Studymate Solutions to CBSE Board Examination

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1 Studymate Solutions to CBSE Board Examination Series : SGN Code No. 58/1 Roll No. Candidates must write the Code on the title page of the answer-book. 4 Please check that this question paper contains 10 printed pages. 4 Code number given on the right hand side of the question paper should be written on the title page of the answer-book by the candidate. 4 Please check that this question paper contains 24 questions. 4 Please write down the Serial Number of the question before attempting it minute time has been allotted to read this question paper. The question paper will be distributed at a.m. From a.m. to a.m., the students will read the question paper only and will not write any answer on the answer-book during this period. ECONOMICS [Time allowed : 3 hours] [Maximum marks : 80] General Instructions: (i) (ii) All questions in both the sections are compulsory. Marks for questions are indicated against each question. (iii) Question number 1 to 4 and 13 to 16 are very short answer type questions carrying 1 mark each. They are required to be answered in one sentence. (iv) Question number 5 to 6 and 17 to 18 are short answer type questions carrying 3 marks each. Answers to them should not normally exceed 60 words each. (v) Question number 7 to 9 and 19 to 21 are also short answer type questions carrying 4 marks each. Answers to them should not normally exceed 70 words each. (vi) Question number 10 to 12 and 22 to 24 are also long answer type questions carrying 6 marks each. Answers to them should not normally exceed 100 words each. (vii) Answer should be brief and to the point and the above word limit be adhered to as far as possible. Disclaimer: All model answers in this Solution to Board paper are written by Studymate Subject Matter Experts. This is not intended to be the official model solution to the question paper provided by CBSE. The purpose of this solution is to provide a guidance to students.

2 Section A 1. State one example of positive economics. Ans. A branch of economics based on data and facts is positive economics. It is the study of What is. Example: Inflation is rising by 7% in hypothetical economy. 2. Define fixed cost. Ans. Fixed costs are the costs that do not change with the level of output in the short run. 3. When the Average Product (AP) is maximum, the marginal product (MP) is: (a) equal to AP (b) less than AP (c) more than AP (d) can be any one of the above Ans. (a) 4. When the total fixed cost o producing 100 units is Rs. 30 and the average variable cost Rs. 3, total cost is: (a) Rs. 3 (b) Rs. 30 (c) Rs. 270 (d) Rs. 330 Ans. (d) 5. Explain the central problem of for whom to produce. Explain the central problem of choice of technique. Ans. For whom to produce? (i) It is the problem of distribution of goods and services in the economy i.e. to determine who is to get what share in the total output produced in the economy. (ii) In a socialist economy the distribution is done either equally or on the basis of needs whereas in a capitalist economy the distribution is done on the basis of income. A person who is getting a higher income gets a higher share because with his higher income he can buy more goods and services. A person getting a lower income gets a smaller share. (iii) Eg. A computer engineer gets a higher income as compared to an unskilled construction worker who gets a lower income and hence gets a smaller share. (iv) In economics the problem of distribution of national product is studied under the Theory of Distribution. Choice of technique (i) It is the question of choice of technique of production. A technique of production which would maximise output or minimise cost should be used. (ii) Generally two types of techniques of production are considered which are labour intensive and capital intensive. In labour intensive method more labour than capital is used whereas in capital intensive method more capital than labour is used. (iii) In India where labour is in abundance, labour intensive techniques should be used. (iv) Every economy should choose the most efficient technique of producing a commodity. In economics the problem of choice of technique of production is studied under Theory of production. 6. What is meant by inelastic demand? Compare it with perfectly inelastic demand. Ans. When change in the price of a commodity brings about a LESS THAN PROPTIONATE CHANGE in the quantity demanded for it, then the demand is said to be relatively inelastic demand. The change in quantity demanded is less than the change in price. Inelastic demand (e d < 1)/Less Elastic Demand The percentage change in quantity demanded is less than the percentage change in price. Comparison of inelastic demand with perfectly inelastic demand Ed = 0 When there is NO CHANGE in the quantity demanded with the change in price then it is called as perfectly inelastic demand. 2

