 13. NDPMP = NNPMP – NFIA. 14. GNPFC = GNPMP – NIT. 15. NDPFC = NDPMP – NIT. 16. Net National Product at factor cost is called National Income while the Net Domestic Product at factor cost is called Domestic Income, i.e., NNPFC = National Income and NDPFC = Domestic Income. 17. Other related aggregates of national income are : (i) Income from domestic product occurring to private sector, (ii) Private income, (iii) Personal income, (iv) Personal disposable income, (v) Gross national disposable income and (vi) Net National disposable income. 18. Income from domestic product occurring to private sector = NDPFC – Surplus of government sector. The main components of surplus of govt. sector are : (i) Income from property and entrepreneurship accruing to government administration departments and (ii) Savings of non-departmental undertakings of government. 19. Private Income is the income of the private sector. It is obtained by adding four terms : (i) Net Factor Income from Abroad, (ii) Net current transfers from the rest of the world, (iii) Current transfers from government and (iv) Interest on national debt to income from domestic product accruing to private sector.
20. Personal income is the income received by individuals or households of a country from all sources. This is obtained by deducting two terms : (i) undistributed profits and (ii) corporate taxes from private income. 21. Personal Disposable Income refers to that part of personal income which is actually available to household for consumption or saving. It is obtained by subtracting personal taxes and other miscellaneous receipts of government (such as fines and penalties) from the personal income. 22. National Disposable Income (NDI) is the sum of all incomes received by the residents of a country which is available for spending on consumption and for saving. 23. There are two measures of NDI : (i) Gross NDI and (ii) Net NDI. 24. Gross NDI is the sum of GNPMP and net current transfers from the rest of the world. Symbolically, Gross NDI = GNPMP + Net current transfers from the rest of the world. 25. Net NDI is the sum of NNPMP and net current transfers from the rest of the world. Symbolically, Net NDI = NNPMP + Net current transfers from the rest of the world. 26. Gross National Income is another name for Gross National Product at factor cost (GNPFC). Alternatively, GNP = NI (or NNPFC) + Depreciation. 27. Gross National Product is another name for Gross National Product at Market Price (GNPMP).
HOTS Q.1)
Introduction of money has separated the acts of ‘sale’ and ‘purchase’. How?
Q.2)
Distinguish between Fiat money and Fiduciary money.
Q.3)
Distinguish between money value of money and commodity value of money.
Q.4)
What impacts the credit creation capacity of the commercial banks?
Q.5)
Explain the Credit Multiplier.
Q.6)
What is Selective Credit Control?
Q.7)
How does bank rate policy help in expending or contracting credit in an economy.
