CBSE-II (2018) CBSE BOAR PAPER WITH SOLUTION ECONOMICS Code No. 58/3 Roll.No. Candidate must write the Code on the titile page of the answer-book. Time allowed : 3 hours Maximum Marks : 80 Code number given on the right hand side of the question paper should be written on the title page of the answer-book by the candidate. Please write down the Serial Number of the question before attempting it. 15 minute time has been allotted to read this question paper. The question paper will be distributed at 10.15 am. From 10.15 a.m. to 10.30 a.m., the students will read the question paper only and will not write any answer on the answer-book during this period. GENERAL INSTRUCTIONS 1. There are 24 Questions in this Paper. All questions in both the Sections are Compulsory. 2. Q. Nos. 1 4 and 13 16 are Very Short Answer Questions carrying 1 Mark each. They are required to be answered in One Sentence each. 3. Q. Nos. 5 6 and 17 18 are Short Answer Questions carrying 3 Mark each. Answers to them should normally NOT ECEE 60 Words each. 4. Q. Nos. 7 9 and 19 21 are also Short Answer Questions carrying 4 Mark each. Answers to them should normally NOT ECEE 70 Words each. 5. Q. Nos. 10 12 and 22 24 are Long Answer Questions carrying 6 Mark each. Answers to them should normally NOT ECEE 100 Words each. 6. Answers should be brief and to the point and the above word limits should be adjered to as far as possible. PAGE - 1
(A) Q 1. 1 Mark Questions SECTION A MICRO ECONOMICS When the Total Fixed Cost (TFC) of producing 100 units is ` 30 and the Average Variable Cost (AVC) is ` 3, Total Cost (TC) is : (A) ` 3 (B) ` 30 (C) ` 270 () ` 330 Q TFC AVC TC 100 30 3 TVC TC = AVC Q = 3 100 = ` 300 = TFC + TVC = 30 + 300 = ` 330 Ans. () Q 2. When the Average Product (AP) is Maximum, the Marginal Product (MP) is : (A) Equal to Average Product (AP) (B) Less than Average Product (AP) (C) More than Average Product (AP) () Can be any one of the above. (A) Equal to Average Product (AP) Output O Units of V.F.(N) MP AP Q 3. State ONE example of Positive Economics. More Quantity is emanded due to Fall in its Price and Less Quantity is emanded due to Rise in its Price. Q 4. efine Fixed Cost (FC). That Cost of Production which remains Constant, whether the Level of Output Increases / ecreases or becomes Zero. Such as Rent. PAGE - 2
(B) 3 Marks Questions Q 5. Explain the Central Problem of Choice of Technique. Explain the Central Problem of For Whom to Produce. After deciding the commodity and quantity of production, the economy has to decide that by which method they should produce this commodity because there are several methods and techniques available to produce the same commodity. This problem arises because available resources are limited and have alternative uses. For eg. in re-construction sector we have to choose among labour intensive technique (technique where ratio of labour is more than capital) and capital intensive technique (technique where ratio of capital is more than labour), in agriculture sector we have to make choice between extensive and intensive cultivation. Generally labour surplus economy prefers labour intensive techniques and capital surplus economy prefers capital intensive techniques. This problem is related with distribution of income generated or output produced. In this problem the economy has to decide that who should consume how much. As we know that output produced is the combined effort of different individuals or different means of production. So in this problem we studies how output produced or income generated is distributed among different means of production or different individuals. This distribution can be classified in personal distribution and functional distribution. (i) Personal distribution : The distribution of income generated or output produced among different individuals is termed as personal distribution. (ii) Functional distribution : The distribution of income generated or output produced among different means of production is termed as functional distribution. Such as rent to landlord, wages to labourer, interest to capitalist and profit to entrepreneur. In market economy the decision for whom to produce is taken by the distribution of income. Because this distribution determines the purchasing power of the people and a capitalist like to produce for that section of society which is capable to purchase so that his profit will be maximum. Q 6. What is meant by Inelastic emand? Compare it with Perfectly Inelastic emand. When the Percentage Change in Quantity emanded is Lesser than the Percentage Change in Price, then it is termed as Inelastic emand. Basis Inelastic emand Perfectly Inelastic emand P % P e P< 1 % Q..< % P P 1 (e = 0) P iagram P 1 Price % Q O Q Q 1 Quantity Price P P 2 O Q Quantity efinition When the percentage (or proportionate) When the quantity demanded remains change in quantity demanded is lesser constant (or changes very minutely) than the percentage (or proportionate) with the too much change in its price change in price, then it is termed as (whether price increases or decreases inelastic demand. then it is termed as perfectly inelastic demand. Co-efficient less than one (ep< 1). Zero (ep = 0). Real or Imaginary can be found in necessary goods cannot be found in practical world PAGE - 3
