STUDY MATERIAL DAKSHINA C L A S S E S. Session:

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1 STUDY MATERIAL DAKSHINA C L A S S E S Class Subject : XII : Economics(Study Material, HOTS and VBQ) Session: Head Office : 305, Green Plaza, L.P Savani Circle, Adajan, Surat. Web Site : aashutosh.dakshina@gmail.com, info@thedakshinaclasses.com Contact : ,

2 Supporting Material Class-XII Economics

3 Supporting Material Economics Design of Sample Question Paper for March, 2013 Examination Time : 3 hours Maximum Marks : 100 The weightage to marks over different dimensions of the question paper shall be as under. Part A : WEIGHTAGE TO CURRENT/SUBJECT UNITS S.No. Content Unit Mark Part A : Introductory Micro Economics 1. Introduction 4 2. Consumer Behaviour and Demand Producer Behaviour and Supply Forms of Market and Price Determination Simple applications of Tools of demand and supply curves Total 50 Part B : INTRODUCTORY MACRO ECONOMICS 1. National Income and Related Aggregates Money and Banking 8 3. Determination of Income and Employment Government Budget and the Economy 8 5. Balance of payments 7 Total 50 Grand Total XII Economics

4 Weightage to Forms of Questions S. Forms of Questions Marks for each No. of Total No. question question Mark 1. Very short answer type (VSA) Short answer type (SAI) Short answer type (SAII) Long answer type (LA) Total C. No. of Sections The questions paper will have two section A and B. D. Scheme of Option There will be no overall choice. However, there is internal choice in one question of 3 marks and one question of 4 marks and one question of 6 marks in each section. E. Weightage to forms of Questions S.No. Estimated Difficulty Percentage Level of Questions 1. Easy 30% 2. Average 50% 3. Difficult 20% F. Typology of Questions In order to asses different abilities related to the subject, the question paper is likely to include open-ended questions and numerical questions. 7 XII Economics

5 CONTENTS S. No. Chapter Page 1. Introduction Consumer s Behaviour & Theory of Demand Production Behaviour and Supply Forms of Market and Price Determination Simple Application of Toos of Demand and Supply Curve National Income Money and Banking Determinations of Income & Employment Government Budget and the Economy Balance of Payment Question Papers Exam. Oriented Questions with Answers XII Economics

6 UNIT 1 INTRODUCTION POINTS TO REMEMBER Study of Economics is divided into two branches (a) Micro economics (b) Macro economics Micro economics studies the behaviour of individual economic units. Macro economics studies the behaviour of the economy as a whole. Economy is an Economic Organisation which provides sources to earn livelihood. Economic problem is the problem of allocation of limited resources available in the economy. Cause of economic problems are : (a) Unlimited Human Wants (b) Limited Economic Resources (c) Alternative uses of Resources. Central Problems of an Economy Allocation of Resources What to produce? How to produce? For whom to produce? For the selection of an opportunity, the sacrifice of next best alternative use is called opportunity cost. Production possibility frontier (PPF) shows different combinations of a set of two goods which can be produced with given resources and production technology. 9 XII Economics

7 Production possibility curve PPC (a) (b) Slopes downward from left to right because if production of one good is to increase then production of other good has to be sacrificed. Concave to the origin because of increasing marginal opportunity cost or (MRT) Rightward shift of PPC indicates increase in resources and improvement in technology. Leftward shift of PPC indicats decrease in resources and degradation in technology. Marginal Rate of Transformation (MRT) is the ratio of number of units of a good sacrificed to increase one more unit of the other good. MRT can also called Marginal opportunity cost. It is defined as the additional cost in terms of number of units of a good sacrificed to increase an additional unit of the other good. VERY SHORT ANSWER TYPE QUESTIONS (1 MARK) 1. With the help of an example, define micro economics. 2. Define macro economics with the help of an example. 3. Define opportunity cost. 4. Why does an economic problem arise? 5. Write two characteristics of resources. 6. What do you mean by scarcity? 7. What do you mean by marginal opportunity cost? 8. What do you mean by an economy? HOTS 9. What is meant by economising the use of resources? 10. What do you mean by alternative uses of resources? 11. What will be the shape of PPF when MRT is constant? 12. Unemployment in India is a subject matter of Microeconomics or Marcoeconomics, give reason. 10 XII Economics

8 SHORT ANSWER TYPE QUESTIONS (3/4 MARKS) 1. Distinguish between microeconomics and macroeconomics. Give example. 2. Why does an economic problem arise? Explain the problem of 'How to Produce'? 3. Explain the problem of 'What to Produce' with the help of an example. 4. For whom to produce is a central problem of an economy. Explain. 5. Why is a production possibility curve concave? Explain. 6. Define opportunity cost with the help of an example, how does it differ from marginal opportunity cost? 7. What is Marginal Rate of Transformation? Explain with the help of an example. HOTS 8. What is PP Frontier? Explain it with the help of an imaginary schedule and diagram. 9. Show the following situation with PPF (a) Fuller utilisation of resources (b) Growth of resources. (c) Under utilisation of resources. 10. An economy always produces on, but not inside a PPC. Defend or refute. 11. A lot of people die and many factories were destroyed because of a severe earthquake in a country. How will it affect the country s PPC? 12. Calculate MOC from the following table. What will be the shape of PPC and why. Combinations Green Chilly (Units) Sugar (Units) A B 95 1 C 85 2 D 70 3 E 50 4 F XII Economics

9 ANSWER OF VERY SHORT TYPE QUESTIONS 1. Micro Economics is that branch of economics in which economic problems are studied at individual level e.g. the behaviour of consumer, firms, etc. 2. Macro economics is that branch of economics which studies the economy as a whole and its aggregates e.g. National income, the level of employment. 3. For the selection of an opportunity, the sacrifice of next best alternative use is called opportunity cost. 4. An economic problem arises due to scarcity of resources having alternative uses in relation to unlimited wants. 5. Resources are scarce (limited) and they have alternative uses. 6. Scarcity refers to a situation in which demand is more than supply. 7. Marginal rate of transformation (MRT) is the ratio of one good sacrificed to increase one more unit of the other good. 8. An economy is an economic organisation which provides sources to earn livelihood. 9. Economising the resources means that resources are to be used in a manner such that maximum output is realised per unit of output. It also means optimum utilisation of resources. 10. Alternate use of resources mean, more than one uses to which a resource can be put. 11. Shape of PPF will be a straight line sloping down ward. 12. Unemployment in India is a subject matter of macroeconomics because it relates to economy as whole. HINTS [3 MARKS QUESTIONS] 12. Combinations MOC A B 5 C 10 D 15 E 20 F XII Economics

10 UNIT 2 CONSUMER'S BEHAVIOUR & THEORY OF DEMAND POINTS TO REMEMBER Consumer : is an economic agent who consumes final goods and services. Total utility : It is the sum of satisfaction from consumption of all the units of a commodity at a given time. Marginal Utility : It is a net increase in total utility by consuming an additional unit of a commodity. Law of Diminishing Marginal Utility : As consumer consumes more and more units of commodity. The Marginal utility derived from the last each successive units goes on declining. Consumer s Bundle : It is a quantitative combination of two goods which can be purchased by a consumer from his given income. Budget set : It is a quantitative combination of those bundles which a consumer can purchase from his given income at prevailing market prices. Consumer Budget : It states the real income or purchasing power of the consumer from which he can purchase the certain quantitative bundles of two goods at given price. Budget Line : Shows those combinations of two goods which a consumer can buy from limited income on same curve. Monotonic Preferences : Consumer s preferences are called monotonic when between any two bundles, one bundle has more of one good and no less of other good. Change in Budget Line : There can be parallel shift (leftwards or rightwards) due to change in income of the consumer. 13 XII Economics

11 Marginal Rate of Substitution (MRS) : It is the rate at which a consumer is willing to substitute good X for good y. Good x MRS = Good y Indifference Curve : is a curve showing different combination of two goods, each combinations offering the same level of satisfaction to the consumer. Properties of Indifference curve : 1. Indifference curves are negatively sloped. 2. Indifference curves are convex to the point of origin. 3. Indifference curves never touch or interesect each other. 4. Higher Indifference curve represents higher level of satisfaction. Consumer s Equilibrium : Consumer is in equilibrium when he gets maximum satisfaction from his limited income. Condition of Consumer s Equilibrium (a) In terms of utility : MU MU x (i) In case of one good MU x = = y P x = MU m Px Py where MU x Marginal utility of good X P x Price of Good X (ii) In case of two goods (b) In terms of Indifference curve : There should be (i) Decreasing MRS (Marginal Rate of substitution). (ii) MRS xy Px = P P x Price of good x P y Price of good y y (iii) Budget line should be tangent to indifference curve. 14 XII Economics

12 Demand : It is that quantity which a consumer purchases or is willing to buy at given price. Market Demand : It is the sum of total quantity purchased by all the consumers at given price in the market. Demand Function : It is the functional relationship between the demand of a good and factors affecting demand. Change in Demand : When demand changes due to change in any one of its determinants other than the price. Change in Quantity Demanded : When demand changes due to change in its own price. Price Elasticity of Demand : It measure the degree of responsiveness of demand to change in price of the commodity. 15 XII Economics

13 Percentage Method E d Elasticity of Demand Q Change in quantity Total Expenditure Method : It measures price elasticity of demand on the basis of change in total expenditure incurred on the commodity by a household as a result of change in its price. P QChange P in Price Q1 Q0 P0 E d= or Ed = ( ) There are three conditions : P PIntitial Q Price P1 P0 Q0 1. If the Total Expenditure on the Q commodity Initial changes Quantityinversely with the price change, the demand is relatively elastic (ed > 1) Or 2. If the total expenditure on the commodity remains the same as before Percentage Change in Quantity and after change in price, then E ddemand = is said to be unitary elastic (ed = 1) Percentage Change in Price 3. It the total expenditure on the commodity increases with an increase in its price and decreases with a decrease in the price, then demand is relatively inelastic (ed < 1) Geometric Method : Elasticity of demand at any point is measured by dividing the length of lower segment of the demand curve with the length of upper segment of demand curve at that point. Lower segment of the demand curve Ed = Upper segment of the demand curve 16 XII Economics

14 Diagram to show Geometric or point method : Elasticity of demand at given point D is mid point of the demand curve Lower part of the demand curve Ed = Upper part of the demand curve Degree of Price Elasticity of Demand 17 XII Economics

15 Factors affecting Price elasticity of Demand (a) Behaviour of the consumer (b) Nature of the commodity (c) Possibility of postponement of consumption. (d) Proportion of income to be spent on the commodity (e) Number of close substitutes (f) Alternative uses of commodity (g) Income of the consumer VERY SHORT ANSWER TYPE QUESTIONS (1 MARK) 1. What is meant by utility? 2. How is Total utility derived from marginal utilities? 3. What is Law of Diminishing Marginal Utility? 4. What will be the behaviour of total utility when marginal utility is zero? 5. State condition of consumer's equilibrium in respect of one good. 6. Define consumers equilibrium. 7. What is meant by Marginal Rate of Substitution (MRS). 8. What is meant by budget set. 9. Define Indifference curve Map. 10. How is budget line defined? 11. Why does higher indifference curve give more satisfaction? 12. What is the impact of diminishing marginal rate of substitution on the slope of indifference curve? 13. Define monotonic preference. 14. How is market demand schedule derived with the help of individual demand schedules? 15. Define normal good. 16. How does availability of substitute good affect the elasticity of demand? 17. Demand of good X falls due to increase in the income of the consumer what type of good X is? 18. What will be the impact on demand of the good due to increase in price of 18 XII Economics

16 the substitute good? 19. A rise in price of a good results in a decrease in expenditure of it. Is its demand elastic or inelastic? 20. What is meant by market demand? 21. Define demand schedule. 22. What cause an upward movement along a demand curve? 23. If the number of consumers increase, in which direction will the demand curve shift? 24. A straight line demand curve is given. What will be elasticity of demand on the mid point of this curve. 25. If the slope of a demand curve is parallel to X-axis, what will be the elasticity of demand? 26. Why is demand of water inelastic? 27. Define price elasticity of demand. H.O.T.S. 28. Why does total utility increases at diminishing rate due to continuous increase in consumption? 29. Due to decrease in price of pen why does the demand of ink increase? 30. What will be the behaviour of total utility when marginal utility curve lies below X-axis? 31. When is demand inelastic? 32. Give two examples of normal goods & inferior goods. SHORT ANSWER TYPE QUESTIONS (3-4 MARKS) 1. Explain the law of diminishing marginal utility with the help of a utility schedule. 2. Explain consumers equilibrium with utility approach in case of single good. 3. What do you mean by budget line? What are the reasons of change in budget line? 4. Explain the relationship between total utility and marginal utility with the help of schedule. Or 19 XII Economics

17 What changes will take place in total utility when (a) (b) (c) Marginal utility curve remains above X axis Marginal utility curve touches X axis Marginal utility curve lies below X axis. 5. State three features of indifference curve. 6. Why does two indifference curves not intersect each other? 7. Under what situations there will be parallel shift in budget line? 8. Explain the effect of a rise in the prices of related goods on the demand for a good X. 9. Why does demand of a normal good increases due to increase in consumer s income? 10. State elasticity of demand of followings : (a) Luxurious goods (b) Goods of alternate use (c) Necessity goods. 11. Distinguish between expansion of demand and increase in demand with the help of diagram. 12. Measure Price Elasticity of Demand on the following points of a straight line demand curve : (a) Centre point of the demand curve. (b) Demand curve intercepting y-axis (c) Demand curve intercepting x-axis. 13. Distinguish between change in demand and change in quantity demanded. 14. What will be the effect of following on elasticity of demand. (a) time factor (b) nature of the product. 15. What will be the slope of demand curve under following situations. (a) Perfectly elastic demand (b) Perfectly inelastic demand (c) Unit elastic demand. 16. State the factors of rightward shift of demand curve. Explain any one. 20 XII Economics

18 17. State the factors of leftward shift of demand curve. Explain any one. 18. How does a proportion of income spent on a good affect elasticity of demand. 19. What will be elasticity of demand if (a) Total expenditure increases due to increase in price. (b) Total expenditure increases due to fall in price. 20. When price of a good is Rs. 7 per unit a consumer buys 12 units. When price falls to Rs. 6 per unit he spends Rs. 72 on the good. Calculate price elasticity of demand by using the percentage method. comment on the likely shape of demand curve based on this measure of elasticity. 21. A consumer buys 10 units of a good at a price of Rs. 9 per unit. At price of Rs. 10 per unit he buys 9 units. What is price elasticity of demand? Use expenditure approach Comment on the likely shape of demand curve on the basis of this measure of elasticity. 22. A consumer buys 20 units of a good at a price of Rs. 5 per unit. He in incurs an expenditure of Rs. 120 when he buys 24 units. Calculate price elasticity of demand of the percentage method. Comment on the likely shape of demand curve based on this information. 23. When the price of a commodity falls by Rs. 2? per unit, its quantity demanded increases by 10 units. Its price elasticity MU n= n of demand is ( ) 1. Calculate its D Q quantity demanded at the price before change which was Rs. 10 per unit. 24. The price elasticity of demand of a commodity is 0.5. At a price of Rs. 20 per unit, total expenditure on it is Rs. 2,000. Its price is reduced by 10 percent. Calculate its demand at the reduced price. H.O.T.S. 25. State four determinants of price elasticity of demand. 26. Fill in the gaps in the following equations : (i) (ii) (iii) MU? = Σ= MU TU q P? e =? Q (iv) 21 XII Economics

19 27. Differentiate between : (i) (ii) Normal goods and Inferior goods Complementary goods and substitute goods. 28. Why should the budget line be tangent to the indifference curve at the point of consumer s equilibrium. 29. Why does consumer stop consumption in case where marginal utility is less than price of a good? 30. What is budget line? Why is it negatively stoped? 31. A consumer consumes only two goods x & y. state & explain the conditions of consumer s equiiprium with the help of utility analysis. 32. Explain the conditions determining how many units of a good the consumer will buy at a given price. 33. Difine marginal rate of substitution. Explain why is an indifference curve convex? LONG QUESTIONS (6 MARKS) 1. Explain the conditions of consumer s equilibrium with the help of the indifference curve analysis. Represent the same in a diagram. 2. Explain the determination of consumers equilibrium with the help of a schedule in case of two commodities by using utility approach. 3. Why does demand curve slope downward? 4. Explain the determinants of price elasticity of demand. 5. With the help of diagrams, explain the effect of following changes on the demand of a commodity. (a) A fall in the income of its buyer. (b) A rise in price of complementary good. 6. What are the conditions of consumer s equilibrium under the indifference curve approach? What changes will take place if the conditions are not fulfilled to reach equilibrium? 7. Explain the three properties of indifference curve. 22 XII Economics

20 H.O.T.S. 8. With the help of numerical example measure price elasticity of demand in the following conditions by total expenditure method : (i) Demand falls when price is constant. (ii) Price falls while demand is constant. 9. Whether the following statements are true or false? Give reasons. (i) Two indifference curves never intersects each other. (ii) Income effect of inferior good is positive. (iii) Change in quantity demanded is the explanations of law of demand. 10. Explain the concept of marginal rate of substitution (MRS) by giving an example. What happens to MRS when consumer moves downwards along the indifference curve? Give reasons for your answer. 11. Following statements are true or false give reasons : (i) (ii) Increase in number of consumers shifts the demand curve rightward. The demand of a commodity becomes elastic if its substitute good is available in the market. (iii) The price elasticity of demand is equal to unity at a point situated in the middle of a straight line demand curve. ANSWERS VERY SHORT ANSWER TYPE QUESTIONS 1. Utility is the power of goods to satisfy human wants. 2. Total utility is derived by summing up the marginal utilities TU = ΣMU. 3. Law of diminishing marginal utility states that as more and more units of a commodity are consumed marginal utility derived from every additional unit must decline. 4. Total utility will be maximum. 5. MU X = P x 6. Consumers equilibrium refers to a situations in which a consumer gets maximum satisfaction from his given income and market price. 23 XII Economics

21 7. MRS is the rate of sacrifice of one good to get an additional unit of other good. 8. The set of bundles available to the consumer with his given income at prevailing market price is called the budget set. 9. A family of indifference curve indicating different levels of satisfaction called indifference map. 10. Budget line is a line showing all different possible combinations of two goods which a consumer can buy with his given income and the price of both goods. 11. Higher difference curve shows a higher level of satisfactions. It shows the various combinations of excess quantity of both goods than lower indifference curve. 12. Indifference curve become convex towards the origin. 13. Consumer s preferences are called monotonic when between any two bundles, one bundle has more of one good and no less of other good. 14. By summations of individual schedules. 15. Normal goods are those goods, the demand for which increases as income of the buyer rise. There in positive relation between income and demand of these goods. 16. The demand of a good becomes elastic if its substitute good is available in the market. 17. Good X is an inferior good. 18. The demand of the good will increase. 19. Elastic. 20. Market demand is the sum of total demand of all the consumers in the market at a particular time and at a given price. 21. Demand schedule is a tabular representation which represent different quantities of the commodity demanded at different prices. 22. Increase in price while other factors are constant. 23. Rightward. 24. Equal to unit. 25. Perfectly elastic. 26. Because water is a necessity good. 24 XII Economics

22 27. The price elasticity of demand is the degree of responsiveness of quantity demanded of a commodity to the change in its price. H.O.T.S. (ANSWERS) 28. As more and more units of commodity are consumed, marginal utility derived from each successive unit tends to diminish so total utility increases at diminishing rate up. 29. These are complementary goods. 30. Total utility start to decline. 31. When percentage change in quantity demanded is less than percentage change in price, the demand is said to be inelastic. 32. Normal goods Rice, Wheat Inferior goods coarse grain, coarse cloth. 25 XII Economics

23 UNIT 3 PRODUCTION BEHAVIOUR AND SUPPLY POINTS TO REMEMBER Total production refers to the sum total of production done by using all units of variable factors over a given period of time. Average production is the per unit output of variable factor (labour) employed. AP = Marginal product is addition to total product resulting from employing one additional unit of variable input. TP Returns to a factor : In a short period variable when input additional units of variable factors are employed with given fixed factors, then returns to a factor operates. Returns to a factor shows the changes in total products, marginal product which arises due to change in ratio between fixed and variable factor. They are as follows : (A) Increasing returns to a factor : In the initial stage as more and more units of variable factor are employed with fixed factor total physical production increases at increasing rate. (B) Diminishing returns to a factor : As more and more units of variable factors are employed with fixed factors, then total product increases at diminishing rate. (C) Negative returns to a factor : This is the last stage of returns to a factor. As more and more units of variable factors are employed with given fixed factors, total production starts decreasing and marginal product becomes negative. Relation between Total, Average and Marginal Product 1. So long as marginal product rises, total product increases at increasing rate. 26 XII Economics

24 2. Marginal product starts falling but remains positive, total product rises at diminishing rate in this stage. 3. When marginal product becomes negative, then total product starts falling in this stage. 4. So long as average production is less than marginal product, average production increases Marginal product intersects average product at the point where average product is maximum. After this average product starts falling and is more than marginal product in this stage. Cost : Cost is the sum of direct (explicit cost) and indirect cost (implicit cost). Those monetary payments, which are incurred by producers for payment those of factor and non-factor inputs which are not owned by produces are called Direct Cost. Implicit cost is the cost of self owned resources of the production used in production process. TC Q Total cost is the sum of total fixed cost and total variable cost. TC = TFC + TVC or TC = AC X Q Total fixed cost remains constant at all levels of output. It is not zero even at zero output level. Therefore, TFC curve is parallel to OX-axis. TFC = TC TVC or TFC = AFC Q Total variable cost is the cost which vary with the quantity of output produced. It is zero at zero level of output. TVC curve is parallel to TC curve. TVC = TC TFC or TVC = AVC Q Average cost is per unit of total cost. It is the sum of average fixed cost and average variable cost. AC = or AC = AFC + AVC 27 XII Economics

25 Average fixed cost is per unit of total fixed cost. AFC = or AFC = AC AVC Per unit of total variable cost is called average variable cost. AVC = or AVC = AC AFC Net increase in cost for producing one additional unit is called marginal cost. MC n = TVC n TVC n 1 or MC = Relation Between Short-Term Costs Total cost curve and total variable cost curve remains parallel to each other. The vertical distance between these two curves is equal to total fixed cost. TFC curve remains parallel to X aixs and TVC curve remains parallel to TC curve. TFC TVC With increase in level of output, the Q vertical Q distance between AFC curve and AC curve goes on increasing. On contrary the vertical distance between AC curve and AVC curve goes on decreasing but these two curves never intersect because average fixed cost is never zero. Marginal cost curve intersects average cost curve and average variable cost curve at their minimum point. After the point of intersection with increase in output, AC curve and AVC curve starts rising. MC curve remains under the AC and AVC curve before inter section point but after inter section point AC and AVC curve remains under the MC curve. Average cost and average variable cost falls till they are more than marginal cost. When these two costs are less than marginal cost, in that situation both (AC and AVC) rise. Money received from the sale of product is called revenue. Total revenue is the amount received from the sale of given units of a commodity over a particular period of time. TR = AR Q or TR= ΣMR 28 XII Economics

26 Per unit revenue received from the sale of given units of a commodity is called average revenue. Average revenue is equal to price. AR = TR Q or = P = Price. Marginal revenue is net addition to total revenue when one additional unit of output is sold. MR = TR Q Behaviour of TR, AR and MR when per unit price remains constant or firm can sell additional quantity of a good at same price (a) (b) Average revenue and marginal revenue remains constant at all levels of output and AR and MR curves are parallel to ox-axis. Total revenue increases at constant rate and TR curve is positively sloped straight line passing through the origin. Behaviour of TR, AR and MR when price falls with additional unit of output sold or there is monopoly or monopolistic competition in the market (a) Average revenue and marginal Prevenue Q curves have negative slope. MR curve lies below AR curve. Q (b) Marginal revenue falls, twice the rate of average revenue. (c) So long as marginal revenue is positive, total revenue increases. When marginal revenue is zero, total revenue is maximum and when marginal revenue becomes negative, TR starts falling. Concept of Producer s Equilibrium : If refers the stage where producer getting maximum profit. (A) MR and MC Approach : Conditions of producers equilibrium according to this approach are : (a) (b) Equality between MR and MC MC curve should cut the MR curve from below at the point of equilibrium. Or MC should be more than MR after the equilibrium point, with increase in output. Supply : Refers to the amount of the commodity that a firm or seller is willing to offer or to sell in a given period of time at various prices. 29 XII Economics

27 Individual Supply : Refers to quantity of a commodity that an individual firm is willing and able to offer for sale at each possible price during a given period of time. Stock : Refers to the total quantity of a particular commodity available with the firm at a particular point of time. Supply Schedule : Refers to a tabular presentation which shows various quantities of a commodity that a producer is willing to supply at different prices, during a given period of time. Supply curve : Refers to the graphical representation of supply schedule which represents various quantities of a commodity that a producer is willing to supply at different prices during given period of time. Law of Supply : States the direct relationship between price and quantity supplied, keeping other factors constant. Exceptions to Law of Supply 1. Future Expectation 2. Agricultural goods 3. Perishable goods 4. Rare goods 5. Backward countries. Price Elasticity of Supply : Refer to the degree of responsiveness of supply of a commodity with reference to a change in price of such commodity. It is always positive due to direct relationship between price and quantity supplied. Price Elasticity of Supply (Es) = Percentage change in quantity supplied Percentage change in price Methods for measuring price elasticity of supply : 1. Percentage Method 2. Geometric Method Degrees of Elasticity of Supply : (a) (b) (c) If the tangent to the supply curve passes through the point of origin, Es at that point is equal to unity. If the tangent intersects the x-axis, Es at that point is less than unity if tangent intersects the y-axis Es at that point will be greater than unity. 30 XII Economics

28 Very Short Answer Type Questions (1 Mark) 1. Define production function. 2. Define marginal product. 3. What will be the behavior of total product when marginal product of variable input is falling but is positive? 4. What is the relation between average and marginal product when average product is falling? 5. Define average production. 6. What do you mean by fixed factors of production? Give example. 7. By which behaviour of marginal product will total product be maximum 31 XII Economics

