Download UNIT : 4 FORMS OF MARKET -10 marks 1. Define market. It is a real

UNIT : 4 FORMS OF MARKET -10 marks
1. Define market.
It is a real or imaginary place where goods and services are purchased and sold
by buyers and sellers respectively and payment is made in return for it.
2. Define perfect competition market.
It is a market in which there are large number of buyers and sellers, selling
homogenous goods. There is free entry into and exit from the market and firm
is price taker and industry is price maker.
3. Define monopoly market.
It is a market where there is only one seller selling a good which does not
haveany substitute. Firm is the price maker and there is restricted entry into
and exit from the market.
4. Define monopolistic competition market.
It is a market in which there are large number of buyers and large number of
small sellers, selling differentiated goods, which are close substitutes. There is
free entry into and exit from the market and firm is price maker.
5. Define oligopoly market.
In this market there are few large sellers selling homogenous or differentiated
good. Firms are mutually interdependent for deciding prices either
competitively or through competition.There is restricted entry into and exit
from the market.
Collusive oligopoly – In this type of oligopoly firms decide price of goods
through mutual cooperation with each other by forming groups or cartels.
Nom collusive oligopoly - In this type of oligopoly firms decide price of goods
through competition with each other
Note: If unable to understand any indirect or hot question based on feature
of market do mention the features of market given in question
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6. Explain the implication of following features of various markets (Eachpart is
for 2 or 3marks):(a)Large number of buyers and sellers in perfect competition market!
Implications(i) As there are large number of sellers’ individual seller cannot
influence market supply or price.
Similarly one buyer cannot affect market demand or price.
(ii) Firms become price takers as they have to accept the equilibrium price that
market demand & supply decide. So market or industry is price maker.
(iii) Due to large number of buyers firm can sell any amount of good at
equilibrium price. Hence they have perfectly elastic,horizontal Average
Revenue (AR) curve.
(b) Homogenous goods in perfect competition market!
Implications: -Perfect competition market has homogenous goods which are
same in shape, size, colour, price etc.
(i) So it is easy for new firms to enter into and exit from the market.
(ii) There is no selling cost as there is no need for advertising the good
(iii) So one firm cannot effect price market decides the price.
(c) Free entry into and exit from the market in perfect competition
market!
Implications:- If in Short Run there is abnormal profit firms will enter the
market & if there are abnormal losses firms will exit the market.
Hencein theLong run firms will earn Normal Profits.
(d) Differentiatedgoods monopolistic competition market!
Implications:- Differentiated goods are different in shape, size, colour,
packaging etc.
(i) New firms can easily enter the market by adding new feature in their
product.
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(ii)Non price competition occurs firms compete on the basis of different
features in good and not on the basis of prices.
(iii) Selling costs are high as differentiated goods of competitors are close
substitutes so firms have to advertise & change the product qualities.
(e) Downward sloping AR curve in monopoly & monopolistic
competition market!
Implications:- Due to downward slope of AR curve & demand curve in
both the markets the firms have to simultaneously decide price and quantity to
be sold. If firm decides to sell at a high price then AR curve indicates that less
quantity will be sold. If they decide on larger quantity to be sold then AR curve
will show the low price to be charged by firms.
More good can be sold at lower price and lessgood can be sold at higher
price.
7. Differentiate between the following:perfect competition market
1 .Large number of buyers and sellers.
2. Firm is price taker and industry is
price maker.
3. Average Revenue (AR) curve is
perfectly elastic & horizontal.
4. There is no Selling cost
perfect competition market
1. Large number of buyers and sellers.
2. There is free entry into and exit
from the market.
3. Firm is price taker and industry is
price maker.
4. Average Revenue (AR) curve
perfectly elastic & horizontal.
monopolistic competition market
1. There are large number of buyers
and large number of small sellers.
2.Firm is the price maker
3. Average Revenue (AR) curve is
downward sloping & elastic.
4. Selling costs are high.
monopoly
1. There is only one seller.
2. There is restricted entry into and
exit from the market.
3. Firm is the price maker
4. Average Revenue (AR) curve is
downward sloping & inelastic.
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monopoly market
1. There is only one seller.
monopolistic competition market
1. There are large number of buyers
and large number of small sellers.
2. There is free entry into and exit
from the market.
3. Selling costs are very high.
2. There is restricted entry into and
exit from the market.
3.Selling costs are low & are onetime
costs
4 .Average Revenue (AR) curve is
4. Average Revenue (AR) curve is
downward sloping and inelastic.
downward sloping elastic.
5. Goods in this market have no close 5. Goods in this market have very
substitutes.
close substitutes.
8. Average Revenue (AR) curve of monopolymarket moreinelastic compared to
AR curve of monopolistic competition market, why?OR
Why is Average Revenue (AR) curve of monopolymarketsteeper compared to
AR curve of monopolistic competition market?
In monopolythere is only one seller, selling a good which has no substitute,
firm is the price maker and there is restricted entry into and exit from the
market.
If the firm increases price buyer do not have any substitute to buy, so quantity
demanded by them changes by lesser degree than change in price. So AR curve
is inelastic and steeper compared to monopolistic competition.
Whereas in monopolistic competitionmarket there are largenumbers of small
sellers, selling differentiated goods, which are very close substitutes & there is
free entry into and exit from the market and firm is price maker.
If the firm increases price of the good buyers will immediately start buying
goods from its competitors. Hence quantity demanded changes by greater
degree compared to prices so AR curve is more elastic & flatter compared to
monopoly.
9(A). What is Price discrimination?
In monopoly market firms sell same good at different prices in different
markets, to different groups and at different places. This is called Price
discrimination.
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9(B). Q) The firm under monopoly is a price maker- Discuss ( 4 )
Ans- Under perfect competition, the firm is price taker. But under monopoly the firm is price
maker. In monopoly there is a single seller of a commodity. He has full control over the price
of his product. He can increase or decrease the price of the product. There is no competition
of other firms as there is only one firm in the market. There is no close substitutes of the
monopoly product. There is no possibility for entry of new firm in the monopoly market.
Hence the monopolist or the monopoly market is price maker.
10.) Explain the feature or concept of product differentiation. ( 3 )
Ans Product differentiation- In monopolistic competition market there are
large number of firms selling goods which are close substitutes. The product of
one firm is different from that of other firm only in colour, size, shape,
packaging, branding, advertising etc, this is known as Product differentiation.
Because of product differentiation, each firm can decide its price but it has to
keep price of competitors in mind. . So each firm is price maker but it has a
partial control over price of its product.
11. If abnormal profits are earned in perfect competition market in the short
run & there is free entry, what will happen to profits in the long run? Explain.
When firms earn abnormal profits in the short run, new firms will be attracted
by profits and will enter the market due to free entry.
Market supply of goods increases.
Share of each firm in market sales falls
So firms will compete with each other and reduce prices to sell stock of goods.
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Profits of each firm declines
New firms will continue to enter till the abnormal profits fall
And all firms earn only normal profits in the longrun.
12.If abnormal losses are incurred in perfect competition market in the short
run & there is free exit, what will happen to losses in the long run? Explain.
When firms have abnormal losses in the short run,
Some firms will exit the market due to free exit.
Share of each firm in market sales increases.
Market supply of goods decreases, due to which prices rise
And losses of each firm declines
New firms will continue to exit till the abnormal losses fall
And all firms earn only normal profits in the longrun.
13. Why is the average revenue curve of perfect competition perfectly elastic
(horizontal) ?
OR How is equilibrium price determined by perfect competition firm?
Market Equilibrium
Firms Equilibrium
S
P
e
P
P1
P1
P1=AR=MR
D
O
quantity demanded
And supplied
O
quantity demanded
and supplied
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P is Price, d-demand, S- supply
E –equilibrium, P1- equilibrium price
In perfect competition market there are large numbers of buyers and sellers,
selling homogenous goods, there is free entry into and exit from the market, so
no individual buyer or seller can effect market demand, supply or price.
Marketdemand & supply decide the equilibrium price and firms can sell any
amount of goods at this price as there are infinite buyers .
Firms will not sell at a price more than equilibrium price otherwise they will
lose their buyers to other sellers selling same good at equilibrium price.
Perfect competition firm earnnormal profits at equilibrium price so firms will
not sell at a lower price than equilibrium price as it will lead to losses.
So demand or AR curve is perfectly elastic and horizontal at equilibrium price.
14. How is equilibrium price determined in perfect competition market?
Explain diagrammatically.
Excess Supply
PriceS
P1 A B
P2 e
P3L
MD
Excess Demand
O
Q2
Quantity demanded and supplied
Market equilibrium occurs at a price level where quantity demanded is equal
to quantity supplied.
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In the diagram given above
Market equilibrium occurs at a price level OP2 at point e ,
Where, quantity demanded = quantity supplied = OQ2
Disequilibrium occurs at any price level above or below equilibriumprice.
 If Market price ( e.g.: OP 3 )is more than equilibrium price
Then quantity demanded (P3A) is less than quantity supplied (P3B) , so Excess
Supply equal to AB occurs.
Sellers will compete with each other to sell excess goods in their stocks, they
will reduce prices, hence quantity demanded rises and quantity supplied falls.
Price is again reduced. This process continues till the excess supply gets wiped
out and equilibriumprice is reached where, quantity demanded = quantity
supplied = OQ2.
 If Market price ( e.g.: OP 1 )is less than equilibrium price
Then quantity demanded (P1M) is more than quantity supplied (P1N) , so
Excess Demand equal to NM occurs.
Buyers will compete with each other and some buyers will be willing to
pay higher prices to get the good.
Sellerswillincrease prices,hence quantity demanded falls and quantity supplied
rises. Price is again raised. This process continues till the excess demand gets
wiped out and equilibriumprice is reached where, quantity demanded =
quantity supplied = OQ2.
Questions Based on Market Equilibrium ( Shifts in Demand & Supply Curves)
----------------------------------------------------------------------------------------------NOTE: In all questions below there are only 2 basic answers whose main
point will be as follows
(1) Excess Demand
Buyers will compete with each
otherand some buyers will be willing
to pay higher prices to get the good.
(2) Excess Supply.
Sellers will compete with each other
to sell excess goods in their stocks,
they will reduce prices,
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Sellerswillincrease prices,
hence quantity demanded falls and
quantity supplied rises.
hence quantity demanded rises and
quantity supplied falls.
Excess Demand occurs in following
cases
Factors effecting Demand Increase
Demand.
Factors effecting Supply Decrease
Supply.
Increase in Demand is more than
Increase in Supply
Demand Increase & Supply decrease
Excess Supply occurs in following
cases
Factors effecting Supply Increase
Supply.
Factors effecting Demand decrease
Demand.
Increase in Supply is more than
Increase in Demand
Supply Increase & Demand decrease
-------------------------------------------------------------------------------------------15. If income of the consumer increasesand consumer consumes normal
goods, explain the effect on equilibrium price with the help of diagram?
OR If income of the consumer decreases and consumer consumes inferior
goods, explain the effect on equilibrium price with the help of diagram?
OR If there is favourable change in fashion, what will happen to equilibrium
quantity &equilibrium price. Explain the chain reaction with the help of
diagram.
OR If there is favourable change in tastes & preferenceswhatwill happen
toequilibrium quantity &equilibriumprice. Explain the chain reaction with the
help of diagram
Or if the price of substitute good rises,whatwill happen toequilibrium quantity
&equilibrium price. Explain the chain reaction with the help of diagram
Or if the price of complementary good falls,whatwill happen toequilibrium
quantity &equilibriumprice. Explain the chain reaction with the help of
diagram.
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Price
S
P2
e2
P1
e1
Excess Demand
A
D2
D1
O
Q1
Q2
Quantity demanded and supplied
Demand will increase
Demand curve will shift upwards to the right from D1 to D2
At original equilibriumprice OP1
New quantity demanded = P 1 A
New quantity supplied =P 1 e 1
The new quantity demanded (P1 A) is more than new quantity supplied
(P1 e1), so Excess Demand equal to (e1 A) occurs.
Buyers will compete with each other and some buyers will be willing to
pay higher prices to get the good.
Sellerswillincrease prices,hence quantity demanded falls and quantity supplied
rises. Price is again raised. This process continues till the excess demand gets
wiped out and newequilibriumis reached at point e2 where, quantity
demanded = quantity supplied = OQ2.
So equilibrium price increases from OP1 to OP2
&equilibrium quantity increases from OQ1 to OQ 2
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16. If the number of firms decreaseswhat will happen to equilibrium quantity
&equilibrium price. Explain the chain reaction with the help of diagram.
OR If the government policy is unfavourable, explain the effect on
equilibrium price with the help of diagram?
OR
If price of input i.e. raw materials increases what will happen to
equilibrium quantity &equilibrium price. Explain the chain reaction with the
help of diagram.
OR If cost of technology is high what will happen to equilibrium quantity
&equilibrium price. Explain the chain reaction with the help of diagram.
OR If weather is unfavourable what will happen to equilibrium quantity
&equilibrium price. Explain the chain reaction with the help of diagram.
S2
Price S1
e2
P2
P1A
e1
Excess Demand
D1
O
Q2
Q1
Quantity demanded and supplied
Supply will decrease
Supply curve will shift upwards to the left from S1 to S2
At original equilibriumprice OP1
New quantity demanded =P 1 e 1
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New quantity supplied =P 1 A
The new quantity demanded (P 1 e 1) is less than new quantity supplied (P 1 A),
so Excess Demand equal to (Ae1 ) occurs.
Buyers will compete with each other and some buyers will be willing to
pay higher prices to get the good.
Sellerswillincrease prices,hence quantity demanded falls and quantity supplied
rises. Price is again raised. This process continues till the excess demand gets
