UNIT-1 National Income (10 Marks) : Consumption Goods or Capital Goods

NATIONAL INCOME 1
UNIT-1
NATIONAL INCOME (10 Marks)
1. Economy: Household
Firms
Governments
Rest of the world
2. Basic activities in economy : (Phases in economy)
3. CONCEPT OF GOODS
BASIS FINAL GOODS INTERMEDIATE GOODS

Meaning These goods are meant for final These goods are used as raw material for
consumption by consumer or for production of other goods or for resale in
investment by firms i.e they can be the same year.
consumption goods or capital goods.
Transformation
National income
Examples
RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

NATIONAL INCOME 2
BASIS CONSUMPTION GOODS CAPITAL GOODS

Meaning Goods which are consumed by ultimate Goods which are purchased only for
consumer for satisfaction of his wants. producing other goods and can be
repeatedly used in process of production
❖ PRODUCER GOODS - includes

(a) Goods used as raw material (eg : wood to make furniture )
(b) Goods used as fixed assets (i.e capital goods) which can be repeatedly used.
➢ All capital goods are producer goods but all producer goods are not capital goods.
4. Factor services/ Factors of production:

NATIONAL INCOME 3
Circular flow of income
 It refers to unending flow of activities of production, income generation and expenditure involving
different sectors (households and firms) of economy.
 The circular flow of income in two sector economy is as follows
(a) Households : These provide factor services (land, labour, capital & entrepreneur) to firm.
(b) Firms : These provide factor payments (rent, wages, interest & profits) to households and
produce goods and services with the help of factor services provided by households.
Households spend their income on purchase of these goods and services.
 Conclusion : The flow of income first goes from firms to households in the form of factor payments
and then comes back from households to firms in the form of consumption expenditure. This
creates a circular flow of income in two sector economy.
Circular flow of Income
Real Flow Money Flow

 It does not involve monetary component It involves monetary component
 Factor services from household to firms Factor payments from firms to households
 Goods and services from firms to households Consumption expenditure from households
to firms
❖ LEAKAGES – It is the amount of money withdrawn from flow of income.




❖ INJECTIONS – It is the amount of money added to the flow of income.




NATIONAL INCOME 4
BASIS FLOW STOCK

Meaning It is the quantity which is measured It is the quantity which is measured at a
over a period of time. particular point of time.
Dimension
National income
Examples
BASIS FACTOR PAYMENTS (INCOME) TRANSFER PAYMENTS (INCOME)

Meaning
Transaction It is a _____________ transaction. It is a ______________ transaction.
National income
Examples
DEFINITIONS:
1. NATIONAL INCOME:
It is the money value of all the final goods and services produced in an economy. (from production
point of view)
OR
It is the sum total of all the factor incomes earned by normal residents* of a country during one
year. (from income point of view)

NATIONAL INCOME 5
2. NORMAL RESIDENTS:
 An individual becomes normal resident of a country when-
(a) His economic interest lies in that country.
(b) His period of stay in that country exceeds one year.
 This concept of normal resident applies to individuals and institutions.
BASIS RESIDENT CITIZEN

Meaning
Concept
Dual
citizenship/residentship
❖ Following are the example of individuals staying in country but are NOT residents :
(a) Foreign students.
(b) People visiting to country for medical treatment.
(c) Crew members of ship/aircrafts of foreign country.
(d) Bureaucrats & politicians of foreign countries.
❖ BORDER WORKERS are taken as normal residents of the country to which they belong.
GDP DEFLATOR
GDP Deflator is also known as ___________________
❖ How to convert Nominal into Real :
BASIS NOMINAL NI/GDP REAL NI/GDP

Meaning NI/GDP is calculated at current prices NI/GDP is calculated at constant prices.
Affected by It is affected by price & quantity both. It is affected by quantity only.
Measure of It is not a good measure of It is a better measurement of development of

development development of society. society.

NATIONAL INCOME 6
❖ LIMITATIONS OF USING REAL GDP AS INDEX OF WELAFARE OF COUNTRY :
Following are the limitations:

 Distribution of GDP- GDP ignores distribution of income and there will be no economic
welfare if distribution of GDP is not equitable.
 Composition of GDP- There may be increase in GDP due to rise in production of defense
goods but that does not indicate the increase in welfare of masses.
OR

NATIONAL INCOME 7
 Non-monetary exchanges- Many activities are not evaluated in monetary terms

(eg-barter system) and these are not considered while calculating GDP. Therefore there is
underestimation of GDP and hence GDP is not a true indicator of welfare.
 Externalities –

NATIONAL INCOME 8
WHAT IS DOMESTIC (ECONOMIC) TERRITORY ?
Territorial waters

NATIONAL INCOME 9
It excludes:-
It is NOT domestic territory of

India and any income generated
inside this area will not be part of
Domestic Income.

NATIONAL INCOME 10
BASIC CONCEPTS FOR CONVERSION
 Depreciation : It is the loss (not capital loss) in the value of asset due to:-
(a)
(b)
BASIS DEPRECIATION CAPITAL LOSS

Meaning It refers to fall in value of fixed assets due It refers to fall in value of fixed asset due
to to
Affect on
production
capacity
Provision
 Net factor income from abroad (NFIA)
 Market Price (MP) / Factor Cost (FC) :
(a) Indirect Tax – As a result of imposition of indirect tax, the market price of commodity increases.
Eg : Sales tax, Excise Duty, GST etc.
(b) Subsidy – It is the grant given by government to the producers and as a result of this, market
price of the product decreases.

