Macroeconomics

Introductory Macroeconomics

Workbook Class XII

4323/3, Ansari Road, Darya Ganj, New Delhi-110002 Ph: 91-11-23250105, 23250106 Fax: 91-11-23250141 [email protected] www.vkpublications.com

Contents Worksheet 1

National Income and Related Aggregates

Worksheet 2

Money and Banking

13

Worksheet 3

Determination of Income and Employment

21

Worksheet 4

Government Budget and The Economy

29

Worksheet 5

Exchange Rate and Balance of Payments

35

Solutions Numericals (with Solutions) CBSE Question Papers–2012 (Solved)

3

WO

1

ET

S RK HE

National Income and Related Aggregates

QUESTION SET–I Define the following concepts: 1. Aggregates of economic system. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Producing sector. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Household sector. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Government sector. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. The external sector. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Stock and flow variables. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. National income. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Circular flow of income. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Money flows and real flows. _________________________________________________________________________________________ _________________________________________________________________________________________

Introductory Macroeconomics

3

Economics–XII

10. Domestic territory of a country. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Normal residents of a country. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Final goods and intermediate goods. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Consumption goods and capital goods. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. Gross investment and net investment. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Depreciation/Consumption of fixed capital. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. Induced investment and autonomous investment. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. Fixed investment and inventory investment. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. Market price and factor cost. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. Domestic income and national income. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. Net of exports and net factor income from abroad. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

4

Economics–XII

21. Value addition. _________________________________________________________________________________________ _________________________________________________________________________________________ 22. Compensation of employees. _________________________________________________________________________________________ _________________________________________________________________________________________ 23. Factor incomes and transfer payments. _________________________________________________________________________________________ _________________________________________________________________________________________ 24. Mixed income of self-employed. _________________________________________________________________________________________ _________________________________________________________________________________________ 25. Leakages and injections. _________________________________________________________________________________________ _________________________________________________________________________________________ 26. Income from domestic product accruing to private sector. _________________________________________________________________________________________ _________________________________________________________________________________________ 27. Private income and personal income. _________________________________________________________________________________________ _________________________________________________________________________________________ 28. Personal disposable income. _________________________________________________________________________________________ _________________________________________________________________________________________ 29. Gross national disposable income and net national disposable income. _________________________________________________________________________________________ _________________________________________________________________________________________ 30. Private factor income. _________________________________________________________________________________________ _________________________________________________________________________________________ 31. Expected obsolescence and unexpected obsolescence. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

5

Economics–XII

32. Change in stock. _________________________________________________________________________________________ _________________________________________________________________________________________ 33. Double counting. _________________________________________________________________________________________ _________________________________________________________________________________________ 34. Non-factor inputs. _________________________________________________________________________________________ _________________________________________________________________________________________ 35. GNP deflator. _________________________________________________________________________________________ _________________________________________________________________________________________ 36. Nominal income and real income. _________________________________________________________________________________________ _________________________________________________________________________________________ 37. Operating surplus. _________________________________________________________________________________________ _________________________________________________________________________________________ 38. Production boundary. _________________________________________________________________________________________ _________________________________________________________________________________________ 39. Gross value added and value of output. _________________________________________________________________________________________ _________________________________________________________________________________________

QUESTION SET–II Defend or refute the following statements. Write ‘yes’ or ‘no’ with reason: 1. National income is a stock concept. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. National income is always greater than domestic income. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

6

Economics–XII

3. Increase in national income always implies increase in domestic income. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. National income at market price is always greater than national income at factor cost. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Remittances from abroad by the NRIs are a part of our national income. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. X–M is equal to net factor income from abroad. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Gross investment can occur even when net investment is zero. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Domestic income as well as national income include only factor incomes. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Private income includes both factor as well as non-factor incomes. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. Private factor income includes net factor income from abroad _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Market price includes the impact of indirect taxes, but not of subsidies. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Obsolescence is a part of depreciation. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Population of a country is a flow concept. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

7

Economics–XII

14. Net investment always implies an increase in the stock of capital. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Mixed income of self-employed includes transfer payments. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. Domestic income is estimated only in the context of a closed economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. Salaries to Indian employees working in Indian embassies abroad are a part of net factor income from abroad. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. Profits earned by non-resident companies in India are not a part of our domestic income. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. Income in the form of old-age-pensions are a part of national income. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. Income received from the sale of shares is a part of domestic income. _________________________________________________________________________________________ _________________________________________________________________________________________

QUESTION SET–III Write your comment on each of the following statements in a sentence or two: 1. Increase in national income implies increase in the flow of goods and services in the economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Compensation of employees includes compensation received after retirement. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Net factor income from abroad is zero in case exports = imports. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

8

Economics–XII

4. Final goods must finally be consumed by the households. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Capital formation includes capital goods only. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. A kind of goods used as intermediary goods can never be final goods. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Autonomous investment never changes. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Inventory investment refers to change in stock and is therefore a stock variable. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. The market value of both final and intermediate goods is included in the estimation of national income. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. Imputed rent on owner occupied houses does not involve any payment to others. Accordingly, it should not be included in the estimation of national income. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Brokerage paid to Real Estate Agents only on the sale and purchase of new houses should be included in the estimation of national income. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Investment on the purchase of shares is a part of net capital formation. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Income in the form of capital gains is a part of capital formation. _________________________________________________________________________________________ _________________________________________________________________________________________

Introductory Macroeconomics

9

Economics–XII

14. Expenditure on the purchase of second-hand plant and machinery from rest of the world is a part of domestic capital formation. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Gross investment includes the value of expected obsolescence. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. Double counting is avoided if GDP is estimated by summing up value of output of all producing units in the country. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. Only final goods and services are to be considered in the estimation of GDP, to avoid double counting. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. Expenditure by the households on the construction of residential buildings should not be treated as investment expenditure. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. Change in stock is not a component of aggregate expenditure in the economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. Net exports are not a component of aggregate expenditure in the economy. _________________________________________________________________________________________ _________________________________________________________________________________________

QUESTION SET–IV Complete the following sentences: 1. Domestic income = National income – _______________________________________________________ 2. Private factor income = Income from domestic product accruing to the private sector + _________________________________________________________________ 3. Value of output – Change in stock = _________________________________________________________ 4. Sales + Change in stock – Intermediate consumption = _________________________________________ 5. Personal income = Private income ± _________________________________________________________ 6. National income at market price = National income ± __________________________________________ 7. Personal disposable income = Private income ± ________________________________________________ Introductory Macroeconomics

10

Economics–XII

8. National income = Domestic income + Factor income from rest of the world – ______________________ 9. Operating surplus + Compensation of employees + Mixed income of self-employed = ______________ 10. Gross value added = Net value added + ______________________________________________________ 11. Three essential precautions while measuring national income according to expenditure method are (i) _________________________, (ii) _________________________, and (iii) _________________________ . 12. Three components of gross domestic fixed investment are (i) _______________________________, (ii) _________________________, and (iii) ___________________________ . 13. While using value added method of measuring domestic income, two essential precautions are (i) ________________________________________, and (ii) _______________________________________. 14. While using income method of measuring domestic income, two essential precautions are (i) ________________________________________, and (ii) _______________________________________. 15. Net national disposable income = National income ± ___________________________________________ 16. Personal disposable income = Personal income ± ______________________________________________ 17. Three important components of depreciation are (i) ____________________, (ii) ____________________, and (iii) _____________________ . 18. Expected obsolescence occurs on account of (i) ____________________, and (ii) _____________________ . 19. Two components of personal disposable income are (i) _________________, and (ii) _________________ . 20. Sales + Change in Stock – Purchase of intermediate products – Net indirect taxes = _________________ 21. NNPMP = Private consumption expenditure + Government consumption expenditure + ______________________________________________________________________

HOTS (Higher Order Thinking Skills) Write ‘true’ or ‘false’ with a reason: 1. If depreciation reserve fund is not maintained, production capacity in the economy would tend to reduce. _________________________________________________________________________________ _________________________________________________________________________________ 2. Both factor income as well as transfer income are included in the estimation of personal income. _________________________________________________________________________________ _________________________________________________________________________________ 3. GDP is the most appropriate index of social welfare. _________________________________________________________________________________ _________________________________________________________________________________ Introductory Macroeconomics

11

Economics–XII

4. While using expenditure method to estimate GDP, we focus only expenditure by the resident household. _________________________________________________________________________________ _________________________________________________________________________________ 5. Purchase of machinery from abroad is to be considered as a part of intermediate consumption. _________________________________________________________________________________ _________________________________________________________________________________ 6. Interest on national debt is treated like a transfer payment. _________________________________________________________________________________ _________________________________________________________________________________ 7. Net indirect taxes are never equal to subsidies. _________________________________________________________________________________ _________________________________________________________________________________ 8. National income exceeds domestic income only when exports are greater than imports. _________________________________________________________________________________ _________________________________________________________________________________ 9. In the determination of social welfare, what matters is the quantum of output rather than the composition of output. _________________________________________________________________________________ _________________________________________________________________________________ 10. Only those goods are included in the estimation of domestic product which are sold or purchased in domestic market of a country. _________________________________________________________________________________ _________________________________________________________________________________ 11. Goods produced but retained for self-consumption (and not sold in the market) are not included in the estimation of national income. _________________________________________________________________________________ _________________________________________________________________________________

Introductory Macroeconomics

12

Economics–XII

WO

2

ET

S RK HE

Money and Banking

QUESTION SET–I Define the following concepts: 1. Money and value of money. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Barter system of exchange and monetary system of exchange. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Supply of money. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Full bodied money and credit money. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Double coincidence of wants. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. High powered money. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Discounting bills of exchange. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Demand deposits and time deposits. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Bank rate and market rate of interest. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

13

Economics–XII

10. Open market operations. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Lender of the last resort. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Repo rate and reverse repo rate. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Credit creation. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. Cheap money policy and dear money policy. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. CRR and SLR. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. Margin requirement. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. Moral suasion. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. Quantitative credit control and qualitative credit control. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. Face value of money and intrinsic value of money. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. Standard of deferred payments. _________________________________________________________________________________________ _________________________________________________________________________________________

Introductory Macroeconomics

14

Economics–XII

QUESTION SET–II Defend or refute the following statements. Write ‘yes’ or ‘no’ with reason: 1. Face value of money is always greater than its intrinsic value. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Double coincidence of wants is a typical feature of monetary system of exchange. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Credit money is the money received as a credit from the banks. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Money has separated the acts of sale and purchase. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. There is no medium of exchange in the barter system. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Money is a measure of value as well as a store of value. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Money facilitates transfer of value. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. High powered money refers to cash reserves of the commercial banks with the central bank. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. All financial institutions are not banking institutions. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. Commercial banks offer loans only for purpose of investment. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

15

Economics–XII

11. Commercial banks do not have the note-issuing authority, but they do contribute to money supply in the economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. The central bank is the banker’s bank. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. The central bank is a lender of last resort. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. CRR and SLR are fixed by the commercial banks themselves. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Open market operations are meant to impact money supply in the economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. Demand deposits are equal to cash deposits with the commercial banks. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. When CRR is raised, flow of credit is enhanced in the economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. CRR and SLR work opposite to each other. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. Money may be used as a commodity. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. Money acts as a store of value only when it is in the form of gold and silver coins. _________________________________________________________________________________________ _________________________________________________________________________________________

Introductory Macroeconomics

16

Economics–XII

QUESTION SET–III Write your comment on each of the following statements in a sentence or two: 1. Demand deposits with commercial banks are a part of money supply. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Money supply in the economy is equal to notes and coins issued by the central bank. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Commercial banks play no role in the stock of money supply in the economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Monetary system of exchange facilitates much greater exchange than the barter system. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Loans offered by the commercial banks are only a part of the cash reserves of the commercial banks. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. If the commercial banks buy government securities, their capacity to create credit is reduced. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. When margins are raised, demand for loans is negatively impacted. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Market rate of interest tends to be positively related to the bank rate. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Money becomes a commodity when intrinsic value of money exceeds its face value. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. Higher bank rate implies higher credit creation capacity of the banks. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

17

Economics–XII

11. The commercial banks design all instruments of monetary policy and the central bank controls them. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. The commercial banks are the controller of credit. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. The central bank is the currency authority. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. By accepting deposits, commercial banks facilitate capital formation. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. There is no common unit of exchange in barter system. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. The central bank is a banker to the government. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. The central bank is the apex bank of the country. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. Overdraft is a loan facility offered by the commercial banks. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. Discounting bills of exchange amounts to offering loans by the commercial banks. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. The central bank issues currency on the basis of CRR. _________________________________________________________________________________________ _________________________________________________________________________________________

Introductory Macroeconomics

18

Economics–XII

QUESTION SET–IV Complete the following sentences: 1. Two principal determinants of credit creation by the commercial banks are (i) ____________________, and (ii) _____________________ . 2. By selling the securities in the open market, the central bank intends to __________________________ . 3. To combat inflation, requirement of margin is _________________________________________________ . 4. According to M1 measure of money stock, supply of money = ____________________________________ 5. According to M2 measure of money stock, supply of money = ____________________________________ 6. According to M3 measure of money stock, supply of money =____________________________________ 7. According to M4 measure of money stock, supply of money = ____________________________________ 8. Primary functions of commercial banks are (i) ____________________, and (ii) _____________________ . 9. Secondary functions of commercial banks are (i) ____________________, and (ii) ___________________ . 10. Two important types of deposit accounts are (i) ____________________, and (ii) _____________________ . 11. Four different ways of giving loans and advances by the commercial banks are (i) ___________________, (ii) ____________________, (iii) ____________________, and (iv) _____________________ . 12. Demand loans refer to _____________________________________________________________________ . 13. Four important functions of the central bank are (i) ___________________, (ii) ____________________, (iii) ____________________, and (iv) _____________________ . 14. As a lender of last resort, the central bank _____________________________________________________ . 15. Five instruments of monetary policy are (i) ______________________, (ii) _______________________, (iii) ____________________, (iv) ____________________, and (v) _____________________ . 16. When bank rate is raised, supply of money in the economy is expected to __________________________ . 17. When the central bank sells government securities in the open market, the supply of money is expected to ______________________________________________________________________________________ . 18. Increase in CRR and SLR are expected to cause _______________________________________________ . 19. With a view to combating speculative investment, margin requirement is __________________________ . 20. Credit creation refers to ___________________________________________________________________ . 21. Credit multiplier refers to __________________________________________________________________ . Introductory Macroeconomics

19

Economics–XII

HOTS (Higher Order Thinking Skills) 1. Write ‘true’ or ‘false’ with a reason: (i) If CRR is lowered, investment demand must rise. ____________________________________________________________________________ ____________________________________________________________________________ (ii) Bank rate is an instrument of selective credit control. ____________________________________________________________________________ ____________________________________________________________________________ (iii) A check on high powered money implies a check on the flow of credit in the economy. ____________________________________________________________________________ ____________________________________________________________________________ (iv) Term deposits are near money, and therefore should be treated as a component of money supply. ____________________________________________________________________________ ____________________________________________________________________________ (v) Commercial banks create credit only on advice of the government. ____________________________________________________________________________ ____________________________________________________________________________ 2. Write a note explaining the process of credit creation by the commercial banks. _________________________________________________________________________________________ _________________________________________________________________________________________ _________________________________________________________________________________________ _________________________________________________________________________________________ _________________________________________________________________________________________ _________________________________________________________________________________________

Introductory Macroeconomics

20

Economics–XII

WO

3

ET

S RK HE

Determination of Income and Employment

QUESTION SET–I Define the following concepts: 1. Aggregate demand. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Aggregate supply. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Aggregate effective demand. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Consumption function. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Saving function. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Average and marginal propensity to consume. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Average and marginal propensity to save. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Ex-ante and ex-post equality between S and I. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Marginal efficiency of capital. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

21

Economics–XII

10. Output multiplier/investment multiplier. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Equilibrium level of income and output. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Excess demand and inflationary gap. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Deficient demand and deflationary gap. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. Autonomous consumption. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Full employment and underemployment equilibrium. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. Voluntary and involuntary unemployment. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. Monetary policy and fiscal policy. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. Psychological law of consumption. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. Investment demand function. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. Equilibrium beyond full employment. _________________________________________________________________________________________ _________________________________________________________________________________________

Introductory Macroeconomics

22

Economics–XII

QUESTION SET–II Defend or refute the following statements. Write ‘yes’ or ‘no’ with reason: 1. Consumption never exceeds income. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Saving can never be negative. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Average propensity to consume can never be greater than one. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. APC and MPC are never equal. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. APC + APS =1. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. MPC + MPS >1. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Ex-post investment > Ex-ante investment. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Equilibrium beyond full employment does not cause increase in output beyond full employment. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Underemployment equilibrium causes excess capacity in the economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. In the context of equilibrium GDP, desired AS = desired AD. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

23

Economics–XII

11. In the Keynesian model of equilibrium GDP, AS is assumed to be perfectly elastic. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Increase in output beyond underemployment equilibrium does not cause inflationary gap. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. S may or may not be equal to I when AS = AD. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. In a situation when planned S > planned I, inventory investment of the producers is expected to be larger than desired. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. The rate at which C increases always tends to be lower than the rate at which Y increases. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. The rate at which S increases always tends to be greater than the rate at which Y increases. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. In the context of equilibrium GDP, Keynes considers only autonomous investment. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. In a situation of inflationary gap, general price level tends to rise. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. There is a direct relationship between MPC and value of investment multiplier. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. Higher saving induces greater investment. _________________________________________________________________________________________ _________________________________________________________________________________________

Introductory Macroeconomics

24

Economics–XII

QUESTION SET–III Write your comment on each of the following statements in a sentence or two: 1. In a situation of deflationary gap, low level of AD causes low level of AS. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. In a situation of inflationary gap, low level of AS causes low level of AD. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Point of equilibrium GDP must always be on the 45° line drawn from the origin. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Inflationary gap can be corrected by lowering the level of autonomous investment. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Deflationary gap can be corrected by increasing the level of AD. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Bank rate should be lowered in a situation of inflationary gap. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. CRR should be raised to combat deflationary gap. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. SLR needs to be raised to combat deflationary gap. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. It is not possible to combat inflationary gap without causing unemployment in the economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. When deflationary gap is combated, the level of employment tends to rise in the economy. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

25

Economics–XII

11. Investment multiplier runs its full course only on the assumption that there is excess capacity in the economy. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. If MPC = 0, output multiplier is also equal to zero. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Output always increases when AD increases. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. A tax on the households reduces their MPC. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. The sum total of APC and APS is always equal to one, even when APC > 1. _________________________________________________________________________________________ _________________________________________________________________________________________ 16. By raising the level of investment in the economy, the government intends to raise the value of output multiplier. _________________________________________________________________________________________ _________________________________________________________________________________________ 17. Equilibrium GDP refers to a situation when: Actual stocks = Desired stocks. _________________________________________________________________________________________ _________________________________________________________________________________________ 18. Equilibrium GDP refers to a situation when: injections = withdrawals. _________________________________________________________________________________________ _________________________________________________________________________________________ 19. Once equilibrium GDP is achieved, the level of output is the same; no matter it is underemployment equilibrium or full employment equilibrium. _________________________________________________________________________________________ _________________________________________________________________________________________ 20. Equilibrium beyond full employment is a better situation (in terms of the level of GDP) than equilibrium at full employment. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

26

Economics–XII

QUESTION SET–IV Complete the following sentences: 1. In the equation C = a + aY, a shows _________________________________________________________ . 2. In the equation S = – a + bY, – a shows _______________________________________________________ . 3. If C = a + aY and S = – a + bY, then a + b = __________________________________________________ . 4. Autonomous I function is diagrammatically shown as __________________________________________ . 5.

DY DI

= ________________________________

6.

1 1 – MPC

= ________________________________

7. MPS .DY

= ________________________________

8. MPC .DY = ________________________________ 9. MPC + MPS = ________________________________ 10. APC + APS = ________________________________ 11. Output multiplier may be estimated as the reciprocal of ________________________________________ . 12. A situation of inflationary gap arises when ___________________________________________________ . 13. A situation of equilibrium beyond full employment arises when _________________________________ . 14. S and I are always equal when ______________________________________________________________ . 15. In a situation when saving exceeds planned investment ________________________________________ . 16. In a situation when planned investment exceeds planned saving ________________________________ . 17. Three monetary measures to combat inflationary gap are (i)__________________________________, (ii) ________________________________, and (iii) ___________________________________ . 18. Three fiscal measures to correct deficient demand are (i) _________________, (ii) __________________, and (iii) ____________________, 19. In a situation of excess demand, general price level ____________________________________________ . 20. In a situation of deficient demand, output level _______________________________________________ .