wiped out and new equilibriumis reached at point e2 where, quantity
demanded = quantity supplied = OQ2.
So equilibrium price increases from OP1 to OP2
&equilibrium quantity decreases from OQ1 to OQ 2
17.If income of the consumer decreases and consumer consumes normal
goods, explain the effect on equilibrium price with the help of diagram?
OR If income of the consumer increases and consumer consumes inferior
goods, explain the effect on equilibrium price with the help of diagram?
OR If there is unfavourable change in fashion, what will happen to
equilibrium quantity &equilibrium price. Explain the chain reaction with the
help of diagram.
OR If there is unfavourable change in tastes & preferenceswhatwill happen
toequilibrium quantity &equilibriumprice. Explain the chain reaction with the
help of diagram
Or If the price of substitute good falls,whatwill happen toequilibrium quantity
& equilibrium price. Explain the chain reaction with the help of diagram
Or If the price of complementary good rises,whatwill happen toequilibrium
quantity &equilibrium price. Explain the chain reaction with the help of
diagram.
PriceExcess supply
S
12
P1A
e1
P2
e2
D1
D2
O
Q2 Q1
Quantity demanded and supplied
Demand will decrease
Demand curve will shift downwards to the left from D1 to D2
At original equilibriumprice OP1
New quantity demanded = P 1 A
New quantity supplied =P 1 e 1
Then quantity demanded (P 1A) is less than quantity supplied (P 1 e 1) , so
Excess Supply equal to Ae 1 occurs.
Sellers will compete with each other to sell excess goods in their stocks, they
will reduce prices, hence quantity demanded rises and quantity supplied falls.
Price is again reduced. This process continues till the excess supply gets wiped
out and new equilibriumis reached at point e 2, where new quantity demanded
=new quantity supplied = OQ2.
So equilibrium price decreases from OP1 to OP2
&equilibrium quantity decreases from OQ1 to OQ 2
18. If the number of firms increaseswhat will happen to equilibrium quantity
&equilibrium price. Explain the chain reaction with the help of diagram.
13
OR If the government policy is favourable, explain the effect on equilibrium
price with the help of diagram?
OR
If price of input i.e. raw material decreaseswhat will happen to
equilibrium quantity &equilibrium price. Explain the chain reaction with the
help of diagram.
OR If cost of technology is lowwhat will happen to equilibrium quantity
&equilibrium price. Explain the chain reaction with the help of diagram.
OR If weather is favourable what will happen to equilibrium quantity
&equilibrium price. Explain the chain reaction with the help of diagram.
S1
Price
Excess Supply S2
P1
e1A
P2
e2
D
O
Q1 Q2
Quantity demanded and supplied
Supply will increase
Supply curve will shift downwards to the left from S1 to S2
At original equilibriumprice OP1
New quantity demanded = P 1 e 1
New quantity supplied =P 1 A
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Then quantity demanded (P 1 e 1) is less than quantity supplied (P 1A) , so Excess
Supply equal to e 1 A occurs.
Sellers will compete with each other to sell excess goods in their stocks, they
will reduce prices, hence quantity demanded rises and quantity supplied falls.
Price is again reduced. This process continues till the excess supply gets wiped
out and new equilibriumis reached at point e 2, where new quantity demanded
=new quantity supplied = OQ2.
So equilibrium price decreases from OP1 to OP2
&equilibrium quantity increases from OQ1 to OQ 2
19. What will happen to equilibrium quantity & equilibrium price when there
is simultaneous decrease inDemand &Supply.(A) Decrease in demand is
greater than decrease in Supply
PriceExcess supply
S2
P1S1
P2A
B
e1
e2
D1
D2
O
Q1
Q2
Quantity demanded and supplied
Demand will decrease,
15
Demand curve will shift downwards to the left from D1 to D2
Supply will decrease
Supply curve will shift upwards to the left from S1 to S2
At original equilibriumprice OP1
New quantity demanded = P 1 A
New quantity supplied =P 1 B
Then quantity demanded (P 1 A) is less than quantity supplied (P 1B) , so Excess
Supply equal to AB occurs.
Sellers will compete with each other to sell excess goods in their stocks, they
will reduce prices, hence quantity demanded rises and quantity supplied falls.
Price is again reduced. This process continues till the excess supply gets wiped
out and new equilibriumis reached at point e 2, where new quantity demanded
=new quantity supplied = OQ2.
So equilibrium price decreases from OP1 to OP2
&equilibrium quantity decreases from OQ1 to OQ 2
(B)Decrease in demand is less than decrease in Supply
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S2
Price
e 2S1
P2
P1 A B
e1
Excess demand
D1
D2
O
Q2
Q1
Quantity demanded and supplied
Demand will decrease
Demand curve will shift downwards to the left from D1 to D2
Supply will decrease
Supply curve will shift upwards to the left from S1 to S2
At original equilibriumprice OP1
New quantity demanded = P 1 B
New quantity supplied =P 1 A
Then quantity demanded (P 1B) is more than quantity supplied (P 1 A) , so
Excess Demand equal to AB occurs.
Buyers will compete with each other and some buyers will be willing to
pay higher prices to get the good.
Sellerswillincrease prices,hence quantity demanded falls and quantity supplied
rises. Price is again raised. This process continues till the excess demand gets
wiped out and new equilibriumis reached at point e2 where, quantity
demanded = quantity supplied = OQ2.
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So equilibrium price increases from OP1 to OP2
&equilibrium quantity decreases from OQ1 to OQ 2
(C)Decrease in demand is equal to decrease in Supply
S2
P rice
P1
S1
e 2 e1
D1
D2
O
Q2 Q1
Quantity demanded and supplied
Demand will decrease
Demand curve will shift downwards to the left from D1 to D2
Supply will decrease
Supply curve will shift upwards to the left from S1 to S2
At original equilibriumprice OP1
New quantity demanded =New quantity supplied = P1 e2
So there is neither ExcessDemand norExcess Supply
Hence, Soequilibrium priceremains constant at OP1
&equilibrium quantity decreases from OQ1 to OQ 2
20. What will happen to equilibrium quantity & equilibrium price when there
is simultaneous increase Demand & Supply?
18
(a) Increase in demand is greater than increase in Supply
Price
S1S2
P1
P2A
e2
B
e 1Excess demand
D2
D1
O
Q1
Q2
Quantity demanded and supplied
Demand will increase
Demand curve will shift downwards to the left from D1 to D2
Supply will increase
Supply curve will shift upwards to the left from S1 to S2
At original equilibriumprice OP1
New quantity demanded = P 1 B
New quantity supplied =P 1 A
Then quantity demanded (P 1B) is more than quantity supplied (P 1 A) , so
Excess Demand equal to AB occurs.
Buyers will compete with each other and some buyers will be willing to
pay higher prices to get the good.
19
Sellerswillincrease prices,hence quantity demanded falls and quantity supplied
rises. Price is again raised. This process continues till the excess demand gets
wiped out and new equilibriumis reached at point e2 where, quantity
demanded = quantity supplied = OQ2.
So equilibrium price increases from OP1 to OP2
&equilibrium quantity increases from OQ1 to OQ 2
(b)Increase in demand is less than increase in Supply
S1
Price
e 1Excess Supply S2
P1
A
P2
B
e2
D2
D1
O
Q1
Q2
Quantity demanded and supplied
Demand will increase
Demand curve will shift downwards to the left from D1 to D2
Supply will increase
Supply curve will shift upwards to the left from S1 to S2
At original equilibriumprice OP1
New quantity demanded = P 1 A
New quantity supplied =P 1 B
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Then quantity demanded (P 1 A) is less than quantity supplied (P 1B) , so Excess
Supply equal to AB occurs.
Sellers will compete with each other to sell excess goods in their stocks, they
will reduce prices, hence quantity demanded rises and quantity supplied falls.
Price is again reduced. This process continues till the excess supply gets wiped
out and new equilibriumis reached at point e 2, where new quantity demanded
=new quantity supplied = OQ2.
So equilibrium price decreases from OP1 to OP2
&equilibrium quantity increases from OQ1 to OQ 2
(C) Increase in demand is equal to increase in Supply
S1
21
P rice
P1
S2
e1
e2
D2
D1
O
Q1
Q2
Quantity demanded and supplied
Demand will increase
Demand curve will shift downwards to the left from D1 to D2
Supply will increase
Supply curve will shift upwards to the left from S1 to S2
At original equilibriumprice OP1
New quantity demanded =New quantity supplied = P1 e2
So there is neither ExcessDemand norExcess Supply
Hence, Soequilibrium priceremains constant at OP1
&equilibrium quantity increases from OQ1 to OQ 2
21. What will happen to equilibrium price and quantity when supply is
perfectly elastic and demand decreases? Explain diagrammatically.
P rice
P1
e2
e1
S
22
D1
D2
O
Q2
Q1
Quantity demanded and supplied
Demand will decrease
Demand curve will shift downwards to the left from D1 to D2
Supply curve will remain S1
At original equilibriumprice OP1
New quantity demanded =New quantity supplied = P1 e2
So there is neither ExcessDemand norExcess Supply
Hence, Soequilibrium priceremains constant at OP1
&equilibrium quantity decreases from OQ1 to OQ 2
22.What will happen to equilibrium price and quantity whendemand is
perfectly elastic and Supply decreases? Explain diagrammatically.
S2
P rice
P1
S1
e2
e1D1
23
O
Q2
Q1
Quantity demanded and supplied
Demand curve will remain D1
Supply will decrease
Supply curve will shift upwards to the left from S1 to S2
At original equilibriumprice OP1
New quantity demanded =New quantity supplied = P1 e2
So there is neither ExcessDemand nor Excess Supply
Hence, Soequilibrium priceremains constant at OP1
&equilibrium quantity decreases from OQ1 to OQ 2
23.What will happen to equilibrium price and quantity whendemand is
perfectly inelastic and Supply increases? Explain diagrammatically.
D1
S1
Price
Excess supply
P1
P2
S2
e1A
e2
24
O
Q1
Quantity demanded and supplied
Demand curve will remain D1
Supply will increase
Supply curve will shift downwards to the right from S1 to S2
At original equilibriumprice OP1
New quantity demanded = P 1 e1
New quantity supplied =P 1 A
Then quantity demanded (P 1 e1) is less than quantity supplied (P 1 A) , so Excess
Supply equal to e1A occurs.
Sellers will compete with each other to sell excess goods in their stocks, they
will reduce prices, hence quantity demanded rises and quantity supplied falls.
Price is again reduced. This process continues till the excess supply gets wiped
out and new equilibriumis reached at point e 2, where new quantity demanded
=new quantity supplied = OQ1.
So equilibrium price decreases from OP1 to OP2
&equilibrium quantity remains constant at OQ1
24. What will happen to equilibrium price and quantity whenSupplyis perfectly
inelastic and demand increases? Explain diagrammatically.
S1
Price
P2
e2
e1A
P1Excess Demand
D2
25
D1
O
Q1
Quantity demanded and supplied
Supply curve will remain S1
Demand will increase
Demand curve will shift downwards to the left from D1 to D2
At original equilibriumprice OP1
New quantity demanded = P 1 A
New quantity supplied =P 1 e1
Then quantity demanded (P 1 A ) is more than quantity supplied (P 1e1) , so
Excess Demand equal to e1A occurs.
Buyers will compete with each other and some buyers will be willing to
pay higher prices to get the good.
Sellerswillincrease prices,hence quantity demanded falls and quantity supplied
rises. Price is again raised. This process continues till the excess demand gets
wiped out and new equilibriumis reached at point e2 where, quantity
demanded = quantity supplied = OQ1.
So equilibrium price increases from OP1 to OP2
&equilibrium quantity remains constant OQ1
25.) With the help of a supply schedule and demand schedule,explain excess
demand or excess supply. ( 6 )
OR
What will happen in the market if the price is more than or less than the
equilibrium price?
PRICE
SUPPLY
DEMAND
26
Ans-
1
2
3
4
5
10
20
30
40
50
50
40
30
20
10
Equilibrium price and quantity of a product is determined at the point where
market demand is equal to the market supply. In the above schedule
equilibrium price is 3,where demand is equal to supply(30).
At priceless than the equilibrium price
At price level 1 and 2, Quantity demanded of product is more than Quantity
supplied. It is a situation of excess demand.
In the situation of excess demand, price increases upto the
equilibrium level(3) leading to increase in Quantity supplied (expansion of
supply) and decrease in Quantity demanded (contraction of demand) till both
are equal at equilibrium.
At pricemore than the equilibrium price
At price level 4 and 5, Quantity demanded of product is less than Quantity
supplied. It is a situation of excess supply.
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In the situation of excess supply, price decreases upto the equilibrium
level(3) leading to decrease in Quantity supplied (contraction of supply) and
increase in Quantity demanded (expansion of demand) till both are equal at
equilibrium.
Note UNIT 5 is not to be evaluated in Exam No marks are allotted to it
UNIT 6
NATIONAL INCOME AGGREGATES-15marks
NOTE: While Revising in this unit first read and learn following then learn
definitions and formula in the end
28
-precautions to be taken in calculation of national or domestic income of the
country
-Consumer goods or consumption goodsCapital goods
-Final goods&Intermediate goods
-Factor income & transfer income
- Concept of Domestic & National income
-Questions at the end based on whether to include or not include in Concept
of Domestic & National income
1. Real Flow - It refers to the flow of factor services from households to firms
and the corresponding flow of goods and services from firms to households.
2. Money Flow - It refers to flow of factor payments from firms to households
for their factor services and corresponding flow of consumption expenditures
from households to firms for purchase of goods and services produced by the
firms. It is also called nominal flow.
3. CIRCULAR FLOW IN A TWO SECTOR ECONOMY
Factor Payments
(Rent, Wages, Interest and Profit)
Factor Services
(Land, Labour, Capital and Enterprise)
HOUSEHHOLDS
FIRMS
Consumption Expenditure
(On goods and services)
Purchase of Goods and Services
Note: outer arrow and lines show Real flow & inner arrow lines show Money
flow
- There are only two sectors in the economy: Households and firms
-Household sectors supplies factor services only to firms and firms hire factor
services only from households.
- Firms produce goods and services and sell their entire output to the
households.
- Households receive factor income for the services and spend the entire
amount on consumption of goods and services
4. CIRCULAR FLOW IN A FOUR SECTOR ECONOMY
29
Subsidies& Transfer
Payments
Transfer Payments
GovernmentNet
Sector
Tax
Payments
Tax Payments
Payment for goods and services
Factor Payments
Savings
Financial market
Savings
Household Sector
Firms or Producer Sector
Borrowings
Net Payment for factor services
Foreign Sector
(ROW)
Payments for Imports
Receipts from Exports
5.
1.
2.
3.
Leakages from CIRCULAR FLOW of
Injections into from CIRCULAR FLOW
income
of income
These flow variables have a
negative impact on the process of
production.
These are withdrawals from the
circular flow of income.
These causes positive impact on
the process of production.
Examples: Saving, taxation and
imports
Examples: Investment, exports and
consumption expenditure.
These are addition to the circular
flow of income.
30
6.Define macroeconomics
It is the branch of economics which studies economic activities, issues
and economic problems at the level of economy as a whole.
7.Give examples of macroeconomic variables.
Aggregate demand, Aggregate supply, national income, per capita
income, unemployment.
8.What are the subjects studied in macroeconomics?
* Income and employment determination
*Problems related to economic growth
*unemployment problem in the economy
*problem of inflation etc..
-----------------------------------------------------------------------------------------------------NOTE: It is not the economic nature of good BUT the USE of the good that
tellswhether the good isConsumer goods or Capital goods; Final goods or
Intermediate goods.
-------------------------------------------------------------------------------------------------------
9.
Consumer goods or consumption
goods
