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Vidyamandir Classes Macro-Economics

(a) National Income


Important Terms :
(i) Private Income : It is the total of factor incomes and transfer incomes received from all sources by private sector
within and outside the country.

P.I. = IAPS + Net current transfers from rest of world + Net current transfer from govt. + Interest on public dept + NFIA.

(ii) Personal Income : It is the sum of earned income and transfer income received by households from all sources
within and outside the country. It shows the purchasing power of the households.

P.I = P.I Corporate Tax Undistributed Profit of Private sector

(iii) Personal Disposable Income : It is that part of personal income which is avaibale to the households for disposal.
P.D.I. = Personal Income Direct Taxes Misc Exp. of govt. administrative department.

(iv) National Disposable Income : It is the sum of earned and unearned incomes received by the residents of a
country.

NDI = National Product + Net Current Transfers from rest of the world

or

= C + S.

(v)

(vi)

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Closed Economy : It is the one which does not have economic relations with rest of the world. There are no experts/
imports of goods and services.

Open Economy : An open economy is the one which has economic relations with rest of the world. It exports goods and
services to rest of the world

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Real National Income and Nominal National Income : National Income at current prices also known as Nominal
income. When the goods and services produced in an year are valued at market prices prevailing in the year of their
production.
National Income at constant prices also known as Real National Income. When goods and services produced in
a year are valued at fixed prices i.e. value of base year.

GNP Deflater : It is used to measure the average level of prices of all goods and services that makes up GNP deflater.
P1 Nominal GNP
GNP deflater 100 100
P0 Real GNP

Factors affecting nominal national income :


(i) Changes in Price (ii) Changes in Quantity / Physical Output

Real National Income :


Changes in quantity is effected by only factor as price remains constant.

Advantages of Real National Income :


(i) It truely reflects the real change in physical output.
(ii) RNI helps to make a year to year comparison of changes in volume of output of goods and services.
(iii) It is helpful in making international comparison of economic performance of different countries.

Green GNP : It is defined as GNP which should help to attain a sustainable use of natural environment and equitable
distribution of benefits of development.
Question :
1. GDP is considered as an index of welfare of the people.
Do you agree with the statement. Explain :
Ans : No, welfare includes economic and non-economic welfare but GDP only takes economic welfare :

(a) Distribution of GDP : An increase in GDP may not lead to increase in total welfare. If its distribution results in
concentration of income in hands of very few industrialists.

(b) Non-Monitary Transactions : The non-market/monitary transactions like services of housewife, leisure time activities
etc. Is not taken in calculating GDP.

(c) Externalities : Negative externalities occur such as smoke of factory pollutes the air, industrial waste occurs air
pollution etc. should not be included in GDP.

(d) Rate of Population Growth : It is the rate of population growth which is higher then the rate of growth of real GDP.

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1. Meaning of National Income


National income is the sum of factor incomes earned by normal residents or a country in the form of rent, interest and profit
in an accounting year.

2. National Income at Current Prices and Constant Prices : (Nominal NI and Real NI)
National income can be measured in terms of money in two waysat current prices and at constant prices.
(a) National inocme at current prices : If goods and services produced in a year are valued at current prices,
i.e. prices prevailing in that particular year, we get national income at current prices. Current price refer to the prices
prevailing in the year in which goods and services are produced. For example, when goods and services produced
during the year 2009-2010 are valued in prices of the same year, i.e., 2009-2010, it will be called national income at current
prices for the year 2009-2010.

(b) National Income at Constant Prices : If goods and services produced in a year are valued at fixed prices,
i.e., prices of the base year, we get national income at constant prices. Constant prices refer to the prices prevailing in
the base year. A base year is a carefully chosen year which is a normal year free from price fluctuations. (In India now
2004-2005 is treated as base year.) For instance, if goods and services produced during the year 2008-2009 are valued
at the prices of the base year (i.e., 2004-2005), it will be called national income at constant prices for the year 2008-2009.

(c) Significance of Difference betweeen Current prices and Constant Prices :


(i) National income at current prices is affected by two factors, namely, (a) change in prices and (b) change in physical
output (amount of goods and services produced). For example, in 1979-80, Indias national income at current prices
increased by 9.1% but at constant prices decreased by 5.2%.

Advance of Real National Income/GNP


(ii) National income measured at constant prices truly reflects the real change in physical output of a country whereas
national income at current prices does not. It is useful in finding out the real development capacity of the economy.
(iii) Real national income (or for that matter GNP) enables us to make a year to year comparison of changes in the
volume of output of goods and services.
(iv) Real national income is also helpful in making international comparisons of economic performance of different
countries.

3. Basic ActivitiesProduction, Consumption, Capital Formation


(a) Production : Production is generally defined as an activity which produces material goods and services or which
increases the value of commodities already produced. For instance, doctors, teachers, accountants, managers, judges,
electricians etc.
(b) Consumption : The process of using up of goods and services for direct satisfaction of individual or human wants
is called consumption. Exception since a house continues to produce housing services almost throughout life of its
owner.

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(c) Capital Formation (Investment) : Capital formation is the net addition to the capital stock of an economy during a given
period. Increase in production leads to increase in consumption or capital formation or both. If whole of production is
consumed, there will be no capital formation and production, capacity will start decreasing.

4. Final Goods and Intermediate Goods


(i) Final goods : All goods which are meant either (a) for consumption by consumers or (b) for investment by firms are
called final goods. They are meant for final use and the final use of a product is only for consumption for investment.
(ii) Intermediate goods : All goods which are used (a) as row material for further production of other goods or (b) for resale
in the same year are known as intermediate goods.

5. Consumption goods and Capital Goods :


(i) Goods which are consumed by the ultimate consumers or which meet the immediate needs of consumers directly are
called consumption (or consumer) goods. For example, food, shirt, shoes, cigarettes, pen, TV set, radio etc. are all
consumer goods because when used, they satisfy immediate needs of the consumers.
Durable goods and those which can be used in consumption again and again over a considerable period of time,
e.g., chair, car, fridge, shoes, TV set. Non-durable goods are like single use goods which are used up by consumers in
a single act of consumption, e.g., milk, fruits, matches, cigarettes, coal, etc.

(ii) Capital goods : Goods which are bought for producing other goods but not for meeting immediate needs of the
consumer are called capital goods. In fact, all goods that are produced for use in future for productive processes are
called capital goods. E.g., tools, implements, machinery, plants, tractors, buildings, transformers, etc. Such goods are
used for generating income by production units.

6. Domestic (Economic) Territory of a Country : Economic territory is the geographical territory administered by a
government within which persons, goods and capital circulate freely.
What domestic (economic) territory includes :
(i) Territory lying within the political frontiers of a country. It includes territorial waters also.
(ii) Ships and aircrafts owned and operated by the residents between two or more countries. For instance, Indian ships
moving between UK and Pakistan regularly or passangers planes operated by Air India between Russia and Japan are
parts of domestic territory of India.
(iii) Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents of a country in the internal
waters or engaged in extraction in areas where the country has exclusive rights of operation. For example, fishing boats
operated by Indian fishermen in the internal waters of the Indian Ocean will be considered as a part of domestic territory
of India.
(iv) Embassies, consulates and military establishments of the country located abroad. To illustrate, Indian embassies in
Russia, America and other countries will form parts of domestic territory of India. Similarly, embassies of other countries
like Japan, Russia, America in India are parts of domestic territories of their own countries and not of India.
What domestic territory does not include :
(i) Territorial enclaves (like embassies) used/administered by foreign governments.
(ii) International organisations which are physically located within goegraphical boundaries of a country. Their offices
form part of international territory.

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7. Resident (Normal Resident) of a Country : National income has also been defined as Sum total of factor incomes earned by
the normal residents of a country during a year.
A resident is said to be a person (or institution) who ordinarily resides in a country and whose centre of economic interest
lies in that country. He is called a normal resident since he normally lives in the country of his economic interest. The period
of stay should be at least one year or more. Following points need to be noted.
(i) Normal residents cover both individuals and institutions.
(ii) Normal residents include both citizens and non-citizens, i.e., foreigners who reside in a country for more than a year and
have economic interest in that country.
(iii) International bodies like World Bank, World Health Organisation or International Monetary Fund are not considered
residents of the country in which these organisations operate but are treated as residents of international territory.
However, the staff of these bodies are treated as normal residents of the country in which the international body
operates. For example, international body like World Health Organisation located in India is not normal resident of India
but Americans working in its office for more than a year will be treated as normal residents of India.
(iv) Local employees working in fogiren embassies located in their country are treated as normal residents.
For example, Indians working in US embassy located in India are residents of India.
(v) Workers from across the border who cross border in the morning to work in the other country (like Indians who work
in Nepal) and return in the evening are not residents of the country where they work.
For example, normal residents of India include (i) Citizens (and institutions) of India, (ii) Citizens of other countries (i.e., non-
citizens) who normally reside in India for more than a year and whose centre of economic interest lies in India. (iii) Citnzens
of India working in (a) international bodies like I.M.F., (b) foreign bodies like banks, enterprises operating in India and (c)
foreign empassies located in India.

8. Investment (gross and net) : Investment means addition to the stock of capital goods such as buildings, equipment or
inventory that adds to the future productive capacity of the economy.
Gross Investment : That part of total final output which comprises capital goods constitutes gross investment of an
economy. It is addition to the capital which also includes replacement cost for the wear and tear that capital stock undergoes
over a period of fime. When investment is expressed as gross investment. It includes depreciation.
Depreciation : Depreciation or fall in value due to normal wear and tear is called consumption of fixed capital.
Net Investment : By deducting depreciation from gross investment, we get net investment. Symbolically:
Net investment = Gross investment Depreciation
Note- The new addition to the capital stock in the econmy is measured by net investment (and not by gross investment).

9. Per Capita Income : Per capita is the average per capita national income. It is income per head of population.

National Income
Per Capita Income =
Mid year Population

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10. Production for Sel-consumption and for Exchange :


(a) Production for self Consumption :
(i) Meaning : Production is for self-consumption if the producers themselves consume the entire output they
produce.
Barter system of exchange is one in which a commodity is exchange for any other commodity. Like goods, services are
also produced for self-consumption, e.g., a teacher teaching his son, a burse bringing up her can child.
(ii) A subsistence production unit is one which is able to produce that much which is just sufficient to meet his family
needs. It is called so because its production is just sufficient for subsistence or just adequate to meet the consumption
needs of the producer. An economy which is dominated by subsistence production units, is called a subsistence
economy. Should production for self-consumption be included in national income because its market value is not
know? Yes, its imputed value should be included because it is presumed that the producer, instead of selling in the
market, has sold his product to himself.

Factors of Production :

(i) Land : It refers to all natural resources which are free gifts of nature. Land, therefore, includes all gifts of nature available
to mankindboth on the surface and under the surface e.g., soil rivers, waters, forests, mountains, mines, deserts,
seas, climate, rains, air, sun, etc.
(ii) Labour : Human efforts done with the aim of earning income is known as labour. Thus, labour is a physical or mental
effort of human being in the process of production. The compensation given to labourers in return for their productive
work is called wages (or compensation of employees).
(iii) Capital : All man-made goods which are used for further production of wealth, are included in capital. Thus, it is man-
made material source of production. Alternatively, as capital. It is the produced means of production. Examples are
machines, trucks, factories, etc. An increase in the capital of the economy means an increase in the productive capacity
of the economy. Logically and chronologically, capital is derived from land and labour and has, therefore, been named
as stored-up labour.

(iv) Entrepreneur : An entrepreneur is a person who organises the other factors and undertakes the risks and uncertainities
involved in the production. He hires the other three factors,organises and coordinates them so as to earn be called an
entrepreneur. An entrepreneur acts as a boss and decides how the business shall run. He decides in proportion factors
should be combined. What and where he will produce and by what method.. Thus, entrepreneurship is a trait or quality
owned by the entrepreneur.
Some economists are of the opinion that basically there are only two factors of productionland and labour. Capital,
they say, is appropriated from gifts of nature by human primary and entrepreneur is only a special variety of labour.

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Land and labour are, therefore, primary factors whereas capital and entrepreneur are secondary factors.
The following statements further clarify it.
Net product = Gross Product Depreciation
Net value added = Gross value added Depreciation
Net domestic capital formation= Gross domestic capital formation Depreciation

Capital Loss : Fall in value of fixed capital due to natural calamities (like earthquakes, floods, fires) and unforeseen
factors like war, thefts, etc. is called capital loss (and not depreciation). Provision of funds made by an enterprise for
replacement of worn out fixed capital over its expected life is called Depreciation Provision. Funds thus accumulated
over lifetime of the asset are used to replace the worn out assets with a new asset.

11. Factor Cost vs Market Price : (or Net Indirect Taxes)


Money value of final goods and services can be estimated in two waysat Factor Cost (FC) and at Market Price (MP).
Briefly, the difference between FC and MP is net indirect tax. And net indirect tax is the difference between indirect tax and
subsidy.
(i) Factor cost refers to all factor payments made by the producing unit (firm) to the factors of production for rendering
productive services in the production of goods and services. It is called factor cost because it is cost to the producer
(firm) who pays to factors in the form of rent, wages, interest, etc.
(ii) Market price is the price at which a commodity is sold and purchased in the market. It is the price what the buyers pay
actually, not what the producers actually get. The point to be noted is that when a product goes to the market for sale,
government levies indirect taxes (like sales tax, excise duty, etc.) which is added to the factor cost of the commodity.
Consequently, market price becomes higher than factor cost. Similarly, sometimes government gives subsidy on sale of
cert ain goods (like sugar, rice, kerosene oil) which is subt ract ed from fact or cost . As a result ,
MP becomes lower than Factor Cost (FC). The difference between indirect tax and subsidy is known as net indirect as
net indirect tax as explained below:
(a) Indirect taxes : Taxes which are levied by the government on production and sale of commodities are called indirect
taxes. e.g., excise duty, sales tax, customs duty octrol, etc. These are called indirect taxes because buyer of a taxed
commodity pays the tax indirectly which in fact is included in the price. Leaving aside the aims of the government
in levying indirect taxes, we study here the effect of an indirect tax on the price of a commodity on which tax is
levied.
(b) These are cash grants given by the government to the enterprises to encourage production of certain commodities
or to promote exports or to sell goods at prices lower than the free market prices. Subsidies are opposite of indirect
taxes.

Significance of Net Indirect Taxes : (To differentiate between MP and FC) : Net Indirect Tax is the difference between the
indirect tax and subsidy. To find out Market Prices (MP), indirect taxes are added and subsidies are subtracted from Factor
Cost (FC) as explained above. Symbolically :
Market Price = Factor Cost + Indirect taxes Subsidies
= Factor Cost + Net indirect taxes
In short, MP includes net indirect tax whereas FC does not. Thus, FC becomes MP when net indirect taxes are added to FC.
In the absence of indirect taxes and subsidies. MP and FC are the same.

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NFIA = Factor income earned from abroad by residents Factor income of non-residents in domestic territory

Components of net factor income from abroad : Following are its three main components:
(i) Net compensation of employees.
(ii) Net income from property and entrepreneurship (rent, interest, profit).
(iii) Net retained earning of resident companies abroad.
Net factor income from abroad = Net compensation of employees + Net income from property and entrepreneurship
+ Net retained earnings of resident companies abroad.

12. Value of Output vs Value Added


(i) Value of output : The goods and services produced by on enterprise during an accounting year constitute its output.
(Output is also called gross output because output includes depreciation).Value of output is the market value of all the
goods and services produced by an enterprise during an accounting year. (Mind, value of output means value of gross
output at MP unless stated otherwise). Money value of output of an enterprise is obtained by multiplying its physical
output of goods and services with its market price. Thus, it is equal to the quantity of output produced multiplied by
its market price per unit. Since output is evaluated at the prices prevailing in the market, therefore, it is called value of
output at market price. For example, if a shoe making enterprise produces 1,000 pairs of shoes annually and sells them
@ ` 175 per pair, the value of its output will be ` 1,75,000 (= 1.000 175). Symbolically:
Value of Output = Quantity of output Price
Alternatively, value of output can be expressed as sum of sales and change in stock because output is either sold or
accumulated as unsold stock. Symbolically:
Value of Output = Sales + Change in stock

(ii) Value added : It refers to the addition of value to the raw material (intermediate goods) by a firm by virtue of its
productive activities.
Value added = Value of output Intermediate consumption
(iii) Distinction between Value of output and value added : The difference between value of output and value added is
intermediate consumption which is included in value of output but excluded from value added. Intermediate
consumption means expenditure incurred on secondary inputs like raw material, power, etc. by a producing unit.

Following steps are taken to derive net value added at FC from value of output.

Value of output = Output x market Price (It is always at MP)

= Sales + Change in stock

Gross value added at MP = Value of output Intermediate consumption

Net value added at MP = Gross value added at MP Depreciation

Net value added at FC = Net value added at MP Net indirect taxes

(Net value added at FC = Sum of factor incomes)

In short, by substracting intermediate consumption, depreciation and net indirect taxes from value of output, we get
NVA at FC.

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13. Factor Payments vs Transfer Payments : (or Factor Income vs Transfer Income)

(i) Factor Payment : Payment made to a factor of production in return for rendering productive (or factor) service is called
factor payment (or factor income). Examples are rent, wages, interest and profit. Income of land is rent,
of labour wages, of capital interest and of enterprise is profit.