Introductory Macroeconomics

27

Economics–XII

HOTS (Higher Order Thinking Skills) Write ‘true’ or ‘false’ with a reason: 1. If I < S, AS tends to contract. _________________________________________________________________________________ _________________________________________________________________________________ 2. If I > S, level of Y must rise. _________________________________________________________________________________ _________________________________________________________________________________ 3. Higher the level of Y, higher should be the level of autonomous consumption in C-function. _________________________________________________________________________________ _________________________________________________________________________________ 4. Increase in MPC implies increase in the slope of C-function. _________________________________________________________________________________ _________________________________________________________________________________ 5. Perfectly elastic AS means AS adjusts itself to all levels of AD. _________________________________________________________________________________ _________________________________________________________________________________ 6. If APC is constant, C and Y should also be constant. _________________________________________________________________________________ _________________________________________________________________________________ 7. Constant increase in I always causes a constant increase in Y. _________________________________________________________________________________ _________________________________________________________________________________ 8. S is always a virtue, as it is a source of investment. _________________________________________________________________________________ _________________________________________________________________________________ 9. Full employment implies that nobody is ever unemployed in the economy. _________________________________________________________________________________ _________________________________________________________________________________ 10. A situation of underemployment is better than that of over-employment because prices tend to a fall. _________________________________________________________________________________ _________________________________________________________________________________ Introductory Macroeconomics

28

Economics–XII

WO

4

ET

S RK HE

Government Budget and The Economy

QUESTION SET–I Define the following concepts: 1. Government budget. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Revenue receipts. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Capital receipts. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Revenue expenditure. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Capital expenditure. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Revenue budget and capital budget. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Tax and non-tax receipts. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Fiscal deficit. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Revenue deficit. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

29

Economics–XII

10. Primary deficit. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Direct and indirect tax. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Progressive and regressive tax. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Plan and non-plan expenditure. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. Development and non-development expenditure. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Deficit financing. _________________________________________________________________________________________ _________________________________________________________________________________________

QUESTION SET–II Defend or refute the following statements. Write ‘yes’ or ‘no’ with reason: 1. Balanced budget is that budget in which revenue receipts = revenue expenditure. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Government budget is a statement of all actual receipts and payments of the government. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Expenditure on law and order is a component of development expenditure. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Non-plan expenditure contributes to economic growth. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

30

Economics–XII

5. Fiscal deficit is zero in case there is no provision for borrowing in the government budget. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Revenue deficit is the excess of capital receipts over and above revenue receipts of the government. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Primary deficit does not include interest payments, while fiscal deficit does. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Revenue receipts do not impact asset and liability status of the government. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Revenue expenditure reduces assets of the government. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. Capital receipts add to liabilities of the government. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Capital expenditure reduces capital stock of the government. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Borrowing by the government is a component of revenue budget. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Disinvestment is a component of capital budget. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. Disinvestment increases liability of the government. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Recovery of loan by the government is a component of revenue budget. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

31

Economics–XII

QUESTION SET–III Write your comment on each of the following statements in a sentence or two: 1. Borrowing by the government is a measure of revenue deficit. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Tax is a capital receipt of the government. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Repayment of loan by the government is a capital expenditure. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Sales tax is a direct tax. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. A regressive tax causes a greater real burden on the rich. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Income tax in India is regressive in nature. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Loans offered by the central government to the state government are to be treated as capital expenditure of the central government. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Payment of interest is a capital expenditure. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Subsidies are not treated as capital expenditure of the government. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. Grants by the government are treated as revenue expenditure. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

32

Economics–XII

11. Construction of fly-over is a revenue expenditure of the government. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Primary deficit is equal to revenue deficit reduced by interest payments. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Other things remaining constant, fiscal deficit increases when the government revises salary structure of its employees, but the primary deficit remains the same. _________________________________________________________________________________________ _________________________________________________________________________________________ 14. Fiscal deficit is only a part of primary deficit. _________________________________________________________________________________________ _________________________________________________________________________________________ 15. Higher revenue deficit always means higher fiscal deficit. _________________________________________________________________________________________ _________________________________________________________________________________________

QUESTION SET–IV Complete the following sentences: 1. Subsidies are revenue expenditure, because __________________________________________________ . 2. Borrowing is not revenue expenditure because _______________________________________________ . 3. Other things remaining constant, if tax rates are increased, fiscal deficit is _________________________ . 4. Two examples of direct tax are (i) __________________________, and (ii) __________________________ . 5. Two examples of non-tax receipts are (i) _______________________, and (ii) _______________________ . 6. Three components of capital receipts are (i) _______________________, (ii) ________________________ and (iii) _______________________ . 7. Two principal components of revenue receipts are (i) _________________, and (ii) __________________ . 8. Two examples of non-development expenditure are (i) ________________, and (ii) _________________ . 9. Dividends on investment is not a capital receipt because _______________________________________ . 10. Mounting fiscal deficit is bad because ________________________________________________________ . Introductory Macroeconomics

33

Economics–XII

11. Two ways of tackling budgetary deficit are (i) ____________________, and (ii) _____________________. 12. Four principal objectives of the government budget are (i) _________________, (ii) __________________, (iii) ____________________, and (iv) ____________________.

HOTS (Higher Order Thinking Skills) 1. Write ‘true’ or ‘false’ with a reason: (i) If revenue budget balances, capital budget also balances. ____________________________________________________________________________ ____________________________________________________________________________ (ii) Government budget is a statement of government receipts and expenditure over the past one year. ____________________________________________________________________________ ____________________________________________________________________________ (iii) Budgetary deficit points to failure of the government to manage its budget. ____________________________________________________________________________ ____________________________________________________________________________ (iv) Revenue deficit increases when the government fails to recover its loans. ____________________________________________________________________________ ____________________________________________________________________________ (v) Balanced budget is always the best budget. ____________________________________________________________________________ ____________________________________________________________________________ 2. Write a note on the importance of government budget. _________________________________________________________________________________________ _________________________________________________________________________________________ _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Briefly describe how the government budget stimulates the process of growth. _________________________________________________________________________________________ _________________________________________________________________________________________ _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

34

Economics–XII

WO

5

ET

S RK HE

Exchange Rate and Balance of Payments

QUESTION SET–I Define the following concepts: 1. Exchange rate and equilibrium exchange rate. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Fixed and variable exchange rate. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Spot market and forward market of foreign exchange. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Visible and invisible items of balance of payment. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Balance of trade and balance of payments. _________________________________________________________________________________________ _________________________________________________________________________________________ 6. Current account balance of payments and capital account balance of payments. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Autonomous and accommodating items of balance of payments. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Surplus and deficit balance of payments. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Appreciation and depreciation of currency. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

35

Economics–XII

10. Parity value. _________________________________________________________________________________________ _________________________________________________________________________________________ 11. Balance of trade and balance of payments on current account. _________________________________________________________________________________________ _________________________________________________________________________________________ 12. Disequilibrium in balance of payments. _________________________________________________________________________________________ _________________________________________________________________________________________ 13. Managed floating. _________________________________________________________________________________________ _________________________________________________________________________________________

QUESTION SET–II Defend or refute the following statements. Write ‘yes’ or ‘no’ with reason: 1. Balance of payments always balances. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Fixed exchange rate is determined by the forces of supply and demand in the international money market. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Current account balance of payments includes export and import of goods only. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Autonomous items of trade are undertaken by the government with a view to restore equilibrium in balance of payments. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Speculative purchases by the domestic investors in the international money market cause loss of foreign exchange. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

36

Economics–XII

6. The rising demand for foreign goods implies higher demand for foreign exchange. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. Flexible exchange rate is determined by the WTO. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. Forward market in foreign exchange is that market which deals with sale and purchase of foreign exchange for current transactions. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Parity value refers to equal value of two currencies in the international money market. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. Borrowing and lending in the international money market is a part of current account balance of payments. _________________________________________________________________________________________ _________________________________________________________________________________________

QUESTION SET–III Write your comment on each of the following statements in a sentence or two: 1. If balance of trade is in deficit, the balance of payments is also in deficit. _________________________________________________________________________________________ _________________________________________________________________________________________ 2. Appreciation of the Indian currency occurs when more rupees are to be paid for a US $. _________________________________________________________________________________________ _________________________________________________________________________________________ 3. Current account deficit in balance of payments occurs when export of goods < import of goods. _________________________________________________________________________________________ _________________________________________________________________________________________ 4. Foreign direct investment is a component of current account balance of payments. _________________________________________________________________________________________ _________________________________________________________________________________________ 5. Balance of payments is balanced through unilateral transfers. _________________________________________________________________________________________ _________________________________________________________________________________________ Introductory Macroeconomics

37

Economics–XII

6. ‘Above the line items’ in balance of payments refer to autonomous as well as accommodating items. _________________________________________________________________________________________ _________________________________________________________________________________________ 7. ‘Below the line items’ in balance of payments are undertaken with a view to maximising profits. _________________________________________________________________________________________ _________________________________________________________________________________________ 8. ‘Transfers to rest of the world’ is a debit component of balance of payments on current account. _________________________________________________________________________________________ _________________________________________________________________________________________ 9. Compensation of employees from rest of the world is a credit component of balance of payments on capital account. _________________________________________________________________________________________ _________________________________________________________________________________________ 10. Foreign private loans are not considered in the construction of balance of payments accounts. _________________________________________________________________________________________ _________________________________________________________________________________________

QUESTION SET–IV Complete the following sentences: 1. In the BoP, repayment of loans by the government is reflected as _________________________________ . 2. In case receipts from rest of the world are less than payments to rest of the world, the country's BoP shows ___________________________________________________________________________________ . 3. In the BoP, commercial borrowings are reflected as ____________________________________________ . 4. Net of exports is a part of ___________________________________________________________________ . 5. Five components of current account BoP are (i) ______________________, (ii) _____________________, (iii) ____________________, (iv) ____________________, and (v) _____________________ . 6. Six components of capital account BoP are (i) ______________________, (ii) _______________________, (iii) ________________, (iv) ________________, (v) __________________, and (vi) ___________________ . 7. Two examples of invisible items of trade are (i) ___________________, and (ii) ______________________ . 8. Four principal merits of fixed exchange rate are (i) ___________________, (ii) ____________________, (iii) ____________________, and (iv) _____________________ . Introductory Macroeconomics

38

Economics–XII

9. Four principal merits of flexible exchange rate are (i) ___________________, (ii) ____________________, (iii) ____________________, and (iv) _____________________ . 10. The principal difference between spot market and forward market is that _________________________ . 11. Demand for foreign exchange arises on account of (i) ___________________, (ii) ____________________, (iii) ____________________, and (iv) _____________________ . 12. Sources of supply of foreign exchange are (i) ______________________, (ii) _______________________, (iii) ____________________, and (iv) _____________________ . 13. Three important functions of foreign exchange market are (i) _____________________________, (ii) ___________________________, and (iii) ___________________________. 14. Transfer function of foreign exchange market refers to _________________________________________ . 15. Credit function of foreign exchange market refers to ___________________________________________ . 16. Hedging function of foreign exchange market refers to _________________________________________ . 17. Disequilibrium in BoP occurs when __________________________________________________________ . 18. Economic causes of disequilibrium in BoP include (i) ___________________, (ii) ____________________, (iii) ________________, (iv) ________________, and (v) ___________________ . 19. Political cause of disequilibrium in BoP refers to _______________________________________________ . 20. Social cause of disequilibrium in BoP refers to ________________________________________________ .

HOTS (Higher Order Thinking Skills) 1. Write ‘true’ or ‘false’ with a reason: (i) Surplus in capital account BoP reflects prosperity of the nation. ____________________________________________________________________________ ____________________________________________________________________________ (ii) Greater flow of foreign exchange from rest of the world indicates higher degree of our development. ____________________________________________________________________________ ____________________________________________________________________________ (iii) Unfavourable BoP reflects high demand for foreign exchange. ____________________________________________________________________________ ____________________________________________________________________________ Introductory Macroeconomics

39

Economics–XII

(iv) Venture capital in the international money market is possible only with flexible exchange rate, not with fixed exchange rate system. ____________________________________________________________________________ ____________________________________________________________________________ (v) Fixed exchange rate system requires huge international reserves. While flexible exchange rate does not. ____________________________________________________________________________ ____________________________________________________________________________ 2. How would you interpret a situation of unfavourable balance of trade for a country like India? Write brief note. _________________________________________________________________________________________ _________________________________________________________________________________________ _________________________________________________________________________________________ _________________________________________________________________________________________ _________________________________________________________________________________________ _________________________________________________________________________________________

Introductory Macroeconomics

40

Economics–XII

SOLUTIONS Introductory Macroeconomics

Worksheet–1

Unit-1: National Income and Related Aggregates

QUESTION SET-I 1. Aggregates of the economic system refer to macroeconomic variables, or the variables which represent the economy as a whole. Example: aggregate demand and aggregate investment. 2. Producing sector refers to all producing units (or firms) in the economy. 3. Household sector refers to consumers engaged in the consumption of goods and services. 4. Government sector refers to government as a welfare agency (engaged in maintaining law and order, defence, and other services of public welfare). It also refers to government as a producer. 5. The external sector also called rest of the world sector, is engaged in the export and import of goods and the flow of capital between the domestic economy and rest of the world. 6. A stock is a quantity, measured at a particular point of time. Example: wealth and capital. A flow is a quantity, measured per unit of time period. Example: income and investment. 7. National income is the sum total of factor incomes earned by normal residents of a country during the period of one year. 8. Circular flow of income refers to the unending flow of the activities of production, income generation and expenditure involving different sectors of the economy. 9. Money flows refer to the flow of money across different sectors of the economy. Real flows refer to the flow of goods and services across different sectors of the economy. 10. Domestic territory of a country refers to that area of economic activity which generates domestic income. 11. Normal residents of a country are those people who (i) normally reside in the country concerned, and (ii) whose centre of economic interest lies in the country concerned. 12. Final goods are those goods which are ready for use by their final users. Intermediate goods are those goods which are used for the production of other goods and services in the form of raw material. 13. Consumption goods are those goods which are used for the direct satisfaction of human wants. Example: vegetables used by households. Capital goods are fixed assets of the producers which are repeatedly used in the production of other goods and services. Example: tractors used by farmers. 14. Gross investment is the expenditure incurred on capital goods during an accounting year. It includes replacement investment. Net investment is the increase in capital stock during an accounting year. It does not include replacement investment. 15. Depreciation or consumption of fixed capital is the loss of the value of fixed capital due to normal wear and tear, foreseen obsolescence and normal rate of accidental damage. 16. Induced investment is that investment which is determined by the level of income (and profits) in the economy. Autonomous investment is that investment which is independent of the level of income in the economy. 17. Fixed investment is addition to the stock of fixed assets of the producers during an accounting year. Inventory investment is addition to the stock of inventory with the producers during an accounting year. 18. Market price refers to the price at which goods and services are sold in the market. It includes the impact of indirect taxes and subsidies. Factor cost refers to the revenue price (or the price actually received by the producers). It does not include the impact of indirect taxes and subsidies. It is equal to cost (or rewards) of factors of production. Factor Cost = Market Price – Net Indirect Taxes + Subsidies. Introductory Macroeconomics

43

Economics–XII

19. Domestic income is the sum total of factor incomes generated within the domestic territory of a country. National income is the sum total of factor incomes earned by normal residents of a country during a given year. 20. Net of exports refer to the difference between exports and imports during an accounting year. Net factor income from abroad is the difference between the factor income earned by normal residents of a country from abroad and the factor income earned by non-residents in our country. 21. Value addition refers to the excess of value of output over and above the value of intermediate consumption. 22. Compensation of employees is the payments by employers, of wages and salaries to their employees in cash and in kind and of contributions paid or imputed in respect of their employees to social security schemes. 23. Factor incomes are the incomes received by the owners of factors of production for rendering their factor services to the producers. Transfer payments are one-sided payments (like charity and grants) which do not involve factor services. 24. Mixed income of self-employed refers to the incomes of the self-employed persons using their own labour, land, capital and entrepreneurship to produce goods and services. 25. Leakages are those savings and such expenditures which cause contraction in the process of production in the economy. Injections are those autonomous expenditures which cause an expansion in the process of production in the economy. 26. Income from domestic product accruing to private sector is the excess of NDPFC over and above income from domestic product accruing to the government sector. 27. Private income is the total income from all sources (factor income as well as current transfers) that accrues to the private sector, during the period of one year. Personal income is the income actually received by the individuals and households from all sources in the form of the current transfer payments and factor income. 28. Personal disposable income is the personal income remaining with individuals and households after deduction of all taxes levied against their income and their property as well as payment of miscellaneous fees and fines. 29. Gross national disposable income refers to GDP at market price along with net current transfers from rest of the world and net factor income from rest of the world. Net National Disposable Income = Gross National Disposable Income – Current Replacement Cost. 30. Private factor income is the sum total of income from domestic product accruing to private sector and net factor income from abroad. 31. Expected obsolescence means loss of value of fixed capital due to change in technique of production or change in demand for goods and services, as expected by the producers during an accounting year. Unexpected obsolescence means loss of value of fixed capital due to natural calamities like flood, earthquake, fire, etc. 32. Change in stock refers to difference between closing stock and opening stock of the accounting year. 33. Double counting means counting the value of goods or services more than once during an accounting year. 34. Non-factor or secondary inputs are those non-durable producer goods (and services) which are used by the producers for purpose of value addition. 35. The GNP deflator measures the average level of the prices of all the goods and services that make up GNP. Introductory Macroeconomics

44

Economics–XII

36. Nominal income refers to national income measured at current prices. Real income refers to national income measured at constant prices. 37. Operating surplus refers to income from property and entrepreneurship in the form of rent, interest and profit. 38. Production boundary refers to the final stage of production process. Goods outside the production boundary are treated as final goods, while those within the production boundary are treated as intermediate goods. 39. Gross value added refers to value added by all the producing enterprises with in the domestic territory of a country during an accounting year. Value of output means market value of the goods and services produced during an accounting year.

QUESTION SET-II 1. No, it is a flow concept. Because it is related to a period of time. 2. No, it can be less than domestic income. National income is greater than domestic income only when net factor income from abroad is positive. 3. No. National Income = Domestic Income + Net Factor Income from Abroad. National income can be less than domestic income in case net factor income from abroad is a negative number. 4. No. National income at market price = National income at factor cost + Net indirect taxes. National income at market price can be less than national income at factor cost in case net indirect taxes is a negative number. 5. No. Because remittances from abroad by the NRIs are transfer payments. 6. No. X – M (Exports – Imports) is equal to net exports. It has nothing to do with factor incomes. 7. Yes. Gross Investment = Net Investment + Depreciation. Therefore, gross investment can occur even when net investment is zero. 8. Yes. National income is the sum total of factor incomes earned by normal residents of a country during a given year. Domestic income is the sum total of factor incomes generated within the domestic territory of a country. 9. Yes. Private income is the total income from all sources (factor income as well as current transfers) that accrues to the private sector, during the period of one year. 10. Yes. Private Factor Income = Income from Domestic Product accruing to Private Sector + Net Factor Income from Abroad. 11. No. Market price includes the impact of both indirect taxes and subsidies. Indirect taxes raise the market price while subsidies lower it. 12. Yes. But only expected obsolescence is to be considered as a part of depreciation. 13. No. Population of a country is a stock concept because it is related to a point of time. 14. Yes. Net investment always implies increase in the stock of capital. Because it does not include replacement investment. 15. No. Mixed income of the self-employed includes only factor incomes. Transfer payments are not included. 16. No. Domestic income estimated in the context of a open economy as well. 17. No. Indian embassy in abroad is a part of domestic territory of India. Therefore, salaries to Indian employees working in Indian embassies abroad are a part of domestic factor income. Introductory Macroeconomics

45

Economics–XII

18. No. It is a part of domestic factor income of India because non-resident companies are within the domestic territory of India. 19. No. Income in the form of old-age-pensions are a part of transfer payments. It is not a compensation for work. 20. No. It is not a part of domestic income because financial transactions are not included in the estimation of domestic income.

