Answer Key Economics Class 2 (Pre Board) Part A (Micro Economics). Which of the following is not an assumption of the theory of demand based on analysis of indifference curve? c) Constant marginal utility of money 2. When a firm is able to sell only by lowering the price TR will b) increase at decreasing rate. If regardless of changes in its price, the quantity demanded of a piece of goods remain unchanged, then the demand curve for goods will be b) vertical. Scarcity and Choices go to altogether. Explain. Scarcity is the root cause of all economic problems. Explain. Scarcity means when demand for resources is more than its supply like land. It could be used for agriculture, warehouses and factory but supply is limited so society chooses that suits best to the need. If things were available in plenty there would have been no choice problem.mk 5. Economic slowdown in some parts of the world has adversely affected demand for Indian exports. What will be its effect on the production possibility frontier of India? Explain. Demand for Indian exports will fall that means economy has potential to produce but due to less demand less is produced this will show underutilization of resources. A point will shift under PPC point a..2mk for explanation and mk for diagram. Good X a Good Y. Why does marginal cost eventually rise as output increases? MC curve is U shaped due to law of variable proportion. In first phase when TP increases at increasing rate marginal cost of producing an additional output will decrease. When TP is max cost would be minimum. But after when TP falls due to overutilisation of resources and poor coordination of factors cost of producing additional output increases mk 7. Suppose the market determined rent for apartments is too high for common people to afford. If the government comes forward to help those seeking apartments on rent by imposing ceiling on rent, what impact will it have on the market for apartments? Price ceiling is the maximum price that sellers can legally charge for a product or service. Since this price is below the eq price, there would be excess demand for the product. It may lead to black marketing.2mk and mk for diag. 8. What is meant by prices being rigid? What are its implications? Price rigidity means when there is change in demand and supply prices remain the same. In oligopoly firms are able to change the prices however they stick to their prices in order to avoid price war. If a firm tries to reduce the price rival will also react so no benefit. If firm tries to increase the price rival firm will not do so. So oligopoly firm leads to price rigidity..mk Giving reasons, state whether the following statements are True or false. Give reasons: a) A monopolist can sell any quantity he likes at a price. Page of 8
False: since monopolist is a price maker still he cannot charge the price he likes as if he will increase the price qty demanded will fall. So in order to sell more he has to reduce the price. b) When equilibrium price of a good is less than its market price, there will be competition among the sellers. False: when eq price of a good is less than market price it will cause competition among buyres..5mk each 9. Under what conditions a consumer would like to purchase more at less price?. substitution effect 2. income effect. Law of DMU.no of uses of commodity. mk each with explanation 0. Elasticity of Good X is half the elasticity of Good Y. A 0% fall in price of Good X leads to increase in its demand from 50 units to 70 units. If price of Good Y increase from Rs 0 to Rs 8, what would be the demand at Rs 8 if initial demand is 00 units. Ed (X) = /2 ed (Y).0.5mk Ed (X) = % change in demand/ % change in price = 20/50*00/0 =.0.5mk = /2 ed (Y) = 8 = ed (Y).mk Ed(Y) = p/q * change in Q/ change in P 8 = 0/00*change in demand/2 Change in demand is 0 hence initial demand will be 0 2mk Explain the concept of Marginal rate of substitution. Explain the reaction of the consumer when marginal rate of substitution is higher than ratio of prices. Marginal rate of substitution is define as rate at which one good is sacrificed to consume another good keeping utility unchanged..mk MRSxy>Px/PY which means consumer prefer more of good X than its market price so a consumer will continue purchasing more of good X and less of good Y till a consumer comes back to eq till MRSxy = Px/Py.mk. Starting from an initial situation of consumer s equilibrium state, how does increase in marginal utility of one rupee affect the quantity demanded of a product? Consumer s Equilibrium in case of Single Commodity: The Law of DMU can be used to explain consumer s equilibrium in case of a single commodity. Therefore, all the assumptions of Law of DMU are taken as assumptions of consumer s equilibrium in case of single commodity..mk A consumer purchasing a single commodity will be at equilibrium, when he is buying such a quantity of that commodity, which gives him maximum satisfaction. The number of units to be consumed of the given commodity by a consumer depends on 2 factors:.mk. Price of the given commodity; 2. Expected utility (Marginal utility) from each successive unit. Marginal Utility in terms of Money = Marginal Utility in utils/ Marginal Utility of one rupee (MU M ) Equilibrium Condition:..2mk Consumer in consumption of single commodity (say, x) will be at equilibrium when: Page 2 of 8