29 8. How does fall in total product affects marginal product? 9. What do you mean by cost? 10. Define explicit costs. 11. Which cost curve is parallel to ox-axis? Why? 12. What do you mean by implicit costs? 13. Define marginal cost. 14. Why does the difference between average total cost and average variable cost falls with increase in output? 15. Define Revenue. 16. At what rate average and marginal revenue falls, with fall in per unit price of a good? 17. What will be the behaviour of Average revenue when total revenue increases at constant rate? 18. What do you mean by marginal revenue? 19. What will be the behaviour of total revenue when marginal revenue is zero? 20. Why does average cost curve and averages variable cost curve never intersect each other? 21. What do you mean by producer s equilibrium? 22. State any two conditions of producers equilibrium according to marginal revenue and marginal cost approach. 23. Define supply. 24. What do you mean by individual supply schedule? 25. Define Market Supply 26. Name two determinants of supply. 27. What is meant by change in supply? 28. What type of change in price is the cause of upward movement along a supply curve? 29. What effect does an increase is tax rates have on supply of a commodity? 30. What causes a downward movement along a supply curve? 31. What is meant by leftward shift of supply curve? 32. How does a decrease in price of input effect supply curve of the commodity? 32 XII Economics

30 33. Why does a supply curve have a positive slope? 34. What is meant by elasticity of supply? 35. What is the price elasticity of supply, if supply curve is parallel to y-axis. 36. When does the elasticity of supply of commodity called equal to unity? 37. When does the producer increase the supply of a good at given price, give two reasons. 38. What causes an extension in supply? 39. If the price of a commodity falls by 10% and, consequently, the quantity supplied decreases by 20%. What will be its price elasticity of supply? H.O.T.S. 40. Why is total variable cost curve parallel to total cost curve? 41. Why does average fixed cost fall with increase in output? 42. Why is total fixed cost curve parallel to ox-axis. 43. Under which situation will MR fall when an additional quantity of a good is sold? 44. What behaviour of per unit price will cause the equality of average and marginal revenue. 45. Give one differences between law of supply and price elasticity of supply. 46. What is the price elasticity of supply associated when the supply curve passing through to intersect to x-axis? 47. Why does a producer moves downward along a supply curve due to decrease in price of commodity? 48. What is the price elasticity of supply associated with when a supply curve passes through the origin at 40 angle? 49. When does the supply curve shift rightward while price remains constant. 50. What effect does an increase in price of competitive good have on the supply of a commodity? 51. How does the imposition of a tax affect the supply curve of a firm? 33 XII Economics

31 SHORT ANSWER TYPE QUESTIONS (3-4 MARKS) 1. Why does the law of diminishing returns apply? 2. How does total product behave with change in marginal product? 3. Briefly explain the causes of increasing returns to a factor with the help of marginal product. 4. Explain the likely behaviour of total product. When only the unit of a variable factor is increased to increase the output. Use numeric example. 5. Distinguish between total fixed cost and total variable cost. 6. Explain with the help of a diagram the relationship between Average cost, Average variable cost and Marginal cost. 7. Why is short run average cost curve U shaped? 8. Explain diagrammatically the relationship between Average cost, Average variable cost and Average fixed cost. 9. What changes will take place in total revenue when (a) (b) (c) Marginal revenue is falling but remains positive. Marginal revenue is zero. Marginal revenue is negative. 10. Define marginal revenue. Explain the relationship between average and marginal revenue when price is constant at all levels of output. 11. How does marginal revenue effect total revenue when price decreases to increase sale. Use Schedule. 12. What do you mean by producers equilibrium? State the conditions of producer s equilibrium with Marginal Revenue and Marginal Cost Curves. 13. Explain producer s equilibrium with the help of a numerical example using marginal revenue and marginal cost approach. 14. Draw in a single diagram the average revenue and marginal revenue curves of a firm which can sell any quantity of the good at a given price. Explain. 15. Complete the following table : Output Total Cost Average Variable Cost Marginal Cost (Units) (Rs.) (Rs.) (Rs.) XII Economics

32 16. Given below is the cost schedule of a firm. Its average fixed cost is Rs. 20 when it produces 3 units. Output (units) Average variable cost (Rs.) Calculate its marginal cost and average total cost at each given level of output. 17. Complete the following table : Output Average Variable Cost Total Cost Marginal Cost (Units) (Rs.) (Rs.) (Rs.) Define market supply. Explain its two determinants. 19. Distinguish between Change in Supply and change in quantity supplied. 20. Explain briefly two causes of a rightward shift of supply curve. 21. Differentiate between contraction in supply and decrease in supply. 22. How does change in price of inputs affect the supply of a good. 23. What is meant by elasticity of supply? What will be the price elasticity under following conditions : (a) (b) Percentage change in quantity is greater than percentage change in price. Supply remain constant due to increase or decrease in price of the good. 24. A seller of potatoes sells 80 quintals a day when the price of potatoes is Rs. 4 per kg. The price elasticity of supply of potatoes is known to be 2. How much quantity of potatoes will the seller supply when the price rises to Rs. 5 per kg. 25. The coefficient of elasticity of supply of a commodity is 3. A seller supplies 20 units of the commodity. How much quantity of this commodity will the seller supply. When price rises by Rs. 2 per unit? 26. The ratio of elasticity of supply of commodities A and B is 1 : percent fall in price of A results in a 40 percent fall in its supply. Calculate 35 XII Economics

33 the percentage increase in supply of B if its price rises from Rs. 10 per unit to Rs. 11 per unit. 27. How does change in price of related goods affect the supply of given good. H.O.T.S. 1. State the causes by which marginal product of a variable factor change from increasing return to diminishing return. 2. What would be the shape of average revenue curve when total revenue is positively sloped straight line passing through origin. Explain with the help of schedule and diagram. 3. What is a supply schedule? Explain how does change in technology of producing a good affect the supply of that good. 4. Following statements are true or false. Give reasons : (a) (b) At the stage of producer s equilibrium, marginal cost will be decreasing. AR curve always remain above MR curve. 5. Whether following statements are true or false. Give reasons. (a) (b) Marginal revenue falls twice the rate at which average revenue falls. Average cost starts increasing when rising portion of marginal cost intersects. 6. Following statements are true or false. Give reasons : (a) (b) Diminishing returns to a factor is applicable only when average product starts falling. AC and AVC curves do not intersect each other 7. Distinguish between leftward shift to supply curve and downward movement along a supply curve. 8. The change in quantity supplied is explanation of law of supply. Explain. 9. Either following statements are true or false. Give reasons. (a) (b) There is inverse impact of change in tax rates on the supply of given good. Future expectation to increase in price increases the market supply of a commodity. 10. Explain the geometric method of measuring price elasticity of supply with the help of diagram. 36 XII Economics

34 LONG ANSWER TYPE QUESTIONS (6 MARKS) 1. Explain diagrammatically the effect on total output when units of one factor is increased and all other inputs are held constant. 2. Complete the following table Output Total Cost Average Fired Average Variable Marginal (Units) (Rs.) Cost Cost Cost What is producer s equilibrium? Explain the conditions of producer s equilibrium through the marginal cost and marginal revenue approach. Use diagram. 4. State whether true or false. Give reasons. (a) (b) (c) Total product is the area under the marginal product curve. When marginal product falls, average product always falls. For the first unit of output MC = AVC. 5. State whether True or False. Give reasons. (a) (b) (c) When marginal revenue is constant and not equal to zero, then total revenue will also be constant. As soon as marginal cost rises, average variable cost also starts rising. Total product always increases whether there is increasing returns or Diminishing return to a factor. 6. State whether the following statements are true or false. Give reasons for your answer. (a) (b) (c) When total revenue is constant average revenue will also be constant. Average variable cost can fall even when marginal cost is rising. When marginal product falls, average product will also fall. 37 XII Economics

35 ANSWERS 1. Diminishing return to a facter 1 MARK QUESTIONS 2. Marginal product is net addition to total product when one additional unit of variable factor is used. 3. Total product increases at diminishing rate. 4. MP falls but it falls at faster rate than AP 5. AP is a per unit output of a variable factor. 6. These factors of production which cannot be varied in short period e.g. machine, land. 7. When marginal product of a factor is zero, then total product will be maximum. 8. When total product falls, marginal product becomes negative. 9. Cost is the sum of explicit and implicit cost. 10. Those monetary payments by producer on factor and non factor payments is called explicit cost. Which are not owned by himself. 11. Total fixed cost because TFC remain constant at all level of output. 12. Implicit cost is the cost of self owned resources of producer. 13. Marginal cost is the net addition to total cost when one additional unit of output is produced. 14. It is because average fixed cost goes on falling with increase in output. 15. Revenue is the amount received from sale of output. 16. Marginal revenue falls twice the rate of average revenue. 17. Average revenue remains constant. 18. Marginal revenue is net additions to total revenue by sale of one additional unit of output. 19. Total revenue will be maximum. 20. Because AFC can never be zero at any level of output. 21. Producer s equilibrium is a situation where he gets maximum profit MR = MC 2. Rising portion of Marginal cost curve intersects marginal revenue curve. 38 XII Economics

36 25. Supply refers to the amount of the commodity that a firm or seller is willing to offer for sale in a given period of time at various prices. 26. Individual supply schedule is a tabular representation showing various quantities of a commodity which a firm is ready to sell at different prices during a given period of time. 27. It referes the sum of tatal quantity supplied by all the firms in a market Number of firms 2. Change in technology 29. Change in supply refers to increase or decrease in supply of a commodity due to change in factors other than price like technology, price of inputs, Goal of producer, Number of firms etc. 30. Due to increase in price. 31. As a result of increase in tax rates production cost increase, so the profit margin of producer will fall and producer will decrease the supply. 32. Decrease in price. 33. Due to change in other factors the supply of a commodity falls at same price than supply curve shifted to leftward. 34. As a result of decrease in price of input production cost falls then producers profit margin will increase so producer will increase the supply of commodity. 35. Because of positive relation between price and supply. 36. Price Elasticity of Supply (Es) is a measure of degree of response of supply for a good to change in its price. 37. Perfectly elastic. 38. When percentage change in price is equal to percentage change in supply. 39. Due to change in other factor like improvement in technology, decrease in price of inputs. 40. Increase in price of a commodity. 41. % change in quantity 20% Es = = = 2 % change in price 10% 39 XII Economics

37 H.O.T.S. 42. Total cost is the sum of total fixed cost and total variable cost. TFC remains constant at all levels of output. 42. AFC can be calculated from TFC. Which remains constant at all level of output. 43. TFC remains constant at all levels of output. 44. When per unit price falls by selling an additional unit of a good. 45. Per unit price remains constant. 46. Law of supply reflects the direction of change in supply where as price elasticity of supply measures the magnitude of change in supply. 47. Inelastic. 48. Because profit margin of firm (producer) decreases. 49. Equal to unity elastic. 50. When the supply of commodity increases due to change in other factors. 51. Supply of the commodity will fall. 52. The supply curve will shift to the left side. 40 XII Economics

38 UNIT 4 FORMS OF MARKET & PRICE DETERMINATION POINTS TO REMEMBER Market implies a system with the help of which the buyers and seller of a commodity or service come to contact with each other and complete the act of sale and purchase. Perfect competition is that type of market in which there are very large number of sellers, sell homogenous goods at constant price without any competition to consumer who have perfect knowledge about the market. Under perfect competition, price remains constant therefore, average and marginal revenue curves also remain constant and parallel to ox-axis. 41 XII Economics

39 Under perfect competition price is determined by an industry (a group of producers and consumers) with the forces of demand and supply. No individual firm or buyer can influence the price or supply of the product. So industry is price maker and firm is price taker. MONOPOLY MARKET Monopoly is that type of market where there is a single seller, selling a product which does not have close substitutes. Under monopoly, due to absence of free entry and exit, firm earn abnormal profit in the long run. Under monopoly, monopolist himself determines price of the product according to the elasticity of demand as he has full control over the supply of the product. Under monopoly elasticity of demand for the good is less than one, therefore, demand curve has steeper slope. (Ed < 1). Under monopoly, average revenue and marginal revenue has negative slope, as per unit price falls with increase in output sold. A monopolist may charge different price from different buyers for the same good it is called price discrimination. MONOPOLISTIC COMPETITION Monopolistic competition is that type of market in which there are large number of firms, sell differentiated product to the consumers who have imperfect knowledge about the product and there is tough competition between firms. Under monopolistic competition due to lack of control over supply each firm determines the price of their product, keeping in view the price level set by other firms. Under monopolistic competition elasticity of demand for the product is greater than one therefore demand curve (AR curve) has flatter slope. Each firm has to incur selling costs (expanditure on advertisement etc.) to promote its sales. This is because, there is a large number of close substitute available in the market. 42 XII Economics

40 OLIGOPOLY Oligopoly is the form of market in which there are few sellers. All the firms produce a certain amount of output of total market supply. All the firms under oligopoly produce homogenous or differentiated product. Under oligopoly entry of firms is not restricted but difficult. Under oligopoly demand curve is undefined. All the firms are interdependent in respect of price determination under oligopoly market. On the basis of production, oligopoly can be categorised in two categories. (i) (ii) Collusive oligopoly is that form of oligopoly in which all the firms determine price and quantity of output on the basis of cooperative behaviour. Non-collusive oligopoly is that form of oligopoly is which all the firms determine the price and quantity of output according to the action and reaction of the firms. 43 XII Economics

41 Equilibrium Price : Which corresponds to the equality between market demand and market supply of a commodity. Equilibraium quantity which corresponds to the equilibrium price in the market. Market equilibrium is a state in which market demand is equal to market supply. There is no excess demand and excess supply in the market. VERY SHORT ANSWER TYPE QUESTIONS (1 MARK) 1. Define market. 2. What do you mean by homogenous product? 3. How is price determined under perfect competition? 4. What is the common feature shared by perfect and monopolistic competition? 5. If the firms are earning abnormal profits, how will the number of firms in the industry change? 6. Define the monopoly market. 7. Under which market there is no difference between firm and industry? 8. What is normal profit? 9. Under which form of market the firm is price taker. 10. What is cartel? 11. What is the relationship between AR curve and demand curve in a monopoly market? 12. What do you mean by price discrimination? 13. Define oligopoly. 14. Define equilibrium price. 15. When does the situation of excess supply arise? 16. What will be the effect on equilibrium price when increase in demand is more than increase in supply? 17. Under what situation does the equilibrium price remains unaffected when there is simultaneous increase in demand and supply. H.O.T.S. 18. What is the relation between average revenue curve and demand curve under monopolistic competition? 44 XII Economics

42 SHORT ANSWER TYPE QUESTIONS (3-4 MARKS) 1. Why is firm under perfect competition a price taker and under monopolistic competition is price maker. Explain? 2. How is the demand curve under monopolistic competition different from demand curve of a firm under perfect competition? 3. Why is a firm under perfect competition a price taker? Explain. 4. Explain three features of perfect competition. 5. Explain the implication of large number of seller feature of perfect competition. 6. What will happen if the price prevailing in the market is above the equilibrium price. 7. Distinguish between monopoly and oligopoly. 8. Explain the concept of excess demand with the help of diagram. 9. Differentiate between Collusive and non-collusive oligopoly. 10. Explain the determination of equilibrium price under perfect competition with the help of schedule. 11. Explain why is the equitibrium price determined only at the output level at which market demand and market supply are equal. H.O.T.S. 12. MR = AR in perfect competition but MR < AR in monopoly and monopolistic competition why? 13. In which condition decrease in demand can not change the price of commodity? 14. Explain how firms are interdependent in an oligopoly market. 15. In which competition the availability of close substitutes is present? How does it effect the price? 16. Explain the implication of freedom of entry and exit to the firms under perfect competition. 45 XII Economics

43 LONG ANSWER TYPE QUESTIONS (6 MARKS) 1. Explain the characteristics of monopolistic competition. 2. Market for a good is in equilibrium. There is simultaneous increase both in demand and supply of the good. Explain its effect on market price. 3. Explain the term market equilibrium. Explain the series of changes that will take place if market price is higher than the equilibrium price. 4. How will a fall in the price of tea affect the equilibrium price of coffee. Explain the chain of effects. 5. Explain the following features of perfect competition. (i) (ii) Large number of firms or Sellers and Buyers Homogeneous Product. 6. Explain features of Oligopoly. 7. Explain how change in price of a substitute commodity would affect market equilibrium of the commodity X. 8. With the help of a diagram explain the effect of decrease in demand of a commodity on its equilibrium price and quantity. 9. There is simultaneous decrease in demand and supply of a commodity, when it result in (i) (ii) no change in equilibrium price a fall in equilibrium price. ANSWERS 1 MARK QUESTIONS 1. Market is a system with the help of it the buyers and seller of a commodity or service come to contact with each other. 2. It means product produced by different firms is identical in all respect like quality, colour, size, weight etc. such products are perfect substitutes. 3. Price is determined by an industry by the forces of demand and supply. 4. (i) Free entry and exit of firms (ii) Perfect mobility of factors. 46 XII Economics

44 5. The number of firms in the industry will increase. 6. It is a form of market under which there is a single seller, selling a product which does not have close substitutes. 7. Monopoly. 8. It is the minimum profit which a firm must get to stay in business. 9. Perfect competition. 10. A cartel is a group of firms which jointly set output and price policy of its product in such a way so as to reap benefits of monopoly. 11. Both AR curve and demand curve are the same in a monopoly market. 12. Price discrimination is a policy under which a seller sells a similar product at different prices to different buyers. 13. Oligopoly is a market structure where there are few firms competing for their homogenous or differentiated products. 14. It is the price at which demand = supply. 15. When market price is more than equilibrium price and market supply is more than market demand. 16. When increase in demand is more than increase in supply, equilibrium price will increase. 17. When increase demand is equal to increase in supply the equilibrium price will remain same. H.O.T.S. 18. Both AR and MR curves have negative slope 47 XII Economics

45 UNIT 5 SIMPLE APPLICATION OF TOOLS OF DEMAND AND SUPPLY CURVE POINTS TO REMEMBER With the help of curves, these variables can be studied, which represent positive or negative relation. Variables are of two types (i) dependent variables (ii) independent variables. Generally independent variables are represented on OY-axis, where as dependent variables are represented on OX-axis. While plotting curves, value on OX-axis or OY-axis should be according to reasonable proportion. Relationship between variables can be understood easily through curves because their effect is long lasting on our minds. In Economics demand and supply curves are used to express following : 1. Data relating to demand and supply. 2. To determine equilibrium in various economic activities. 3. To show the effect of change in demand and supply on equilibrium and market price. 4. For graphic representation of different categories of elasticity of demand and supply. 5. Determination of floor price and price ceiling in situation of excess demand and excess supply. Govt. determines maximum and minimum price ceiling with the help of demand and supply. Govt. determines tax rate in accordance with elasticity of demand and supply. 48 XII Economics

46 Demand and supply curve explain equilibrium under following situations : 1. Rate of interest (Demand for money and supply for money) 2. Wage rate 3. Price determination of factors of production. 4. Determination of foreign exchange rate. 5. Determination of tax. 6. Saving of consumer. 49 XII Economics

47 UNIT 6 NATIONAL INCOME POINTS TO REMEMBER Good : In economics a good is defined as any physical object, natural or man-made, that could command a price in the market. Consumption Goods : Those goods which satisfy human wants directly. Capital Goods : Those final goods which help in production. These goods are used for generating income. Final Goods are those goods which are used either for final consumption or for investment. Intermediate Goods refers to those goods and services which are used for further production or for resale. These goods do not fulfil needs of mankind directly. Investment : Addition made to the stock of capital during a period is called investment. It is also called capital formation. Depreciation : is expected fall in value of fixed capital goods due to normal wear and tear and obsolescence. Gross Investment : Total addition of capital goods to the existing stock of capital during a time period at market price. Net Investment : is a measure of net availability of new capital or new addition to capital stock in an economy. Net Investment = Gross investment Depreciation. Stocks : Variables whose magnitude is measured at a particular point of time are called stock variables. Flows : Variables whose magnitude is measured over a period of time are called flow variable. 50 XII Economics

48 Economic Territory : Economic (or domestic) Territory is the geographical territory administrated by a Government within which persons, goods, and capital circulate freely. Scope of Economic Territory : (a) (b) (c) (d) Political frontiers including territorial waters and airspace. Embassies, consulates, military bases etc. located abroad. Ships and aircraft operated by the residents between two or more countries. Fishing vessels, oil and natural gas rigs operated by residents in the international waters. Normal Resident of a country : is a person or an institution who ordinarily resides in a country and whose centre of economic interest lies in that country. Domestic Aggregates NATIONAL INCOME AGGREGATES Gross domestic Product at Market Price (GDP MP ) is the market value of all the final goods and services produced by all producing units located in the domestic territory of a country during a financial year. Net Domestic Product at Market Price (NDP MP ) : NDP MP = GDP MP Depreciation (consumption of Fixed capital) Domestic Income : (NDP FC ) : It is the factor income accruing to owners of factors of production for suppling factor services with in domestic territory during an accounting year. NATIONAL AGGREGATES Gross National Product at Market Price (GNP MP ) is the market value of all the final goods and services produced by all producing units (in the domestic territory and abroad) of a country during a financial year. GDP MP + NFIA = GNP MP National Income (NNP FC ) : is a measure of factor earnings of the residents of a country both from economic (Domestic) territory and from abroad during an accounting year. 51 XII Economics

49 NNP FC = NDP FC + NFIA = National Income. National Income at Current Prices (Nominal National Income) : It is the money value of all final goods and services valued at current prices produced by normal residents of a country over a particular period of time. Real National Income or National Income at Constant Prices : It is also called as real income. It is the money value of all final goods and services valued at constant prices produced by normal residents of a country. Value of Output : Market value of all goods and services produced by an enterprise during an accounting year. Value added : It is the difference between value of output of a firm and value of inputs bought from the other firms during a particular period of time. Double Counting : Counting the value of a commodity more than once while estimating national income is called double counting. Ways to solve the problem of double counting. (a) (b) By taking the value of only final goods. By taking value added. National Disposable Income (NDI) : It is defined as net national product at Market price (NNP MP ) plus net current transfer from rest of the world. NDI = NNP MP + Net current transfers from rest of the world. 52 XII Economics

50 OR = National income + net indirect tax + net current transfers from the rest of the world. Gross National Disposable Income (Gross NDI) = GNP MP + Net current Transfers from rest of the world. Net National Disposable Income (Net NDI) = NNP MP + Net current Transfers from rest of the world. = Gross NDI Depreciation. OR Concept of Value Added of One Sector or One Firm 1. Value output = Sales + Net Stock. 2. Gross Value added at market prices (GVA MP ) = Value of output Intermediate consumption 3. Net value added at market price (NVA MP ) = GVA MP Depreciation. 4. Net value added at factor cost (NVA FC ) = NVA MP Net indirect tax. Note: By adding up NVA FC of all the sectors, we get NDP FC or Domestic Income. 53 XII Economics

51 54 XII Economics

52 55 XII Economics

53 5. When will be NDP MP be less than NDP FC? 6. State the meaning of consumption of fixed capital? 7. State the meaning of injection in income flow, with the help of an example. 8. What do you mean by leakage in income flow? 9. State whether the following are stock or flow : (i) Losses (ii) Capital (iii) Production (iv) Wealth 10. Define Nominal GNP 11. What do you mean by Real GNP? 12. Define stock variable. 13. Define capital goods. H.O.T.S. 1. Which of the two NVA FC and NVA MP is equal to sum of factor income. 2. Why is money received from sale of shares is not included in domestic factor income. 3. What aggregate do we get, when we add up the net value added of all producing sectors of an economy? 4. How value added method solve the problem of double counting? 5. What is per capita real GDP. 6. Complete the following aggregates. (i) National Income = Domestic income... (ii) Personal Income = Private income... (iii) Net value added at FC = Gross output... SHORT ANSWER TYPE QUESTIONS (3 MARKS) 1. Distinguish between real and nominal gross domestic product. 2. Explain the basis of classifying goods into intermediate and final goods. Give suitable examples. 56 XII Economics

54 3. Distinguish between consumer goods and capital goods. Which of these are final goods? 4. Explain how distribution of G.D.P. is its limitation as a measure of economic welfare. 5. Explain the meaning of Domestic Territory of a country. 6. Distinguish between factor income and transfer income. 7. Classify the following into stock and flow : (i) Population of India (ii) Exports (iii) Investment (iv) Expenditure on food by household. (v) National Capital (vi) Deposits in saving account of bank. 8. Explain how distribution of Gross domestic product is a limitation in taking domestic product as an Index of welfare. 9. How can externalities be a limitation of using gross domestic product as an index of welfare. 10. Giving reasons, classify the following into intermediate and final goods : (i) (ii) Machines purchased by a dealer of machines. A car purchased by a house hold. 11. Distinguish between stock and flows. Give an example of each. 12. What is meant by a normal resident? State which of the followings are treated as normal resident of India. (i) (ii) An American working in the office of WHO located in India. Indian working in U.S.A. embassy located in India. 13. Which of the following is factor income from abroad for an Indian resident and why? (a) (b) Interest income received by Indian resident on the bonds of companies operating in USA. Remittances by Indians settled abroad to their families in India. Giving reason explain how should the following be treated in estimating national income: (i) (ii) Expenditure on fertilizers by a farmer Purchase of tractor by a farmer. 57 XII Economics

55 H.O.T.S. 14. Explain why subsidies are added to and indirect taxes deducted from domestic product at market price to arrive at domestic product at factor cost. 15. Giving reasons, explain how are the following treated in estimating national Income by the income method. (a) (b) Interest on a car loan paid by an individual Interest on a car loan paid by a Govt. owned company. 16. Why do we include the imputed value of goods but not services while estimating production for self consumption? 17. Define operating surplus, write its components. 18. Distinguish between domestic product and national product. When can domestic product be more than National Product. LONG ANSWER QUESTIONS (6 MARKS) 1. How will you treat the following while estimating national income of India. (a) (b) (c) Dividend received by an Indian from his investment in shares of a foreign company. Money received by a family in India from relatives working abroad. Interest received on loan given to a friend for purchasing a car. 2. How will you treat the following while estimating national income of India? Give reason for your answer? (a) (b) (c) Dividend received by a foreigner from investment in shares of an Indian Company. Money received by a family in India from relatives working abroad. Interest received on loan given to a Friend for purchasing a car. 3. Explain the problem of double counting in estimating national income, with the help of an example. Also explain two alternative ways of avoiding the problem. 58 XII Economics

56 4. Distinguish between real gross domestic product and nominal gross domestic product. Can gross domestic product be used as an index of welfare of the people? Give two reasons. 5. How will you treat the following in estimating national income of India? Give reasons for your answer. (a) (b) (c) Value of bonus shares received by share holders of a company. Fees received from students. Interest received on loan given to a foreign company in India. 6. Explain the steps of measuring national income by income method. 7. Giving reasons, categories following into transfer payment or factor payments. (a) (b) (c) Financial help gives to flood victims Old age pension. Imputed rent. 8. Calculate private income : Rs. (Crore) (i) National interest 10 (ii) Personal disposable income 150 (iii) Corporate Profit Tax 25 (iv) Personal Taxes 50 (v) Retained earnings of private corporations 05 [Ans. : Rs. 230 crores] 10. Giving reasons explain whether the following are included in domestic product of India. (i) (ii) Profit earned by a branch of foreign bank in India. Payment of salaries to its staff by an embassy located in New Delhi. (iii) Interest received by an Indian resident from firms abroad. 59 XII Economics