QUESTION SET-III 1. Yes. Because, national income is defined as the market value of the goods and services produced during the period of one year. 2. Yes. Compensation of employees = Wages and salaries in cash + Payment in kind + Employer’s contribution to social security schemes + Pension on retirement. 3. No. Net factor income from abroad is the difference between the factor income earned by normal residents of a country from abroad and the factor income earned by non-residents in our country. It has nothing to do with exports and imports. 4. No. Final goods can finally be consumed by the households as well as by the producers. 5. No. Change in the stock of consumer goods also forms a part of capital formation. 6. No. The same good may be a final good or an intermediate good. It all depends on the end-use of the goods. Example: Sugar is a final good when used by households. It is an intermediate good when used by candy-makers. 7. No. Autonomous investment can change, though it is independent of the level of income. 8. No. Inventory investment is a flow concept because it is related to a period of time. 9. No. Only the value of final goods is included in the estimation of national income. 10. No. Imputed rent is included in the estimation of national income as a component of rent. 11. No. Brokerage paid to Real Estate Agents on the sale and purchase of new as well as second hand houses should be included in the estimation of national income. 12. No. Net capital formation is the increase in the stock of physical capital. Whereas shares are a part of financial capital only. 13. No. Income in the form of capital gains means income accruing to the individuals on account of increase in prices of land, shares, bonds, etc. They do not add to the stock of physical capital. 14. Yes. Expenditure by all domestic institutional units on the net purchase of old physical assets from rest of the word is a part of domestic capital formation. It adds to the stock of national capital. 15. Yes. Gross investment = Net investment + Depreciation. And, expected obsolescence is a part of depreciation. 16. No. Double counting is avoided if GDP is estimated by summing up value added by all the producing units in the country. 17. Yes. Only final goods and services are to be considered to avoid double counting in the estimation of GDP. Because, final goods and services do not require further value-addition. These are outside the boundary line of production. 18. No. Expenditure on the construction of residential buildings by the households is a part of investment expenditure. Therefore, it should be treated as investment expenditure. 19. No. Change in stock as a part of investment expenditure is a component of aggregate expenditure in the economy. 20. No. Net exports (exports – imports) is a component of aggregate expenditure in the economy. Introductory Macroeconomics

46

Economics–XII

QUESTION SET-IV 1. net factor income from abroad. 2. net factor income from abroad. 3. sales. 4. gross value added or gross domestic product at market price. 5. – corporate savings – corporate profit tax. 6. + net indirect taxes (indirect tax – subsidy) 7. – corporate saving – corporate profit tax – direct personal taxes – miscellaneous fees and fines paid by the households. 8. factor income to rest of the world. 9. NDPFC or domestic income. 10. depreciation 11.

(i) only final expenditure (or expenditure on final goods) is to be taken into account to avoid error of double counting (ii) expenditure on second hand goods is not to be included

(iii) 12. (i) (ii) (iii) 13. (i) (ii) 14. (i) (ii)

expenditure on shares and bonds is not to be included. business fixed investment investment on residential construction government fixed investment. avoid double counting, by considering only the final goods sale of second-hand goods should not be considered. income from transfer payments should not be included income in terms of capital gains should not be included.

15. + net indirect tax + current transfers from rest of the world. 16. – direct personal taxes – miscellaneous fees and fines paid by the households. 17. (i) normal wear and tear (ii) normal rate of accidental damages (iii) expected obsolescence. 18. (i) change in technology (ii) change in demand. 19. (i) household consumption (ii) household saving. 20. GDPFC. 21. + gross domestic capital formation + net exports – depreciation + net factor income from abroad.

HOTS (Higher Order Thinking Skills) 1. True. If depreciation reserve fund is not maintained, production capacity in the economy would tend to reduce. Because depreciation reserve fund facilitates replacement investment (replacement of worn out assets). 2. True. Personal income = Private factor income + Transfers payments to the private sector – Corporate saving – Corporate profit tax.

Introductory Macroeconomics

47

Economics–XII

3. False. Because social welfare depends not only on GDP, but also on the distribution of GDP across different sections of the society. 4. False. In GDP we include expenditure by the resident household as well as expenditure by the government. Example: Exports are a part of GDP, and it involves expenditure by the non-residents on domestic product. 5. False. Purchase of machinery from abroad is not part of intermediate consumption. Instead, it is a part of gross domestic fixed capital formation. 6. True. Because it is assumed that loans by the government (related to public debt) are used for consumption purpose only. 7. False. Net indirect taxes are equal to subsidies in case indirect taxes are zero. 8. False. When factor income from abroad is greater than factor income to abroad, national income exceeds domestic income. Exports/imports have nothing to do with net factor income from abroad. 9. False. Social welfare depends on the composition of output as well. If goods are produced primarily for richer sections of the society (oblivious to the interest of poorer sections of the society) social welfare is bound to be low. 10. No. Exports are also a part of domestic product, and these are the goods sold in rest of the world (or foreign markets). 11. False. Goods produced and used for self-consumption are included in the estimation of national income. Because that goods are like those produced for the market and involve value-addition.

Introductory Macroeconomics

48

Economics–XII

Worksheet–2

Unit-2: Money and Banking

QUESTION SET-I 1. Money is something which is generally acceptable as a means of exchange and/or as a measure and store of value. Value of money refers to the amount of goods/services that a unit of money can buy. 2. Barter system is a system in which goods are exchanged for goods. Monetary system is a system in which money serves as a medium of exchange. 3. Money supply refers to the total quantity or stock of money available in the economy at a point of time. 4. Full-bodied money is a money whose commodity value is equal to the face value. Credit money is a money whose face value is more than commodity value. 5. Double coincidence of wants implies that goods in possession of two different individuals are needed by each other at the same time. 6. High powered money means cash (coins and notes) with the people and cash reserves with the commercial banks. 7. Discounting bills of exchange is a method through which a holder of a bill of exchange can get it discounted by the bank. 8. Demand deposits refers to those deposits which can be withdrawn from the bank by the depositors on demand by issuing a cheque. Time deposits refers to those deposits which are kept with the bank for a fixed period of time. 9. Bank rate is the rate at which the central bank gives credit to the commercial banks. Market rate of interest is the rate at which people borrow from the commercial banks. 10. Open market operations refer to the sale and purchase of securities in the market by the central bank. 11. Lender of last resort means that if a commercial bank fails to get financial accommodation from anywhere it approaches the central bank as a last resort. Central bank advances loan to such a bank against approved securities. 12. Repo rate refers to the interest rate at which the central banks offers short-term credit to the commercial banks. Reverse repo rate refers to the interest rate at which commercial banks can park their funds (short period) with the central bank. 13. Credit creation refers to creation of credit through demand deposits by the commercial banks on the basis of their cash reserves. 14. Cheap money policy refers to the situation when credit is easily available at a low rate of interest. Dear money policy refers to the situation when credit is not easily available and therefore, it become scarce and expensive. 15. CRR (cash reserve ratio) refers to the percentage of demand deposits which the commercial banks are required to keep as cash reserves with the central bank. Every bank is required to maintain a fixed percentage of its assets in the form of cash or other liquid assets, called SLR (statutory liquidity ratio). 16. Margin requirement refers to the difference between the current value of the security offered for loans and the value of loans granted. 17. Moral suasion refers to moral pressure exercised by the central bank on the commercial banks follow its guidelines with regard to overall credit flow as well as credit flow across different sectors of the economy. Introductory Macroeconomics

49

Economics–XII

18. Quantitative credit control refers to controlling the flow of credit across all sectors in economy. Qualitative credit control refers to controlling the flow of credit to specific sectors in the economy. 19. Face value of money refers to what is indicated on a note or a coin. Intrinsic value of money refers to market value of the material which the money is made of. 20. Standard of deferred payments refers to the function of money which it performs as a standard for future payments.

QUESTION SET-II 1. No. In case coins are made of gold and silver, intrinsic value of money may over time exceed its face value. 2. No. Double coincidence of wants is a typical feature of barter system of exchange. 3. No. Credit money is money whose face value is more than its commodity value. 4. Yes. With the introduction of money, an individual can buy or sell a thing without selling or buying anything in return. 5. No. Under barter system, goods themselves are the medium of exchange for goods. Of course, there is no common medium of exchange like money. 6. Yes. Money serves as a measure of value in terms of unit of account and store of value in terms of store of wealth. 7. Yes. Money serves as a convenient mode of transfer of value because of its general acceptability and the merit of liquidity. 8. No. High powered money refers to currency with public and cash reserves with the commercial banks. 9. Yes. All financial institutions are not banking institutions but all banking institutions are financial institutions. Example: LIC is a financial institution, but not a banking institution. 10. No. Commercial banks advance loans both for investment as well as consumption purposes. 11. Yes. The central bank is the sole authority of issuing notes in the country. However, by advancing loans through credit creation, commercial banks contribute to money supply in the economy. 12. Yes. The central bank is an apex bank of all banks in the country. 13. Yes. A central bank advances loan to a bank who fails to get financial accommodation from anywhere against approved securities. 14. No. CRR and SLR are fixed by the central bank of the country. 15. Yes. In order to increase or decrease money supply in the economy, central bank purchases or sells securities in the open market. 16. No. Demand deposits are many times more than the cash deposits with the commercial banks. The differential between the two explains how commercial banks create credit in the economy. 17. No. When CRR is raised, flow of credit is reduced in the economy. 18. No. CRR and SLR are complementary to each other. 19. Yes. It happens when intrinsic value of money exceeds its face value. 20. No. Money acts as a store of value even when it is not in the form of gold or silver coins. Example: Deposits with the bank are a store of value.

Introductory Macroeconomics

50

Economics–XII

QUESTIONS SET-III 1. Yes. Demand deposits with the commercial banks are a part of M1 measure of money supply. M1 = Currency + Demand Deposits + Other Deposits. 2. No. Money supply in the economy includes notes and coins with the people as well as demand deposits with the banks. 3. No. Commercial banks contribute to the stock of money supply in the economy by way of credit creation. 4. Yes. Because monetary system (unlike Barter system) does not require double coincidence of wants. 5. No. Loans offered by the commercial banks are a part of demand deposits by the commercial banks. 6. Yes. As a result of buying government securities, central bank withdraws cash balances from the economy and the capacity of commercial banks to create credit is reduced. 7. Yes. When margins are raised, the difference between the market value of the security offered for loans and value of loans granted becomes high. It is now expensive for the people to take loans from the banks. Therefore, demand for loans reduces in the economy. 8. Yes. Increase or decrease in bank rate is often followed by increase or decrease in the market rate of interest. 9. Yes. Because when intrinsic value exceeds face value of money ( as it often happened in case of gold and silver coins), money is used as a commodity (implying metal content of money is sold as a commodity). 10. No. Higher bank rate implies lower credit creation capacity of the banks. 11. No. Central bank designs all instruments of monetary policy and also controls them. 12. No. The central bank controls the supply of credit in the economy. 13. Yes. The central bank is the sole issuing authority in the country. It has the exclusive right of note-issuing. 14. Yes. Commercial banks offer facilities of deposits and mobilise savings of the people. This contributes to capital formation. 15. Yes. There is a lack of common unit of exchange in barter system. Evolution of money offered a common unit of exchange. 16. Yes. As a banker to the government, central bank keeps the accounts of all government banks and manages government treasuries. 17. Yes. Central bank is the apex bank that controls the entire banking system of a country. 18. Yes. Overdraft is a facility by which banks advance loans to their clients for short-term. 19. Yes. Discounting bills of exchange is an important method of advancing loans by the commercial banks. 20. No. Central bank does not issue currency on the basis of CRR. The ratio CRR impacts credit creation capacity of the commercial banks.

QUESTION SET-IV 1. (i) Cash reserves, and (ii) CRR. 2. decrease money supply in the economy. 3. increased. 4. Currency with Public + Demand Deposits + Other Deposits with the Reserve Bank. 5. M1 + Deposits with Post Office Saving Bank Account. 6. M1 + Net Time Deposits with the Commercial Banks. 7. M3 + Total Deposits with Post Offices (Other than National Saving Certificate.) Introductory Macroeconomics

51

Economics–XII

8.

(i) accepting deposits (ii) advancing loans.

9.

(i) purchase and sale of securities (ii) locker facilities.

10.

(i) fixed or time deposit account (ii) current or demand deposit account.

11.

(i) cash credit (ii) overdraft (iii) demand loans (iv) short-term loans.

12. those loans which can be called back by the banks on demand. 13.

(i) issuing of notes (ii) controller of credit (iii) banker to the government (iv) banker’s bank.

14. gives loans to those commercial banks who fail to get financial accommodation from other sources. 15.

(i) bank rate (ii) open market operations (iii) cash reserve ratio (iv) statutory liquidity ratio (v) margin requirement.

16. decrease. 17. decrease. 18. decrease in money supply in the economy. 19. increased. 20. creation of credit (or adding to the flow of credit) by the commercial banks by way of demand deposits several times more than their cash reserves. 1 21. . CRR

HOTS 1.

(i) Yes. If CRR is lowered credit creation capacity of the commercial banks is enhanced. Availability of easy credit increases investment demand. (ii) No. Bank rate is an instrument of quantitative credit control. (iii) Yes. Because high powered money includes currency with the public as well as cash reserves with the banks. It serves as the basis of credit-creation by the commercial banks. (iv) Yes. According to broader concept of money supply, M3 = M1 + Net Time Deposits (or term deposits or fixed deposits) with the commercial banks. (v) No. Commercial banks do not create credit only on the advice of government. However, their capacity to create credit depends on credit policy of the central bank of the country.

Introductory Macroeconomics

52

Economics–XII

2. Credit creation is an important function of the commercial banks. By creating credit commercial banks contribute to money supply in the economy. Credit creation capacity of the commercial banks depends on their cash reserves and cash reserve ratio. Commercial banks create credit several times more than their cash reserves. Credit creation occurs in the form of demand deposits. Ratio between demand deposits and cash reserves of the commercial banks is called credit-multiplier. It is also estimated as the reciprocal of CRR (cash reserve ratio). Thus, 1 Credit multiplier = CRR Assuming cash reserve ratio of 10 per cent, if commercial banks received demand deposits of ` 1,000, total credit creation in the economy will be: 1 = × Demand Deposits CRR 1 = ´1,000 = ` 10,000 10% That is after keeping cash reserve ratio of 10 per cent, of ` 1,000, the commercial bank can offer loan up to ` 10,000. Loans are reflected as demand deposits in the accounts of the borrowers. Accordingly, deposits of the banks are 10 times their cash reserves.

Introductory Macroeconomics

53

Economics–XII

Worksheet–3

Unit-3: Determination of Income and Employment

QUESTION SET-I 1. Aggregate demand refers to the sum total of demand for all goods and services during the period of an accounting year. 2. Aggregate supply refers to the flow of goods and services in the economy during an accounting year. 3. Aggregate effective demand refers to that level of aggregate demand where AD = AS. 4. Consumption function refers to the functional relationship between consumption and income. 5. Saving function refers to the functional relationship between saving and income. 6. Average propensity to consume is the ratio of aggregate consumption expenditure to aggregate income. Marginal propensity to consume is the ratio of change in consumption to change in income. 7. Average propensity to save is the ratio of aggregate saving to aggregate income. Marginal propensity to save is the ratio of change in saving to change in income. 8. Ex-ante equality between S and I implies that planned (or desired) saving is exactly equal to planned investment in the economy. Equilibrium is struck what ex-ante S = ex-ante I.

9. 10. 11. 12.

13.

14. 15.

16.

17.

Ex-post equality between S and I refers to equality between actual saving and actual investment in the economy. It is an accounting identity. Marginal efficiency of capital refers to the rate of expected returns from an additional investment in the economy. Output/Investment multiplier is the ratio of a change in output/income to a given change in investment. Equilibrium level of income and output is that level of income and output where AS = AD. Excess demand refers to the situation when aggregate demand is in excess of aggregate supply corresponding to full employment in an economy. Inflationary gap is the excess of aggregate demand over and above its level required to maintain full employment equilibrium in the economy. Deficient demand refers to a situation when aggregate demand (AD) is short of aggregate supply (AS) corresponding to full employment in an economy. Deflationary gap is the deficiency of AD required to maintain full employment equilibrium in the economy. Consumption at zero level of income is known as autonomous consumption. Full employment equilibrium refers to the situation where aggregate demand = aggregate supply and all those who are able to work and willing to work (at the existing wage rate) get work. Underemployment equilibrium refers to the situation where AD = AS even when there is some unemployment in the economy. Voluntary unemployment is a situation in which a worker is not willing to work at the current rate of wages. Involuntary unemployment is a situation in which a worker is willing to work at current rate of wages but does not get work. Monetary policy refers to that policy of the government which combats the situations of excess and deficient demand by regulating interest rate and availability of credit in the economy. Fiscal policy refers to revenue and expenditure policy of the government to combat the situations of excess and deficient demand.

Introductory Macroeconomics

54

Economics–XII

18. Psychological law of consumption states that when income increases consumption also increases but increase in consumption lags behind the increase in income. 19. Investment demand function is the functional relationship between rate of interest and investment demand. 20. Equilibrium beyond full employment occurs when AD = AS, and the level of AD is beyond full employment in the economy. Since full employment is already reached there is no increase in real output to cope with higher level of AD. Only the monetary value of output (or market value of output) matches with AD (beyond full employment).

QUESTION SET-II 1. No. Consumption can be greater than income. There is always some minimum level of consumption even when income is zero. 2. No. Saving can be negative when consumption is greater than income. Negative saving amounts to borrowing. 3. No. Average propensity to consume can be greater than one when consumption is greater than income. 4. No. APC and MPC can be equal. When APC is constant, APC will be equal to MPC. 5. Yes. We know that, Y=C+S Y C S (Dividing both sides by Y) = + Y Y Y C S 1= + Y Y Þ

APC + APS = 1.

6. No. MPC + MPS = 1. 7. Yes. Because, expost investment includes undesired/unwanted change in stock while ex-ante investment does not. 8. Yes. Equilibrium beyond full employment does not cause increase in output beyond full employment because economy is already in the state of full capacity production. Only the market value of output tends to rise. 9. Yes. In the situation of underemployment equilibrium, AD fails to cope with full employment of the factors. Implying the existence of excess capacity in the economy. 10. Yes. Equilibrium GDP is achieved where AS = AD or desired AS = desired AD. 11. Yes. In the Keynesian model of equilibrium GDP, AS is assumed to be perfectly elastic, implying that AS converges with AD at all levels of AD without causing any increase in the price level in the economy. 12. Yes. Increase in output beyond underemployment equilibrium does not cause inflationary gap because excess capacity exists in the economy and AS catches up with AD at the existing price level. 13. No. When AS = AD, S necessarily be equal to I. 14. Yes. When planned S > planned I, some output would remain unsold and producers will have undesired stock of goods. 15. Yes. The rate at which consumption increases is often less than the rate at which income increases. This is in accordance with the Psychological Law of Consumption. 16. No. Because a part of increased income is also spend on consumption. 17. Yes. In the context of equilibrium GDP, Keynes considers only autonomous investment which is independent of the level of income. Introductory Macroeconomics

55

Economics–XII

18. Yes. In the situation of inflationary gap, excess demand implies pressure of demand on the existing resources. Consequently, cost of production rises causing a rise in the general price level. 19. Yes. There is a direct relationship between MPC and value of investment multiplier. Higher the value of MPC, higher the multiplier and vice versa. 20. No. According to Keynes, saving causes a leakage in the circular flow of income. Higher saving implies lower consumption which reduces the inducement to invest.

QUESTION SET-III 1. Yes. Under deflationary gap or deficient demand, underemployment equilibrium occurs at a point where level of AD is less than that of full employment. Since AS is assumed to be perfectly elastic, it adapts itself to the low level of AD. 2. Yes. In the situation of inflationary gap, output remains constant and pressure of demand on the existing output causes rise in prices. Due to this AD ultimately comes down to full employment level of AS. 3. Yes. Equilibrium GDP must be struck on the 45o line because it is only on this line that AD = AS. 4. Yes. Inflationary gap or excess demand can be combated by reducing autonomous investment expenditure because investment is a component of AD. 5. Yes. Deflationary gap can be corrected by increasing the level of AD. Because it is the deficiency of AD that causes deflationary gap. 6. No. Bank rate should be increased in a situation of inflationary gap in order to lower money supply in the economy. Implying that AD should reduce. 7. No. CRR should be lowered to combat deflationary gap. This raises capacity of the commercial banks to create credit in the economy. Thus, AD tends to rise. 8. No. SLR should be lowered. This raises capacity of the commercial banks to create credit in the economy. Thus, AD tends to rise. 9. No. When inflationary gap is combated, the economy is brought back to its full employment level. Hence no question of decrease in employment. 10. Yes. Because deflationary gap causes a fall in the level of employment. When deflationary gap is combated, there is rise in the employment level in the economy. 11. Yes. Multiplier process assumes the existence of excess capacity in the economy. é ù 1 1 êK= 1 – MPC = 1 – 0 =1ú ë û

12. No. When MPC = 0, multiplier (K) = 1.

13. No. In response to increase in AD, output increases only till full employment equilibrium is struck in the economy. 14. No. A tax on the households only reduces their disposable income. 15. Yes. APC + APS = 1, even when APC > 1. Because consumption and saving are the only two components of income. 16. No. By raising the level of investment, the government intends to increase the level of AD in the economy. 17. Yes. Equilibrium GDP is attained when actual stocks = desired stocks. It implies that the producers do not suffer the burden of unwanted stock or the loss of unfulfilled demand. 18. Yes. Equilibrium GDP is achieved when S= I since S refers to withdrawals from the circular flow and I refers to injections into circular flow, it implies that at a point of equilibrium injections = withdrawals. Introductory Macroeconomics

56

Economics–XII

19. No. GDP level is lower corresponding to underemployment equilibrium compared with full employment equilibrium. 20. No. Output remains constant even beyond full employment equilibrium. It is equal to output of full employment equilibrium. Because, full employment equilibrium output is the maximum output.