(ii) Transfer Payment : Payment received without any good or service provided in return is called transfer payment
(or transfer income). Transfer income is a receipt concept as compared to factor income which is an earning concept.
Such payments for which no productive services are rendered are known as transfer payments.

Income Method

1. Income Method, Steps and Precautions :Net domestic income is the income generated in the form of wages, rent, interest
and profit in the domestic territory of a country by all producers (normal residents and non-residents) in an accounting
year.

(a) Method : The Income Method measures national income from the side of payments made to the primary factors of
production in the form of rent, wages, interest and profit for their productive services in an accounting year.
(i) Identify enterprises which employ factors of production (land, labour, capital and enterprise).
(ii) Classify factor payments into various categories like rent, wages, interest, profit and mixed income (or classify
factor payments into compensation of employees, mixed income and operating surplus).
(iii) Estimate amount of factor payments made by each enterprise.
(iv) Sum up all factor payments made within domestic territory to get Domestic Income (NDP at FC).
(v) Estimate net factor income from abroad which is added to Domestic Income to derive National Income.

2. Domestic Income and its Components:


(a) Meaning : Domestic income is the sum total of factor incomes generated by all the production units located within the
domestic territory of a country during a period of account.
(i) Wages and salaries paid both in cash and kind and (ii) Employers contribution to social security schemes.
Remuneration in cash includes wages and salaries, dearness allowance, bonus, city compensatory allowance, house
rent allowance, leave travelling allowance, etc., whereas in kind (i.e., in the form of goods and services) it includes rent-
free quarter, free water and electricity, free uniform, free services of vehicles (car, scooter), amount of interest on
interest-free loans, etc. Employers contribution to social security schemes consists of contribution to life insurance,
casually insurance, provident fund, pension schemes, etc. Mind, old-age pension is a transfer payments but retirement
pension is a part of compensation of employees.

Note : Compensation to injured worker, employers contribution to social security schemes, TA relating to business
promotion, amount of loan, etc. not included in compensation of employees.

Royalty, is amount a receivable by a landlord for granting leasing rights of sub-soil assets (deposits of coal, iron,
natural gas, etc.) and for use of patents, copyrights, etc., is also included in the rent.

3. Interest : Interest is the price for the funds borrowed. It is the amount that the debtor becomes liable to pay to the creditor
over a given period of time.

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Product accruing to product accruing to private sector


public sector = Income from property and entrepreneurship accruing to govt. administrative
departments + Savings of non-departmental enterprises.

Nationanl disposable income = NNP at MP + Net current transfers from rest of the world
= National income + net indirect taxes + net current transfer
from rest of the world
Gross NDI = GNP at MP + Net current transfers from ROW
Net NDI = NNP at MP + Net current transfers from ROW
= Gross NDI Depreciation
Expenditure Method :
(a) Method : Expenditure measures final expenditure on Gross Domestic Product at market price (GDP at MP) during a
period of account. Since all domestically produced goods and services are purchased for final use either by consumers
for consumption or by producers for investment, therefore, we take sum of final expenditure on consumption and
investment. This sum equals GDP at MP. Final expenditure is the expenditure made on purchase of domestically
produced goods and services for final use, i.e., for consumption and investment. By adding up all the items of final
consumption expenditure and final investment expenditure within the domestic economy, we get the aggregate called
GDP at MP. By subtracting depreciation and net indirect taxes from GDP at MP and adding to it net factor income from
abroad, we get NNP at FC or national income. Thus, under expenditure method, national income is measured at the
point of actual expenditure.
Mind, income generated by factors of production in the production process is spent by them on final goods.
Final use of a commodity is either for consumption or for investment and expenditure on them is called Final
Consumption Expenditure and Final Investment Expenditure, respectively. By adding up all the items of final
consumption expenditure and final investment expenditure within the domestic economy, we get the aggregate called
GDP at MP.
(b) Steps Involved : Expenditure method involves the following steps:
(i) Identification of economic units incurring final expenditure, e.g., household (or consuming) sector, firm
(or producing) sector and government sector.
(ii) Classification of final aggregate expenditure into following components:
1. Private final consumption expenditure.
2. Government final consumption expenditure.
3. Gross fixed capital formation.
4. Change in stocks.
5. Net exports.

(iii) Measurement of final expenditure on the above components. Sum total of the above five items gives us the value
of GDP at MP. By deducting depreciation and net indirect taxes from GDP at MP, we get NDP at FC.
(iv) Estimation of net factor income from abroad which is added to NDP at FC (Domestic Income) to obtain NNP at FC
(National Income).

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(c) Precautions : The following precautions need to be taken for correct estimation of national income by expenditure
method. Alternatively, following items of expenditure should not be included.
(i) To avoid double counting, expenditure on all intermediate goods and service is excluded. For example, purchase of
vegetables by a restaurant, expenses on electricity by a factory, etc., are not included as they are for intermediate
consumption.
(ii) Government expenditure on all transfer payments such as scholarships, unemployment allowance, old-age
pension, etc. is excluded because no productive service is rendered by the recipients in exchange.
(iii) Expenditure on purchase of secondhand goods is excluded from national income because this type of expenditure
is not on currently produced goods.
(iv) Expenditure on purchase of old shares/bonds or new shares/bonds, etc. is excluded because it is not payment for
goods or services currently produced. It shows mere transfer of property from one person to another. Likewise,
gifts from abroad which bring transfer payment are not included.
(v) Imputed expenditure on own account output (e.g., owner occupying his house, self-consumed output by a farmer)
should be included.

Circular Flow of Income :


Circular flow of Income leads to comsumption and consumption inturn induces more production. The process goes on and
is called circular flow of income.
The circular flow of income and product is based on four basic principles :
(i) Total production of goods and services by producing sector = Total consumption of goods and services by household
sector.
(ii) Consumption expenditure of households sector = Income of the household sector.
(iii) Factor payment by producing sector = Factor income of household sector.
(iv) Flow of goods and services = Flow of money.

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Product Market : It is a market where goods and services are sold and purchased.
Factor Market : It is a market where factor of production are sold and purchased.

Circular flow of Income has two flows :


(i) Real flow :
There is a flow of goods and services from purchasing sector to household sector and inturn flow of factor
services from household to producing sector.

(ii) Money flow :


There is a flow of goods and services from household sector to producing sector and inturn flow of factor
payments from producing sector to household sector.

Important Terms
Private Income : Private income refers to the income which accrues to the private sector from all sources whether
received or not. it is the sum of factor income and transfer incomes received by private sector. It also includes net factor
income from abroad. The main constituents of private income are as follows :
1. Income from domestic product accuring to private sector.
2. Net factor income from abroad.

Private Income : Income from domestic product accruing to Private Sector + Current Transfer Income form Government
+ Net Current Transfers from Rest of the World + Interest on National Debt + Net Factor Income from abroad.

Personal Income : The sum of total income actually received by the households or individuals from all sources is called
personal income. It includes transfer as well as factor incomes.

Personal Income : Private Income Corporation Tax Undistributed Profits.

OR

Personal Income : National Income Income from Domestic Product Accruing to Public Sector Corporation

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Tax Undistributed Profits + Transfer Incomes.

Personal disposable income (PDI) : PDI is the part of income which may be spent or consumed by the households.
This income can be spent by households according to their desire.

PDI = Pesonal Income Direct Taxes Miscellaneous Receipts of the Government.

OR

PDI = Consumption + Saving

Questions :
1. When is the national income larger than domestic factor income ?
Ans : When NFIA is positive.

2. 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 ?

3. 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.

4. Why is the study of the problem of unemployment in India considered a macroeconomic study ?

Ans : The problem of unemployment in India is an economic issue at level of economy as a whole, hence considered as
macroeconomic study.

5. When is gross domestic product of an economy equal to gross national product ?

Ans : When NFIA is zero.

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 tincome 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.

7. All capital goods are producer goods, but all producer goods are not capital goods : Explain ?

Ans : Producer goods are all those goods which are used in the process of production. These goods may be raw material
or plant and machinery. Goods used as raw material are not durable goods because these goods can not be used in the
process of production again. So it is true that all capital goods are producer goods, but all producer goods are not capital
goods.

8. What is final goods ?

Ans : These are those goods which have crossed the boundary line of production and are ready for use by their final users.

9. Purchase of a machine is always a final goods. Do you agree ?

Ans : Machine purchased by a household is a final goods. Machine purchased by a firm is a final goods when it is used

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by the producer in the process of production but a machine purchased by one firm from the other for purchase of resale
is an intermediate goods.

10. Are the following included in the estimation of National Income of India ?
(i) Profit earned by a foreign company/bank in India.
(ii) Money received from sale of shares.
(iii) Salary paid to Americans working in Indian embassy in America.
(iv) Salary paid to Indians working in Indian embassy in America.
(v) Remittances from abroad.
Ans :
(i) No, as it is a factor income paid abroad (it is earned by non-residents).
(ii) No, it is only a transfer of paper claims.
(iii) No, this factor income belongs to non-residents.
(iv) Yes, as it is a factor income paid to normal resident of India.
(v) No, it is only a transfer payments.
(vi) No, it is only a transfer payments. No commodity is sent or services rendered return for this.

11. Are the following included in the estimation of National Income a country ? Give reason.
(i) Services rendered by family members to each other.
(ii) Wheat growth by a farmer but used entirely for familys consumption.
(iii) Expenditure government on providing free education.
(iv) Payment of fees to a lowyer 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 player 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 to 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 be included in NI because it is a wind fall 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.

12. Are the following included in the estimation of National Income a country ?
(i) Indirect Tax (Sale tax/Excise duty).
(ii) Salary received by the workers under NREGA.
(iii) Income Tax.
(iv) Corporation Tax.

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Macro-Economics Vidyamandir Classes

Ans :
(i) It is not included in NI because it does not add in the flow of goods and services.
(ii) It is a included in NI because it is a factor income.
(iii) 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.
(iv) 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.
13. Whether school/examination fee paid by students is included in national income not ?
Ans : It is included in national income as these are payments for the services rendered.

14. Whether purchase of those by the tenant of the house is included in national income or not ?
Ans : It is not included as it does not add to national product.

15. Whether expenditure on providing meals to the beggars is included in national income or not ?
Ans : It is not included as it is a transfer payment.

16. Whether salary of a defence personnel is included in national income or not ?


Ans : It is included as it is drawn for rendering productive service.

17. Whether increase in price of stock lying with a trader is included in national income or not ?
Ans : It will not be included in national income as there is no corresponding increase in output.

18. Whether value of interest foregone on loans provided by employer to employee is included in national income or not ?
Ans : It is included as it is a part of compensation of employees.

19. Whether government expenditure on street-lighting is included in national income or not ?


Ans : It is included as it is a part of govt. final consumption.

20. Whether gifts from abroad is included in national income or not ?


Ans : It is not included as it is a transfer payment.

21. Interest on national debt does not produce goods and services. It is only interest on borrowing.

22. Whether remittances by a NRI to his family in India are included in national income ?
Ans : It is not included as it is a transfer payment.

23. Whether sales tax is included in national income (NNP at FC) ?


Ans : It is included in NNP at MP but not in NNP at FC.

24. Whether free meals to workers are included in national income ?


Ans : Yes, it is included as it is wage in kind which is a part of compensation to employees.

25. Whether mineral wealth will be included which has been extracted in that particular year.
Ans : That part of mineral wealth will be included which has been extracted in that paticular year.

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Vidyamandir Classes Macro-Economics

26. Whether interest received by a household from a commercial bank is included in national income ?
Ans : Households both receive and pay interest. We include in national income only the net interest, that is the differences
between interest amount paid and the interest income received by households.

27. Whether commission received by a dealer of old car is included in national income or not ?
Ans : It is included as it is a productive service.

28. Whether expenditure on road construction is included in national income ?


Ans : It is included as it is a part of gross domestic fixed capital formation.

29. Whether payment of bus fare by a traveller is included in national income or not ?
Ans : It is included as it is a part of private final consumption expenditure.

30.(a) Can national income at constant prices be greater than national income at current prices ?
Ans : Yes national income at constant prices can be more than national income measured at current price under the
following two cases :
(a) When current year price index is low as compared to base year price index and output of goods and services
remains unchanged.
(b) When current output is less than the base year output, price index remaining the same.

(b) Does DNP measures economic welfare ?


Ans : GNP is not the measures of economic welfare as mere increase in national income does not lead to national welrafe.
Green GNP is the measure of economic welfare as it ensures sustainable use of national environment and equitable
distribution of the fruits of development.

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Vidyamandir Classes Macro-Economics

1. From the hypothetical figures given below about an economy, calculate NDPFC.
(` in Crore)
(i) Private income 10,000
(ii) Income form domestic product accruing to govt. sector 925
(iii) Transfer payments 125
(iv) Net income from abroad () 200
(v) Net indirect taxes 250
Ans. NDPFC = (i) (iii) (ii) (iv)
= 10,000 125 + 925 (200) = 11,000
2. From the following data about an economy, estimate : (a) Personal Disposable Income (b) Private Income and (c)
National income.
(` in Crore)
(i) Personal income 1,225
(ii) Savings of private corporate sector 12
(iii) Corporate tax 23
(iv) Current transfers from government adm. Deptt. 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 enterprises 20
(viii) Net indirect taxes 195
(ix) Direct taxes paid by the households 25
Ans. (a) Personal disposable income = (i) (ix)
= 1,225 25 = 1,200 crore
(b) Private Income = Personal Income + (ii) + (iii)
= 1,225 + 12 + 23 = 1,260 crore
(c) National Income = Private Income (iv) (v) + (vi) + (vii)
= 1,260 30 25 25 20 = 1,250 crore
3. From the following data estimate : (i) Personal Income (ii) Private Income and (iii) Personal Disposable Income from Set
I and III. Also calculate : (i) National Income (ii) Personal Income (iii) Private Income from Set II.
(` in crore)
Set I Set III Set II
(i) National Income 2,500 1300
(ii) Corporate profit tax 25 15 10
(iii) National debt interest 30 10 10
(iv) Direct personal taxes 75 40
(v) Saving of private corporate sector 50 25 15
(vi) Income from property and entrepreneurship
accruing to government adm. Departments 75 35 25
(vii) Current transfers from
Government adm. Departments 70 30 25
(viii) Savings of non-departmental public enterprises 10 5 5
(ix) Current transfer from rest of the world 30 15 10

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4. From the following data, calculate GNP at FC.


(` in crore)
Set I Set II
(i) Gross Fixed capital formation 100 150
(ii) Change in stocks 20 30
(iii) Net capital formation 110 160
(iv) Mixed Income of self employed 200 250
(v) Net Factor Income from abroad () 10 () 20
(iv) Net exports () 20 70 Export
100 Import
(vii) Compensation of employees 250 300
(viii) Operating surplus 400 500
(ix) Net indirect taxes 50 70
Ans. Domestic Income (NDPFC)
Set I = 200 + 250 + 400 = 850 crore
Set II = 250 + 300 + 500 = 1,050 crore
GNPFC (Set I) = 850 + depreciation 10[(i) + (ii) (iii)] + (10)
= 850 crore
(Set II) = 1,050 + depreciation 20 + (20)
= 1,5050 crore
5. Calculate (a) GDP at MP (b) GNP at MP from the following data :
(` in crore)
(i) Personal consumption expenditure 27,500
(ii) Government consumption expenditure 3,000
(iii) Gross domestic fixed capital formation 2,500
(iv) Import of goods and service 500
(v) Net factor income from abroad () 250
(vi) Subsidy 250
(vii) Fall in stock 300
(viii) Export of goods and services 450
(ix) Depreciation 1,000
(x) Net indirect taxes` 1,000
Ans. (a) GDP at MP = 32,650 crore
(b) GNP at MP = 32,400 crore
6. From the following data, calculate : (i) GDPMP (ii) GDPFC (iii) NDPFC and (iv) NNPFC
(` in crore)
(i) Personal consumption expenditure 45,000
(ii) Government consumption expenditure 5,000
(iii) Gross domestic fixed capital formation 1,000
(iv) Exports 6,000
(v) Imports 3,000
(vi) Net indirect taxes 3,500
(vii) Consumption of Fixed Capital 4,500
(viii) Change in stocks 1,000
(ix) Net factor income from abroad () 2,000
Ans. (i) GDPMP = 55,000 crore (ii) GDPFC = 51,500 crore
(iii) NDPFC = 47,000 crore (iv) NNPFC = 45,000 crore

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Vidyamandir Classes Macro-Economics

7. Find out GNP at MP from the following data.


(` in crore)
Set I Set III Set II
(i) Consumption of fixed capital 60 50 30
(ii) Government final consumption expenditure 200 180 100
(iii) Net factor income from abroad ()10 ()5 ()10
(iv) Private final consumption expenditure 800 700 400
(v) Exports 50 50 25
(vi) Opening stock 30 20 15
(vii) Imports 60 60 35
(viii) Closing stock 20 15 10
(ix) Gross stock 20 15 10
(x) Gross domestic fixed capital formation 230 200 120
Ans. GNP at MP
(Set I) = 200 + 800 + 50 60 + 230 + ( 10) 30 + 20 = 1,200 crore
(Set II) = 180 + 700 + 50 60 + 200 + ( 5) + 15 20 = 1,060 crore
(Set III) = 100 + 400 + 25 35 + 120 + (10) + 10 15 = 595 crore
8. From the following data, calculate GNP, GDP, NNP, NDP at FC and MP.
(` in crore)
(i) Gross investment 90
(ii) Net exports 10
(iii) Net indirect taxes 5
(iv) Depreciation 15
(v) Net factor income from abroad ()5
(vi) Personal consumption expenditure 350
(vii) Govt. purchases of goods and service 100
Ans. (a) GDPMP = (vi) + (i) + (vii) + (ii)
=350 + 90 + 100 + 10 = 550 crore
(b) GNPMP = GDPMP + (v) = 550 + 5 = 545 crore
(c) NDPMP = GDPMP Depreciation = 550 15 535 crore
(d) NNPMP = NDPMP + (v) = 535 5 530 crore
(e) GDPFC = GDPMP + Net indirect taxes = 550 5 545 crore
(f) GNPFC = 545 5 540 crore
(g) NDPFC = 535 5 = 530 crore
(h) NNPFC = 530 5 = 525 crore
9. Calculate GDP at MP through Income Method and National Income by Expenditure Method from the following data.