1. These are directly used by ultimate
consumer household for satisfaction
of wants.
2. These are final goods
3. They are not used in production by
producer.
4 . They may be changed during use
by consumer like tea leaves are used
Capital goods
1. These are fixed assets used by the
producers in the production process.
2. These are final goods.
3. They help in production of other
goods.
4. They do not change during
production process.
31
to make tea.
5.eg: Durable goods- car, washing
machine
5. eg: machines ,
plants and equipment used in
production process.
10.Define Consumer goods or consumption goods
These are final goods (Durable goods, Semi durable goods, Non-durable or
perishable goods,Services) directly used by ultimate consumer household for
satisfaction of wants. They may be change during use.
For example:- sugar if used by consumer to make biscuits is consumer good.
11.Define Capital goods
These are durable final goodsused by the producers in the production
process. They do not change during production process. For example fixed
assets like machines, plants and equipment used in production process.
12. All capital goods are producer goods , but all producer goods are not
capital goods. Explain.
Producer goods are all those goods which are used in production process they
are:(a) goods used as raw material
(b) fixed assets like machines
Raw material like coal, wood etc are not capital goods as they lose their
identity in production process. They are intermediate or a single use
producer goods and cannot be used again in the production process.
Capital goods are durable final goods used to help production. Only fixed
assets are capital goods like machines,plants and equipment.So all capital
goods are producer goods. But all producer goods are not capital goods , as
raw materials are not capital goods.
13.
Final goods
1. These are ready for final use
by consumer for consumption or
Intermediate goods
1. These are not ready for use;
they are for resale or used
32
By producer for investment.
forfurther production.
2.These are:(a)Consumer goods used for
satisfaction of wants. They may
change during use.
(b) Capital goods which help in
production process. Thy do not
transform during use,;
2.
These are purchased by one
firm from another for following
purpose:(a) Resale during the year
(b) Use as raw materialin
production process. So they may
change during production process
3. Once sold these pass out of
production boundary.
4. These are included in national
income
3.These are inside the
production boundary.
4. These are not included in national
income.
14. Define Final goods
These refer to the goods used either for consumption or for investment. They
are neither resold nor used for further production of goods.
15. Define Intermediate goods
These are goods used as raw material in production process or are for resale
during the financial year.
16.
Stocks
1. Stock variables are measured
at a particular point in time.
2. They do not have a time
dimension,
3. Eg: Capital stock, inventory,
wealth on a particular day.
4.Stock is static concept
Consumption of fixed capital
Flows
1. Flow variables are measured
over a period of time,
2. They have a time dimension,
3. Eg: Capital formation during a
year, change in stock, national
income during a year.
4.Flow is dynamic concept.
Capital Loss
33
1.
2.
3.
It is loss in the value of fixed assets due
to normal wear and tear and expected
obsolescence
It is expected loss in the value of asset
Provision for depreciation is by
maintaining depreciation reserve fund.
Factor income or Factor payment
1.
2.
3.
It is the income received in return for
rendering factor services by the factors
of production.
These are included in national income.
Example: Rent, wages, interest, and
profit.
Retirement pension.
It is loss in the value of fixed assets due
to natural calamities and unexpected
obsolescence.
It is unexpected loss in the value of
asset.
Provision for capital loss is by getting
insurance done.
Transfer Income or Transfer payment
It is the income received without any
corresponding services.
These are not included in national
income
Example: old age pension, scholarship of
students, unemployment allowance,
charity ,gifts, expenditure on birthday /
Marriage, pocket money, remittances from
abroad, financial help to earthquake
victims, beggars, meals to beggars,
compensation given to accident victims
etc.
17. Classify the following into factor income and transfer receipt. Give reason
for your answer.
i) Employer’s contribution to social security schemes.
It is a factor income as it is earned because employees are rendered
corresponding services to the employer.
ii) Scholarship given to students by the government.
It is transfer receipt as it is unearned because students are not rendered any
corresponding services to the government.
iii) Old age pension given by the government.
It is transfer receipt as it is unearned because pensioners are not rendered any
corresponding services to the government.
iv) Bonus given to employees by employer.
34
It is a factor income as it is earned because employees are rendered
corresponding services to the employer.
18. Definedepreciation or consumption of fixed capital.
It is the loss in the value of fixed assets during use due to
(a) Normal wear and tear and
(b) Expected obsolescence
It does not include capital loss due to unexpected obsolescence like
natural calamities, theft or accident.
19. Explain gross investment.
Total capital formation (or total investment) in a financial year is called gross
investment. It includes:(a) Stock of raw material, work in progress and finished goods,
(b) Fixed capital assets like machinery, equipment, buildings etc.
It also includes depreciation.
20.
Real GDP or
GDP at constant prices or
GDP at base year prices
1. It is the monetary value of all goods
and services produced in an economy
during a financial year, estimated
using base year prices.
Nominal GDP or
GDP at market prices or
GDP at current year prices
1. It is the monetary value of all goods
and services produced in an economy
during a financial year, estimated
using current market prices.
2. Base year price is taken as constant. 2. Market prices do not remain
constant.
35
3. This GDP changes only due to
3. It changes due to change in both
change in output of the economy. So
price and output of the economy. So it
it is a reliable measure of economic
is not a reliable measure of economic
growth.
growth.
21. NOTE: Application based questions come from this topic
Explain Normal resident of a country.
A normal resident is said to be a person:
country. For example: A larger number of Indian Nationals have settled in USA,
England etc. as residents (not as nationals) of those countries. For India, they
are non-resident Indians but are nationals.
Examples of Non-residents:
They are called non-residents because they do not fulfil the creation of centre
of economic interest:
residence of any country but of international area. These are non-resident
organizations for the country in which these are situated.
countries to which they belong and not of the international area.
given country. They are treated as residents of the country where they live and
not the residents of the country where they work.
treatment, recreation or take part in sports, cultural events etc. These are nonresidents for the country they are visiting.
given country.
36
--------------------------------------------------------------------------------------------------------NOTE: These six (6) conceptsgiven below are not definitions but areHINTS to
define and differentiate measures of national income
While defining aggregates
Firstly,define Gross or Net
Secondly, definemarket Price or Factor Cost
Thirdly, defineDomestic or National product.
(1) Net product
It is the Net Value of all final goods
and services produced in a financial
year.
(2) Gross product
It is the Gross Value of all final goods
and services produced in a financial
year.
It does not include depreciation
It includes depreciation
Net product= Gross productdepreciation
gross product= Net product
+depreciation
(3) National product
It is the value of all final goods and
services produced by
Normal Residents of a country
within or outsidedomestic territoryin
a financial year
(4) Domestic product
It is the value of all final goods and
services
produced within domestic territory of
a country
by all producers during a financial
year
It includes Factor income from abroad It does not include Factor income
from abroad
It does not include Factor income to
abroad
It includes Factor income to abroad
Factor income from abroad
National product = Domestic product
+Factor income from abroad
Domestic product =National productNet Factor income from abroad
37
(5) Product at Factor Cost
It is the Income earned byall the
factors of production in a financial
year.
(6) Product at Market Price
It is the Market Value ofall final goods
and servicesproducedin a financial
year
It does not include Indirect taxes
It includes Indirect taxes
It includes subsidies
It does not include subsidies
Product at Factor Cost= Product at
Market Price – Net Indirect taxes
Product at Market Price =Product at
Factor Cost +Net Indirect taxes
----------------------------------------------------------------------------------------------------
22.Definitions formed Using hints given above
1. GDPMP - It is the GrossMarket Value of all final goods and services
producedby all producers within domestic territory of a country in a financial
year
2. NDPMP- It is the NetMarket Value of all final goods and services producedby
all producers within domesticterritory of a country in a financial year
3. GNPMP-It is the GrossMarket Value of all final goods and services
producedbyNormal Residents of a country within or outsidedomestic territory
in a financial year
4. NNPMP -It is the NetMarket Value of all final goods and services producedby
Normal Residents of a country within or outside domestic territory in a
financial year
5. NDPFC -It is the Netfactor Income earned by all the factors of production
within domestic territory of a countryin a financial year
6. GDPFC-It is the Grossfactor Income earnedby all the factors of production
within domestic territory of a countryin a financial year
38
7. GNPFC-It is the Grossfactor Income earnedby ( all the factors of production
owned by)Normal Residents of a country within or outsidedomestic territoryin
a financial year
8. NNPFC or National Income- It is the Netfactor Income earned by (all the
factors of production owned by)Normal Residents of a country within or
outside domestic territoryin a financial year.
23. Calculation of Personal disposable income from NDP FC
NDP FC
- Income from property and entrepreneurship accruing to the
government administrative departments
39
- Savings of non-departmental public sector enterprises
Income from domestic
product accruing to private
sector
+ Net factor income from abroad
+ Net current transfers from rest of the world
+ Net current transfers from government administrative departments
+ National debt interest
Private income
- Corporate Tax
- Retained earnings of private corporations
Personal income
- Direct personal taxes
- Miscellaneous receipts of fees & fines by government administrative
departments
Personal disposable income
Personal disposable income = Private final consumption expenditure + savings
of households
--------------------------------------------------------------------------------------------------40
NOTE: TheHints in following table will help in understanding definitions given
below it
Item
Type of income
Sector earning it
Factor or Transfer (government,
income
Firm, or
Household)
NDPFC
factorIncome
Income from
NDP FC accruing
to Government
factorIncome
Income from
NDP FC accruing
to Private sector
Private income
factorIncome
Government
Firm
household
Government
Firm
household
Income earned in
Domestic territory
or
by normal
residents
(National income)
Domestic
Domestic
Domestic
factor& transfer
Firm
National
Income
household
Personal income factor& transfer
household
National
Income
-----------------------------------------------------------------------------------------------------24. Definitions
NDPFC -It is the Net factor Income earned by all the factors of production
(owned by all sectors government, firm,household) within domestic territory
of a countryin a financial year.
Income from NDP FC accruing to Government - It is the factor Income
earnedby public sector ( government ) within domestic territory of a countryin
a financial year.
Income from NDP FC accruing to Private sector– It is the factor Income
earned by all firms and householdswithin domestic territory of a countryin a
financial year.
41
Private Income - It is the Income earned from all sources (factor & transfer
Income) by allnormal residentfirms and householdfrom within or outside
domestic territoryin a financial year.
Personal Income - - It is the Income earned from all sources (factor & transfer
Income) by all normal residenthouseholdfrom within or outside domestic
territoryin a financial year.
Personal Disposable Income – It is the personal income remaining with all
households for private final consumption expenditure and savingof household.
25. Net National Disposable Income = National Income (NNPFC)+Net Current
Transfers from Abroad + Net Indirect Taxes
Gross National Disposable Income = GNPFC +Net Current Transfers from
Abroad + Net Indirect Taxes
26.
Personal Disposable Income
1. It is the income of all Normal
resident households of an
economy, from all sources
which is left with them for Final
consumption and saving,
during a financial year
2. It does not include Direct&
Indirect taxes.
3. Personal Disposable Income = P
is Private Final Consumption
Expenditure of household +
Savings of Household
Net National Disposable Income
1. It is the income of all sectors of an
economy (Government, firm &
household sector) from all sources
during a financial year.
2. It includes both Direct & Indirect
taxes.
3. NNDI= NNPFC +NIT + NCTfROW
27. Problem of Double Counting
Double counting means counting of the value of same product (or expenditure) for more than once.
If certain items are counted for more than once resulting in over estimation of national product to
the extent of the value of intermediate goods included, this will cause the problem of double
counting e.g there are four producers – farmer, mill owner, baker and shopkeeper.
Producers – Product
Value of Output
(Rs)
Intermediate
Consumption
(Rs)
Value Added (Rs)
42
1
Farmer – sells to mill
owner
2
2000
0
2000
Mill Owner- sells to baker 2500
2000
500
3
Baker – sells to
Shopkeeper
3600
2500
1100
4
Shopkeeper – sells to
customers
4000
3600
400
12100
8100
GVA=4000
If for the purpose of calculation we take value of output as (2000+2500+3600+4000) =
12100, this will be double counting. In this, value of wheat has been included four times,
flour for three times and bread for two times, whereas value of final product is Rs 4000 only
i.e the value of bread (121800-8100 = 4000). To avoid double counting, we should use the
following:
*Value added method. By this method we take value added only i.e,
Value of output – Intermediate consumption i.e 12100 – 8100 = 4000 or,
** Final output method. By this method we take value of final good only i.e,
Value of output i.eRs 4,000.
28. Value Added Method for calculation of National Income
Step 1 Calculate gross value added by Primary, Secondary & tertiary sectors
Formula 1
GVAMP =
+GVOMP
Formula2
GVAMP =
+Sales
Formula3
GVAMP =
+Domestic Sales
Formula4
GVAMP =
+Sales to
household
+Sales to
43
-Intermediate
Consumption
+Change in stocks
+Exports
+Closing Stocks
-Opening Stocks
- Intermediate
Consumption
- Intermediate
Consumption
government
+Exports
+Closing Stocks
-Opening Stocks
-Domestic
purchase of raw
material
-Import of Raw
material
Step 2
GDPMP = GVAMP PrimarySector + GVAMP Secondary Sector + GVAMP Tertiary
Sector
Step 3
NNPFC = GDPMP – Depreciation + Net factor income from abroad + net indirect
taxes
29. Income Method for calculation of National Income
Step 1
Formula 1
NDP FC =
+Mixed Income of self
employed
Formula 2
NDP FC =
+Mixed Income of self
employed
Formula 3
NDP FC =
+Mixed Income of self
employed
44
+Compensation of
employees
+Wages & Salaries
+Wages & Salaries in
cash
+Wages & Salaries in
kind
+Employers contribution +Employers contribution
to social security scheme to social security scheme
+Operating Surplus