NATIONAL INCOME 11
PRODUCTION (VALUE ADDED) METHOD

NATIONAL INCOME 12
INCOME METHOD

NATIONAL INCOME 13
EXPENDITURE METHOD

NATIONAL INCOME 14
Q1) State the industrial classification of producing enterprises for the purpose of estimation national
income.
Ans Primary Sector, Secondary Sector, Tertiary Sector.
Q2) Distinguish between Domestic product and National product. When can domestic product be more
than national product ?
Ans
BASIS DOMESTIC PRODUCT NATIONAL PRODUCT
Meaning It is the money value of all net flow of It is the money value of net flow of final
final goods and services produced goods and services produced by normal
within the domestic territory of a residents of country during a year.
country during an year.
Concept It is a geographical concept. It is an economic concept.
Domestic product can be more than National product when NFIA is negative i.e FITA > FIFA.
Q3) State the components of NFIA.

Ans NFIA = FIFA - FITA
(1) Net income from work i.e compensation of employees.
(2) Net income from property i.e rent and interest.
(3) Net income from entrepeneurship in form of dividend.
(4) Net retained earnings i.e difference of retained earnings of resident company located abroad and
retained earnings of non-resident company located in India.
Q4) Explain why subsidies are added and Indirect taxes are deducted from Domestic product at market
price to arrive at Domestic product at factor cost ?
Ans – Subsidies are financial grants given by the government to the firms and indirect taxes are paid by the
firms to the government.
Subsidies reduce the market price and indirect taxes increases the market price.
Subsidies and indirect taxes do not have any effect on factor payment.
What production unit actually receive is not the market price but MP (-) IT (+) Subsidy.
i.e. Factor cost = MP (-) IT (+) Subsidy
Q5) Why net exports are included in the estimation of domestic product by expenditure method ?
Ans Exports are included in estimation of domestic product because all the goods and services which are
exported are produced by the producers in the domestic territory during the year.
Similarly, imports are the domestic product of other country. Hence, net exports are included in
estimation of domestic product by expenditure method.
Q6) What are the components of Factor income to abroad ?

Ans – (1) Compensation of employees paid to non-residents working in domestic territory.
(2) Income from property (Rent & Interest) and entrepeneurship (dividend) paid to rest of world
(3) Retained earnings of enterprises owned by non-resident within the domestic territory.
Q7) Define
(a) Gross Investment – TOTAL addition to capital stock of the economy.
(b) Net Investment – ACTUAL addition to capital stock of the economy.

NATIONAL INCOME 15
Q8) Distinguish between:
BASIS DEPRECIATION CAPITAL LOSS

Meaning It refers to fall in value of fixed assets It refers to fall in value of fixed asset due to
due to normal wear and tear or unforeseen obsolescence like earthquake,
expected obsolescence. theft, or accident, etc.
Affect on
production
capacity
Provision
Q9) Explain the problem of double counting while estimating national income. Also explain two
alternatives to correct it. (6 marks)
Ans
Farmer Flourmill Baker Shopkeeper Final Consumer
(wheat) 100 130 210 250
Value added _____ ______ _______ _______ = _______

 Double counting means counting the same output more than once while measuring national
income through production method.
 It leads to overestimation of value of goods.
 This problem can be explained with the help of given example :
When the wheat is sold by a farmer to flourmill, flour is sold by the flourmill to baker, the bread is sold
by the baker to shopkeeper and finally the shopkeeper sells the bread to the consumer. Here, the
value of wheat is counted 4 times, value of services of flourmill 3 times, value of services of baker 2
times. Therefore it is necessary to count only value added by each producer.
Two alternatives of avoiding double counting :

(1) We should count only value added by each production unit.
(2) We should count only the value of final product consumed by final consumer.
Q10) Explain why value added (NVAFC) generated in an enterprise is always equal to the factor
incomes distributed by it ? (3 marks)
Ans In every production unit, the owners of the factors of production i.e land, labour, capital
& entrepreneur contribute their productive services. The value added generated in the
production unit is a result of their contribution. Thus, the value added is to be paid in the form of
factor incomes i.e rent, interest, wages & salaries and profits in return for their productive services. In
fact, value added is looked at from view point of firm and factor income is looked at from view point
of factors of production.
Conclusion : NVAFC = Rent + Interest + Profit + Wages & Salaries
i.e NVAFC = Factor Incomes

NATIONAL INCOME 16
Q:- Whether the following are included or not included in
NI DI
1. Profits earned by foreign bank from its branches in India.
2. Scholarships given by given government of India.
3. Profits earned by Indian company in Singapore.
4. Salaries received by US residents working in US Embassy in India.
5. Salaries received by Indian residents working in US Embassy in India.
6. Salaries received by Indian residents working in Indian Embassy in US.
7. Salaries received by US residents working in Indian Embassy in US.
8. Salaries received by US residents working in US Bank in India.
9. Salaries received by Indian residents working in SBI in US.
10. Old age pension given by Government.
11. Retirement pension given by Government.
12. Factor income from abroad.
13. Factor income to abroad.
14. Salaries to Indians working in Russian Embassy in India.
15. Profits earned by Nonresident company in India.
16. Profits earned by SBI in England.
17. Rent received by a resident Indian from his property in Singapore.
18. Rent paid by the embassy of Japan in India to a resident Indian.
19. Remittances from non - resident Indian to their families in India.
20. Profits earned by a company in India, which is owned by a non - resident.
Q:- State whether the following are Intermediate expenditure (Goods) or Final expenditure (Goods)
Transactions F/I
1. Purchase of train ticket for train by an individual.
2. Furniture purchased by school.
3. Expenditure on adding a floor to the building.
4. Purchase of equipment for installation in factory.
5. Expenditure on improvement of a machine in a factory.
6. Purchase of tractor by farmer.
7. Computer installed in an office.
8. Expenditure on education of children.
9. Car purchased a household.
10. Purchase of car by an employer for office use by his employees.
11. Purchase of eatables by a firm.
12. Chalks, dusters purchased by school.
13. Mobile sets purchased by mobile dealers.
14. Expenditure on maintenance of an office building.
15. Purchase of food grains by hotels.
16. Purchase of armaments by military.
17. Fees paid to the lawyer by a producer.
18. Payment of electricity bill by school.
19. Expenditure on fertilizers by farmer.
20. Milk purchased by a hotel.