(` in crore)
Set I Set III Set II
(i) Mixed Income of self - employed 280 560 850
(ii) Compensation of employees 240 490 730
(iii) Net Factor Income from rest of the world ()5 ()10 () 10
(iv) Imports 60 110 170
(v) Exports 50 100 140
(vi) Government final consumption expenditure 75 150 220

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Vidyamandir Classes Macro-Economics

(vii) Indirect taxes 90 180 260


(viii) Change in stocks 35 60 100
(ix) Private final consumption expenditure 510 1,020 1,530
(x) Consumption of fixed capital 40 80 120
(xi) Gross fixed capital formation 130 180 net 400
(xii) Subsidies 10 20 30
(xiii) Rent, interest and profits 100 190 290
(xiv) Interest on national debt 10 20 40
Ans. GDPMP (Set I) = 280 + 240 + 90 + 40 + 100 10
= 740 crore
(Set II) = 560 + 490 + 180 + 80 + 190 20
= 1,480 crore
(Set III) = 850 + 730 + 260 + 120 + 290 30
= 2,220 crore
NNPFC (Set I) = 50 + 75 + 35 + 510 + 130 + 10 5 60 90 40
= 615 crore
10. Calculate GDPMP in Set I, II and National Income in Set III by (a) Production Method and (b) Income Method.
(` in crore)
Set I Set II Set III
(i) Intermediate consumption of :
(a) Primary sector 500 100 400
(b) Secondary sector 400 50 300
(c) Tertiary sector 300 50 100
(ii) Value of output of :
(a) Primary sector 1,000 300 1,000
(b) Secondary sector 900 200 800
(c) Tertiary sector 700 100 600
(iii) Rent 10 10 40
(iv) Emoluments of employees 400 150 500
(v) Mixed Income 650 50 800
(vi) Operating surplus 300 100 200
(vii) Net Factor Income from abroad () 20 () 10 10
(viii) Interest 5 20 50
(ix) Consumption of Fixed Capital 40 40 80
(x) Net indirect tax 10 60 I. Tax 30
Subs. 10
Ans. (a) GDP at MP by Production Method:
(Set I) = (1,000 + 900 + 700) (500 + 400 + 300) = 1,400 crore
(Set II) = (300 + 200 + 100) (100 + 50 + 50) = 400 crore
(Set III) = (1,000 + 800 + 600) (400 + 300 + 100) = 1,600 crore
National Income:
(Set III) = 1,600 80 30 + 10 + 10 = 1,510 crore
(b) GDP at MP by Income Method:
(Set I) = 400 + 650 + 300 + 40 + 10 = 1,400 crore
(Set II) = 150 + 50 + 100 + 40 + 60 = 400 crore
National Income :
(Set III) = 500 + 800 + 200 + 10 = 1,510 crore

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Vidyamandir Classes Macro-Economics

11. Calculate GNP at MP by (a) Expenditure Method and (b) Income Method from the following data:
(` in crore)
(i) Net capital formation 200
(ii) Private final consumption expenditure 1,000
(iii) Operating surplus 360
(iv) Wages and salaries 900
(v) Rent 100
(vi) Govt. final consumption expenditure 300
(vii) Consumption of fixed capital 50
(viii) Net indirect taxes 200
(ix) Net Factor Income from abroad ()10
(x) Employers contribution to S.S. Scheme 50
(xi) Net exports 10
Ans. (a) GNP at MP (Exp. Method)
= 200 + 1,000 + 300 + 50 + ( 10) + 10 = 1,550 crore
(b) GDP at MP (Income Method)
= 360 + 900 + 50 + 200 + (10) + 50 = 1,500 crore

12. Calculate National Income by (a) Income Method and (b) Expenditure Method.
(` in crore)
Set I Set II Set III
(i) Wages and Salaries 500 500 500
(ii) Govt. final consumption expenditure 120 120 120
(iii) Royalty 20 20 20
(iv) Interest 40 40 40
(v) Household final consumption expenditure 600 600 600
(vi) Change in stocks 10 10 10
(vii) Indirect taxes 100 100 100
(viii) Rent 50 50 50
(ix) Final consumption expenditure of private
non-profit institutions serving household 30 30 30
(x) Net Domestic Fixed Capital formation 60 60 60
(xi) Profit after tax 100 100 100
(xii) Corporate tax 20 20 20
(xiii) Net export () 20 () 20 () 20
(xiv) Subsidies 30 30 30
(xv) Net Factor Income from abroad () 5 5 () 10
Ans. (a) National Income (NNP at FC) by Income method:
(Set I) = 500 + 20 + 40 + 50 + 100 + 20 + (5) = 725 crore
(Set II) = 500 + 20 + 40 + 50 + 100 + 20 (+5) = 735 crore
(Set III) = 500 + 20 + 40 + 50 + 100 + 20 ( 10) = 720 crore
(b) National Income by Expenditure Method:
(Set I) = 120 + 600 + 10 + 100 + 30 + (20) + 30 + ( 5)
= 725 crore
(Set II) = 120 + 600 + 10 100 + 30 + 60 + ( 20) + 30 + 5
= 735 crore
(Set III) = 120 + 600 + 10 100 + 30 + 60 + (20) + 30 + ( 10)
= 720 crore

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Vidyamandir Classes Macro-Economics

13. From the following data, calculate GNP at MP by (a) Income Method and (b) Expenditure Method.
(` in crore)
(i) Govt. final consumption expenditure 250
(ii) Change in stocks 65
(iii) Net Domestic Capital formation 150
(iv) Interest 90
(v) Profits 210
(vi) Corporate tax 50
(vii) Rent 100
(viii) Factor Income from abroad 20
(ix) Indirect taxes 55
(x) Factor Income to abroad 40
(xi) Exports 60
(xii) Subsidies 25
(xiii) Imports 80
(xiv) Consumption of fixed capital 20
(xv) Private final consumption expenditure 500
(xvi) Compensation of employees 450
(xvii) Value of rent free accommodation to employees 40
Ans. (a) GNP at MP (by Income Method)
= 90 + 210 + 100 + 20 + 55 40 25 + 20 + 450
= 880 crore
(b) GNP at MP (by Exp. Method)
= 250 + 150 + 20 40 + 60 80 + 20 + 500
= 880 crore
14. From the following data, calculate GDP at FC by (a) Expenditure Method (b) Income Method.
(` in crore)
(i) Personal consumption expenditure 700
(ii) Wages and Salries 700
(iii) Employers contribution S.S. Schemes 100
(iv) Gross business fixed investment 60
(v) Profits 100
(vi) Gross residential construction investment 60
(vii) Govt. purchase of goods and services 200
(viii) Gross public investment 40
(ix) Rent 50
(x) Inventory investment 20
(xi) Exports 40
(xii) Interest 50
(xiii) Imports 20
(xiv) Net Factor Income from abroad () 10
(xv) Mixed income 100
(xvi) Depreciation 20
(xvii) Subsidies 10
(xviii) Indirect taxes 20
Ans. (a) GDP at FC (by Exp. Method)
= 700 + (60 + 60 + 40 + 20) + 200 + 40 (40 20) + (10 20)

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Vidyamandir Classes Macro-Economics

= 1,090 crore
(b) GDP at FC (by Income Method)
= 700 + 100 + 50 + 50 + 100 + 20
= 1,020 crore
15. From the following data, calculate National Income (NNP at FC) by (a) Income Method and (b) Expenditure Method.
(` in crore)
Set I Set II Set III
(i) Compensation of employees 1,200 600 500
(ii) Net Factor Income from abroad () 20 () 10 () 10
(iii) Net indirect taxes 120 60 165
(iv) Profit 800 400 220
(v) Private final consumption expenditure 2,000 1,000 900
(vi) Net Domestic Capital formation 770 385 200
(vii) Consumption of Fixed Capital 130 65
(viii) Rent 400 200 90
(ix) Interest 620 310 100
(x) Mixed income of self employed 700 350 400
(xi) Net exports () 30 ()15 ()25
(xii) Govt. final consumption expenditure 1,100 550 400
(xiii) Net current transfers from ROW 50
Ans. (a) (Income Method) NI = DI + NFIA
(Set I) = 1,200 20 + 800 + 400 + 620 + 700
= 3,700 crore
(Set II) = 600 10 + 400 + 200 + 310 + 350
= 1,850 crore
(Set III) = 500 10 + 220 + 90 + 100 + 400
= 1,300 crore
(b) (Exp. Method) NNFC = GDP at MP NIT Dep. + NFIA
(Set I) = 2,000 + 1,100 + 770 30 120 20
= 3,700 crore
(Set II) = 1,000 + 550 + 385 15 60 10
= 1, 850 crore
(Set III) = 900 + 400 + 200 25 165 10
= 1,3000 crore
16. From the following data, calculate National Income by (a) Income method and (b) Expenditure method.
(` in crore)
(i) Interest 150
(ii) Rent 250
(iii) Government final consumption expenditure 600
(iv) Private final consumption expenditure 1200
(v) Profit 640
(vi) Compensation of employees 1000
(vii) Net factor income from abroad 30
(viii) Net indirect taxes 60
(ix) Net exports () 40
(x) Consumption of fixed capital 50
(xi) Net domestic capital formation 340

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Vidyamandir Classes Macro-Economics

Ans. (a) National Income (Income method) = 150 + 250 + 640 + 1000 30
= 2010 crore
(b) GDP at MP = 600 + 1200 + ( 40) + (50 + 340) = 2150
National income (NNP at FC) = GDP at MP (x) + (vii) (viii)
= 2150 50 + ( 30) 60 = 2010 crore
17. Calculate (a) GDP at MP and (b) Factor income from abroad from the following data

(` in Crore)
(i) Profit 500
(ii) Exports 40
(iii) Compensation of employees 1,500
(iv) GNP at FC 2,8000
(v) Net current transfer from rest of the world 90
(vi) Rent 300
(vii) Interest 400
(viii) Factor income to abroad 120
(ix) Net indirect taxes 250
(x) Net domestic capital formation 650
(xi) Gross fixed capital 700
(xii) Change in stock 50
Ans. NDP at FC (Domestic income)
= 500 + 1500 + 300 + 400 = 2700
Deprecation = (xi) + (xii) (x) = 700 + 50 650 = 100
(i) GDP at MP = NDP at FC + Depreciation + NIT
= 2700 + 100 + 250
= 3050 crore
(ii) NFIA = NNP at FC NDP at FC
= (2800 100) 2700 = 0
Factor income from abroad = NFIA + Factor income to abroad
= 0 + 120
= 120 crore
18. What are various money stock measures?
Ans. Following four measures of money stock are used
(i) M1 = C + DD + OD
(ii) M2 = M1 + Saving deposits in post office saving banks.
(iii) M3 = M1 + Net time deposits of banks.
(iv) M4 = M1 + Total deposits with post office saving organisation.
19. What is High Powered Money?
Ans. The total liability of monetary authority of the country (RBI in India) is called High Powered Money or monetary base.
20. What is Reserve Deposit Ratio (RDR) ?
Ans. It is ratio of total deposits which commercial banks keep as reserve.
21. Define liquidity trap.
Ans. It is situation of very low rate of interest where people are ready to hold whatever stock of money is supplied expecting
interest rate to rise in future and bond prices to fall.
22. What is credit money?

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Vidyamandir Classes Macro-Economics

Ans. It refers to that money whose value as money (i.e., face value) is more than intrinsic value, i.e., commodity value of the
material money is made of e.g., cheques, drafts, notes, etc.
23. What is meant by demand for money?
Ans. Demand for money is the demand for liquidity, i.e., demand for cahs.
24. Which institution performs the function of clearing house in commercial banking system?
Ans. Central Bank, i.e., RBI in India.
25. Name the institution which acts as custodian of nations foreign exchange reserve.
Ans. In India it is RBI.
26. Distinguish between narrow money and broad money.
Ans. Narrow money consists of currency notes and coin (C) and demand deposits (DD) held by public in commercial banks.
Symbolically
M = C + DD
This definition is based on its medium of exchange function. As against it, broad money consists of narrow money + time
deposits (TD) held by commercial banks and Post Office saving organisations.
M = C + DD + TD. This definition is based on store of value function.
27. Why are financial institution like UTI, LIC not considered bank?
Ans. Because such financial institutions do not accept chequable deposits.
28. Why are Post Office savings banks not treated as bank?
Ans. Because they do not perform banks essential function of lending.
29. What are least (i) Repo Rate (ii) Reverse Repo Rate and Cash Reserve Ratio (CRR) in India?
Ans. Since 2009 in India (i) Repo Rate is 4.75% (Repo rate is the rate at which RBI lends short-term funds to banks) , (ii)
Reverse Repo Rate is 4% (Reverse Repo Rate is the rate at which banks part their surplus funds with RBI), and (iii) CRR
is 5.75% w.e.f. February 1, 2010 (CRR is the proportion of money which banks have to keep mandatorily with RBI at nil
rate of interest).
30. In an economy investment increases by Rs. 10 crore. As a result, income increases by Rs. 50 crore. What is the value of
multiplier?
Y (Change in income) 50
Ans. K 5
I (Change in investment) 10

31. Calculate : Change in Income when MPC = 0.8 and Change in Investment = Rs. 1.000.
1 1 1 1
Ans. K(Multiplier) 5
1 MPC 1 0.8 0.2 1
5
Change in Income = Change in investment K
= 1,000 5 = 5,000
32. MPC in economy is 0.8. If investment is increased by Rs. 5 crore, how much would be the increase in income?
1 1 1 1
Ans. K 5
1 MPC 1 0.8 0.2 1/ 5
Increase in income = Change in investment K
= 5 5 = 25 crore
33. If in an economy MPC is 0.8 and investment is increased by Rs. 1,000 crore, calculate total increase in income.
1 1 1
Ans. K 5
1 MPC 1 0.8 0.2

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Total increase in income = Increase in investment K (multiplier)


= 1,000 5 = 5,000 crore
34. In an economy, MPC is 0.75. If investment expenditure is increased by Rs. 100 crore, calculate total increase in income
and consumption expenditure.
1 1 1 1
Ans. K 4
1 MPC 1 0.75 0.25 1/ 4
Total increase in income = Increase in investment K
= 500 4 = 2,000 crore
Total increase in consumption expenditure = 0.75 of 2,000 = 1,500 crore
35. In an economy, investment expenditure is increased by Rs. 400 crore and MPC is 0.8. Calculate total increase in income
and savings.
1 1 1 1
Ans. K 5
1 MPC 1 0.8 0.2 1/ 5
Total increase in income = 400 5 = 2,000 crore
Total increase in saving = 0.2 (=1 0.8) of 2,000 = 400 crore
36. As a result of increase in investment by Rs. 20 crore, national income increases by 100 crore. Find out MPC.
Y 100
Ans. K 5
I 20
1 1
K or 5
1 MPC 1 MPC
or 5 MPC = 5 1 = 4
or MPC = 4/5 = 0.8
37. In an economy investment increase by Rs. 120 core. The value of multiplier is 4. Calculate MPC.
1 1
Ans. K or 4
1 MPC 1 MPC
4 4MPC = 1 or 4MPC = 4 1 = 3
MPC = 3/4 = 0.75
38. A Rs 200 crore increase in investment leads to a rise in national income by Rs. 1,000 crore. Find out marginal propensity
to consume (MPC).
Increase in national income 1000
Ans. K (multiplier) 5
Increasein investment 200
1 1
K or 5
1 MPC 1 MPC
or 5 5MPC = 1
5 MPC = 4 (=5 1)
MPC = 4/5 = 0.8
39. An increase of Rs. 250 crore in investment in an economy resulted in total increase in income of Rs. 1,0000 crore.
Calculate the following .
(a) Marginal propensity to consume (MPC). (b) Change in savings
(c) Change in consumption expenditure (d) Value of multiplier.
y 1000
Ans. K 4
l 250

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Vidyamandir Classes Macro-Economics

1 1
(a) K or 4
1 MPC 1 MPC
or 4 4 MPC = 1
or 4 MPC = 3
MPC = 3/4 = 0.75 (Also, MPS = 1 0.75 = 0.25)
(b) Change in saving S = Y MPC
= 1000 0.25 = 250 crore
(c) C = Y MPC
= 1000 0.75 = 750 crore
Y 1000
(d) Value of multiplier (K) = 4
l 250