3 Elasticity of demand is less than 1. Elasticity of demand is equal to 0. Demand curve is downward sloping with the steep slope. Demand curve is a straight line parallel to y-axis. 7. Given the price of a good, how will a consumer decide as to how much quantity to buy of that good? Explain. What is indifference curve? State three properties of indifference curves. Ans. A consumer will decide as to how much quantity to buy of that good based on satisfaction derived from the commodity and price of the commodity. There are two equilibrium conditions as per this approach: 1. MU x (`) = Price, i.e., MU x = Px MUm If MU x (money) > P x, consumer keeps on consuming more units. When he consumes more unit, the additional utility derived from consuming x keeps on falling. He keeps on consuming till MU x (money) = P x. If MU x (money) < P x, he will decrease the consumption of x. When he decreases the consumption of x, the marginal utility of x will increase. He will keep on decreasing consumption of x till MU x (money) = P x. Thus, MU x (money) = P x is the condition for consumer s equilibrium in a simple commodity case. 2. Total gain falls as more is purchased after equilibrium. The consumer continues to purchase so long as gain is increasing or at least constant. Indifference curve refers to the graphical representation of various alternative combinations of the goods which provide same level of satisfaction to the consumer. Properties of Indifference Curve 1. The indifference curve slopes downwards from left to right 2. The indifference curve is strictly convex to the origin 3. Higher indifference curve represents higher utility 8. When the price of a commodity changes from Rs. 4 per unit to Rs. 5 per unit, its market supply rises from 100 units to 120 units. Calculate the price elasticity of supply. Is supply elastic? Give reason. Ans. P = Rs. 4 P 1 = Rs. 5 Q = 100 Q 1 = 120 DP = 5 4 = Rs 1 DQ = = 20 e s = Percentage change in quantity supplied Percentage change in price Q 100 Q Q P es = = = = = P 100 P Q P 3

4 No, supply is not elastic as Es < 1, then supply for such a commodity is said to be less elastic. 9. What is meant by price ceiling? Explain its implications. Ans. Price ceiling or maximum price: It refers to fixing of the maximum price of a commodity at a level lower than the equilibrium price. Government imposes price ceiling in case of essential commodities (Wheat, Sugar, Kerosene etc.) Implications (a) Black marketing: Price ceiling leads to black marketing. It means when the commodities are sold at a price higher than the maximum price fixed by the government. (b) Rationing: To avoid black marketing government adopts rationing. It is a technique adopted by the government to sell a minimum quota of essential commodities at a price lower than equilibrium price to enable poor people to buy the commodity. Rationing has to be administered by the government effectively otherwise it will result in black marketing. (c) Dual marketing: Government adopts dual marketing, i.e., the same commodity is sold at different prices in the market. 10. Explain the conditions of consumer s equilibrium using Indifference Curve Analysis. Ans. Consumer Equilibrium by Indifference Curve Analysis According to indifference curve approach, consumers equilibrium is determined if the following two conditions are satisfied. (i) MRS XY = MRE = P X / P Y (ii) MRS XY is declining. MRS XY is the rate at which the consumer is willing to sacrifice Y to obtain one more unit of X. MRE is the rate at which market requires a consumer to sacrifice units of Y to buy one more unit of X which is equal to ratio of prices of X and Y good. MRE = P X /P Y. If MRS XY > MRE it implies that the consumer is willing to sacrifice more unit of Y than what market requires. This induces the consumer to buy more of X. When he buys more of X, utility derived from X falls and he is willing to sacrifice less of Y. Thus MRSxy starts declining. He continues to consume more of X, till MRS XY = MRE = P x /P Y. If MRS XY < MRE, it implies consumer is willing to sacrifice less units of Y than what the market requires. He decreases the consumption of X. Due to this MRS XY began to rise, he continues to decrease the consumption of X till MRS XY = MRE. Thus we can say that A consumer is in equilibrium at a point where budget line is tangent to indifference curve. Slope of indifference curve = Slope of budget line i.e. MRS XY = P X /P Y. In the diagram, equilibrium is at point E, where the budget line touches the highest attainable indifference curve IC 2 within consumer s budget. Bundles on the indifference curve IC 3 are not affordable within budget. Bundles on the indifference curve IC 1 (i.e., points F and G) are lying on a lower indifference curve i.e. will have lower utility levels as compared to the tangency point E. Therefore, the consumer will choose only the tangency point on the budget line. Therefore, E is a point of consumer s equilibrium where he maximizes his satisfaction. Point E is also called the Optimum Consumption Point where he consumes OX 1 of X and OY 1 of Y. 4