+Interest
+Interest
+Profit
+Corporate taxes
+Dividend
+Undistributed Profit
+Rent
+Royalty
+Rent
+Royalty
Step 2
NNPFC = NDP FC + Net factor income from abroad
30. Explain the components of Income method.
(1) Compensation of Employees – it is the payment employees receive from
the enterprise for work done by them. It includes the following:(a) Wages & salaries in cash for example basic pay , bonus , dearness
allowance , house rent allowance , sick leave allowance etc.
(b) Wages & salaries in kind for example rent free accommodation,
transport facilities, interest free loan,and food, uniform.
(c) Employers contribution to social security scheme like their
contribution to GPF, medical insurance, retirement pension etc.
(2) Operating Surplus – It is the income from property,
likerent,interest,royalty,& income for running enterprise is profit.
45
(a) Interest – It is the price paid for borrowing assets like machinery or money
borrowed by producers . Interest earned by consumers on their bank deposits
is also included. Interest paid by consumers on money borrowed is not
included.
(b) Profit – It is the payment to the owners of the firm for doing business.
Profit is used for the following:(i)
To pay corporate taxesi.e. the tax paid by the firm to the
government on profit of the firm.
(ii)
To pay part of firms profit to the shareholders or owners of the
firm as Dividend.
(iii) The profit remaining with the firm after paying tax & dividend is
called undistributed profit or retained Earnings of Private
Corporations; it is used for expansion or for future expenditure.
(c) Rent – It is the income for giving land, building, machinery etc. on hire
by landlords or owners. It includes imputed rent of owner occupied
houses.
(d) Royalty – It is income earned by owners for renting subsoil assets like
mines of iron ores, oil, or payment for use of patents, copyrights, trade
mark etc.
(3) Mixed income of self-employed - self-employed people like doctors,
lawyers, shopkeepers etc., own many factors of production land, labour,
capital & enterprise. The contribution of each factor cannot be identified &
separated into rent, wages, interest and profit,So their income is called mixed
income of self-emplo
31 (A).Expenditure Method for calculation of National Income
Step 1
Formula 1
GDPMP =
+P
+Gross
Investment
Formula2
GDPMP =
+P
+GDCF
Formula3
GDPMP =
+P
+GDFCF
Formula4
GDPMP =
+P
+Gross Business
fixed investment
46
+Change in Stock
+G
+G
+G
+X-M
+X-M
+X-M
Where, P is Private Final Consumption Expenditure
+Change in Stock
+Gross residential
construction
investment
+Gross public
investment
+G
+X-M
G is Government Final Consumption Expenditure
Net Exports = X- M = Exports – Imports
GDCF = Gross Domestic Capital Formation = GDFCF + Change in Stock
GDFCF is Gross Domestic Fixed Capital Formation
Step 2
NNPFC = GDPMP – Depreciation + Net factor income from abroad + net indirect
taxes
------------------------------------------------------------------------------------------------[ NOTE: when any component of investment in above formula is given as NET
value then in
31(B)
Step 1 we get NDPMP
47
Formula 1
NDPMP =
+P
+Net Investment
Formula2
NDPMP =
+P
+NDCF
Formula3
NDPMP =
+P
+NDFCF
+Change in Stock
+G
+X-M
+G
+X-M
+G
+X-M
Formula4
NDPMP =
+P
+Net Business
fixed investment
+Change in Stock
+Net residential
construction
investment
+Net public
investment
+G
+X-M
Step 2 will be
NNPFC =NDPMP + Net factor income from abroad + net indirect taxes
------------------------------------------------------------------------------------------------32. . Explain the components of Expenditure method.
(1) Private Final Consumption Expenditure–It is the expenditure done by
resident households & non-profit institutions ( like Schools, clubs ) on the
purchase of goods & services. Like purchase of :(i) durable goods – TV, washing machine
(ii) Semidurablegoods – clothes , shoes
(iii) Perishable goods (Non durable goods) - vegetables etc
(iv) Services – banking , medical facilities etc.
(2) Government Final Consumption Expenditure–It is general government
purchases of goods & services in domestic market & from abroad for
satisfaction of collective wants like education , health care , defence etc. It
includes following :(i) compensation of Employees paid by government
(ii) goods& services purchased from domestic market
(iii) Net purchases from abroad
48
(3) Net Exports = X- M =It is the difference between Exports of goods & nonfactor servicesminus imports of goods & non-factor services
Exports refer to sale of goods (eg. India sells tea, garments etc )& non-factor
services like banking, insurance etc. to foreigners in domestic territory or to
other country.
Imports refer to purchase of goods & non-factor services from rest of the
world.
(4)Gross Domestic Capital Formation or GrossInvestment–It is the
expenditure on Gross Domestic Fixed Capital Formation & change in stock. It
includes :(i) Business fixed investment – Expenditure by producer on purchase of
plant, machinery etc.
(ii) Fixed investment expenditure by households on construction of
residential buildings.
(iii) public investment by the government like expenditure on
construction of roads, bridges etc.
(iv) Inventory investment – It refers to the change in stock of raw
materials , work in progress & finished goods. It is the difference between
closing stock & opening stock.
33. Why is GDP not a good measure of welfare?
1.It does not consider level of prices in the country. If prices are high, even high
income will also not lead to high standard of living.
2. It does not show the composition of output. Increase of GDP could also be
due to war goods or socially undesirable goods such as drugs etc. if share of
wage goods does not increase it may not increase economic welfare.
49
3. Rise in GDP could be due to increase in industrialisation & urbanisation
which would lead to pollution, environmental degradation which reduces
welfare.
4. Increase in GDP does not indicate distribution of income . Its increase may
lead to increasing income inequalities & poverty, which reduces economic
welfare,
5. It does not indicate unemployment in the country .Economic welfare will
increase by removing unemployment & not just by increasing GDP.
6. It does not indicate the skills of population or resources which will indicate
economic welfare of people.
34. What precautions should be taken in calculation of national or domestic
income of the country?
1. Transfer incomes should not be included like taxes, subsidies, gifts,
donations etc. because these neither lead to flow of goods and services, nor
use factors of production in return for money flow.
2.Sale of second hand good should not be included as their production would
have been counted in the year in which it was produced. Counting it again
would lead to double counting.
3. financial transactions like sale & purchase of share, bonds etc lead to
transfer of ownership only. It does not lead to any productive activity, hence it
should not be included in the calculation of national income.
4.Windfall gains, lottery capital gains etc also do not result in any productive
activity so they should also not be included in national income.
5. Illegal activities like smuggling, gambling, illegal arms sale etc. should not be
included as it is black money it is not accounted or reported , it is unlawfully
earned to evade tax.
6. Non marketed goods and services are not included like growing vegetables
in kitchen garden, because national income includes only those transactions
that occur through organised market activities.
------------------------------------------------------------------------------------------50
NOTE: Following items are to be includedin calculation of national or domestic
income of the country
1.Imputed rent of owners occupied houses as house providers’ service to the owners.
2.Imputed value of goods and services produced for self-consumption by producer
enterprise as these contribute to the current year’s output.
35. Categorize the following into intermediate goods and final goods. Give
reason for your answer.
intermediate goods
final goods
ii) Purchase of food items by a hotel.
i) A new car purchased by a taxi
Ans: Purchase of food item by a hotel driver.
is an intermediate product because it Ans: A new car purchased by a taxi
is used to prepare food for further
driver is a final good since it is an
resale.
investment and purchased by taxi
driver for final investment.
iii) Stationary purchased by the
iv) Wheat purchased by the
government.
Households.
Ans: It is intermediate goods because
it is fully used to produce services.
vi) Paper purchased by a publisher.
v) Purchase of equipments for
installation in a factory.
viii) Purchase of sugar by grocery shop vii) Milk purchased by households.
ix) Cloths used by tailors
x) Construction of houses by
consumer household.
xii) Chemical fertilizer used by the
xi) Purchase of milk by a consumer.
farmer.
xiv) Coal purchased by a factory.
xiii) Machine purchased by a firm
xvi) Book purchased by a book seller
xv) Text book purchased by a student.
xvii) Expenditure on research and
development by a company.
xviii) Seeds purchased by a farmer.
xix) Electricity consumption in a
business.
NOTE: ( For writing reasons from IV to XIX refer ans. I to III.)
--------------------------------------------------------------------------------------------------------------
51
Note following are parts of compensation of employee in case categorisation
question comes in exam.
Compensation of employees
1. Wages and salaries in cash.
2. Compensation in kind
ance facilities
employees.
3. Employer’s contribution to social security
schemes such as
t is different
form old age provision which is transfer
36. Will the following be included or net in the domestic factor income of
India? Give reasons for your answer.
i) Salaries of non-residents working in India Embassies in Russia.
Ans: Yes it will be included because Indian embassy is a part of domestic
territory of India.
ii) Salaries to Indian residents working in Indian embassy in Russia.
Ans: Yes it will be included in the domestic factor income as the Indian
embassy is a part of domestic territory of India.
52
iii) Salaries toRussian residents working in Indian embassy in Russia.
Ans: Yes it will be included in the domestic factor income as the Indian
embassy is a part of domestic territory of India.
iii) Salaries to Indian residents working in Russian Embassy in India.
Ans: No it will not be included in the domestic factor income as the Russian
embassy is not a part of domestic territory of India.
iv) Salaries received by Indian workings in American Embassy in India.
Ans: No it will not be included in the domestic factor income as the American embassy is not a part
of domestic territory of India.
v) Salaries paid to non-resident Indians working in Indian Embassy in America.
Ans: Refer Ans 1
vi) Salaries paid to Koreans working in Indian Embassy in Korea.
Ans: Yes it will be included in the domestic factor income as the Indian embassy is a part of domestic
territory of India.
vii) Salaries to India working in Japanese embassy in India.
Ans: No it will not be included in the domestic factor income as the Japenese embassy is not a part
of domestic territory of India.
viii) CEO to the residents of Japan working in Indian Embassy in Japan.
ix) Ans: Yes it will be included in the domestic factor income as the Indian embassy is a part of
domestic territory of India.
x) Profit earned by a branch of an American Bank of India.
xii) Profit earned by an Indian company from its branch in Singapore.
Ans: No it will not be included in domestic factor income of India because Singapore is not a part of
domestic territory of India.
xiii) Profits earned by a resident of India from his company in Singapore.
Ans: refer ans(xiii)
xiv) Rent received by an Indian from his building in London.
Ans: No, it will not be included in the domestic factor income as the rent is earned outside the
domestic territory of India.
xv) Rent received by a resident Indian from his property in Singapore.
Ans: No, refer Ans(xv)
xvi) Rent paid by the embassy of Japan in India to a resident Indian.
Ans: No, it will not be included in the domestic factor income as the Japenese embassy is not a part
of the domestic territory of India.
53
37. Giving reasons state whether the following are included in national Income.
i) Salary received by an Indian resident working in US embassy in New Delhi.
Ans: Yes, it will be included in national income as salary received by Indian
resident working in US embassy in New Delhi is a part of factor income from
abroad.
ii) Salaries paid to non-resident Indians working in Indianembassy in America.
Ans: This is a exceptional case It is included in the national income of India as
salaries paid to non-resident Indians working in Indian embassy in America is
a part of compensation of employees from abroad.
iii) Salaries received by an Indian resident working in Russian embassy in
India.
Ans: Yes, it will be included in national income as it is a part of factor income
from abroad.
iv) Salaries paid to Russian working in Indian embassy in Russia.
Ans: No, it will not be included in national income as it is a part of the factor
income paid to abroad.
v) Wages received by Indian employees working in Pakistan embassy.
Ans: Yes, it will be included in national income as it is a part of factor income from abroad.
vi) Profit earned by foreign banks in India.
Ans: : No, it will not be included in national income as it is a part of the factor income paid to
abroad
vii) Profits of Reliance industries from its chemicals business in Australia.
Ans: Yes, it will be included in national income as it is a part of factor income from abroad.
viii) Profit earned by an Indian bank from its branches abroad.
Ans: Yes, it will be included in national income as it is a part of factor income from abroad.
ix) Profit earned by Indian companies from their branches abroad.
Ans: Yes, it will be included in national income as it is a part of factor income from abroad.
x) Profit earned by Indian company from its branch in London.
Ans: Yes, it will be included in national income as it is a part of factor income from abroad.
xi) Rent received by Indian residents on their buildings rented out to foreigners in India.
Ans: Yes, it will be included in national income as it is a part of factor income from abroad.
54
Students are suggested to attempt more questions related to concept of
National and Domestic Income refer to items above
Students are advised to practice more and more numerical Questions from
CBSE papers of last five years
UNIT - 7
MONEY AND BANKING-8marks
Q1 .Define money.
Money :- It is anything which is generally acceptable as a medium of exchange
and at the same time acts as a measure of value, store of value and means of
deferred payments.
Q2. Define High Powered Money
55
High Powered Money (H) :- High powered money or monetary base refers to
the total liability of the monetary authority of the country i.e. Central Bank
(RBI). It consists of currency (notes and coins in
circulation with the public and vault cash of commercial banks) and deposits
held by Government of India and commercial banks with RBI.
Q3. Define Money multiplier or deposit multiplier.
Total deposits created due to a new deposit in bank is many
times the initial deposit. The multiple by which deposits can increase due to an
initial deposit is called money multiplier.
Money multiplier =1/LRR, where LRR is legal reserve ratio.
Q4. Explain the Process of credit creation by commercial banks.
Credit creation (or deposit creation or money creation) by the banks is
determined by
(i) the amount of the initial fresh deposits and
(ii) the Legal Reserve Ratio (LRR), the minimum ratio of deposit legally
required to be kept as cash or in liquid form by the banks.
It is assumed that all the money that goes out of banks is redeposited into the
banks, and LRR consists of CRR and SLR decided by RBI.
Example :- Let the LRR be 20% and there is a fresh deposit of Rs.10,000. As
required the banks keep 20% i.e. Rs.2,000 as cash. Suppose the banks lend the
remaining Rs. 8,000. Those who
borrow, use this money for making payments.
As assumed those who receive payments put the money back into the banks.
In this way bank receives fresh deposits of Rs. 8,000.
The bank again keep 20% i.e. Rs.1,600 as cash and lend Rs.6,400, which is also
80% of the last deposits. The money again comes back to the banks leading to