QUESTION SET-IV 1. minimum level of consumption, even when Y=0. 2. negative saving when Y = 0 and there is some minimum level of consumption in the economy. 3. one. 4. a horizontal straight line parallel to X-axis. 5. investment multiplier. 6. value of investment multiplier. 7. DS (change in saving). 8. DC (change in consumption). 9. one. 10. one. 11. MPS. 12. there is excess of AD over and above its level required to maintain full employment equilibrium in the economy. 13. AD is in excess of its full employment level. 14. AD = AS. 15. actual stocks > desired stocks. 16. actual stocks < desired stocks. 17. (i) rise in bank rate (ii) rise in CRR (iii) rise in SLR. 18.

(i) rise in government expenditure. (ii) cut in taxation (so that disposable income rises) (iii) a cut in public borrowing so that liquidity is not reduced in the economy.

19. tends to rise. 20. tends to be lower than at full employment.

HOTS 1. True. When I < S, producers will have undesired stock. In order to clear their stock, the producers would like to produce less output implying AS tends to contract. 2. True. When I > S, producers would plan to produce higher output to cope with higher demand. However, output/income level will rise only upto the point of full employment. 3. False. Because autonomous consumption is not related to the level of Y. 4. True. Because MPC shows the rate at which consumption increases in response to increase in Y. Or, MPC is the slope of C-function. Introductory Macroeconomics

57

Economics–XII

5. True. Perfectly elastic AS implies that whenever AS is greater than or less than AD, it is AS that adjusts itself to AD to restore the equilibrium. 6. False. Constant APC only implies that the ratio C/Y is constant. 7. False. It depends on the value of MPC. Constant increase in I will cause constant increase in Y only if MPC is constant. 8. False. Saving is a vice as well. Increasing S causes a cut in consumption expenditure. Implying a cut in AD. Accordingly, economy may be driven to a state of underemployment equilibrium. 9. False. Even in a state of full employment, there is some minimum level of the employment, called natural unemployment. 10. False. Because in a situation of underemployment, the economy is caught in a low level equilibrium trap.

Introductory Macroeconomics

58

Economics–XII

Worksheet–4

Unit-4: Government Budget and The Economy

QUESTION SET-I 1. A government budget is a statement showing estimated receipts and expenditure of the government during a fiscal year. 2. Revenue receipts are those receipts which do not either create a liability or cause a reduction in assets. 3. Capital receipts are the receipts which either create a liability or causes a reduction in assets. 4. Revenue expenditure is that expenditure which does not cause increase in assets or decrease in liability. 5. Capital expenditure is an expenditure which causes increase in assets or reduction in liabilities. 6. Revenue budget is the statement of estimated revenue receipts and estimated revenue expenditure during a fiscal year. Capital budget is the statement of estimated capital receipts and estimated capital expenditure during a fiscal year. 7. Tax revenue receipts are receipts from all types of direct and indirect taxes, like income tax, corporation tax, wealth tax, sales tax, excise duty, etc. Non-tax revenue receipts are receipts from interest, dividend, profit, external grants etc. 8. Fiscal deficit is equal to the excess of total expenditure over the sum of revenue receipts and capital receipts excluding borrowing. 9. Revenue deficit is equal to the excess of total revenue expenditure over the total revenue receipts. 10. Primary deficit is equal to fiscal deficit reduced by interest payments. 11. Direct tax is a tax levied on income and wealth and its final burden cannot be shifted on to others. Indirect tax is a tax levied on goods and services and its final burden can be shifted on to others. 12. Progressive tax is a tax that causes relatively less real burden on the poor and more on the rich. Regressive tax is a tax that causes relatively more real burden on the poor and less on the rich. 13. Plan expenditure is the expenditure to be incurred during the year in accordance with the plan for the year. Non-plan expenditure is the expenditure other than the plan expenditure during the year. 14. Development expenditure is the expenditure on activities which are directly related to economic and social development like, education and health. Non-development expenditure is the expenditure on essential general services of the government, like law and order. 15. Deficit financing refers to the financing mechanism of the government to cover the gap between expenditure and receipts.

QUESTION SET-II 1. No. Balanced budget is that budget in which total expenditure = total receipts. 2. No. Government budget is a statement of expected receipts and expenditure of the government during a fiscal year. 3. No. Expenditure on law and order is a component of non-development expenditure because it does not directly add to the flow of goods and services in the economy. 4. No. Non-plan expenditure does not contributes to economic growth because it is not incurred in accordance with planned development programmes of the country. 5. Yes. Because fiscal deficit is equal to total borrowing by the government. Introductory Macroeconomics

59

Economics–XII

6. No. Revenue deficit is the excess of revenue expenditure over revenue receipts. 7. Yes. Primary deficit is the difference between fiscal deficit and interest payment. 8. Yes. Revenue receipts are those receipts who do not cause reduction in assets or increase in liability for the government. 9. No. Revenue expenditure is that expenditure of the government which does not cause increase in assets or a reduction in liabilities. 10. Yes. Capital receipts are those receipts which cause a reduction in assets of the government. 11. No. If incurred on the creation of assets (like construction of government buildings) capital expenditure increases capital stock of the government. 12. No. Borrowing by the government is a component of capital budget. Because, it increases liability of the government. 13. Yes. Disinvestment causes reduction in assets of the government. Therefore, it is a capital receipt of the government. 14. No. Disinvestment raises receipts of the government. 15. No. Recovery of loan by the government is a component of capital budget. Because, it reduces assets of the government.

QUESTION SET-III 1. No. Borrowing by the government is not a measure of revenue deficit. It is a measure of fiscal deficit. 2. No. Tax is a revenue receipt of the government. It does not impact asset/liability status of the government. 3. Yes. Because repayment of loan causes reduction in liabilities of the government. Therefore, it is a capital expenditure. 4. No. Sales tax is an indirect tax because its burden can be shifted on to other persons. 5. No. A regressive tax, by definition, causes a greater real burden on the poor. 6. No. Income tax in India is progressive in nature. Because tax rate increases with increase in income. 7. Yes. Because loans offered by the central government to state government create assets for the central government. 8. No. Payment of interest is a revenue expenditure because it does impact asset/liability status of the government. 9. Yes. Subsidies are treated as revenue expenditure of the government, because subsidies do not impact asset/liability status of the government. 10. Yes. All grants, as a matter of convention are treated as revenue expenditure of the government. 11. No. Construction of fly-over is a capital expenditure of the government because it adds to assets of the government. 12. No. Primary deficit is equal to fiscal deficit reduced by interest payments. 13. Revision of salary structure enhances revenue expenditure of the government. If other things are constant (implying that interest payment by the government is also constant), increase in fiscal deficit should also be reflected as increase in primary deficit (Fiscal deficit – Interest payment = Primary deficit). 14. No. Primary deficit is only a part of fiscal deficit. Fiscal deficit = Primary deficit + Interest payment. 15. No. Because fiscal deficit also depends on capital receipts and expenditures of the government. Introductory Macroeconomics

60

Economics–XII

QUESTION SET-IV 1. these do not impact asset/liability status of the government. 2. it creates liability for the government. 3. reduced. 4.

(i) income tax (ii) wealth tax.

5.

(i) interest (ii) dividend.

6.

(i) recovery of loans (ii) borrowing (iii) receipts through disinvestment

7.

(i) taxes (ii) interest.

8.

(i) expenditure on tax collection (ii) expenditure on defence.

9. it do not create a liability or lead to reduction in assets of the government. 10. it reflects borrowings by the government. It compounds liability for the future generations. 11.

(i) decreasing government expenditure (ii) increasing government receipts.

12.

(i) redistribution of income and wealth (ii) reallocation of resources (iii) economic stability (iv) managing public enterprises.

HOTS (Higher Order Thinking Skills) 1.

(i) False. Because revenue budget shows revenue receipts and revenue expenditure while capital budget shows capital receipts and capital expenditure. (ii) False. Government budget is a statement of estimated receipts and expenditure of the government for the fiscal year which is to begin. (iii) False. Budgetary deficit reflecting borrowing by the government may in fact be a part of designed strategy of the government to accelerate the pace of growth or to achieve macro stability in the economy. (iv) False. Revenue deficit is the excess of revenue expenditure over revenue receipts. While the recovery of loans by the government is a capital receipt. (v) False. Balanced budget is not always the best budget because it is not conducive to growth and development programmes of less developed country.

2. Following points highlight the importance of the government budget: (i) It reflects the fiscal policy, that is, the expenditure and receipts of the government. It is a part of overall economic and social policy of the government. (ii) It shows how much and on what items government is going to spend during the year. (iii) It shows how the government is going to get money (mainly out of taxation) to finance its expenditure. Introductory Macroeconomics

61

Economics–XII

3. Free play of market forces (or the forces of supply and demand) are bound to generate trade cycles, also called business cycles. These refer to the phases of recession, depression, recovery and boom in the economy. The government of a country is always committed to protect the economy from business cycles. Budget is used as an important policy instrument to combat the situations of deflation and inflation. By doing it, the government tries to achieve economic stability. Economic stability stimulates the inducement to invest and increases the rate of growth and development.

Introductory Macroeconomics

62

Economics–XII

Worksheet–5

Unit-5: Exchange Rate and Balance of Payment

QUESTION SET-I 1. Exchange rate is the rate at which one currency can be exchanged for the other currency in the international foreign exchange market. Equilibrium exchange rate occurs where supply of and demand for foreign exchange are equal to each other. 2. Fixed rate of exchange is a rate fixed and determined by the government of a country and the government alone changes it. Flexible rate of exchange is that rate which is determined by the demand for and supply of different currencies in the foreign exchange market. 3. Spot market in foreign exchange is that market which covers sale and purchase of foreign exchange of the daily nature. Forward market in foreign exchange refers to that market which covers sale and purchase of foreign exchange for future delivery. 4. Visible items include all commodities of exports and imports. Invisible items refer to all types of services which are rendered to rest of the world as exports or received from the rest of the world as imports. 5. Balance of trade is defined as the difference between the value of imports and exports of only physical goods or visible items. Balance of payments refers to the statement of accounts recording all economic transactions of a country with rest of the world in one year. 6. Current account balance of payments is that account which records imports and exports of goods and services and unilateral transfers. Capital account balance of payments is that account which records all such transactions which cause a change in the asset or liability status of the residents of a country or of its government. 7. Autonomous items of balance of payments are related to those transactions which are determined by considerations of profit. Accommodating items of balance of payments are not determined by considerations of profit. These items are meant to restore BoP identity. 8. When the payments (debit) of the country are less than its receipts (credit), the BoP is said to be in surplus. When the payments (debit) of the country are more than its receipts (credit), then it is called deficit BoP. 9. When value of a domestic currency increases in relation to value of foreign currency, it is known as appreciation of domestic currency. When value of a domestic currency decreases in relation to value of foreign currency, it is known as depreciation of domestic currency. 10. Parity value refers to the value of one currency in terms of the other for a given basket of goods and services. 11. Balance of trade on current account refers to the balance occurring on account of export and import of visible items. Balance of payments on current account refers to the balance occurring on account of export and import of visible and invisible items as well as unilateral transfers. 12. Disequilibrium in balance of payments refers to a situation of either a surplus or a deficit in the BoP account. 13. Managed floating is a system that allows adjustments in exchange rate according to a set of rules and regulations which are officially declared in the foreign exchange market. Introductory Macroeconomics

63

Economics–XII

QUESTION SET-II 1. Yes. But, it is only in the accounting sense that balance of payments always balances. Thus, loans from rest of the world may be a balancing item, but certainly it is a liability of the government. 2. No. Fixed rate of exchange is not determined by the forces of demand and supply in the international money market. Instead, it is fixed or declared officially by the government of a country. 3. No. Current account balance of payments includes export and import of goods and services, i.e., it includes value of export and import of both visible and invisible items. 4. No. Autonomous items are not meant to restore equilibrium in BoP. These are determined entirely by considerations of profit. 5. No. Speculative purchases by the domestic investors in the international money market only cause demand for foreign exchange. 6. Yes. The rising demand for foreign goods implies greater imports and hence higher demand for foreign exchange. 7. No. Flexible exchange rate is determined by the forces of supply and demand in the international market. 8. No. Forward market in foreign exchange is that market which deals with sale and purchase of foreign exchange for future delivery. 9. No. Parity value refers to the value of one currency in terms of the other for a given basket of goods and services. 10. No. Borrowing and lending in the international money market is a part of capital account balance of payments.

QUESTION SET-III 1. No. Because balance of trade is only a part of balance of payments current account. 2. No. In case of appreciation, the value of domestic currency increases in relation to the value of other currency and hence less rupees are to be paid for a US$. 3. No. Because current account balance depends on: (i) export and import of goods (ii) export and import of services (iii) unilateral transfers from one country to another. 4. No. Foreign direct investment is a component of capital account balance of payments. 5. No. Balance of payments is not balanced through unilateral transfers. These transfers are only a component of current account BoP. 6. No. ‘Above the line items’ in balance of payments refer to autonomous items only. 7. No. ‘Below the line items’ in balance of payments are not undertaken with a view to maximising profits. These are meant to restore balance of payments identity. 8. Yes. Transfers to rest of the world is recorded as negative item and therefore reflected in the debit side of balance of payments on current account. This is because it involves the payment of foreign exchange to rest of the world. 9. No. Compensation of employees from rest of the world is a credit component of balance of payments on current account. 10. No. Foreign private loans are included in the capital account of balance of payments. Introductory Macroeconomics

64

Economics–XII

QUESTION SET-IV 1. debit item of capital account balance of payments. 2. unfavourable balance of payments. 3. credit item of capital account balance of payments. 4. current account balance of payments. 5.

(i) export and import of visible items (ii) export and import of invisible items (iii) transfers (iv) investment income (v) compensation of employees.

6.

(i) private foreign loan flow (ii) movement in banking capital (iii) official capital transaction (iv) reserves, monetary gold and SDRs (v) gold movement (vi) miscellaneous.

7.

(i) export and import of banking services (ii) expenditure by tourists.

8.

(i) it ensures stability in the international money market and promotes mobility of capital (ii) it encourages international trade (iii) it helps formulation of macroeconomic policies and promotes bilateral trade agreements (iv) it avoids speculation in the international money market.

9.

(i) gold reserves not required (ii) international mobility of capital is promoted (iii) venture capital is encouraged (iv) optimum resource allocation is achieved.

10. spot market deals with current sale and purchase of foreign exchange while forward market deals with such transactions which cover sale and purchase of foreign exchange for future delivery. 11.

(i) payments of international loans (ii) gifts and grants to rest of the world (iii) investment in rest of the world. (iv) direct purchases abroad as well as imports from rest of the world.

12.

(i) purchases of domestic goods by the foreigners (ii) direct foreign investment as well as portfolio investment by the foreigners (iii) speculative purchases of foreign exchange (iv) transfer of foreign exchange by the residents of the country settled abroad.

13.

(i) transfer function (ii) credit function (iii) hedging function.

Introductory Macroeconomics

65

Economics–XII

14. transfer of purchasing power in terms of foreign exchange across different countries of the world. 15. provision of credit in terms of foreign exchange for international trade. 16. protection against risk related to variations in foreign exchange rate. 17. payments of foreign exchange are not equal to receipts of foreign exchange. 18.

(i) large scale development expenditure (ii) business cycles (iii) high inflation rate (iv) development of import substitutes (v) change in cost structure of trading partners.

19. political instability in the country. 20. change in tastes and preferences across different parts of the world.

HOTS (Higher Order Thinking Skills) 1.

(i) False. Because surplus in capital account balance of payments may have been achieved through loans which are a financial obligation to rest of the world. (ii) False. Because greater flow of foreign exchange may be occurring on account of borrowings from rest of the world. (iii) True. Unfavourable balance of payments occur when there is high demand for foreign exchange on account of factors like ‘high imports.’ (iv) True. Because, venture capital assumes the existence of uncertainties of exchange rate in the international money market, as caused by supply and demand forces. (v) True. Fixed exchange rate system is always supported with huge international reserves, so that stability of the exchange rate is not challenged in the international money market.

2. Unfavourable balance of payments occurs when receipts are less than payments of foreign exchange on account of factors other than borrowings from rest of the world. Unfavourable balance of payments status of a country like India shows greater financial obligations to rest of the world. It also reflects low forex reserves of the country. This enhances our vulnerability in the international market. Our currency suffers depreciation in the international money market. Implying that the foreigners can buy more goods from the Indian markets for (say) a dollar of US currency. This may increase pressure on domestic supplies and trigger inflation. On the other hand, we need more foreign exchange to cope with our mounting development imports. Ultimately, we may be driven into a debt trap. Thus, we should be cautious in maintaining deficit within manageable limits.

Introductory Macroeconomics

66

Economics–XII

NUMERICALS (With Solutions) National Income and Related Aggregates 1.

Sol.

Ans. 2.

Sol.

Ans. 3.

Sol.

Ans.

Calculate Gross National Disposable Income from the following data: Items (` in crore) (i) Net national product at factor cost 3,000 (ii) Net factor income from abroad (–)50 (iii) Consumption of fixed capital 150 (iv) Net indirect taxes 250 (v) Net current transfers from rest of the world 300 Gross National Disposable Income = Net national product at factor cost + Consumption of fixed capital + Net indirect taxes + Net current transfers from rest of the world = ` 3,000 crore + ` 150 crore + ` 250 crore + ` 300 crore = ` 3,700 crore Gross national disposable income = ` 3,700 crore. Calculate Gross National Disposable Income from the following data: Items (i) National income

(` in crore) 2,000

(ii) Net factor income from abroad (-)50 (iii) Consumption of fixed capital 200 (iv) Net current transfers from rest of the world 150 (v) Net indirect taxes 250 Gross National Disposable Income = National income + Consumption of fixed capital + Net current transfers from rest of the world + Net indirect taxes = ` 2,000 crore + ` 200 crore + ` 150 crore + ` 250 crore = ` 2,600 crore Gross national disposable income = ` 2,600 crore. Find out National Disposable Income from the following data: Items (` in crore) (i) Current transfers from government administrated departments 215 (ii) Saving of non-departmental enterprises 7 (iii) Net national product at factor cost 325 (iv) Net factor income from abroad 12 (v) Net current transfers from rest of the world 12 (vi) Indirect taxes 35 (vii) Subsidies 10 National Disposable Income = Net national product at factor cost + Net current transfers from rest of the world + Net indirect taxes (Indirect tax – Subsidies) = ` 325 crore + ` 12 crore + (` 35 crore – ` 10 crore) = ` 325 crore + ` 12 crore + ` 25 crore = ` 362 crore National disposable income = ` 362 crore.

Introductory Macroeconomics

67

Economics–XII

4.

Sol.

Ans. 5.

Sol.

Ans. 6.

Sol.

Ans.

From the following data calculate National Income: Items (` in crore) (i) Private income 1,200 (ii) National debt interest 40 (iii) Current transfers from the government administrative departments 40 (iv) Other current transfers from rest of the world 12 (v) Income from property and entrepreneurship accruing to government departments 16 (vi) Savings of government departmental enterprises 8 National Income = Private income – National debt interest – Current transfers from the government administrative departments – Other current transfers from rest of the world + Income from property and entrepreneurship accruing to government departments + Savings of government departmental enterprises = ` 1,200 crore – ` 40 crore – ` 40 crore – ` 12 crore + ` 16 crore + ` 8 crore = ` 1,132 crore National income = ` 1,132 crore. Calculate Private Income from the following data: Items (` in crore) (i) National debt interest 30 (ii) Gross national product at market price 400 (iii) Current transfers from government 20 (iv) Net indirect taxes 40 (v) Net current transfers from rest of the world (–)10 (vi) Net domestic product at factor cost accruing to government 50 (vii) Consumption of fixed capital 70 Private Income = Gross national product at market price – Net domestic product at factor cost accruing to government – Net indirect taxes – Consumption of fixed capital + National debt interest + Current transfers from government + Net current transfers from rest of the world = ` 400 crore – ` 50 crore – ` 40 crore – ` 70 crore + ` 30 crore + ` 20 crore + (–) ` 10 crore = ` 400 crore – ` 50 crore – ` 40 crore – ` 70 crore + ` 30 crore + ` 20 crore – ` 10 crore = ` 280 crore Private income = ` 280 crore. Calculate Personal Income from the following data: Items (` in crore) (i) Undistributed profits of corporations 20 (ii) Net domestic product accruing to private sector 500 (iii) Corporation tax 55 (iv) Net factor income from abroad (–)10 (v) Net current transfers from government 15 (vi) National debt interest 40 (vii) Net current transfers from rest of the world 15 Personal Income = Net domestic product accruing to private sector + Net factor income from abroad + Net current transfers from abroad + Net current transfers from rest of the world + National debt interest – Corporation tax – Undistributed profits of corporations = ` 500 crore + (–) ` 10 crore + ` 15 crore + ` 15 crore + ` 40 crore – ` 55 crore – ` 20 crore = ` 485 crore Personal income = ` 485 crore.