57 11. How will you treat the following while estimating national income. Give reasons for your answer. (i) (ii) Capital gain on sale of house. Prize won is lottery. (iii) Interest on public debt. 12. While estimating national income. How will you treat the following. Give reason for your answer. (i) (ii) Imputed rent of occupied house. Interest received on debentures. (iii) Financial help received by Flood victims. NUMERICALS FOR PRACTICE 1. Calculate (i) gross domestic product at factor cost and (ii) net national disposable income : 6 Rs. (in Crores) (i) Net indirect tax 130 (ii) Government final consumption expenditure 100 (iii) Profit 90 (iv) Net domestic capital formation 120 (v) Change in stocks ( ) 10 (vi) Private final consumption expenditure 500 (vii) Net imports 20 (viii) Net current transfers to abroad 10 (ix) Net factor income to abroad 30 (x) Gross domestic capital formation From the following data calculate GNP at FC by (a) Income method 60 XII Economics

58 (b) Expenditure method. Rs. (Crore) (i) Net domestic capital formation 500 (ii) Compensation of employees 1850 (iii) Consumption of fixed capital 100 (iv) Govt. final consumption expenditure 1100 (v) PVT. final consumption expenditure 2600 (vi) Rent400 (vii) Dividend 200 (viii) Interest 500 (ix) Net Exports ( ) 100 (x) Profits 1100 (xi) NFIA ( ) 50 (xi) Net Indirect taxes 250 [Ans. : Rs Crore] 3. There are only two producing sectors A and B in an economy. Calculate: (a) Gross value added at market price by each sector (b) National income. Rs. (Crore) (i) Net factor income from Abroad. 20 (ii) Sales by A 1000 (iii) Sales by B 2000 (iv) Change in stock of B ( ) 200 (v) Closing stock of A 50 (vi) Opening stock of A 100 (vii) Consumption of fixed capital by A and B 180 (viii) Indirect taxes paid by A and B 120 (ix) Purchase of raw material by A 500 (x) Purchase of raw material by B 600 (xi) Exports by B 70 [Ans. : Rs Crore] 61 XII Economics

59 4. From the following data, calculate (a) Gross Domestic Product at Factor Cost (GDP FC ) and (b) Factor income to abroad. Rs. (Crore) (i) Gross Domestic Capital formation 600 (ii) Interest 200 (iii) Gross national product at market price 2800 (iv) Rent300 (v) Compensation of employees 1600 (vi) Profit 400 (vii) Dividends 150 (viii) Factor income from abroad. 50 (ix) Change in stock 100 (x) Net indirect taxes 240 (xi) Net fixed capital formation 400 (xii) Net Export ( ) 30 [Ans. : (a) GDP FC = 2600 Crores (b) FIPA = 90 Crores] 5. Calculate net national product at factor cost and gross national disposable income from the following : Rs. (Crore) (i) Net current transfers to Row 10 (ii) Savings of non-departmental enterprises 60 (iii) Net indirect tax. 90 (iv) Income from property and entrepreneurship to the Govt. administrative departments 80 (v) Consumption of fixed capital 70 (vi) Personal Tax 100 (vii) Corporation tax 40 (viii) National debt interest 30 (ix) Current transfer payments by Govt. 50 (x) Retained Earnings of PVT. Corporate 10 (xi) Personal disposable income [Ans. : (a) NNP FC = Rs Crores (b) GNDI = 1470 Crores] 62 XII Economics

60 6. Calculate (a) Gross domestic product at market price (GDP MP ) (b) Factor income from abroad. Rs. (Crore) (i) Profit 500 (ii) Export 40 (iii) Compensation of Employees 1500 (iv) Net current transfer from Row 2800 (v) Rent90 (vi) Interest 300 (vii) Factor income to abroad 400 (viii) Net indirect tax 120 (ix) Gross fixed capital formation 250 (x) Net domestic capital formation 650 (xi) Gross fixed capital formation 700 (xii) Change in stock 50 [Ans. : GDP MP = 3050 Crores (b) FIRA = 120 Crores] 7. From the following data calculate (a) GDP MP and (b) Factor income from abroad. Rs. (Crore) (i) Gross national product at factor cost 6150 (ii) Net export ( ) 50 (iii) Compensation of Employees 3000 (iv) Rent800 (v) Interest 900 (vi) Profit 1300 (vii) Net Indirect tax 300 (viii) Net domestic capital formation 800 (ix) Gross fixed capital formation 850 (x) Change in stock 50 (xi) Dividend 300 (xi) Factor income to abroad. 80 [Ans. : GDPMP = 6400 Crores; FIFA = 130 Crores] 63 XII Economics

61 8. Calculate Net National Disposable Income and Personal Income from the following data. Rs. (Crore) (i) Personal tax 212 (ii) Net national product at factor cost 2500 (iii) Net indirect tax 180 (iv) Domestic product accruing to Govt. 500 (v) Retained earnings of PVT. Corporations 80 (vi) NFIA23 (vii) National debt interest 100 (viii) Net current transfer from abroad 20 (ix) Corporation tax 70 (x) Current transfer from Government 30 [Ans. : NNDI = 2700 Crore; P.I. = 2000 Crore] 9. Find out (a) national income and (b) net national disposable income : Rs. (Crore) (i) Factor income from abroad 15 (ii) Private final consumption expenditure 600 (iii) Consumption of Fixed capital 50 (iv) Government final consumption expenditure 200 (v) Net current transfers to abroad ( ) 5 (vi) Net domestic fixed capital formation 110 (vii) Net factor income to abroad 10 (viii) Net imports ( ) 20 (ix) Net indirect tax 70 (x) Change in stocks ( ) 10 [Ans. : N.I Crore NNDI Crore] 64 XII Economics

62 10. From the following data show that net value added at factor cost (NVA FC ) is equal to the sum of factor incomes. (i) Rs. (Crore) Purchase of raw material and other input from the domestic market 600 (ii) Increase in stock 200 (iii) Domestic sales 1800 (iv) Import of raw material 100 (v) Exports 200 (vi) Depreciation of fixed capital 75 (vii) Salaries and wages 600 (viii) Interest payments 450 (ix) Rent75 (x) Dividends 150 (xi) Undistributed profits. 80 (xi) Corporate profit tax 20 (xii) Indirect tax 50 [Ans. : 1375 Crores] 11. From the following data calculate (a) Private income (b) Personal income (c) Personal disposable income. (i) Rs. (Crore) Income from property and entrepreneurship accruing to the Govt. administrative Dept. 100 (ii) Saving of non-departmental enterprises 80 (iii) Factor income from NDP occurring to Private sector 500 (iv) Corporation tax 30 (v) Saving of Pvt. corporate sector 65 (vi) Direct taxes paid by house hold 20 (vii) Current transfers from Govt. Administrative departments 10 (viii) Current transfer from Row 20 (ix) Factor income from abroad 5 (x) Operating surplus 150 (xi) Factor income to abroad 15 [Ans. : (a) 520 Crore (b) 425 Crore (c) 405 Crore] 65 XII Economics

63 ANSWERS 1 Mark Questions 1. Net Export means the difference between export and imports. Net export = Export Imports 2. Current transfers are those transfers which are paid from current income and are added in current income of recipient. 3. Normal resident of a country is that person or institution whose centre of economic interest lies in that country. 4. Economic territory means that geographical territory administrated by a Govt. within which persons, goods and capital circulates freely. 5. When subsidies are more than indirect taxes. 6. It decreases in the value of fixed capital due to normal wear and tear and foreseen obsolescence. 7. Injection is that economic concept, which add to flow of income and goods e.g., investment, Exports. 8. Leakage is that economic concept, which has negative impact on flow of income. 9. (i) Flow (ii) Stock (iii) Flow (iv) Stock 10. It is the gross money value of National Product of current year valued at current prices. 11. It is the gross money value of National product of current year valued at base year price. 12. A variable whose value is measured at a point of time. 13. Goods used is producing other goods are called capital goods. H.O.T.S. 1. NVA FC 2. It is the financial transactions and does not have any impact on production. 3. NDP. 66 XII Economics

64 4. By deducting intermediate consumption from value of output, the problem of double counting can be solved. 5. When per capita income is measured from real GDP (measured at constant price) is called per capita real GDP. 6. (i) National income = Domestic Income + Net factor income from abroad. (ii) Personal income = Private income Corporate tax Undistributed profit. (iii) Net value added at FC = Gross Output Intermediate Consumption Depreciation Net Indirect Tax HINTS 3-4 Marks Questions 7. (a) Stock (b) Flow (c) Flow (d) Stock (e) Stock (f) Stock 10. (a) Intermediate good because it is for resale (b) final good because purchased by ultimate consumer. 15. (a) Not include as paid for consumption expd. (b) Included as paid for production expd. NUMERICAL QUESTIONS (6 MARKS) 1. (i) GDP FC : VI + II VII + X I = 610 (ii) NNDI 610 ( ) = XII Economics

65 2. GNP FC (a) Income Method : = (ii) + (vi) + (viii) + (x) + (xi) NNP FC = ( 50) = 3800 GNP FC = = 3900 Crores (b) Expd. Method = (i) + (iii) + (iv) + (v) + (ix) + (xi) (xii) ( 100) + ( 50) 250 = 3900 Crore 3. GVA MP of Sector A = 450 GVA MP of Sector B = 1200 Total = 1650 NNP FC = = 1370 Crores 4. GDP FC : NDP FC = (v) + (ii) + (iv) + (vi) = = 2500 GDP FC = NDP FC +CFC CFC = GDCF NDCF (NFCF + S) = 600 ( ) = 100 GDP FC = = 2600 Crore. FIPA GNP MP = GDP FC + NFIA + NIT 2800 = NFIA XII Economics

66 NFIA = 40 NFIA = FIFA FIPA 40 = 50 FIPA FIPA = = 90 Crores 5. NNP FC = (xi) + (vi) + (vii) + (x) (viii) (ix) + (i) + (ii) + (iv) = = 1320 Crores GNDI = NNP FC + (iii) + (v) (i) = = 1470 Crores 6. (a) GDP MP : NDP FC = (iii) + (v) + (vi) + (vii) = = 2700 Crores GDP MP = NDP FC + CFC + NIT CFC = (GFCF + S) 650 = ( ) 650 = 100 NIT = 250 GDP MP = = 3050 (b) FIFA GNP FC = GDP MP + NFIA NIT 2800 = NFIA 250 NFIA = 0 NFIA = FIFA FIPA 69 XII Economics

67 0 = FIFA 120 FIFA = 120 Crores 7. GDP MP : NDP FC = (iii) + (iv) + (v) + (vi) = = 6000 GDP MP = NDP FC + CFC + NIT CFC = GDCF NDCF = (GFCF + s) NDCF = ( ) 800 = 100 NIT = 300 GDP MP = = 6400 Crores FIFA : GNP FC = GDP MP + NFIA NIT 6150 = NFIA 300 NFIA = 50 NFIA = FIFA FIPA 50 = FIFA 80 FIFA = NNDI = (ii) + (iii) + (viii) = = 2700 Pr. I = (ii) (iv) + (vii) + (viii) + (x) (ix) (v) = = 2000 Crores 70 XII Economics

68 9. N.I. = (ii) + (iv) + (vi + x) (viii) (ix) (vii) = ( 10) ( 20) = = 840 Crores NNDI = N.I + ix v = ( 5) = 915 Crore 10. NVA FC = (ii) + (iii) + (v) (i) (iv) (vi) (xiii) = = 1375 Crores Sum of factor income = (vii) + (viii) + (ix) + (x) + (xi) + (xii) = = (a) PVT Income Rs. 520 Crore (b) (c) P.I. Rs. 425 Crore P.D.I. = Rs. 405 Crore 71 XII Economics

69 UNIT 7 MONEY AND BANKING POINTS TO REMEMBER Money : Money may be defined as anything which is generally acceptable as a medium of exchange and does the function of unit of account and measures of value. Barter Exchange : It is a system of exchange in which transactions are made by exchange of goods. Difficulties involved in the Barter Exchange 1. Absence of a common unit. 2. The lack of double coincidence of wants 3. Lacks of any satisfactory units to engage in contracts involving future payments. 4. Does not provide for any method of storing generalised purchasing power. 5. Lack of divisibility. Supply of Money : Total stock of money with the public at a given point of time. Commercial Banks : Commercial Banks is a financial institution who accepts deposits from the general public and provide loans facilities. Central Banks : The central Bank is the apex institution of monetary and banking system of country. 72 XII Economics

70 73 XII Economics

71 5. Custodian of foreign exchange. 6. Controller of money supply and credit. MONEY CREATION CREDIT CREATION BY COMMERCIAL BANKS K = K = Credit Multiplier R = Cash reserve ratio VERY SHORT ANSWER TYPE QUESTIONS (1 MARK) 1. Define money. 2. What is meant by M. 3. What is meant by the term money supply? 4. What is bank rate? 1 5. State two primary functions of money. 6. What is meant by credit creation? 7. What is credit multiplier? 8. Write two functions of central banks. 9. What is cash reserve ratio (CRR)? 10. What is statutory liquidity ratio (SLR)? 11. What is demand deposits by banks? 12. State two monetary measures of credit control by central bank. 13. What are various money stock measures? H.O.T.S. 14. What is margin requirement of loans. 74 XII Economics

72 SHORT ANSWER TYPE QUESTIONS (3-4 MARKS) 1. Explain the function of money as Unit of value. 2. How does money solve the problem of double coincidence of wants? 3. Explain Store of value function of money. 4. What are open market operations? What is their effect on availability of credit? 5. Explain the lender of last resort function of central bank. 6. Distinguish between SLR and CRR. Explain the Role of SLR and CRR in credit control. 7. How does changes in Bank rate affect money creation by commercial Bank? Explain. 8. State the role of central Bank as a banker of the Government. 9. State any four functions of money. 10. Explain the Standard of deferred payment. 11. How central bank is controller of credit? 12. Explain how does followings helps to control the credit creation. (i) (ii) Open market operation Margin requirement of loans H.O.T.S. 13. What is meant by statutory liquidity ratio (SLR). State the effect of rise in rate of SLR on creation of credit. 14. Explain currency authority and controller of credit functions of central bank. 15. Explain effect of increase in bank rate on credit creation by commercial banks. 75 XII Economics

73 LONG ANSWER TYPE QUESTIONS (6 MARKS) 1. Define Central Bank. What are the functions of Central Bank? 2. Explain any four functions of money. 3. How does a central bank influence credit creation by commercial banks through open market operation explain. 4. Explain the process of credit creation or money creation by commercial banks with the help of numerical example. ANSWERS 1 MARK QUESTIONS 1. Any thing which is generally acceptable by the people as medium of exchange, measure of value, standard of deferred payment and performs the function of store of value. 2. M 1 = currency held with public + demand deposit in banks + other deposit in RBI Total stock of money which are held by the public at a particular point of time in an Economy. LRR 4. Rate at which central bank lends to the commercial bank Medium of Exchange 2. Measure of value 6. Credit creation means power to expand demand deposits of Commercial Banks. 7. Credit multiplier measures, number of times deposits are multiplied as credit. Credit multiplier = 8. (i) Currency Authority (ii) Controller of money and credit 76 XII Economics

74 9. Commercial Banks are required under law to keep a certain percentage of their total deposit in the central banks in the form of cash reserves. This is called CRR. 10. Every Commercial Bank is required to keep a fixed percentage (ratio) of its assets in liquid form, called SLR. 11. Demand deposits are deposits which can be withdrawn from bank at any time by the account holder. 12. (i) Bank Rate policy. (ii) Open market operation 13. Following four measures of money stock are used. M1 = C + DD + OD M2 = M1 + Saving deposit in Post Office Saving banks. M3 = M1 + Net time deposit of banks M4 = M3 + Total deposits with post office saving organisation (except NSC). HOTS 14. Marginal requirement of loan means the difference in percentage between the amount of the loan and market value of the security offered by the borrower against the loan. HINTS 3-4 MARKS QUESTIONS 11. Quantitative measures and qualitative measures of monetary policy. 13. Increase in SLR reduces credit availability. 77 XII Economics

75 UNIT 8 DETERMINATIONS OF INCOME & EMPLOYMENT POINTS TO REMEMBER Aggregate demand refers to total demand for goods and services in the economy. AD represents the total expenditure on goods and services in an economy. Main components of Aggregate demand are : (i) (ii) Household consumption expenditure (C). Investment expenditure (I). (iii) Govt. consumption expenditure (G). (iv) Net export (X M). In two sector economy AD = C + I. Aggregate supply is the total supply of goods and services in the economy. It is also the value of total output available is an economy during a given period of time. AS = C + S Aggregate supply represents the national income of the country. AS = Y (National Income) Consumption function shows functional relationship between consumption and Income. C = F(Y) where C = Consumption Y = National Income F = Functional relationship. 78 XII Economics

76 Consumption function (propensity to consume) is of two types. (a) (b) Average propensity to consume (APC) Marginal propensity to consume (MPC) Average propensity to Consume (APC) : Average propensity to consume refers to the ratio of consumption expenditure to the corresponding level of income. APC = Important Points about APC (i) (ii) APC is more than 1 : as long as consumption is more than national income before the break-even point, APC > 1. APC = 1, at the break-even point, consumption is equal to national income. (iii) APC is less than 1 : beyond the break-even point. Consumption is less than national income. (iv) APC falls with increase in income. (v) APC can never be zero : because Consumption(C) even at zero level of national income, there is autonomous consumption. Income(Y) Marginal Propensity to Consume (MPC) : Marginal propensity to consume refers to the ratio of change in consumption expenditure to change in total income. MPC = Change in consumption C Change in Income Y Important Points about MPC (1) Value of MPC varies between O and 1 : If the entire additional income is consumed, then C = Y, making MPC = 1. However, if entire additional income is saved, then C = 0, making MPC = 0 Saving function refers to the functional relationship between saving and national income. S = f (y) where S = saving Y = National Income F = Functional relationship. 79 XII Economics

77 Saving function (Propensity to Save) is of two types. (i) (ii) Average Propensity to Save (APS) Marginal propensity to Save (MPS) Average Propensity to Save (APS) : Average propensity to save refers to the ratio of savings to the corresponding level of income. APS = Savings(S) Income(Y) Important Point about APS (1) APS can never be 1 or more than 1 : As saving can never be equal to or more than income. (2) APS can be zero : At break even point C = Y, hence S = 0 (3) APS can be negative or less than 1 : At income levels which are lower than the break-even point, APS can be negative as there will be dissavings in the economy. (4) APS rises with increase in income. Marginal Propensity to Save (MPS) : Marginal propensity to save refers Change Y C in Savings S C to the ratio of change in savings to change = = in total income. YChange Y in Income Y Y MPS = MPS varies between 0 and 1 (i) (ii) MPS = 1 if the entire additional income is saved. In such a case, S = Y. MPS = 0 If the entire additional income is consumed. In such a case, S = 0 Relationship between APC and APS The sum of APC and APS is equal to one. It can be proved as under we know : Y = C + S Dividing both sides by Y, we get 80 XII Economics

78 APC + APS = 1 because income is either used for consumption or for saving. Relationship between MPC and MPS The sum of MPC and MPS is equal to one. It can be proved as under : We know Y = C + S Dividing both sides by Y, we get Y C S = + Y Y Y 1 = MPC + MPS C S C = MPC, APC = MPS = Y Y Y MPC + MPS = 1 because total increment 1 = APC + in APS income is either S used for consumption or for saving. APS = Y Investment refers to the expenditure incurred on creation of new capital assets. The investment expenditure is classified under two heads : (i) Induced investment (ii) Autonomous investment. Induced Investment : Induced investment refers to the investment which depends on the profit expectations and is directly influenced by income level. Autonomous Investment : Autonomous investment refers to the investment which is not affected by changes in the Level of income and is not induced solely by profit motive. Marginal Efficiency of Investment (MEI) : MEI refers to the expected rate of return from an additional investment. Ex-Ante Savings : Ex-ante saving refers to amount of savings which household intended to save at different levels of income in the economy. 81 XII Economics

79 Ex-Ante Investment : Ex-ante investments refers to amount of investment which firm plan to invest at different level of income in the economy. Ex-Post Saving : Ex-post savings refer to the actual or realised savings in an economy during a financial year. Ex-Post Investment : Ex-post investment refers to the actual or realised investment in an economy during a financial year. Equilibrium level of income is determined only at the point where AD = AS or S = I. But it cannot always be at full employment level also as it can be at less than full employment. Full employment is a situation when all those who are able and willing to work at prevailing wage rate, get the opportunity to work. Voluntary unemployment is a situation where person is able to work but not willing to work at prevailing wage rate. Involuntary unemployment is a situation where worker is able to willing to work at current wage rate but does not get work. Under employment is a situation where AD is less than required AS at full employment level. Investment multiplier (K) is the ratio of increase in income ( Y) due to change in investment I. Y K = I 1 1 K = or K = 1 MPC MPS Excess demand refers to the situations when aggregate demand is in excess of aggregate supply corresponding to full employment. Deficient demand refers to a situation when aggregate demand is short of aggregate supply corresponding to full employment. Inflationary gap is the gap by which actual aggregate demand exceeds the level of aggregate demand required to establish full employment. It measures the amount of excess of aggregate demand. Deflationary gap is the gap by which actual aggregate demand is less than the level of aggregate demand required to establish full employment. It measures the amount of deficiency of aggregate demand. 82 XII Economics

80 1. Define aggregate demand. 2. Define aggregate supply. 1 MARK QUESTIONS 3. What is meant by Ex-Post investment? 4. What is meant by average propensity to consume? 5. Define marginal propensity to consume. 6. What is autonomous consumption? 7. What is Ex-ante aggregate demand? 8. Can the value of APC be greater than one? 9. Can APC be ever zero? 10. What is the relationship between APC and APS? 11. If APS is 0.6, how much will be the APC? 12. What is meant by Ex-ante saving? 13. If MPC and MPS are equal, what is the value of the multiplier? 14. What can be the minimum value of investment multiplier? 15. What can be the maximum value of multiplier? 16. Can average propensity to consume be negative? 17. What do you mean by investment multiplier? 18. What will be the impact of increase in cash reserve ratio on the aggregate demand? 19. What is investment? 20. Why can the value of marginal propensity to consume not be greater than one? H.O.T.S. 21. What is the impact of deficient demand on production and employment? 22. Define inflationary gap. 23. Under which situation is consumption function represented by a straight line. 83 XII Economics

81 24. What is the impact of continuous increase in income on average propensity to consume? 25. How much additional income will be generated in an economy with additional investment of Rs. 100 crore, when MPC = 1/2? SHORT ANSWER TYPE QUESTIONS (3-4 MARKS) 1. Define aggregate demand. State its components. 2. Distinguish between average propensity to consume and marginal propensity to consume with the help of numerical examples. 3. Savings and investment are always equal discuss. 4. What is meant by investment multiplier? Explain the relationship between MPC and K? 5. State briefly the effect of excess demand on output, employment and price. 6. Explain the concept of inflationary gap with the help of a diagram? 7. Explain the situation of deficient demand in an economy with the help of a diagram. 8. State briefly any three measures to control excess demand in an economy. Find consumption expenditure if autonomous consumption = Rs. 100 marginal propensity to consume = 0.70 national income = Rs What is monetary policy? Explain the role of (i) Bank rate and (ii) Margin requirements in influencing the availability of credit in an economy. 10. Give the meaning of excess demand? Explain any two fiscal measures to current excess demand. 11. What is fiscal policy? What possible fiscal measures can be taken with respect to deficient demand in an economy? 12. What do you mean by full employment equilibrium? Explain with the help of diagram. 13. Explain with the help of diagram the concept of under-employment equilibrium. 14. Distinguish between induced investment and autonomous investment? 15. Explain the concept of consumption function. 16. Briefly explain the relationship between MPC and MPS. 84 XII Economics

82 17. Giving reasons, state whether the following statements are true or false : (i) (ii) When marginal propensity to consume is zero, the value of investment multiplier will also be zero. Value of average propensity to save can never be less than zero. 18. If national income is 50 crore and saving Rs. 5 crore, find out APC. When income rises to Rs. 60 crore and saving to Rs. 9 crore. What will be the APC and MPS. 19. An economy is in equilibrium. Its national income is Rs and autonomous consumption expenditure is Rs What is the total consumption expenditure if MPC is 0.7? 20. Complete the following table : Level of Income Savings MPC APC APS 0 (80) Given marginal propensity to save equal to 0.25, what will be the increase in national income if investment increases by Rs. 125 crore. Calculate multiplier. 22. Find out equilibrium level of income, when S = Y and investment is Rs Can an economy be is equilibrium when there is unemployment in the economy? Explain. 24. How does change in bank rate controls the situations of excess and deficient demand? 25. Briefly explain with the help of diagram the relationship between savings and income? 85 XII Economics

83 H.O.T.S. 26. Does an excess of AD over AS always imply a situation of inflationary gap? Explain. 27. What happens if AD > AS prior to the full employment level of output? 28. Find saving function when consumption function is given as : C = Y. 29. In a two sector economy, the saving function is given as : S = Y and investment function is expressed as I = Y. Calculate the equilibrium level of income? 30. State whether the following statement are true or false. Give reasons for your answer (a) When investment multiplier is 1, the value of MPC is zero. (b) The value of average propensity to save can never be greater than Giving reasons, state whether the following statements are true or false : (i) (ii) When marginal propensity to consume is zero, the value of investment multiplier will also be zero. Value of average propensity to save can never be less than zero. 32. Find national income from the following : autonomous consumption = Rs. 100 marginal propensity to consume = 0.80 investment = Rs. 50 LONG ANSWER TYPE QUESTIONS (6 MARKS) 1. Why must aggregate demand be equal to aggregate supply at the equilibrium level of income and output? Explain with the help of a diagram? 2. Explain the equilibrium level of income with the help of saving and investment curves. If saving exceed planned investment, what changes will bring about the equality between them? 3. Explain the working of multiplier with the help of a numerical example. 4. When planned investment is more than planned savings, what will be its impact on income and employment. Explain with the help of diagram. 86 XII Economics