a fresh deposit of Rs.6,400. The money goes on
multiplying in this way this process continues till new deposit become nil., and
ultimately total money creation is Rs.50,000.
Total money creation = initial deposit x 1/LRR =10000 x1/20%
= 10000 x100/20
Total money creation = 50000.
The whole process can be explained through following table:Banks
Initial Deposit Rs. Legal Reserve
Ratio (20%)
Secondary
Deposit
(Lending) Rs.
56
A
B
.
.
.
.
N
10000
8000
.
.
.
.
.
2000
1600
.
.
.
.
.
8000
6400
.
.
.
.
.
Total
50000
10000
40000
Where Money multiplier is 1/LRR=1/20%=1/20*100=10/2= 5
It is the multiple by which total deposits increase due to initial deposit.
Q5. Explain Functions of Money.
Functions of Money are:(1) Medium of Exchange:- It is generally accepted means of payment for exchange of goods and
services.
- Facilitates trade, widens area of market by separating act of sale and
purchase.
- Reduces time and labour needed for trade in case of using goods for trade
(Barter System).
(2) Measure of Value or Unit of Value:- All goods and services can be given one unique value (Price) by expressing
them in terms of money.
-It is common unit of measurement of all goods. Thus makes exchange easier.
-Helps developing efficient accounting system. Goods and services can be
accounted for easily in terms of rupees. It would have been difficult to make
account in many units like litres, quintals, meters etc. and adding up different
units is not possible.
-Comparisons can be made.
-Its value remains constant.
(3) Store of Value
-It is liquid store of value.
-It comes in convenient denominations.
-Value remains constant, it is not perishable easily portable, requires less place
to store& there is no storage cost.
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(4)Standard of deferred Payments -Or future payments like salaries,
pension, interest etc.
-Facilitates borrowing and lending.
-It led to creation of financial institutions
-itovercomes disagreements and risks that are there is Barter system regarding
future payments to be made as value of money remain constant.
Q6. Explain Quantitative credit control measures used by Central Bank (RBI)
Quantitative credit control measures used by Central Bank (RBI) are:1. Cash Reserve Ratio (CRR) :- It is of certain ratio of commercial banks net
demand deposits & times liabilities which it has to keep with central bank RBI
as cash.
If RBI increases CRR, Banks have to keep larger percentage of their deposits
with RBI, their credit giving ability decreases and money supply decreases.
Conversely, if RBI decreases CRR, money supply Increases.
2, Statutory Liquidity Ratio (SLR) :- It is the ratio or percentage of net total
demand & time liabilities of commercial banks which they have to keep in form
of liquid assets as excess reserves, they have to invest in government securities
or in securities approved by RBI and current account balances with other
banks.
If RBI increases SLR then credit giving ability of bank decreases and money
supply decreases.
If RBI decreases SLR banks credit giving ability and thus money supply
increases.
3. Open Market Operations (OMO) :- It is the buying and selling of
government security by the Central Bank from/to the public and banks on its
own account.
Sale of government securities will reduce reserves.
* RBI sells securities Bank gives RBI a cheque for the securities.
* The RBI collects the amount by reducing the bank’s reserves by the particular
amount.
* This directly reduces bank’s ability to give credit.
* Therefore this decreases money supply in the economy.
When RBI buys securities from banks
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* RBI gives the bank a cheque drawn on itself in the payment for the securities.
* When cheque clears, RBI increases reserves of the bank by the particular
amount.
* This directly increases the bank’s ability to give credit.
* Thus money supply increases.
4. Bank Rate Policy
Bank rate is the rate at which Central Bank lends funds to commercial banks.
If bank rate increases:
* Cost of borrowing from RBI increases.
* So banks borrow less
* Their credit giving ability decreases.
* Banks also increase lending rates i.e. rate at which they lend to public.
* This discourages businessmen from taking loans. This reduces volume of
credit and money supply.
A decrease in bank rates on the other hand will increase credit and money
supply.
Q7. Mention various Measures of Money Supply.
Measures of Money Supply are:M1 is most liquid measure of money supply
M1 = C + DD + OD
C = Currency held by public (currency & coins).
Demand Deposits (DD):- Only net demand deposits of banks are included in
money supply, as other part of demand deposit that represents inter-bank
deposits held by one bank with anotherdoes not constitute demand deposit
held by public.
Other Deposit (OD) with RBI: - These are the deposits held by the RBI of all
economic units except the government and banks. OD includes demand
deposits of public financial institution (Like IDBI) foreign central banks,
foreign government, the IMF, the World Bank etc.
M2 = M1 + saving deposits with post office saving banks.
M3 = M1 + Net time deposits of banks
M4 = M3 + Total deposits with post office savings organisations (excluding
National saving certificates).
Q8. Define the following terms:-
59
(a) LRR - Legal Reserve Ratio: - It is legally compulsory for the banks to keep a
certain minimum fraction of its demand deposits as cash. This fraction is called
LRR. It has two components –
(a) A part of LRR is to be kept with the Central Bank and this is called
cash reserve ratio (CRR) and
(b) The other part is kept by the commercial banks themselves in form
of cash or liquid assets it is called statutory liquidity ratio SLR.
Q9. Explain main functions of Central Bank (RBI).
Functions of Central Bank:
1. Currency Authority:
- Central Bank has monopoly over issue of notes (currency). Coins and one
rupee note are issued by Government of India but Central Bank puts currency
notes &coins into circulation and withdraws it from circulation. Issue of notes
is monetary liability of Central Bank as it backs currency by assets of equal
value gold coins, gold bullions, foreign securities & domestic government’s
local currency securities.
-Central government borrows money from RBI (Central Bank) and increases
money supply.
2. Banker to Government
• Banker to State and Central Government:- Carries all banking business of government
- Government keeps its cash balances in current account with Central Bank
(RBI).
- RBI accepts receipts and makes payments for the government, &
- RBI carries out exchange & other remittances.
- RBI provides short term credit to government.
- Agent to Government:• RBI manages public debt by
(a) Managing all new issues of govt. loan
(b) Servicing public debt outstanding
(c) Creating market for govt. securities.
- Advises the govt. on banking and finance matters regarding - money market,
capital market,Government loans, on economic policy matters etc.
3. Banker to Banks’
• RBI keeps cash reserves of banks as determined by CRR.
- Banks also keep their surplus cash with RBI.
• RBI supervises and regulates commercial bank through regulations related
to:- Licensing of banks,
- Branch expansion, liquidity of assets,
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- Management, amalgamation and liquidation of banks.
• RBI controls banks through periodic inspection of banks and returns filed by
them.
- When banks fail to meet obligations of their depositors and are facing bank
failures RBI lends them short term funds as a lender of last resort to
commercial banks.
• RBI is Clearing house for interbank payments .RBI
providescentralisedclearance, settlement &transfer facilities for interbank
payments.
4. RBI is Custodian of Foreign Exchange Reserves.
- And RBI helps overcome BOP difficulties & maintains foreign exchange rate
by
Buying & selling foreign currency.
5. Controller of Money Supply and Credit
- RBI controls money supply and credit by using monetary measures.
(a) Quantitative Credit control instruments like CRR, SLR, Bank rate Policy, and
open market operations.
(b) Qualitative credit control instruments like moral suasion, selective credit
control, Imposing margin requirement on secured loans
Q10. ) Explain the Qualitative credit control measures used by Central bank
(RBI)?
Qualitative credit control measures used by Central bank (RBI) are:(i) Moral suasion – This is a combination of persuasion and pressure that the
central bank applies on other banks in order to get them to fall in line with its
policy. This is exercised through discussions, letters, speeches and hints to
banks.
The central bank frequently announces its policy and urges the banks to fall in
line.
(ii) Selective credit control – It is applied in a positive manner to use it to
channel credit to particular sectors, usually the priority areas.
It is applied in negative manner to restrict the flow of credit to particular
sectors.
(iii) Imposing margin requirement on secured loans – a margin is the
difference between the amount of the loan and market value of the security
offered by the borrower against loan. If margin imposed by central bank is 40%
then the bank is allowed to give a loan only up to 60% of the value of security.
If Central bank increases margin requirements people take less credit from
banks and this prevents price rise or taking loans for speculative purposes.
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Q11. Explain the Lender of Last Resort Function of Central Bank.
Lender of Last Resort Function of Central Bank:When commercial banks fail to meet obligations of their depositors and are
facing bank failure due to Bank runs, Central bank supports them by acting as
lender of Last resort.
Here instead of rediscounting RBI gives short term advances to commercial
banks against the bills of exchange, promissory notes, treasury bills,
government securities etc.
But banks have to first approach all other sources to get credit like call money
market, then only approach RBI.
RBI stands by commercial banks as a guarantor and extends loans to ensure
the solvency of the commercial bank.
Q12. Explain the role of Central Bank as clearing house for commercial banks.
Central Bank as clearing house for commercial banks
OR
RBI is bank of central clearance, settlement and transfer
RBI settles mutual indebtedness between banks. It makes entire process of
collecting bank to bank payments easy and much less time consuming.
Central bank has a clearing house where mutual indebtedness between banks
is settled.
Representatives of different banks meet daily in the clearing house to settle
interbank payments by debt and credit entries in the cash reserve account held
by commercial bank with RBI.
The differences between various banks at the end of the day of each daily
clearing are settled by transfer between their respective accounts with RBI.
62
63
UNIT 9Government Budget and the Economy (8 Marks)
1.Government Budget -A government budget is the statement of estimated
total revenue and estimated total expenditure of financial year.
2.Components of Government Budget
(A) Revenue Budget- It consists of those Government receipts & Government
expenditures which neither Create nor Reduce, Assets or Liabilities
1. Revenue Receipts - It consists of those Government receipts which
neither Create Liabilities nor Reduce Assets.
Types of Revenue Receipts
(i). Tax Revenue:- It consists of proceeds of taxes and other duties
levied by the Union government. It is a compulsory payment made
to the Govt. in return for which no goods or services are provided
directly by Govt.
-Direct tax
- Indirect Tax
(ii). Non Tax Revenue: - Income from sources other than taxes is called
non-tax revenue. It arises on account of administrative function of
the govt.in return for which Govt. either gives goods or services or
privileges or permit to perform a service
Types of Non TaxRevenue
(i)Commercial revenue- It is received by Govt. in the form of
prices paid by people for goods or services that Govt.
Provides like railway, postage, electricity etc.
(ii)Administrative revenue-It arises on account of administrative
functions of the Govt.
(a) Fees-Payment received for providing certain services
for public interest like Govt. college or hospital fees
Fines & penalties charged for breaking of laws or disobeying
rules & regulations
(b)License fee & Permit - Payment received for giving
privileges or permit to perform a service. Like registration
and license fee for industries or automobile.
(c) Escheat-income Govt. gets by taking possession of
property which has no claimant or legal heir.
(iii) Interest Receipts- interest received by the Govt. credit
corporations on loans given by them
64
(iv) Profits of PSU’s –Profits earned by public sector enterprises or
dividend received by Govt. on investment made by it.
2. Revenue Expenditure - It consists of those Government expenditures
which neither Create Assets nor Reduce Liabilities.
Types of Revenue Expenditure
(i) Daily expenses in running Govt offices
(ii) Compensation of employees of central Govt.
(iii) Interest payments
(iv) Grants-in-aid to state Govt.
(v) Subsidies
(B) Capital Budget- It consists of those Government receipts & Government
expenditures which Create or Reduce, Assets or Liabilities
1. Capital Receipts:- It consists of those Government receipts which
either Create Liabilities or Reduce Assets.
Types of Capital Receipts
(i) Borrowings (CL) - Borrowings by Govt. from various sources like
general public, Reserve bank of India, foreign Govt. and other bodies to
meet its financial requirements.
(ii) Recovery of loans (RA)-Loans recovered by Govtwhich it gives
to State Govt., union territories, local bodies etc.
(iii) Disinvestment (RA)- Funds received by Govt. from the sale of
the part or the whole of equity shares of the public sector enterprises to
private sector.
2. Capital Expenditure - It consists of those Government expenditures
which either Create Assets or Reduce Liabilities.
Types of Capital Expenditure
(i) Repayment of loan (RL)
(ii) Expenditure on construction & purchase of Assets (CA)
NOTE: in brackets above reason is given why those items are part of
Capital Receipts or Capital Expenditure
65
---------------------------------------------------------------------------------------Following table will help in learning Components of Government Budget
Learn only Definition of Capital Expenditure or&Capital Receipts& relate it to
define other Components
Revenue
Receipts
Do not CL or RA
Do not Create
Liabilities(CL)
Do not Reduce
Assets (RA)
Revenue
Expenditure
Do not CA or RL
Do not Create
Assets(CA)
Do not Reduce
Liabilities(RL)
Capital Receipts
CL or RA
Create
Liabilities(CL)
Reduce Assets
(RA)
Capital
Expenditure
CA or RL
Create
Assets(CA)
Reduce
Liabilities(RL)
----------------------------------------------------------------------------------------------3. Categories the following into capital and revenue expenditure and
Give reasons for your answer.
(i)Subsidised LPG given to public
Ans. It is revenue expenditure, because it neither Create Assets nor
Reduce Liabilities
(ii)Construction of Government School building
Ans. It is capital expenditure, because it Create Assets
(iii)Salary paid to Central government employees
Ans. It is revenue expenditure, because it neither Create Assets nor
Reduce Liabilities
(iv) Old age pension given by government
Ans. It is revenue expenditure, because it neither Create Assets nor
Reduce Liabilities
(v) Help given by govt. to flood victims
Ans. It is revenue expenditure, because it neither Create Assets nor
Reduce Liabilities
4. Categories the following into capital and revenue Receipts
And Give reasons for your answer
(i) Profits of PSU’s
Ans. It is revenue Receipts, because it neither Create Assets nor Reduce
Liabilities
(ii) Borrowings
Ans. It is capital Receipts, because it Create Liabilities
(iii) Disinvestment
66
Ans. It is capital Receipts, because it involves sale of shares of PSU’s to
private sector which Reduce Assets.
(iv) Gain tax
Ans. It is revenue Receipts, because it neither Create Assets nor Reduce
Liabilities
5.
Direct tax
It is levied on income & wealth of
individual or firms
it cannot be shifted
The incidence & the burden of the
tax falls on the same person.
It cannot be avoided it has to be
paid
Eg. Income tax ,Corporate or gain
tax, wealth tax etc.
Indirect Tax