Introductory Macroeconomics

68

Economics–XII

7.

Sol.

Ans. 8.

Sol.

Ans. 9.

Find out Personal Income from the following data: Items (` in crore) (i) Income from domestic product accruing to private sector 224 (ii) Net current transfers from rest of the world 3 (iii) Net current transfers from the government 9 (iv) Interest on national debt 8 (v) Undistributed profits 1 (vi) Corporation tax 3 (vii) Direct tax 2 Personal Income = Income from domestic product accruing to private sector + Net current transfers from rest of the world + Net current transfers from the government + Interest on national debt - Undistributed profits - Corporation tax = ` 224 crore + ` 3 crore + ` 9 crore + ` 8 crore - ` 1 crore - ` 3 crore = ` 240 crore Personal income = ` 240 crore. From the following data estimate (a) Net Indirect Taxes, and (b) Net Domestic Product at Factor Cost: Items (` in crore) (i) Net national product at market price 1,400 (ii) Net factor income from abroad (–)20 (iii) Gross national product at factor cost 1,300 (iv) Consumption of fixed capital 100 (v) National debt interest 18 (a) Net Indirect Taxes = Net national product at market price – Net national product at factor cost (Gross national product at factor cost – Consumption of fixed capital) = ` 1,400 crore – (` 1,300 crore – ` 100 crore) = ` 1,400 crore – ` 1,300 crore + ` 100 crore = ` 200 crore (b) Net Domestic Product at Factor Cost = Gross national product at factor cost – Consumption of fixed capital – Net factor income from abroad = ` 1,300 crore – ` 100 crore – (–) ` 20 crore = ` 1,300 crore – ` 100 crore + ` 20 crore = ` 1,220 crore (a) Net indirect taxes = ` 200 crore. (b) Net domestic product at factor cost = ` 1,220 crore. From the following data estimate (a) National Income, (b) Personal Income, and (c) Private Income: Items (` in crore) (i) Net national product at market price 1,015 (ii) Income from property and entrepreneurship accruing to government administrative departments (iii) Indirect taxes

25 150

(iv) Subsidies

20

(v) Saving of non-departmental enterprises

5

(vi) National debt interest

10

(vii) Current transfers from government

25

(viii) Current transfers from rest of the world

10

Introductory Macroeconomics

69

Economics–XII

Sol.

(ix) Saving of private corporate sector (x) Corporate profit tax (a) National Income = Net national product at market price – Indirect taxes + Subsidies

15 10

= ` 1,015 crore – ` 150 crore + ` 20 crore = ` 885 crore (b) Personal Income = National income – Income from property and entrepreneurship accruing to government administrative departments – Saving of non-departmental enterprises + National debt interest + Current transfers from government + Current transfers from rest of the world – Saving of private corporate sector – Corporate profit tax = ` 885 crore – ` 25 crore – ` 5 crore + ` 10 crore + ` 25 crore + ` 10 crore – ` 15 crore – ` 10 crore = ` 875 crore (c) Private Income = Personal income + Saving of private corporate sector + Corporate profit tax = ` 875 crore + ` 15 crore + ` 10 crore = ` 900 crore Ans.

10.

Sol.

Ans.

(a) National income = ` 885 crore. (b) Personal income = ` 875 crore. (c) Private income = ` 900 crore. Calculate from the following data (a) Private Income, (b) Personal Disposable Income, and (c) Net National Disposable Income: Items (` in crore) (i) National income 3,000 (ii) Savings of private corporate sector 30 (iii) Corporation tax 80 (iv) Current transfers from government administrative departments 60 (v) Income from property and entrepreneurship accruing to government administrative departments 150 (vi) Current transfers from rest of the world 50 (vii) Savings of non-departmental governments enterprises 40 (viii) Net indirect taxes 250 (ix) Direct taxes paid by households 100 (x) Net factor income from abroad (–)10 (a) Private Income = National income + Current transfers from government administrative departments + Current transfers from rest of the world – Income from property and entrepreneurship accruing to government administrative departments – Saving of non-departmental governments enterprises = ` 3,000 crore + ` 60 crore + ` 50 crore – ` 150 crore – ` 40 crore = ` 2,920 crore (b) Personal Disposable Income = Private income – Savings of private corporate sector – Corporation tax – Direct taxes paid by households = ` 2,920 crore – ` 30 crore – ` 80 crore – ` 100 crore = ` 2,710 crore (c) Net National Disposable Income = National income + Net indirect taxes + Current transfers from the rest of the world = ` 3,000 crore + ` 250 crore + ` 50 crore = ` 3,300 crore (a) Private income = ` 2,920 crore. (b) Personal disposable income = ` 2,710 crore. (c) Net national disposable income = ` 3,300 crore.

Introductory Macroeconomics

70

Economics–XII

Methods of Calculating National Income 1.

From the following about firm ‘X’, calculate Gross Value Added at Factor Cost by it: ( ` in thousand) 500

Items (i) Sales

Sol.

Ans. 2.

(ii) Opening stock

30

(iii) Closing stock

20

(iv) Purchase of intermediate products

300

(v) Purchase of machinery

150

(vi) Subsidy 40 Gross Value Added at Factor Cost by Firm X = Sales + Change in stock (Closing stock – Opening stock) + Subsidy – Purchase of intermediate products = ` 500 thousand + (` 20 thousand – ` 30 thousand) + ` 40 thousand – ` 300 thousand = ` 500 thousand – ` 10 thousand) + ` 40 thousand – ` 300 thousand = ` 230 thousand Gross value added at factor cost by firm X = ` 230 thousand. From the following about firm ‘Y’, calculate Net Value Added at Market Price by it: ( ` in thousand) 300

Items (i) Sales (ii) Depreciation

20

(iii) Net indirect taxes

30

(iv) Purchase of intermediate products

150

(v) Change in stock Sol.

(-) 10

(vi) Purchase of machinery Net Value Added at Market Price by Firm Y

100

= Sales + Change in stock – Purchase of intermediate products – Depreciation = ` 300 thousand + (–) ` 10 thousand – ` 150 thousand – ` 20 thousand = ` 120 thousand Ans. 3.

Net value added at market price by firm Y = ` 120 thousand. Calculate Operating Surplus from the following data: tems (i) Rent

(` in crore) 120

(ii) Profit

200

(iii) Domestic income

800

(iv) Mixed income

70

(v) Wages and salaries

350

(vi) Indirect tax

150

(vii) Subsidies Sol.

50

(viii) Depreciation Operating Surplus

200

= Domestic income – Wages and salaries – Mixed income = ` 800 crore – ` 350 crore – ` 70 crore = ` 380 crore Ans.

Operating surplus = ` 380 crore.

Introductory Macroeconomics

71

Economics–XII

4.

Sol.

Calculate GDPMP and NDPMP with the help of expenditure method from the data give below: Items (` in crore) (i) Personal disposable income 8,600 (ii) Personal savings 1,500 (iii) Fixed capital formation 8,600 (iv) Net exports (–)300 (v) Net factor income from abroad (–)500 (vi) Net indirect taxes 600 (vii) Government final consumption expenditure 2,200 (viii) Change in stock 800 (ix) Consumption of fixed capital 450 GDPMP = Personal disposable income – Personal savings + Net exports + Fixed capital formation + Change in stock + Government final consumption expenditure = ` 8,600 crore – ` 1,500 crore + (–) ` 300 crore + ` 3,000 crore + ` 800 crore + ` 2,200 crore = ` 12,800 crore NDPMP = GDPMP – Consumption of fixed capital = ` 12,800 crore – ` 450 crore

Ans.

= ` 12,350 crore GDPMP = ` 12,800 crore. NDPMP = ` 12,350 crore.

5.

Sol.

Ans. 6.

From the following data calculate National Income: Items (` in crore) (i) Compensation of employees 800 (ii) Rent 200 (iii) Wages and salaries 750 (iv) Net exports (–)30 (v) Net factor income from abroad (–)20 (vi) Profit 300 (vii) Interest 100 (viii) Depreciation 50 (ix) Remittances from abroad 80 (x) Taxes on profits 60 National Income = Compensation of employees + Rent + Profit + Interest + Net factor income from abroad [Income method] = ` 800 crore + ` 200 crore + ` 300 crore + ` 100 crore + (–) ` 20 crore = ` 1,380 crore National income = ` 1,380 crore. Find out Factor Income from Net Domestic Product accruing to the Private Sector from the following data: Items (` in crore) (i) Operating Surplus 30 (ii) Income from property and entrepreneurship accruing to government administrative departments 5 (iii) Compensation of employees 100 (iv) Mixed income of the self-employed 180 (v) Saving of non-departmental enterprises 5

Introductory Macroeconomics

72

Economics–XII

Sol.

Ans. 7.

Sol.

Ans.

8.

Factor Income from Net Domestic Product accruing to Private Sector = Compensation of employees + Operating surplus + Mixed income of the self-employed – Income from property and entrepreneurship accruing to government administrative departments – Saving of non-departmental enterprises = ` 100 crore + ` 30 crore + ` 180 crore – ` 5 crore – ` 5 crore = ` 300 crore Factor income from net domestic product accruing to private sector = ` 300 crore. Find out: (a) Value of Output at Market Price, (b) Gross Value Added at Market Price, (c) Net Value Added at Market Price, and (d) Net Value Added at Factor Cost from the following data relating to a firm: Items (` in crore) (i) Opening stock 800 (ii) Closing stock 1,200 (iii) Purchase of raw material 1,400 (iv) Sales 3,200 (v) Corporation tax 200 (vi) Undistributed profit 100 (vii) Dividends 100 (viii) Rent 300 (ix) Consumption of fixed capital 400 (x) Indirect taxes 300 (xi) Subsidies 100 (xii) Wages and salaries 700 (xiii) Interest 200 (a) Value of Output at Market Price = Sales + Change in stock (Closing stock – Opening stock) = ` 3,200 crore + (` 1,200 crore – ` 800 crore) = ` 3,200 crore + ` 400 crore = ` 3,600 crore (b) Gross Value Added at Market Price = Value of output at market price – Purchase of raw material = ` 3,600 crore – ` 1,400 crore = ` 2,200 crore (c) Net Value Added at Market Price = Gross value added at market price – Consumption of fixed capital = ` 2,200 crore – ` 400 crore = ` 1,800 crore (d) Net Value Added at Factor Cost = Net value added at market price – Indirect taxes + Subsidies = ` 1,800 crore – ` 300 crore + ` 100 crore = ` 1,600 crore (a) Value of output at market price = ` 3,600 crore. (b) GVAMP = ` 2,200 crore. (c) NVAMP = ` 1,800 crore. (d) NVAFC = ` 1,600 crore. From the following data, calculate: (a) Personal Disposable Income, and (b) National Income: Items (i) Private income (ii) Compensation of employees

Introductory Macroeconomics

73

(` in crore) 3,000 800 Economics–XII

(iii) Mixed income of self-employed (iv) (v) (vi) (vii) (viii) (ix) (x) (xi)

Sol.

Ans.

900

Net factor income from abroad Net retained earnings of private enterprises Rent Profit Consumption of fixed capital Direct taxes paid by households Corporation tax Net indirect taxes

(-)50 600 350 600 200 300 350 250

(xii) Net exports (-)70 (xiii) Interest 450 (a) Personal Disposable Income = Private income – Net retained earnings of private enterprises – Corporation tax – Direct taxes paid by households = ` 3,000 crore – ` 600 crore – ` 350 crore – ` 300 crore = ` 1,750 crore (b) National Income = Compensation of employees + Rent + Profit + Interest + Mixed income of self-employed + Net factor income from abroad = ` 800 crore + ` 350 crore + ` 600 crore + ` 450 crore + 900 crore + (–) 50 crore = ` 3,050 crore (a) Personal disposable income = ` 1,750 crore. (b) National income = ` 3,050 crore.

9.

From the following data relating to a firm, (a) estimate the Net Value Added at Market Price, (b) show that Net Value Added at Factor Cost is equal to the sum of factor incomes. Items (` in thousand) (i) Salaries and wages 120 (ii) Interest payments 90 (iii) Dividends 30 (iv) Undistributed profits 20 (v) Rent payments 15 (vi) Increase in stocks 40 (vii) Imports of raw material 20 (viii) Indirect taxes 10 (ix) Depreciation of fixed capital 15 (x) Domestic sales 360 (xi) Exports 40 (xii) Domestic purchase of raw materials and other inputs 120 Sol. (a) Net Value Added at Market Price = (Domestic sales + Exports + Increase in stocks) – (Domestic purchase of raw materials and other inputs + Imports of raw material) – Depreciation of fixed capital = (` 360 thousand + ` 40 thousand + ` 40 thousand) - (` 120 thousand + ` 20 thousand) – ` 15 thousand = ` 285 thousand (b) (i) Net Value Added at Factor Cost = Net value added at market price – Indirect taxes = ` 285 thousand – ` 10 thousand = ` 275 thousand

Introductory Macroeconomics

74

Economics–XII

(ii) Sum of Factor Incomes = Salaries and wages + Interest payments + Dividends + Undistributed profits + Rent payments = ` 120 thousand + ` 90 thousand + ` 30 thousand + ` 20 thousand + ` 15 thousand = ` 275 thousand Ans. 10.

Sol.

Ans. 11.

Sol.

Ans.

(a) Net value added at market price = ` 285 thousand. (b) Net value added at factor cost = Sum of factor incomes = ` 275 thousand. Calculate Net Domestic Product at Factor Cost and Gross National Disposable Income from the following data: Items ( ` in crore) (i) Net current transfers from abroad (–)5 (ii) Private final consumption expenditure 250 (iii) Net factor income from abroad 15 (iv) Government final consumption expenditure 50 (v) Consumption of fixed capital 25 (vi) Net exports (–)10 (vii) Subsidies 10 (viii) Net domestic capital formation 30 (ix) Indirect tax 20 Net Domestic Product at Factor Cost = Private final consumption expenditure + Government final consumption expenditure + Net domestic capital formation + Net exports – Indirect taxes + Subsidies = ` 250 crore + ` 50 crore + ` 30 crore + (–) ` 10 crore – ` 20 crore + ` 10 crore = ` 310 crore Gross National Disposable Income = NDPFC + Net current transfers from abroad + Net indirect taxes + Consumption of fixed capital + Net factor income from abroad = ` 310 crore + (–) ` 5 crore + ( ` 20 crore – ` 10 crore) + ` 25 crore + ` 15 crore = ` 310 crore – ` 5 crore + ` 10 crore + ` 25 crore + ` 15 crore = ` 355 crore Net domestic product at factor cost = ` 310 crore. Gross national disposable income = ` 355 crore. Calculate Gross Domestic Product at Factor Cost from the following data: Items (` in crore) (i) Private final consumption expenditure 800 (ii) Net domestic capital formation 150 (iii) Change in stock 30 (iv) Net factor income from abroad (–)20 (v) Net indirect tax 120 (vi) Government final consumption expenditure 450 (vii) Net exports (–)30 (viii) Gross fixed capital formation 170 (ix) Export of machinery 40 Gross Domestic Product at Factor Cost = Private final consumption expenditure + Government final consumption expenditure + Gross fixed capital formation + Change in stock + Net exports – Net indirect taxes = ` 800 crore + ` 450 crore + ` 170 crore + ` 30 crore + (–) ` 30 crore – ` 120 crore = ` 1,300 crore Gross domestic product at factor cost = ` 1,300 crore.

Introductory Macroeconomics

75

Economics–XII

12.

Sol.

Ans. 13.

Sol.

Ans.

Calculate Net Domestic Product at Factor Cost and Gross National Disposable Income from the following data: Items (` in crore) (i) Net current transfers from abroad (–)5 (ii) Private final consumption expenditure 250 (iii) Net factor income from abroad 15 (iv) Government final consumption expenditure 50 (v) Consumption of fixed capital 25 (vi) Net exports (–)10 (vii) Subsidies 10 (viii) Net domestic capital formation 30 (ix) Indirect tax 20 Net Domestic Product at Factor Cost = Private final consumption expenditure + Government final consumption expenditure + Net domestic capital formation + Net exports – Indirect taxes + Subsidies = ` 250 crore + ` 50 crore + ` 30 crore + (–) ` 10 crore – ` 20 crore + ` 10 crore = ` 310 crore Gross National Disposable Income = NDPFC + Net current transfers from abroad + Net indirect taxes + Consumption of fixed capital + Net factor income from abroad = ` 310 crore + (–) ` 5 crore + ( ` 20 crore – ` 10 crore) + ` 25 crore + ` 15 crore = ` 310 crore – ` 5 crore + ` 10 crore + ` 25 crore + ` 15 crore = ` 355 crore Net domestic product at factor cost = ` 310 crore. Gross national disposable income = ` 355 crore. Calculate National Income and Net National Disposable Income from the following data: Items (` in crore) (i) Net current transfers to abroad 15 (ii) Net exports (–)20 (iii) Private final consumption expenditure 400 (iv) Net factor income to abroad 10 (v) Government final consumption expenditure 100 (vi) Indirect tax 30 (vii) Net domestic capital formation 50 (viii) Change in stocks 7 (ix) Subsidy 5 National Income = Private final consumption expenditure + Government final consumption expenditure + Net domestic capital formation + Net exports – Net factor income to abroad – Net indirect taxes (Indirect tax – Subsidy) = ` 400 crore + ` 100 crore + ` 50 crore + (–) ` 20 crore – ` 10 crore – (` 30 crore – ` 5 crore) = ` 495 crore Net National Disposable Income = National income + Net indirect taxes – Net current transfers to abroad = ` 495 crore + (` 30 crore – ` 5 crore) – ` 15 crore = ` 495 crore + ` 25 crore – ` 15 crore = ` 505 crore National income = ` 495 crore. Net national disposable income = ` 505 crore.

Introductory Macroeconomics

76

Economics–XII

14.

Sol.

From the following data, calculate National Income by (a) income method, and (b) expenditure method: Items (` in crore) (i) Private final consumption expenditure 2,000 (ii) Net capital formation 400 (iii) Change in stock 50 (iv) Compensation of employees 1,900 (v) Rent 200 (vi) Interest 150 (vii) Operating surplus 720 (viii) Net indirect tax 400 (ix) Employers’ contribution to social security schemes 100 (x) Net exports 20 (xi) Net factor income from abroad (-)20 (xii) Government final consumption expenditure 600 (xiii) Consumption of fixed capital 100 (a) Income Method: National Income = Compensation of employees + Operating surplus + Net factor Income from abroad = ` 1,900 crore + ` 720 crore + (–) ` 20 crore = ` 2,600 crore (b) Expenditure Method: National Income = Private final consumption expenditure + Government final consumption expenditure + Net capital formation + Net exports + Net factor income from abroad - Net indirect taxes = ` 2,000 crore + ` 600 crore + ` 400 crore + ` 20 crore + (-) ` 20 crore - ` 400 crore = ` 2,600 crore

Ans. 15.

Sol.

National income (by income and expenditure methods) = ` 2,600 crore. From the following data calculate Net National Product at Factor Cost by (a) income method, and (b) expenditure method: Items (` in crore) (i) Current transfers from rest of the world 100 (ii) Government final consumption expenditure 1,000 (iii) Wages and salaries 3,800 (iv) Dividend 500 (v) Rent 200 (vi) Interest 150 (vii) Net domestic capital formation 500 (viii) Profits 800 (ix) Employers’ contribution to social security schemes 200 (x) Net exports (–)50 (xi) Net factor income from abroad (–)30 (xii) Consumption of fixed capital 40 (xiii) Private final consumption expenditure 4,000 (xiv) Net indirect tax 300 (a) Income Method: Net National Product at Factor Cost = Wages and salaries + Profit + Rent + Interest + Employers’ contribution to social security schemes + Net factor income from abroad

Introductory Macroeconomics

77

Economics–XII

= ` 3,800 crore + ` 800 crore + ` 200 crore + ` 150 crore + ` 200 crore + (–) ` 30 crore = ` 5,120 crore (b) Expenditure Method: Net National Product at Factor Cost = Government final consumption expenditure + Net domestic capital formation + Net exports + Private final consumption expenditure + Net factor income from abroad – Net indirect tax = ` 1,000 crore + ` 500 crore + (–) ` 50 crore + ` 4,000 crore + (–) ` 30 crore – ` 300 crore = ` 5,120 crore Ans.