NATIONAL INCOME 17
Q:- Whether the following are included or not included in NATIONAL INCOME
Transactions Yes/No
1. Profits earned by foreign bank from its branches in India.
2. Scholarships given by given government of India.
3. Profits earned by Indian company in Singapore.
4. Salaries received by US residents working in US Embassy in India.
5. Salaries received by Indian residents working in US Embassy in
India.
6. Salaries received by Indian residents working in Indian Embassy in
US.
7. Salaries received by US residents working in Indian Embassy in US.
8. Salaries received by US residents working in US Bank in India.
9. Salaries received by Indian residents working in SBI in US.
10. Old age pension given by Government.
11. Retirement pension given by Government.
13. Factor income to abroad.
14. Salaries to Indians working in Russian Embassy in India.
15. Profits earned by Nonresident company in India.
16. Profits earned by SBI in England.
17. Rent received by a resident Indian from his property in Singapore.
19. Remittances from non - resident Indian to their families in India.
20. Profits earned by a company in India, which is owned by a non -
resident.
Very Short Answer Type Questions (1 Mark)

1. Define stock variable.
Ans. A variable whose value is measured at a point of time.
2. Define capital goods.
Ans. Goods used is producing other goods are called capital goods.
3. What is nominal gross domestic product ?
Ans. When GDP of a given year is estimated on the basis of price of the same year, it is called
nominal GDP.
4. Define flow variables.
Ans. Any variable whose magnitude is measured over a period of time is called a glow variable.
5. Define ‘real’ gross domestic product.
Ans. When GDP of a given year is estimated on the basis of base year prices it is called real gross
domestic product.
6. Define capital formation.
Ans. Increase in the stock of capital in the given period is called capital formation
7. When is the national income less than domestic income?
Ans. When NFIA is negative.
8. When is the national income larger than domestic factor income?
Ans. When NFIA is positive.
9. 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.

NATIONAL INCOME 18
10. 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.
11. Why is the study of the problem of unemployment in India considered a macro economic study?
Ans. The problem of unemployment in India is an economic issue at level of economy as a whole,
hence considered as macroeconomic study.
12. When is gross domestic product of an economy equal to gross national product?
Ans. When NFIA is zero.
Short Answer Type Questions(3-4 Marks)

1. Will the following be included in gross domestic product / Domestic Income of India? Give
reasons for each answer.
i. Consultation fee received by a doctor.
ii. Purchase of new shares of a domestic firm.
iii. Profits earned by a foreign bank from its branches in India.
iv. Services charges paid to a dealer (broker) in exchange of second hand goods.
Ans.
i. Yes, It is a factor income. It is his salary.
ii. No, It is not included in GDP, because it is a merely financial transaction which does not
help directly in production.
iii. Yes, It is a factor income in domestic territory.
iv. It is included because it is his factor income (salary).
2. How will you treat the following while estimating domestic product of India? Give reasons.
i. Rent received by a resident Indian from his property in Singapore.
ii. Profits earned by a branch of an American Bank in India.
iii. Salaries paid to Koreans working in Indian embassy in Korea.
Ans.
iv. It will not be included in domestic product of India as this income is earned outside the
domestic (economic) territory of India.
v. It will be included in domestic product of India as the branch of American bank is located
within the domestic territory of India.
vi. It will be a part of domestic product of India because this income is earned within the
domestic territory of India. Indian embassy in Korea is treated as located within the domestic
territory of India.
3. State whether the following is a stock or flow:

(a) Wealth, (b) Cement production, (c) Saving of a household, and (d) Income of household.
Ans. Stock – (a) & (b), since these are variables measurable at a point of time.
Flow – (c) & (d), since these are variables measurable over period of time.
4. State whether the following is a stock or flow:

(a) National capital, (b) Exports, (c) Capital formation, and (d) Expenditure on food by
households.
Ans. Stock – (a), since national capital is a variable measurable at a point of time.
Flow – (b), (c) & (d), since these are variables measurable over period of time.
5. Are the following included in the estimation of National Income a country? Give reasons.
a. Bonus received by employees.
NATIONAL INCOME 19
b. Government expenditure on defence.
c. Money sent by a worker working abroad to his family.
d. Profit earned by a branch of Indian Bank in London.
Ans.
a) It should be included in NI because it is a part of the compensation of employees (salary in
cash).
b) It should be included in NI because defence service is considered final service so far as it
provides peaceful and secure environment to the citizens.
c) It is included in NI because it is a part of NFIA.
d) It is included in NI of India because it is a part of NFIA.
i. Rent free house to an employee by an employer.
ii. Purchases by foreign tourists.
iii. Purchase of a truck to carry goods by a production unit.
iv. Payment of wealth tax by a household.
Ans.
i. It should be included in NI because it is a part of the compensation of employees (salary in
kind).
ii. It is included in NI because it is a part of the final consumption expenditure on domestic
product.
iii. It should be included in NI because it is an addition to the capital stock of the production
unit.
iv. It should not be included in NI because it is a compulsory transfer payment and paid from
past savings of the tax payers.
7. Is net export a part of NFIA? Explain.