It is levied on production of &
consumption expenditure on
Goods & services
it can be shifted
The incidence of tax is on one
person & the burden of payment
of the tax falls on another person
It can be avoided by not producing
or purchasing goods and services
that are taxed.
Eg. Sales
6. Categories the following into Direct tax & Indirect Tax and Give reasons for
your answer
(i)Income tax
Ans.It is Direct tax Because it is levied on the income of individual and it cannot
be shifted. The incidence & the burden of the tax falls on the same person
(ii) Excise duty
Ans.It is Indirect tax Because it is levied on the production &transfer of good
across states and it can be shifted. The incidence of tax is on one person & the
burden of payment of the tax falls on another person.
(iii) Service tax
Ans.It is Indirect tax Because it is levied on the services given and it can be
shifted. The incidence of tax is on one person & the burden of payment of the
tax falls on another person
(iv) Gain tax
Ans.It is Direct tax Because it is levied on the profits of firm and it cannot be
shifted. The incidence & the burden of the tax fall on the firm.
7.Types ofBudget Deficit
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(1) Revenue Deficit:-It refers to the excess of total revenue expenditure of the
government over its total revenue receipts.
Revenue deficit = Total Revenue expenditure - Total Revenue receipts.
OR
Revenue deficit = Total Revenue expenditure - Tax Revenue- Non Tax Revenue
(2) Fiscal Deficit: Fiscal deficit is defined as excess of total expenditure over
total receipts excluding borrowing during a fiscal year.
Fiscal deficit shows the borrowings requirements of the govt. during the
budget year. Fiscal deficit reflects the borrowing requirements of the govt. for
financing the expenditure including interest payments.
Fiscal deficit = Total budget expenditure - Total budget receipts excluding
borrowings
OR
Fiscal Deficit = (Revenue expenditure + Capital expenditure) – (Revenue
Receipts + Capital receipts excluding borrowings)
Fiscal deficit = Revenue expenditure+ capital expenditure- Revenue receiptscapital Receipts excluding borrowings
OR
Fiscal deficit = Revenue expenditure+ capital expenditure - Tax Revenue- Non
Tax Revenue-recovery of loans-disinvestment
OR
Fiscal deficit = borrowings
(3)Primary Deficit: Primary deficit is defined as fiscal deficit minus interest
payments on previous borrowings.
Primary deficit shows the borrowing requirements of the govt. for meeting
expenditure excluding interest payment.
Gross Primary deficit = Fiscal deficit - Interest payments
Net Primary deficit = Fiscal deficit+ Interest received - Interest payments
Deficit met by:(i) Borrow loansing from domestic sources.
(ii) Borrowing from external sources.
(iii) Deficit financing (printing of extra currency notes):
8.Implications of Budget deficit
68
 Debt Trap: Fiscal deficit refers to the total borrowings
requirement of the government create problem of repayments of
loans and interest payments. Interest payments increase the
revenue expenditure, which leads to revenue deficit. Repayments
of loans increase capital expenditure & Fiscal deficit. The
government has to borrow further to correct deficit. Thus, a
vicious cycle of increasing deficit is created called debt trap.
 Foreign Dependence: Government also borrows from the rest of
the world, which results in economic interdependence on them &
economic interference by the lending countries. It causes
economic slavery, if the lending county dictates its terms on the
borrowing country.
 Causes Inflation: The government resort to borrowing from the
Reserve Bank of India (RBI) to meet its fiscal deficit. It is done by
‘Deficit Financing’ Or ’ Monetisation of Debt’ , Which means RBI
prints currency 7 gives it to Govt. to finance debt. This increases
the circulation of money in the economy and creates inflationary
pressure, if there is excess supply of money.
 Restricts Economic Development: When Govt. has to borrow to
finance deficits, to repay loans and interest on loans, less money is
left with the Govt. for economic development.
 Financial burden for future generation: Borrowings lead to
burden for future generations as payment of loans and interest on
loans get accumulated whose burden is to be borne by the future
generations in the form of more tax and non-tax revenues.
9. OBJECTIVES OF A BUDGET
i.
ii.
Redistribution of Income and Wealth. – The government uses fiscal
instruments for Equitable distribution of income & wealth to ensure social
justice . To improve the distribution of income and wealth in the economy It
taxes the rich and gives subsidies on essential items, expenditure is done on
social security or public works etc..
Reallocation of resources – The government seeks to reallocate with a view
to balance the goals of profit maximization and social welfare. A production
69
iii.
iv.
of goods which are injurious to health like wine is discouraged through heavy
taxation. On the other hand production of socially useful goods like Khadi is
encouraged through subsidies.
Economic stability –using its revenue and expenditure policy in Budget the
government ensures economic stability in the economy by maintaining price
stability and high levels of employment. The forces of supply and demand
generate trade cycles in the economy, which govt. tries to prevent and
control.
Direct participation and Economic growth by Managing Public sector
Enterprises – The Government targets to increase the rate of growth by
establishing public sector enterprises to produce goods and services at low
cost to promote social welfare like railways. Provisions are made in the
budget for these PSU’s. Often, public sector enterprises are encouraged in
areas where private monopolies occur.
70
Unit-10 Balance of Payments Marks : 07
Chapter Foreign Exchange Rate
1. Foreign exchange rate- It is the rate at which currency of one country can be exchanged
for currency of another country. For example 1$ = Rs. 45
(In other words, It is the price of domestic currency expressed in terms of foreign currency
i.e. 1 Re=1/45$ or
It is the price of foreign currency expressed in terms of domestic currency i.e. 1 Re=1/45$)
2. The foreign exchange market is the market where international currencies are traded for
one another.
3. Flexible Exchange Rate/ Floating Exchange Rate-In a system of Flexible exchange rate the
exchange rate is determined by the demand and supply and there is no intervention by the
monetary authority.
4. Fixed Exchange Rate System: It is the exchange rate which is officially fixed by the Govt. or
monetary authority or central banks of a country. It is not determined by market forces.
5.Managed Floating- It is a mixture of Fixed Exchange Rate System & Flexible Exchange Rate
System .in this system the exchange rate is allowed to change freely due to changes in
demand and supply and monetary authorities intervene to manipulate the Exchange Rate
when required. There are no rules or conditions as to when to intervene.
Dirty Floating- When central bank of a country intervenes excessively in manipulating its
exchange rate for its benefit and is detrimental to other country then it is called Dirty
Floating
6.
Appreciation of currency
Appreciation means increase in price of
domestic currency due to changes in
demand and supply of foreign exchange.
Depreciation of currency
Depreciation means decrease in price of
domestic currency due to changes in
demand and supply of foreign exchange.
increasing in price of rupee from rupee 55/$
to rupees 45/$
Appreciation occurs in Flexible Exchange
Rate
decreasing in price of rupee from rupee55/$
to rupees 65/$
depreciation occurs in Flexible Exchange
Rate
7.
Revaluation of currency
the central monetary authority increases
devaluation of currency
the central monetary authority decreases
71
value of domestic currency in terms of
foreign currency.
For eg. Central bank revalues rupee by
increasing its value from rupee 55/$ to
rupees 45/$
monetary authority fixes the the exchange
rate
value of domestic currency in terms of
foreign currency.
For eg. Central bank devalues rupee by
decreasing its value from rupee 55/$ to
rupees 65/$
monetary authority fixes the the exchange
rate
8. The price of 1 US Dollar has fallen from Rs. 50 to Rs. 48. Has the Indian currency
Appreciated or depreciated?
Ans. Indian currency has depreciated.
9.
Spot market
Foreign exchange Operations of daily nature
are termed as spot
market or current market
A foreign exchange spot transaction is an
agreement between two parties to buy one
currency against selling another currency at
an agreed
price for settlement on the spot.
Forward market
Foreign exchange Operations for future
delivery are termed as
Forward market.
Forward market refers to the market in
which the sale and purchase of
Foreign currency is settled on a specified
future date at a rate agreed upon today to
reduce the uncertainties in the exchange
rate.
Forward contract is made for two reasons (a)
To minimize the risk of loss due to adverse
changes in the exchange rate (through
hedging) ; (b) To make profit (through
Speculation).
10. What are the Sources of demand for foreign exchange? OR
Give reasons why people want to have foreign exchange?
Ans: People demand for foreign exchange for the following purpose:a) To purchase goods and service from other countries (for Imports)
b) To send gifts and grants to abroad
c) To purchase i.e invest in Physical and financial assets abroad
d) To visit foreign country for education.
72
e) To visit foreign country for medical treatment
f) To speculate in the foreign currencies market.
g) To visit foreign country as tourists
11. What are the Sources of supply for foreign exchange:Ans: a) Exports of goods of the country to the rest of the world brings in the supply of
foreign exchange
b) Foreigners visiting a country as tourists
c) Foreigners visiting a country for education
D) Foreigners visiting a country for purchase (i.e to invest) of Physical and financial assets
e) Direct foreign investment or any investment by foreigners in home country
c) Speculative purchase of domestic currency by the non- residents in the domestic market.
d) Gifts and grants by the foreigners.
e) Direct purchase of the goods and services by the non- residents in the domestic
Market (exports)
---------------------------------------------------------------------------------------------------Appreciation – Increase in value of domestic currency in terms of foreign currency due to
change in demand or supply for foreign exchange in called appreciation.
For eg. Change from rupees 55/$ to Rupees 40/ $ is appreciation of rupee & depreciation of
$.
NOTE: Dollar (Foreign Exchange ) behaves like a Good
*If price of a good rises its, quantity supplied rises and quantity demanded falls
*Similarly if Foreign Exchange rate rises or dollar Appreciates (i.e. price of dollar rises), its
quantity supplied rises and quantity demanded falls
73
# Similarly if there is Excess Demand for a good its price rises , its quantity supplied rises and
quantity demanded falls
# Similarly if there is Excess Demand for Foreign Exchange i.e.$ Dollar, its price rises (i.e.
Dollar Appreciates), its quantity supplied rises and quantity demanded falls
* Similarly if there is Excess Supply for a good its price falls , its quantity supplied falls and
quantity demanded rises
* Similarly if there is Excess Supply for Foreign Exchange i.e.$ Dollar, its price falls(i.e. Dollar
depreciates), its quantity supplied falls and quantity demanded rises.
Q12. How is equilibrium in foreign exchange rate determined under fixed exchange rate
system?
Ans. Equilibrium Foreign Exchange rate is rupees55/$ at point e where demand & supply
for foreign exchange (i.e. dollar $) is equal .
(Rs./$)
Excess Supply
60Rs./$ P
A
Rs.55/$
Rs.40/$ R
S
B
e
L
M
Excess Demand
O
D
Quantity Demanded & Supplied of foreign exchange
74
When market foreign exchange rate in more than Equilibrium exchange rate, i.e it is
rupees 60/$ then
Quantity Demanded of $=PA
Quantity supplied of $ = PB
EXCESS SUPPLY for $ occurs equal to AB.
so in order to bring the rate back to Equilibrium foreign exchange rate, Monetary authority
revalues to rupees 55/ $. But to reach this rate the monetaryauthority or the govt. buys
excess $ from the market
When market foreign exchange rate in less than Equilibrium foreign exchange ratei.e
rupees 40/$
Quantity Demanded of $=RM
Quantity supplied of $ = RL
EXCESS DEMAND for $ is created equal to LM.so, the central monetary authority will
devalue rupee to rupees 55/$ to bring back Equilibrium for this monetary authoritywill have
to provide more dollars to the market to remove excess demand.
Excess demand
Q13. a) What will happen to Equilibrium foreign exchange rate if The number Of tourists
going abroad from India increases. OR
b) What will happen to Equilibrium foreign exchange rate if More Indians go abroad for
education? OR
c) What will happen to Equilibrium foreign exchange rate if More Indians going abroad for
medical treatment. OR
d) What will happen to Equilibrium foreign exchange rate if More Indians invest abroad in
financial assets or property. OR
e) What will happen to Equilibrium foreign exchange rate if Imports of India in increase. OR
Ans demand for foreign exchange increased
75
So demand curve for foreign exchange ($) rises upwards to the right from D1 to D2 At
original Equilibrium foreign exchange rate.
(Rs./$)
S
60Rs./$
e2
Rs.55/$ P
e1
A
Excess Demand
D2
D1
O
Q1
Q2
Quantity Demanded & Supplied of foreign exchange
Now Quantity Demanded of $=PA
Quantity supplied of $ = Pe1
So Excess demand for $ =e1 A is created.
Hence $ will appreciate due to which Quantity supplied of $ will increase &
Quantity Demanded of $ will decrease till new Equilibrium foreign exchange is reached at
point e2 Where Quantity Demanded of $ = Quantity supplied of $ =OQ2, at rupees 60/$
Q14.
a) What will happen to equilibrium foreign exchange rate if number of foreign tourist
coming to India decrease?
b) What will happen to equilibrium foreign exchange rate if number of foreign medical
tourists coming to India decrease?
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c) What will happen to equilibrium foreign exchange rate if Foreigners visiting India
decreases.
d) What will happen to equilibrium foreign exchange rate if foreign exports of India
decrease?
NOTE: ANSWER to all questions above will be same
Ans Supply for foreign exchange decreases.
So supply curve for foreign exchange rises upwards to left form S1 to S2.
S2
(Rs./$)
60Rs./$
Rs.55/$P
e2
A
S1
e1
Excess Demand
D
O
Q2
Q1
Quantity Demanded & Supplied of foreign exchange
At original Equilibrium foreign exchange rate rupees 55/$
Now Quantity Demanded of $=Pe1
Quantity supplied of $ = PA
So excess demand of $ = Ae1 created.
Hence $ will appreciate, due to which Quantity supplied $ will increase
77
Quantity Demanded of $ will decrease this process will continue till new Equilibrium
foreign exchange rate is reached at E2, where Qd of $= Qs of $= OQ2.
Q15. Why does demand for foreign exchange ($) decreases when its price decreases? Give
Reasons.
OR why does demand for $ decrease when $ appreciate? Give Reasons.
OR Why does demand for foreign exchange ($) decreases when domestic currency i.e
rupees depreciates? Give Reasons.
Ans when dollar appreciate (i.e. rupee depreciates) for c.g from rupees 55/$ to rupees 60/$
So $ becomes costly for Indians, so demand for dollar decreases due to following reasons
 Going abroad by Indians for education becomes costly so they demand less dollars.
 Going abroad by Indian for medical treatment becomes costly. So they demand less
dollars.
 Import of foreign goods by Indians becomes costly So demand for $ decreases.
 Investing abroad becomes costly so Indians buy less physical financial asset from
abroad so demand for $ falls.
Q16. Why does supply for foreign exchange ($) increase when in price increases? Give
Reasons. OR
Why does supply for $ increase when $ appreciates? Give Reasons.
OR
Why does supply for $ increase when domestic currency i.e rupees depreciates? Give
Reasons.
Ans When $ appreciates for eg from rupees 55/$ to rupees 60/$ (i.e. rupee depreciates),.
Now with one Dollar ($) foreigners can buy more Rupees’. So Indian goods become cheaper
for foreigners. The reason why supply of $ increases are:Export of Indian goods increases as Indian goods are cheaper for foreigners so supply of $
rises.
78