40. In an economy 75% of increase in income is spent on consumption. Investment is increased by Rs. 1000 crore. Calculate.
(a) Total increase in income (b) Total increase in consumption expenditure.
75 3 3 1
Ans. MPC MPS 1
100 4 4 4
1 1
K 4
MPS 1/ 4
Y Y
(a) K or 4 or Y = 4 1000 = 4000
I 1000
Increase in income = 4000 crore
(b) Increase in consumption expenditure, i.e., C
C = Y I
= 4000 1000 = 3000 crore
41. In an economy C = 500 + 0.9Y and I = 1000 (where C = consumption. Y= Income, I = Investment). Calculate the
following:
(i) Equilibrium level of income (ii) Consumption expenditure at equilibrium level of income.
Ans. (i) For equilibrium Y = C + I
\Y = 500 + 0.9Y + 1.000 (Substituting values of C and I)
Y 0.9Y = 1,500
0.1Y = 1,500
1
or Y = 1,500
10
Y = 15,000 (Equilibrium level of income)
(ii) Y=C+I
15,000 = C + 1,000
C = 15,000 1,000
= 14,000
Consumption expenditure at equilibrium level of income = 14,000
42. Given consumption function C = 100 + 0.75Y (where C = consumption expenditure and Y = Nation income) and
investment expenditure Rs. 1,000. Calculate the following.
(i) Equilibrium level of national income,
(ii) consumption expenditure at equilibrium level of national income.
Ans. (i) For equilibrium Y = C + I (i.e., AS = AD)
Y = 100 + 0.75Y + 1,000 (Given C = 100 + 0.75Y)
Y 0.75Y = 1,100

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or 0.25Y = 1,100
100
Y 1,100 4, 400 (Equilibrium level of income)
25
(ii) C = 100 + 0.75Y (Given)
=100 + 0.75 4,400
= 100 + 3/4 4,400 = 3,400 (Consumption expenditure)

43. From the following information about an economy, calculate (i) its equilibrium level of national income and (ii) savings
at equilibrium level of national income. Consumption function C = 200 + 0.9Y (where C = consumption expenditure and
Y = National income). Investment expenditure I = 3,000.
Ans. (i) For equilibrium Y=C+I
Y = (200 + 0.9Y) + 3,000
Y 0.9Y = 3,200
or 0.1Y = 3,200
10
Y = 3,200 = 32,000 (National income)
1
(ii) C = 200 + 0.9Y (Given)
= 200 + 0.9Y (Y = 32,000 proved)
9
= 200 + 32,000
10
= 200 + 28,800 = 29,000
Saving = Y (National income) C (Consumption)
= 32,000 29,000 = 3,000
44. Define marginal propensity to save (MPS).
Ans. The ratio of change in saving (S) to change in income (Y) is called MPS.
Symbolically : MPS = S/Y
45. What is multiplier?
Ans. Investment multiplier (K) is the ratio of increased income (Y) due to an increase in investment (I). Symbolically : K =
Y / I.
46. What is deficient demand?
Ans. When aggregate demand is for a level of output that is less than full employment level of output, it is said to be
deficient demand.
47. What is excess demand?
Ans. When aggregate demand is for a level of output that is more than full employment level of output, then it is known as
excess demand.
48. How does the introduction of government sector affect the economy?
Ans. It impacts the level of aggregate demand through government expenditure and taxes. For example, an increase in
government expenditure increases the level of aggregate demand whereas increase in taxes causes a fall in aggregate
demand.
49. What is the basic difference between two expressions ex-ante and ex-post?
Ans. Ex-ante expression indicates variable before the beginning of even but ex-post expression indicates variable after the end
of the event.
50. Can consumption exceed income? If yes, what is the saving then?
Ans. Yes, consumption can exceed income when income is zero or less than subsistence consumption level. Then there is
negative saving.

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51. What is meant by autonomous consumption?


Ans. Autonomous consumption refers to minimum level of consumption needed for survival even when income is zero.

52. Given autonomous consumption ( C ) = 500 crore, MPC (b) = 0.8, write equation of consumption function and determine
value of consumption when income (Y) = Rs. 3,000 crore.
Ans. Equation of consumption is C = C + bY, where C represents consumption function, C autonomous consumption, b
represents MPC and Y is level of income. By substituting values in the equation, we get.
C = 500 + 0.8 (3000)
= 500 + 2400 = Rs. 29,00 crore
53. How is equilibrium level of output determined under short run fixed price?
Ans. Under short run fixed price, equilibrium level of output is determined by level of exante aggregate demand. (It is assumed
that suppliers are willing to supply whatever amount of goods consumers will demand at the fixed price).
54. Define (a) Fiscal deficit (b) Budget deficit
(c) Revenue deficit and (d) Primary deficit.
Ans. (a) Fiscal deficit is defined as excess of total expenditure of government over sum of its revenue receipts and non-
debt capital receipts during a fiscal year.
(b) Budget deficit refers to the excess of total budgetary expenditure over total budgetary receipts (both revenue
receipts and capital receipts) of the government.
(c) Revenue deficit refers to the excess of governments revenue expenditure over its revenue receipts.
55. How can a deficit be financed?
Ans. A deficit may be financed:
(i) by printing new currency, i.e., monetary expansion and
(ii) by borrowing from internal source (i.e., public) and external source (i.e., foreign governments, World Bank)
56. Give two examples of debt creating capital receipts.
Ans. Net borrowing by government at home, borrowing from abroad.
57. Give two examples of non-debt capital receipts.
Ans. Recovery of loan, sale proceeds of public enterprises (i.e., disinvestment).
58. Why are borrowings by government capital receipts?
Ans. Because these create liability of government for repayment of loan.
59. Why is repayment of loan a capital expenditure?
Ans. Because it reduces governments liability.
60. Why are subsidies treated as revenue expenditure?
Ans. Because these neither result in creation on assets nor reduce governments liability.
61. Can there be a fiscal deficit in a government budget without a revenue deficit? Give reasons.
Ans. Yes (i) When revenue budget is balanced but capital budget shows a deficit or (ii) when there is surplus in revenue budget
but deficit in capital budget is higher than surplus in revenue budget.
62. State three items each of (a) debt creating capital receipts and (b) Non-debt creating capital receipts.
Ans. (a) (i) Borrowing at home,(ii) Borrowing from abroad, and (iii) Loans from RBI are debt creating capital receipts.
(b) (i) Recovery of loans, (ii) Proceeds from sale of Public sector units, and (iii) Paratial sale government shares in a
company.
63. State three implications of fiscal deficit.
Ans. (i) Fiscal deficit, i.e., borrowing creates problems of not only payment of interest but also of repayment of
loans.

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(ii) High fiscal deficit generally leads to wasteful and unnecessary expenditure by the government.
(iii) Payment of interest increases revenue expenditure leading to higher revenue deficit which, in turn, may lead
to more borrowing. This may compel the government to borrow more to finance even interest payment creating
vicious circle and debt-trap.
64. What are (a) spot and (b) Forward markets in foreign exchange?
Ans. (a) If the operation is of daily nature, it is called spot market or current market and the exchange rate that
prevails in the spot market is called spot rate.
(b) A market for foreign exchange for future delivery is known as forward market. Here foreign exchange is
bought and sold for delivery at a future date.
65. Define (a) NEER, (b) REER and (c) RER
Ans. (a) NEER is the measure of average relative strength of a given currency without eliminating the effect of price
change.
(b) REER is an effective exchange rate base on real exchange rates instead of nominal rates.
(c) Real Exchange Rate (RER) is the exchange rate that is based on constant prices to eliminate the effect of price
changes.
66. What is meant by balance of trade (BOT)?
Ans. BOT is the difference between money value of exports and imports of material goods.
67. When is there deficit in BOT?
Ans. When value of exports is less than value of imports, then BOT is called in deficit.
68. State various forms of capital account transactions.
Ans. (i) Private transactions,
(ii) Official transactions,
(iii) Direct investment and
(iv) Portfolio investment.
69. What does BOP account of a country record?
Ans. BOP account of a country records all transactions in goods, service and assets between residents of a country and rest
of the world.
70. Which two transactions determine BOT?
Ans. Export of goods and import of goods determine balance of trade.
71. Why are autonomous items called above the line items?
Ans. Because they are recorded in BOP account as first items before calculating deficit and surplus. In fact, deficit or surplus
occurs due to autonomous items.
72. Describe the causes for disequilibrium in BOP.
Ans. 1. Large imports due to large-scale development expenditure.
2. High domestic prices,
3. New sources of supply and new substitutes.
4. Political instability,
5. Changes in taste, fashion and preference.

73 State two merits and two demerits of flexible exchange rate system.
Ans. (a) merits are :
(i) Deficit or surplus is automatically corrected.
(ii) It frees the government from problem of BOP.
(b) Demerits are :

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(i) It encourages speculations leading to fluctuations in exchange rate.


(ii) Wide fluctuations in exchange rate discourage investment and international trade.
74. State four source each of demand for foreign exchange and supply of foreign exchange.
Ans. (a) Sources of Demand are:
(i) To purchase goods and services from foreign countries.
(ii) to invest and purchase financial assets in a foreign country.
(iii) For sending gifts abroad and
(iv) To undertake foreign tours.
(b) Sources of Supply are :
(i) Direct foreign investment in the domestic territory,
(ii) When foreigners purchase home countrys goods and services,
(iii) Remittances by non-residents abroad and
(iv) When foreign tourists come to home country.

75. Why does a rise in foreign exchange rate cause a rise in its supply?
Ans. A rise in foreign exchange rate makes home countrys (say, Indias) goods cheaper to foreigners. As a result, demand for
Indian goods increases leading to increase in Indias exports. This brings a greater supply of foreign exchange. Thus,
there is direct relation between price (rate) of foreign exchange and supply of foreign exchange. (Mind, there is inverse
relation between price of foreign exchange and demand for foreign exchange.)

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(b) Money and Banking


Barter System :
Direct exchange of goods against goods without use of money is called barter exchange.

For Example : When a weaver gives cloth to the farmer in return for getting wheat from the farmer, this is called barter
exchange.

Inconviences in Barter System :


(a) Lack of Double coincidence of wants of Exchange : It is necessary for a person who wants to trade his goods or
service to find some other person who is not willing to buy his good or service, but also possesses rice and wants to
exchange it for sugar. In the barter system, he has to find out a person who not only have sugar but also wants rice.
But ,such a double coincidence is a rare possibility.

(b) Problem of Storing Wealth : It is difficult to store value in the absence of money, the individuals have to store wealth
in the form of goods like horses, shoes, wheat etc, it is very expensive to store goods in this form for a long time.

(c) Lack of common measure of value : In the barter system, there is lack of common measure of value. One goods value
for one person is different from that goods value for other. The rate of exchange will be arbitrarily fixed.

(d) Lack of Standard of Deferred Payments : Another drawback of this is that it lacks a standard of future payments.
So, credit transactions cannot take place smoothly under barter trading. Both parties run the risk that the value of
goods to be repaid may decrease or increase in future.

Money : Anything which is generally acceptable by the people in exchange of goods and service or in repayment of
debts.

Features :
(i) Medium of Exchange : Money is a thing that acts as medium of exchange for the sale and purchase of of goods and
services.
(ii) Measure of Value : The value of all goods and service is expressed in terms of money, which is known as price, so
we can say that it is measure of value.
(iii) It is the most liquid form of assets.
(iv) Money possesses general acceptability.
(v) Money is a means and not an end in itself.

Functions of Money :
(i) Medium of Exchange : As money as the quality of general acceptability, therefore, all the exchanges in an
economy takes place in terms of money.
(ii) Measure in Value : The second function of money is that it acts as common measure of value. All the value of
goods and services can be measured and expressed in terms of money. It provides a basis for keeping accounts,
estimating national income, calculating profit and loss, costing etc.
(iii) Store of Value : Storing wealth has become easy with the introduction of money. It is a source of further
investment money can be stored easily as it remains stable as compared to other commodities. It does not need
much space.

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(iv) Standard of Deferred Payments : These are those payments which are made in future. When we borrow money
from somebody, we have to return both the principal as well as interest amount but it was difficult in barter system
but with the introduction of money, money performs this function most effectively.

Producer of Money : Producers of money refer to suppliers of money. They include :


(i) The government of the country.
(ii) The banking system of a country including both the central bank and commercial banks.

Fiat of Money : It refers to money by order or authority of the government.


It includes notes or coins.

Fiduciary Money : It refers to money backed up by trust between the payer and the payee. Cheques are fiduciary
money as these are accepted as a means of payment on the basis of trust.

Statutory Liduidity Ratio : Every bank is required to maintain a fixed percentage of its assets in the form of cash or
other liquid assets called SLR.

Question : Money acts as a yardstick of standard measure of value to which all other things can be compared. Explain :
Answer : Money service as a measure of value in terms of unit of account. Measurement of value was the main difficulty
of the barter system. It acts as a yardstick of standard measure of value to which all other things can be compared.
Money measures the value of everything or the prices of all goods and service can be expressed in terms of money.
This function of money also enables the trading firms to acertain their costs, reveness, profits and losses.

Question : The central bank acts as lender of last resort. How ?


Answer : The central bank also acts as lender of last resort for the other banks of the country. It means that if a commercial
bank fails to get financial accommodation from anywhere, it approaches the central bank as a last resort. It advances loan
against approved securities. As a lender of the last resort, central bank exercises central over the entire banking system of
the country.
Question : Central bank performs the function of a clearing houses. How ?
Answer : Every bank keeps cash reserves with the central bank. The claims of banks against one another can be easily and
convinently settled by simple transfers from and to their account. Supposing, Bank A receives a cheque of Rs.10,000
drawn on Bank B and Bank B receives a cheque of Rs.15,000 drawn on Bank A. The most convenient method of settling or
clearing their mutual claims is that Bank A should issue a cheque amounting to Rs.5000 in favour of Bank B, drawn on central
bank. As a result of this transference, a sum of Rs.5000 will be debited to the account of A and credited to B. There is no need
of each transactions between the banks concerned. It facilitates cash transactions across the entire banking system, it also
reduces requirement of cash reserves of the commercial banks.

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Central Bank Control Flow of Credit in Economy


Quantitative
(i) Bank rate Policy : The bank rate is the rate at which the central bank gives credit to the commercial banks. In order
to control the volume of credit, the central bank raised its bank rate. It will increase the cost of bourouring by
banks. It will reduce the volume of bank loans and advances. If central bank wants to increase volume of credit, the
central bank fall its bank rate, it will decrease the cost of borrouring by banks. It will increase the volume of banks
loans and advances.

(ii) Open Market Operations : The central bank buys and sells government securities in the open market. When the
central bank wants to contract credit it sells government securities which are sold by commercial banks and
households. It will increase the money of commercial bank and households by which credit creation will be
increased.

(iii) Cash Reserve Ratio : They are required under law to keep with central bank a minimum percentage of their
deposits as cash reserves. This is called CRR When central bank wants to reduces the flow of money, they can
increase the CRR by which there will be less amount remain with the commercial bank. On the other bank,
when central bank wants to increase the flow of money, they can decrease the CRR by which there will be more
amount remain with the commercial bank. It will increase credit creation.

Qualitative :
(i) Margin Requirements : It refers to the difference between the current value of the security offered for loans and
the value of loans granted.

(ii) Moral Suasion : It means persuasion, request and appeal by the central bank to the member banks to expand or
contract credit, as the situation demands. For eg., the central banks may request the commercial bank not to grant
loans for speculative purposes.

(iii) Rationing of Credit : It is another method of selective credit control. Under this, the reserve bank fixed credit
quota for member banks. If the member banks seek more loans than their fixed quota, they will have to pay high
interest.

Central Bank : It is an apex institution of the monetary and banking structure of the country. It regulates the entire
banking system of the country.

Functions :
(i) Bank of Note issue : It has the sole monopoly to issue currency notes. It has an issue department which is solely
responsible for the issue of notes and coins.

(ii) Banker to the Government : It manager accounts of the government banks across all in the country. It keeps
some cash balances of the commercial bank as a compulsory deposit.

(iii) Bankers Bank : Central bank is the bank of all the banks which operates in the country. It keeps some cash
balance of the commercial bank as a compulsory deposit.

(iv) Lender of Last Resort : If a commercial bank fails to get financial accomodation from anywhere, can go to central
bank. It can give advance loans to such a bank.

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(v) Custodian of Foreign Exchange reserves : It also functions as the custodian of all the foreign exchange
reserves key currencies such as US-dollars.

(vi) Controller of Credit : The central bank establishes stability not only in the internal price level, but also in the
foreign exchange rates. It helps in economic growth and smooth functioning of the economy.
Functions of Commercial Bank :
(i) Internet Banking : It facilitates the account holder to operate his account through internet by using his personal
computer.

(ii) ATM Facilities : The ATM machines are being provided by the bank. These machines can be used by the account
holder within the country.

(iii) Credit Cards : Commercial banks issue credit cards to their customers. The card holders can purchase goods and
services from various shops without making cash payments. The card issuing banks make payments immediately
to the sellers but receive the amount from the buyer after 30 to 45 days.

Money and Near Money :


(i) Money consists of coins, currency notes etc near money includes financial assets like time deposits, bonds,
shares etc.
(ii) It possesses 100% liquidity whereas near money lacks perfect liquidity. It has to be converted into money before
spending.
(iii) Money is the common measure of value. Near money on the other hand, does not perform such functions.
(iv) Money does not yield any income whereas near money assets are income yielding assets.