Price (C) Q 7. 4 Marks Questions When the Price of a Commodity changes from ` 4 Per Unit to ` 5 Per Unit, its Market Supply rises from 100 Units to 120 Units. Calculate the Price Elasticity of Supply. Is Supply Elastic? Give reason. P Q 4 100 5 120 e s = Q P P Q = ( 120 100) 4 (5 4) 100 = 20 1 1 25 = 4 5 = 0.8 (e p < 1) No, the Supply is NOT Elastic. It is Inelastic because the Co-efficient is Less than ONE (or the Proportionate Change in Quantity Supplied is Lesser than Proportionate Change in Price. Q 8. What is meant by Price Ceiling? Explain its Implications. Price ceiling means, fixing the price of commodity by government below the equilibrium price to benifit the consumers (when the equilibrium price is presumed to be too high so that the common S buyer is unable to afford such commodities at that price). Sometimes the equilibrium price determined (OP) by the independent powers of demand and supply may be very high, P E so that most of the consumers are unable to purchase this P 1 commodity at the prevailling prices, specially in the case of necessary commodities like wheat, sugar, rice etc.. O In those cases government directly interfere in price Quantity determination and decide the price (OP 1 ) of the commodity below the equilibrium price. This price is also known as control price. In this condition government decides the maximum limit of price. At this price level the quantity demanded is more than the quantity supplied. The implication of Price Ceiling is as follows : (i) Shortage : Control price are lesser than equilibrium price, therefore sellers wants to sale less of the commodity whereas consumers wants to purchase more of the commodity, which creates the problem of shortage in market. (ii) Hoarding and Black Marketing : Because control price is lesser than the equilibrium price which will decrease the profit margin of sellers, therefore they will try to hoard the commodity as much as possible. ue to shortage and rationing some buyer will try to purchase more units by giving higher prices than control price, which lead to black-marketing. PAGE - 4
Q 9. Given the Price of a Good, how will a Consumer decide as to how much quantity to buy of that good? Explain. What is Indifference Curve? State THREE Properties of Indifference Curves. Consumer will buy that much amount of a commodity by which consumer receives maximum satisfaction from his given income and he has no tendency to make any changes in his existing consumption (or existing expenditure on commodity). Assumptions : (i) The consumer is assumed to be a rational person. His aim is to achieve maximum satisfaction through his limited monetary income. (ii) Utility derived from the consumption of commodity can be expressed in terms of numbers, such as 1, 2, 3, 4 etc. (iii) It is assumed that utility of commodity can be measured by money and marginal utility of money remains constant. (iv) Income and mental status of consumer remains constant during the act of consumption. (v) Price of concerned commodity and price of other commodities remains constant. (vi) Units of concerned commodity are homogenous. (vii) It is assumed that law of diminishing marginal utility operates for the commodity consumed. (viii) Other factors which can affect the utility are assumed to be remain constant. Condition for equilibrium :- MUx = Px Explaination of the law : Suppose Price of commodity = ` 10 per unit. MU of 1 ` (MU M ) = 5 utils As consumer buys any commodity then he has to make sacrifices in terms of money ( or in terms of utils) and in return he get some utility from the commodity. But due to application of law of diminishing marginal utility, the utility derived from every additional unit goes on diminishing. On the other hand the price of the commodity and marginal utility of money remains constant (due to assumptions of the law). Which means that the sacrifices made by the consumer remains constant. In our present example at first and second units of the commodity MUx > Px, which means that the sacrifices made by the consumer is lesser than the satisfaction gained by him at these units. So the consumer will increase the level of consumption in order to maximise the level of satisfaction until MUx becomes equal to the Px. But at fourth and fifth units of the commodity MUx < Px, which means that the sacrifices made by the consumer is greater than the satisfaction gained by him at these units. So the consumer will decrease the level of consumption in order to maximise the level of satisfaction until MUx becomes equal to the Px. Consumer will be in the state of equilibrium when marginal utility of commodity is equal to the marginal utility of money paid for it (or the sacrifices made by consumer becomes equal to the satisfaction gained by him). In our present example this condition is satisfied at 3rd unit of the commodity, which means that consumer will purchase 3 units of the commodity in order to maximise his satisfaction. y Q Mux (in utils) Px (in `) Px (in utils)=px (in `) MUm 1 70 10 10 5 =50 2 60 10 10 5 =50 3 50 10 10 5 =50 4 40 10 10 5 =50 5 30 10 10 5 =50 P A B E O Q 1 Q Q 2 x C Units of commodity In present diagram at OQ 1 units of commodity MUx is AQ 1 and Px is BQ 1. Which means marginal utility of commodity is greater than price paid for the commodity (or satisfaction gained by consumer is more than the sacrifices made by him). In such conditions consumer will increase level of consumption until MUx becomes equal to Px in order to maximise his satisfaction. Similarly at OQ 2 units of commodity MUx is Q 2 and Px is CQ 2. Which means marginal utility of commodity is lesser than price paid for the commodity ( or satisfaction gained by consumer is lesser than sacrifices made by him). In such conditions consumer will decrease the level of consumption until MUx becomes equal to Px in order to maximise his satisfaction. At OQ level of consumption consumer will receive maximum satisfaction because at this level condition for consumer's equilibrium (MUx = Px) is satisfied where consumer is gaining maximum satisfaction. So at this level consumer has no tendency to change his existing level of consumption. So the consumer s equilibrium in present diagram is at OQ level of consumption. Utility P x MU x PAGE - 5
Indifference curve is a form of curve which shows all those combinations of two commodities which provides same level of satisfaction to the consumer, therefore the consumer is indifferent or neutral among chosing any of these combinations. He does not prefer any of the combination over the other combination because all of these combination provides same level of satisfaction. In the present diagram A, B, C, and E combinations provides same level of satisfaction. Units of y Three properties of indifference curves are as follows :- (i) Higher indifference curve represents higher level of satisfaction : Higher indifference curve shows higher level of satisfaction in comparison to lower indifference curve, because along the higher indifference curve we are using more units of one commodity with the same units of another commodity or more units of both the commodities. Therefore the satisfaction level of such 1 2 combinations will be more. As in the present diagram : At A combination O + O At B combination O + O 1 B > A At C combination O 1 + O C > A Commodity y O O A A B C E Units of x B C 2 1 Commodity x IC IC 2 IC 1 At combination O 2 + O 2 > A (ii) Indifference curves are negative sloping : Indifference curves are always slopes downwards to the right or negative sloping, because if consumer increases units of one commodity, then to maintain the same level of satisfaction consumer has to decrease the units of another commodity. So as the units of is increased then units of has to be decreased and vice-versa. ue to this negative relationship indifference curves are downward sloping. As in the present diagram as consumer moves from A to B the combination changes from O + O to O 1 + O 1. While moving from A to B, units of is increased and units of is decreased. Units of y y A O x x 1 Units of x Slope of indifference curve will never be horizontal, vertical or upward sloping because in all these three cases, the basic feature of indifference curve, i.e., same level of satisfaction is derived at different points along the same indifference curve, is neglected. (iii) Indifference curves are convex towards the origin : Indifference curves are convex towards the origin because marginal rate of substitution continously decreases (because as the stock of one commodity decreases its marginal importance for the consumer will continously increases and as the stock of another commodity increases its marginal importance for the consumer will continously decreases, therefore he is ready to sacrifice lesser and lesser units of one commodity for the every extra unit of another commodity to maintain the same level of satisfaction). As shown in the diagram when consumer increases one unit of commodity he decreases commodity P O A y 1 B C 1 2 3 4 Commodity B IC Convex to origin equal to PQ, whereas for next unit of commodity he decreases commodity equal to QR. As we can see that PQ > QR, it represents that MRS xy is decreasing and due to that indifference curve will become convex towards the origin. Commodity Q R S IC PAGE - 6
() Q 10. 6 Marks Questions State THREE Characteristics of Monopolistic Competition. Which of the Characteristics separates it from Perfect Competition and Why? Explain the Implications of the following : (a) Freedom of Entry and Exit of Firms under Perfect Competition. (b) Non - Price Competition under Oligopoly. (i) (ii) (iii) Many Sellers : In monopolistic competition market, there are large number of firms producing the same commodity. An individual firm is not able to affect the market because the share of single firm is very minute proportion of total supply of the market. But the number of firms in this market is comparatively less than perfect competition market. Close Substitute Goods (Product ifferentiation) : In monopolistic competition market close substitutes of the commodity are available in the market. The commodity produced by different firms are similar but not identical. We