Ans. No, it is not.Net export, the difference between export and import (X- M), is a part of
expenditure on domestic product. While NFIA is the difference between income earned from abroad
by the normal residents of a country and income earned by non-residents in the domestic territory of
that country. It is not included in the domestic product rather it is a component of NI. Therefore both
are different concepts.
8. Calculate gross value added of factor cost :

(i) Units of output gold (units) 1000
(ii) Price per unit of output (Rs.) 30
(iii) Depreciation (Rs.) 1000
(iv) Intermediate cost (Rs.) 12000
(v) Closing stock (Rs.) 3000
(vi) Opening stock (Rs.) 2000
(vii) Excise (Rs.) 2500
(viii) Sales Tax 3500
Ans. GVAFC = (ixii) + v – vi – iv – vii – viii
= (1000X30) + 3000 – 2000 – 12000 – 2500 – 35000 = Rs. 13000
9. Calculate Net Value added at factor cost :

(i) Consumption of Fixed capital (Rs.) 600
(ii) Import duty (Rs.) 400

NATIONAL INCOME 20
(iii) Output sold (units) 2000
(iv) Price per unit of output (Rs.) 10
(v) Net change in stock (Rs.) (–) 50
(vi) Intermediate cost (Rs.) 10000
(vii) Subsidy (Rs.) 500
Ans. NVAFC = (iii x iv) + v – vi – ii + vii – i
= (2000x10) + (–50) – 10000 – 400 + 500 – 600 = Rs. 9450
10. Find Net Value added at market price :

(i) Output sold (units) 800
(ii) Price per unit of output (Rs.) 20
(iii) Excise (Rs.) 1600
(iv) Import duty (Rs.) 400
(v) Net change in stock (Rs.) (–) 500
(vi) Depriciation (Rs.) 1000
(vii) Intermediate cost (Rs.) 8000
Ans. NVAmp = (i x ii) + v – vii – vi
= (800x20) + (–500) – 8000 – 1000 = Rs. 6500
Long Answer Type Questions (6 Marks)

1. How will you treat the following which estimating national income of India? Give reasons.
1. Dividend received by an Indian from his investment in shares of a foreign company.
2. Money received by a family in India from relatives working abroad.
3. Interest received on loans given to a friend for purchasing a car.
4. Dividend received by a foreigner from investment in shares of an Indian company.
5. Profit earned by a branch of an Indian bank in Canada.
6. Scholarship given to Indian students studying in India by a foreign company.
7. Fees received from students.
8. Profits earned by branch of a foreign bank.
9. Interest paid by an individual on a loan taken to buy a car.
10. Expenditure on machines for installation in a factory.
11. Profit earned by a branch of foreign bank in India.
12. Payment of salaries to its staff by an embassy located in New Delhi.
13. Interest received by an Indian resident from firms abroad.
14. Salaries received by Indians working in branches of foreign banks in India
15. Profits earned by an Indian bank from its branches abroad.
16. Rent paid by embassy of Japan in India to an Indian resident.
17. Imputed rent of self occupied house
18. Interest received on debentures
19. Financial help received for flood victims.
Ans.
1. It is factor income from abroad so will be included in national income.
2. It is transfer receipts, so it is not included in national income.
3. Not included in national income, because it is a non-factor receipt as loan is not used for
production for consumption
4. Included as it is a factor income to abroad.
5. It is a part of NFIA and will be included in national income.
6. It is transfer receipts, so it is not included in national income.

NATIONAL INCOME 21
7. It is included in national income because it is a part of the private final consumption
expenditure of the house hold.
8. Included in national income because it is part of domestic factor income of India.
9. Not included because it is a non-factor income as loan is not used for production but for
consumption.
10. Included because it results in flow of income throught productive activities
11. Included, because it is a part of domestic product of India.
12. Not included because it is not a part of domestic product of India
13. Included as it is the part of NFIA.
14. Included because it is earned in domestic territory of India.
15. Included because it is aprt of NFIA
16. Included as it is paid to an Indian resident out side the domestic territory of a country. It will
be included in NFIA.
17. Included as a part of rent as it is payment to self for housing services.
18. Included because it is a factor earning
19. Not included as it is a transfer payment.
2. How will you treat the following which estimating domestic factor income of India? Give
reasons.
1. Remittances from non-resident Indian to their families in India
3. Profit earned by branches of foreign bank in India.
4. Payment of salaries to its staff by embassy located in India.
5. Interest received by an Indian resident from firms abroad.
Ans.
1. Not included as it is a transfer payment
2. Not included because Japanese embassy in India does not fall with in the domestic territory
of India.
3. Included because it falls with in the domestic territory of India
4. Not included as an embassy located in India is not fall with in the domestic territory of India
5. Not included in domestic product but it is the part of NFIA.
3. Are the following part of a country’s net domestic product at market price? Explain
1. Net indirect tax
2. Net export
3. NFIA
4. Consumption of fixed capital
Ans.
1. Yes, because market price = factor cost + Net Indirect tax
2. Yes, because NDPMP includes net exports
3. No, because domestic means it excludes NFIA
4. No, net means consumption of fixed capital is excluded.
4. Will the following be included in gross domestic product / Domestic Factor Income of India?
Give reasons for each answer.
1. Old age pension given by govt.
3. Salaries to Indian residents working in American embassy in India.