Demand Deposits and Fixed Deposits :


(i) Demand Deposits can be withdrawn by their depositors at any time without notice. Fixed deposits can be
withdrawn only after the expiry of a certain fixed time period.
(ii) Demand Deposit can be withdrawn through cheque but fixed deposits are not chequeable.
(iii) No interest is paid on old and FD carry high rates of interest.
Supply of Money :
It is a stock concept. It refers to total stock of money held by the people of a country at a point of time. It does not include
stock of money held by the government and stock of money held by the banking of a country.

Functions of Money :
(i) Medium of Exchange : Money acts as a means of payments 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. Therefore money reduces trading cost.
(ii) Unit of Value : Monetary unit is a unit in which the values of goods and services are expressed. The value of each
good or service can be expressed in terms of price i.e. the number of monetary units. For eg. If a notebook is worth
Rs.10 and a pen is worth Rs.5 then the note book is worth of 2 pens.
(iii) Store of Value : Money is a best form of reserve. The holders of money are the holders of generalised purchasing
power. It can be spent over a period of time. For eg., Money can be stored in the form of deposits in bank, purchase
of wants and shares, purchase of fixed assets etc. it can be liquified when required.

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(iv) Standard of Deferred Payments : The money can be used for making future payments. It helps in borrowings,
lendings and formulating capital market. For eg., The situation of future payments are pensions, principle and
interest on debt, salaries etc. Here once an agreement is made to pay a certain amount of money then the value
remains fixed as the value of money remains fixed.

Money Supply : It can be defined as total amount of money is the economy held by public at a given point of time.

Constituents of Money Supply :


(i) It is called legal tendor money because it is issued by government. It is of two types. Coins and paper currency
.The metallic value of coins or paper value is much less than their face value. In India Re.1 rupee note or the coins
are issued by Ministry of Finance Govt. of India. The other paper currency is issued by RBI.

(ii) Demand Deposit by Commercial Bank : It is known as bank money. Banks demand deposit are referred to as
money supply because they are transferable by cheques in the settlement of debts. Bank is agreed to pay money
on demand at any time.

Measures Adopted by RBI to Calculate money supply


M1, M2, M3, M4
M1 : C + DD + OD where C = currency held by public
DD = demand deposit of commercial bank and cooperative bank
OD = other deposits held by RBI
[Narrow definition of money supply]
M2 : M1 + Savings with the post office
M3 : M1 + Time deposits of all commercial and coorperative banks.
(known as aggregate monetary resources of India and in using it to calculate money supply)
M4 : M3 + total savings with post office saving organisations.

Credit Creation : It is the most important function of commercial banks. Credit plays an important role in the monetary
business system. It adds to the money supply in the economy.

Generally people open their current accounts in the commercial banks and can meet its obligations. But when credit is
granted by the bank, the bank do not give the cash money to the borrowers, they open a loan amount of the borrowers and
the money is transferred to the loan account. In this may bank create credit by advancing loans.

Example :
(a) Suppose banks has total deposit of Rs.1000 [primary deposit]. The bank can analyse that the whole of money is
not demanded at one time. But sum amount of money can be withdrawn anytime.
(b) So, 20% of the deposit that is 200 will be kept as reserve by the bank and the remaining will be given as a loan.
(c) Then remaining amount i.e. 800, will be transferred to the loan account of the borrowers.
(d) Then again 20% of 800 i.e. 160 will be kept as reserve and the remaining will be given as loan.
(e) So, at the end of this process with the primary deposit i.e. 1000, the bank can create the total deposit of 5000.

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Macro-Economics Vidyamandir Classes

1
Credit Creation = Primary deposit
CRR
100
1000 = Rs.5000.
20

(c) Government Budget and Economy


Budget : It means the annual financial statement containing an estimate of all anticipated revenue and expenditure of the
government for the coming financial year.

Features of a Budget :
(i) It is a statement of expected revenue and proposed expenditure.

(ii) It requires some authority to sanction it.

(iii) It is annually prepared.

Public Expenditure : It refers to the expenditure incurred by the government for the satisfaction of collective needs of
the people.

Types of Public Expenditure :


Revenue Expenditure

Capital Expenditure

(a) Revenue Expenditure : It is the expenditure incurred for the normal running of the government departments and
provision for various services. It includes expenditure like expenditure on civil administration, public health etc.

It neither creates assets for the government nor reduction in the libilities. It is of recurring nor reduction in the
liabilities. It is of recurring type. It is called non-development expenditure.

(b) Capital Expenditure : It refers to expenditure which leads to creation of assets or reduces liabilities. It is a
non-reducing type of expenditure. It is called development expenditure. Expenditure on acquisition of assets, land
and building etc.

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Vidyamandir Classes Macro-Economics

Difference between Tax and Price :


(i) Tax is a compulsory contribution to be paid by every citizen upon whom it is imposed, whereas the price is to be
paid by the persons who purchase goods and services produced by the government.
(ii) The payments made by tax is used in the public interest without specific person whereas goods and services are
available to those persons only who pay price.

Objectives of Government Budget :


(i) Increase in Government Activities : The activities of the government have increased. Therefore, large
resources have to be mobilized to meet the expenditure required to perform those activities. All this cannot be
conducted properly without a budget.
(ii) Solving Various Problems : Budget is an important instrument of promoting economic development and solving
various problem facing the economy like problem of inflation and deflect in the balance of payments etc.
(iii) Reduction in Inequalities of Wealth and Income : The budgetary policy can be used to reduce inequalities in
the distribution of wealth and income. The imposition of progressive taxes and death duties would secure funds
for the government which would be utilized for the welfare of weaker sections of the society.

How Deficit in Budget be Financed :


(a) Printing on New Notes : By printing of new notes deficit can be financed. The RBI issue currency to government
and government returns this money in the form of treasury bills.
(b) Borrouring from the Public : By borrouring from the public, deficit can be financed. This involves the burden of
interest payments.
(c) Disinvestment : The government may choose the sell its existing shares. This process is popularly known as
Privatisation.
Tax : It is compulsory payments imposed on the persons or companies by the government to meet the expenditure
incurred on providing common benefits to the people.

Types of Taxes :
(i) Direct and Indirect Taxes (ii) Proportional, progressive and regressive

(iii) Specific and advalorem takes

Proportional Tax : Taxes in which the tax rate remains constant whatever size of the tax base may be.
Progressive Tax : Taxes in which the rate of tax increases are called progressive taxes. In India income tax is a progressive
tax.

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Regressive Tax : When the rate of tax decreases as the tax base increases the tax are called regressive tax.

Deficits in Government Budget :


Budgetary Deficit : It represents excess of all expenditure on both revenue and capital accounts over all receipts on
revenue and capital accounts including borrourings by the central government.

There are three types of depicit :

(a) Revenue Deficit : It refers to the excess of revenue expenditure over revenue receipts.
Recenue deficit = Total revenue expenditure Total revenue receipts

(b) Fiscal Deficit : It refers to the excess of total expenditure both on revenue and capital accounts over revenue
receipts and only non-borrouring type of capital receipts.

Fiscal Deficit : Total budget expenditure Revenue Receipts non-debt Capital receipts

or Total budget expenditure Total budget non-debt receipts

(c) Primary deficit :

Primary Deficit = Fiscal Deficit Interest Payments

Balanced Budget : A budget is said to be balance when revenue and expenditure are equal.
Unbalanced Budget : If expenditure exceeds revenue, the budget will be unbalanced. The unbalanced may be due to
an excess of expenditure over revenue, this budget is called deficit budget or may be due to an excess of revenue over
expenditure, this budget is called surplus budget.

Components of Budget :
(i) Budget receipts (ii) Budget Expenditure

(i) Budget Receipt : It refer to the estimated money receipts of a government from all sources during a fiscal year.
Budget receipts can be of two types : revenue receipts and capital receipts.

(a) Revenue Receipts : These are those receipts of the government which neither create any liability for the
government nor cause any reduction in the assets of the government. For example : tax is a revenue receipts
as it does not create any liability for the government.

(b) Capital Receipts : These are those receipts of the government which either creates any liability for the
government or cause any reduction in the assets of the government. These include items of non-routine
nature.

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1mark Questions :
1. Why is tax-treated as revenue receipts ?
Ans: Because tax neither create a liability for the government nor reduces assets of the govt.

2. What indicates zero primary deficit ?


Ans: Zero primary deficits means that the government has to resort to borrourings only to make interest payments.

3. Classify the borrourings and recovery of loans into revenue and capital receipts of govt. budget ? Give reason.
Ans: Borrouring on capital receipts because the government is under obligation to return the amount along with
interest so it creates liability of the govt. Recovery of loans is also a capital receipt because these reduce assets
of the govt.

4. What indicates zero primary deficit ?


Ans: It means that the government has to resort to borrourings only to make interest payments.

5. What will be the value of fiscal deficit if primary deficit is Rs.53000 crores and intt. on borrourings is
Rs.5000 crores ?
Ans: Fiscal defifit = Primary deficit + Interest Payment
= 53000 + 5000
= 58000 crores

6. Can there be capital deficit without revenue deficit ?


Ans: Yes, this can happen and can prevail without revenue deficit. The possibilities are :
(i) Revenue budget is balanced with (Revenue Expenditure = Revenue Receipt)
and capital budget is in deficit (Capital Expenditure > Capital Receipt)
(ii) The surplus in revenue budget (Revenue Receipt > Revenue Expenditure)
is less than the deficit in capital budget (Capital Expenditure > Capital Receipt)
Classifications of Government Expenditure :
(a) Developmental : It refers to expenditure on activities that are related to economic and social development of the
country. It adds to the flow of goods and services in the economy. For eg. Expenditure on education, health,
rural development, scientific research etc.

(b) Non Developmental : It refers to expenditure incurred on essential general services of the government. It helps in
smooth functioning of an economy. It does not adds to flow of good and services.

(c) Planned : It is that public expenditure which represents current development and investment that arise due to plan
proposal. For eg., infrastructure development.

(d) Non-Planned : It refers to expenditure provided in the budget for routine functionining of the government. For eg.,
expenditure on emergency needs, subsidies, pensions etc.

How is Deficit Met by :


(i) Monetary expansion i.e. printing of currency notes by RBI.

(ii) By borrouring from internal sources (public) through issuing bonds and shares and external sources (IBRD, IMF).

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(iii) Disinvestment [a part or a whole of the govt. sector)

(iv) Reducing government expenditure.

(v) Increasing government revenue by increase in taxes.

Fiscal Deficit with its Implication :


It is defined as excess of total expenditure over total receipts excluding borrourings.

Fiscal Deficit = Total Expenditure Total Receipts

Debt capital receipt = Borrourings

Non-debt capital receipt = Rocovery of Loans + Disinvestment

Implication :
(a) It measures the amount of borrourings required by the govt. and extent of govt. dependance on others to meet its
budget expenditure.

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(b) Govt. borrours from RBI i.e. deficit financing which leads to increase in circulation of money and causes inflation.
(c) Indebatness : govt. borrourings from rest of the world which increases the dependance on other countries and effect
the growth and development. This increases the financial burden on future generation to pay loans and interest
amount.

(d) Debt Trap : As the govt. expanditure increases, its liability in future to repayloan with interest also increases.
The increase in interest amount leads to increase in revenue expenditure. Increase in revenue expenditure leads to
increase in revenue deficit. The gap between revenue receipt is met by borrourings.

Revenue Deficit with its Implication : It refers to excess of total revenue expanditure of the government over its
total revenue receipts.

Revenue Deficit = Total Revenue Receipt Total Revenue Expenditure

Implication :
(a) It indicates the dissavings on government account because the government has to make the uncovered gap by
drawing capital receipts i.e. either through borrourings or disinvestment.

(b) Revenue deficit results in government liabilities and decrease in government assets and therefore increases the
repayment burden in future.

(d) Balance of Payments


Foreign Exchange Rate
Foreign Exchange : It refers to all the currencies other than domestic currency of a given country.

Foreign Exchange Rate : The rate at which one currency can be converted into another currency. Suppose 1 US dollar can
be obtained by paying INR 50, then the foreign exchange rate is 1 US dollar = 50 INR ,
1 pound = 70 INR.

Types of Exchange Rates : The conversion rate between two currencies is decided by :
(i) Government (ii) Market

(a) Fixed Exchanged Rate : If the government decides the conversion rate, it is called fixed exchanged rates. Such a rate
does not vary with changes in demand and supply of foreign currency. Only government has the power to change it.

(b) Floating Exchange Rate : If the market forces determined the conversion rate, it is called floating exchange rate,
this rate varies with changes in demand and supply of foreign currencies. There is a well organised foreign exchange
market in a country having floating exchange rate.

(c) Managed Flating Rate : This system of exchange rate have emerged recently. This is essentially a floating rate, it is
called managed because the centralbank tries to influence the rate by entering the market as a bulk buyer or seller.

When the central bank finds floating rate too high, its start selling foreign exchange from it reserves to bring down the
rate.

When it finds the rate too low it starts buying to raise the rate. This kind of floating is also called dirty floating rate.

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Sources of Demand and Supply of Foreign Exchange


(i) Sources of Demand of Foreign Exchange : Indias demand for US dollar arises because Indians want to buy things
whose prices are quoted in US dollar. Those who demand US dollars in India are holders of Indian rupee seeking them
to exchange them for US dollar.
There are many sources of demand :
For improving goods and services.
For making transfer payments in form of gifts, donations etc.
For making income payments in form of profit, dividend etc.
For making investment abroad in financial and physical assets.
For lending money and for making the payments to foreign countries.

(ii) Source of Supply in Exchange Rate : The supply of US dollars in India comes from those who earn these dollars by
selling goods and services to the countries to make payments in US dollars. There are many sources of supply of
foreign exchange :
From exporting goods goods and services.
From transfer payments in the form of gifts, remittances.
From income receipts.
From investments in financial and physical assets from rest of the world.
From borrouring money and receiving re-payements from foreign currencies.

Determination of Foreign Exchange Rate in Free Market :


It is determined by demand for and supply of a given currency on foreign exchange rate (market).

Relation of Price and Demand :


There is an inverse relation between price of foreign exchange and demand for that foreign exchange in terms of domestic
currency.
The higher the price, the lower is the demand for foreign exchange and the lower the price, higher is the demand
eg. : The higher price of US dollars in India, the lower is likely to be its demand.
At a lower price of US dollar India is likely to buy more goods from USA, this raises the demand for US dollars so, lower the
price of US dollars, the higher is the demand for US dollars.

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Demand curve is normally downward sloping at price OP0, demand for foreign exchange is (PO), at lower price OP1, demand
is (F1) which is higher. At higher price (P2), demand is lower (F2).

Relation betwen Supply and Price : There is a direct relationship between price of exchange and supply of that foreign
exchange. The higher the price, the higher is the supply, the lower the price, the lower will be supply.

The supply curve is normally upward sloping at price PO, supply for foreign exchange is F0, at lower price P1, supply is
F1 i.e. lower. At higher price P2 supply is F2 is higher.

Determination for Foreign Exchange Rate : Like the price of a good foreign exchange is also determined by the
forces of demand and supply of foreign exchange. There are organised foreign exchange markets in every country where
buyers and sellers meet and bargain.
The price that prevails at a particular point of time is the equilibrium exchange rate. This equilibrium occurs at that rate at
which the quantity demanded by a foreign currency equals the quantity supplied of that currency.

The price of foreign exchange is determined at the intersection of demand and supply curves relating to foreign exchange.
OP is the market demand and OF is the demand and supply of foreign exchange at this rate.

Appreciation of Currency : It means rise in the external value of a currency. If today 1 dollar can be exchange at Rs.45
and after one month, 1 dollar is exchanged at Rs.40 then we can say that there is appreciation in the value of an Indian
currency.

Depreciation of Currency : It means falls in the external value of a currency. If today 1 dollar can be exchanged at
Rs.45 and after one month, 1 dollar is exchanged at Rs.50 then we can say that there is depreciation in the value of
Indian currency.

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Balance : Means the difference between the sum of credits and sum of debits.

Balance of Trade : Expert of goods Import of goods

Balance on current account = sum of credits Sum of debits

A deficit in BOP occurs when during the year autonmous inflow of foreign exchange.

Autonomous Transaction (Above the line Current account)

A BOP transaction independent of all other BOP transactions.

Accommodating Transaction (Below the line Capital account)

Questions :
1. Why is supply curve a positive sloped curve ?
Ans : As rate of exchange increases the demand for US $ also increases and vice versa. It is become as rate increases the
home countrys goods become more cheaper for the foreigners and supply is more for US $.

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As the rate increases from Rs.46 to Rs.47, then the supply of US $ also increases from 8 to 10 units, Here units the increases
in exchange rate, the rupee value is depreciating.

2. Define depreciation of currency ?


Ans : It is defined as decrease in the value of currency in terms of another currency.
1 US $ = Rs.46
US $ = Rs 47
Here, rupee value is depreciating

3. Define appreciation of currency.


Ans : It is defined as increase in the value of currency in terms of another currency.
1 US $ = Rs.46
US $ = Rs 47

4. Define balance of capital account.


Ans : It records the changes in financial assets and financial liabilities at a particular point of time. It includes :
(a) Investment : It comprises of investments from abroad in share of Indian companies in real state.
(b) Borrouring and lending : It includes all borrourings and lendings from and to abroad by private individuals,
institutions, government etc. It also include loan repayment by foreigners etc.
(c) Changes in foreign exchange reserve : There are the financial assets of the government held in the central bank which
consists of gold, foreign exchange and special drawing rights.