can see the difference between commodities of different firms, in colour, taste, shape, size, brand name, trademark, etc. ue to this a firm can distinguish its product from others. In this market we can see a personal attachment by consumers to a particular firm. In monopolistic competition market a large number of firms produces the similar commodity. Every firm spends huge amount of monetary resources on advertisements, selling techniques, posters, banners etc. in order to increase their sales. This cost plays an important role in their sales. Free Entrance and Exit : In monopolistic competition market there is free entrance and exit of the firm. There is no barrier or restrictions on them just like perfect competition market. In monopolistic competition market the firm will receive only normal profit in long run period due to free entrance and exit of the firm. If in short run period the firms are getting super-normal profit, then some new firms will attracts towards the market and as the number of firms increases in the market, the supply of commodity also increases, which results in fall in price and this process will continue until AR becomes equal to AC and vice-versa. Therefore firms will receive normal profit in long run. BASIS Perfect Competition Monopolistic Competition 1. Selling Cost In this market selling cost is absent In this market selling cost exist and because goods produced by firms plays an important part in determination are homogenous. Firm did not get of sales of particular firm because the direct response from the consumers. commodity produced by different firm So it is a wasteful expenditure from is similar but not identical i.e. close firms part. substitute to each other. So they spent huge amount of money on sale promotions. 2. AR and MR In this market AR = MR and both In this market AR > MR and both these these curves are parallel to axis curves are downward sloping because because firms are price takers means firms are price makers means they are they are following dependent price following independent price policy. policy. They are charging same They are charging lesser amount of amount of money for every additional money for every additional unit of the unit of the commodity. Therefore MR commodity in order to increase their remains constant and AR equivalent sales to increase their profit. Therefore to MR. MR decreases and AR also decreases but AR is greater than MR. 3. emand curve In this market demand curve is In this market demand curve is elastic perfectly elastic because on large because of many sellers and many number of sellers and homogenous sellers and many close substitute goods. goods. PAGE - 7
(a) (b) In long run peiod a perfect competitive firm always receives normal profit due to free entrance and exit of firms. In short run period if there is a situation of abnormal profits or super normal profits ( AR > AC ), then it will attracts new firms to the industry and existing firms try to expand their production process. New firms will easily enter into the market because of free entrance. ue to entrance of new firms, number of firms operating in the market will increases. It will increases the competition in the market. ue to this, supply of the commodity in the market will also increases, which will lower the prices and profits. This condition will continue until the price (AR) becomes equal to AC. So supernormal profit will converts into normal profit in long run period due to free entrance of firms in the market and vice versa. In oligopoly market there are few firms producing same commodity. Goods produced by them are either homogenous or ifferentiated (close substitute). They tend to avoid the price war because each firm ultimately loses huge amount of money in such conditions. So they try to focus on non price competition i.e. competition other than price. They spent huge amount of money on sale promotions, such as in India different firms are selling soft drinks in the market. To promote their sales they are spending huge money on advertisements, running different schemes to promote sales, sponsor different games and sports. ue to all these reasons the amount of selling tends to be very high and in certain cases it even becomes more than cost of production. So as a result its market price tends to be very high. It is considered as wastage of resourses and reduction in social welfare. Q 11. Explain the conditions of Consumer s Equilibrium using Indifference Curve Analysis. Consumer s equilibrium means the level of consumption at which the consumer gets maximum satisfaction with his limited monetary income and the consumer has no tendency to make any changes in his existing consumption or existing expenditure on commodities. Assumptions : In indifference curve analysis there are some assumptions which are used in explanation of consumer's equilibrium : (i) Consumer is rational and make rational expenditure on commodities to attain maximum satisfaction. (ii) The consumer has a fixed income to be spent entirely on two commodities. (The two commodities can be extended to many by using algebra). (iii) Prices of concerned commodities, prices of other