NATIONAL INCOME 22
4. Compensation of employees given to residents of china working in Indian embassy in
China.
5. Profit earned by a company in India, which is owned by a non-resident.
6. Profit earned by an Indian company from its branch in Singapore.
Ans.
1. No, because pension is paid on account of old age of a pensioner and not for his rendering
productive services.
2. No, because factor income is earned not within the domestic territory of a country but from
abroad.
3. No, because American embassy is not a part of domestic territory of India.
4. Yes, because Indian embassy in China is a part of domestic territory of India.
5. Yes, because the company within India’s domestic territory earns profit.
6. No, because the branch is located outside the domestic territory of India.
5. Why are exports included in the estimation of domestic product by the expenditure method?
Can gross domestic product be greater than gross national product? Explain.(4+2)
Ans. Expenditure method estimates expenditure on domestic product, i.e. expenditure on final goods
and services produced within the economic territory of the country. It includes expenditure by
residents and non- residents both. Exports, though purchased by nonresidents, are produced within
the economic territory, and therefore, a part of domestic product.
Domestic product can be greater than national product if factor income paid to the rest of the world
is greater than the factor income received from the rest of the world is i.e. when net-factor income
received from abroad is negative.
6. Are the following included in the estimation of National Income of India? Give reasons for
each answer.
1. Profit earned by a foreign company bank in India.
2. Money received from sale of shares.
3. Salary paid to Americans working in Indian embassy in America.
4. Salary paid to Indians working in Indian embassy in America.
5. Scholarship received by a student.
6. Remittances from aboard.
Ans.
1. No, as it is a factor income paid abroad (it is earned by non-residents).
2. No, it is only a transfer of paper claims.
3. No, this factor income belongs to non-residents.
4. Yes, as it is a factor income paid to normal resident of India.
5. No, it is only a transfer payment.
6. No, it is only a transfer payment. No commodity is sent or services rendered return for this.
7. Will the following be included National Income? Give reasons for each answer.
1. Services of owner occupied houses.
2. Purchase of new shares of a domestic firm.
3. Purchase of second-hand machine from a domestic firm.
4. Consultancy fee paid to a foreign expert.
5. Commission paid to agent for the sale and purchase of shares.
6. Dividend received on shares.
Ans.
1. Yes, Imputed rent of owner occupied houses will be included in NI.
NATIONAL INCOME 23
2. No, because it is a financial transaction which does not help directly in production.
3. No, because it is not related with current flow of goods and services.
4. No, as it is a factor income paid abroad (it is earned by non-residents).
5. Yes, It is included in NI since it is paid for rendering productive services.
6. Yes, dividends are a part of corporate profit and therefore, include in NI.
8. Will the following be included National Income? Give reasons for each answer.
1. Free Medical facility to employees by the employer.
2. Money received from sale of old house.
3. Government expenditure on street lighting.
4. Interest received by a household from a commercial bank.
5. Receipts from sale of land.
6. Interest on public debt.
Ans.
1. Yes, as it is a supplementary income paid in kind and hence a part of compensation of
employees.
2. No, as it has already been taken into account when the house was constructed.
3. Yes, It is a part of Government final consumption expenditure and it adds to flow of services.
4. Yes, as it is payment for use of capital.
5. No, as it does not add to flow of goods & services.
6. It should not be included in NI because public debt is a loan taken on to meet consumption
expenditure by the government.
1. Services rendered by family members to each other.
2. Wheat grown by a farmer but used entirely for family’s consumption.
3. Expenditure government on providing free education
4. Payment of fees to a lawyer engaged by a firm.
5. Man of the match award to a player of the Indian cricket team.
6. Payment of the match fee to players of Indian cricket team.
Ans.
1. 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.
2. Imputed value of self-consumed wheat grown by a farmer must be included in NI, because it
adds in the flow of goods.
3. It should be included in NI because the government expenditure on the free services is
considered as a part of government final consumption expenditure.
4. Yes, as it is factor income against the service of lawyer.
5. It should not be included in NI because it is a windfall gain and it does not add in the flow of
goods and services.
6. It should be included in NI of India because they render productive services as professionals.
1. Unemployment allowance under NREGA.
2. Indirect tax (Sale tax/excise duty).
3. Salary received by the workers under NREGA.
4. Income tax.
5. Corporation tax.
6. Travelling expenses paid to salesman by the employer.
NATIONAL INCOME 24
Ans.
1. It is transfer payment received by those persons who are not employed; therefore it should
not be included in NI.
2. It is not included in NI because it does not add in the flow of goods and services.
3. It is included in NI because it is a factor income.
4. 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.
5. 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.
6. Travel expenses incurred by employees for business purpose which are reimbursed by the
employers are excluded because these are a part of intermediate consumption of the
employers
SELF PRACTICE QUESTIONS
Q.1 Calculate National Domestic Product at Factor Cost.
Gross National product at MP 78,300

Consumption of fixed capital 4,500
Indirect taxes 9,300
Subsidies 1,200
Net factor income from abroad 1,620
Q.2 Calculate (a) National Income (b) Domestic Income.
Depreciation 2,400
Indirect tax 3,600
Subsidy 300
GNPMP 17,450
NFIA 1,600
Q.3 Calculate (a) GNPMP (b) NNPMP (c) NDPMP (d) NDPFC
GNPFC 1,13,882
Indirect taxes 6,744
Subsidies 2,839
Depreciation 8,048
NFIA 298
Q.4 Calculate National product by value added method.
A, B, C are 3 industries
A sells for ` 300 to B and for ` 200 to C.
B sells for ` 100 to private consumer and for ` 300 to C.
C sells for ` 1,200 to private consumer.
Q.5 Calculate (a) NNPMP (b) National Income.
Sales 5,500
Decrease in stock of finished goods 400
Raw Material bought 800
Depreciation 50

NATIONAL INCOME 25
Indirect Tax 100
Subsidy 80
Q.6 Find (a) Value added by firm A & B (b) GDPMP
Exports by firm A 200

Imports by firm A 500
Sales to households by firm A 900
Sales to firm B by firm A 400
Sales to firm A by firm B 300
Sales to households by firm B 600
Q.7 Find (a) Value added by firm A and B (b) GDPFC
Sales by firm A 1,000

Purchase from B by A 400
Purchase from A by B 600
Sales by firm B 2,000
Closing stock by A 200
Closing stock of B 350
Opening stock of A 250
Opening stock of B 450
Indirect taxes paid by A & B both 300
Q.8 Calculate value added by firm C
Sales by firm A to firm B 200

Value added by firm B 400
Value added by firm D 300
Sales by firm C to firm B 700
Final sales 1,300
Q.9 Calculate Value added by A and B
Sales by firm B to Government 1,000

Sales by firm A 5,000
Purchases by households from B 3,000
Exports by B 500
Change in stock of A 200
Change in stock of B 100
Imports by firm A 700
Sales by firm Z to A 2,500
Purchase by firm B from A 2,000
Q.10 Calculate GVAFC
Sales 700
Depreciation 150
Wages & Salaries 250
Intermediate Consumption 400
Opening stock 150
Closing stock 100
Subsidies 50
Purchase of Raw Material 200
Q.11 Calculate (a) GVAMP for A and B and (b) National Income