Foreign tourist coming to India rises as it becomes cheaper to visit India supply of $
rises.

Medical treatment in India for foreigners becomes cheaper. So they come for
medical treatment.

Education in India becomes cheaper for foreigners, so they come to India for
education $ supply rises.

Foreign invest more money in India as it is cheaper to buy physical & financial assets
in India , so $ supply rises
Q17. Why does supply of $ decrease when $ depreciates rupee appreciates?
Ans. Hint mention Sources of supply of $ which Cause decrease in $ supply
Q18. Why does demand for $ increases when $ depreciates Rupee appreciates?
Ans . Hint: Mention Sources of Demand for $ that cause increase in demand for $.
Excess supply
Q19. a) What will happen to foreign exchange rate if The no. of tourists coming to India
increases.
b) What will happen to foreign exchange rate if the exports of India increase?
c) What will happen to foreign exchange rate if tourists coming to India increases?
d)what will happen to foreign exchange rate if Medical tourists from foreign countries
coming to India increases .
e) what will happen to foreign exchange rate if More foreigners invest in India.
NOTE: ANSWER to all questions above will be same except first sentence
Ans It the number of tourists coming to India increases them the supply of foreign currency
($) increases,
Supply curve, Of $ shifts downwards to right from S1 toS2 ,
Supply for foreign exchange (i.e. dollar $) is equal.
79
S1
(Rs./$)
Excess Supply
60Rs./$ A
e1
Rs.55/$
B
S2
e2
D
Q1 Q2
O
Quantity Demanded & Supplied of foreign exchange
At original Equilibrium foreign exchange rate of OA (ruppees55/$)
Now Quantity Demanded of $=Ae1
Quantity supplied of $ = AB
So excess Supply of $ = e 1 Bcreated.
Hence $ will depreciate, due to which Quantity supplied $ will decrease
Quantity demanded of $ will increase this process will continue till new Equilibrium foreign
exchange rate is reached at E2, where Qd of $= Qs of $=OQ2.
Q20. The market price of US Dollar has increased considerably leading to rise in prices of
imports of essential goods. What can the Central bank do to ease the situation?
Ans: The Central bank can start selling US dollars from its reserves.
Q21. a)what will happen to Equilibrium foreign exchange rate if The number Of tourists
going abroad from India decreases. OR
80
b)what will happen to Equilibrium foreign exchange rate if less Indians go abroad for
education. OR
c) what will happen to Equilibrium foreign exchange rate if less Indians going abroad for
medical treatment. OR
d) What will happen to Equilibrium foreign exchange rate if less Indians invest abroad in
financial assets or property. OR
e) What will happen to Equilibrium foreign exchange rate if Imports of India in decrease
NOTE: ANSWER to all questions above will be same except first sentence
Ans It the number of Indian Tourists going to Abroad decreases then,
Demand for foreign Currency decreases
Demand curve of $ Shifts downwards to left from D1 to D2
(Rs./$)
Excess Supply
60Rs./$ B
Rs.55/$ P
A
S
e1
e2
D1
D2
O
Q2
Q1
Quantity Demanded & Supplied of foreign exchange
81
At original Equilibrium foreign exchange rate of OB (ruppees55/$)
Now Quantity Demanded of $=BA
Quantity supplied of $ = B e1
So excess Supply of $ = e 1 A is created.
Hence $ will depreciate, due to which Quantity supplied $ will decrease
Quantity Demanded of $ will increase this process will continue till new Equilibrium
foreign exchange rate is reached at E2, where Qd of $= Qs of $.
Chapter: Balance of Payment
Balance of payment Account
1.Balance of Payment (BOP)-It records all the transactions during a financial year between
residents a of country and rest of the world which leads to inflow and outflow of foreign
exchange.
2.Components of or Items of BOP
Autonomous Transactions or items
OR
Independent Transactions or items
OR
Above the line items
(It includes-
I. Current Account
(a)Trade of goods. (tangible item or visible
trade)-Export & import of goods.
(b)Trade of services
(intangible items or
invisible trade) )-Export & import of services
(i)Factor
services
like
income
I Current Account
from entrepreneurship i.e profit or payment
II Non reserve Items of Capital account)
for capital i.e. interest.
(ii)Non-factor services - banking , shipping
insurance
(iii)unilateral transfer – gifts, donation
remmittances.
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II. Capital A/c (Short term and long
them
borrowings
,sale
and
purchase of physical & financial
assets)

Banking capital

Private capital

Government or public borrowing
or capital
Accommodating Transactions or items
OR

Errors and omissions.