Marginal Utility (MU x ) is equal to Price (P x ) paid for the commodity; i.e. MU = Price Let us now determine the consumer s equilibrium if the consumer spends his entire income on single commodity. Suppose, the consumer wants to buy a good (say, x), which is priced at Rs. 0 per unit. Further suppose that marginal utility derived from each successive unit (in utils and in is determined and is given in Table 2. (For sake of simplicity, it is assumed that util = Rs., i.e. MU M = Rs. ). Table 2.: Consumer s Equilibrium in case of Single Commodity Units Price Margina Marginal Difference Remarks 2mk of (P x ) l utility utility in MU X and X (Rs.) (utils) Rs. (MU X ) util =Rs. P x 0 20 20/ = 20 20-0= 0 MU X >P x> so 2 0 / = -0= consumer will increase the consumption 0 0 0/ = 0 0-0= 0 Consumer s Equilibrium (MU X =P X ) 0 / = -0= - MU X <P x, so 5 0 0 0/ = 0 0-0=-0 consumer will decrease the consumption 0 - - / = - --0=- 2. a) What are the conditions of profit maximization under Imperfect competition? Explain in brief. MR = MC 2. slope of MC > slope of MR after this mk for condition mk for diagram mk for explanation in brief b) Why MP cuts AP from above? MP rises at a faster rate therefore reaches its max point earlier than AP therefore cuts AP from above...2mk and mk for diagram. Equilibrium price of an essential medicine is too high. Explain what possible steps can be taken to bring down the equilibrium price but only through market forces. Also explain the series of changes that will take place in the market. Govt can lower the excise duty of medicine. Can offer subsidy to producer 2mk In both the situations market supply will increase. Page of 8
Price P E E 2mk P S S D Qty D and S If supply will shift rightwards then excess supply will be created which will decrease price triggering extension of demand and contraction of supply. Hence eq price lowered..2mk The following headline appeared in Hindustan Times on 2 nd August 20. Crop Damaged in Himachal sent tomato prices roaring in Delhi. Use a diagram and economic theory to analyse the statement. When tomato crop damaged. Supply curve will shift leftward. This will create a situation of excess demand. In this situation buyers would compete to raise the market price. As market price would rise demand will contract and supply would expand till reaches a new eq..mk and 2mk for diagram D S S Price P E P E D O Q Q Qty D and S. a) Prove that any straight line supply curve passing through the origin has unitary value of elasticity of supply. Straight line supply curve passing through origin has es =. Consider ABC and AOF they are similar Price A therefore ration of sides is equal AF/OF = AC/BC or P/Q = P/ Q hence es = B C O F Qty Supplied(2mk and mk for explanation) b) What is change in supply? How government policy affects the change in supply? Change in supply means change due to factors other than price. Increase or decrease in supply at a given price...mk Govt policy is of two types: Taxation policy due to which it increases the cost of production hence reduces the supply at given price.mk Subsidy policy that will decrease the cost of production hence increase in supply..mk Part B (Macro Economics) 5. Which of the following is not a stock concept? d) Inventories. Which of the following system is followed by RBI for issuing currency? c) Minimum reserve system 7. Commercial banks accept deposits from the public in the form of: b) Demand deposits 8. The government budget has a revenue deficit. This gets financed by: Page of 8
i) Borrowings ii) Disinvestment iii) Tax revenue iv) Indirect taxes c) (i) and (ii) 9. Which of the following is not true for fiscal deficit? b) is the difference between total expenditure and total receipts 20. Explain with the help of numerical example how increase in investment in an economy affects level of income. Suppose the government invest 00 cr in the economy. Now the money invested would be distributed among the contractors, labourers, supplier of raw materials etc. as money was invested in construction work Suppose MPC in the economy is 0.5 The following action will Take place investment increase in Y consumption saving 00 00 50 50 50 25 25 25 2.5 2.5 - - - - Now this process will go on until the whole of money comes in circulation. K = /-MPC K = 2 Therefore change in total income would be twice the investment = 200 cr also K = change in income/ change in investment 2. What happens to the national income if aggregate demand falls short of aggregate supply? Use diagrams. If AD < AS Atsuch like s level of output AD (C + I) curve is below AS curve. Which means that planned expenditure is less than planned output thus consumer and firms together would be buying less goods than produced this is the case of excess of inventories.that is unplanned desire increase in inventories. Producer suffer burden of unwanted supplies due to excess of stock and therefore would respond to this by decreasing output and employment for the next production period. this process would be shown by leftward arrow till economy is back at equilibrium mk What happens to national income in the economy if planned savings are no equal to planned investment? If S > I If planned savings exceed planned investment this means people are saving more than what the firms are wanting to invest. People saving more means spending less hence AD is less than AS.. If S < I If planned savings are less than planned investment this means people are saving less than what the firms are wanting to invest. People saving less means spending more hence AD is more than AS...5 mk each 22. What is the role of Central Bank in the following exchange rate? a) Fixed Exchange rate Central bank actively uses its foreign currency reserves to maintain the officially determined exchange rate. Page 5 of 8