NATIONAL INCOME 26
Sales by A 1,000
Sales by B 2,000
NFIA 20
Change in stock of B (-)200
Closing stock of A 50
Opening stock of A 100
Consumption of fixed capital 180
Indirect taxes 120
Purchase of raw material by A 500
Purchase of raw material by B 600
Exports by B 70
Q.12 Calculate sales from following :-
NVAFC 300
Intermediate consumption 200
Depreciation 30
Indirect tax 20
Change in stock (-) 50
Q.13 Calculate value of output from the following :
Net value added at factor cost 100

Intermediate consumption 75
Excise Duty 20
Subsidy 5
Q.14 Calculate NVAFC
Subsidy 40
Sales 800
Depreciation 30
Exports 100
Closing Stock 20
Opening Stock 50
Intermediate Purchase 500
Purchase of machine for own use 200
Imports of raw material 60
Q.15 Calculate GVAFC
Units of output sold 1,000

Price per unit of output 30
Depreciation 1,000
Intermediate Purchase 12,000
Closing Stock 3,000
Opening Stock 2,000
Excise Duty 2,500
Sales Tax 3,500
Q.16 Calculate (i) Domestic Income and (ii) National income
Wages 5,000

NATIONAL INCOME 27
Interest 2,000
Rent 1,000
NFIA (-) 250
Profit tax 100
Surplus of public sector 750
Mixed income 6,000
Undistributed profits 500
Dividend 1,250
Q.17 Calculate GDPFC
Mixed income of self employed 5,265

Depreciation 525
NFIA (-) 225
Compensation of employees 16,820
Rent, Interest and Profit 4,735
Q.18 Calculate National Income (Expenditure method)
Private consumption expenditure 4,500

Govt. consumption expenditure 500
Gross domestic fixed investment 500
Increase in stock 100
Export of goods & services 600
Import of goods & services 700
Net Indirect taxes 500
Factor income to abroad 100
Factor income from abroad 50
Q.19 Find out GDP (Expenditure Method)
Gross domestic fixed investment 1,500

Increase in Inventories 250
Government consumption expenditure 1,250
Export of goods 850
Imports of goods 1,050
Personal disposable income 11,500
Personal saving 1,550
Q.20 Calculate (i) GDP MP and (ii) GNP MP
Private Final Consumption expenditure 55,000

Govt. Final Consumption expenditure 6,000
Gross domestic fixed capital formation 5,000
Import of goods & services 1,000
NFIA (-)500
Economic subsidy 500
Decrease in stock 600
Excise Duty 2,000
Exports of goods & services 900
Depreciation 2,000
Q.21 Calculate National Income
Opening stock 500

NATIONAL INCOME 28
Private final consumption expenditure 5,000
Closing stock 600
Net Exports (-) 50
NFIA (-) 100
Compensation of employees paid by Govt. 1,000
Direct Purchase from abroad by Govt. 100
Net Purchase of goods by Govt. in domestic market 1,000
Net Capital formation 600
Net indirect taxes 500
Q.22 Calculate National income by both (a) Income method (b) Expenditure method
Interest 150
Rent 250
Govt. final consumption expenditure 600
Profits 640
NFIA 30
Net exports (-)40
Depreciation 50
Net domestic capital formation 340
Q.23 Calculate NNP FC by (a) Income method (b) Expenditure Method
Current transfers from ROW 100

Govt. final consumption expenditure 1,000
Wages and salaries 3,800
Dividend 500
Rent 200
Interest 150
Net Domestic Capital formation 500
Profits 800
Employer’s contribution to S.S. scheme 200
Net imports 50
NFIA (-) 30
Net Indirect taxes 300
Q.24 Calculate NNPMP by (a) Income method and (b) Expenditure method
Personal consumption expenditure 700

Wages and salaries 680
Employer’s contribution to S.S. scheme 100
Gross business fixed investment 60
Gross residential construction investment 60
Gross public investment 40
Inventory Investment 20
Profits 100
Govt. Purchase of goods & services 200
Rent 50
Net exports 20
Interest 40
Mixed Income 100
NFIA (-) 10
Depreciation 20

NATIONAL INCOME 29
Q.25 Calculate GNPMP by (a) Income method and (b) Expenditure method
Net exports 10
Rent 20
Private final consumption expenditure 400
Interest 30
Dividends 45
Undistributed profits 5
Corporate tax 10
Govt. final consumption expenditure 100
Compensation of employees 400
NFIA (-)10
Q.26 Calculate GNPMP
Wages & salaries 5,000

Exports 500
Imports 600
Net capital formation 1,000
Gross capital formation 1,200
Employer's contribution to S.S. scheme 200
NFIA (-) 100
Rent , Interest 2,500
Profits 4,000
Q.27 Calculate Gross fixed capital formation

Government final consumption expenditure 500
Net exports (-)50
Net factor income from abroad 20
Gross domestic product at market price 2,500
Opening stock 300
Closing stock 200
Q.28 Calculate (a) GDPFC and (b) Factor income to abroad
Compensation of employees 800

Profits 200
Dividends 50
Gross national product at market price 1,400
Rent 150
Interest 100
Gross domestic capital formation 300
Net fixed capital formation 200
Change in stock 50
Factor income from abroad 60
Q.29 Calculate (a) GDPMP and (b) Factor income from abroad

NATIONAL INCOME 30
Profits 500
Exports 40
Gross national product at factor cost 2,800
Net current transfers from ROW 90
Interest 400
Rent 300
Change in stock 50
Factor income to abroad 120
Gross fixed capital formation 700
Q30 :- Calculate operating surplus :

1) Gross value of output at market price 9,000
2) Consumption of fixed capital 700
3) Wages & Salaries 4,000
4) Indirect taxes 500
5) Subsidies 200
6) Intermediate consumption 1,000
7) Mixed Income of self employed Nil
8) Profits 250
Q31 :- Calculate compensation of employees :

1) Dearness allowance 100
2) Medical expenses on employees 10
3) Wages in kind 250
4) Life insurance premium paid by employees 5
5) Contribution to PF by employers 20
Q32 :- Calculate factor income from abroad :