commodities and income of consumer remain constant. (iv) MRS continously diminishes. Conditions for Consumer's Equilibrium : There are three conditions which are required for the consumer's equiiibrium. If these conditions applies, then the consumer is said to be in equiiibrium. (i) (ii) (iii) The total amount of money available should be equal to total money spent on two commodities. The budget line should be tangent with the indifference curve (or the slope of budget line should be equal to the slope of indifference curve or ratio of the prices of two commodities must be equal to the marginal rate of substitution). At the point of tangency indifference curve must be convex towards the origin. A Commodity O C Slope of IC> Slope of Budget line E (MRS > Commodity xy. Slope of IC= Slope of Budget line (MRS = P x P y ) B P x xy ) P y Slope of IC< Slope of Budget line P (MRS < x xy ) P y IC 2 IC 1 PAGE - 8
Explanation : (i) First condition : The total amount of money available to the consumer should be equal to the total expenditure made on these two commodities together. This condition fulfills only on the budget line. TOTAL MONETAR INCOME = ( Px Qx ) + ( Py Qy ) Point C,,E satisfies this condition of equilibrium. But the consumer give preference to combination of point E in comparison to C and because point E is on the IC 2 whereas point C and are on IC 1. As we know that higher indifference curve shows higher level of satisfaction. Therefore the consumer will give prefrence to E combination, as it provides higher level of satisfaction without any extra expenditure. (ii) (iii) Second condition : The budget line should be tangent to the indifference curve or we can say that the slope of budget line should be equal to the slope of indifference curve. Slope of the budget line = Px / Py, whereas the slope of indifference curve = MRSxy. In the present diagram at C point MRSxy > Px / Py (means units of commodity which a consumer is willing to sacrifice is more than units of commodity which a consumer has to sacrifice in order to consume one extra unit of commodity). So in order to maximise the total satisfaction consumer will shift the resourses from commodity to commodity (or increase the consumption of commodity and decrease the consumption of commodity) until marginal rate of substitution becomes equal to the ratio of the prices of two commodities or willingness to sacrifice becomes equal to the actual sacrifices. In the present diagram at point MRSyx > Py / Px (means units of commodity which a consumer is willing to sacrifice is more than units of commodity which a consumer has to sacrifice in order to consume one extra unit of commodity). So in order to maximise the total satisfaction consumer will shift the resourses from commodity to commodity (or increase the consumption of commodity and decrease the consumption of commodity) until marginal rate of substitution becomes equal to the ratio of the prices of two commodities or willingness to sacrifice becomes equal to the actual sacrifices. At E point MRSxy = Px / Py (means consumer is willing to sacrifice same amount of commodity which he has to sacrifice in order to consume one extra unit of commodity). So consumer will not shift its resourses from commodity to commodity, means point E represents consumer s equilibrium. Third condition : At the point of tangency indifference curve must be convex towards the origin. At point E indifference curve is convex towards the origin. Therefore point E satisfies the third condition also. So in order to attain the maximum satisfaction the above three conditions of equilibrium should be applied at the same point. In the present diagram at E point all three conditions are satisfied, therefore point E will be the equilibrium point and that s why consumer will consume O units of commodity and O units of commodity in order to maximise the level of satisfaction. Q 12. Explain the Conditions of Producer s Equilibrium in terms of Marginal Revenue (MR) and Marginal Cost (MC). The producer's equilibrium refers to the situation in which producer maximizes his profits (or minimizes his loss) and the producer has no intention to make any changes in his existing production or to make any changes in his existing expenditure on means of production. Profit of the firm operating in perfect competition market, is maximised where the price line ( AR = MR ) intersects the MC curve and MC should be rising. ASSUMPTIONS : (i) Rational behaviour of producer. (ii) The goal of producer is profit maximisation. (iii) Price of means of production remains constant. (iv) There is perfect competition exist in market. (vi) Technique of production and management remains constant. PAGE - 9