b) Flexible Exchange rate Central Bank does not maintain any reserve of foreign currency as market automatically adjust to determine market driven exchange rate. c) Managed Floating enters the foreign market to buy and sell foreign currency in order to control fluctuations in the market. mk each 2. Distinguish between Balance of payment account and Balance on current account. Remittances from the family abroad would be included in which account and why? BOP Current account of BOP It is a financial statement of all the economic It is one of the account of BOP containing transactions taken place between domestic visible, invisibles and unilateral transfers countries and other countries It is a broader concept as it includes current It is narrow concept as it is included in BoP account It includes export and import of goods,services, transfer payments and investments abroad mk each Remittances would be included in current account as unilateral transfers.mk It includes only export and import of goods and services. 2. Only one product X is produced in the country. Its output during the year 202 and 20 was 00 units and 0 units respectively. The market price during the year was Rs 50 and Rs 55 respectively. Calculate the percentage change in real and nominal GDP in the year 20 using 202 as base year. Year Output Price Real GDP(p0q) Nominal GDP(pq) 202 00 50 5000 5000 20 0 55 5500 050 Percentage change in real GDP = 500/5000*00 = 0% Percentage change in nominal GDP = 050/5000*00= 2% 2mk for calculating real and nominal GDP and 2 mk for calculating percentage 25. State whether the following statements are True or False. Give reasons. a) Machine purchased is always a capital good. False It depends upon the use if machine is purchased for final consumption it will be a consumer good but if purchases by a factory for further production it will be capital good. b) Capital formation is a flow. True Capital formation means change in the asset and change is always a flow. 2mk each Outline the steps taken to calculate National income using expenditure method. Step : calculate different types of expenditure: Private final consumption expenditure Govt final consumption expenditure Gross domestic capita; formation Net exports Add all the expenditure PFCE + GFCE + GDCF + NX = GDPmp.2mk Step 2: Subtract Net indirect taxes and depreciation GDPmp- NIT Dep = NDPfc..mk Page of 8
Step : Add NFIA to get NNPfc mk 2. What do you mean by Fiscal policy? What possible measures can be taken under Fiscal policy to correct excess and deficient demand? Use diagrams. Fiscal policy is the policy of the government expenditure and revenue.. Government taxes: in case of excess demand government should increase the taxes so that people are left with less disposable income and hence would spend less. Vice a versa for deficient demand 2. Government investment: in case of deficient demand government should invest in various projects to generate employment and to increase the income in the economy. In case of excess demand investment should be reduced.. Deficit financing: it means printing of currency. In case of excess demand there should be less printing of currency and vice a versa. 2 mk each point 27. From the following data calculate (a) Gross Domestic product at market price and (b) Indirect taxes. Items In crores Compensation of employees paid by govt. 00 Profits 200 Compensation paid in cash 500 GNPmp 00 Rent 50 Interest 00 Gross domestic capital formation 00 Net fixed capital formation 200 Change in stock 50 Compensation in kind 00 Net factor income from abroad 20 Subsidies 0 Solution: NDPfc = 500 + 00 (COE ) + OS ( 200 + 50 + 00 ) = 250.2mk GNPmp dep NFIA NIT = NDPfc 00 (gross - Net fixed + change in stock ) 20 NIT = 250 00 (50) 20 NIT = 250 0 NIT = 250 80 = NIT mk IT sub = NIT IT 0 = 80 IT = 90 mk From the following data calculate (a) Domestic income and (b) Net national Disposable income: Items In crores Household income 900 Current transfers to abroad -0 National Debt interest 0 Misc. receipts received by the government 0 Page 7 of 8
Wealth tax 5 Current transfers by government 0 Direct taxes paid by firms 20 NFIA -0 Retained earnings 0 Share of government in national income 50 NIT 0 PDI = 900 PDI + direct taxes + misc fee and fines = Personal income.mk 900 + 0 + 5 95 + retained earnings + Corp tax = private income 95 + 0 +20 = 975.mk 975 current transfers from abroad current transfers form govt National debt interest 975 0 0 0 925 = income accruing to private sector + income accruing to govt sector..mk 925 + 50 = 075 = NNPfc NFIA = NDPfc..mk = 075 (-0) = 085 = domestic income.mk NNDI = NNPmp + current transfers from abroad = NNPfc + NIT + ct from abroad 075 + 0 + 0 5 mk 28. What are the quantitative measures of credit control used by RBI? Explain.. CRR: percentage of bank s deposit to be kept with central bank. In case of excess demand it is increased and vice a versa 2. SLR: bank s total deposit to be kept with the bank itself. It is also increased during excess demand.. OMO: buying and selling of government securities: in case of excess demand central bank sells it to commercial banks to take the money from them and decrease their lending capacity.. bank rate or repo rate: rate at which central bank give loan to commercial banks. In case of excess demand it is increased. 5. reverse repo rate: interest rate given on commercial bank s deposit with central bank. It is increased during excess demand. mk each and mk for differentiating between bank and repo rate. 29. In the government of India s budget for the year 20 20, the Finance Minister proposed to raise the excise duty on cigarettes. He also proposed to increase income tax on individual earning more than one crore per annum. Identify and explain the types of taxes proposed by Finance Minister. Was the objective only to earn revenue? What possible welfare objectives could the government be considering? Excise duty Indirect tax.mk Income tax Direct.mk Besides raising revenue by charging high tax on cigarettes it will discourage smoking and positive impact on the health of public.2mk Raising income tax means reducing the gap between rich and poor..mk Extra revenue could be used for improving the welfare of the people.mk Page 8 of 8