5 11. Explain the conditions of producer s equilibrium in terms of marginal revenue and marginal cost. Ans. Two conditions of producer s equilibrium are 1. MC = MR; 2. MC curve cuts the MR curve from below. MR is the addition to total revenue from the sale of one more unit of output and MC is the addition to total cost for increasing the production by one unit. As long as the addition to revenue is greater than the addition to cost, it is profitable for a firm to continue producing more units of output. Condition 1: MC = MR. This can be explained with the help of illustration and diagram. Output (Units) Marginal revevenue (In Rs.) Marginal cost (In Rs.) Firm s Behaviour MR > MC; profit earned on the last unit, overall profit is increasing; therefore, increase output MR = MC; no profit on the last unit. Producer s equilibrium MR < MC; loss on the last unit, overall profit is decreasing; therefore, decrease output. Two other situations may exist (a) MR > MC: At output level less than OQ, MR > MC, this implies that the firm is earning profit on the last unit of output. The marginal profit provides an incentive to the firm to increase production and move towards OQ units of output. Therefore when MR > MC, the firm increases output to maximise its profit. (b) MR < MC: At output level more than OQ, MR < MC. This implies that the firm is making a loss on its last unit of output. Hence, in order to maximise profit, a rational producer decreases output as long as MC > MR. Thus the firm moves towards producing OQ units of output. In the diagram, AR = MR = P. The marginal cost (MC) curve is U-shaped. Now, the condition of MR = MC is satisfied at two points; R and K. However, profits are maximised at point K, corresponding to OQ level of output. 12. State three characteristics of monopolistic competition. Which of the characteristics separates it from perfect competition and why? Explain the implications of the following: (a) Freedom of entry and exit of firms under perfect competition (b) Non-price competition under ogilopoly. Ans. Characteristics of monopolistic competition (1) There are large number of sellers and buyers: (2) Freedom of entry and exit of firms (3) Differentiated products 5

6 Dissimilarities Perfect Competition The product is homogeneous, it is identical in shape, size, colour, quality, etc. Since all products are identical no selling cost is incurred as buyers and sellers have perfect knowledge about market conditions. Since there are large number of firms selling homogeneous products price is determined by the industry and the firm is a price taker. Demand curve is perfectly elastic as price remains the same at all levels of output. y Monopolistic Competition The product is differentiated on the basis of shape, size, colour, brand etc. Heavy selling costs are incurred on sales due to lack of knowledge among sellers and buyers. Since products are differentiated, the firm has partial control over the price. Demand curve slopes downwards as more output can be sold only by lowering the price. y O Units/Quantity Under this market form AR = MR = Price. Perfect mobility of the factors of production. (a) (b) x O Units/Quantity AR and MR curves are downward sloping and MR < AR. Lack of perfect mobility of the factors of production. Implication of freedom of entry and exit of firms under perfect competition market: The implication of this assumption is that given sufficient time, all firms in the industry will be earning just normal profit. Suppose the existing firms are earning super normal profits. Attracted by the positive profits, the new firms enter the industry. The industry s output, i.e., market supply goes up. The price comes down. New firms continue to enter till economic profits are reduced to zero. Now suppose the existing firms are incurring losses. The firms start leaving the industry. The industry s output starts falling and price starts going up. All this continues till losses are wiped out. The remaining firms in the industry once again earn just the normal profits. Implication of Non-price competition under oligopoly: When there are only a few firms they are normally afraid of competing with each other by lowering the price. It may start a price war and firm who starts the price war may ultimately lose. Thus, firms indulge in non-price competition in order to increase their shares in sales and profit. Under nonprice competition they mainly utilise publicity and selling techniques for increasing the sales of their product. Non price competition involves promotional expenditures such as advertising, selling costs and lead to price rigidity. As the selling costs is high it will lead to wastage of resources of economy. x Section B 13. Which of the following effects national income? (a) Good and Services tax (b) Corporation tax (c) Subsidies (d) None of the above Ans. (d) 14. Define money supply. Ans. The supply of money means the total stock of all the forms of money (paper money, coins and demand deposits of banks) which are held by the public at any particular point of time. 6