84 5. What do you mean by Fiscal Policy? How it helps in controlling excess demand? 6. Can there be equilibrium in case of underemployment. Explain with the help of a diagram? 7. How quantitative and qualitative instruments of Govt. monetary policy controls deficient demand? 8. Distinguish between inflationary gap and deflationary gap. Show deflationary gap on a diagram. Can this gap exist at equilibrium level of income? Explain. 9. In an economy S = Y is the saving function (where S = saving and Y = national income) and investment expenditure is Calculate. (i) (ii) Equilibrium level of national income Consumption expenditure at equilibrium level of national income. 10. C = y is a consumption function where C = consumption expenditure and Y = national income and investment expenditure is 800. On the basis of this information calculate. (i) (ii) Equilibrium level of national income. Saving at equilibrium level of national income. 11. Given below is the consumption function in an economy. C = Y with the help of a numerical example show that in this economy, as income increase APC will decrease. HOTS (6 MARKS QUESTIONS) 12. Draw on a diagram a straight line saving line curve for an economy. From it derive the consumption curve, explaining the method of derivation. Show a point on the consumption curve at which APC is equal to How increase in investment will effect income level of an economy? Explain with the help of an example and diagram. 14. Briefly explain the concept of under employment equilibrium with the help of diagram. How increase in investment helps in achieving, full employment equilibrium? 15. What is deficient demand in macroeconomics? Explain the role of open market operations in correcting it. 87 XII Economics

85 16. Explain the step taken in derivation of the saving curve from the consumption curve use. Use diagram. ANSWERS 1 MARK QUESTIONS 1. Aggregate demand refers to total demand for goods & services in an economy, measured in terms of total expenditure. 2. Aggregate supply is the money value of the final goods and services or national product produced in an economy during one year. 3. Ex-post investment refers to the actual or realised investment in an economy during a financial year. 4. Average propensity to consume is the ratios of consumption expenditure to income. APC = C Y 5. Marginal propensity to consume is the C ratio of change in consumption to change in income. Y MPS = 6. Autonomous consumption refers to minimum level of consumption, even when income is zero. 7. Estimated demand of goods and service in an economy during a financial year. 8. Yes, the value of APC > 1 before the break-even point is attained. 9. APC can never be equal to zero as consumption can never be zero at any level of income. 10. The sum of APC and APS is equal to one. APC + APS = APC = 1 APS = = Exante-saving refers to amount of saving which household intended to save at different level of income in an economy. 88 XII Economics

86 13. We know that MPS + MPC = 1 MPS + MPC = 1 Give that MPS = MPC MPS = K = The minimum value of K = 1, when MPC = O 15. The maximum value of k = when MPC = No, because consumption can never be zero even at zero level of income. 17. Investment multiplier measures the ratio of change in investment and change in income. 18. Aggregate demand will fall. 19. Investment is an addition to capital stock. It is also called capital formation. 20. It is because change in consumption cannot be greater than change in income Production and employment will decrease K = due = = to shortage = of = aggregate MPS MPC1/ demand Inflationary gap refers the situation under which AD is excess than required AS at full employment equilibrium. 23. When marginal propensity to consume remains constant. 24. APC falls with continuous increase in income. 25. and Y = K. I = 2 x 100 = 200 Crore. 89 XII Economics

87 HINTS 3-4 MARKS QUESTIONS 18. (i) 200 Crore (ii) 400 Crore 19. (i) I = 7000 Crore. (ii) C = 6300 Crore. 20. APC =, 1.5, 1.1, 0.96, 0.9 APS =, ( ),.5, ( ) 0.1,.033,.1 S = 80, 50, 20, 10, K = 4 Y = 4 x 125 = 500 Crore. 22. Rs Rs MARKS QUESTIONS 9. (i) National income (Y) = (ii) Consumption expenditure (C) = (i) Equilibrium National Income (Y) = 3600 (ii) Saving = XII Economics

88 UNIT 9 GOVERNMENT BUDGET AND THE ECONOMY POINTS TO REMEMBER Budget is a financial statement showing the expected receipt and expenditure of Govt. for the coming fiscal or financial year. Main objectives of budget are : (i) Reallocation of resources. (ii) Redistribution of income and wealth (iii) Economic stability (iv) Management of public enterprises. There are two components of budget : (a) Revenue budget (b) Capital budget Revenue Budget consists of revenue receipts of Govt. and expenditure met from such revenue. Capital budget consists of capital receipts and capital expenditure. 91 XII Economics

89 Revenue Receipts : (i) (ii) Neither creates liabilities for Govt. Nor causes any reduction in assets. Capital Receipts : (i) It creates liabilities or (ii) It reduces assets. Revenue Expenditure : (i) Neither creates assets (ii) Nor reduces liabilities Capital Expenditure : (i) It creates assets (ii) It reduces liabilities. Revenue Deficit : Total revenue expenditure > Total revenue receipts Revenue deficit when total revenue expenditure excess total revenue receipts. Implications of Revenue Deficit are : (i) (ii) It leads to repayment burden in future without investment. It shows wasteful expenditures of Govt. on administration. (iii) It increase the burden of taxes. Fiscal Deficit : Total expenditures > Total Receipts excluding borrowing. Fiscal deficit : When total expenditure exceeds total receipts excluding borrowing. Implications of Fiscal Deficits are : (i) (ii) It leads to inflationary pressure. A country has to face debt trap. (iii) It reduces future growth and development. 92 XII Economics

90 Primary Deficit : Fiscal deficit Interest payments. Primary Deficit : By deducting Interest payment from fiscal deficit we get primary deficit. Budgetary Deficit : Total Expenditure > Total Receipts. Budgetary Deficit : Total expenditure exceeds total receipts. VERY SHORT ANSWER TYPE QUESTIONS (1 MARK) 1. Define Budget. 2. What is meant by non-tax receipts? 3. What are revenue receipts? 4. What are capital receipts? 5. Give two examples of non-tax revenue receipts. 6. What are the two sources of capital receipts? 7. Define revenue deficit. 8. Define fiscal deficit. 9. Why is repayment of loan a capital expenditure? 10. Why is recovery of loan treated a capital receipt? 11. What is a balanced budget. 12. Define capital expenditure. 13. In a Govt. Budget primary deficit is Rs. 25,000 Cr. and interest payments are Rs. 15,000 Cr. How much is the fiscal deficit? 14. Define a Tax. 15. What is Direct Tax 16. Define Primary Deficity 17. What are Budget Receipts? H.O.T.S. 18. In a Govt. Budget, revenue deficit is Rs. 8,00,000 Cr. and borrowings are Rs. 50,000 Cr. How much is the fiscal deficit? 19. What is disinvestment? 20. What does zero primary deficit mean? 93 XII Economics

91 SHORT ANSWER TYPE QUESTIONS (3-4 MARKS) 1. Explain the allocation of resources objective of Govt. budget. 2. What is the difference between revenue budget and capital budget? 3. What is meant by revenue receipts? Explain the components of revenue receipts of the Govt. 4. Distinguish between direct tax and indirect tax. 5. What do you mean by capital receipts? What are the main components of the capital receipts? 6. Give the meaning of revenue deficit and fiscal deficit. What problems can the fiscal deficit create? 7. What is fiscal deficit? What are its implications? 8. Distinguish between revenue expenditure and capital expenditure with an example of each. 9. Explain the redistribution of income objective of Govt. budget. 10. Explain the Economic stability objective of Govt. budget. HOTS (3-4 MARKS) 11. Under which situations deficit budget is beneficial for the economy. 12. Are fiscal deficits necessarily inflationary? Give reasons in support of your view. 13. Discuss the issue of deficit reduction. 14. How can surplus budget be used during inflation. 15. Giving reasons, classify the following as direct and indirect taxes. (i) Entertainment tax (ii) Corporation tax (iii) Excise tax (iv) Capital gains tax. 94 XII Economics

92 16. From the following data about a government budget find (a) revenue deficit, (b) fiscal deficit and (c) primary deficit. (Rs. arab) (i) Plan capital expenditure 120 (ii) Revenue expenditure 100 (iii) Non-plan capital expenditure 80 (iv) Revenue receipts 70 (v) Capital receipts net of borrowing 140 (vi) Interest payments Distinguish between : (i) (ii) Capital expenditure and Revenue expenditure Fiscal deficit and Primary deficit. 18. Why the fiscal Deficit equal to borrowings. ANSWERS 1 MARK QUESTIONS 1. Budget is a financial statement showing the estimated receipts and estimated expenditure of the Govt. for coming fiscal year. 2. All the revenue receipt of Govt. other than tax receipts. 3. Revenue receipts are those receipts which neither creates liabilities for Govt. nor cause any reduction in assets. 4. Capital receipts are those receipts which either creates a liability or leads to reduction in assets. 5. Interest, Fee. 6. Borrowings, Recovery of loans. 7. When total revenue expenditure exceeds total revenue receipts. 8. When total expenditure exceeds total receipts excluding borrowing. 95 XII Economics

93 9. As it leads to reduction in liability. 10. As it leads to reduction in assets. 11. Balanced budget is that when estimated receipts are equal to estimated expenditure. 12. Capital expenditure is that which creates assets and which reduces liabilities. 13. Fiscal Deficit = Primary Deficit + Interest Payment = 25, ,000 = 40,000 Crore. 14. Tax is a legally compulsory payment imposed by Govt. 15. It refer the tax whose primary and final burdon borne by the person on whom it is imposed. 16. It is the difference of fiscal deficit and interest paid. 17. Estimated money receipt received by the Govt. from different sources in fiscal year are called budgetary receipts. 18. Rs. 50,000 Crore. 19. Disinvestment refers to withdrawal of existing investment. 20. Zero primary deficit means that interest commitment on earlier loans have compelled the Govt. to borrow. HINTS 15. (i) Indirect tax 3-4 MARKS QUESTIONS (ii) Direct tax (iii) Indirect tax (iv) Direct tax 96 XII Economics

94 UNIT 10 BALANCE OF PAYMENT POINTS TO REMEMBER 97 XII Economics

95 Balance of trade is the net difference of Import and export of all visible items between the normal residents of a country and rest of the world. Autonomous items are those items of balance of payment which are related to such transaction as are determined by the motive of profit maximisation and not to maintain equilibrium in balance of payments. These items are generally called Above the Line items in balance of payment. Accommodating item refers to transactions that take place because of other activity in Balance of Payment. These transactions are meant to restore the Balance of Payment identity. These items are generally called Below the Line items. Foreign exchange rate refers to the rate at which one unit of currency of a country can be exchanged for the number of units of currency of another country. SYSTEM OF EXCHANGE RATE Fixed exchange rate Flexible exchange rate. The epitome of the fixed exchange rate system was the gold standard in which each participant country committed itself to convert freely its currency into gold at a Fixed Price. Merit of Fixed Exchange Rate (i) (ii) Stability in exchange rate Promotes capital movement and international trade. (iii) No scope for speculation. Demerits of Fixed Exchange Rate (i) (ii) Need to hold foreign exchange reserves. No automatic adjustment in the Balance of payments. (iii) Enhance dependence on external sources. In a system of flexible exchange rate (also known as floating exchange rates), the exchange rate is determined by the forces of market demand and supply of foreign exchange. 98 XII Economics

96 The demand of foreign exchange have inverse relation with flexible exchange rate. If flexible exchange rate rise the demand of foreign exchange falls. Vice versa. Sources of Demand for Foreign Exchange (a) (b) (c) (d) (e) (f) To purchase goods and services from the rest of world. To purchase financial assets (i.e., to invest in bonds and equity shares) in a foreign country. To invest directly in shops, factories, buildings in foreign countries. To send gifts and grants to abroad. To speculate on the value of foreign currency. To undertake foreign tours. The supply of foreign exchange have positive relation with foreign exchange rate. If foreign exchange rate rise the supply of foreign exchange rate also rise and vice versa. Sources of Supply of Foreign Exchange (i) (ii) Direct purchase by foreigners in domestic market. Direct investment by foreigners in domestic market. (iii) Remittances by non-residents living abroad. (iv) Flow of foreign exchange due to speculative purchases by N.R.I. (v) Exports of goods and services. Merits of Flexible Exchange Rate (i) (ii) No need to hold foreign exchange reserves Leads to automatic adjustment in the balance of payments. (iii) To increase the efficiency in the economy by achieving optimum resources allocation. (iv) To remove obstacles in the transfer of capital and trade. Demerits of Flexible Exchange Rate (i) (ii) Fluctuations in foreign exchange rate. Encourages speculation. (iii) Discourages international trade and investment. 99 XII Economics

97 In currency depreciation, there is a fall in the value of domestic currency in term of foreign currency. In currency appreciation, there is a rise in the value of domestic currency in term of foreign currency. In currency appreciation, there is a rise in the value of domestic currency in terms of foreign currency. Equilibrium flexible exchange rate is determined at a level where demand for and supply of foreign exchange are equal to each other. Managed floating system is a system in which the central bank allows the exchange rate to be determined by market forces but intervenes at times to influence the rate. VERY SHORT ANSWER TYPE QUESTIONS (1 MARK) 1. What is meant by balance of trade? 2. Define balance of payment. 3. When is there a deficit in the balance of trade. 4. The balance of trade shows a deficit of Rs. 300 crs. and the value of exports is Rs. 500 crs. What is the value of imports? 5. List two items included in the balance of trade account. 6. List two items of the capital accounts of balance of payment. 7. Give meaning of managed floating exchange rate. 8. What is meant by invisible items? 9. What is meant by unilateral transfer? 10. What is meant by Autonomous transactions? 11. Write the name of those economic transactions which are made by the government to make equilibrium in balance of payment. 12. What do you mean by Fixed Exchange Rate? 13. Define Flexible Exchange rate? 14. State two merits of Flexible Exchange Rate. 15. State two demerits of Flexible Exchange Rate. 16. State two merits of fixed exchange rate. 100 XII Economics

98 17. State two demerits of fixed exchange rate. 18. What is the slope of demand curve of foreign exchange? 19. What is the slope of supply curve of Foreign Exchange? 20. What will be the effect on exports, if foreign exchange rate increases? 21. What will be the effect on imports if foreign exchange rate increases. 22. Define Devaluation of Domestic Currency. 23. What is meant by Depreciation of Domestic Currency? 24. What is meant by Appreciation of Domestic Currency? HOTS (1 MARK) 26. In which circumstances, the devaluation of currency will be in favour of economy? 27. In which circumstances the appreciation of currency will be non favourable for the economy? 28. Under which circumstances, the purchasing power of foreign currency increases in comparison to domestic currency? 29. With the help of which item BOP gets balanced? 30. Does BOP always remain balanced? SHORT ANSWER TYPE QUESTIONS (3-4 MARKS) 1. Write any three points of difference between BOT and BOP. 2. Distinguish between current account and capital account of BOP. 3. How can deficit in BOP be financed? 4. What are the components of the current account of the balance of payment account. 5. Give difference between the autonomous and accommodating items included in BOP. 6. Distinguish between autonomous and accommodating transaction in the balance of payment account. Give an example each. 101 XII Economics

99 7. Give three reasons why people desire to have foreign exchange. 8. Give any three/four sources of supply of foreign exchange. 9. Explain the relationship between foreign exchange rate and demand for it. 10. Explain the relationship between foreign exchange rate and supply of foreign exchange. 11. Explain the terms appreciation and depreciation of currency. 12. Explain the merit and demerits of fixed exchange rate. 13. Explain the merits and demerits of flexible exchange rate. 14. How is flexible exchange rate determined in a free market economy? Explain with the help of diagram. 15. Higher the foreign exchange rate, lower the demand fore foreign exchange. Explain why? 16. Lower the foreign exchange rate, higher the demand for foreign exchange. Explain why? 17. Explain the impact of Devaluation of domestic currency on the export and imports of an economy. 18. Give the meaning of fixed flexible and managed floating exchange rate. 19. Why the demand for foreign exchange falls when the foreign exchange rate rise explain with the help of an example. 6 MARKS QUESTIONS 1. Explain the distinction between Autonomous and Accommodating transactions in balance of payments. Also explain the concept of balance of payments defict in this context. 2. What is balance of payments accounts? Name three components each of its current account and capital account. 3. How is balance of trade different from balance of payments? State the items not included in balance of trade. 102 XII Economics

100 HOTS 20. What is the impact of appreciation of currency on the demand for foreign exchange? 21. What is the impact of appreciation of currency on the supply of foreign exchange? 22. What is the impact of depreciation of currency on the demand for foreign exchange? 23. What is the impact of depreciation of currency on the supply of foreign exchange? 24. Distinguish between devaluation and depreciation of domestic currency. 25. Giving reasons state whether the following statements are true or false : (i) (ii) Excess of foreign exchange receipts over foreign exchange payments on account of accommodating transactions equals deficit in the balance of payments. Export and import of machines are recorded in capital account of the balance of payments account. ANSWERS 1 MARK QUESTIONS 1. It is the difference between monetary value of exports and imports of material goods or visible items. 2. A balance of payment is a statement of double entry system of all economic transactions between residents of a country and the residents of foreign countries during a given period of time. 3. When the value of imports is more than value of exports Crores. 5. Visible items Watch, Petrol, Electronic item. 6. (i) Direct Foreign Investment (ii) Loans 103 XII Economics

101 7. Exchange rate influenced by the intervention of the central bank in the foreign exchange market. 8. Invisible items are all those type of services which are exported and imported. 9. These refers to one sided transfers from one country to other. These are not trading transactions. 10. Autonomous transactions refer to international economic transactions in the current and capital account that are undertaken for profit. 11. Accommodating items. 12. Fixed exchange rate is the rate which is officially fixed in terms of Gold or any other currency by the govt. or adjusted only frequently. 13. Flexible exchange rate is determined by demand for and supply of a given currency in foreign exchange market. 14. (i) No need to hold foreign exchange reserve. (ii) Optimum resource allocation. 15. (i) Fluctuations in foreign exchange rate. (ii) Encourages speculation. 16. (i) Stability in Exchange rate. (ii) No scope for speculation. 17. (i) Need to hold foreign exchange reserves. (ii) No automatic adjustment in the Balance of Payments. 18. Negative slope. 19. Positive slope. 20. Exports will increase because Indian goods have become cheaper for foreigners. 22. Import will decrease because foreign goods have become costlier for Indians. 23. Devaluations means to reduce parity rate of its currency with respect of gold or any other currency by the Government. 24. When the value of domestic currency reduce with respect to other currency by the demand and supply forces of foreign exchange in a free exchange market. 104 XII Economics

102 25. Appreciation of currency refer when the value of foreign currency reduce with respect to domestic currency. It occurs in a free exchange market by the forces of demand and supply of currency. 1 MARK HOTS QUESTIONS 26. When economy adopt the policy of Export Promotions. 27. When we adopt the policy of Import Substitution. 28. Capital account records capital transfer such as loans and investment between one country and the rest of the world which causes a change in the asset or liability status of the residents of a country or its government. 29. With the help of international loans. 30. Always in equilibruim in the sense of accounting. 105 XII Economics

103 SAMPLE QUESTION PAPER SET I ECONOMICS Time : 3 Hours Maximum Marks : 100 General Instructions : (i) (ii) All questions in both the sections are compulsory. Marks for questions are indicated against each. (iii) Question Nos. 1 5 and are very short-answer questions carrying 1 mark each. They are required to be answered in one sentence each. (iv) Question Nos and are short-answer questions carrying 3 marks each. (v) Question Nos and are also short-answer questions carrying 4 marks each. Answer to them should not normally exceed 70 words each. (vi) Question Nos and are long-answer questions carrying 6 marks each. Answer 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. SECTION A 1. Give one example each of microeconomics and macroeconomics. 2. When is the demand of a commodity said to be inelastic? 3. Define production function. 4. What causes a downward movement along a supply curve? 5. Define monopoly. 6. Why does an economic problem arise? Explain. OR Explain the problem of What to produce. 7. Distinguish between a normal good and an inferior good. Give example in each case. 106 XII Economics

104 8. How is the price elasticity of demand of a commodity affected by the number of its substitutes? Explain. 9. Explain the effect of rise in input prices on supply of a commodity. 10. Why is a firm under perfect compititon a price-taker? Explain. 11. Define marginal cost. State the relation between marginal cost and average cost. OR Define revenue. State the relation between marginal revenue and average revenue. 12. Commodities X and Y have equal price elasticity of supply. The supply of X rises from 400 units to 500 units due to a 20 percent rise in its price. Calculate the percentage fall in supply of Y if its price falls by 8 percent. 13. Explain the meaning and the conditions of producer s equilibrium (under marginal revenue & marginal cost approach) 14. Explain the conditions of consumer s equilibrium in case of (i) single commodity and (ii) two commodities. Use utility approach. 15. Giving reasons, state whether the following statement are true or false: (i) When there are diminishing returns to a factor, total product always decreases. (ii) Total product will increase only when marginal product increases. (iii) When marginal revenue is zero, average revenue will be constant. 16. Explain the implications of the following features of perfect competition. (i) (ii) Homogeneous products Freedom of entry and exit to firms. OR Market for a good is in equilibrium. Suppose supply decreases. Giving reasons,explain its effect on equilibrium price and quantity. Use diagram. 107 XII Economics

105 SECTION B 17. Why is repayment of loan a capital expenditure? 18. Define bank rate. 19. Give meaning of foreign exchange. 20. Define involuntary unemployment. 21. Define aggregate demand. 22. State three objectives of a governement budget. OR Give meanings of revenue deficit, fiscal deficit and primary deficit. 23. Explain the circular flow of income. 24. Where is inverse relation between foreign exchange rate and demand for foreign exchange. Why? Explain. 25. List the items of the current amount of balance of payments account. Also define balance of trade. 26. Explain bankers bank and supervisor function of central bank. 27. Distinguish between. (i) (ii) Revenue receipts and capital receipts Direct tax and indirect tax 28. There is increase in investment of Rs. 100 Crore in an economy. Marginal propensity to consume is 1. What can you say about total increase in income? Calculate. 29. Explain process of credit creation by commercial bank. OR State the four function of money. Explain anyone of them. 30. Explain the concept of excess demand in macroeconomics. Also explain the role of open market operation in correcting it. OR Explain the concept of deficient demand in macroeconomics. Also explain the role of Bank Rate in correcting it. 108 XII Economics

106 31. How will you treat the following while estimating domestic factor income of India? Give reasons for your answer. (i) (ii) Remittances from non-resident Indians to their families in India. Rent paid by the embassy of Japan in India to a resident Indian. (iii) Profits earned by branches of foreign bank in India. 32. There are only two producing sectors A and B in on economy. Calculate : (I) Gross value added at market price by each sector. (II) National Income (Rs. Crore) (i) Net factor income from abroad 20 (ii) Sales by A 1000 (iii) Sales by B 2000 (iv) Change in stock of B ( ) 200 (v) Closing stock of A 50 (vi) Opening stock of A 100 (vii) Consumption of fixed capital by A & B 180 (viii) Indirect taxes paid by A & B 120 (ix) Purchases of raw materials etc. by A 500 (x) Purchases of raw materials etc. by B 600 (xi) Exports by B XII Economics

107 SET II SECTION A 1. How does change in technology affect the possibilities of production. 2. Give meaning of change in quantity supplied. 3. Define implicit cost. 4. Why the demand of the commodity which have alternative uses, is more elastic? 5. What is meant by market equilibrium? 6. Giving example distinguish between total fixced cost and total variable cost. OR Explain the relation between average fixed cost, average variable cost and average total cost. 7. When the price of a commodity falls by Rs. 4 per unit its quantity demanded rise by 20 units. Its price elasticity of demand is ( 1). Calculate. its quantity demanded at the price before change which was Rs. 20 per unit. 8. Why is the demand curve of a firm indeterminate in a oligopoly market? 9. How is a production possibility curve affected when resaurces are inefficiently employed in an economy? Explain. 10. Explain the relation of total revenue and marginal revenue, when a firm can sold more units of a good by lowering the price. 11. Explain the geometric method of measuring price elasticity of demand. 12. Explain how a fall in price of the related good affects the demand for the given good. Give example. 13. Explain any two causes of rightward shift of supply curve. OR What is a supply schedule? Explain how does change in technology of producing a good affect the supply of that good. 14. Giving reason, explain the behaviour of total product under the law of variable proporation. Use numerical example. 110 XII Economics

108 15. Explain the conditions of consumers equilibrium in case of two goods. Use indifference curve approach. 16. Market for a good is in equilibrium. Explain the chain effects of increase in supply of the good on the equilibrium us diagram. OR Distinguish between monopoly and monoplistic competition on the basis of following features. (i) (ii) Price determination Entry and exit of a firm in the market (iii) Elasticity of demand of the good. 17. Define demand deposits. Section B 18. What is meant by autonomous transactions in the balance of payments? 19. What is capital goods? 20. Define nominal GDP. 21. What is statutory liquidity ratio? 22. Define the capital account of balance of payment. 23. Explain the relation of marginal propensity to consume and multiplier. 24. An economy is in equilibrium its national income is Rs. 10,000 and autonomous consumption expenditure is Rs. 1,000. What is the total consumption expenditure if marginal propensity to consume is 0.7? 25. Why does the supply fo foreign currency fall when its price falls? Explain. OR Why does the demand of foreign currency fall when its price rises? Explain. 26. Explain how is the unequal distribution a limitation of taking gross domestic product as an index of welfare. 27. What is meant by fiscal deficit in goverernment budget. State the implications of fiscal deficit. OR Explain the price stability objective of a government budget. 111 XII Economics

109 28. Giving reason categorise the following as revenue expenditure and capital expenditure. (i) (ii) Free supply of book by the government to students studying in schools. Expenditure by the government for the establishment of printing press. 29. Giving reason explain the treatment assigned to the following while estimating national income. (i) (ii) Contribution by employers to provident fund. Petrol expenditure provided by the company to employee. 30. Explain the role of the following in correcting excess demand in an economy (i) Government Tax (ii) Cash Reserve Ratio OR Explain the role of the following in correcting deficient demand in an economy. (i) (ii) Open market operations. Margin requirement 31. How do commercial bank creats money? Explain with the help of numeric example. 32. From the following information calculate. (A) Gross domestic product at factor cost (B) Net National disposable income (Rs. Crore) (i) Net indirect tax 260 (ii) Government final consumption expenditure 200 (iii) Profits 180 (iv) Net domestic capital formation 240 (v) Change in stocks ( ) 20 (vi) Private final consumption expenditure 1,000 (vii) Net imports 40 (viii) Net current transfer to abroad 20 (ix) Net factor income to abroad 60 (x) Gross domestic capital formation XII Economics

110 SET-III SECTION A 1. Define microeconomics What is the behaviour of average fixed cost as output increases 1 3. What is Individual demand? 1 4. What is a price maker firm? 1 5. What is the behaviour of average revenue in perfect competition market? 1 6. Explain the properties of production possibility curve. 7. Give the relation between marginal cost and average variable cost with the help of diagram. 8. Explain the implication of large number of sellers in a perfectly competitive market. OR Explain the features of an oligopoly market What are implicit and explicit cost exlain with the help of examples. 10. Explain condition of consumer s equilibrium in case of single good. 11. Define an indifference map. Explain why an indifference curve to the right shows higher utility level When price of a good is Rs. 7 per unit, a consumer buys 12 units. When price falls to Rs. 6 per unit he spends Rs. 72 on the good. Calculate price elasticity of demand by using the percentage method. Comment on the likely shape of demand curve based on this measure of elasticity Explain how changes in prices of other products influence the supply of a given product OR What does the law of variable proportions show? State the behaviour of total product according to this law. When more of variable inputs are employed Explain the conditions of producer s equilibrium in terms of marginal cost and marginal revenue? Use a schedule XII Economics