Official reserve transactions –
changes in gold, SDR’s , foreign
Exchange reserves.
Below the line items
Current Account- It records all the exports and imports of goods and services. These
transactions do not affect asset and liability position of a country. Exports and all receipts of
foriegtn exchange from unilateral transfers are recorded on the credit side with(+) sign.
The main components of Current Account are:
i) Export and import of goods ie. Visible trade or trade of Tangible items
ii) Export and import of Services i.e. Invisible trade or trade of intangible items:
a)Non factor services like shipping, banking, insurance etc.
b)Factor services like income
capital i.e. interest.
from entrepreneurship i.e profit or payment for
iii) Unilateral or Transfer payments: These refer to those receipts and payments,
which take place without any service in return. It includes gifts, donations,
Personal remittances etc..
83
Capital Account- Any transaction between resident of a country and rest of the world
whichresults in change in asset and liability position of a country with rest of the world is
recorded in capital A/c it includes long term & short term borrowings; sale & purchase of
physical and financial assets, changes in the official reserves of foreign exchange, gold, SDR’s
with the monetary authorities
The main components of Capital Account are

A)Banking capital

B)Private capital

C)Government or public borrowing or capital

D) Errors and omissions.

E) Official reserve transactions – changes in gold, SDR’s , foreign Exchange
reserves.
Note in other words you can write components of Capital Account as given
below
Components of Capital account
i) Private capital transactions: Capital transactions undertaken by the private sector
of the country in the form of short-term and long-term foreign loans.
ii) Government capital transactions: It includes the transactions undertaken by the
government with the rest of the world. For example, govt. borrows from IMF.
iii) Banking capital: It refers to capital movements and investment by foreign
branches of banks.
iv) Foreign direct investment: It refers to purchase of assets in the rest of the world
such that it gives direct control over the asset. For example, acquisition of
foreign firm by an Indian firm.
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v) Portfolio Investment: It refers to purchase of assets in the rest of the world such
that it does not give direct control over the asset. For example, purchase of
shares of a foreign firm by an Indian firm.
vi) errors and Omissions and

vii)official reserve transactions- These include transactions by monetary
authority i.e Central bank which causes changes in reserves of gold, SDR’s ,
foreign Exchange etc. with central bank.
3.
Autonomous items or transactions
Accommodating items or transactions
Or Independent
Or Below the line
Or above the line
Items/ Transactions
Items / Transactions
These include Current Account items, I.e These include official reserves of gold SDR’s,
export import of
goods services &Non Foreign Exchange etc.
reserve Items of Capital account
These transactions are done by all the These transactions are done only by the
sectors in economy i.e. household, firm, monetary officials (RBI)
govt, etc.
those international economic transactions
that take place due to some economic
motive such as profit maximization.
These transactions are done to balance the
BOP i.e. to bring Equilibrium in balance of
payment in accounting terms to correct
disequilibrium created by autonomous items
in the BOP .like government financing,
borrowings from IMF etc.
4.
85
Balance of Trade
Balance of Payments
(BOT)
(BOP)
It is the difference b/w exports and imports It includes
of Goods only
Current A/c, i.e export import of goods as
BOT = (Exports – Imports )of goods only
well as services.
Capital A/c (non-reserve items of Capital A/c
)
It is unfavourable when imports are more In accounting terms BOP is always in
than exports.
equilibrium.
It is favourable when imports are less than But in economic terms there can be
exports.
disequilibrium. & BOP can have deficit or
surplus.
5. The balance of trade shows a deficit of Rs. 600 crores, the value of exports is
Rs.1000 crores. What is value of Imports?
Ans: Balance of Trade = Exports of goods – import of goods
Import of good = Export of goods – (B.O.T)
= 1000- (-600)
= Rs. 1600.
6.’ There can be disequibrium in BOP’. comment.how can it be corrected?
OR
BOP is always in equilibrium comment.
or BOP always balances comment.
86
AnsIn accounting terms BOP always balancesbecauses it is based on double-entry book
keeping system and the sum of credit side is always equal to sum of debit side items.
The individual items in BoP may not balance but the total credits of the country must be
equal to total debits.
A deficit or surplus in current account is balanced by surplus or deficit in capital account.
If there is difference between the autonomous items, it would be settled by
accommodating items which are intended to balance the BoP. Hence Balance of payment
always balances.
Disequilibrium occurs in BOP in economic terms.
When sum of credit side of autonomous items is more than sum of debit side then there is
surplus in BOP
Correction of surplus in BOP in done by monetary authority by increasing reserves of gold,
foreign exchange with RBI and increasing SDRS held with the IMF (International monetary
fund)
When Debit Side of autonomous items is more than credit side, deficit in BOP Occurs.
Correction of deficit in BOP in done by monetary authority by decreasing foreign exchange
reserves, reducing SD R,s held with the IMF.
7. What is the balance of visible items in the balance of payments account called?
Ans:- Balance of trade.
8. CAUSES of DISEQUILIBRIUM in THE BALANCE OF PAYMENTS
There are a number of factors that cause disequilibrium in the balance of payments showing
either a surplus or deficit. These causes are categorized into 3 factors.
I Economic factors: Large scale development expenditure that may cause large imports.
II Cyclical fluctuations in general business activities such as recession or depression.
III High domestic prices may result in imports.
87
II Political factors: Political instability may cause large capital outflows and hamper the
inflows of foreign capital.
III Social factors:
exports.
Changes in tastes, preferences and fashions may affect imports and
88
UNIT 1 – INTRODUCTION 4marks
1. Opportunity cost:- Opportunity cost refers to value of a factor in its next best (or second
best) alternative use.in other wordsIt is the cost of next best alternative foregone.
2.Production possibility curve/ Production possibility frontier or boundary
ortransformation line or transformation curve:- The production possibility curve shows all
the possible combination of two goods that can be produced with the help of given
resources and technology.
3.MARGINAL OPPORTUNITY COST: MOC of a particular good along PPC is the amount of other
good which is sacrificed for production of additional unit of another good.
4.MARGINAL RATE OF TRANSFORMATION: MRT is the ratio of units of one good sacrificed to
produce one more unit of other good.
Unit of one good sacrificed
∆y
MRT = --------------------------------------------- = ---More unit of other good produced
∆x
5.How is the growth of an economy be presented through PPC ?
Ans:- Rightward shift of PPC.
6.State the economic problems relating to the allocation of resources.
Ans:-The problems related to allocation of resources has three aspects:
(i) What to produce? (ii) How to produce? (iii) For whom to produce?
(i) What to produce ?:-As we know resources are scares, we can not produceseverything in
whatever quantity we wish to. We are bound to face the problem of what to produce and
how much. The economy has to decide what goods and services are to be produced. For
instance which of the consumer goods like sugar, cloth, wheat, ghee, etc. are to be
produced and which of the capital goods like machines, tractors etc,. are to be produced.
Similarly choice has also to be made between the production of war time goods like rifles,
guns, tanks and peace time goods like bread and butter.
(ii) How to produce ?:- How to produce means how to organise production this problem is
concerned with the choice of technique of production. For example, production of cloth is
possible either by handlooms or by modern machines this problem is to concerned with
the efficient use of resources. There are two technique of production:(a) Labour intensive technique:- Under this technique, labour is used more than capital.
(b) Capital intensive technique:- Under this technique, capital is used more than labour.
(iii) For whom to produce ?:- It is a problem relating to choice of user of the goods and
services, should we produce for those who can pay high price ? If yes is the answer, we shall
89
end up producing goods and services for a respectively richer section of society or even for a
richer section of the world commodity. There quality of life would improve, but that of the
poor would stagnate or deteriorate further. As such, the gulf between the rich and the poor
would keep on widening. On the other hand if goods are produced for the poor only, they
may not afford to buy, reducing profits of the producers. Accordingly, level of output may
remain low, and the process of growth will suffer. Hence the problem of choice related to
the final users of goods and services.
7.Differentiate between positive and normative economics :-
SNo
Positive Economics
Normative Economics
1
It deals with what is what was.
It deals with what ought to be.
2
It is based on cause and effect of It is based on ethics.
facts.
3
It can be verified with actual data
4
In this value of judgments are not In this value of judgments are given.
given.
It cannot be verified with actual data.
8. What is production possibility curve? state its features & give a brief discussion
Ans:- Production possibility curve shows different combinations of two goods which can be
produce with the given resources on the assumptions that
(i) Resources are fully and efficiently utilised (ii) Technique of production remains constant.
Features of PPC:(i) Production possibility curve slopes downward:-production possibility curve slopes
downward from left to right. It is because in a situation of fuller utilisation of the given
resources, production of both the goods cannot be increased. More of a good-X can be
produced only only by giving up the production of another goodsY.
(ii) Production possibility curve is concave to the point of origin:-PPC is concave to the origin
because of increasing marginal opportunity cost.
It is because to produce each additional unit of good-X, more and more units of good-Y will
have to be sacrificed than before. Opportunity cost of producing every additional unit of goodX tends to increase in terms of the loss of production of good-Y.
90
(Production Possibility Schedule)
Production
possibilities
Goods
A
B
C
D
E
Wheat
100
90
70
40
0
Gun
0
10
20
30
40
Production possibility curve
9.How is the growth of a country shown with the help of production possibility curve?
Growth of resources:-Overtime an economy may generate more resources. Gulf countries, for
example, have acquired additional sources of oil. By selling oil these countries have acquired
more capital goods. They have enhanced their production capacity. Accordingly, their PPC has
shifted to the right. Fig. shows shift in PPC to the right when availability of resources increases.
91
Owing to increase in resources, (which generally happens in every economy overtime) PPC
shifts to the right. It shows higher level of output of both the goods. Thus, PP shows higher
level of output thanAD.
10
Microeconomics
Macroeconomics
1-Microeconomics
studies
economics issues or economic
problems at thlevel of an
individual-an individual firm,
an individual household or
individual consumer.
1. macro economics studies
economic
issues
or
economic problems at the
level of the economy as a
whole.
2-Allocation of resources to
different uses is the central
issue in microeconomics.
2. Raising the level of output
and growth is the central
issue in macro economics.
3. Examples:- consumer’s demand,
market price of commodity, firm’s
output.
3. Examples:aggregate
demand, general price level
in the economy, aggregate
supply in the economy.
11.
Market economy
In a market economy decisions relating
to what, how and for whom to produce
are governed by the market forces of
supply and demand.
The government does not interfere the
process of decision making.
Planned economy
It is an economy inwhichdecisions
relating to what, how and for whom to
produce are taken by some central
authority appointed by the government.
It is an economic system, in which all
material means of production are owned
and operated by the private sector with
profit motive.
In this economy all material means of
production are owned by the government
or by a centrally planned authority.
Economic decisions are taken for social
welfare.
12. Draw a production possibility curve and mark the following situations:
a) underutilization of resources
b) full employment of resources
92
c) scarcity of resources
Ans. Every point on PP curve like ABCDEF indicates full employment and efficient uses of resources.
Any point below or inside PP curve like G underutilization of resources.
Any point above PP curves like H indicates Scarcity of resources.
Wheat
14
12
P
A
B
H (scarcity of resources)
10
C
Full employment of resources
8
6
*G
E
4
2
0
Under utilizationof
resources
F
1
2
3
4
5
Cloth
13.Production Possibility Curve And Opportunity Cost
It refers to a curve which shows the various production possibilities that can be produced with given
resources and technology.
93
1. Production Possibilities
Production
Commodity
A
Possibility
Commodity
Marginal opportunity
B
cost of commodity A
A
0
15
-
B
1
14
15-14=1
C
2
12
14-12=2
D
3
09
12-9=3
E
4
05
9-5=4
F
5
0
5-0=5
Commodity A
If the economy devotes all its resources to the production of commodity B, it can produce 15 units
but then the production of commodity A will be zero. There can be a number of production
possibilities of commodity A & B
If we want to produce more commodities B, we have to reduce the output of commodity A &vise
versa.
14. (1) causes of Upward shiftin PP curve
(a) When there is improvement in technology.
(b) Increase in resources.
94
y
o
x
(2) Down ward shift
When Resources depletes
y
X
O
15..Distinguish between a centrally planned economy and a market economy.
SNo Planned Economy
Market Economy
1
All the materials means of production All the materials means of production are
are owned by government.
owned by private individuals.
2
Main objectives of production is social Main
objectives
of
welfare
maximization of profit.
3
Ownership of property
government control.
4
All the economic problems are solved as All the economic problems are solved through
per
direction of
the
planning price mechanism i.e., demand and supply.
commission.
is
production
are
under There is no limit to private ownership of
property.
95
16. From the following PP schedule calculate MRT of good x.
Production possibilities
A
B
C
D
E
Production of good x units
0
1
2
3
4
Production of good y units
14
13
11
8
4
Production of good X Production of good
units
Y units
MRT = ∆y / ∆x
0
14
-
1
13
1:1
2
11
2:1
3
8
3:1
4
4
4:1
96