7 15. The central bank can increase availability of credit by: (Choose the correct alternative) (a) Raising repo rate (b) Raising reverse repo rate (c) Buying government securities (b) Selling government securities. Ans. (c) 16. Why does consumption curve not start from the origin? Ans. Consumption curve does not start from origin because consumption cannot be zero even if income is zero. 17. Which among the following are final goods and which are intermediate goods? Give reasons: (a) Milk purchased by a tea stall (b) Bus purchased by a school (c) Juice purchased by a student from the school canteen Give nominal income, how can we find real income? Explain. Ans. (a) Milk purchased by a tea stall is intermediate good as it is used up in production process (b) Bus purchased by a school is final good as it is investment expenditure and adds to the capital stock of the school. It is included at GDCF. (c) Juice purchased by a student from school canteen is final good as it is purchase for consumption purpose. It is included as PFCE. Nominal income (National Income at current price): If goods and services produced in a year are valued at current prices, i.e., prices prevailing in that particular year, we get nominal income. Current prices refer to the prices prevailing in the year in which goods and services are produced. Nominal Income = Current Price (P 1 ) Current quantity (Q 1 ) Real income (National Income at Constant Price): If goods and services produced in a year are valued at fixed prices, i.e., prices of the base year, we get Real income. Constant prices refer to the prices prevailing in the base year. Real income = Base Year Price (P 0 ) Current quantity (Q 1 ) Conversion of nominal income into real income Nominal income is converted to Real income by the following formula Nominal income Real income = Current Price index 100 If price index for the current year is 200 and nominal income is ` 2,00,000, then the Real income will be: 200,, 000 Real income = 100 = Rs. 100,, 000 crores Define multiplier. What is the relation between marginal propensity to consume and multiplier? Calculate the marginal propensity to consume if the value of multiplier is 4. Ans. Multiplier explains how many times the income increases as a result of an increase in the investment. Multiplier refers to the ratio of change in income to a change in investment. Symbolically: k = D Y DI Relationship between MPC and Investment multiplier: There exists a direct relationship between MPC and the value of multiplier. Higher the MPC, more will be the value of multiplier, and vice-versa. The concept of multiplier is based on the fact that one person s expenditure is another person s income. People spend a part of this increased income on consumption. But the amount of increased income which is spent on consumption depends on the value of MPC. Thus, Given: K = 4, MPC =? 7

8 K 1 = 1 MPC 1 4 = 1 MPC 4(1 MPC) = 1 3 \ MPC = = Explain the role of the Reserve Bank of India as the lender of last resort. Ans. Lender of the Last Resort: When commercial banks fail to meet their financial requirements from other sources, they can approach the central bank which gives loans and advances as lender of the last resort. The rate, at which the central bank advances long term loans to commercial banks, is known as bank rate. Central bank assists these banks through discounting of approved securities and bills of exchange. The direct lending to commercial banks by central bank is referred to as the lender of the last resort function of a central bank. 20. What it meant by inflationary gap? State three measures to reduce this gap. What is aggregate demand? State its components. Ans. When at full employment income level, AD is higher than AS, the excess of AD over AS is called excess demand. In other words excess demand refers to a situation when the current aggregate demand is more than the aggregate demand required to achieve full employment of resources. At full employment income OF Aggregate Demand = AF Aggregate Supply = BF = OF Since AD > AS, there is excess demand in the economy which creates inflationary gap. Inflationary Gap = AF BF = AB Three measures to reduce this gap (1) Rise in bank rate (2) Rise in reverse repo rate (3) Rise in CRR and SLR Aggregate demand (AD) refers to the total value of final goods and services which all the sectors of an economy are planning to buy at a given level of income during a period of one accounting year. Components of aggregate demand: (1) Private final consumption expenditure: It is the total expenditure that all households in an economy are willing to incur on the purchase of goods and services for their personal consumption in a given period of time. (2) Investment Demand (I): The desired demand for capital goods by private investors during a given period of time. It means that addition to the capital stock or the expenditure 8