111 15. Explain how do the following influence demand for a good. (i) Rise in prices of the related goods (ii) Fall in income of the consumer Define equilibrium price. Show the effect of an increase in supply of a commodity on its equilibrium price, demand remaining unchanged. 6 OR Market for a good is in equilibrium. There is simultaneous decrease both in demand and supply of the good. Explain its effect on market price. 114 XII Economics

112 SECTION B 17. Define flow variable What are intermediate goods? What are demand deposits? Define indirect tax Give the meaning of managed floating exchange rate Calculate net value added at factor cost : (i) Output sold (units) = 200 (ii) Price per unit of output (Rs.) = 10 (iii) Closing stock (Rs.) = 100 (iv) Opening stock (Rs.) = 150 (v) Consumption of fixed capital (Rs.) = 600 (vi) Import duty (Rs.) = 400 (vii) Intermediate cost (Rs.) = 10,000 (viii) Subsidy (Rs.) = 500 (Ans : Rs. 9450) 23. Distinguish between revenue expenditure and capital expenditure in a government budget. Give examples. 3 OR Explain the Price Stability objective of a government budget Explain the Banker to the Government function of the Central Bank Distinguish between consumption function equation and saving function equation Find investment from the following auto nomous consumption = Rs. 100 National Income = Rs. 500 Marginal propensity to consume = 0.75 (Ans. Rs. 25) 115 XII Economics

113 27. Giving reason explain how should the following be treated in estimating national income: (i) Interest paid by banks on deposits by individuals. (ii) National debt interest Explain any two functions of money. 4 OR Explain the components of legal reserve ratio Explain revenue deficit in a Government budget. What does it indicate? Explain the concept of excess demand in macroeconomics. Also explain the role of Bank Rate in correcting it. 6 OR Explain the concept of deficient demand in macroeconomics. Also explain the role of open market operation in correcting it What is balance of payments account? name three components each of its current account and capital account Find out (a) Gross national product at market price and (b) Net current transfers from abroad. (4+2) = 6 (Rs. Crore) (i) Net Indirect Tax 35 (ii) Private final consumption expenditure 500 (iii) Net national disposable income 750 (iv) Closing stock 10 (v) Govt. final consumption expenditure 150 (vi) Net domestic fixed capital formation 100 (vii) Net factor income to abroad ( ) 15 (viii) Net imports 20 (ix) Opening stock 10 (x) Consumption of fixed capital 50 (a) 795 crore (b) Rs. 5 crore 116 XII Economics

114 EXAM. ORIENTED QUESTIONS WITH ANSWERS UNIT 1 INTRODUCTION 3-4 MARKS QUESTIONS Q.1 Why is a production possibilities curve concave? Explain. Ans. The production possibility curve being concave means that MRT increases as we move downward along the curve. MRT increases because it is assumed that no resource is equally efficient in production of all goods. As resources are transferred from one good to another, less & less efficient resources have to be employed. This raises cost and raises MRT. Q. 2 Explain properties of a production possibilities curve. Ans. There are two properties of a production possibilities curve. 1 Downward sloping : It is because as more quantity of one good is produced some quantity of the other good must be sacrificed. 2. Concave to the origin : It is because the marginal rate of transformation increases as more of one good is produced. Q. 3 Explain the problem of what to produce. Ans. An economy can produce different possible combinations of goods & services with given reasources. The problem is that, out of these different combinations, which combination is produced. If production of one good increases then less resources will be available for other goods. Q. 4 What is Merginal Rate of transformation? Explain with the help of an example. Ans. MRT is the rate at which the units of one good have to be sacrificed to produce one more unit of the other good in a two goods economy. 117 XII Economics

115 Suppose an economy produces only two goods X and Y. Further suppose that by employing these resources fully and officiently, the economy produces 1X + 10Y. If the economy decides to produce 2X, it has to cut down production of Y by 2 units. Then 2Y is the opportunity cost of producing 1X. Then 2Y:1X is the MRT. Q. 5 Explain the problem How to produce. Ans. Broadly, there are two techniques of production. (i) (ii) Labour intensive Technique : Under this technique, production depends more on the use of labour. Capital Intensive Technique : Under this technique, production depends more on the use of machines (called capital) efficient technique of production is that which uses minimum possible inputs for a given amount of output. So that, cost per unit of output is minimised. 118 XII Economics

116 CONSUMER BEHAVIOUR AND DEMAND UNIT MARKS QUESTIONS Q.1 Distinguish between increase in demand and increase in quantity demanded of a commodity. Ans. When demand increases at given price then it is called increase in demand. On the other hand, when demand increases by decrease in the price of a commodity then it is called increase in quantity demand. Q. 2 Given price of a good, how does a consumer decide as to how much of that good to buy? Ans. Consumer purchases upto the point where marginal utility is equal to the price (MU=P). So long as marginal utility is greater than price, he keeps on purchasing. As he makes MU X MU X purchases PXY = MU falls and at a particular quantity of the good MU PX becomes P equal to price. Consumer Y Y Y purchases upto this point. Q. 3 A consumer consumers only two goods X and Y. State & explain the conditions of consumer s equilibrium with the help of utility analysis. Ans. There are two conditions of consumer equilibrium : (i) MU P X X = OR MU P Y Y Explanation : If, the consumer is not in equilibrium because he can raise his total utility by buying less of Y and more of X. 119 XII Economics

117 Similarly if MU P X X MU P Y Y the consumer is not in equilibrium as he can raise his total utility by buying less of X and more of Y. (ii) MU falls as consumption increases : If MU does not fall as consumption increases the consumer will end up buying only good which is unrealistic or consumer will never reach the equilibrium position. Q. 4 Explain how the demand for a good is affected by the price of its related goods. Give examples. Ans. Related goods are either substitutes or complementary Substitutes Goods : When price of a substitude falls, it becomes cheaper than the given good. So the consumer substitutes it for given good will decrease. Similarly, a rise in the price of substitute will result in increase in the demand for given good. For example Tea and Coffee. Complementary Goods : When the price of a complementary good falls its demand rises and the demand for the given good will increase. Similarly when price of complementary good increases, then demand for given good decreases. For example : Car & Petrol. Q. 5 Distinguish between normal goods and inferior goods. Give example also. Ans. Normal Goods : These are the goods the demand for which increases as income of the buyer rises. There is a positive relationship between income and demand or income effect is positive. Example ; Rice, Wheat Inferior Goods : These are the goods the demand for which decreases as income of buyer rises. Thus, there is negative relationship between income and demand or income effect is negative. Example : coarse grain, coarse cloth. 120 XII Economics

118 Q. 6 Explain any four factors that affect price elasticity of demand. Ans. 1. Nature of Commodity : Necessories like Salt, Kerosene oil etc. have inelastic demand and luxuries have elastic demand. 2. Availability of substitutes : Demand for goods which have close substitudes is relatively more elastic and goods without close substitutes have less elastic demand. 3. Different uses : Commodities that can be put to different uses have elastic demand for instance electricity has different uses. 4. Habit of the consumer : Goods to which consumers become habitual will have inelastic demand. Examples Liquor and Cigarette. Q. 7 Explain relationship between total utility and marginal utility with the help of a schedule. Ans. Quantity (Units) Total utility Marginal utility (1) As long as MU is positive, TU increases. (2) When marginal utility is equal to zero then total utility is maximum. (3) When marginal util[ity is negative; Total utility starts diminishing. Q. 8 Define marginal utility. State the law of diminishing merginal utility. Ans. Marginal Utility : It is addition more to the total utility as consumption is increased by one more unit of the commodity. Law of Diminishing Merginal utility : It states that as consumer consumes more and more units of a commodity, the utility derived from each successive unit goes on decreasing. According to this law TU increases at decreasing rate and MU decreases. 121 XII Economics

119 6 MARKS QUESTIONS Q.1 Explain the three properties of indifference curves. Ans. Three properties of indifference curves are as follow. 1. Slopes downward from left to right : To consume more of one good the consumer must give up some quantity of the other good so that total utility remains the same. 2. Convex towards the origin : MRS declines continuously due to the operation of the law of diminishing marginal utility. 3. Higher indifference curves represents higher utility : Higher indifference curve represent large bundle of goods. Which means more utility because of monotoric preference. Q. 2 Explain the conditions of consumer s equilibrium using indifference curve analysis. Use diagram. Ans. There are two conditions for consumer s equilibrium. (i) (ii) P MRS = X PY PX P X PY P Y MRS is continuously falling. Explanation Suppose there are two goods X and Y. the first condition of consumer s equilibrium is MRS = If MRS. It means consumer values X more than what market values & willing to give more price than market price he will purchase more of X this cause fall in MRS and it will continue P upto that when MRS = X PY If MRS. It means consumer values X less than what market values. Consumer is willing to give less price as market price & 122 XII Economics

120 he will purchase less of X, by this MRS will increase and it will P continue till MRS = X PY (ii) Unless the MRS is continuously falling the equality between the MRS and will not be achieved. PX PY Consumer is in equilibrium at point E. 123 XII Economics

121 PRODUCER BEHAVOUR AND SUPPLY UNIT III 3-4 MARKS QUESTIONS Q. 1 Explain the likely behaviour of total product under the stage of increasing return to a factor with the help of numerical example. Ans. Increasing return to a factor is the first phase of the Law of return to a factor. When more and more units of a variable factor is combined with fixed factor up to a certain level total physical product increases with increasing rate. Machine Units of labour Total physical product Q. 2 With the help of example distinguish between total fixed cost and total variable cost. Ans. Total fixed cost Total variable cost 1. Fixed cost remains constant 1. variable cost changes with the at each level of output ie change in quantity. It increase it do not change with or decrease as the output change in quantity. change. 2. It can not be zero when 2. it is zero when output is zero output is zero. 3. Its curve is parallel to 3. Its curve is parallel to the X-aixs curve of total cost. 4. Example :- Rent, wages 4. Example :- cost of raw material, of permanent staff. wages of casual labour. 124 XII Economics

122 Q. 3 Draw average cost, average variable cost and marginal cost curves on a single diagram and explain their relations. Ans. Relation of AC, AVC and MC 1. MC interects to AC and AVC at their minimum level 2. AC and AVC decreases before the interection by MC, but remain greater than MC. 3. AC and AVC starts to increase after the itersection by MC, and becomes less than MC. 4. As output increases, AC and AVC tends to be closer but the difference between AC and AVC can naver be zero. Q. 4 Draw average cost, average variable cost and average fixed cost curves on a single diagram and explain their relation. 1. AC is the vertical summation of AVC and AFC 2. The difference between AC and AVC falls as output increases but 125 XII Economics

123 the difference of AC and AFC increases. 3. As output increases AC and AVC tends to be closer but their curves do not interect each other because AFC always remains more than zero. Q.5 Explain the relation between average revenue and marginal revenue when a firm can sell an additional unit or a good by lowering the price. Ans. 1. AR and MR both decreases. 2. MR decrease at the rate of twice than AR. 3. MR become zero and negative but AR can never be zero. Q. 6 Distingush between change in quantity supplied and change in supply. Ans. Change in quantity supplied change in supply 1. It refers the change in 1. It refer s the change in supply supply due to change in due to the change in the price of the good determinents of supply other than price 2. Determinents of supply 2. Price of the good remains other than price remains unchanged. unchanged 3. Law of supply apply 3. Law of supply does not apply. 4. There is upward and 4. supply curve shifted to leftward downward movement along or rightward under this with supply curve in this condition. situation. Q. 7 Explain how does change in price of input affect the supply of a good. Ans. Increase in price of input : increase in price of input is cause of a decrease in the supply of a good because the production cost of a good will increase due to increase in price of input. It will reduced the profit. So producer will decrease the supply of the good. Decrease in price of Input : Decrease in price of input is a cause of increase in supply because when the price of input decrease the production cost of a good also also decreases. Decrease in cost increases the profit margin. It motivate to producer to increase the supply of the good. 126 XII Economics

124 Q. 8 Explain how changes in prices of other products influence the supply of a given product. Ans. The supply of a good is inversly influenced with the change in price of other product which can explain as fallows. A. Rise in price of other product : When there is rise in the price of other product the production of these product become more profitable due to unchanged cost in comparison of the production of given produce. As a result the producer will produce more quantity of other product so the supply of given good will decrease. B. Fall in the price of other product : When there is fall in the price of other product the production of these product become less profitable due to unchanged cost in comparison of the production of given product. As a result producer will produce less quantity of other product so the factors of production shifted for the production of given good. It cause an increase in supply of given good. Q. 9 Explain how technological advancement influence the supply of a given product. Ans. Technological advancement brings a positive impact in the supply of a given product. It reduces per unit cost and increase the productivity of given factors of production. Due to these reasons production of given product becomes more profitable. Q. 1 Explain the law of variable proporation with the help of diagram/ schedule. OR What is the likely behaviour of total product/marginal product when only one input is increased for increasing production? Use diagram/ schedule. Ans. Law of variable proportion state the inpact of change in unit of a variable factor on the physical output. When more and more unit of a variable factor combined with fixed factor physical product passes though following phases. Behaviour of TP (i) (ii) (iii) TP increases at an increasing rate TP increases at diminishing rate TP falls 127 XII Economics

125 Behaviour of MP (i) (ii) (iii) MP increases and becomes maximum. MP decreases and becomes zero. MP becomes negative. Machine unit of labour TPP MPP XII Economics

126 First Phase : TPP increases with increasing rate upto A point. MPP also increase and becomes maximum of point C. Second Phase : TPP increases with diminishing rate and it is maximum on point B. MPP start to decline and becomes zero at D point. Third Phase : TPP starts to decline and MPP becomes negative. Important instruction for giving the answer of above question. Do not use diagram for the explaination of this question if it is instructed to use schedule and do not use schedule if the explaination of this question asked with the help of diagram. Do not explain the behaviour of marginal product with the help of schedule and diagram. If there is instruction to explain only the behaviour of total product. Do not explain the behaviour of total product with help of schedule and diagram if there is instruction to explain only the behaviour of marginal product. Q. 2 What is producer s equilibrium? Explain the conditions of produce s equilibrium through the marginal cast and marginal revenue approach. use diagram/schedule. Ans. Producer s equilibrium refer s the stage under which with the help of given factor s of production producer attain that level of production of which he is getting maximum profit. The conditions of producer s equilibrium through the marginal cost and marginal revenue approach are as follows. 1. Marginal cost should be equal to marginal revenue. 2. With the increase in output after equilibrium marginal cost should be greater than marginal revenue. 129 XII Economics

127 Output MR MC OR Output MR MC XII Economics

128 Explanation of conditions : (i) (ii) So long as MC is less than MR, it is profitable for the producer to go on producing more because it adds to its profits. He stops producing more when MC becomes equal to MR. When MC is greater than MR after equilibrium if means the profit will decline if producer will produce more units of the good. Important instruction for giving the answer of the above question Use only one schedule/diagram given as above for the explaination. Do not use diagram for the explaination of this question if it is instructed to use schedule and do not use schedule if the explaination of this question is asked with the help of diagram. 131 XII Economics

129 FORMS OF MARKET AND PRICE DETERMINATION UNIT IV 3-4 MARKS QUESTIONS Q.1 Explain the implication of large number of buyers in a perfectly competetive market. Ans. The implication is that no single buyer is in a position to influence the market price on its own because an individual buyer s purchase forms a negligible proportion of the total purchase of the good in the market. Q. 2 Explain why are firms mutually interdependent in an oligopoly market. Ans. Firms are mutually interdependent because an individual firms takes decision about price and output after considering the possible reactions by the rival firms. Q. 3 Explain the inplication of freedom of entry and exit to the firms under perfect competition. Ans. The firms enter the industry when they firnd that the existing firms are earning super normal profits. Their entry raises output of the industry, brings down the market price and thus reduce profits. The entry continues till profits are reduced to normal (or zero) The firms start leaving the industry when they are facing losses. This reduces output of the industry, raises market price and reduces losses. The exit continues till the losses are wiped out. Q. 4 Explain the implication of perfect knowledge about market under perfect competition. Ans. Perfect knowledge means that both buyers and sellers are fully informed about the market price. Therefore no firm is in a position to charge a different price and no buyer will pay a higher price. As a result a uniform price prevails in the market. Q. 5 Why is the demand curve more elastic under monopolistic competition than under monopoly. 132 XII Economics

130 Ans. The elasticity of demand is high when the product has close substitutes and that elasticity of demand tends to be low when the product does not have close substitutes as we know in monopolistic competition there is large number of close substitutes while in monopoly there is no close substitutes hence the demand curve under monopolistic competition is more elastic than under monopoly. Q. 6 Why is a firm under perfect competition a price taken while under monopoly a price maker? Explain in brief. Ans. A firm under perfect competition a price taker by the following reasons: 1. Number of firms : The number of firms under perfect competition is so large that no individual firm by changing sale, can cause any meaningful change in the total market supply. Hence, market price remains unaffected. 2. Homogenuous product : All firms in a perfectly competitive industry produce homogeneous product. Hence, price remains same. 3. Perfect knwledge : All the buyers and sellers have perfect knowledge about market price so no firm charge a different price than market price. Hence a uniform price prevails in the market. A firm under monopoly a price maker by the following reasons : 1. A monopolist is a single seller of the product in the market. Hence it has full control over supply 2. There are no close substitutes of the monopoly product, hence the demand is less elastic or inelastic. 3. There are legal, technical and natural barriers to the entry of new firms so that there is no fear of increase in market supply. Q. 7 Differentiate between price discrimination and product differentiation. Ans. Price discrimination : Price discrimination is a situation when a monopolist charges different price from different buyers of the same product. This is generally done to maximise profits. Product Differentiation : Product differentitation is a situation when different producers under monopolistic competition, try to differentiate their product in terms of its shape, size, packaging, trade mark or brand name. This is done to attract buyers from the rival firms in the market. 133 XII Economics

131 Q. 8 Distinguish between perfect competition and monopoly. Ans. Perfect competition Monopoly 1. Large numer of buyers 1. One seller & large and sellers no. of buyers. 2. Products are 2. There is no close substitutes homogeneous of goods. 3. Free entry & exit 3. Barriers to entry 4. There is no control 4. There is full control over over price market price. Q. 9 Differentiate between monopoly & monopolistic competition. Ans. Monopoly Monopolistic competition 1. Single seller & large 1. Large number of buyers no. of buyers. and sellers. 2. No. close substitutes 2. There is product of products. differentiation. 3. Barriers to entry 3. Free entry and exit. 4. Selling cost is zero. 4. Heavy selling costs are incurred. Q. 10 What is oligopoly? State its main properties/features. Ans. Oligopoly : It is a form of the market in which there are a few big sellers of a commodity and a large number of buyers. There is a high degree of interdependence among the sellers regarding their price & output policy. Following are some principal features of oligopoly : 1. A few firms 2. High degree of interdependence. 3. Non-price competition. 4. Entry barriers. 5. Formation of cartels. 134 XII Economics

132 6 MARKS QUESTIONS Q.1 Distinguish between collusive and non-collusive oligopoly. Explain how the oligopoly firms are interdependent in taking price and output decisions. Ans. Collusive oligopoly is one in which the firms cooperate with each other in deciding price and output where as, non-collusive oligopoly is one in which the firms compete with each other. The firms are interdependent because each firm takes into consideration the likely reactions of its rival firms when deciding its output and price policy. It makes a firm dependent on other firms. The firm may have to reconsider the change in the light of the likely reactions. Q. 2 Market for a good is in equilibrium. There is an increase in demand for this good. Explain the chain of effects of this change. Use diagram. Increase in demand shifts the demand curve from D 1 to D 2 to the right leading to excess demand E 1 F at the given price OP 1. Since the consumers will not be able to buy all they want to buy at this price, there will be competition among buyers leading rise 135 XII Economics

133 in price. As price rises, demand starts falling (along D 2 ) and supply starts rising (along S) as shows by arrows in the diagram. This change continue till D and S are equal at E 2. The quantity rises to OQ and price to OP 2. Q. 3 Market for a good is in equilibrium. There is simultaneous decrease both in demand and supply of the good. Explain its effect on market price. Ans. There are three possibilities : 1. If the relative (percentage) decrease in demand is greater than the decrease in supply, price will fall. The price will fall because of excess supply in the market. 2. If the relative (percentage) decrease in demand is less than the decrease in supply price will rise. The price will rise because of excess demand in the market. 3. If the relative (percentage) decrease in demand is equal to the decrease in supply price will remain unchanged The price will remain unchanged because there is neither excess demand nor excess supply in the market. Q.4 Explain why the equilibrium price of commodity is determined at that level of output at which its demand equals its supply. Ans. Suppose demand is greater than supply. Since the buyers will not be able to buy all what they want, there will be competition among the buyers. It will have on upward influence on the price. As a reasult demand will start falling and supply rising. It will go on till demand is equal to supply again. It demand is less than supply. Since the sellers will not able to sell all what they want, there will be competition among the sellers. It will have a downward influence on the price. As a reasult demand will start rising and supply falling. It will go on till demand is equal to supply again. Hence, the equilibrium price of a commodity is determined at that level of output at which its demand equals its supply. 136 XII Economics

134 UNIT VI 3-4 MARKS QUESTIONS NATIONAL INCOME AND RELATED AGGREGATES 1. Define stock variable. 1 Mark Questions with Answer Ans. A variable whose value is measured at a point of time. 2. Define capital goods. Ans. Goods used is producing other goods are called capital goods. 3. What is nominal gross domestic product? Ans. When GDP of a given year is estimated on the basis of price of the same year, it is called nominal GDP. 4. Define flow variables. Ans. Any variable whose magnitude is measured over a period of time is called a glow variable. 5. Define real gross domestic product. Ans. When GDP of a given year is estimated on the basis of base year prices it is called real gross domestic product. 6. Define capital formation. Ans. Increase in the stock of capital in the given period is called capital formation 137 XII Economics

135 3/4 Marks Questions with Answers 1. Calculate gross value added of factor cost : (i) Units of output gold (units) 1000 (ii) Price per unit of output (Rs.) 30 (iii) Depreciation (Rs.) 1000 (iv) Intermediate cost (Rs.) (v) Closing stock (Rs.) 3000 (vi) Opening stockf (Rs.) 2000 (vii) Exise (Rs.) 2500 (viii) Sales Tax 3500 Ans. GVA FC = (ixii) + v vi iv vii viii = (1000X30) = Rs Calculate Net Value added at factor cost : (i) Consumption of Fixed capital (Rs.) 600 (ii) Import duty (Rs.) 400 (iii) Output sold (units) 2000 (iv) Price per unit of output (Rs.) 10 (v) Net change in stock (Rs.) ( ) 50 (vi) Intermediate cost (Rs.) (vii) Subsidy (Rs.) 500 Ans. NVA FC = (iii x iv) + v vi ii + vii i = (2000x10) + ( 50) = Rs Find Net Value added at market price : (i) Output sold (units) 800 (ii) Price per unit of output (Rs.) 20 (iii) Excise (Rs.) XII Economics

136 (iv) Import duty (Rs.) 400 (v) Net change in stock (Rs.) ( ) 500 (vi) Defniciation (Rs.) 1000 (vii) Intermediate cost (Rs.) 8000 Ans. NVA mp = (i x ii) + v vii vi = (800x20) + ( 500) = Rs Giving reasons classify the following into intermediate products and final products (i) (ii) Furniture purchased by a school. Chalk, duster, etc, purchsed by a school. Ans. (i) It is final product because it is purchased for final investment. (ii) These are intermediate products because these are taken to be used up completely during the same year. 5. Giving reasons, explain the treatment assigned to the following which estimating national income. (i) (ii) Family members working free on the farm owned by the family. Payment of interest on borrowings by general government. Ans. (i) Imputed salaries of these members will be included in national income. (ii) It will not be included in national income because it is non-factor payment as general government borrows only for consumption purpose. 6. Giving reasons, explain the treatment assigned to the following which estimating national income. (i) (ii) Payment of income tax by a firm Festival gifts to employes. Ans. (i) Not included, as it is transfer payment from firm to government. (ii) Not included, as it is transfer payment. 139 XII Economics

137 7. Explain the basis of classifying goods into intermediate and final goods. Give suitable examples. Ans. Goods which are purchased by a production unit from other production units and meant for resale or for usingup completely during the same year are called intermediate goods for example : raw material. Goods which are purchased for consumption and investment are called final goods for example : Purchase of machinery for instalation in factory. 8. Giving reason classify the following into intermediate and final goods. (i) (ii) Machine purchased by a dealer of machine. A car purchased by a house hold. Ans. (i) It is an intermediate good because it is meant for resale in the market. (ii) It is a final good because it is meant for final consumption. 9. How will you treat the following in estimating rational income of India? Give reasons for your answer. (i) (ii) Value of bonus shares received by shareholders of a company. Interest received on loan given to a foreign company in India. Ans. (i) It is not included in national income because it is the return of financial capital and not of the goods & services. (ii) It is included in the national income as interest is a factor income and a part of domestic income. 6 Mark Questions 1. How will you treat the following which estimating national income of India? Give reasons. (a) (b) (c) (d) (e) Divident received by an Indian from his investment in shares of a foreign company. Money received by a family in India from relatives working abroad. Interest received on loans given to a friend for purchasing a car. Dividend received by a foreigner from investment in shares of an Indian company. Profit earned by a branch of an Indian bank in Canada. 140 XII Economics

138 (f) (g) (h) (i) (j) (k) (l) (m) (n) (o) (p) (q) (r) (s) Scholarship given to Indian students studying in India by a foreign company. Fees received from students. Profits earned by branch of a foreign bank. Interest paid by an individual on a loan taken to buy a car. Expenditure on machines for installation in a factory. Profit earned by a branch of foreign bank in India. Payment of salaries to its staff by an embassy located in New Delhi. Interest received by an Indian resident from firms abroad. Salaries received by Indians working in branches of foreign banks in India Profits earned by an Indian bank from its branches abroad. Rent paid by embassy of Japan in India to an Indian resident. Imputed rent of self occupied house Interest received on debentures Financial help received for flood victims. 2. How will you treat the following which estimating domestic factor income of India? Give reasons. (i) (ii) (iii) (iv) (v) Remittances from non-resident Indian to their families in India Rent paid by the embassy of Japan in India to a resident Indian. Profit earned by branches of foreign bank in India. Payment of salaries to its staff by embassay located in India. Interest received by an Indian resident from firms abroad. 3. Are the following part of a country s net domestic product at market price? Explain (a) (b) (c) Net indirect tax Net export NFIA (d) Consumption of fixed capital 141 XII Economics