Net national product at factor cost (by income and expenditure methods) = ` 5,120 crore.

Aggregate Demand and its Components 1. Sol.

Find the value of C, when C = 50, Y = 500 and marginal propensity to consume is 0.2. We know that,

C = C + bY = 50 + 0.2(500) = 50 + 100 = 150

Ans. 2. Sol.

Ans. 3.

Consumption (C) = 150. Find saving, when S = 100, Y = 500 and marginal propensity to save = 0.4. We know that,

S = – S + sY = – 100 + 0.4(500) = – 100 + 200 = 100

(s = MPS = 0.4)

Saving (S) = 100. Find the values of marginal propensity to consume and marginal propensity to save from the following data: Income (`)

Saving (`)

750

150

1,000

200

Sol. Income (Y) (`)

Change in Income (DY) (`)

Saving (S) (`)

Consumption (C) (`)

Change in Consumption (DC) (`)

750

-

150

600

–

1,000

1,000 - 750 = 250

200

800

800 - 600 = 200

DC 200 = = 0.8 DY 250 MPS = 1 – MPC = 1 – 0.8 = 0.2

Marginal propensity to consume =

Ans. 4.

Sol.

MPC = 0.8. MPS = 0.2. What will be the value of average propensity to save when (i) C = 200 at Y = 1,000? (ii) S = 450 at Y = 1,200? S APS = Y

Introductory Macroeconomics

78

Economics–XII

(i) We know that,

S =Y–C = 1,000 – 200 = 800 S 800 APS = = Y 1,000

= 0.8 (ii) When S = 450 and Y = 1,200 S 450 APS = = Y 1,200 = 0.375 Ans. 5.

(i) APS = 0.8. (ii) APS = 0.375. Complete the following table: Level of Income (™)

Consumption Expenditure (™)

Marginal Propensity to Consume

Marginal Propensity to Save

400

240

¾

¾

500

320

¾

¾

600

395

¾

¾

700

465

¾

¾

Sol.

6.

Level of Income (Y) (™)

Consumption Expenditure (C) (™)

Saving (S) = Y – C (™)

Marginal Propensity to Consume DC (MPC) = DY

Marginal Propensity to Save DS (MPS) = DY

400

240

160

—

—

500

320

180

0.8

0.2

600

395

205

0.75

0.25

700

465

235

0.7

0.3

Complete the following table: Level of Income (™)

Consumption Expenditure (™)

Marginal Propensity to Consume

Marginal Propensity to Save

1,000

900

¾

¾

1,200

1,060

¾

¾

1,400

1,210

¾

¾

1,600

1,350

¾

¾

Sol. Level of Income (Y) (™)

Consumption Expenditure (C) (™)

Saving (S) = Y – C (™)

Marginal Propensity to Consume DC (MPC) = DY

Marginal Propensity to Save DS (MPS) = DY

1,000

900

100

—

¾

1,200

1,060

140

0.8

0.2

1,400

1,210

190

0.75

0.25

1,600

1,350

250

0.7

0.3

Introductory Macroeconomics

79

Economics–XII

7.

Complete the following table: Income (`)

Consumption Expenditure (™)

Marginal Propensity to Consume

Average Propensity to Save

0

20

¾

¾

50

55

¾

¾

100

90

¾

¾

150

125

¾

¾

Sol.

8.

Income (Y) (`)

Consumption (C) (`)

Saving (S) = Y – C (`)

Marginal Propensity to Consume DC (MPC) = DY

Average Propensity to Save S (APS) = Y

0

20

–20

—

—

50

55

–5

35 = 0.7 50

–5 = –0.1 50

100

90

10

35 = 0.7 50

10 = 0.1 100

150

125

25

35 = 0.7 50

25 = 0.16 150

Income (`)

Marginal Propensity to Consume

Saving (`)

Average Propensity to Save

Average Propensity to Consume

0

0.5

–80

¾

¾

50

0.5

—

¾

¾

100

0.5

—

¾

¾

150

0.5

—

¾

¾

200

0.5

—

—

—

Complete the following table:

Sol. Income (Y) (`)

Marginal Propensity to Consume (MPC)

Saving (S) = Y – C (`)

Consumption (C) (`)

Average Propensity to Save S (APS) = Y

Average Propensity to Consume C (APC) = Y

0

—

–80

80

—

—

50

0.5

–55

80 + 25 = 105

–55 = –11 . 50

105 = 2.1 50

100

0.5

–30

80 + 50 = 130

–30 = –0.3 100

130 = 13 . 100

150

0.5

–5

80 + 75 = 155

–5 = –0.03 150

155 = 103 . 150

200

0.5

20

80 + 100 = 180

20 = 0.1 200

180 = 0.9 200

[Hint: C = C + cY; where, C = 80 at Y = 0 and c = 0.5.]

Short Run Equilibrium Output 1.

Sol.

If the value of multiplier is 4 (i) what will be MPC and MPS? (ii) What will be marginal propensity to consume when marginal propensity to save is 0.2? 1 (i) K = MPS

Introductory Macroeconomics

80

Economics–XII

Substituting, K = 4 1 MPS 1 MPS = = 0.25 4 4=

MPC = 1 - MPS = 1- 0.25 = 0.75

Ans. 2. Sol.

(ii) MPC = 1 - MPS = 1 - 0.2 MPC = 0.8 (i) MPC = 0.75; MPS = 0.25. (ii) MPC = 0.8. In an economy investment expenditure is increased by ` 700 crore. The marginal propensity to consume is 0.9. Calculate the total increase in income and consumption expenditure. MPC = 0.9; DI = ` 700 crore

1 1 1 = = = 10 1 - MPC 1 - 0.9 0.1 Increase in income (DY) = K ´ DI = 10 × ` 700 crore = ` 7,000 crore Increase in consumption (DC) = DY ´ MPC = ` 7,000 crore × 0.9 = ` 6,300 crore Increase in income = ` 7,000 crore. Increase in consumption expenditure = ` 6,300 crore. Multiplier (K) =

Ans. 3. Sol.

In an economy investment expenditure is increased by ` 400 crore and marginal propensity to consume is 0.8. Calculate the total increase in income and saving. MPC = 0.8; DI = ` 400 crore

1 1 - MPC 1 1 = = =5 1 - 0.8 0.2 MPS = 1 - MPC = 1 – 0.8 = 0.2 Increase in income (DY) = K ´ DI = 5 × 400 = ` 2,000 crore Increase in saving = DY × MPS = ` 2,000 crore × 0.2 = ` 400 crore Increase in income = ` 2,000 crore. Increase in saving = ` 400 crore. In an economy, investment is increased by ` 600 crore. If the marginal propensity to consume is 0.6, calculate the total increase in income and consumption expenditure. MPC = 0.6; DI = ` 600 crore 1 Multiplier (K) = 1 - MPC 1 1 = = = 25 . 1 - 06 . 0.4 Increase in income (DY) = K ´ DI = 2.5 × ` 600 crore = ` 1,500 crore Multiplier (K) =

Ans. 4. Sol.

Introductory Macroeconomics

81

Economics–XII

Ans.

ncrease in consumption (DC) = DY ´ MPC = ` 1,500 crore ´ 0.6 = ` 900 crore Increase in income = ` 1,500 crore. Increase in consumption expenditure = ` 900 crore.

5.

A ` 200 crore increase in investment leads to a rise in national income by ` 1,000 crore. Find out marginal propensity to consume.

Sol.

Given, increase in investment (DI) = ` 200 crore Increase in national income (DY) = ` 1,000 crore We know, DY 1,000 Multiplier (K) = = =5 DI 200 We also know, 1 K= 1– MPC 1 1 – MPC = 5 1 – MPC = 0.2 MPC = 1 – 0.2 = 0.8 Marginal propensity to consume = 0.8. An increase in investment leads to total rise in national income by ` 500 crore. If marginal propensity to consume is 0.9. What is the increase in investment? Calculate.

Ans. 6. Sol.

Ans. 7. Sol.

Ans.

Increase in national income (DY) = ` 500 crore MPC = 0.9 We know, 1 Multiplier (K) = 1 - MPC 1 1 = = 10 = 1– 0.9 1– 0.1 We also know, DY K= DI DY 500 Þ = = 50 DI = K 10 Increase in investment = ` 50 crore. Given marginal propensity to save equal to 0.25, what will be the increase in national income if investment increases by ` 125 crore? Calculate. Given, MPS = 0.25 Increase in investment (DI) = ` 125 crore We know, 1 1 Multiplier (K) = = 1 - MPC MPS 1 = =4 0.25 We also know, DY K= DI Þ DY = K × DI = 4 × 125 = 500 Increase in national income = ` 500 crore.

Introductory Macroeconomics

82

Economics–XII

8. Sol.

Ans. 9. Sol.

Ans.

It is planned to increase national income by ` 1,000 crore. How much increase in investment is required to achieve this goal? Assume that marginal propensity to consume is 0.6. Calculate. Desired increase in national income = ` 1,000 crore MPC = 0.6 We know, 1 Multiplier (K) = 1 - MPC 1 1 = = = 2.5 1 - 06 . 0.4 DY We also know, K= DI DY 1000 , DI = = Þ = 400 K 25 . Desired increase in investment = ` 400 crore. An increase in investment by ` 400 crore leads to increase in national income by ` 1,600 crore. Calculate marginal propensity to consume. Increase in investment (DI) = ` 400 crore Increase in national income (D Y) = ` 1,600 crore DY Multiplier (K) = DI 1,600 Þ K= =4 400 1 We know, K= 1 - MPC 1 4= 1 - MPC 1 1 – MPC = 4 1 – MPC = 0.25 MPC = 1 – 0.25 = 0.75 Marginal propensity to consume = 0.75.

10.

An increase in investment by ` 500 crore leads to increase in national income by ` 2,500 crore. Calculate marginal propensity to consume and change in saving.

Sol.

Increase in investment (DI) = ` 500 crore Increase in national income (D Y) = ` 2,500 crore DY Multiplier (K) = DI 2,500 Þ K= =5 500 1 We know, K= 1 - MPC 1 5= 1 - MPC 1 1 – MPC = 5 1 – MPC = 0.2 MPC = 1 – 0.2 MPC = 0.8 We also know, MPC + MPS = 1

Introductory Macroeconomics

83

Economics–XII

Or,

Ans.

MPS = 1– MPC = 1 – 0.8 = 0.2 Change in saving (DS) = DY ´ MPS = ` 2,500 crore ´ 0.2 = ` 500 crore Marginal propensity to consume = 0.8. Change in saving = ` 500 crore.

Government Budget and The Economy 1. Sol.

Ans. 2.

Sol.

Total expenditure of a government budget is ` 75,000 and total receipts is ` 45,000. How much is the budget deficit? Budget Deficit = Total expenditure - Total receipts = ` 75,000 crore – ` 45,000 crore = ` 30,000 crore Budget deficit = ` 30,000 crore. Calculate budgetary deficit from following data: Items (i) Revenue expenditure (ii) Capital expenditure (iii) Revenue receipts (iv) Capital receipts

(` in crore) 60,000 30,000 50,000 25,000

Budgetary Deficit = Revenue expenditure + Capital expenditure - (Revenue receipts + Capital receipts) = ` 60,000 crore + ` 30,000 crore – ` 50,000 crore – ` 25,000 crore = ` 90,000 crore – ` 75,000 crore = ` 15,000 crore

Ans. 3.

Sol.

Budgetary deficit = ` 15,000 crore. Find fiscal deficit from the information given below: Items (i) Borrowing by the government

(` in lakh) 600

(ii) Revenue receipts

100

(iii) Capital receipts

750

(iv) Interest payment Fiscal Deficit = Borrowing by the government

150

= ` 600 lakh Ans. 4.

Fiscal deficit = ` 600 lakh. Find primary deficit from the following data: Items (i) Fiscal deficit

(` in crore) 9,000

(ii) Interest payment by the government Sol.

Ans.

900

Primary Deficit = Fiscal deficit - Interest payment by the government = ` 9,000 crore – ` 900 crore = ` 8,100 crore Primary deficit = ` 8,100 crore.

Introductory Macroeconomics

84

Economics–XII

5. Sol.

In a government budget, primary deficit is ` 10,000 crore and interest payment is ` 8,000 crore. How much is the fiscal deficit? Fiscal Deficit = Primary deficit + Interest payment by the government = ` 10,000 crore + ` 8,000 crore = ` 18,000 crore

Ans.

Fiscal deficit = ` 18,000 crore.

Balance of Payments 1. Sol.

Ans. 2. Sol.

Ans. 3.

Sol.

Ans. 4.

Sol.

The balance of trade shows a deficit of ` 5,000 crore and the value of imports are ` 9,000 crore. What is the value of exports? Balance of trade = (-) ` 5,000 crore Value of imports = ` 9,000 crore Balance of Trade = Exports - Imports Exports = Balance of trade (Deficit) + Import = – ` 5,000 crore + ` 9,000 crore = ` 4,000 crore Value of exports = ` 4,000 crore. The balance of trade shows a deficit of ` 300 crore. The value of exports are ` 500 crore. What is the value of imports? Balance of Trade = Exports - Imports = (-) ` 300 crore Imports = Exports - Balance of trade (Deficit) = ` 500 crore - (-) ` 300 crore = ` 800 crore Value of imports = ` 800 crore. Find current account balance from the following data: Items (` in lakh) (i) Balance of visible trade 9,000 (ii) Export of services 9,000 (iii) Import of services 3,000 Current Account Balance = Balance of visible trade + Balance of invisibles (Export of services – Import of services) = ` 9,000 lakh + ` 9,000 lakh – ` 3,000 lakh = ` 15,000 lakh Current account balance = ` 15,000 lakh. Find the balance on non-factor services from the following information: Items (` in crore) (i) Balance of visible trade 500 (ii) Income 200 (iii) Transfers 100 (iv) Current account balance 900 Current Account Balance = Trade balance + Balance on non-factor services + Balance on income + Balance on transfers Or, Balance on Non-factor Services = Current account balance – Trade balance – Balance on income – Balance on transfers = ` 900 crore - ` 500 crore - ` 200 crore - ` 100 crore = ` 100 crore

Ans.

Balance on non-factor services = ` 100 crore.

Introductory Macroeconomics

85

Economics–XII

5.

If balance of trade shows a surplus of ` 300 crore and unilateral payments is ` 50 crore, how much is the balance on the capital account of balance of payments?

Sol.

Capital Account Balance = Current account balance + Unilateral payments = ` 300 crore + ` 50 crore = ` 350 crore

Ans.

Capital account shows a deficit of ` 350 crore.

Introductory Macroeconomics

86

Economics–XII

CBSE Question Papers–2012 (Delhi, All India & Foreign)

Introductory Macroeconomics

Introductory Macroeconomics

87

Economics–XII

CBSE QUESTION PAPERS–2012 INTRODUCTORY MACROECONOMICS

1 MARK QUESTIONS 1. Define stock variable. Ans. Stock variable is that quantity of an economic variable which is measured at a particular point of time. 2. Define capital goods. Ans. Capital goods are fixed assets of the producers which are repeatedly used in the production of other goods and services. 3. What are demand deposits? Ans. Demand deposits are those deposits which can be withdrawn from the bank on demand or by writing a cheque any time. 4. Define a tax. Ans. A tax is a legally compulsory payment imposed by the government on the households, firms and producers. 5. Give meaning of managed floating exchange rate. Ans. Managed floating is a system that allows adjustments in exchange rate according to a set of rules and regulations which are officially declared in the foreign exchange market. 6. Define flow variable. Ans. Flow variable is that quantity of an economic variable which is measured per unit of time period. 7. Define consumption goods. Ans. Consumption goods are those goods which are used for the direct satisfaction of human wants. Example: Milk used by households. 8. What are time deposits? Ans. Time deposits are those deposits which cannot be withdrawn from the bank as and when needed or by writing a cheque any time. These deposits involve a lock-in period. 9. Define a ‘direct tax’. Ans. A direct tax is that tax the final burden of which falls on that very person who is liable to pay it to the government. 10. What is a fixed exchange rate? Ans. Fixed rate of exchange is a rate which is fixed and determined by the government. 11. What is bank money? Ans. Bank money is the money created by the bank in the form of demand deposits, over and above cash deposits of the people with the banks. It is a credit money, and not a legal tender. 12. Define indirect tax. Ans. Indirect tax is a tax on goods and services. Those who are liable to pay this tax need not bear the final burden of this tax. 13. What is a flexible exchange rate? Ans. Flexible rate of exchange is that rate which is determined by the demand for and supply of different currencies in the foreign exchange market.

3 MARKS QUESTIONS 1. Calculate Gross Value Added at Factor Cost: Items (i) Units of output sold (units)

1,000

(ii) Price per unit of output (™)

30

Introductory Macroeconomics

89

Economics–XII

(iii) Depreciation (™)

1,000

(iv) Intermediate cost (™)

12,000

(v) Closing stock (™)

3,000

(vi) Opening stock (™)

2,000

(vii) Excise (™)

2,500

(viii) Sales tax (™) Ans. Gross Value Added at Factor Cost

3,500

= Sales (Units of output sold ´ Price per unit of output) + Closing stock - Opening stock – Intermediate cost – Excise – Sales tax = (1,000 ´ ` 30) + ` 3,000 – ` 2,000 – ` 12,000 – ` 2,500 – ` 3,500 = ` 30,000 + ` 3,000 – ` 2,000 – ` 12,000 – ` 2,500 – ` 3,500 = ` 13,000 Gross value added at factor cost = ` 13,000. 2. Explain the significance of the ‘store of value’ function of money. Ans. Store of value means store of wealth in terms of money. In the absence of money, people used to save in terms of expensive goods which involved difficulty of storage and transportation/portability. With the invention of money, people found a very convenient means of saving their wealth on account of the following characteristics of money: (i) Saving in terms of money allows convenient portability. It involves only paper titles which can be handled anywhere and in any part of the world with just a click of the mouse. (ii) Saving in terms of money allows fractional denominations to any extent. It is unlike saving in terms of goods which have limited divisibility. (iii) Saving in terms of money allows a high degree of liquidity which is not possible in case of goods. Note: While saving is a virtue from the individual’s point of view, it may not always be so from the viewpoint of the economy as a whole. Saving means not spending, which may lead to a situation of deficiency of aggregate demand and therefore a situation of recession or depression in the economy. 3. Outline the steps taken in deriving saving curve from the consumption curve. Use diagram. Y

Ans. Fig. 1 shows how saving curve is derived from consumption curve.

Y

It involves the following steps:

(ii) Point P on the saving curve is marked corresponding to point Q on the consumption curve. While Q indicates that Y = C, point P indicates that S = 0. Obviously, when Y = C, S = 0. (iii) By joining points A ¢ and P and stretching it to form a straight line, we get S curve. S-function is linear C-function.

C= Consumption/Saving

(i) We take OA ¢ =OA. Because OA = consumption when Y = 0. So that, OA ¢ (= OA) is negative saving when Y = 0. It is indicated by – C in the saving function.

C+

bY

C

Break-even point Q

A

– S=

C

1– +(

b )Y S

45° O

P

Income

X

A' Y'

Figure 1 Note: Since MPC + MPS = 1, MPS = 1 – MPC. So that while in C-function MPC is indicated by b, in S-function it is indicated by 1 – b.

Introductory Macroeconomics

90

Economics–XII

4. Find national income from the following: Autonomous consumption = ™100. Marginal propensity to consume= 0.80. Investment = ™50. Ans.