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5.

6.

(e) Determination of Income & Employment


Assumptions
(a) It is a theory of short period i.e. the concept of EXANTE (Planned) and EXPOST (Actual).
(b) Price is constant (perfect competition) and constant marginal physical product.
(c) Supply is perfectly elastic.
(d) Demand creates supply.
(e) No foreign sector (NFIA = 0)

Aggregate Demand :
It is defined as the total demand for final goods and services planned to be purchased by all sectors of economy at a given
level of income in a period of time.

Components :
AD = Consumption + Investment
These components can be understood in four parts :
(a) Private consumption demand (b) Government demand for goods and services

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(c) Private Investment demand (d) Demand for net exports

(a) Private Consumption Demand : It means planned demand for final consumer goods and services by
households during a period of time. It is influenced by the disposable income of the households. From the income
the consumer consumes and the rest he saves.

(b) Govt. Demand for Goods and Services : It means planned consumption expenditure of general government
on providing free services to the people and on capital formation during a period. Eg. services of law and order,
defence, education, health, sanitation, roads, flyovers, railways etc.

(c) Private Investment Demand : It means planned expenditure on making addition to capital goods by private
producers during a period of time. For eg. expenditure on fixed assets and inventeries. Investment is categorised
into two parts :
(i) Induced (ii) Autonomous

(d) Demand for Net Exports : It means the planned net foreign demand for the goods and services produced in the
country during a period. Generally net export demand is a small proportion. Therefore, the Keynes has ignored this
component.

Aggregate Supply : Total value of final goods and services produced in the given period of time.

Component :
National Income = Consumption + Savings

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The value of this output is equal to the cost planned to be incurred on producing this output which the producer expects
to recover during this period. The cost includes the payments to the factors of production i.e. rent, wages, interest, profit.
Rent + Wages + Intt. + Profit = NNPFC ignoring NFIA

Propensity to Consume : It is a functional between consumption and income.


c = f (y)
c = Consumption
f = function
y = Income
(i) When income is zero, consumption is positive. It is known as autonomous consumption.
(ii) When income increases, consumption also increases but at a lesser rate.

Schedule :

It is known as kenes fundamental psychological law.


Propensity to consume can be explained through following equation.
c c by
where c : Consumption function
c : Autonomous consumption
b : Rate of change in consumption in respect to
y : Level of income

Schedule :

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Behaviour of MPC :
MPC changes between 0 to 1
0<b<1
(i) When income is zero consumption is positive. Therefore, MPC can never be zero.
(ii) When income increases, consumption also increases but at a slower rate.
Therefore, MPC can never be 1 or greater than it.

Propensity to Save : It is a fundamental relationship between saving and income


C = f (y)
(i) When income in zero, consumption is positive and saving is negative.
(ii) When income increases, consumption increases at a lesser rate, saving increase at a higher rate. This can be explained
through equation.
y=C+S
S=yC


S = y C by
S = y C by
S = C y by

S = C y 1 by
when income is zero.

Propensity to consume is studied into two parts :


(i) Marginal propensity to consume (MPC) (ii) Average propensity to consume (APC)

Marginal Propensity to Consume : The ratio of change in consumption to change income.


C
MPC
y

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For eg., If the national income of the country increases from 1000 crores to 1200 crores and the consumption increases from
800 crores to 900 crores.
100
Then, MPC 0.5
200
Therefore, a rupee change income causes 0.5 rupee change in consumption.

Average Propensity to Consume : It is the ratio of consumption to income i.e. the proportion of income spend on
consumption.
C
APC
y
For eg., If nationalincome of the country is 1000 crores and the consumption is 800 crores.
800
APC 0.8
1000
Therefore, the economy 80% of its income.

S C y 1 by
whereas S = Savings function

C = Dissaving
(1 b) = Rate of change in saving in respect to

y = level of income

Propensity to save to divided into two parts :


(i) Marginal propensity to save (MPS)
(ii) Average propensity to save (APS)

Marginal Propensity to Save : It is the ratio of change in saving in income.


For eg., If national income of the country increases from 1000 crores to 1200 crores, and the saving increases from
200 crores to 300 crores, then
300 200 100
MPS 0.5
1200 1000 200
Therefore from a rupee earned 0.5 rupee is saved.

Average Propensity to Save : It is the ratio of savings to income.


S
APS
y
For eg., If the national income of the country is Rs.1000 crores and the saving is Rs.200 crores, then
200
APS 0.2
1000

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Therefore the economy saves 20% of its income.

Questions :
1. Can APC can greater than 1 or equal to 1 or less than 1 Yes or No. Prove the statement.

Ans :

APC is greater than 1 before the break even point (point B) where consumption is greater than income.

APC is equal to 1 at break even point where C = I.

APC is less than 1 after break even point.

2. What is the behaviour of MPS ?


Ans : MPS ranges between 0 to 1 because MPC also ranges between 0 to 1.
i.e. when income is zero, consumption is positive ; when income increases at a lesser rate ; if MPC is 0.8 then MPC is 0.2

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Therefore MPC + MPS = 1. It can be proved numerically :

3. APS is negative, APS is equal to 0, is positive but less than 1. Give reasons.
S
Ans : APS can be negative when saving is negative, APS
y
When it is before break even point.
Eg. y C S
80
100 180 80 APS = 0.8
100
APS can be zero when saving is zero, at break even point
Eg. y C S
0
500 500 0 APS = 0
500
APS can be less than 1 but positive because saving is positive beyond break even point.
Eg. y C S
20
600 530 20 APS = 0.3
600
4. APS can never be greater than 1. Prove.
Ans : APS can never be greater than 1 because APC + APS = 1.
APS can never be zero or negative and therefore APS can never be greater than 1.

5. What is the relationship between APS and APS ?


Ans : y = C + S
Dividing both sides by common factor y is income.
y C S

y y y
1 = APC + APS

6. What is the relationship between MPC and MPS ?


Ans : y = C + S
Also y = C + S
Dividing both sides by the common factor y
y C S

y y y
1 = MPC + MPS

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Income Determination of an Economy


There are two approaches to explain the determination of national income :
At equilibrium : AD = AS
C+I=C+S . . . .(i)
I=S
(a) Consumption and Investment Approach
(b) Saving and Investment Approach

Consumption and Investment Approach :

The line (C + I) i.e. aggregate demand and the 45line depicts the equilibrium level of national income. The 45 line enables
us the identify the equilibrium because here planned planned output (A.S.).
Important Terms :
(a) Exante Saving Investment : In an economy what we plan to save during a particular period, it is known as
planned saving whereas what we plan to invest during a particular period, it is known as planned investment.
(b) Expost Saving and Investment : In an economy what we actually save is export or realised saving and what are
actually invest is called export investment or realised investment.
Actual Investment = Planned Investment + Unplanned Investment
(c) Full Employment : It means maximum efficient utilisation of the economics available resources i.e. every able
body who is willing to work in the current wage rate is employed.
(d) Voluntary Unemployment : It refers to the population which prefer not to work at the prevailing wage rate.
They are not the part of labour force.

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(e) Involuntary Unemployment : It refers to a situation in which all able person who are willing at work at current
wage rate cannot get work. According to kenes it is due deficiency of aggregate demand. It is due to wage price
rigidity and constant marginal physical product.

Case 1 : A. D. > A.S.


The economy is at a level of output less than equilibrium level M i.e. loint P. At this point C + I line lies above the 45 line.
Here planned spending is greater than planned output. This would lead to unplanned decrease in stocks. Firm will increase
employment, output. This process of increase in output will continue till the economy reaches to equilibrium i.e. point M.
Here planned spending is equal to planned output.

Case 2 : A.D. < A.S.


The economy is at a level of output greater than equilibrium level M i.e. at point N. At this point C + I line lies below the
45 line. Here planned spending is less than planned output. This would lead to unplanned increase in unsold stock.
Firm will decrease employment, output. This process of decrease in output will continue till the economy reaches to
equilibrium i.e. point M. Here planned spending is equal to planned output.

Saving and Investment Approach :

Case 1 : S < I
The economy is at a level of output less than M i.e. point P. At this level of income, the saving function lies below the
investment schedule. At this level of income households are saving an amount less than firms plan to invest. The effect
of this is reduction in inventories. The firm will increase the production, employment. The economy returns to equilibrium
output level M. Here planned saving is equal to planned investment.

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Case 2 : S > I
The economy is at a level of output greater than M i.e. point N. The saving function lies above the investment schedule.
At this level of income the households are saving more then the firms plan to invest. The effect of this will lead to
unplanned increase in inventories. The firm will reduce the production, employment. The economy returns to equilibrium
output level M. Here planned saving is equal to planned investment.
Multiplier : It is a measure of change in national income as a result of initial change in investment.
y
k
I

Multiplier shows that a change in investment i.e. by I, income increases by a greater income i.e., y.
For eg., If an increase in investment is Rs.100 crores which causes an increase in income of Rs.300 crores then the
multiplier is
y 300
k 3times
I 100
Relationship between Multiplier and MPC
(i) The value of multiplier is determined by MPC. Higher the MPC, greater is the size of multiplier. Lower the MPC,
smaller is the size of multiplier.
1
k
1 MPC
(ii) Expenditure of one individual is the income of other. When investment increases, income of the people also
increases. They spend a part of the increased income on consumption and the rest they save.
(iii) How much of their income, the people would spend on consumption will depend on MPC.
(iv) If MPC is more, it will generate income for another.
(v) Therefore, increase in investment does not cause increase in income in the same same proportion rather increase
in income is more than initial increase in investment.
(vi) The factor by which the income increase depends upon MPC. Therefore, higher than MPC, higher is the value of
multiplier.

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Short Run fixed Price Analysis : Exante demand for final goods : In an economy without a government and foreign
trade, exante aggregate demand (planned aggregate demand) for final goods i.e. the sum total of exante consumption
expenditure and exante investment expenditure on final goods. AD = C + I.
It is measured by summing up the consumption f (x) and constant investment (autonomous investment)
AD = C + I

AD C by I
In case of exante investment expenditure, the assume constant price (rate of interest) over a short period of time to
determine level of aggregate demand
At equilibrium AS = AD
Income = AD

= C by I

C = Autonomous consumption
I = Autonomous investment

Deficient Demand : It can be when aggregate demand falls hort of aggregate output at full employment level.

Q* = Full employment output level


Point F = Full employment equilibrium
FG = Deflationary gap
Point E = Underemployment equilibrium
(a) At output level Q* the economy is at full employment level i.e. all the resources are fully utilised.
(b) Suppose the AD falls from point F to point G known as deficient demand will lead to unplanned increase in stock.
(c) This will create involuntary unemployment due to it ,the production will reduce.
(d) The national income will decline till the new equilibrium point is achieved i.e. point E known as underemployment
equilibrium.
(e) The gap due to deficient demand at full employment level is known as deflationary gap.

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Deflationery Gap : It is the difference between actual aggregate demand and required aggregate demand at full
employment level. It is negative for our economy.
Excess Demand : Where AD > AS, at full employment level, it is known as excess demand.

Q* = Output level
FG = Inflationery gap
Point F = Full employment equilibrium
Point E = Over employment equilibrium
(i) At output Q*, the economy is at full employment level. At point F is full employment equilibrium.
(ii) Suppose the AD increases at full employment level i.e. point from F to G. The economy will face inflationary
pressure.
(iii) The rise in price will lead to rise in national income.
(iv) This increase in national income is due to rise in price i.e. increase in nominal national income and not due to
increase in quantity produced i.e. real national income.
(v) The rise in national income will lead to new equilibrium position i.e. point E known as over employment
equilibrium.

Policies to Correct Deficient Demand :


1. Monetary Policy : It is the policy adopted by Central Bank (RBI) to control the supply of money and credit
availability in the economy to achieve economic stability.

(a) Quantitative :
(i) Bank Rate : It is the rate at which the Central Bank leads to the commercial bank. To check depression,
the central bank reduces the bank rate. It enables the commercial bank to take more loan from it and in
turn give more loans to the producer at a low rate of interest. It increase the investment demand and
therefore, aggregate demand which eliminates the deflationery gap.

(ii) Open Market operations : It refers to buying and selling of the securities by the Central Bank. Central
Bank purchases govt. bonds and securities from commercial bank by payment in cash, which increases
the cash stock with commercial bank. It increases the lending capacity and therefore increases the
investment and aggregate demand.

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(iii) Legal Reserves : There are two types of legal reserves : CRR and SLR
CRR : It is the minimum percentage of deposits kept by the commercial banks with the central bank.
In deficient demand, it is reduced.

SLR : It is the minimum percentage of deposits to be kept by the commercial bank with itself is called SLR.
The SLR is reduced to correct the problem of deficient demand.

(b) Quantitative :
(i) Margin requirements : It refers to the difference between the current value of the security offered for
loans and the value of loan granted. In case of deficient demand the central bank reduces the margin.
Thereby increasing investment demand and finally aggregate demand.

(ii) Moral Suasion : The central bank appeals to the commercial bank to encourage lending to the selected
sector to expand credit.

2. Fiscal Policy : It is a budgetary policy of the govt. related to revenue expenditure of the govt. to correct the problem
of deficient demand.

(i) Govt. Expenditure : Deficient demand can be corrected by increasing the level of govt. expenditure by an
amount equal to deflationery gap. The expenditure is either consumption or investment expenditure.

(ii) Deficit Financing : It is increased to increase the purchased power in the economy.
(iii) Taxes : The taxes are decreased in case of deficient demand. The govt. adopts progressive taxation policy i.e.
higher the income higher than taxes. The MPC of the rich people is lower as compared to the poor.

* Opposite of all deficient demand is for the excess demand.

Money Multiplier : New deposits in banks leads to creation of more deposits by banks. Total deposits is many times the
initial deposits. The multiple by deposits can increase due to an initial deposit in called money/deposit multiplier.
The value of money multiplier is determined by LRR.
1
Deposit multiplier =
LRR
20
It suppose LRR = 20%, deposit = 0.2
100
1 1 1 10
Multilier = 5
LRR 0.2 0.2 2
10

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Working :

1. New deposits of Rs.1000 is made in Bank. LRR = 20%. The bank keeps 20% deposits as cash, so Rs.200 as kept as cash
reserve and bank lends the remaining amount of Rs.800.

2. Lending means that bank create deposits of Rs.800 in the name of the borrouers. This is the first round creation and
is equal to 80% of the initial deposit.

3. Borrouer withdraw the entire amount of loan and spend the same on goods and services.

4. The seller of the goods and services receives Rs.800 of revenue and deposit the same in their respective bank.

5. The bank gets new deposits and keep the 20% and lend the remaining amount of Rs.640. This is the second round
increase. It is 80% of previous round increase.

Legal Reserve Ratio : It is that fraction of deposits with the commercial bank which is legally compulsory for the
banks to keep in the form of cash. Eg.: A bank has a deposit of 100 lakhs and the LRR = 20%, it means bank must hold
Rs.20 lakh as cash.

Concept of LRR with examples :


When people make demand deposits, they are free to withdraw part of whole of the amount as and when they like.

The bank do not keep the entire deposit in the form of cash as by doing so, it will not earn any profit.

The banks keeps only a fraction of deposits as cash and use the remaining for giving loans.

At any point of time, the bank has to meet the withdrawl demand of the depositor failing which a legal violation
of contract arises between depositor and bank.

It is because from experience it is found that not only depositor withdraw money at the same time and that they
withdraw any fraction of deposits.

At the same time, they continue to make new deposits. Therefore, there is no need for banks to keep the entire
amount as cash, they banks can easily meet the daily withdrawl of the depositors.

Components of Legal Reserve Ratio :


(i) SLR : The fraaction of deposits which banks are required to keep as cash within the bank itself.
(ii) SRR : The fraction of deposits the banks are required to keep with the central bank.
6. Like this creation in each of the further round will be 80% of the previous round. In each round, the increase becomes
smaller and smaller and ultimately, it becomes zero.

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8. The sum total of all deposits will ultimately be Rs.5000 i.e. 5 times the initial deposits.

Money Creation by Commercial Banks : There are two components of money :

Supply :
(i) Currency with public

(ii) Demand deposits with commercial banks currency is created by central bank of country because it has sole rights of
using notes. This currency is called high powered money. Demand deposits are created by commercial banks and are
called bank money.

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1 MARK QUESTIONS MICRO & MACRO ECONOMICS

1. Explain how scarcity and choice go together.


Ans. Scarcity of resources having alternative uses compels every individual and society to make choice in the use of resources
in order to obtain maximum satisfaction. Clearly, choice arises due to scarcity. Thus, scarcity and choice go together.
2. How are central problems solved in an economy?
Ans. By price mechanism because it is the market price which guides the producers what, how and for whom to produce.
3. Define the production possibility curve (PPC).
Ans. PPC shows all combinations of two goods that can be produced with available technologies and given resources which are
fully and efficiently employed.
4. What does a point below PP curve indicate?
Ans. It indicates under-utilisation and inefficient use of resources reflecting fall in output.
5. What does a point on PPC indicate?
Ans. It indicates full employment and efficient use of resources.