1) NNPMP 50,000
2) Income tax 2,000
3) Subsidy 1,200
4) Operating surplus 5,000
5) Mixed income of self employed 2,000
6) Sales tax 1,000
7) Profits 5,000
8) Factor income to abroad 1,800
9) Compensation of employees 15,000
Q33 :- In an economy, only the following transactions take place. Firm A sells all of its product worth 4,000
to the firm B. Firm B sells its entire output for 8,000 to firm C. Firm C sells its goods for final
demand at 14,000. Calculate :
a) Value added by each firm.
b) Indirect tax of 20% is levied on A's product. This burden of tax is shifted on to the consumers.
Find market price of good for each firm.
Q34 :- Calculate (a) GDPMP and (b) Factor income from abroad
1) Profits 500
2) Exports 40
4) Gross national product at factor cost 2,800
NATIONAL INCOME 31
5) Net current transfers from ROW 90
6) Interest 400
7) Rent 300
8) Net domestic capital formation 650
9) Change in stock 50
10) Factor income to abroad 120
11) Net indirect taxes 250
12) Gross fixed capital formation 700
Q35 :- Calculate NDPFC
1) Private final consumption expenditure 800

2) Net domestic capital formation 150
4) Net factor income from abroad (-) 20
5) Net indirect tax 120
6) Government final consumption expenditure 450
7) Net exports (-) 30
8) Gross fixed capital formation 170
9) Export of machinery 40
Q36 :- Calculate GNPMP by (a) Income method and (b) Expenditure method
Personal consumption expenditure 350

Wages and salaries 340
Contribution to S.S. scheme 200 (25% by employer)
Gross business fixed investment 30
Inventory Investment 10
Profits 50
Govt. Purchase of goods & services 100
Rent 25
Net imports (-)10
Gross residential construction investment 30
Interest 20
Mixed Income 50
Net factor income to abroad 5
Depreciation 15
Gross public investment 20
Q37 :- Calculate operating surplus :

1) Gross value of output at market price 1,000
2) Rent 125
3) Compensation of employees 300
4) Indirect taxes 60
5) Subsidies 10
6) Intermediate consumption 375
7) Mixed Income of self employed 75
Q38 :- Calculate compensation of employees :

1) Wages in cash 125
2) Dearness allowance 75
3) Medical expenses on employees 5

NATIONAL INCOME 32
4) Free food to employees on Diwali 10
5) Life insurance premium paid by employees 2
6) Contribution to PF by employees 35
Q39 :- Calculate Subsidy :

1) NNPMP 25,000
2) Wealth tax 1,000
3) Net factor income to abroad (-) 14,100
4) Operating surplus 2,500
5) Mixed income of self employed 1,000
6) Sales tax 500
7) Profits 2,500
Q40 :- Calculate NDPMP
1) Personal disposable income 8,600

2) Fixed capital formation 3,000
3) Personal savings 1,500
4) Consumption of fixed capital 450
6) Net exports (-)300
7) Net factor income from abroad (-)500
8) Government final consumption expenditure 2,200
9) Net indirect taxes 600

MONEY & BANKING 33
UNIT-2
MONEY AND BANKING (6 Marks)
Barter System : It is a system where exchange of goods for goods takes place without the use of money.
 C - C economy (Commodity)
Limitations :
(1) Lack of double coincidence of wants i.e the goods possessed by two different individuals must be
needed by each other.
(2) Lack of common measure of value i.e one good is valued in terms of another good since there was
no money.
(3) Lack of standard of deffered payment (or future payment).

(4) Lack of store of value.
(5) Lack of system for transfer of funds (value).

MONEY & BANKING 34
Money: “Money is what money does”

 “Money can be defined as anything that is generally accepted as a medium of exchange and act as
measure and store of value.”
EVOLUTION OF MONEY :
Money was evolved through different stages according to time, place, and circumstances. In ancient times,
agricultural products were used as medium of exchange. Later on, it was realized that all these goods
cannot be stored for a longer period. Therefore people started using metallic coins such as iron, copper
etc. These metallic coins were scarce and bulky. Therefore silver and gold coins were accepted as most
suitable form of money. From 1930 onwards most countries have shifted to paper money because
production of gold and silver cannot match the requirement of industry. The latest development in
evolution of money is introduction of plastic money. Example : Debit & Credit card.
FUNCTIONS OF MONEY
PRI MARY FUNCTIONS

1. Medium of exchange :
2. Measure of value : (Unit of Account)

MONEY & BANKING 35
SECONDARY FUNCTIONS :
1. Standard of deferred payments :
2. Store of value :
MONEY SUPPLY
 Principal Components of money supply are :

• Currency held by public
• Demand deposits (Current A/c) of people with commercial banks
• Other deposits with RBI
MEASUREMENT OF MONEY SUPPLY (Alternative definitions of money)
M1 =
M2 =
M3 =
M4 =

MONEY & BANKING 36
❖ Difference between broad money and narrow money is _______________________.
BANKS
Commercial banks Central Bank
LEGAL RESERVE RATIO (LRR)
 LRR is the ‘minimum ratio’ of the deposits which every commercial bank has to keep as
‘cash reserves’.
 LRR can be of two types :-

(a) Cash Reserve Ratio (CRR)
(b) Statutory Liquidity Ratio (SLR) :
Q: Why only fraction of deposits are kept as cash reserve ?