We know that,

Y= C + I

Or,

Y = C + MPC(Y) + I Y = 100 + 0.80Y + 50 Y – 0.80Y = 150 0.20Y = 150 Y = 750

National income = ™ 750. 5. Distinguish between revenue expenditure and capital expenditure in a government budget. Give examples. Or Explain the role of government budget in allocation of resources. Ans. Revenue expenditure is that expenditure of the government which does not either create assets for the government or causes a reduction in liabilities of the government. Example: Expenditure on interest payments, expenditure on salaries, etc. Capital expenditure is that expenditure of the government which either creates assets for the government or causes a reduction in government liability. Example: Expenditure on purchase of shares, expenditure on purchasing building, etc. Or Through its budgetary policy, the government of a country directs the allocation of resources in a manner such that there is a balance between the goals of profit maximisation and social welfare. Production of goods which are injurious to health is discouraged through heavy taxation. On the other hand, production of ‘socially useful goods’ is encouraged through subsidy. Larger budgetary allocations to the production of ‘merit goods’ in the public sector also impacts the allocation of resources. 6. Calculate Net Value Added at Factor Cost: Items (i) Consumption of fixed capital (™)

600

(ii) Import duty (™)

400

(iii) Output sold (units)

2,000

(iv) Price per unit of output (™)

10

(v) Net change in stocks (™)

(–)50

(vi) Intermediate cost (™)

10,000

(vii) Subsidy (™) Ans. Net Value Added at Factor Cost

500

= Sales (Output sold × Price per unit of output) + Net change in stocks – Intermediate cost – Consumption of fixed capital - Import duty + Subsidy = (2,000 ´ ` 10) + (–) ` 50 – ` 10,000 – ` 600 – ` 400 + ` 500 = ` 20,000 – ` 50 – ` 10,000 – ` 600 – ` 400 + ` 500 = ` 9,450 Net value added at factor cost = ` 9,450. Introductory Macroeconomics

91

Economics–XII

7. Find ‘investment’ from the following: National income =™ 500. Autonomous consumption = ™100. Marginal propensity to consume = 0.75. Ans. We know that,

Y= C + I

Or,

Y = C + MPC(Y) + I

Or,

I = Y – C – MPC(Y) I = 500 – 100 – 0.75(500) I = 500 – 100 – 375 I = 25

Investment = ™ 25. 8. Find Net Value Added at Market Price: Items (i) Output sold (units)

800

(ii) Price per unit of output (™)

20

(iii) Excise (™)

1,600

(iv) Import duty (™)

400

(v) Net change in stocks (™)

(–)500

(vi) Depreciation (™)

1,000

(vii) Intermediate cost (™) Ans. Net Value Added at Market Price

8,000

= Sales (Output sold ´ Price per unit of output) + Net change in stocks - Intermediate cost – Depreciation = (800 ´ ` 20) + (–) ` 500 – ` 8,000 – ` 1,000 =

` 16,000 – ` 500 – ` 8,000 – ` 1,000

= ` 6,500 Net value added at market price = ` 6,500. 9. Find consumption expenditure from the following: Autonomous consumption = 100 (™). Marginal propensity to consume = 0.70. National income = 1,000 (™). Ans. We know that,

C = C + MPC(Y) = 100 + 0.70(1,000) = 100 + 700

= 800 Consumption expenditure = ™ 800. 10. Find Net Value Added at Market Price: Items (i) Depreciation (™)

700

(ii) Output sold (units)

900

(iii) Price per unit of output (™) Introductory Macroeconomics

40 92

Economics–XII

(iv) Closing stock (™)

1,000

(v) Opening stock (™)

800

(vi) Sales tax (™)

3,000

(vii) Intermediate cost (™) Ans. Net Value Added at Market Price

20,000

= Sales (Output sold × Price per unit of output) + Closing stock – Opening stock – Intermediate cost – Depreciation = (900 ´ ` 40) + ` 1,000 – ` 800 – ` 20,000 – ` 700 = ` 36,000 + ` 1,000 – ` 800 – ` 20,000 – ` 700 = ` 15,500 Net value added at market price = ` 15,500. 11. Explain the ‘standard of deferred payment’ function of money. Ans. Deferred payments refer to those payments which are made in future. Money is accepted as a standard of deferred payments because, (a) its price remains stable, (b) it has general acceptability, (c) it is more durable compared to other commodities. Briefly, money is a convenient means of borrowing and lending and is therefore accepted as a standard for deferred payments. 12. Outline the steps taken in deriving consumption curve from the saving curve. Use diagram. Y

Ans. Fig. 2 shows how consumption curve is derived from the saving curve.

Y

It involves the following steps:

(ii) Point Q on the Y-line (45° angle) is marked corresponding to point P on the saving curve. Because at P, saving = 0, and at point Q, consumption = income (implying that S = 0). (iii) Joining points A & Q and stretching it to form a straight line, we get C-curve. C-function is linear as it is derived from a linear S-function. Note: Since MPC + MPS = 1, MPS = 1 – MPC. So that while in C-function, MPC is indicated by b, in S-function it is indicated by 1 – b.

C= Consumption/Saving

(i) We take OA = OA ¢. Because OA ¢ = negative saving when Y = 0, and this is exactly equal to minimum consumption when Y = 0.

C+

C

bY

Break-even point Q

A

S=

–C

1 +(

–b

)Y S

45° O

P

Income

X

A' Y'

Figure 2

13. Find consumption expenditure from the following: National income = ™ 5,000. Autonomous consumption = ™ 1,000. Marginal propensity to consume = 0.80. Ans. We know that,

C = C + MPC(Y) = 1,000 + 0.80(5,000) = 1,000 + 4,000 = 5,000

Consumption expenditure = ™ 5,000.

Introductory Macroeconomics

93

Economics–XII

14. Distinguish between revenue receipts and capital receipts in a government budget. Give example in each case. Or Explain the role of government budget in bringing economic stability. Ans. Revenue receipts are those receipts which do not create either a liability or lead to reduction in assets. For example, receipts from tax revenue like income tax and sales tax and receipts from non-tax revenue like interest and dividends. On the other hand, capital receipts are those receipts which either create a liability or lead to reduction in assets. For example, recoveries of loans from state governments, market loans, and disinvestment. Or Free play of market forces (or the forces of supply and demand) tend to generate trade cycles, also called business cycles. These cycles bring a situation of inflation or deflation in the economy. Such situations are not conducive to the process of growth. Pace of growth enhances only in situations of economic stability. Budget is used as an important policy instrument to correct the situations of deflation and inflation. Policy of deficit budget is pursued to combat deflationary gap. Policy of surplus budget is pursued to combat (or correct) inflationary gap. In other words, in a situation of inflation, the government can increase taxes and also lower its expenditure to moderate the level of aggregate demand in the economy. In a situation of deflation, on the other hand, tax rates may be lowered and government expenditure increased, so that the level of aggregate demand is raised. 15. Find Gross Value Added at Factor Cost: Items (i) Units of output sold

2,000

(ii) Price per unit of output (™)

20

(iii) Depreciation (™)

2,000

(iv) Change in stock (™)

(–)500

(v) Intermediate cost (™)

15,000

(vi) Subsidy (™) Ans. Gross Value Added at Factor Cost

3,000

= Sales (Units of output sold × Price per unit of output) + Change in stock – Intermediate cost + Subsidy = (2,000 × ` 20) + (–) ` 500 – ` 15,000 + ` 3,000 = ` 40,000 – ` 500 – ` 15,000 + ` 3,000 = ` 27,500 Gross value added at factor cost = ` 27,500. 16. Find national income from the following: Autonomous consumption = ™100. Marginal propensity to consume = 0.60. Investment =™200. Ans. We know that,

Y= C + I

Or,

Y = C + MPC(Y) + I Y = 100 + 0.60Y + 200 Y – 0.60Y = 300 0.40Y = 300 Y = 750

National income = ™750. Introductory Macroeconomics

94

Economics–XII

17. Find out Net Value Added at Factor Cost: Items (i) Price per unit of output (™)

25

(ii) Output sold (units)

1,000

(iii) Excise duty (™)

5,000

(iv) Depreciation (™)

1,000

(v) Change in stocks (™)

(–)500

(vi) Intermediate costs (™) Ans. Net Value Added at Factor Cost

7,000

= Sales (Output sold ´ Price per unit of output) + Change in stocks - Intermediate costs - Depreciation - Excise duty = (1,000 × ` 25) + (–) ` 500 – ` 7,000 – ` 1,000 – ` 5,000 = ` 25,000 – ` 500 – ` 7,000 – ` 1,000 – ` 5,000 = ` 11,500 Net value added at factor cost = ` 11,500. 18. Find investment from the following: National income = ™ 600. Autonomous consumption = ™150. Marginal propensity to consume = 0.70. Ans. We know that,

Y= C + I

Or,

Y = C + MPC(Y) + I

Or,

I = Y – C – MPC(Y) I = 600 – 150 – 0.70(600) I = 600 – 150 – 420 I = 30

Investment = ™ 30. 19. Find out Net Value Added at Market Price: Items (i) Intermediate cost (™)

10,000

(ii) Change in stock (™)

1,000

(iii) Output sold (™)

750

(iv) Price per unit of output (™)

40

(v) Import duty (™)

2,000

(vi) Consumption of fixed capital (™) Ans. Net Value Added at Market Price

3,000

= Sales (Output sold × Price per unit of output) + Change in stock – Intermediate cost – Consumption of fixed capital = (750 × ` 40) + ` 1,000 – ` 10,000 – ` 3,000 = ` 30,000 + ` 1,000 – ` 10,000 – ` 3,000 = ` 18,000 Net value added at market price = ` 18,000. Introductory Macroeconomics

95

Economics–XII

20. Explain the ‘unit of account’ function of money. Ans. Money serves as a measure of value in terms of unit of account, i.e., in monetary unit. For example, value of sugar can be expressed in monetary unit by saying that price of sugar is ` 15 per kg. In the absence of money as a unit of account, some goods were used as a unit of account to assess the value of other goods. It was a cumbersome procedure and a hindrance in the process of exchange. Money serves as a standard unit of account for all goods and services. It has enhanced the process of exchange. 21. Draw consumption curve and saving curve in a single diagram and mark the ‘break-even point’. Y Consumption (C)/Savings (S)

Ans. In Fig. 3, C is the consumption curve and S is the saving curve. OA is the minimum consumption when income level is zero and OA ¢ is negative saving when income is zero. At point E, consumption is equal to income, and saving is equal to zero. This is called the break-even point.

Y=C G Break-even point E

C E1

A G' O

S

Note: Break-even occurs when Y = C, or when S = 0

45º Y1

Y2

X Income (Y)

A' Y¢

Figure 3

22. Find ‘investment’ from the following: National income =™ 800. Autonomous consumption= ™ 50. Marginal propensity to consume = 0.8. Ans. We know that,

Y= C + I

Or,

Y = C + MPC(Y) + I

Or,

I = Y – C – MPC(Y) I = 800 – 50 – 0.8(800) I = 800 – 50 – 640 I = 110

Investment = ™ 110. 23. Distinguish between revenue expenditure and capital expenditure in a government budget. Give example in each case. Or Explain the role of government budget in reducing income inequalities. Ans. Revenue expenditure is that expenditure which creates no assets or causes no reduction in liabilities of the government. Examples: (i) Expenditure on interest payments, (ii) Expenditure on salaries. Capital expenditure is that expenditure of the government which either creates assets or causes a reduction in government liability. Examples: (i) Expenditure on purchase of shares, (ii) Expenditure on buildings. Or Government’s budgetary policy can help reduce inequalities of income through redistribution of income and wealth in the economy. To achieve this objective, government uses fiscal instruments of taxation and subsidies. By imposing taxes on rich and giving subsidies to the poor, government redistribute income in favour of poorer sections of the society. Equitable distribution of income and wealth is a sign of social justice. Introductory Macroeconomics

96

Economics–XII

24. Find Net Value Added at Factor Cost: Items (i) Intermediate cost (™)

15,000

(ii) Output sold (units)

9,000

(iii) Price per unit of output (™)

4

(iv) Consumption of fixed capital (™)

2,000

(v) Excise duty (™)

4,000

(vi) Change in stock (™) Ans. Net Value Added at Factor Cost

(–)1,000

= Sales (Output sold ´ Price per unit of output) + Change in stock - Intermediate cost – Consumption of fixed capital - Excise duty = (9,000 × ` 4) + (–) ` 1,000 – ` 15,000 – ` 2,000 – ` 4,000 = ` 36,000 – ` 1,000 – ` 15,000 – ` 2,000 – ` 4,000 = ` 14,000 Net value added at factor cost = ` 14,000. 25. Find consumption expenditure from the following: Autonomous consumption =™150. Marginal propensity to consume = 0.75. National income = ™ 1,000. Ans. We know that,

C = C + MPC(Y) = 150 + 0.75(1,000) = 150 + 750

= 900 Consumption expenditure = ™ 900. 26. Find Gross Value Added at Factor Cost: Items (i) Import duty (™)

1,000

(ii) Excise (™)

1,000

(iii) Output sold (units)

5,000

(iv) Price per unit of output (™)

6

(v) Change in stock (™)

600

(vi) Intermediate cost (™)

16,000

(vii) Subsidy (™) Ans. Gross Value Added at Factor Cost

500

= Sales (Output sold × Price per unit of output) + Change in stock – Intermediate cost – Import duty – Excise + Subsidy = (5,000 × ` 6) + ` 600 – ` 16,000 – ` 1,000 – ` 1,000 + ` 500 = ` 30,000 + ` 600 – ` 16,000 – ` 1,000 – ` 1,000 + ` 500 = ` 13,100 Gross value added at factor cost = ` 13,100.

Introductory Macroeconomics

97

Economics–XII

27. Find national income from the following: Autonomous consumption= ™ 200. Marginal propensity to consume = 0.70. Investment = ™ 700. Ans. We know that, Or,

Y= C + I Y = C + MPC(Y) + I Y = 200 + 0.70Y + 700 Y – 0.70Y = 900 0.30Y = 900

Y = 3,000 National income = ™ 3,000.

4 MARKS QUESTIONS 1. Giving reason explain how should the following be treated in estimating national income: (i) Expenditure on fertilisers by a farmer. (ii) Purchase of tractor by a farmer. Ans.

(i) Expenditure on fertilisers by a farmer is not included in national income, because it is an intermediate cost for the farmer as fertilisers are used up in the process of production. (ii) Purchase of tractor by a farmer is included in national income because it is investment expenditure or capital formation. A tractor is used by the farmer for several years in the process of farming and he is a final user of it.

2. Explain the components of Legal Reserve Ratio. Or Explain ‘bankers’ bank’ function of central bank. Ans. Legal reserve ratio has two variants: (i) Cash reserve ratio and (ii) Statutory liquidity ratio. Cash reserve ratio (CRR) refers to cash reserves of commercial banks with the central bank as a percentage of their deposits. Statutory liquidity ratio (SLR) refers to reserves in the form of liquid assets (including: (i) cash, (ii) gold, and (iii) approved securities) with the commercial banks themselves, as a percentage of their total deposits. Note:

(i) Both CRR and SLR are fixed by the central bank, and both are a legal binding for the commercial banks. In this sense, both CRR & SLR are legal reserve ratios. (ii) CRR and SLR cannot be treated as components of legal reserve ratio. Because, whereas CRR by definition includes cash reserves only, SLR includes (a) cash reserves, (b) gold reserves, and (c) reserves of approved securities, with the commercial banks. (iii) If CRR and SLR are treated as components of legal reserve ratio, both CRR and SLR should add up to LRR (legal reserve ratio). In practice, however, this is not true. If CRR + SLR = LRR then, in a situation when LRR is constant, any increase in CRR must imply a corresponding decrease in SLR. There is no evidence to such a situation whatsoever. Hence, the students are advised to treat CRR and SLR NOT as components of LRR, but only as variants of LRR. Or Central bank is an apex bank of all banks in the country. The central bank has almost the same relation with other banks in the country as a commercial bank has with its customers. As a banker’s bank, the central bank offers loans to the commercial bank, and also accepts deposits from them. The central bank keeps some cash balances of the commercial banks as a compulsory deposit. Central bank uses

Introductory Macroeconomics

98

Economics–XII

these funds to offer loans to the commercial banks as and when they need it. For its short period loans to commercial banks, the banks charges interest rate, often called Repo Rate. The central bank also offers commercial banks the facility of parking their surplus funds with it. The interest paid to commercial banks for these funds is called ‘Reverse Repo Rate’. This is how the central bank of a country plays the role of a banker’s bank. 3. Explain ‘revenue deficit’ in a government budget? What does it indicate? Ans. Revenue deficit is the excess of revenue expenditure of the government over its revenue receipts for the year of estimation. Revenue deficit indicates that the current expenditure of the government is greater than its current receipts. It points to the need for borrowing. 4. Giving reason explain how should the following be treated in estimating national income: (i) Payment of bonus by a firm. (ii) Payment of interest on a loan taken by an employee from the employer. Ans.

(i) Payment of bonus by a firm is included in national income as it is a component of compensation of employees. (ii) Payment of interest on the loan taken by an employee is not included in national income as the loan is not taken for production purposes.

5. Giving reason explain how should the following be treated in estimating national income: (i) Interest paid by banks on deposits by individuals. (ii) National debt interest. Ans.

(i) Interest paid by banks on deposits by individuals is included in national income because banks are expected to have used individual’s saving for productive purpose. (ii) National debt interest is not included in national income as it is assumed that government uses the national debt for the consumption purpose only.

6. Should the following be treated as final expenditure or intermediate expenditure? Give reasons for your answer. (i) Purchase of furniture by a firm. (ii) Expenditure on maintenance by a firm. Ans.

(i) Purchase of furniture by a firm is a final expenditure because furniture is repeatedly used by the firm for several years and these are of high value. (ii) Expenditure on maintenance by a firm is an intermediate expenditure as the things purchased for repair and maintenance are used-up during the period of one year.

7. Explain the ‘lender of last resort’ function of the central bank. Or Explain ‘government’s banker’ function of the central bank. Ans. The central bank acts as lender of last resort for the commercial banks of the country. It means that if a commercial bank fails to get financial accommodation from anywhere it can approach the central bank as a last resort. Central bank advances loan to such a bank against approved securities. It helps commercial banks to manage their financial crises. Or Central bank acts as a banker, agent and financial advisor to the government. As a banker to the government, it keeps the accounts of all government banks and manages government treasuries. The loans are given to the government without any interest for short-term. It also transfers government funds. It also buys and sells securities, treasury bills on behalf of the government. Being the apex bank of the country, it advises the government from time to time on economic, financial and monetary matters. Introductory Macroeconomics

99

Economics–XII

8. Explain the concept of ‘fiscal deficit’ in a government budget. What does it indicate? Ans. Fiscal deficit is the excess of budgetary expenditure over the budgetary receipts of the government, excluding borrowing. It indicates ‘borrowing requirement’ of the government to cope with the expenditures. Higher borrowing implies higher burden of repayment of loans and of interest on the future generations. Higher fiscal deficit points to lack of financial discipline in the economy. Often it triggers inflationary pressures in the economy and lowers credit-rating of the domestic economy in the international markets. Accordingly, investment process is hampered and GDP growth is challenged. 9. Giving reason, explain how should the following be treated while estimating national income: (i) Expenditure on free services provided by government. (ii) Payment of interest by a government firm. Ans.

(i) Expenditure on free services provided by government should be included in the estimation of national income because expenditure on these services is a part of government final consumption expenditure. (ii) Payment of interest by a government firm should be included while estimating national income because it is a kind of factor payment.

10. How should the following be treated while estimating national income? Give reasons. (i) Expenditure on education of children by a family. (ii) Payment of electricity bill by a school. Ans.

(i) Expenditure on education of children by a family is included in national income since it is a part of private final consumption expenditure. (ii) Payment of electricity bill by a school is not included in national income since it is a part of intermediate consumption.

11. Giving reason, explain how the following should be treated while estimating national income: (i) Payment of excise duty by a firm. (ii) Payment of interest by a firm. Ans.

(i) Payment of excise duty only increase the market value of final goods and services. Therefore, this is not included in the estimation of national income. (ii) Payment of interest by a firm is included in the national income because a firm takes loans for productive purposes.

12. Explain ‘bank of issue’ function of central bank. Or Explain the distinction between ‘Statutory liquidity ratio’ and ‘Legal reserve ratio’. Ans. The central bank is the sole note-issuing authority in the country. Often, the central banks divides its functions into two departments–banking department and issuing department. It is the issuing department that is responsible for note-issuing. It issues currency to cope with the demand for it, which depends upon the level of economic activity in the economy. Or Statutory liquidity ratio (SLR) requires the commercial banks to maintain a specified percentage of their deposits (implying their liabilities) in the form of liquid assets. The liquid reserves may be in the form of (i) cash reserves, (ii) gold reserves, and (iii) unencumbered approved securities. Legal reserve ratio may be defined as CRR, referring to cash reserves held by the commercial banks with the central bank as a percentage of their demand deposits, and as a matter of legal requirement. Note: Legal Reserve Ratio should not be confused as comprising of two components, viz., SLR and CRR. These are just the two variants of legal reserve ratio. Introductory Macroeconomics

100

Economics–XII

13. Explain the concept of ‘primary deficit’ in a government budget. What does it indicate? Ans. Primary deficit is the difference between fiscal deficit and interest payment. Primary Deficit = Fiscal Deficit – Interest Payment Primary deficit indicates borrowing requirement of the government owing to fiscal deficit net of interest payment. Payment of interest highlights the extent to which we are already in debt trap. Primary deficit indicates the extent to which we are adding to the pile of existing debt during the budgetary year. 14. How should the following be treated while estimating national income? Give reasons for your answer. (i) Festival gift from an employer. (ii) Rent free house from an employer. Ans.