6. Why is a PP curve concave?


Ans. PPC is concave because of increasing marginal opportunity cost.
7. What does a rightward shift of PP curve indicate?
Ans. It indicates growth of resources of technological improvement.
8. What is microeconomics?
Ans. It is that part of economic theory which deals with the individual parts of the economic system like individual households,
individual firm, etc.
9. What is macroeconomics?
Ans. It is that part of economic theory which studies economy in its totality, i.e., it studies broad aggregates like national
income, employment, price level, etc.
10. What do you understand by positive economic analysis?
Ans. Positive economic analysis deals with things as they are (i.e., actuals).
11. What do you understand by normative economic analysis?
Ans. Normative economic analysis deals with thing as they ought to be (i.e., ethics).
12. Can a PP curve be a straight line? State reason.
Ans. Yes, if marginal rate of transformation (MRT) is constant. It means that for every unit increase in production of one good,
sacrifice of units of production of other good remains the same. This is possible when resources are equally efficient in
production of different goods.
13. Why is MRS always diminishing?
Ans. Because for every increase in quantity of good 1, the consumer will be willing to sacrifice lesser quantity of good 2.
14. Name two determinants of demand.
Ans. (i) Price of the goods itself, (ii) Income of the consumer
15. Define change in quantity demanded.
Ans. When change (rise or fall) in quantity demanded is caused by change in price of the commodity itself, it is called change in
quantity demanded. It graphically implies movement along a demand curve.
16. What causes upward movement along a demand curve?
Ans. Fall in price of the commodity itself causes downward movement along a demand curve.

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17. If a product price increases, a familys spending on the product has to increase. Comment
Ans. The answer depends upon two factors, namely, (i) Elasticity of demand, and (ii) Availability of substitute. If demand for
the product whose price has increased is inelastic and the product has no substitute, a familys spending will increase. On
the other hand, if demand is elastic or the products substitutes are available, a familys spending need to increase.
18. What is meant by cross price effect? Give two examples.
Ans. It is the effect of change in price of one product on quantity demanded of other product. For example, when price of petrol
rises, demand for cards falls. When price of coffee rises, demand for tea rises. Cross price effect happens in case of related
goods.
19. If price of good x rises and it leads to an increase in demand for good y, how are the two goods related?
Ans. The two goods are complementary to each other.
20 Will the total expenditure change in the opposite direction or same direction of price change if % change in quantity is (i)
greater than (ii) less than % change in price of the commodity?
Ans. (i) Total expenditure will change in the opposite direction of price change if % change in quantity > % change in price and
(ii) in the same direction of price change if % change in quantity < % change in price.
21. What will you say about MPP of a factor when TPP is falling?
Ans. MPP is negative ().
22. What will you say about MPP of a factor when TPP is rising at diminishing rate?
Ans. MPP is falling but remains positive.
23. When MPP is falling and is positive, at what rate TPP is changing?
Ans. TPP is rising at a diminishing rate.
24. When APP falls, what is the relation between MPP and APP?
Ans. MPP is less than APP.
25. What happens to TPP when MPP of the variable input is negative ()?
Ans. TPP falls when MPP is negative.
26. When APP rises, what is the relation between MPP and APP?
Ans. MPP is greater than APP.
27. When APP is maximum, what is the relation between MPP and APP?
Ans. MPP is equal to APP.
28. What does division of labour mean?
Ans. it refers to allocation of tasks (work) among workers according to their specialisation.
29. What are volume discounts?
Ans. It is discount (deduction) on price when a large quantity is purchased.
30. The following table gives MPP of factor. It is also known that TPP at zero level of employment is zero. Determine its TPP
and schedules.
Level of employment 1 2 3 4 5 6
MPP 20 22 18 16 14 6

Ans. TPP 20, 42, 60, 76, 90, 96; APP 20, 21, 20, 19, 18, 16

31. The following table gives APP of a factor. It is also known that the TPP at zero level of employment is zero. Determine
TPP and APP schedules.
Level of employment 1 2 3 4 5 6

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APP 50 48 45 42 39 35

Ans. TPP 50, 96, 135, 168, 195, 210;APP 50, 46, 39, 33, 27, 15
32. Do ATC and AVC curves intersect? Give reasons.
Ans. ATC curve and AVC curve do not intersect each other because the difference between ATC and AVC is AFC which is
always positive.
33. Why is MC curve in short run U-shaped?
Ans. MC curve in short run is U-shaped due to operation of law of returns (i.e., law of variable proportion). As output is
increased, MC first falls, reaches its minimum and then rises due to operation of increasing, constant and diminishing
returns in production.
34. Increasing and decreasing returns to scale respectively imply downward and upward slopping portion of long run average
cost (LAC) curve. Comment
Ans. The above statement which reflects U-shape of LAC curve is defended. U-shape is the result of operation of returns to
scale according to which a firm experiences increasing returns to scale (i.e., diminishing cost) in the beginning, followed
by constant returns and then by diminishing returns to scale (i.e., increasing cost). This makes the LAC curve first sloping
downward and then upward.
35. Why is AC curve U-shaped in the ling run?
Ans. LAC curve is U-shaped because of operation of law of returns to scale.
36. What change will take place in AC if MC is rising?
Ans. AC will also rise because rising MC will pull AC up.
37. Why is AC curve U-shaped in the short run.
Ans. SAC curve is U-shaped because of operation law of returns to a variable proportion.

38. How does AFC behave as level of output is increased?


Ans. AFC decreases as level of output is increased.
39. From the following data on the cost schedule of a firm. Calculate (i) AFC and (ii) AVC of producing three units.
Units of Output (Number) 0 3
Total Cost (Rs thousand) 51 96
Ans. Units of Output TC TFC AFC TVC AVC
0 51 51 ___ ___ ___
3 96 51 17 45 15
40. From the data given below, calculate (a) AFC (b) AVC and (c) MC.
Output (kg) 0 1 2 3 4 5
Total Cost (Rs) 40 100 120 130 150 190
Ans. Output TC TFC AFC TVC AVC MC
0 40 40 ___ ___ ___ ___
1 100 40 20 60 60 60
2 120 40 20 80 40 20
3 130 40 13.3 90 30 10
4 150 40 10 110 27.5 20
5 190 40 8 150 30 40

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41. From the following data for a firm, find (i) AFC, (ii) AVC and (iii) MC.
Output (units) 0 1 2
Total Cost (Rs) 75 95 110
Ans. Output TC FC VC AFC AVC MC
0 75 75 ___ ___ ___ ___
1 95 75 20 75.0 20.0 20
2 110 75 35 37.5 17.5 15
42. Given that total fixed cost is Rs 60, complete the following table.
Output (units) AVC (Rs) TC (Rs) MC (Rs)
1 20
2 15
3 20
Ans. Output AVC TVC TFC TC MC
1 20 20 60 80 20
2 15 30 60 90 10
3 20 60 60 120 30
43. The table given below shows the total cost of a firm at different levels of output. Calculate MC and AVC at each level of
output.
Output (units) 0 1 2 3 4
Total Cost (Rs) 100 160 212 280 356
Ans. Output TC MC TVC AVC
0 100 ___ ___ ___
1 160 60 60 60
2 212 52 112 56
3 280 68 180 60
4 356 76 256 64
44. TFC of firm is Rs 12. Given below is its MC schedule. Calculate TC and AVC from each given level of output.
Output (units) 1 2 3 4 5 6
MC (Rs) 9 7 2 4 8 12
Ans. Output TFC MC TVC AVC TC
1 12 9 9 9 21
2 12 7 16 8 28
3 12 2 18 6 30
4 12 4 22 5.5 34
5 12 8 30 6 42
6 12 12 42 7 54
45. Calculate MC and TC from the following cost schedule of a firm whose total fixed costs are Rs 15.
Output (units) 1 2 3 4
Total Variable Cost (Rs) 10 19 29 49
Ans. Output(Units) TVC(Rs) FC (Rs) TC (Rs) MC (Rs)
1 10 15 25 10
2 19 15 34 9
3 29 15 44 10
4 40 15 55 11

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46. Complete the following table:


Output (units) TVC (Rs) AVC (Rs) MC (Rs)
1 10 ___ ___
___ ___ 8 6
3 27 ___ ___
___ ___ 10 13
47. Why is AR always equal to MR for a competitive firm?
Ans. Because a firm, being a price taker, can sell any amount of its product of this price with the result that with the sale of its
every additional unit, its MR = AR = Price.
48. Why is TR curve facing a competitive firm a straight line passing through the origin?
Ans. TR curve is a straight line because MR is constant and TR increases at the same (constant) rate as increase in units of
commodity sold. Again, it passes through the origin since at zero output, TR is zero.
49. What is price line under perfect competition?
Ans. It is a horizontal line that represents market price facing a competitive firm.
50. What is the shape of total revenue curve under perfect competition?
Ans. TR curve under perfect competition is a straight 45 positive sloped line.
51. What is the effect of increasing TR at a decreasing rate?
Ans. MR falls but remains positive.
52. What is the effect on MR when TR increases at constant rate?
Ans. The MR is constant and positive.
53. From the following schedule, find out the level of output at which producer is in equilibrium. Give reason for your answer.
Output (units) Price (Rs.) Total Cost (Rs)
1 24 26
2 24 50
3 24 72
4 24 92
5 24 115
6 24 139
7 24 165

Ans.
Output Price TR TC Profit MR MC
1 24 24 26 2 24
2 24 48 50 2 24 24
3 24 72 72 0 24 22
4 24 96 92 4 24 20
5 24 120 115 5 24 23
6 24 144 139 5 24 24
7 24 168 165 3 24 26

At output level of 6 units, producer is in equilibrium because at this level producer gets maximum profile (i.e., `. 5) after
which profit falls as more is produced (TR and TC approach). According to MR and MC approach also, at level of 6 units
MR = MC and after this MC becomes greater than MR.

54. Given below is a cost and revenue schedule of a producer. At what level of output the producer is in equilibrium. Give
reasons for your answer.

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Output (units) Price (Rs.) Total Cost (Rs)


1 10 13
2 10 22
3 10 30
4 10 38
5 10 47
6 10 57
7 10 71
Ans.
Output Price TR TC Profit MR MC
1 10 10 13 3 10 13
2 10 20 22 2 10 9
3 10 30 30 0 10 8
4 10 40 38 2 10 8
5 10 50 47 3 10 9
6 10 60 57 3 10 10
7 10 70 71 1 10 14
At 6 units of output the producer is in equilibrium because according to TR and TC approach at 6 units (i) profit is
maximum, i.e. , Rs 3 and (ii) profit falls if more is produced. This satisfies MR = MC condition also because (i) MR = MC
= 10 and (ii) after this MC becomes greater than MR.
55. On the basis of information given below, determine the level of output at which producer will be in equilibrium. Use the
MC and MR approach. Given reasons for your.
Output (units) Average Revenue (Rs.) Total Cost (Rs)
1 7 7
2 7 15
3 7 22
4 7 28
5 7 33
6 7 40
7 7 48
Ans.
Output AR TC MC MR
1 7 7 7
2 7 15 8 7
3 7 22 7 7
4 7 28 6 7
5 7 33 5 7
6 7 40 7 7
7 7 48 8 7
At level of 6 units of output the producer will be in equilibrium because at this level (i) MC = MR and (ii) after this MC
becomes greater than MR.
56. Is condition of P = MC for firms equilibrium in perfect competition different from condition of MR = MC ?
Ans. No, because in perfect competition Price (P) = AR = MR, i.e., price and MR are same in perfect competition.
57. At a particular level of output, a productions MC < MR. What should a producer do to maximise his profit?
Ans. The producer should increase his production to attain equilibrium, i.e., to get maximum profit.

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Vidyamandir Classes Macro-Economics

58. Due to improvement of technology, marginal costs of production televisions have gone down. How will it affect the
supply curve of television?
Ans. The supply curve will shift to the right.
59. What effect does a cost saving technical progress have on supply curve of product?
Ans. The supply curve shifts to the left. (As profit falls due to rise in cost.)
60. If a farmer grows rice and wheat, how will an increase in price of wheat affect supply curve of rice?
Ans. The supply curve of rice will shift leftward. (Because producers will reduce supply of rice and instead increase production
of more profitable wheat.)
61. What is the price elasticity associated with a straight line supply curve passing through the origin?
Ans. Price elasticity of straight line supply curve passing through the origin is equal to one.
62. A new technique of production reduces the marginal cost of producing stainless steel. How will this affect the supply curve
of stainless steel utensils?
Ans. Supply curve of stainless steels utensils will shift rightward because fall in marginal cost means more profit margin with
induce producers to produce more.
63. Because of cyclone in a coastal are, the sea level covers a lot of rice fields. This reduces productivity of land. How will it
affect supply curve of rice of that region?
Ans. Supply curve of rice will shift to the left because fall in productivity of land caused by cyclone will result in fall in
production/ Supply of rice.
64. Can there be some fixed cost in the long run? If not, why?
Ans. No there cannot be fixed cost in the long run because there is no fixed factor/input in the long run.
65. At a particular level of output a producer finds that MC is greater than MR. What will he do to maximise his profit?
Ans. The producer will reduce his production to increase his output.
66. A perfectly competitive firm is price taker and industry the price maker. Comment.
Ans. Under perfect competition, price of a product is determined by equilibrium between demand and supply of the whole
industry. Since every firm has to accept the market price thus determined by the industry, therefore, a firm is said to be the
price taker and industry the price maker.
67. If the firms are earning abnormal profits, how will be the number of firms in the industry change?
Ans. The number of firms will increase in the industry because new firms will be attracted to avail of abnormal profits.
68 What is the relationship between break even price and MC at the long run competitive equilibrium?
Ans. Break-even price = MC at the long run competitive equilibrium.
69. Which point on the long run AC curve does a competitive firm produce in the long run equilibrium?
Ans. At the lowest (minimum) point on the long run average cost curve.
70. What are patent rights?
Ans. Paten right is an exclusive right (licence) granted to a company (or an individual) to produce a particular product or to use
a particular technology for claiming to be discoverer of that particular product or technology.
71. Why MR is less than AR for a monopoly firm?
Ans. Because it can sell more only by lowering the price of commodity. Decreasing price (AR) implies decreasing MR. As
result, MR from sale of successive units will be less than the price (AR).

72. How market demand curve is a constraint facing a monopoly firm?

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Ans. In monopoly as out increases / decreases, price changes according to what consumers are willing to pay along demand
curve. So, market demand curve facing a monopoly firm is a constraint.
73. For a non-viable industry, where does the supply curve lie relative to demand curve.
Ans. The supply curve lies above demand curve.
74. How does an increase in the price of a substitution good in consumption affect the equilibrium price?
Ans. Equilibrium price will increase.
75. How does a cost saving technological process affect the market price and quantity exchange?
Ans. It will cause a rise in market price and a fall in the quantity exchanged.
76. What does the FAD theory of famines say?
Ans. When the available quantity of foodgrains falls leading to a rise in its price, the poor people can no longer afford to by
even minimum quantity of foodgrains for survival. This causes heavy starvation taking the shape of a famine.
77. Why does a surplus emerge in the case of support price?
Ans. Surplus emerges because supply exceeds demand due to support price which is always higher than equilibrium price.
78. What will be the impact on market price and quantity exchanged when:
(i) There is rightward shift in demand curve;
(ii) The demand curve is perfectly elastic and supply curve shifts out (rightward);
(iii) Both the demand and supply curves decrease in the same proportion?
Ans. (i) Equilibrium (market) price and quantity will increase presuming supply to be constant.
(ii) It will lead to decrease in price and increase in quantity transacted.
(iii) Equilibrium price will not be affected but quantity supplied and demanded will decrease in the same ratio.
79. Equilibrium price may or may not change with shifts in both demand and supply curves. Comment.
Ans. (i) Equilibrium price will not change if both the demand curve and supply curve shift in the same direction
(leftward or rightward) in the same proportion.
(ii) Equilibrium price will change if both the demand curve and supply curve shift in the same direction
(rightward or leftward) but in unequal proportion or if demand curve and supply curve shit in opposite
direction.
80. Why is MR less than AR in monopoly and monopolistic competition?
Ans. Because a firm can sell more only by lowering the price of its commodity.
80. What happens to equilibrium price and quantity when :
(i) increase in demand is equal to increase in supply.
(ii) decrease in demand is equal to increase in supply.
Ans. (i) Equilibrium price will not change but quantity supplied and demanded will increase in the same ratio.
(ii) There will be no change in equilibrium quantity but equilibrium price will fall.
81. Suppose the demand and supply curve of a commodity x in a perfectly competitive market are given by :
Qd = 700 P
Qs = 500 + 3P
Find the equilibrium price and the equilibrium
Ans. At equilibrium price Qd = Qs (Quantity demanded = Qty. supplied)
700 P = 500 + 3P
700 500 = 3P + P
4P = 200 or P = 50
So, equilibrium quantity = 700 P
= 700 50

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Vidyamandir Classes Macro-Economics

= 650 (Demand side)


Equilibrium quantity = 500 + 3P
= 500 + (3 50)
= 650 (Supply side)
82. Suppose the demand and supply curves of salt are given by :
Qd = 1000 P
Qs = 700 + 2P
(a) Find the equilibrium prime and quantity.
(b) Now suppose that the price of an infeut used to produce salt increased so that the new supply curve is:
Qs = 400 + 2P
How does an equilibrium price and quantity change?
(c) Supposed that the government and imposed a tax of Rs. 3 per unit of sale. How does it affect the
equilibrium price and quantity?
Ans. (a) At equilibrium price Qd = Qs
1000 P = 700 + 2P
1000 700 = 2P + P
3P = 300 or P = 100
Hence, equilibrium price = Rs. 100
Equilibrium quantity : Qd = 1000 P
= 1000 100 = 900 units
Qs = 700 + 2P
= 700 + (2 100)
= 900 units.
(b) New supply curve is : Qs = 400 + 2P
At equilibrium price : Qd = Qs
1000 P = 400 + 2P
1000 400 = 2P + P
3P = 600 or P = 200
Hence, equilibrium price = Rs 200
Equilibrium quantity : Qd = 1000 P
= 1000 200
= 800 (Demand side)
Qs = 400 + 2P
= 400 + (2 200)
= 800 (Supply side)
(c) New supply curve equation after imposition of tax of Rs 3 per unit of sale is
Qs = 700 + (P 3)
= 700 + 2P 6
= 2P + 694
At equilibrium price : Qd = Qs
1000 P = 2P + P
3P = 306 or P = 102
Equilibrium price has increased from Rs. 100 Rs. 102.
Equilibrium quantity : Qd = 1000 P
= 1000 102 = 898
Qs = 2P + 694
= (2 102) + 694 = 898
83. What are various money stock measures?