139 Ans. (a) It is factor income from abroad so will be included in national income. (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m) (n) (o) (p) (q) (r) (s) Ans. 2 (i) (ii) It is transfer receipts, so it is not included in national income. Not included in national income, because it is a non-factor receipt as loan is not used for production for consumption Included as it is a factor income to abroad. It is a part of NFIA and will be included in national income. It is transfer receipts, so it is not included in national income. It is included in national income becuase it is a part of the private final consumption expenditure of the house hold. Included in national income because it is part of domestic factor income of India. Not included because it is a non-factor income as loan is not used for production but for onsumption. Included because it results in flow of income throught productive activities Included, because it is a part of domestic product of India. Not included because it is not a part of domestic product of India Included as it is the part of NFIA. Included because it is earned in domestic territory of India. Included because it is aprt of NFIA Included as it is paid to an Indian resident out side the domestic territory of a country. It will be included in NFIA. Included as a part of rent as it is payment to self for housing services. Included because it is a factor earning Not included as it is a transfer payment. Not included as it is a transfer payment Not included because Japanese embassy in India does not fall with in the domestic territory of India. 142 XII Economics

140 (iii) (iv) (v) Ans. 3 (a) (b) (c) (d) Included because it falls with in the domestic territory of India Not included as an embassy located in India is not fall with in the domestic territory of India Not included in domestic product but it is the part of NFIA. Yes, because market price = factor cost + Net Indirect tax Yes, because NDP MP includes net exports No, because domestic means it excludes NFIA No, net means consumption of fixed capital is excluded. 143 XII Economics

141 MONEY AND BANKING UNIT VII 3-4 MARKS QUESTIONS Q.1 Explain the significance of the Store of Value function of money. OR State the importance of the Store of Value function of money. Ans. People save a part of their earnings for use in future. But in what form? Money fulfills this need of the people. Money as a store of value means that money is an asset and can be stored for use in future one can hold one s earnings until the time one wants to spend it. This is the store of value function of Money. Q.2 Explain the Unit of Account function of money? Ans. The Unit of Account function of money is also called the measure of value function. Money as a unit of account means a standard unit for quoting prices. It makes money a powerful medium of comparing prices of goods and serives. Q.3 Explain the Medium of Exchange function of money? Ans. Money as a medium of exchange means money as a means of payment for exchange of goods and services. Goods and services are exchanged for money when people sell things. Money is exchanged for goods and services when people buy things. The medium of exchange function of money solves the problem of double coincidence of wants inherent in the barter system of trade. Q.4 Explain the Lender of Last Resort function of the central bank. Ans. Central bank also lends money directly to commercial banks. Instead of rediscounting, central bank given loans against the bill of exchange promissory notes, treasury bills, government securities, etc. The direct lending to commercial bank is referred to as the lender of the last resort function of central bank. 144 XII Economics

142 Q.5 Explain the Government s Bank function of a central bank. Ans. A central bank conducts the banking account of government departments. It performs the same banking functions for the government as commercial bank performs for its customers. It accepts their deposits and undertakes inter-bank transfers. It also gives loans to the government. A central bank also provides various services as agent of the government. It manages public debt. It also gives advice to the government regarding money market, capital market, government loans and economic policy matters. 6 - Marks Questions with Answers Q.1 What do you mean by credit/money creation? Explain the process of moeny creation by the commercial banks with the help of a numerical example. Ans. Money creation is a process in which a commercial bank creates total deposits many times the initial deposits. The capacity of commercial bank to create depends on two factors: 1. Amount of initial fresh deposit 2. 1 Legal reserve ratio LRR LRR 0.2 Money multiplier = Money Creation = Initial Deposit Money multiplier The Working : Suppose (i) Initial Deposit = Rs (ii) LRR = 20% As required, the bank keeps 20% ie Rs. 200 as cash reserve and lend the remaining Rs Those who borrow use the money for making payments. As assumed those who receive these payments put the money back into their bank accounts. This creates a fresh deposit of Rs The bank again keep 20% ie Rs. 160 and lend Rs In this way the money goes on multiplying leading to total money creation of Rs Money creation = Initial Deposit = XII Economics

143 UNIT VIII DETERMINATION OF INCOME AND EMPLOYMENT 1 - Mark Questions with Answers 1. Give the meaning of ex-ante savings. Ans. : Ex-ante savings are the planned savings or expected savings 2. Give the meaning of deflationary Gap. Ans. It is the gap between excess of aggregate supply over aggregate demand at full employment level. 3. What is Ex-ante aggregate demand? Ans. It is planned or desired aggregate demand. 4. Give the meaning of Inflationary Gap. Ans. It refers to the amount by which the actual aggregate demand exceeds the level of aggregate demand required to establish the full employment equilibruim. 5. What is meant by ex-ante investment? Ans. : It is planned or desired investment during a particular period. 6. Define aggregate demand. Ans. Aggregte demand is defined as the money value of total goods and services demanded by an economy during a given period. 7. What is propensity to consume? Ans. Which shows the level of consumption at different levels of income in an economy. 8. Define marginal propensity to consume. 146 XII Economics

144 Ans. It is defined as measure of the rate at which aggregate consumption expenditure Changes as national income changes. MPC= C/Y 9. What is involuntry unemployment? Ans. When people who are willing to work at the giving wage rate do not get work. 10. What is meant by excess demand in macro economics? Ans. In macro economics, when aggregate demand is more than aggregate supply at full employment level, then there is excess demand. 11. What can be the minimum value of investment multiplier? Ans. Investment multiplier K=1/1-mpc if mpc = 0 than K=1/1-0 = 1 which is minimum value of investment multiplier 12. Give the meaning of aggregate supply? Ans. Aggregate supply is the money value of total supply of goods and services available for purchase by an economy during a given period. 13. Can the value of APS be negative? Ans. Yes, when there are dissavings. 14. Write the relation ship between MPS and multiplier? Ans. K=1/1-MPC = 1/MPS or inverse relationship between MPS and the size of the mulitiplier 3/4 - Marks Questions with Answers 1. In an economy the MPC is Investment expenditure in the economy increase by Rs.75 crore. Calculate total increase in national income. Ans. : K= Y/ I = 1/1-MPC Y= Ix1/1-MPC = 75x1/ = 300 Crore 2. An economy is in equilibrium. Its consumption function is C= Y. and investment is 700 find national income. 147 XII Economics

145 Ans. : C= Y Y = C+I Y = Y+700 = Giving reasons, state whether the following statements are true or false. (1) When MPC is zero, the value of investment multiplier will also be zero. (2) Value of APS can never be less than zero (3) When MPC>MPS, the value of investment multiplier will be greater than 5. (4) The value of MPS can never be negative (5) When investment multiplier is 1, the value of MPC is zero. (6) The value of APS can never be qreater than 1. Ans. (1) False because when MPC = 0 Value of investment multiplier is one K=1/1-MPC = 1/1-0 = 1 (2) False because APS is negative when there are dissavings (3) True, if MPC is greater than 0.8 or false if MPC > 0.5 but not greater than 0.8 or (4) True, since MPS = S/ Y if S = 0 than MPS can at the most be zero. (5) True because K = 1/1-MPC = 1/1-0=1 (6) True, because APC + APS = 1 4. Explain the distinction between voluntary and involuntry employment. Ans. Voluntary unemployment is that part of the working force not willing to engage itself is gainful occupation. Involuntary unemployment is that part of labour force which is willing and able to work at the prevailing wage rate but is out of work. 5. Explain the relationship between investment multiplier and MPC? Ans. K=1/1-MPC, It shows direct relationship between MPC and the value of 148 XII Economics

146 Multiplier. Higher the proportion of increased income spend on consumption, higher will be value of investment multiplier. Higher the proportion of increased income spend on consumption, higher will be value of investment multipler. 6 - Marks Questions 1. Explain the role of the following in correcting deficient demand in an Economy. (1) Open market operation (2) Bank rate Ans : (1) Open market operation refer to the sale and purchase of securities by the Central Bank incase of deficient demand when AD falling short of AS at full employment, the Central Bank buys securities in the open market and makes payment to the sellers. The money flows out of the central bank and reaches the commercial bank as deposits. This raises the lending capacity of the banks, people can borrow more. This will raise AD. (2) Incase of deficient demand central bank decrease the bank rate which the central bank charges on the loan given to commercial bank. This forces the commercial banks to reduce lending rate. Since borrowing become cheaper and people borrow more. Arises. 2. Explain the role of the following in correcting 'Excess demand in an Economy' (1) Bank Rate (2) Open market Ans : (1) To Correct excess demand central bank can rise the bank rate. This forces commercial bank to increase lending rates. This reduces demand for borrowing by the public for investment and consumption. Aggregate demand falls. (2) When there is excess demand Central Bank sells securities. This leads to flow of money out of the commerical banks to the central bank when people make payment by cheques. This reduces deposits with the banks leading to decline in their lending capacity. Borrowing decline. AD declines. 149 XII Economics

147 3. Explain the role of following in correcting the deflationary gap in an economy. 1) Govt. Expenditure 2) Legal Reserve Ratio Ans. 1) In a situation of deflationary gap or deficient demand. The Govt. should raise its expenditure i.e. there will be more economic activities in the economy like, building of roads, bridges, canal etc. This will raise the level of exployment. It will in turn increase the income and the purchasing power. Thus aggregate demand will rise. 2) During deficient demand, central bank reduces the CRR. The result of reducing CRR will be seen in the surplus cash reserves with the banks which can be offered for credit. The bank s credit bank reduces SLR, this will have expansionary effect on the credit position of the banks leading to increase in thier leading capacity borrowing increases & AD increases. 4. Explain the role of margin requirements for correcting the deflationary gap. Ans. : Deflationary gap refers to a situation when at full employment level of income AD falls short of AS. It is called deficient demand. Margin requirements refers to the margin on the security provided by the borrower. When margin is lower, the borrowing capacity of the barrover is higher. When central bank lowers the margin the borrowing capacity of the borrowers increase. This raise AD. 5. In an economy 75% of the increase in income is spent on consumption. Investment increased by Rs.1000 Crore. Calculate (1) Total increase in income (2) Total increase in consumption expd. Ans. : MPC = 75% = 75/100 =3/4 MPS = 1-3/4 = 1/4 K=4 (1) Y = I x K = 1000 x 4 = 4000 Crore 150 XII Economics

148 (2) Y = C + I C = Y - I = = Rs Crore 6. In an economy the equilibruim level of income is Rs.1200 Crore. MPC : MPS = 3:1 I =? Ans. New equilibruim income = Rs Crore = =8000 Crore K= 1/MPS = 1/0.25 = 4 I = Y/K = 8000/4 = Rs.2000 Crore 151 XII Economics

149 GOVT. BUDGET AND THE ECONOMY UNIT IX Q.1 Explain the redistribution of income objective of a government budget. OR Explain how the government budget can help in a fair distribution of income in the economy. Ans. Budgetary policies are useful medium to reduce inequalities of income for the fair distribution of income. government can use tax policy and public expenditure as a tool. govt can reduce the disposable income and wealth of Rich by imposing heavy tax and can spend more on providing free services to the poor. It raise the disposable income welfare of the poor. Q. 2 Explain the Reallocation of resources objective of a government budget. Ans. Through its Budgetary policy the government directs the allocation of resources in a manner such that there is a balance between the goal or of profit maximisation and social welfare. Government can provide subsidy and reduction in tax rate to motivate investment into areas where private sector initiative is not coming. Production of goods which are injurious to social life is discouraged through heavy taxation. Q. 3 Distingush between revenue receipts and capital receipts with the help of example. Ans. Revenue receipts Capital Receipts 1. These receipts do not 1. These receipts create liability create any liability for for the govt. the govt. 2. These receipts do not 2. These receipts cause a cause any reduction in reduction in assets of the govt. assets 3. Example : Tax receipts 3. Example: Loan by govt. disinvestment. 152 XII Economics

150 Q. 4 Distingush between revenue expenditure and capital expenditure with the help of example. Ans. Revenue Expenditure Capital Expenditure 1. These expenditure do 1. These expenditure are causes not cause increase in increase in govt. assets govt. assets 2. These expenditure do not 2. These expenditure are causes cause any reduction in reduction in govt. liability govt. liability 3. Example: transfer payment 3. Example: Repayment of loan by govt. by govt. Q. 5 Distingush between direct and indirect tax Ans. Direct Tax Indirect Tax 1. Direct tax is a tax whose 1. The liability to pay and liability to pay and incidence incidence of indirect tax do lie on the same person not lie on the same person 2. Its incidence can not be 2. Its incidence can be shifted shifted to some other to some other person person 3. Example : income tax 3. Production tax Q. 6 What is meant by fiscal deficit. Write its implications. Ans. Fiscal deficit is equal to excess of total expenditure over the sum of revenue receipts and capital receipts excluding borrowings. ie. Fiscal deficit means borrowing of the government. Fiscal Deficit : Total expenditure Total receipts net of borrowings Implication of Fiscal deficit 1. It increase the supply of money in the economy 2. it increase financial burden for future generation. 3. it is cause of inflation. 153 XII Economics

151 UNIT X 1. Define foreign exchange rate. Ans. : BALANCE OF PAYMENT Foreign exchange rate is the price of a foreign currency in terms of demestic currency 2. What is foreign exchange? Ans. Any currency other than the domestic currency. 3. What is balance of payment Accounts? Ans. : It is a systematic record of all economic transactions between the residents of a country and the rest of the world in a given period (one year) of time 4. State two sources of supply of foreign exchange. Ans. : Exports and foreign tourism. 5. State two sources of demand of foreign exchange. Ans. : Import of goods & services and to get education in abroad. 6. What does a deficit in balance of trade indicate. Ans. Deficit in balance of trade indicates that the imports of good are qreater than the exports. 7. What is fixed exchange rate? Ans. When rate of exchange is fixed by the Government in an economy. 8. Define flexible exchange rate Ans. : The rate of exchange in terms of other currencies are determind by market forces of demand and supply. 9. Define managed floating exchange rate. 154 XII Economics

152 Ans. It is a system in which the central bank or Government allow the exchange rate to determined by market forces but they take decisions to intervene whenever they feel it appropriate. 10. State the components of capital account of balance of payment. Ans. 1. Borrowing and lending to and from abroad. 2. Investment to and from abroad. 3. Change in foreign exchange reserves 11. Which transactions determine the balance of trade? When is balance of trade in surplus? Ans. : Exports of goods and imports of goods determines BOT. When the value of exports of goods is greater than the value of imports of goods. 12. What are the components of current account of the BOP account? Ans. (1) Exports and imports of goods (2) Exports and imports of services (3) Unilateral transfers 13. Explain the meaning of deficit in BOP Ans. When autonomous foreign exchange payments exceeds autonomous foreign exchange receipts, the difference is called balance of payments deficit. 14. Distinguish between devaluation and depriciation of domestic currency Ans. When Government or authorities reduce the price of domestic currency in terms of all foreign currencies is called devaluation. The fall in market price of domestic currency (due to demand supply in the market) in terms of a foreign currency is called depreciation. 15. When price of a foreign currency rises its supply also rises. explain why? Ans. If exchange rate increases, this will make domestic country's goods cheaper to foreigners. The demand for our exports will rise. It implies more supply of foreign exchange. 155 XII Economics

153 HOTS (Higher Order Thinking skills) 1. An agriculturist increased his capital and labour by 20% in the cultivation of his land. But he found that the amount of production raised increased by 15% only. (He had actually not employed any improved technology.) Point out which law does account for the phenomenon? The Law of Diminishing Returns 2. Increasing and decreasing returns to scale respectively imply downward and upward sloping portion of the long run average cost curve. Defend or refute. Like the short run average cost curve, the long run average cost curve (LAC) and marginal cost curves (LMC) are U shaped. The LMC curve cuts the LAC curve at its minimum point. The reason behind the U shape of LAC is the pattern of the returns to scale. Increasing returns to scale means that if output is increased at a given rate (say 10%), inputs need to be increased only by less than proportionately (say 7%). This implies that average cost must fall as output expands. Similarly decreasing returns to scale imply that the average cost must rise with output. Finally, if returns to scale are constant, the average cost is constant independent of output. Increasing returns to scale Þ LAC decreases with (IRS) output Constant returns to scale Þ LAC does not change (CRS) with output Decreasing returns to scale Þ LAC increases with Cost 0 (DRS) IRS CRS Quantity of output LMC LAC output q 0 DRS In the diagram, LAC curve is U shaped. This means that as output is increased starting from a small level,there are increasing returns to scale (in the output range 0 to q 0 ). Therefore LAC falls in the initial stage of production. In other words, the downward sloping portion of LAC curve represents increasing returns to scale. LAC remains constant at output level q 0. LAC increases at output levels higher than q 0. So we can say that the upward sloping portion of LAC curve shows decreasing returns to scale. 3. In the year 2006, all major domestic airlines in India reduced their air fares for certain sectors. Because they wanted to attract luxury class train passengers and to fill their vacancies. Most airlines have an occupancy rate of between 50 to 60%. Discuss how marginal cost and average cost play an important role in the cost function of these airlines. Marginal cost can be defined as the extra or additional cost of producing one extra unit of output. Average cost is the total cost divided by the total number of units produced. Normally the occupancy rate in the airline industry is only 50 to 60 percent. When we divide the total cost by the number of passengers travelling, we can arrive at the average cost of flying a plane. Here it includes the capital investment (fixed cost) as well as the salary, fuel, etc. (variable cost) involved in flying a plane. So the average cost is very high since the occupancy rate is low. With the addition of more passengers, the marginal cost does not increase but the average cost comes down. When the occupancy rate is low, discounts on air fares increase the occupancy rate, without adding any further cost of flying. As the occupancy rate increases, the average cost per passenger comes down. So even if the airlines give discounts, it does not increase the marginal cost. 4 Considering the rising demand for natural rubber, the Rubber Board encouraged farmers to use more fertilizer for increasing rubber production. But the Farmer s Forum warned the farmers about the consequence of heavy doze fertilization. Make your stand in the context of the Law of Diminishing Returns. The Rubber Board encouraged farmers to use more fertilizer to increase rubber production in tune with the rising demand for the natural rubber. But the farmer s forum warned the farmers about the use of heavy doze of fertilizers. The reason behind the warn- 1

154 Economics ing is nothing but the Law of Diminishing Returns. Any production unit has a maximum capacity, which can be reached by changing the variable factors of production. Thus an optimum combination will be reached. Beyond such combination returns will become constant and then gradually, start declining. Farmers should keep this in mind while using more fertilizer for increasing rubber production. If they go on increasing one factor of production and keep others constant, finally the rubber production will end up with losses. 1. Definition is the accurate description of an idea or an object. Collect some important definitions of the term Money. Money is what money does - Walker Anything which is commonly used and generally accepted as a medium of exchange or as a standard of value. Kent Money is the pivot around which economic science clusters... the major part of the subject matter of economics is concerned with the functioning and malfunctioning of money. Alfred Marshall. Money is anything that is habitually and widely used as a means of payments and is generally acceptable in the settlement of debts G.D.H. Cole 2. Without money no nation can go ahead towards economic development. Discuss the role of money in economic development. The role of money in promoting economic development is discussed below: 1. Money stimulates productivity and economic growth. 2. Money promotes investments. 3. Money facilitates investments in high yielding assets. 4. Creation of new credit or bank money exploits idle resouces and unemployed human resources that exists in developing economies. 5. Funding on new investment or capital accumulation by creating more mony, causes rise to price in a developing economy. This increase in prices will force people to reduce their present level of consumption. This leads to more savings. 3. The buying of securities by the Central Bank will have an effect on the money supply. What happens to the money supply? Ans. Money supply increases. 4. The Reserve Bank of India lends funds as a Lender of last resort to a commercial bank, at a particular interest rate. What this rate is known as? Ans. Bank rate 5. The government adopted the most effective quantitative method to control inflation in our economy. Which method? Ans. Cash Reserve Ratio 6. The Reserve Bank of India decides to print currency notes worth Rs. 500 crore, additionally. Does it require to increase its reserves in this respect? If not, why? Ans.The Reserve Bank of India can print and issue any amount of notes by keeping a statutory minimum reserve, which is Rs. 200 crore. Therefore the reserves need not be increased to print notes worth Rs. 500 crore. 1. Price of a commodity under perfect competition is determined by one of the following: Which? (a) Market forces (b) Firm (c) Buyer Ans: Market forces 2. Point out which type of market structure is the exact opposite of perfect competition. Ans: Monopoly 3. Examine the main features of perfect competition. Perfect competition is an extreme form of market which rarely exists in practice. It is a market situation in which there are a large number of buyers and sellers dealing with homogeneous products. The following are the features of perfect competition: (1) Existence of large number of buyers and sellers: Under perfect competition, the number of buyers and sellers will be large. Each seller sells a very small proportion of the total quantity sold in the market. Be- 1 cause of this reason, a single buyer or seller cannot influence the price of the commodity. (2) Homogeneous product: The commodity bought and sold must be homogeneous or identical in all respects ie, in size, colour, shape, smell, packing, etc. (3) Perfect mobility of goods and factors of production: Under perfect competition, there will be freedom of 2

155 movement for goods and factors of production. Goods can be taken from one place to another and factors of production can freely move between firms and industries. (4) Freedom of entry and exit: Freedom of entry and exit means that new firms can enter the industry and existing firms can leave the industry freely. (5) Perfect knowledge of market conditions: Under perfect competition, buyers and sellers will have complete knowledge about the availability of goods, their costs, prices etc. (6) Absence of transport cost: Absence of transport costs is an important assumption of perfect competition. If prices are to be uniform, we have to assume that transport costs do not enter the price. 4. Under perfect competition, the seller is a pricetaker. Explain. Price Since there are large number of buyers and sellers under perfect competition, a single seller or buyer cannot influence the price. The price is determined by the market forces of demand and supply. The total demand for the product and the total supply of the product together determine the price. The implication of product being homogeneous is that all firms have to charge the same price for the product. If any one producer happens to charge a price higher than the prevailing price, no one will demand from him. Product homogeneity and the existence of a large number of firms together imply that each firm is very small compared to the whole market and no single firm can influence the market price. Each seller accepts the prevailing market price as determined by market demand and supply. Therefore, a firm under perfect competition is called a price-taker. It is illustrated in the following diagram. P O D S E Q S D Output P O M HOTS (Higher Order Thinking skills) Output M 1 M 2 D In the diagram, equilibrium price determined by the forces of demand and supply is OP. A particular firm only takes the price prevailing in the market. At the equilibrium price, a firm can sell any quantity of the commodity. He has to only decide how much of the commodity he should sell at the market price. 1. Find the odd one out and justify your answer. Bank rate/open market operation/ Cash Reserve Ratio/ Taxation Taxation : Except this, all others in the group are monetary measures. 2. During inflation government should raise taxes. (True or false, justify your answer) True. To cut personal consumption expenditure the rates of personal corporate and commodity taxes should be raised. 3. Deficient demand leads to deflationery gap. (Say whether True or False, justify your answer) Ans: True: Deficient demand gives rise to deflationary gap which causes the economy s income, output and employment to decline, thus pushing the economy into an under employment equilibrium. 4. Mr. Tom found his salary doubled in the last two years. However he could purchase the very same quantity of goods evenafter his increased income. How will you explain this situation? When Mr. Tom s salary doubled he could purchase only very same basket of goods. This shows that he has not consumed anything additionally. Therefore, he might have saved the increased portion of the salary. Saving is what is left over after consumption expenditure. Here, the ratio of change in consumption to change in income is MPC (DC/DY) 1. Examine how an increase in input price affect the equilibrium quantity exchanged in the product market? Prices of factors of production influence the supply of commodities. If price of an input increases, the cost of production of a commodity using more of that input increases. Therefore the supply of the commodity will decrease. When the input price rises, the supply curve shifts to the left. An increase in input price, therefore increases the equilibrium price and the equilibrium quantity falls. It is illustrated in the given figure. 3

156 Economics Y P 1 P Price O S 1 S Quantity D S 1 Q 1 2. Show the determination of market equilibrium with the help of demand and supply schedules and a diagram. Equilibrium price is determined by the intersection of demand and supply curves. The point at which demand curve and supply curve intersect with each other is called equilibrium point. The following market demand and supply schedules illustrate the determination of equilibrium price in a market. Price of Quantity Quantity Bananas (in Rs.) demanded supplied 18 10,000 1, ,000 2, ,000 4, ,000 6, ,000 7, ,500 8, Give one example of direct intervention and indirect intervention in the market mechanism. In a free enterprise economy, price of a commodity is determined by the forces of demand and supply. But in certain situations the government may interfere in price fixation. There are some policies, eg. different kinds of taxes and subsidies, that change the market price indirectly via shifting the demand and supply curves. Sales taxes and excise taxes are common examples. These are called indirect interventions. There are other policies by which prices are fixed directly by the government; these are called direct interventions. Examples of direct intervention are price control on products and support price for commodities. It is thought that if necessary items like sugar, Q D S X rice etc. were left to the play of free market entirely, poor people would not be able to afford them at the market-clearing price. Hence, for a long time, the government has adopted a system of price control through ration shops for such commodities. In terms of demand and supply curves, price control means fixing price below the equilibrium price. This may lead to rationing system or blackmarketing. Inorder to protect the interest of farmers the government fixes minimum price or support price for commodities. It is fixed above the equilibrium price to insulate farmers from income fluctuations resulting from price variation in the free market. 4. Equilibrium price may or may not change with shifts in both demand and supply curves. Comment. The equilibrium price and quantity will change if there are changes in demand and supply conditions. It is possible that both demand and supply shifts occur simultaneously. It may be noted that when both demand and supply increase, the equilibrium quantity will increase, and when they decrease, the equilibrium quantity will decrease. But in both cases, the new equilibrium price may rise, fall or remain at the same level depending upon the relative change in demand and supply. The effect of change in both demand and supply is shown in the following diagram. Price > P 1 P O D S D 1 S 1 S Q Q 1 Quantity demanded S 1 D D 1 > 4