9 incurred for the creation of new capital assets of a country (such as buildings, plant machinery). (3) Government Demand (G): The total expenditure incurred by government on consumer goods and capital goods to satisfy the common needs of the economy. It means, government incurs consumption expenditure as well as investment expenditure. (4) Net Demand by Foreigners (X M): Net demand by foreigners is the demand by the rest of the world for the goods and services of an economy in a given period of time. AD = C + I + G + X M 21. The value of marginal propensity to consume is 0.6 and initial income in the economy is Rs. 100 crores. Prepare a schedule showing Income, Consumption and Saving. Also show the equilibrium level of income by assuming autonomous investment of Rs 80 crores. Ans. Since, C is not given in the question assume any value of C and prepare a schedule. Also show the equilibrium in the schedule. Here we assume C = 40 MPC = 0.6 Y C S I C + I = AD AS Equilibrium level of income is at 300. Where AD = AS. 22. Explain the meaning of the following: (a) Revenue deficit (b) Fiscal deficit (c) Primary deficit Explain the following objectives of government budget: (a) Allocation of resources (b) Reducing income inequalities Ans. (a) Revenue deficit: It refers to the excess of total revenue expenditure of the government over its total revenue receipts. Revenue deficit = Revenue expenditures Revenue receipts It signifies that the government s current expenses are greater than current income. The bulk of these expenses is interest payment, wages for government employees and defence personnel. (b) Fiscal deficit: Its defined as excess of total expenditure over total receipts excluding borrowing during a fiscal year. Fiscal deficit = Total budget expenditure Total budget receipts excluding borrowings Fiscal deficit indicates the total borrowing requirements of the government. Borrowings create problem of not only repayment of loans, but also of regular interest payments. Interest payments raise the revenue expenditure, which leads to revenue deficit. The government takes more loans to repay the earlier loans. (c) Primary deficit: Primary deficit is defined as fiscal deficit minus interest payments on previous borrowings. Primary deficit = Fiscal deficit Interest payment Fiscal deficit reflects the borrowing requirements of the government for financing the expenditure inclusive of interest payments, Primary deficit shows the borrowing requirements of the government for meeting its existing expenses other than interest payment. (a) Reallocation of Resources (i) (ii) The government aims to reallocate resources according to economic and social priorities through its budgetary policy. Government encourages the production of certain commodities by giving subsidies or tax reliefs. For e.g. government encourages the use of khadi products by providing subsidies. 9

10 (b) (iii) Government can discourage the production of harmful goods like liquor or cigarettes, by imposing heavy excise duties or taxes. Reducing income inequality (i) (ii) Economic inequality is an inherent part of every economic system. The government aims to reduce such inequalities of income and wealth, through its budgetary policy. The Government can impose higher taxes on the rich people. In India government uses progressive taxation i.e. people belonging to higher income levels have to pay more proportion of their income as tax to the government. (iii) The Government can provide subsidies and other amenities to poor people. Expenditure is incurred by the government on unemployment allowance, old age pension, social security etc. to help poor people. 23. (a) Explain the impact of rise in exchange rate on national income. (b) Explain the concept of deficit in balance of payments. Ans. (a) Rise in exchange rate implies depreciation of domestic currency and appreciation of foreign currency. Due to depreciation of domestic currency (b) (i) (ii) Domestic goods become cheaper to foreigners. They will buy more of domestic goods. As a result export of domestic country will increase. Imports become expensive and the demand for imports will fall. Since, net exports are included in national income national income will increase. A deficit in the BOP occurs when during the year the autonomous inflow of foreign exchange falls short of autonomous outflow. i.e. Autonomous payments > Autonomous receipts. To coverup this deficit the following accommodating transactions are undertaken. (i) (ii) Borrowing from IMF In case of deficit in BOP, RBI borrows from IMF which results in inflow of foreign exchange. Depletion of foreign exchange reserves - Foreign exchange reserves are held by RBI in the form of gold, foreign currency securities and SDRs (Special Drawing Rights). Every country is allowed under SDR to avail foreign exchange in the proportion of the quantity of the country s currency available. Reduction in these reserves is taken as a credit item as it causes inflow of foreign exchange. Thus a deficit in BoP is balanced by borrowing and reduction in foreign exchange reserves. 24. Calculate (a) Net national Product at market price, and (b) Gross Domestic Product at factor cost: (Rs. in crores) (i) Rent and interest 6,000 (ii) Wages and salaries 1,800 (iii) Undistributed profit 400 (iv) Net indirect taxes 100 (v) Subsidies 20 (vi) Corporation tax 120 (vii) Net factor income to abroad 70 (viii) Dividends 80 (ix) Consumption of fixed capital 50 (x) Social security contribution by employers 200 (xi) Mixed income 1,000 Ans. GDP at FC = (i) + [(ii) + (x)] + [(iii) + (vi) + (viii)] + (xi) + (ix) = [ ] + [ ] = = Rs cr. NNP at MP = GDP at FC + (iv) (ix) (vii) = = Rs.9630 cr. 10