CONITIONS F PROUCER S EQUILIBRIUM : (a) MR = MC. (b) MC should be rising at that level of output. (or MC curve intersects MR curve from below). If the producer is producing OQ 1 units of commodity (output less than OQ), MR is equal to AQ 1 and MC is equal to BQ 1 which means MC < MR. W hich means that the cost incurred on producing additional unit is lesser than the revenue received from the sale of that unit, which indicates that the producer is receiving profit on that unit. So in order to maximise total profit producer will further increase the level of output until MC becomes equals to MR. C/R P O R Q3 Output A E B Q Q 1 MC C AR = MR Q 2 But if the producer is producing OQ 2 units of commodity (output more than OQ), MR is equal to Q 2 and MC is equal to CQ 2 which means MC > MR. Which means that the cost incurred on producing additional unit is more than the revenue received from the sale of that unit, which indicates that the producer is receiving loss on that unit. So in order to minimise the loss or to maximise the profit producer will decrease the level of output until MC becomes equals to MR. But if the producer is producing at OQ 3 units of the commodity then MR is equal to MC but MC is falling means first condition for equilibrium is satisfied but not the second condition. At this particular unit firm will receive only loses because on all unit before this output level MC > MR means firm recovered only loss on all those units but if firm further increases production beyond this level then they will receive super normal profit on all units. So the firm will increses the level of output till again MR and MC both becomes equal. At OQ units of commodity then MR and MC both are equal to EQ which means MC = MR and MC is rising. Which means both the conditions for producer s equilibrium are satisfied at this level means firm is receiving maximum total profit at this output level. So producer will maintain this level of output for maximum profit. PAGE - 10
PART B MACRO ECONOMICS (A) 1 Mark Questions Q 13. efine Money Supply. The Supply of Money refers to the volume of money held by the public in an economy at any given time. The term public includes all economic units, such as householders, firms etc. (except Government and Banking system) Q 14. Which of the following affects National Income? (A) Goods and Services Tax (B) Corporation Tax (C) Subsidies () None of the above (B) Corporation Tax. Because Corporation Tax is a Part of Profit and Included in National Income. Q 15. Why does Consumption Curve NOT Start from the Origin? Because Consumption Exist even at Zero Level of Income i.e. Autonomous Consumption. It is must for Survival because you have to Consume even at Zero Income. It starts from above the origin. Q 16. The Central Bank can Increase Availability of Credit by : (A) Raising Repo Rate (B) Raising Reverse Repo Rate (C) Buying Government Securities () Selling Government Securities (C) Buying Government Securities (B) 3 Marks Questions Q 17. Given Nominal Income, how can we find Real Income? Explain. Which among the following are Final Goods and which are Intermediate Goods? Give reasons. (a) Milk Purchased by a Tea Stall (b) Bus Purchased by a School. (c) Juice Purchased by a Student from the School Canteen. Nominal Income : When Output Produced in Current ear is Valued on the Basis of Prices Prevailing in Current ear. Real Income : When Output Produced in Current ear is Valued on the Basis of Prices Prevailing in Base ear. Basic ifference between these concepts is Price Level (output considered in both these concepts belongs to same year). If Nominal Income is given and we have to find Real Income, then we can use this formula : Real Income = Nominal Income 100 Pr ice Index let us Assume : Nominal Income = ` 240 Crores ; Price Index (P I) = 120 240 Real Income = 100 = ` 200 Crores 120 PAGE - 11
(a) (b) (c) Intermediate Goods. Because it is Purchased by Producer for Further Production and Used as Non-urable Producer Goods. Final Capital Goods. School is a Producing Enterprise and used as urable Producer Goods for Further Income Generation. Final Consumer Goods. Because Juice Purchased by a Student from School Canteen means a Good Purchased by Consumer for Consumption Purpose or to Satisfy his Needs. Q 18. efine Multiplier. What is the relation between Marginal Propensity to Consume (MPC) and Multiplier? Calculate the Marginal Propensity to Consume (MPC), if the Value of Multiplier is 4. The multiple increase in income due to increase in investment, is known as multiplier. or Multiplier means the ratio of change in income to the change in investment". K Here K = Multiplier ; = Change in Income; I I = Change in investment. There is a positive relationship between MPC and K. As the value of MPC increases the value of multiplier will also increases and as the value of MPC decreases the value of multiplier will also decreases. 1 K = 1 MPC As the value of MPC increases, means consumption expenditure increases and due to increase in consumption expenditure, income generation will also increases (because expenditure of one person is income of another person). ue to increase in income generation the effect of multiplier will also increases and that s why the value of multiplier will also increases and vice-versa. k = 4 MPC =? k = 1 1 MPC 4 = 1 1 MPC 4 4 MPC = 1 4 MPC = 1 4 + 4 MPC = + 3 MPC = 3 4 = 0.75 PAGE - 12