157 HOTS (Higher Order Thinking skills) In the diagram, the rate of increase in demand is greater than the rate of increase in supply. Therefore, the new equilibrium quantity and equilibrium price will increase. The change in the equilibrium price depends upon the relative changes in demand and supply. A few instances are given below. (1) When increase in supply is equal to increase in demand, the equilibrium price will remain unaffected, while equilibrium quantity will increase. (2) When increase in supply is greater than increase in demand, the equilibrium price will fall while equilibrium quantity will increase. (3) When increase in supply is less than increase in demand, equilibrium price will rise, and quantity will rise. 5. Analyse the determination of equilibrium price with a diagram. In the market, there are two forces, viz. supply and demand. Equilibrium refers to a market where quantity demanded is equal to quantity supplied. The equality of demand and supply determines the equilibrium price. Equilibrium price is the amount at which buyers want to buy and sellers want to sell. The amount is equal. Only at the equilibrium price, wishes of both the buyers and sellers are satisfied. \ Equilibrium D = S Price Surplus E Shortage Quantity Demanded S > D Excess Supply D = S Equilibrium D > S Excess Demand Diagrammatic Explanation: When price is P, demand is equal to supply at point E. At this point E, both the quantity demanded and quantity supplied are equal, at Q. ie., Demand = Supply. This is the point of equilibrium, E. At this point, there is no excess supply (D < S) or excess demand (D > S) for the commodity. Equilibrium price P is therefore called market clearing price. Here, price is an outside factor. So, when it changes, equilibrium is disturbed. This leads to equilibrium situations. When price moves up to P1, there is lesser demand and more supply. This leads to excess supply. When price moves down to P2, demand is more than supply. This creates excess demand. These two conditions are called disequlibrium states. Marshall likened the forces of demand and supply to the two blades of a scissors, moving in opposite directions. Just as both the blades moves in the opposite directions to cut a piece of paper, demand and supply moving in opposite ways together and at the same time, determine the equilibrium price. 6. Give one example of direct intervention and indirect intervention in the market mechanism. In a free enterprise economy, price of a commodity is determined by the forces of demand and supply. But in certain situations the government may interfere in price fixation. There are some policies, eg. different kinds of taxes and subsidies, that change the market price indirectly via shifting the demand and supply curves. Sales taxes and excise taxes are common examples. These are called indirect interventions. There are other policies by which prices are fixed directly by the government; these are called direct interventions. Examples of direct intervention are price control on products and support price for commodities. It is thought that if necessary items like sugar, rice etc. were left to the play of free market entirely, poor people would not be able to afford them at the market-clearing price. Hence, for a long time, the government has adopted a system of price control through ration shops for such commodities. In terms of de- 5

158 Economics mand and supply curves, price control means fixing price below the equilibrium price. This may lead to rationing system or blackmarketing. In order to protect the interest of farmers the government fixes minimum price or support price for commodities. It is fixed above the equilibrium price to insulate farmers from income fluctuations resulting from price variation in the free market. 7. Examine how an increase in the price of a substitute good in consumption affect the equilibrium price? Equilibrium price is the price at which quantity demanded and supplied are exactly equal. When there is a change in demand or supply condition, the equilibrium price also will be changed. For eg. tea and coffee are substitute goods. Suppose the price of coffee rises for some reason. The demand curve for tea will shift to the right due to increase in the price of coffee. Thus, as the price of a substitute good in consumption rises, the price of a given product rises and its quantity exchanged increases. 1. Budget receipts can be classified into two. Mention those two components and expalin them. Budget receipts may be classified as revenue receipts and capital receipts. (a) Revenue receipts: Revenue receipts may be divided into tax revenue and non-tax revenue. A tax is a compulsory contribution from a person to the government to meet the expenses incurred in the common interest of all. Non-tax revenue consists of all other revenue receipts such as commercial revenue and administrative revenue. (b) Capital Receipts: Capital receipts refer to all money mobilised by the government that either creates a liability of repayment or involves a sale of an asset. The main items of capital receipts are: (i) Loans raised by the government for the public. (ii) Borrowing by the government from the RBI through sale of treasury bills. (iii) Loans raised from foreign governments. (iv) Recoveries of loans granted to State and Union territory governments. (v) Small savings and deposits in the public provident fund, etc. 2. The budget is a tool for the government to implement its various policies. Do you agree with this statement? Explain. The budget is an annual statement of the estimated receipts and expenditures of the government over the fiscal year which runs from April 1 to March 31. The government has several policies it wishes to implement in the overall task of performing its functions. Implementation of these policies requires expenditure by the government and some source of funding for that expenditure. The budget is a tool for the government to implement its various policies. The objectives pursued by the government through the budget are the following. 1) Activities to secure a reallocation of resources: The government has to reallocate resources in line with social and economic considerations in case the market fails to do so or does so inefficiently. 2) Redistributive Activities: The government redistributes income and wealth to reduce inequalities by expenditures on social security, subsidies, public works etc. 3) Stabilising Activities: The government tries to prevent business fluctuation and maintain economic stability ie, high level of employment and price stability. 4) Management of public enterprises. Government undertakes commercial activities through its public enterprises. The commercial activities are of the nature of natural monopolies, heavy manufacturing etc. A natural monopoly is a situation 6

159 HOTS (Higher Order Thinking skills) where there are economies of scale over a large range of output; then one firm can produce at a lower average cost than more than one firm could. Eg. railway, electricity etc. These usually come under state regulation because if left unregulated, there will be a tendency of the monopolist to curtail output in pursuit of profit, thereby lowering social welfare. 1. A monopoly market structure may arise in various ways. How will you justify this statement with the help of examples? In monopoly market structure there is only one seller. This is defined in the context of a given geographical location or space. For example in India before liberalisation in the power sector, the generation and distribution of electricity were in the hands of State Electricity Boards (SEBs). A monopoly market structure emerges because of any of the following reasons: (a) The government gives licence to only one company for producing a product or providing a service in a given locality or space. For instance, till 2002, VSNL had monopoly in India in providing international telephone service. (b) Big private companies engage in research and come up with new products or new technology in producing an existing product. As a reward for their risk and investment in research the government grants patent rights. In other words, monopoly arises because of granting patent certificate or what is called patent rights. (c) Sometimes, firms retain their individual identity but they co-ordinate their outputs and pricing policy so as to act as if it is a monopoly. This is called a cartel. The OPEC (Organisation of Petroleum Exporting Countries) in the 1970 s is an example of a cartel that led to virtual monopoly in the world market for oil. 2. The concept of monopolistic competition was introduced by Prof.Chamberlin. In what way you can explain this market situation? The concept of monopolistic competition was introduced by Prof. Chamberlin. Monopolistic competition is a market situation in which both the monopoly element and competitive element are present. In this market situation, many producers produce goods which are close substitutes and engage in acute competition among themselves. The following are the features of monopolistic competition: (1) Large number of buyers and sellers: The number of firms is fairly large though not very large as in perfect competition. For example, there is large number of firms in the market for products like tooth pastes, soaps, etc. The number of firms may vary from industry to industry. (2) Product differentiation: An important characteristic of monopolistic competition is product differentiation. Each firm produces a product which is differentiated from the products of rival firms. Product differentiation means differentiation of the product in terms of colour, shape, sme[ll, packing, taste, brand name etc. For example, toilet soaps like Pears, Rexona, Hamam, Lifebuoy etc. 1. Disequilibrium in the BoP results in favourable (Surplus) or unfavourable (Deficit) BoP. Examine the causes responsible for unfavourable BoP and mention the measures used to correct BoP deficit? Causes responsible for unfavourable BoPs are mainly the following. 1. More demand for consumption goods During post-war period demand for goods increased considerably. Due to demand of tea, oil seeds, and iron ore within the country the exports of these goods went down. Consequently unfavourable balance of trade increased. 2. Imports of machinery and equipments Since independence heavy import of machinery was 7

160 Economics made for the replacement of obsolete machines. We also had to import more machines to satisfy our desire for rapid industrialisation. The imports of machines made our balance of payment unfavourable. 3. Imports of war equipments The Indo-China and Indo-Pak war forced us to import war equipments to defend our country. 4. Setting up of embassies After independence we had to incur heavy expenditure in setting up embassies and high commissions abroad. It also contributed to our unfavourable balance of payments. 5. Increase in foreign competition Our major exports were jute, tea and textiles. But these days we have tough competition from Bangladesh in exports of jute. Sri Lanka and Indonesia are our rivals in the exports of tea. We have also tough competition from Korea and China in the exports of cloth. All these competitions have reduced our exports in these commodities leading to balance of payment deficit. 6. Hike in the petrol prices The price of petrol which was 2 dollar per barrel in 1973 has now increased to 36 dollar per barrel. The continuous rise in the consumption of petrol and its regular hike in price has increased balance of payment deficit. 7. Eruption of gulf war In there was a Gulf war between Iraq and several Western Countries. It increased the price of petrol, on one hand and on the other hand stopped the remittances by Indians working in Gulf area like Kuwait, Iraq etc. This worsend the situation further and increased our balance of payment deficit. 8. Disintegration of USSR. We have very large amount of foreign trade with USSR. Disintegration fatally affected our foreign trade. 9. Payment of interest on foreign trade We had borrowed substantial loan from abroad. Its repayment together with interest thereon mounted very fast. Interest on these loans approximated to Rs. 70,970 crores in It has also resulted in the balance of payment deficit. 10. Slow growth of exports Our exports has not been increasing as fast as the imports are increasing. The trade deficit is still widening. This has also resulted in the balance of payment deficit. The measures used to correct BoP deficit are: 1. Increase in production 2. Promotion of exports 3. Favourable bilateral trade agreements 4. Reduction in imports 5. Deflation 6. Encouragement to foreign investment 7. Devaluation of Indian currency 8. Foreign assistance 9. Import substitution 2. The term trade is commonly understood to mean exchange of goods wares or mechandise among people. How will you distinguish between internal trade and international trade? Trade implies an exchange of goods and services between two individuals or groups of individuals. An exchange of goods and services between two individuals living in the same locality or in two different regions of the same country is internal trade. It is trade with in the same country. International trade is an exchange of goods and services between two individuals or groups of individuals living in two different countries. It is trade between two nations. 8

161 UNIT I INTRODUCTION QUESTIONS BASED ON HOTS WITH MODEL ANSWERS VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q.1. Why is there a need for economizing of resources? Ans. Because resources are limited. Q.2. Why does economic problem arise? Ans. It arises mainly because of scarcity of resources. Q.3. Why is PPC downward sloping from left to right? Ans. Because in situation of full employment of resources, production of one good can be increased only with less of other good. Q.4. What does a rightward shift of PPC indicate? Ans. The rightward shift of PPC indicates growth of resources or technological progress. Q.5. What does a point below PPC indicate? Ans. It shows inefficient/under-utilization of resources. Q.6. What does slope of PPC show? Ans. Negative slope of PPC shows that in order to produce more units of one good, some units of the other good must be sacrificed. Q.7. When allocation of resources is considered as inefficient? Ans. Allocation of resources is considered as inefficient when economy performs below the PPC curve. SHORT ANSWER TYPE QUESTIONS: (3/4 Marks Each) Q.1. Does production take place only on the PP curve? Ans. Yes and no, both. Yes, if the given resources are fully and efficiently utilized. No, if the resources are underutilized or inefficiently utilized or both. Refer to the above figure; on a point anywhere on the PPC the resources are fully and efficiently employed. On point U, below the PPC or any other point but below the PPC, the resources are either underutilized or inefficiently utilised or both. Any point below the PP curve thus highlights the problem of unemployment and inefficiency in the economy. 1

162 Y A B PPC Cloth C. U D O Wheat X Q.-3 Massive unemployment will shift the PPC to the left. Defend or refute. Ans.- Production is drawn on the basis that the given resources are fully as well as efficiently utilized. Massive unemployment is a situation when resources are not fully utilized. Or it is a situation of under employment. It would only mean that the economy is not operating on the PPC but some-what inside the PPC. Therefore PPC will not shift to leftward. UNIT- II CONSUMER S CHOICE AND DEMAND ANALYSIS VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q.-1 All points below the budget line shows the various possible bundles which cost exactly equal to consumer s income. Is it right or wrong? Ans.- Wrong. Q.-2 If Ram is offered Ice Cream free of cost. How much Ice Cream will he consume? Ans.- Ram should consume Ice-Cream to that extent to which the marginal utility of Ice-Cream becomes equal to zero 2

163 Q.-3 What happens to the budget set if both the prices as well as the income doubled? Ans.- The budget set remains same. Q.-4 A consumer consumes only two goods X and Y. At a consumption level of these two goods, he finds that the ratio of marginal utility of price in case of X is higher than in case of Y. Explain the reaction of the consumer. Ans.- The consumer will increase the consumption of good-x and will decrease the consumption of good-y. Q.-5 Does a fall in income have the same effect on the demand for the given commodity? Ans.- No, it will depend upon the nature of the good. If good is normal then its demand will increase and if the good is inferior then its demand will decrease Q.-6 There is train and bus service between New Delhi and Jaipur. Suppose that the train fare between the two cities comes down. How will this affect demand curve for bus travel between the two cities? Ans.- As train and bus service are substitute to each-other, the demand curve for bus service between the two cities will shift leftward to the initial demand curve of bus service Q.-7 Determine how the following changes (or shifts) will affect market demand curve for a product. (a) A new steel plant comes up in Jharkhand people who were previously unemployed in the area are now employed. How will this affect the demand for colour T.V. and Black and White T.V. in the region? (b) In order to encourage tourism in Goa. The Government of India suggests Indian Airlines to reduce air fare to Goa from the four major cities of Chennai, Kolkata, Mumbai and New Delhi. If the Indian Airlines reduces the fare to Goa, How will this affect the market demand curve for air travel to Goa? (c) There are train and bus services between New Delhi and Jaipur. Suppose that the train fare between the two cities comes down. How will this affect demand curve for bus travel between the two cities? Ans: (a) There will be rightward shift in market demand curve for colour and Black and White T.V. This is because of increase of income of the people due to employment in the new steel plant. 3

164 (b) The demand for travel to Goa will expand in response to reduction in the air fare. However, this will be reflected by a movement along the demand curve. There will be no shifts in the demand curve. (c) As train fare comes down the demand for bus travel will reduce. Demand curve for the bus travel will shift to the left showing less demand at the same price. Q 8. If a good can be used for many purposes, the demand for it will be elastic. Why? Ans: If a good can be used for many purposes, the demand for it will be more elastic because with a decrease in its price it is put to several uses and with a rise in its price it is withdrawn from its many existing uses. So that, there is a considerable change in demand in response to some change in price. Q 9. If a product price increases, a family s spending on the product has to increase. Defend or refute. Ans: When product price increases, expenditure on the commodity will not increase in the situation when E d >1 (elasticity of demand is greater than unity). It will increase only in situation when E d <1. In a situation when E d =1. Expenditure will remain constant, even when prices rise. Q 10. Suppose there are 30 consumers for a good, having identical demand function: d(p) =10-3P for any price less than or equal to 10/3 and d(p)=0 for any price greater than 10/3. Write the market demand function. Ans: Market demand function is simply a horizontal summation of individual demand functions. Since demand function for all the 30 consumers is identical, we can write market demand simply as individual demand function multiplying by a factor of 30. Thus: Individual demand function : D(p)= 10-3P Market demand function: M d (p)=10 x 30 3 (30)P = P. Q.11 How would you comment on the elasticity of demand when 8% decrease in price of a commodity causes 2% increase in expenditure of the commodity? Ans: Elasticity of demand must be greater than unity (implying a situation of elastic demand) when expenditure on the commodity responds inversely to any change in price of the commodity. 4

165 Q12. A dentist was charging Rs.300 For a standard cleaning job and per month it used to generate TR is equal to Rs. 30,000. She has since last month increased the price of dental cleaning to Rs.350. As a result fewer customers are now coming for dental cleaning, but the TR is now Rs. 33,250.From this, what can we conclude about the elasticity of demand for such a dental service? Ans. PRICE TOTAL EXPENDITURE (Rs.) , ,250 When price increases, total expenditure also increases. So elasticity is less than 1. Q. 13. The elasticity of demand for X is twice the elasticity of demand for Y. Price of X falls by 5% and Price of Y rises by 5%. What will be the % change in the quantity demanded of X and Y? Ans. Suppose elasticity of demand for Y = 1, and elasticity of demand for X will be = 2 So, % decrease in qt. demanded of Y will be 5%, because price rises by 5%, and % increase in qt. demanded of X will be 10%, because price falls by 5%. Q.14 If prices of salt and cigarettes, both rises by 10%, will the qt. demanded of both goods affected in an equal manner? Ans. No, because the nature of the two goods is different. Salt, a necessary good, will have constant consumption and marginal consumers will reduce the consumption of cigarettes, which is non-essential. Q 15. Given e D = , and percentage increase in price = 20%, find change in expenditure on the commodity. 5

166 Implying that expenditure on the commodity increses by 15.2% owing to increase the commodity by 20%. Which is why e d is less than 1.. MUX MUY Q. 16 If, then the consumer should buy more of commodity Y and PX PY less of commodity X to reach the equilibrium position. Is it right or wrong? 6

167 Ans.- Wrong. Because in that situation consumer should increase consumption of good-x so that the ration of MU X to its price may become equal to the ratio of MU Y to its price. Q. 17 Law of diminishing marginal utility will operate even if consumption takes place in intervals. Defend or refute. Ans.- No, the of diminishing marginal utility will operate even if consumption takes place in intervals. Because it is based on the assumption that consumption is taking place in continuation Q. 18 What changes will take place in TU, when: (i) MU curv remain above the X-axis, (ii) MU curve touches the X-axis, (iii) MU curve lies below the X- axis. Ans.- (i) TU increases at decreasing rate. (ii) TU becomes maximum. And (iii) TU starts to decline Q. 19 A good may be an inferior good for one consumer and normal for another consumer. Defend or refute. Ans.- Yes it is right. A good may be inferior for a higher income person and the same good may be a superior good for a low income person UNIT III PRODUCER BEHAVIOUR AND SUPPLY VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q.1. What happens to MPP when TPP increases at decreasing rate? Ans. MPP falls but remains positive. Q.2. As the variable input is increased by one unit, total output falls. What would you say about of marginal productivity labour? Ans. Marginal productivity of labour is negative. Q.3. Why is MC curve in short run U-shaped? Ans. MC Curve in short run is U-shaped due to operation of the law of returns to a factor. Q.4. Why does fixed cost not influence marginal cost? Ans. Because marginal cost do not include fixed cost. Q.5. When a seller sells his entire output at a fixed price, what will be the shape of AR & MR curves? Ans. Both AR & MR are equal and coincide with each other on a horizontal line. 7

168 Q.6. Show that average revenue equals price. AR TR PXQ = = = P = Pr ice Ans. Q Q Q.7. What effect does a cost saving technical progress have on the supply curve? Ans. Supply curve will shift to the right. Q.8. What effect does an increase in excise tax have on the supply curve? Ans. Supply curve will shift to the left. Q.9. What happens to TPP when marginal productivity of variable input is negative? Ans. TPP falls. Q.10. When is TPP maximum in relation to MPP? Ans. When MPP is zero. Q.11. What happens to MPP when TPP is declining? Ans. MPP declines and remains negative. Q.12. How does fall in MPP affect TPP? Ans. TPP increases at decreasing rate. Q.13. What effect does an increase in input price have on the supply curve? Ans. The supply curve will shift towards left-hand side. Q.14. Why does average cost fall as output rises? Ans. AC falls due to operation of the law of increasing returns to a factor as output rises. Q15. Does fixed cost affect marginal cost? Give the answer with reason. Ans. No, because fixed cost is not subject to change and it is not considered while calculating MC. Q.16. What would be the effect of increase in the output on the TFC? Ans. There would not be any effect of increase in the output on the TFC, It will be constant at different levels of production. Q.17. If marginal revenue falls, will total revenue fall? Ans. It may fall when MR falls and becomes negative. If MR falls but remains positive then TR may increase with diminishing rate. Q.18. What is the price elasticity of supply of a commodity whose straight line supply curve passes through the origin forming an angle of 25º? Ans. Price elasticity of supply will be equal to one when a straight line supply curve passes through the origin; angle does not matter anything. Q. 19. Can MC be equal to TVC? Ans.- Yes MC may be equal to TVC at output level one. 8

169 Q. 20 Why does the minimum point of AC curve fall towards right of AVC curve? Ans.- Because AC is sum total of AVC and AFC. Q.21. The two inversely S-shaped short run cost curves are parallel to each other and maintain a constant distance of Rs. 50. What is indicated by Rs. 50? Also identify the two inversely S-shaped short run cost curves. Ans.- Rs. 50 is TFC. And two inversely S-shaped cost curves are TVC and TC respectively. Q. 22. The equality of MC and MR is a condition necessary for equilibrium, but it is not by itself sufficient to ensure the attainment of producer s equilibrium. Comment. Ans.- Yes. For consumers equilibrium it is also essential that after the equilibrium level of production MC should be greater than MR. Other-wise there will be an incentive to increase the output in order to maximize the profit. Q. 23. Ram produces both Jeans and Shirts. How will an increase in the price of Jeans affect the supply curve of Shirts? Ans.- An increase in the price of Jeans will decrease the supply of Shirts, because now it will be profitable to the producer to produce and sell more of Jeans instead of Shirts, as it has become expensive. Q. 24. Will a firm stop production at break-even point in short run? Why? Ans.- No, firm will not stop the production at break-even point because that firm has given best employment to its factors of production. SHORT ANSWER TYPE QUESTIONS: (3/4 Marks Each) Q.1. Why is more of a commodity supplied only at a higher price? Ans.- Because increase in production leads to decrease in returns to a factor. That in turn leads to increase in cost. That is why more of a commodity supplied only at a higher price Q. 2. Suppose the functions of demand and supply curves of a commodity are given by: q D = 100-p q S = 60 + p for p 15 = 0 for 0 p<15 9

170 (i) (ii) (iii) What does p =15 indicate? Find the equilibrium price and equilibrium quantity. Whether the given commodity comes under the category of viable industry. (iv) Calculate market demand and supply at price of Rs. 25 and Rs. 10. Show that at price of Rs. 25, there is excess supply and at price of Rs. 10, there is excess demand. Ans.- (i) (ii) (iii) (iv) P=15 indicates that the minimum average cost of the firm is Rs. 15 and firm will not supply the commodity for any price less than Rs. 15 Equilibrium Price = Rs. 20 and equilibrium quantity = 80 units Yes, the given commodity comes under the category of viable industry as there is some price, at which supply and demand happens to coincide. At price Rs. 25 market demand = 75 units and market supply = 85 units. Therefore there will be excess supply of 10 units And at price of Rs. 10 market demand = 90 units and market supply = 70 units. Therefore there will be excess demand of 20 units. Q. 3. There are three different supply curves passing through the origin. A curve makes an angel of 60 o. Curve B makes an angel of 45 o and curve C makes an angel of 30 o. What will be the price elasticity of curve A, B and C? Ans.- Price elasticity of supply of good will be equal to one if supply curve is passing through the origin point, irrespective of the angel made by it with the origin. Q. 4. Why should MC curve cut MR curve from below to achieve producer s equilibrium? Ans.- Because after equilibrium level of output, marginal cost should become greater than the marginal revenue. Other-wise there will be an incentive to increase the output in order to maximize the profit. 10

171 Q. 5. The gap between AC and AVC keeps on decreasing with rise in output, but they never meet each other. Comment. Ans.- Yes it is right statement. Because the gap between AC and AVC is equal to AFC which goes on diminish as output increases. Since TFC is fixed at all levels of output, AFC goes on diminish as output increases Q. 6. If TVC=0, TC is also zero. Is it true or falls? Give reason for your answer. Ans.- It is falls. Because in short TC = TFC + TVC. Therefore in short run TC will be some-thing positive even if TVC=0. But in long run TC = TVC. Therefore in long run TC will be zero if TVC=0. Q. 7. Why increasing MP not sustainable? Ans. Decrasing MP set in due to following reasons:- 1. Fixity of the factor: As more and more units of the variable factor continue to be combined with the fixed factor, the later gets over-utilized. 2. Imperfect Substitution among Factor: Beyond a certain limit, factors of production cannot be substitute for one another e.g. more and more of labour cannot be continuously used in place of additional capital. Q. 8. Why MC cuts AC at its minimum? Ans. because (i) When MC < AC, AC falls. (ii) When MC = AC, AC is minimum. (iii) When MC > AC, AC rises. (iv) MC falls & rises faster than AC. (v) Both are obtained from TC. AC TC Q MC TC =, = Q 11

172 Q. 9. How do changes in MR affect TR? Ans. i) If MR increases, TR increases at increasing rate. ii) If MR is constant, TR increases at constant rate. ii) IF MR falls, TR increases at diminishing rate. Q.10. What is MR? How is it related to AR? Ans. MR refers to the change in TR due to sale of an additional unit. Relation (i) If AR (Price) is constant, MR = AR (ii) If AR (Price) falls, MR < AR. (iii) If AR (Price) rises, MR > AR. Q. 11. What will be the price elasticity of supply if the supply curve is a positively sloped straight line? Ans. Es = 1 if the curve starts from the origin point. Es> 1 if the curve starts from the y-axis and E<1 if the curve starts from the x-axis. Q. 12. State the relation between marginal revenue and average revenue when a firm: (i) is able to sell more quantity of output at the same price. (ii) is able to sell more quantity of output only by lowering the price. Ans. Marginal revenue is the addition to total revenue from producing one more unit of output. 12

173 (i) MR = AR at all levels of the output. (In case of perfect completion market) (ii) MR will be less than AR at all levels of the output. (In case of monopoly and monopolistic market) LONG ANSWER TYPE QUESTIONS: (6 Marks Each) Q. 1. In the following table, identify the different phases of the law of variable proportions and explain them with the help of the table and a diagram. Variable input (units) Total product (units) Ans. Law of Variable Proportion states that if we go on using more and more units of a variable factor along with a fixed factor, the total output initially increases at an increasing rate, after that it increases at diminishing rate and finally it declines. It can be explained through the following three stages: Units of labour TPP MPP Stages of Production Stage I Stage II Stage III 13

174 Y Stage I Stage II Stage III TPP & MPP TPP X Labour MPP Y Stage 1: TPP increases at an increasing rate. MP increases and reaches at its maximum at the end of the stage. This is also called stage of increasing returns. Stage 2: TPP increase but at diminishing rate. MPP starts decline but remains positive. This stage comes to an end when TPP is maximum and MPP is zero. Stage 3: TP starts decline. MP becomes negative. This is also called stage of decreasing/negative returns. 14

175 NUMERICAL PROBLEMS WITH SOLUTIONS: PRODUCTION: Q. 1. Find out APP and MPP. Labour TPP Ans. APP MPP Q. 2. Find out the TPP and APP. Labour MPP Ans. TPP APP Q. 3. Calculate the APP and MPP. Labour TPP Ans. APP MPP Q. 4. The following table gives APP of a factor. It is also known that (TPP) total product at O level of employment is O. Determine its total product and marginal product. Labour APP Ans. TPP MPP

176 COST: Q. 1. Calculate the TVC, AFC,AVC, and MC. Output TC Ans. TFC TVC AFC AVC MC Q. 2. Calculate TC and AVC. Output AFC MC Ans. TC TFC TVC AVC Q. 3. Calculate MC and AC if fixed cost is 40. Output TVC Ans. MC TC AC Q.4 OUTPUT AC AVC MC ANS. OUTPUT AC AVC