(i) Festival gift from an employer is not included in the estimation of national income because this is a transfer payment. (ii) Rent free house from an employer is included in the estimation of national income because it is a kind of wages in kind, and therefore a part of compensation of employees.

15. Giving reason, explain how the following should be treated while estimating national income: (i) Free medical facilities by the employer. (ii) Contribution to provident fund by employees. Ans.

(i) Free medical facilities by the employer is included in the estimation of national income because it is a kind of wages in kind, and therefore a part of compensation of employees. (ii) Contribution to provident fund by the employees is an integral component of income. It is paid out of income. It is therefore not separately added in the estimation of national income.

6 MARKS QUESTIONS 1. Find out (a) National Income, and (b) Net National Disposable Income: Items (i) Factor income from abroad

(™ crore) 15

(ii) Private final consumption expenditure

600

(iii) Consumption of fixed capital

50

(iv) Government final consumption expenditure

200

(v) Net current transfers to abroad

(–)5

(vi) Net domestic fixed capital formation

110

(vii) Net factor income to abroad

10

(viii) Net imports

(–)20

(ix) Net indirect tax

70

(x) Change in stocks Ans. (a) National Income

(–)10

= Private final consumption expenditure + Government final consumption expenditure + Net domestic fixed capital formation + Change in stocks – Net imports - Net indirect tax – Net factor income to abroad = ` 600 crore + ` 200 crore + ` 110 crore + (-) ` 10 crore – (-) ` 20 crore – ` 70 crore - ` 10 crore = ` 600 crore + ` 200 crore + ` 110 crore - ` 10 crore + ` 20 crore – ` 70 crore - ` 10 crore = ` 840 crore Introductory Macroeconomics

101

Economics–XII

(b) Net National Disposable Income = National income + Net indirect tax – Net current transfers to abroad = ` 840 crore + ` 70 crore – (–) ` 5 crore = ` 840 crore + ` 70 crore + ` 5 crore = ` 915 crore (a) National income = ` 840 crore. (b) Net national disposable income = ` 915 crore. 2. Explain the concept of ‘excess demand’ in macroeconomics. Also explain the role of ‘open market operation’ in correcting it. Or Explain the concept of ‘deficient demand’ in macroeconomics. Also explain the role of bank rate in correcting it. Ans. Excess demand refers to a situation when aggregate demand (AD) is in excess of aggregate supply (AS) corresponding to full employment in the economy. It causes inflationary gap in the economy. Open market operations is the policy that focuses on increasing and decreasing the stock of liquidity (or cash balances) with the people, through sale and purchase of securities by the central bank. When cash balances need to be reduced as during situations of excess demand, the central bank starts selling securities. Sale of securities sucks purchasing power from the money market. Also primary deposits with the commercial banks are reduced which lowers their credit creation capacity, and therefore their capacity to lend. Consequently, aggregate demand is reduced and excess demand is corrected. Or Deficient demand refers to a situation when aggregate demand (AD) is short of aggregate supply (AS) corresponding to full employment in the economy. It causes deflationary gap in the economy. Bank rate is the rate at which the central bank lends money to the commercial banks. To correct the situation of deficient demand, bank rate is decreased. As a follow-up action, the commercial banks lower the market rate of interest (the rate at which the commercial banks lend money to the consumers and the investors). This increases demand for credit. Consequently, consumption expenditure and investment expenditure are increased. Implying a expansion in aggregate demand, as required to correct deficient demand. 3. Explain the distinction between autonomous and accommodating transactions in balance of payments. Also explain the concept of balance of payments ‘deficit’ in this context. Ans. Autonomous items of BoP (balance of payments) are those items which are autonomous of (or independent of) the BoP status. These are those economic transactions with rest of the world which are largely governed by the consideration of profit. It is on account of these transactions that there arises surplus or deficit in the country’s BoP. These are also called ‘above the line items of BoP.’ Accommodating items are those items which are meant to correct the situation of deficit in BoP or cover up the situation of surplus BoP. It is because of the accommodating items that BoP always balances. Balance of payments deficit refers to a situation when payments of a country on account of autonomous transactions exceed the receipts of the country on account of these transactions. Deficit on balance of payments is estimated only by the autonomous transactions (also known as above the line items of BoP) of the domestic economy with rest of the economy. 4. Find out (a) Net National Product at Market Price, and (b) Gross National Disposable Income: Items (™ crore) (i) Net current transfers from abroad

(–)10

(ii) Wages and salaries

1,000

Introductory Macroeconomics

102

Economics–XII

(iii) Net factor income to abroad

(–)20

(iv) Social security contributions by employers (v) Net indirect tax

100 80

(vi) Rent

300

(vii) Consumption of fixed capital

120

(viii) Corporation tax

50

(ix) Dividend

200

(x) Undistributed profits

60

(xi) Interest Ans. Net National Product at Market Price

400

= Wages and salaries + Social security contributions by employers + Rent + Interest + Corporate tax + Dividend + Undistributed Profits + Mixed income + Net indirect tax – Net factor income to abroad = ` 1,000 crore + ` 100 crore + ` 300 crore + ` 400 crore + ` 50 crore+ ` 200 crore + ` 60 crore + ™80 crore – (-) ` 20 crore = ` 1,000 crore + ` 100 crore + ` 300 crore + ` 400 crore + ` 50 crore+ ` 200 crore + ` 60 crore + ™80 crore + ` 20 crore = ` 2,210 crore Gross National Disposable Income = Net National Product at Market Price+ Consumption of fixed capital + Net current transfers from abroad = ` 2,210 crore + ` 120 crore + (–) ` 10 crore = ` 2,320 crore (a) Net national product at market price = ` 2,210 crore. (b) Gross national disposable income = ` 2,320 crore. 5. Find out (a) Gross National Product at Market Price, and (b) Net Current Transfers from Abroad: Items (™ crore) (i) Net indirect tax

35

(ii) Private final consumption expenditure

500

(iii) Net national disposable income

750

(iv) Closing stock

10

(v) Government final consumption expenditure

150

(vi) Net domestic fixed capital formation

100

(vii) Net factor income to abroad

(–) 15

(viii) Net imports

20

(ix) Opening stock

10

(x) Consumption of fixed capital Ans. Gross National Product at Market Price

50

= Private final consumption expenditure + Government final consumption expenditure + Net domestic fixed capital formation + Change in stocks (Closing stock – Opening stock) + Consumption of fixed capital – Net imports – Net factor income to abroad = ` 500 crore + ` 150 crore + ` 100 crore + ( ` 10 crore – ™ 10 crore) + ` 50 crore – ` 20 crore – (–) ` 15 crore Introductory Macroeconomics

103

Economics–XII

= ` 500 crore + ` 150 crore + ` 100 crore + ` 0 crore + ` 50 crore – ` 20 crore + ` 15 crore = ` 795 crore Net National Disposable Income = Gross National Product at Market Price – Consumption of fixed capital + Net current transfers from abroad Or, Net Current Transfers from Abroad = Net National Disposable Income – Gross National Product at Market Price + Consumption of fixed capital = ` 750 crore – ` 795 crore + ™ 50 crore = ™ 5 crore (a) Gross national product at market price = ™ 795 crore. (b) Net current transfers from abroad = ` 5 crore. 6. Find out (a) Gross National Product at Market Price, and (b) Net Current Transfers to Abroad: Items (™ crore) (i) Private final consumption expenditure

1,000

(ii) Depreciation

100

(iii) Net national disposable income

1,500

(iv) Closing stock

20

(v) Government final consumption expenditure

300

(vi) Net indirect tax

50

(vii) Opening stock

20

(viii) Net domestic fixed capital formation

110

(ix) Net exports

15

(x) Net factor income to abroad Ans. (a) Gross National Product at Market Price

(–)10

= Private final consumption expenditure + Government final consumption expenditure + Net domestic fixed capital formation + Change in stocks (Closing stock – Opening stock) + Depreciation + Net exports – Net factor income to abroad = ` 1,000 crore + ` 300 crore + ` 110 crore + ( ` 20 crore – ™ 20 crore) + ` 100 crore + ` 15 crore – (–) ` 10 crore = ` 1,000 crore + ` 300 crore + ` 110 crore + ` 0 crore + ` 100 crore + ` 15 crore + ` 10 crore = ` 1,535 crore (b) Net National Disposable Income = Gross national product at market price – Depreciation – Net current transfers to abroad Or, Net Current Transfers to Abroad = Gross national product at market price – Depreciation – Net national disposable income = ` 1,535 crore – ` 100 crore – ` 1,500 crore = (–) ` 65 crore (a) Gross national product at market price = ` 1,535 crore. (b) Net current transfers to abroad = (–) ` 65 crore.

Introductory Macroeconomics

104

Economics–XII

7. Explain the concept of ‘inflationary gap’. Also explain the role of ‘legal reserves’ in reducing it. Or Explain the concept of ‘deflationary gap’. Also explain the role of ‘margin requirements’ in reducing it. Ans. Inflationary gap is the excess of aggregate demand over and above its level required to maintain full employment equilibrium in the economy. Legal reserves refer to that part of bank deposits which commercial banks are legally required to set aside in the form of (i) cash, (ii) gold, or (iii) approved securities. These reserves are determined by CRR (cash reserve ratio), and SLR (statutory liquidity ratio). During inflation, both CRR and SLR are raised with a view to mopping up liquidity from the banking system. This reduces credit creation capacity of the commercial banks. Accordingly, availability of credit decreases in the capital market. As a result, aggregate demand reduces as required to correct inflationary gap in the economy. Or Deflationary gap is the shortfall in aggregate demand from the level required to maintain full employment equilibrium in the economy. Margin requirements refer to minimum down payment that the borrowers are to make as a percentage of their total borrowing from the commercial banks. Margin requirement is reduced to correct situations of deflationary gap. Lower margin requirement induces borrowing. This raises borrowing capacity of even the marginal borrowers. Implying a rise in the flow of credit and therefore a rise in aggregate demand. This is what is required to correct deficient demand or deflationary gap. 8. Give the meaning of ‘foreign exchange’ and ‘foreign exchange rate’. Giving reason, explain the relation between foreign exchange rate and demand for foreign exchange. Ans. Foreign exchange refers to any currency other than the domestic currency. Foreign exchange rate is the rate at which one currency can be exchanged for the other currency in the international foreign exchange market.

Rate of Exchange

Y Foreign exchange rate and demand for foreign D exchange are inversely related to other. When the R2 price of foreign currency falls, (or the availability of foreign exchange becomes cheaper than before) we get more dollar per unit of our currency. Accordingly, R domestic traders would tend to buy more goods in the international market. This raises demand for R1 foreign currency from OD to OD1 when exchange rate falls from OR to OR1 in Fig. 4. Similarly, when O D2 D1 D the price of foreign currency rises, we get less dollar Quantity Demanded per unit of our currency. Accordingly, domestic (Foreign Currency) traders would be able to buy less goods in the Figure 4 international market. As a result, demand for foreign currency will fall from OD to OD2 when exchange rate rise from OR to OR2 in Fig. 4.

D X

9. Find out (a) National Income, and (b) Net National Disposable Income: Items

(™ crore)

(i) Net imports

(–)10

(ii) Net domestic fixed capital formation

100

(iii) Private final consumption expenditure

600

(iv) Consumption of fixed capital

60

(v) Change in stocks Introductory Macroeconomics

(–)50 105

Economics–XII

(vi) Government final consumption expenditure

200

(vii) Net factor income to abroad

20

(viii) Net current transfers to abroad

30

(ix) Net indirect tax

70

(x) Factor income from abroad Ans. (a) National Income

10

= Private final consumption expenditure + Government final consumption expenditure + Net domestic fixed capital formation + Change in stocks – Net imports – Net indirect tax – Net factor income to abroad = ` 600 crore + ` 200 crore + ` 100 crore + (-) ` 50 crore – (-) ` 10 crore - ` 70 crore - ` 20 crore = ` 600 crore + ` 200 crore + ` 100 crore - ` 50 crore + ` 10 crore - ` 70 crore - ` 20 crore = ` 770 crore (b) Net National Disposable Income = National income + Net indirect tax – Net current transfers to abroad = ` 770 crore + ` 70 crore – ` 30 crore = ` 810 crore (a) National income = ` 770 crore. (b) Net national disposable income = ` 810 crore. 10. Find out (a) Net National Product at Market Price, and (b) Gross National Disposable Income from the following: Items (™ crore) (i) Undistributed profits

20

(ii) Compensation of employees

800

(iii) Rent

300

(iv) Dividend

100

(v) Royalty

40

(vi) Net current transfers to abroad

(–)30

(vii) Corporation tax

50

(viii) Interest

400

(ix) Depreciation

70

(x) Net factor income from abroad

(–)10

(xi) Net indirect tax Ans. (a) Net National Product at Market Price

60

= Compensation of employees + Rent + Royalty + Interest + Undistributed Profits + Dividend + Corporation tax+ Net indirect tax + Net factor income from abroad = ` 800 crore + ` 300 crore + ` 40 crore + ` 400 crore + ` 20 crore + ` 100 crore + ` 50 crore + ™ 60 crore + (-) ` 10 crore = ` 800 crore + ` 300 crore + ` 40 crore + ` 400 crore + ` 20 crore + ` 100 crore + ` 50 crore + ™ 60 crore - ` 10 crore = ` 1,760 crore

Introductory Macroeconomics

106

Economics–XII

(b) Gross National Disposable Income = Net national product at market price + Depreciation – Net current transfers to abroad = ` 1,760 crore + ` 70 crore – (–) ` 30 crore = ` 1,760 crore + ` 70 crore + ` 30 crore = ` 1,860 crore (a) Net national product at market price = ` 1,760 crore. (b) Gross national disposable income = ` 1,860 crore. 11. Find (a) Net National Product at Market Price, and (b) Gross National Disposable Income: Items

(™ crore)

(i) Wages and salaries

700

(ii) Rent

100

(iii) Net current transfers to abroad

10

(iv) Net indirect tax

70

(v) Royalty

50

(vi) Profits

300

(vii) Net factor income to abroad

(–)20

(viii) Consumption of fixed capital

120

(ix) Social security contribution by employers

60

(x) Social security contribution by employees

40

(xi) Interest

400

Ans. (a) Net National Product at Market Price = Wages and salaries + Social security contribution by employers + Rent + Royalty + Profits + Interest + Net indirect tax – Net factor income to abroad = ` 700 crore + ` 60 crore + ` 100 crore + ` 50 crore + ` 300 crore + ` 400 crore + ™ 70 crore – (-) ` 20 crore = ` 700 crore + ` 60 crore + ` 100 crore + ` 50 crore + ` 300 crore + ` 400 crore + ` 70 crore + ™ 20 crore = ` 1,700 crore (b) Gross National Disposable Income = Net national product at market price + Consumption of fixed capital – Net current transfers to abroad = ` 1,700 crore + ` 120 crore – ` 10 crore = ` 1,810 crore (a) Net national product at market price = ` 1,700 crore. (b) Gross national disposable income = ` 1,810 crore. 12. Explain the concept of ‘deflationary gap’. Also explain the role of ‘open market operations’ in reducing it. Or Explain the concept of ‘excess demand’. Also explain the role of ‘bank rate’ in reducing it. Ans. Deflationary gap is the shortfall in aggregate demand from the level required to maintain full employment equilibrium in the economy. It causes deflationary gap in the economy. Owing to Introductory Macroeconomics

107

Economics–XII

deficient demand, planned level of output is reduced. Along with reduction in the level of output, level of income and employment also tend to reduce. The economy is driven into a state of low level equilibrium trap. Open market operations is the policy that focuses on increasing and decreasing the stock of liquidity (or cash balances) with the people as well as with the commercial banks, through sale and purchase of securities by the central bank. During the situations of deflationary gap, when cash balances need to be increased (to stimulate the level of aggregate demand) the central bank starts buying securities. Purchase of securities injects purchasing power into the money market. Cash balances of the commercial banks start picking up. This enhances their capacity to create credit. Consequent upon the greater flow of credit in the economy, aggregate demand is increased. Deflationary gap is corrected. Or Excess demand refers to a situation when aggregate demand (AD) is in excess of aggregate supply (AS) corresponding to full employment in the economy. It causes inflationary gap in the economy. Price level tends to rise without any rise in the level of income or employment. Bank rate is the rate at which the central bank lends money to the commercial banks. To correct the situation of excess demand, bank rate is increased. As a follow-up action, the commercial banks raise the market rate of interest (the rate at which the commercial banks lend money to the consumers and the investors). This reduces demand for credit. Consequently, consumption expenditure and investment expenditure are reduced. Implying a reduction in aggregate demand, as required to correct excess demand. 13. Give two sources each of demand and supply of foreign exchange. Giving reason, explain the relation between foreign exchange rate and supply of foreign exchange. Ans. Two sources of demand for foreign exchange are as these: (i) Payments of international loans. (ii) Gifts and grants to rest of the world. Two sources of supply of foreign exchange are as these: (i) Purchases of domestic goods by the foreigners. (ii) Direct foreign investment as well as portfolio investment in home country. Y S Rate of Exchange

Ordinarily, foreign exchange rate and supply of foreign exchange are positively related. Suppose, when the price of foreign currency falls (in relation to domestic currency), purchasing power of foreign currency in the domestic economy tends to reduce. This causes reduction in export from the domestic economy. Accordingly, supply of foreign currency reduces from OS to OS2 when exchange rate falls from OR to OR2 as shown in Fig. 5.

R1 R R2 S O

S1 S2 S Quantity Supplied (Foreign Currency)

X

Similarly, when the price of foreign currency rises (in Figure 5 relation to domestic currency), purchasing power of foreign currency in the domestic economy tends to increase. This causes increase in export from the domestic economy. Accordingly, supply of foreign currency increases from OS to OS1 when exchange rate rises from OR to OR1 as shown in Fig. 5.

Introductory Macroeconomics

108

Economics–XII

14. Find out (a) Gross National Product at Market Price, and (b) Net Current Transfers from Abroad: Items (™ crore) (i) Net national disposable income

1,100

(ii) Net indirect tax

120

(iii) Private final consumption expenditure

750

(iv) Government final consumption expenditure

250

(v) Net domestic fixed capital formation

200

(vi) Net imports

(–)40

(vii) Net factor income to abroad

(–)20

(viii) Depreciation

50

(ix) Change in stock Ans. (a) Gross National Product at Market Price

10

= Private final consumption expenditure + Government final consumption expenditure + Net domestic fixed capital formation + Depreciation + Change in stock – Net imports – Net factor income to abroad = ` 750 crore + ` 250 crore + ` 200 crore + ™ 50 crore + ` 10 crore – (–) ` 40 crore – (–) ` 20 crore = ` 750 crore + ` 250 crore + ` 200 crore + ™ 50 crore + ` 10 crore + ` 40 crore + ` 20 crore = ` 1,320 crore (b) Net National Disposable Income = Gross national product at market price – Depreciation + Net current transfers from abroad Or, Net Current Transfers from Abroad = Net national disposable income – Gross national product at market price + Depreciation = ` 1,100 crore – ` 1,320 crore + ` 50 crore = (–) ` 170 crore (a) Gross national product at market price = ` 1,320 crore. (b) Net current transfers from abroad = (–) ` 170 crore. 15. Find out (a) National Income, and (b) Net National Disposable Income: Items (i) Net domestic fixed capital formation

(™ crore) 200

(ii) Factor income from abroad

30

(iii) Change in stock

(–)20

(iv) Net indirect tax

120

(v) Net current transfers to abroad

(–)10

(vi) Private final consumption expenditure

800

(vii) Consumption of fixed capital

100

(viii) Government final consumption expenditure

300

(ix) Net factor income to abroad

40

(x) Net imports

(–)50

Ans. (a) National Income = Private final consumption expenditure + Government final consumption expenditure + Net domestic fixed capital formation + Change in stock – Net imports – Net indirect tax – Net factor income to abroad

Introductory Macroeconomics

109

Economics–XII

= ` 800 crore + ` 300 crore + ` 200 crore + (–) ` 20 crore – (–) ` 50 crore – ` 120 crore – ` 40 crore = ` 800 crore + ` 300 crore + ` 200 crore – ` 20 crore + ` 50 crore – ` 120 crore – ` 40 crore = ` 1,170 crore (b) Net National Disposable Income =National income + Net indirect tax – Net current transfers to abroad = ` 1,170 crore + ` 120 crore – (–) ` 10 crore = ` 1,170 crore + ` 120 crore + ` 10 crore = ` 1,300 crore (a) National income = ` 1,170 crore. (b) Net national disposable income = ` 1,300 crore. zzz

Introductory Macroeconomics

110

Economics–XII