(C) 4 Marks Questions Q 19. What is meant by Inflationary Gap? State THREE measures to Reduce this Gap. What is meant by Aggregate emand? State its Components. The extent at which present aggregate demand is greater A AS 1 > Af than the aggregate demand which is required for full Total (A > AS) employment level, is known as inflationary gap. This gap outlay is termed as Inflationary Gap because price of goods and E 1 services increases in this condition. This condition can be L found in economy in the case of Excess emand. In such { E cases Aggregate emand would be more than Aggregate C Supply. Inflationary Gap = A 1 A f O f = L 1 f E f National Income = LE (i) Increase in CRR : Central bank increase the CRR to control the condition of excess demand, due to this commercial bank has to keep more ratio of its deposits with central bank which decreases their credit creation ability and hence the credit creation also decreases which in turn decreases the money supply and aggregate demand of economy. (ii) Increase in SLR : Central bank increases the SLR to control the condition of excess demand, due to this commercial bank has to keep more ratio of its deposits with itself, which decreases their credit creation ability and hence the credit creatin also decreases which in turn decreases (iii) the money supply and aggregate demand also decreases. Selling of Securities in Open Market : Central bank starts to sale the securities in open market with the help of commercial banks, this will decreases the availability of cash with commercial banks and hence decreases the credit creation ability of commercial banks. Which would further decreases the credit creation and money supply in an economy and hence aggregate demand also decreases. emand of all final goods and services by all the consumers of an economy at given price level is known as aggregate demand. The components of aggregate demand are :- A.. = C + I + G + N.E. (a) (b) (c) (d) emand for Private Consumption (C) : The demand of goods and services by the households during a given time period, is included in this. It is affected by many variables such as, price of the goods, income of consumer, expected income, wealth, tastes and preferences of individuals, consumption function, propensity to consume, etc. emand for Private Investment (I) : It includes the investment in new fixed assets and change in stock, such as addition of new machinery, residential structures, etc. This investment demand is affected by rate of interest and marginal efficiency of investment. emand for Government Expenditure (G) : It includes the expenditure made by government for collective wants (such as Government schools, hospitals, roads, etc.) and investment expenditure on Government enterprises. This expenditure depends on the condition of economy, form of Government, policies of Government, needs of public, etc. emand for Net Exports (N.E.) : Net exports is the difference between exports and imports. It depends on the quality of goods produced, price of the commodity, availability of commodity, income and living standard of people of that country, etc. A 1 A f PAGE - 13
Q 20. The Value of Marginal Propensity to Consume is 0.6 and Initial Income in the Economy is ` 100 Crores. Prepare a schedule showing Income, Consumption and Saving. Also show the Equilibrium Level of Income by assuming Autonomous Investment of ` 80 Crores. MPC = 0.6 Autonomous Investment = ` 80 Crores Initial Income = ` 100 Crores Let us assume, Autonomous Consumption = ` 40 Crores Change in Income = ` 100 Crores. y C S I C = MPC 0.4 A = C + I 100 40 + 60 = 100 0 80 0.6 100 = 60 180 200 100 + 60 = 160 0 80 0.6 100 = 60 240 300 160 + 60 = 220 0 80 0.6 100 = 60 300 400 220 + 60 = 280 0 80 0.6 100 = 60 360 500 280 + 60 = 340 0 80 0.6 100 = 60 420 600 340 + 60 = 400 0 80 0.6 100 = 60 480 700 400 + 60 = 460 0 80 0.6 100 = 60 540 At Equilibrium level of Income, Aggregate emand (A) = Aggregate Supply (AS) C + I = y C + b y + I = y 40 + (0.6 y) + 80 = y 120 + 0.6 y = y 120 = y 0.6 y 120 = 0.4 y y = 120 10 ` 300 Crores 0.4 Q 21. Explain the Role of the Reserve Bank of India (RBI) as the Lender of Last Resort. The central bank acts as a lender of the last resort for commercial banks. When commercial banks fail to meet obligations of their depositors or they are in some financial crisis, they try to arrange it from market or from other commercial bank. But if they fail to arrange the funds the last destination for them is Central bank. Central bank comes to their rescue. The central bank advances necessary credit against eligible securities subject to certain terms and conditions. This saves banks from a possible breakdown and hence works as ultimate financer to the commercial banks. Central bank never refuses to accommodate any eligible bank and help them in need. PAGE - 14