177 MC REVENUE: Q. 1. Find AR and MR. Output TR Ans. AR MR Q. 2. Find out TR and MR. Output AR Ans. TR MR Q. 3. Complete the following table: Output Price MR TR Ans. Output Price MR TR Q. 4. Calculate TR and AR Output MR Ans. TR AR

178 ELASTICITY OF SUPPLY: Q.1. If price elasticity of supply of a commodity is 5. A producer supplies 500 units of this product at a price of Rs. 5 per unit. How much quantity of this product will be supplied, at the price of Rs. 6 per unit? Ans. e s = 5 P Q q = x x p = 1 p = 5 q = 500 e = q p x p q 5 = x = x = x = x x = 1000 (units) Q.2. Due to a 10 per cent rise in the price of a commodity, its quantity supplied rises from 400 units to 450 units. Calculate its price elasticity of supply. Is the supply elastic? Ans. P = 10% Change in quantity % Change in quantity supplied = x 100 Original quantity x 100 = = 12.5% e s = e s =

179 Q.3. e s = 1.25 (Yes, its supply is elastic.) The quantity supplied of a commodity at a price of Rs. 8 per unit is 400 units. Its price elasticity of supply is 2. Calculate the new price at which its quantity supplied will be 600 units? Ans. es = 2 p q q = p = x - 8 x 600 p = 8 q = 400 e = e 2 2 q p x p q 200 = x x = x Q.4. 2 (X - 8) = 4 2 x - 16 = 4 2 x = x = 20 x = 10 Hence the new price is Rs. 10. When the price of a commodity rises from Rs.10 to Rs.12 per unit, its quantity supplied rises by 100 units. If e s = 2, Calculate its quantity supplied at increased price. Ans. e s = 2 q = 100 p = 2 p = 10 e = q p x p q 2 = x 2 q 4q = 1000 q = 250 (original quantity) 19

180 Quantity supplied at increased price = = 350 units Q.5. If e s = 3, A seller supplies 20 units of the commodity at a price of Rs.8 per unit. How much quantity of the commodity will the seller supply when price rises by Rs.2 per unit? Ans. e s = 3 q = 20 p = 8 p = 2 e = q p x p q 3 = q 8 x q = 120 q = 15 (change in quantity) Quantity supplied at increased price = = 35 units UNIT-IV FORMS OF MARKET AND PRICE DETERMINATION VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q. 1. What is the value of MR when demand curve is elastic? Ans. MR is positive. Q. 2. In which market DD curve is indeterminate? Ans.- Oligopoly Market. Q 2. Who determines price under perfect competition? Ans: Price under perfect competition is determined by the forces of market demand and market supply in industry. Q 3. How much loss can a firm bear? Ans: A firm can bear losses upto its total fixed costs in short run. Q 4. Explain the motivation behind granting patent rights. Ans: Motivation behind granting patent rights are: (A) To encourage research and development; and (B) To encourage new discoveries and innovations. 20

181 SHORT ANSWER TYPE QUESTIONS: - (3 /4 Marks Each) Q 1. Explain how the efficiency may increase if two firms merge? Ans: When the two firms merge, their combined efficiency is expected to improve owing to: (A) Increase in the scale of output and the consequent economies of scale. (B) Better division of labour and specialization; and (C) Use of better technology, saving the cost of production. Q 2. Why is the demand curve facing a monopolistically competitive firm likely to be very elastic? Ans: It is because the products produced by the monopolistically competitive firms are close substitutes to each other. If products are close substitutes to each other the elasticity of demand is high, which is what makes the firm s demand curve(under monopolistic competition) very elastic. Q 3. Why is the demand curve facing a firm perfectly elastic under perfect competition but less than perfectly elastic under monopolistic competition? Ans. The demand curve under perfect competition is perfectly elastic. Perfectly elastic demand curve means any quantity can be sold only at a given price. Under perfect competition, the price of the product is determined by the industry by the forces of demand and supply and the firm has no option but to accept it. Uniform price prevails because all firms are selling a homogeneous product. A firm cannot influence or alter the price. Implying that a firm can sell any quantity at the given price. Therefore, the demand curve will be a straight line parallel to the X-axis as shown in Fig. ; which is perfectly elastic, showing E d =infinity The demand curve under monopolistic competition is less than perfectly elastic. It means more can be sold only at lower price. Under monopolistic competition, the seller sells a differentiated product, so he exercises partial control over price. But he can sell more only by lowering the price; certainly not at the existing price. This is what makes the demand curve less than perfectly elastic. Q 4. Which features of monopolistic competition are monopolist in nature? Ans. (i) Product differentiation (ii) Control over price (iii) Downward sloping demand curve 21

182 Q 5. How does an increase in the price of a substitute good in consumption affect the equilibrium price? Ans: With increase in the price of the substitute good, the equilibrium price of the concerned good will increase owing to shift in demand curve to the right. Q 6. Changes in both demand any supply of a commodity may or may not affect its equilibrium price. Explain. Ans: If the demand and supply of a commodity change equally, and in the same direction there will be no effect on its price. On the other hand, an unequal change in demand and supply will affect equilibrium price. When demand increases more than supply, equilibrium price will rise. On the other hand, when supply increases more than demand, equilibrium price will fall. Q 7. When will the equilibrium price of a commodity not change even if its demand and supply both increase? Explain with the help of a diagram. Ans. If both increases equally. Q 8. A severe drought results in a drastic fall in the output of wheat. Analyze how will it affect the market price of wheat? Ans: As a result of severe drought, the output of wheat is reduced. It means the supply of wheat in the market will reduce, causing a shift of supply curve to the left. Accordingly, market price of wheat will increase. 22

183 Q 9. Suppose the demand for jeans increases. At the same time, because of an increase in price of cotton, the supply of jeans decreases. How will it affect the price and quantity sold of jeans? Ans: Increase in market demand for jeans along with a decrease in the supply of jeans should raise the price of jeans and the quantity sold will decline. Q 10. China is a big manufacturer of technology of telephone instruments. It has recently become a member of W.T.O., which means it can sell its products in other member countries like India. Suppose that it does export a large number of telephone instruments to India: (A) How will it affect the price and quantity sold of telephone instruments in India? (B) Suppose that the demand for telephone instruments is relatively elastic. How will it affect India s total expenditure on telephone instruments? Ans: (A) As a result of large export of telephone instruments by Chine to India, the market supply of telephone instruments increases. It reduces the price of telephone instruments while the quantity sold will increase. (B) If the demand for telephone instruments is relatively elastic, reduction in price should increase total expenditure on telephone instruments in India. Q 11. Mrs. Ramgopal says that economists say inconsistent things: as price falls, demand rises, but as demand rises, price rises. Defend or refute. Ans: The statement of Mrs. Ramgopal that as price falls, demand rises, but as demand rises, price rises, can be defended. The first part of the statement i.e. as price falls demand rises is the general behavior of the consumer in the market. This is simply a forward movement along a demand curve. Demand changes due to change in the price of the commodity. But, there may also be situation when increase in demand leads to increase in price. When the supply of the commodity remains unchanged. And demand increases (due to factors other than price such as increase in income of the consumer or change in taste preference of the consumer.) The demand curve shifts upward and it raises the market price. Fig. illustrates the two situations: 23

184 Q 12. Answer all the questions in terms of shifts in or movements along the demand and supply curves. (A) In 2001, the Supreme Court of India banned smoking in public places. How is this likely to affect the average price of cigarettes and the quantity sold? (B) New discoveries of oil reduce the price of petrol and diesel. Consider their effects on the market for new cars. (C) New environmental regulations require the drug industry to use a more environment friendly technology whose running cost are higher but which discharges less chemicals than before. How would it affect the price of drug? Ans: (A) A ban on cigarette smoking in public places should cause a backward shift in demand curve. Consequently average price of cigarettes should fall. Fall in average price of cigarette should cause a fall in quantity sold. (B) New discoveries of oil reducing the price of petrol/diesel should imply increase in demand for cars (in terms of shift in demand curve to the right), as cars and petrol/diesel are complementary goods. (C) Due to the use of costlier (environment friendly) technology, supply curve of drug will shift to the left, causing a rise in the price of drug. Q 13. In a state of equilibrium, price greater than MC is ruled out for a perfectly competitive firm. Show diagrammatically. Ans: Fig illustrates how prices greater than MC is ruled out for a perfectly competitive firm in a state of equilibrium. Equality between price (AR) and MC is struck at point Q where all the conditions of equilibrium are satisfied. OL is the equilibrium level of output. Suppose the firm decides to produce 24

185 OL1 output where AR(=L 1 Q 1 )>MC(=L 1 T 1 ). As a consequence of shifting from Q to Q 1 ; loss of TR=Q 1 L 1 LQ, while the TC is saved to the tune of Q 1 TQ. Evidently, reduction in TC (=Q 1 TQ) is only a part of reduction in TR(=Q 1 L 1 LQ). Implying that the differential between TR and TC(= profit) would reduce in case the firm shifts from Q to Q 1 Profit is maximized only at point Q where price = MC. Q 14. In a state of equilibrium, price lesser than MC is ruled out for a perfectly competitive firm. Show diagrammatically.(question for practice) Q 15. What is firm s supply curve in the short run, operating under perfect competition? Ans: It is MC curve of the firm starting from a point where MC=AVC (minimum). In Figure, short period supply curve of the firm is MC curve starting from point Q where AR= AVC (minimum). Q.16 In which market situation, the influence of an individual seller is zero? 25

186 Ans. In the Perfectly Competitive market situation. Q.17 How is a single buyer a price taker in perfect competition? Ans. A single buyer s share in total market demand is so significant that the buyer cannot influence the market price on his own by changing his demand. Q.18 Normal profit means zero economic profit. Why? Ans. Suppose the existing firms are earning above normal profits. Attracted by the positive profits, the new firms enter the industry.the market supply increases and the price comes down. New firms continue to enter and the price continues to fall till economic profits are reduced to zero. In case of losses, firms start leaving the industry, supply falls and prices starts going up and all this continues till losses are wiped out. Remaining firms in the industry then once again earn just normal profits / zero profit. Q. 19. Why does there are few firms in oligopoly market? Ans.- There are only few firms in oligopoly market because there are some restrictions on the entry of firms in the market. Which are inter-dependence of firms, big requirements of funds, great competition among the firms. The only firms which can break these restrictions are able to enter the market. Q. 20. Does a monopolist has full control over the price? Ans. No, because price is determined by the forces of demand and supply. a monopolist controls only the supply side and demand side remain uncontrolled. 26

187 UNIT VI NATIONAL INCOME AND RELATED AGGREGATES VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q.1. When is the national income less than domestic income? Ans. When NFIA is negative. Q.2. When is the national income larger than domestic factor income? Ans. When NFIA is positive. Q.3. What is the effect of an indirect tax and a subsidy, on the price of the commodity? Ans. The effect of an indirect tax on a commodity is to increase the price and the effect of subsidy is to reduce the price in the market. Q.4. Are the wages and salaries received by Indians working in American Embassy in India a part of Domestic Product of India? Ans. No, because American embassy is not a part of domestic territory of India. Q.5. Why is the study of the problem of unemployment in India considered a macro economic study? Ans. The problem of unemployment in India is an economic issue at level of economy as a whole, hence considered as macroeconomic study. Q.6. When is gross domestic product of an economy equal to gross national product? Ans. When NFIA is zero. Q.7 Name a product whose value is included in GDP but its consumption reduce welfare? Ans. Liquor. Q.8 Why is interest paid by consumers not a factor payment? Ans. Because consumer borrow money for consumption purpose. Q.9 If compensation of employees in a firm constitutes 55 % of net value added at factor cost of the firm, find the proportion of operating surplus. Ans. 100 % - 55 % = 45 % ( assuming mixed income is Zero) SHORT ANSWER TYPE QUESTIONS: (3/4 Marks Each) Q.1. Will the following be included in gross domestic product / Domestic Income of India? Give reasons for each answer. (i) Consultation fee received by a doctor. 27

188 (ii) Purchase of new shares of a domestic firm. (iii) Services charges paid to a dealer (broker) in exchange of second hand goods. Ans. (i) Yes, It is a factor income. It is his salary. (ii) No, It is not included in GDP, because it is a merely financial transaction which does not help directly in production. (iii) It is included because it is his factor income (salary). Q.2. State whether the following is a stock or flow: (a) Wealth, (b) Cement production, (c) Saving of a household, and (d) Income of household.(e)profit Ans. Stock (a) & (b), since these are variables measurable at a point of time. Flow (c), (d)& (e), since these are variables measurable over period of time. Q.3. State whether the following is a stock or flow: (a) National capital, (b) Exports, (c) Capital formation, and (d) Expenditure on food by households. Ans. Stock (a), since national capital is a variable measurable at a point of time. Flow (b), (c) & (d), since these are variables measurable over period of time. Q.4. Are the following included in the estimation of National Income a country? Give reasons. (i) Bonus received by employees. (ii) Government expenditure on defence. (iii) Money sent by a worker working abroad to his family. (iv) Profit earned by a branch of Indian Bank in London. (V) Expenditure by government in providing free education. Ans. (i) It should be included in NI because it is a part of the compensation of employees (salary in cash). (ii) It should be included in NI because defence service is considered final service so far as it provides peaceful and secure environment to the citizens. (iii) It is included in NI because it is a part of NFIA. (iv) It is included in NI of India because it is a part of NFIA. (v) yes, it is a part of government final consumption expenditure. Q.5. Are the following included in the estimation of National Income a country? Give reasons. (i) Rent free house to an employee by an employer. (ii) Purchases by foreign tourists. (iii) Purchase of a truck to carry goods by a production unit. (iv) Payment of wealth tax by a household. 28

189 Ans. (i) It should be included in NI because it is a part of the compensation of employees (salary in kind). (ii) It is included in NI because it is a part of the final consumption expenditure on domestic product. (iii) It should be included in NI because it is an addition to the capital stock of the production unit. (iv) It should not be included in NI because it is a compulsory transfer payment and paid from past savings of the tax payers. Q.6. Is net export a part of NFIA? Explain. Ans. No, it is not.net export, the difference between export and import (X- M), is a part of expenditure on domestic product. While NFIA is the difference between income earned from abroad by the normal residents of a country and income earned by non-residents in the domestic territory of that country. It is not included in the domestic product rather it is a component of NI. Therefore both are different concepts. Q.7 Should we treat subsidy as transfer payment? Ans. No, value addition has already accrued. In fact, subsidies tend to lower the market value of the good produced.accordingly, these are added to the market price to make it equal to the factor cost. Subsidies are a part of NNP FC which is why these are deducted from factor cost to equate it with market price. LONG ANSWER TYPE QUESTIONS: (6 Marks Each) Q. 1. Will the following be included in gross domestic product / Domestic Factor Income of India? Give reasons for each answer. (i) interest free loan to bank employees from bank (ii) Factor income from abroad. (iii) Compensation of employees given to residents of china working in Indian embassy in China. (iv) Profit earned by a company in India, which is owned by a nonresident. Ans. (i) no, it is to be repayed. (ii) No, because factor income is earned not within the domestic territory of a country but from abroad. (iii) Yes, because Indian embassy in China is a part of domestic territory of India. (iv) Yes, because the company within India s domestic territory earns profit. 29

190 Q.2. Why are exports included in the estimation of domestic product by the expenditure method? Can gross domestic product be greater than gross national product? Explain.(4+2) Ans. Expenditure method estimates expenditure on domestic product, i.e. expenditure on final goods and services produced within the economic territory of the country. It includes expenditure by residents and non- residents both. Exports, though purchased by non- residents, are produced within the economic territory, and therefore, a part of domestic product. Domestic product can be greater than national product if factor income paid to the rest of the world is greater than the factor income received from the rest of the world is i.e. when net-factor income received from abroad is negative. Q.3. Are the following included in the estimation of National Income of India? Give reasons for each answer. (i) profits earned by Dabur India in U.K. (ii) Money received from sale of shares. (iii) Salary paid to Americans working in Indian embassy in America. (iv) payment of electricity bill by a factory (v) direct purchases of government in a foreign country. (vi) Remittances from aboard. Ans. (i) Yes, it is a part of factor income earned from abroad. (ii) No, it is only a transfer of paper claims. (iii) No, this factor income belongs to non-residents. (iv) No. it is intermediate consumption. (v) Yes, it is government final consumption expenditure. (vi) No, it is only a transfer payment. No commodity is sent or services rendered return for this. Q.4. Will the following be included National Income? Give reasons for each answer. (i) Services of owner occupied houses. (ii) Purchase of new shares of a domestic firm. (iii) Purchase of second-hand machine from a domestic firm. (iv) Consultancy fee paid to a foreign expert. (v) Commission paid to agent for the sale and purchase of shares. (vi) Dividend received on shares. Ans. (i) Yes, Imputed rent of owner occupied houses will be included in NI. (ii) No, because it is a financial transaction which does not help directly in production. (iii) No, because it is not related with current flow of goods and services. (iv) No, as it is a factor income paid abroad (it is earned by non-residents). (v) Yes, It is included in NI since it is paid for rendering productive services. 30

191 (vi) Yes, dividends are a part of corporate profit and therefore, include in NI. Q.5. Will the following be included National Income? Give reasons for each answer. (i) Free Medical facility to employees by the employer. (ii) Money received from sale of old house. (iii) Government expenditure on street lighting. (iv) Interest received by a household from a commercial bank. (v) Receipts from sale of land. (vi) Interest on public debt. Ans. (i) Yes, as it is a supplementary income paid in kind and hence a part of compensation of employees. (ii) No, as it has already been taken into account when the house was constructed. (iii) Yes, It is a part of Government final consumption expenditure and it adds to flow of services. (iv) Yes, as it is payment for use of capital. (v) No, as it does not add to flow of goods & services. (vi) It should not be included in NI because public debt is a loan taken on to meet consumption expenditure by the government. Q.6. Are the following included in the estimation of National Income a country? Give reasons. (i) Services rendered by family members to each other. (ii) Wheat grown by a farmer but used entirely for family s consumption. (iii) Expenditure government on providing free education. (iv) Payment of fees to a lawyer engaged by a firm. (v) Man of the match award to a player of the Indian cricket team. (vi) Payment of the match fee to players of Indian cricket team. Ans. (i) Services rendered by family members to each other should not be included in NI because these are not rendered for the purpose of earning income. (ii) Imputed value of self-consumed wheat grown by a farmer must be included in NI, because it adds in the flow of goods. (iii) It should be included in NI because the government expenditure on the free services is considered as a part of government final consumption expenditure. (iv) Yes, as it is factor income against the service of lawyer. (v) It should not be included in NI because it is a windfall gain and it does not add in the flow of goods and services. (vi) It should be included in NI of India because they render productive services as professionals. 31

192 Q.7. Are the following included in the estimation of National Income a country? Give reasons. (i) Unemployment allowance under NREGA. (ii) Indirect tax (Sale tax/excise duty). (iii) Salary received by the workers under NREGA. (iv) Income tax. (v) Corporation tax. (vi) Travelling expenses paid to salesman by the employer. Ans. (i) It is transfer payment received by those persons who are not employed; therefore it should not be included in NI. (ii) It is not included in NI because it does not add in the flow of goods and services. (iii) It is included in NI because it is a factor income. (iv) It is a part of compensation of an employee (income). While calculating NI by income method, compensation of employees is to be included while doing so, income tax to be paid by them should not be included separately. (v) It is a part of profit of corporate sector. While calculating NI by income method, profit is to be included while doing so, Corporation tax should not be included separately. (vi) Travel expenses incurred by employees for business purpose which are reimbursed by the employers are excluded because these are a part of intermediate consumption of the employers NUMERICAL PROBLEMS WITH SOLUTIONS: Q.1. Calculate private income, personal income, personal disposable income and National disposable income from the following data: (Rs. in Crores) (i) National income 3000 (ii) Savings of private corporate sector 30 (iii) Corporate tax 80 (iv) Current transfer from government 60 (v) Income from property and entrepreneurship to government 150 (vi) Current transfers from rest of the world 50 (vii) Savings of non-departmental government sector 40 (Viii) Net indirect taxes 250 (ix) Direct taxes paid by household 100 (x) Net factor income from abroad (-) 10 32

193 Solution: - Private income = (i) - (iv + vii) + (iv + vi) = ( ) + ( ) = 2920 Crores. Personal income = (ii) - (iii) = = Rs 2810 Crores. Personal Disposable Income = (ix) = = Rs 2710 Crores. National Disposable Income = (i) + (vi) + (viii) = =Rs 3300 Crores. Q2. Calculate NI by income and expenditure method: (Rs. in Crores) (i) Subsidies 5 (ii) Private final consumption expenditure 100 (iii) NFIA (-) 10 (iv) Indirect Tax 25 (v) Rent 5 (vi) Government final consumption expenditure 20 (vii) Net domestic fixed capital formation 30 (viii) Operating surplus 20 (ix) Wages 50 (x) Net export (-) 5 (xi) Addition to stock (-) 5 (xii) Social security contribution by employers 10 (xiii) Mixed income 40 Solution: - Income method NI= (ix) + (xii) + (viii) + (xiii) (iii) = =Rs 110 Crores. Expenditure method NI = (ii) + (vi) + (vii) + (xi) + (x) - (iv) + (i) + (iii) = (-) 5 + (-)

194 =Rs 110 Crores. Q.3. Calculate the value added by Firm A and Firm B from the following data: - (Rs. in Lakhs) (i) Purchase by Firm A from the rest of the world 40 (ii) Sales by Firm B 100 (iii) Purchases by Firm A from Firm B 60 (iv) Sales by Firm A 120 (v) Exports by Firm A 40 (vi) Opening stock of Firm A 45 (vii) Closing stock of Firm A 30 (viii) Opening stock of Firm B 40 (ix) Closing stock of Firm B 30 (x) Purchases by Firm B from Firm A 60 Solution: - Value Added by Firm A = (iv) + [(vii) (vi)] (i) (iii) = [30 45] = Rs 5 Lakhs. Value Added by Firm B = (ii) + [(ix) (viii)] - (x) = [30 40] - 60 = Rs 30 Lakhs. Q.4. Estimate (i) Personal Income, (ii) Private Income and (iii) Personal Disposable Income with the help of the following data. (Rs. in Crores) (i) National income 1300 (ii) Corporate tax 15 (iii) Direct personal taxes 40 (iv) Savings of private corporate sector 25 (v) Income from property and entrepreneurship accruing to Government Administrative Departments 35 (vi) Current transfer from government administrative departments 30 (vii) National Debt Interest 10 (viii) Savings of non departmental government enterprises 5 (ix) Current transfers from rest of the world 15 Solution: - Private Income = (i) - (v) (viii) + (vii) + (vi) + (ix) = = Rs crores. 34

195 Personal Income = Private Income (ii) (iv) = = Rs 1275 crores. Personal Disposable Income = Personal Income (iii) = = Rs 1235 Crores. Q.5. Estimate (i) Personal Disposable Income, (ii) Private Income and (iii) National Income from the following data: (Rs. in Crores) (i) Personal income 1225 (ii) Saving of private corporate sector 12 (iii) Corporate tax 23 (iv) Current transfer from government administrative departments 30 (v) Current transfer from rest of the world 25 (vi) Income from property and entrepreneurship accruing to Government Administrative Departments 25 (vii) Savings of non departmental government enterprises 20 (viii) Net indirect tax 195 (ix) Direct tax paid by the households 25 Solution: - Personal Disposable Income = Personal income - Direct tax = = 1200 Crores Private Income = Personal income + Saving of private corporate sector + Corporate tax = = 1260 Crores National Income = Private Income (iv) (v) + (vi) + (vii) = = 1260 Crores 35

196 Q.6. Estimate the following with the help of given data: (i) GDP MP, (ii) Net Value Added at factor cost; and (iii) prove that it is equal to the income generated. (Rs. in Crores) (i) Increase in the stock of unsold goods 1000 (ii) Sales 10,000 (iii) Net indirect tax 800 (iv) Purchase of raw materials from other firms 1650 (v) Purchase of fuel and power 850 (vi) Consumption of fixed capital 500 (vii) Rent 700 (viii) Wages and salaries 3500 (ix) Interest payment 1000 (x) Dividend 1500 (xi) Corporate gain tax 300 (xii) Undistributed profit 200 Solution: - GDP MP = Sales + Increase in the stock - Purchase of raw materials - Purchase of fuel and power. = 10, = 11, = 8500 Crores. Net Value Added at factor cost = Sales + Increase in the stock - Purchase of raw materials Purchase of fuel and power - Consumption of fixed capital - Net indirect tax. = 10, = 11, = 7200 Crores. Income generated = Rent + Wages and salaries + Interest + Dividend + Corporate gain tax + Undistributed profit. = = 7200 Crores. Hence it is proved that Net Value Added at factor cost = Income Generated 36

197 UNIT VII DETERMINATION OF INCOME AND EMPLOYMENT VERY SHORT ANSWER TYPE QUESTIONS: - (1 Mark Each) Q. 1 Can consumption exceed income? If yes, what is the saving then? Ans. Yes, when income is zero or less than subsistence level of consumption. Saving is ve. Q.2 How much new income will be generated in an economy with an increase in investment by Rs. 200 and when two-third of rise in income spent on consumption. Ans. 600 Rs. Q.3 Why can the value of MPC be not greater than 1? Ans. It is because change in consumption can never be greater than change in income. Q.4 Does an excess of AD over AS always imply a situation of inflationary gap? Ans. No. Inflationary gap occurs only when AD>AS corresponding to full employment level of employment. Q.5 What happens in an economy, when credit availability is restricted and credit is made costlier? Ans. Aggregate demands falls SHORT ANSWER TYPE QUESTIONS: - (3 /4 Marks Each) Q.1 What happens if AD>AS prior to full employment level of employment? Ans. It is a state of disequilibrium in economics. When AD>AS, producers have to cater to demand out of their existing stock of goods, implying that the desired level 37

198 of stocks will decrease. It implies greater production & therefore there is increase in AS.This process continues till equilibrium is struck between AD and AS. Q.2 In poor countries like India, people spend a high percentage of their income so that APC and MPC are high. Yet, value of multiplier is low. Why? Ans. Working of the multiplier process is based on one fundamental assumption: that there exists, excess capacity in the economy, so that whenever consumption expenditure rises (implying increase in demand ) there is a corresponding increase in production (implying increase in income ). But poor countries like India, lack in production capacity. Accordingly, whenever demand increases (in terms of increase in consumption expenditure), there is increasing pressure of demand on the existing output (implying inflation or rise in prices) rather than the increase in output or income. Q.3 Show a point on the consumption curve at which APC= 1. Ans. APC = C/Y =1 is possible if C=Y, i.e. Consumption is equal to Income. Q.4 In what respect foreign trade will be useful in removing the adverse economic effects of deficient demand? Ans. Export increases the demand for goods and services produced in the domestic territory and is helpful to reduce deficient demand. 38