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Vidyamandir Classes Macro-Economics

Ans. Following four measures of money stock are used


(i) M1 = C + DD + OD
(ii) M2 = M1 + Saving deposits in post office saving banks.
(iii) M3 = M1 + Net time deposits of banks.
(iv) M4 = M1 + Total deposits with post office saving organisation.
84. What is High Powered Money?
Ans. The total liability of monetary authority of the country (RBI in India) is called High Powered Money or monetary base.
85. What is Reserve Deposit Ratio (RDR) ?
Ans. It is ratio of total deposits which commercial banks keep as reserve.
86. Define liquidity trap.
Ans. It is situation of very low rate of interest where people are ready to hold whatever stock of money is supplied expecting
interest rate to rise in future and bond prices to fall.
87. What is credit money?
Ans. It refers to that money whose value as money (i.e., face value) is more than intrinsic value, i.e., commodity value of the
material money is made of e.g., cheques, drafts, notes, etc.
88. What is meant by demand for money?
Ans. Demand for money is the demand for liquidity, i.e., demand for cash.
89. Which institution performs the function of clearing house in commercial banking system?
Ans. Central Bank, i.e., RBI in India.
90. Name the institution which acts as custodian of nations foreign exchange reserve.
Ans. In India it is RBI.
91. Distinguish between narrow money and broad money.
Ans. Narrow money consists of currency notes and coin (C) and demand deposits (DD) held by public in commercial banks.
Symbolically
M = C + DD
This definition is based on its medium of exchange function. As against it, broad money consists of narrow money + time
deposits (TD) held by commercial banks and Post Office saving organisations.
M = C + DD + TD. This definition is based on store of value function.
92. Why are financial institution like UTI, LIC not considered bank?
Ans. Because such financial institutions do not accept chequable deposits.
93. Why are Post Office savings banks not treated as bank?
Ans. Because they do not perform banks essential function of lending.
94. What are least (i) Repo Rate (ii) Reverse Repo Rate and Cash Reserve Ratio (CRR) in India?
Ans. Since 2009 in India (i) Repo Rate is 4.75% (Repo rate is the rate at which RBI lends short-term funds to banks) , (ii)
Reverse Repo Rate is 4% (Reverse Repo Rate is the rate at which banks part their surplus funds with RBI), and (iii) CRR
is 5.75% w.e.f. February 1, 2010 (CRR is the proportion of money which banks have to keep mandatorily with RBI at nil
rate of interest).
95. In an economy investment increases by Rs. 10 crore. As a result, income increases by Rs. 50 crore. What is the value of
multiplier?
Y (Change in income) 50
Ans. K 5
I (Change in investment) 10
96. Calculate : Change in Income when MPC = 0.8 and Change in Investment = Rs. 1.000.

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1 1 1 1
Ans. K(Multiplier) 5
1 MPC 1 0.8 0.2 1
5
Change in Income = Change in investment K
= 1,000 5 = 5,000
97. MPC in economy is 0.8. If investment is increased by Rs. 5 crore, how much would be the increase in income?
1 1 1 1
Ans. K 5
1 MPC 1 0.8 0.2 1/ 5
Increase in income = Change in investment K
= 5 5 = 25 crore
98. If in an economy MPC is 0.8 and investment is increased by Rs. 1,000 crore, calculate total increase in income.
1 1 1
Ans. K 5
1 MPC 1 0.8 0.2
Total increase in income = Increase in investment K (multiplier)
= 1,000 5 = 5,000 crore
99. In an economy, MPC is 0.75. If investment expenditure is increased by Rs. 100 crore, calculate total increase in income
and consumption expenditure.
1 1 1 1
Ans. K 4
1 MPC 1 0.75 0.25 1/ 4
Total increase in income = Increase in investment K
= 500 4 = 2,000 crore
Total increase in consumption expenditure = 0.75 of 2,000 = 1,500 crore
100. In an economy, investment expenditure is increased by Rs. 400 crore and MPC is 0.8. Calculate total increase in income
and savings.
1 1 1 1
Ans. K 5
1 MPC 1 0.8 0.2 1/ 5
Total increase in income = 400 5 = 2,000 crore
Total increase in saving = 0.2 (= 1 0.8) of 2,000 = 400 crore
101. As a result of increase in investment by Rs. 20 crore, national income increases by 100 crore. Find out MPC.
Y 100
Ans. K 5
I 20
1 1
K or 5
1 MPC 1 MPC
or 5 MPC = 5 1 = 4
or MPC = 4/5 = 0.8
102. In an economy investment increase by Rs. 120 core. The value of multiplier is 4. Calculate MPC.
1 1
Ans. K or 4
1 MPC 1 MPC
4 4MPC = 1 or 4MPC = 4 1 = 3
MPC = 3/4 = 0.75
103. A Rs 200 crore increase in investment leads to a rise in national income by Rs. 1,000 crore. Find out marginal propensity
to consume (MPC).

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Vidyamandir Classes Macro-Economics

Increase in national income 1000


Ans. K (multiplier) 5
Increasein investment 200
1 1
K or 5
1 MPC 1 MPC
or 5 5MPC = 1
5 MPC = 4 (=5 1)
MPC = 4/5 = 0.8
104. An increase of Rs. 250 crore in investment in an economy resulted in total increase in income of Rs. 1,0000 crore.
Calculate the following .
(a) Marginal propensity to consume (MPC). (b) Change in savings
(c) Change in consumption expenditure (d) Value of multiplier.
y 1000
Ans. K 4
l 250
1 1
(a) K or 4
1 MPC 1 MPC
or 4 4 MPC = 1
or 4 MPC = 3
MPC = 3/4 = 0.75 (Also, MPS = 1 0.75 = 0.25)
(b) Change in saving S = Y MPC
= 1000 0.25 = 250 crore
(c) C = Y MPC
= 1000 0.75 = 750 crore
Y 1000
(d) Value of multiplier (K) = 4
l 250
105. In an economy 75% of increase in income is spent on consumption. Investment is increased by Rs. 1000 crore. Calculate.
(a) Total increase in income (b) Total increase in consumption expenditure.
75 3 3 1
Ans. MPC MPS 1
100 4 4 4
1 1
K 4
MPS 1/ 4
Y Y
(a) K or 4 or Y = 4 1000 = 4000
I 1000
Increase in income = 4000 crore
(b) Increase in consumption expenditure, i.e., C
C = Y I
= 4000 1000 = 3000 crore
106. In an economy C = 500 + 0.9Y and I = 1000 (where C = consumption. Y= Income, I = Investment). Calculate the
following:
(i) Equilibrium level of income (ii) Consumption expenditure at equilibrium level of income.
Ans. (i) For equilibrium Y = C + I
Y = 500 + 0.9Y + 1.000 (Substituting values of C and I)
Y 0.9Y = 1,500
0.1Y = 1,500

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Vidyamandir Classes Macro-Economics

1
or Y = 1,500
10
Y = 15,000 (Equilibrium level of income)
(ii) Y=C+I
15,000 = C + 1,000
C = 15,000 1,000
= 14,000
Consumption expenditure at equilibrium level of income = 14,000
107. Given consumption function C = 100 + 0.75Y (where C = consumption expenditure and Y = Nation income) and
investment expenditure Rs. 1,000. Calculate the following.
(i) Equilibrium level of national income,
(ii) consumption expenditure at equilibrium level of national income.
Ans. (i) For equilibrium Y = C + I (i.e., AS = AD)
Y = 100 + 0.75Y + 1,000 (Given C = 100 + 0.75Y)
Y 0.75Y = 1,100
or 0.25Y = 1,100
100
Y 1,100 4, 400 (Equilibrium level of income)
25
(ii) C = 100 + 0.75Y (Given)
=100 + 0.75 4,400
= 100 + 3/4 4,400 = 3,400 (Consumption expenditure)
108. From the following information about an economy, calculate (i) its equilibrium level of national income and (ii) savings at
equilibrium level of national income. Consumption function C = 200 + 0.9Y (where C = consumption expenditure and Y =
National income). Investment expenditure I = 3,000.
Ans. (i) For equilibrium Y=C+I
Y = (200 + 0.9Y) + 3,000
Y 0.9Y = 3,200
or 0.1Y = 3,200
10
Y = 3,200 = 32,000 (National income)
1
(ii) C = 200 + 0.9Y (Given)
= 200 + 0.9Y (Y = 32,000 proved)
9
= 200 + 32,000
10
= 200 + 28,800 = 29,000
Saving = Y (National income) C (Consumption)
= 32,000 29,000 = 3,000
109. Define marginal propensity to save (MPS).
Ans. The ratio of change in saving (S) to change in income (Y) is called MPS.
Symbolically : MPS = S/Y
110. What is multiplier?
Ans. Investment multiplier (K) is the ratio of increased income (Y) due to an increase in investment (I). Symbolically : K =
Y / I.
111. What is deficient demand?
Ans. When aggregate demand is for a level of output that is less than full employment level of output, it is said to be deficient
demand.

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Vidyamandir Classes Macro-Economics

112. What is excess demand?


Ans. When aggregate demand is for a level of output that is more than full employment level of output, then it is known as
excess demand.
113. How does the introduction of government sector affect the economy?
Ans. It impacts the level of aggregate demand through government expenditure and taxes. For example, an increase in
government expenditure increases the level of aggregate demand whereas increase in taxes causes a fall in aggregate
demand.
114. What is the basic difference between two expressions ex-ante and ex-post?
Ans. Ex-ante expression indicates variable before the beginning of even but ex-post expression indicates variable after the end
of the event.
115. Can consumption exceed income? If yes, what is the saving then?
Ans. Yes, consumption can exceed income when income is zero or less than subsistence consumption level. Then there is
negative saving.
116. What is meant by autonomous consumption?
Ans. Autonomous consumption refers to minimum level of consumption needed for survival even when income is zero.
117. Given autonomous consumption ( C ) = 500 crore, MPC (b) = 0.8, write equation of consumption function and determine
value of consumption when income (Y) = Rs. 3,000 crore.
Ans. Equation of consumption is C = C + bY, where C represents consumption function, C autonomous consumption, b
represents MPC and Y is level of income. By substituting values in the equation, we get.
C = 500 + 0.8 (3000)
= 500 + 2400 = Rs. 29,00 crore
118. How is equilibrium level of output determined under short run fixed price?
Ans. Under short run fixed price, equilibrium level of output is determined by level of exante aggregate demand. (It is assumed
that suppliers are willing to supply whatever amount of goods consumers will demand at the fixed price).
119. Define (a) Fiscal deficit (b) Budget deficit
(c) Revenue deficit and (d) Primary deficit.
Ans. (a) Fiscal deficit is defined as excess of total expenditure of government over sum of its revenue receipts and non-
debt capital receipts during a fiscal year.
(b) Budget deficit refers to the excess of total budgetary expenditure over total budgetary receipts (both revenue
receipts and capital receipts) of the government.
(c) Revenue deficit refers to the excess of governments revenue expenditure over its revenue receipts.
120. How can a deficit be financed?
Ans. A deficit may be financed:
(i) by printing new currency, i.e., monetary expansion and
(ii) by borrowing from internal source (i.e., public) and external source (i.e., foreign governments, World Bank)
121. Give two examples of debt creating capital receipts.
Ans. Net borrowing by government at home, borrowing from abroad.
122. Give two examples of non-debt capital receipts.
Ans. Recovery of loan, sale proceeds of public enterprises (i.e., disinvestment).
123. Why are borrowings by government capital receipts?
Ans. Because these create liability of government for repayment of loan.

124. Why is repayment of loan a capital expenditure?

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Vidyamandir Classes Macro-Economics

Ans. Because it reduces governments liability.


125. Why are subsidies treated as revenue expenditure?
Ans. Because these neither result in creation on assets nor reduce governments liability.
126. Can there be a fiscal deficit in a government budget without a revenue deficit? Give reasons.
Ans. Yes (i) When revenue budget is balanced but capital budget shows a deficit or (ii) when there is surplus in revenue budget
but deficit in capital budget is higher than surplus in revenue budget.
127. State three items each of (a) debt creating capital receipts and (b) Non-debt creating capital receipts.
Ans. (a) (i) Borrowing at home, (ii) Borrowing from abroad, and
(iii) Loans from RBI are debt creating capital receipts.
(b) (i) Recovery of loans, (ii) Proceeds from sale of Public sector units, and
(iii) Partial sale government shares in a company.
128. State three implications of fiscal deficit.
Ans. (i) Fiscal deficit, i.e., borrowing creates problems of not only payment of interest but also of repayment of loans.
(ii) High fiscal deficit generally leads to wasteful and unnecessary expenditure by the government.
(iii) Payment of interest increases revenue expenditure leading to higher revenue deficit which, in turn, may lead
to more borrowing. This may compel the government to borrow more to finance even interest payment creating
vicious circle and debt-trap.
129. What are (a) spot and (b) Forward markets in foreign exchange?
Ans. (a) If the operation is of daily nature, it is called spot market or current market and the exchange rate that
prevails in the spot market is called spot rate.
(b) A market for foreign exchange for future delivery is known as forward market. Here foreign exchange is
bought and sold for delivery at a future date.
130. Define (a) NEER, (b) REER and (c) RER
Ans. (a) NEER is the measure of average relative strength of a given currency without eliminating the effect of price
change.
(b) REER is an effective exchange rate base on real exchange rates instead of nominal rates.
(c) Real Exchange Rate (RER) is the exchange rate that is based on constant prices to eliminate the effect of price
changes.
131. What is meant by balance of trade (BOT)?
Ans. BOT is the difference between money value of exports and imports of material goods.
132. When is there deficit in BOT?
Ans. When value of exports is less than value of imports, then BOT is called in deficit.
133. State various forms of capital account transactions.
Ans. (i) Private transactions, (ii) Official transactions,
(iii) Direct investment and (iv) Portfolio investment.
134. What does BOP account of a country record?
Ans. BOP account of a country records all transactions in goods, service and assets between residents of a country and rest
of the world.
135. Which two transactions determine BOT?
Ans. Export of goods and import of goods determine balance of trade.

136. Why are autonomous items called above the line items?

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Vidyamandir Classes Macro-Economics

Ans. Because they are recorded in BOP account as first items before calculating deficit and surplus. In fact, deficit or surplus
occurs due to autonomous items.
137. Describe the causes for disequilibrium in BOP.
Ans. 1. Large imports due to large-scale development expenditure.
2. High domestic prices,
3. New sources of supply and new substitutes.
4. Political instability,
5. Changes in taste, fashion and preference.
138. State two merits and two demerits of flexible exchange rate system.
Ans. (a) Merits are :
(i) Deficit or surplus is automatically corrected.
(ii) It frees the government from problem of BOP.
(b) Demerits are :
(i) It encourages speculations leading to fluctuations in exchange rate.
(ii) Wide fluctuations in exchange rate discourage investment and international trade.
139. State four source each of demand for foreign exchange and supply of foreign exchange.
Ans. (a) Sources of Demand are:
(i) To purchase goods and services from foreign countries.
(ii) To invest and purchase financial assets in a foreign country.
(iii) For sending gifts abroad and
(iv) To undertake foreign tours.
(b) Sources of Supply are :
(i) Direct foreign investment in the domestic territory,
(ii) When foreigners purchase home countrys goods and services,
(iii) Remittances by non-residents abroad and
(iv) When foreign tourists come to home country.
140. Why does a rise in foreign exchange rate cause a rise in its supply?
Ans. A rise in foreign exchange rate makes home countrys (say, Indias) goods cheaper to foreigners. As a result, demand for
Indian goods increases leading to increase in Indias exports. This brings a greater supply of foreign exchange. Thus, there
is direct relation between price (rate) of foreign exchange and supply of foreign exchange. (Mind, there is inverse relation
between price of foreign exchange and demand for foreign exchange.)

Board Notes 147 Class-XII