() 6 Marks Questions Q 22. (a) Explain the Impact of Rise in Exchange Rate on National Income. (b) Explain the Concept of eficit in Balance of Payments (BoPs). (a) (b) Rise in foreign exchange rate means now to arrange one unit of foreign currency we have to sacrifice more units of domestic currency. As a result exports now becomes cheaper and hence they increase and imports becomes costlier and hence they decreases. this will results in increase in national income. Means Indian goods will become cheaper for foreigners and foreign goods becomes costlier for Indians. So there will be more demand of Indian goods which results in more investments, more production and more income generation. Balance of payments is a systematic record of all economic transactions which are occuring between normal residents of reportin countries with rest of the world during an accounting year. eficit in Balance of Payments means that the sum of credit side of balance of payment is lesser than the sum of debit side of balance of payment. (or in other words sum of balance on current account and balance on capital account is negative). Which means inflow of currency is lesser than outflow of currency. That means that receipts of foreign exchange is lesser than the payment obligations. Which means we have to arrange foreign exchange to meet out this gap. Causes responsible for this deficit are increase in imports, decrease in exports, large scale outflow of foreign capital and decrease in inflow of foreign capital, etc. This deficit can be meet out through by selling gold in international market, by using reserves of foreign exchange held by Central bank or borrowings by Government from IMF. Q 23. Calculate : (a) Net National Product at Market Price and (b) Gross omestic Product at Factor Cost (` in Crores) (a) Rent and Interest 6,000 Wages and Salaries 1,800 Undistributed Profit 400 Net Indirect Taxes 100 Subsidies 20 Corporation Tax 120 Net Factor Income to Abroad 70 ividends 80 Consumption of Fixed Capital 50 Social Security Contribution by Employees 200 Mixed Income 1,000 NNP MP = (Wages and Salaries + Social Security Contribution by Employees) + Rent and Interest + (Undistributed Profit + Corporation Tax + ividends) + Mixed Income + Net Factor Income from Abroad + Net Indirect Taxes = (1,800 + 200) + 6,000 + (400 + 120 + 80) + 1,000 + ( 70) + 100 = 2,000 + 6,000 + 600 + 1,000 70 + 100 (All figures in ` Crores) = ` 9,630 Crores Ans. (b) GP FC = NNP MP + Consumption of Fixed Capital Net Factor Income from Abroad Net Indirect Taxes = 9,630 + 50 ( 70) 100 = 9,630 + 50 + 70 100 (All figures in ` Crores) = ` 9,650 Crores Ans. PAGE - 15
Q 24. Explain the meaning of the following : (a) Revenue eficit (b) Fiscal eficit (c) Primary eficit Explain the following objectives of Government Budget. (a) Allocation of Resources (b) Reducing Income Inequalities (a) (b) Revenue eficit refers to the Excess of Total Revenue Expenditures over Total Revenue Receipts. Revenue eficit = Total Revenue Expenditures Total Revenue Receipts. It signifies that government will not be able to meet its revenue expenditures fully from its revenue receipts. It indicates that the Government has to make up for this shortfall from capital receipts, which will increase the liability or decrease the assets of the Government. Fiscal eficit refers to the Excess of Total Expenditures over the Sum of Revenue Receipts and Capital Receipts excluding Borrowings. Fiscal eficit = Revenue Expenditure + Capital Expenditure Revenue Receipts Capital Receipts (Excluding Borrowings) Fiscal eficit indicates borrowing requirements of the Government during the budget year. Borrowings may create the problem for the Government and the economy. It increases the future liability of the Government in two ways : (i) Government has to repay loans in the coming year. (ii) It has to pay interest on these loans also. (c) Primary eficit is the difference between Fiscal eficit and Interest Payments. Primary eficit = Fiscal eficit Interest Payment. Primary eficit is that part of Fiscal eficit which indicates borrowing requirements to make up Short fall in Receipts on accounts of Expenditure other than the Interest Payments. (a) (b) Allocation of Resources : Many times market fails to allocate the resources idealy and creates certain types of disparity and imbalances ( such as economic disparity, regional disparity and sectoral disparity ) which are not according to the social and economic requirement of the country. Then Government reallocate the resources by budget to decrease these disparity. For example government can invest in backward areas or provide facilities to private sector or provide tax concession or tax holidays to private sector in order to invest in remote areas, rural areas and backward areas which will help in reduction of regional disparity. Government can provide subsidies in agricultural inputs to encourage agriculture sector to reduce sectoral disparity. Reducing Inequalities of Income : Budget is a powerful tool which is used to reduce economic inequalities or disparity of income and wealth. To decrease the income and wealth gaps between rich and poor, Government imposes more taxes on income of rich persons and standard deduction on the income of economically weaker persons by progressive taxation on income (it will decrease the disposable income of rich person ) or increasing the exemption limit of income tax and make expenditure on social security, subsidies to poor, provide food items at cheaper rate for BPL families, public works, etc. which will raise the level of poor people. Allocation of funds on social welfare schemes such as MGNREGA helping much in rural areas to reduce the gap between rich and poor. PAGE - 16