Ans :

MONEY & BANKING 37
CREDIT CREATION
1. Assumptions :
2. Process :
(i) Credit creation is determined by two factors

1.
2.
(ii) Suppose LRR=20% and there is a fresh deposit of Rs.10,000 ; Now bank keeps Rs.2,000 as
cash reserve and lends the remaining Rs.8,000 to the borrowers.
(iii) Suppose the borrowers spend the entire amount of Rs.8,000 for making payments. Since all
the transactions are routed through bank the money spent by borrowers comes back into the
bank in the form of deposits of those who receive this payment.
(iv) Now bank again keeps 20% i.e Rs.1,600 as cash reserves and lend Rs.6,400 to other borrowers.
This process will keep on repeating till ____________________________________________
_____________________________________________________________________________
(v) Here ultimately total money creation is Rs. as shown in the table below :

MONEY & BANKING 38
CENTRAL BANK
 It is an apex institution of monetary and banking system of a country. Eg : RBI in India.
FUNCTIONS OF CENTRAL BANK
(1) Bank of Issue
(2) Banker to the Government :
(3) Banker’s Bank and Supervisor :
(4) Custodian of National Reserves of International Currency :
(5) Clearing House Function :

MONEY & BANKING 39
(6) Lender of Last Resort :
(7) CREDIT CONTROL :

 It is the most important function of central bank to act as controller of credit i.e it controls the
money supply in the country. The methods of credit control are categorized as :
QUANTITATIVE METHOD QUALITATIVE METHOD

(General Control Measures) (Specific Control Measures)
 Bank rate/ Discount rate Moral Suasion
 Repo & Reverse Repo Rate Margin Requirement
 CRR/ SLR Credit Rationing
 Open Market Operations
1. BANK RATE : [Currently ______ ]

 Bank rate means the Rate of Interest at which central bank lends to commercial banks
generally for a long period or it is the minimum rate at which commercial banks rediscount
its securities. It is also known as discount rate.
 An increase in bank rate leads to an increase in commercial banks lending rate of interest.
 As a result of this, credit becomes costlier and an increase in bank rate discourages commercial
banks to borrow from central bank.
 Hence the commercial bank’s lending capacity also reduces and in this way money supply in the
market will go down.
2. REPO RATE : [Currently ______ ]

 Repo rate is the rate at which commercial banks borrow money from RBI. It is also called as
repurchase rate.
 Whenever the banks have any shortage of funds they can borrow it from RBI. RBI lends money
to bankers against approved securities for meeting their day to day requirements or to fill short
term gap.
 An increase in repo rate discourages commercial banks to borrow from central bank.
 Hence the commercial bank’s lending capacity also reduces and in this way money supply in the
market will go down.
3. REVERSE REPO RATE : [Currently ______ ]

 It is the rate at which RBI borrows money from commercial banks. An increase in reverse repo
rate can prompt the banks to park more funds with RBI to earn higher returns on idle cash.
Thus, an increase in reverse repo rate will ultimately lead to contraction of credit.
MONEY & BANKING 40
4. OPEN MARKET OPERATIONS :

 It means policy of central bank to buy and sell government securities in the open market.
 Open Market Operations effect the cash reserves with commercial banks and thus the overall
availability of credit.
 Sale of government securities to the commercial banks reduces the cash reserves with the banks
resulting in decline of money supply.
 Purchase of government securities by central bank increases the cash reserves of commercial
banks resulting in increase in money supply.
5. CRR/ SLR :
 An increase in CRR/SLR requirements by RBI reduces the lending capacity of commercial banks
as they are now need to maintain higher amount of deposits as cash reserves and can lend
lesser amount to public resulting in decrease in money supply in the economy.
 Similarly a decrease in CRR/SLR requirements by RBI increases the lending capacity of
commercial banks as they are now need to maintain lower amount of deposits as cash reserves
and can lend more amount to public resulting in increase in money supply in the economy.
6. MORAL SUASION :
 It means persuasion and request by the central bank to the commercial banks to follow the
monetary policy of the central bank.
 The central bank can use its moral influence and persuade the banks to restrict the money
supply. Moral suasion is exercised through discussions, letters, speeches, advices, etc.
7. MARGIN REQUIREMNT :
 Margin is the difference between value of security and amount of loan .
 If margin requirement increases then borrowings may come down . While a fall in margin
requirement leads to expansion of credit.
8. CREDIT RATIONING :
 Credit rationing means imposing limits and charging higher/ lower rate of interest in selective
sectors. Such measures restrict the flow of credit to a particular sector.

MONEY & BANKING 41
Very Short Answer Type Questions (1 Mark)
1. Define money.
Ans. Any thing which is generally acceptable by the people as medium of exchange, measure of
value, standard of deferred payment and performs the function of store of value.
2. What is meant by M.
Ans. M1 = currency held with public + demand deposit in banks + other deposit in RBI.
3. What is meant by the term money supply?
Ans. Total stock of money which are held by the public at a particular point of time in an Economy.
4. What is bank rate?
Ans. Rate at which central bank lends to the commercial bank.
5. State two primary functions of money.
Ans. 1. Medium of Exchange
2. Measure of value
6. What is meant by credit creation?
Ans. Credit creation means power to expand demand deposits of Commercial Banks.
7. What is credit multiplier?
Ans. Credit multiplier measures, number of times deposits are multiplied as credit.
Credit multiplier = 1Reserve requirement1Reserve requirement
m=1Rm=1R
8. Write two functions of central banks.
Ans. (i) Currency Authority
(ii) Controller of money and credit
9. What is cash reserve ratio (CRR)?
Ans. Commercial Banks are required under law to keep a certain percentage of their total deposit
in the central banks in the form of cash reserves. This is called CRR.
10. What is statutory liquidity ratio (SLR)?
Ans. Every Commercial Bank is required to keep a fixed percentage (ratio) of its assets in liquid
form, called SLR.
11. What is demand deposits by banks?
Ans. Demand deposits are deposits which can be withdrawn from bank at any time by the account
holder.
12. State two monetary measures of credit control by central bank.
Ans. (i) Bank Rate policy.
(ii) Open market operation
13. What are various money stock measures?
Ans. Following four measures of money stock are used.
M1 = C + DD + OD
M2 = M1 + Saving deposit in Post Office Saving banks.
M3 = M1 + Net time deposit of banks
M4 = M3 + Total deposits with post office saving organisation (except NSC).
1. Explain the “Lender of Last Resort’ function of the central bank.

Ans. Central bank also lends money directly to commercial banks. Instead of rediscounting, central
bank given loans against the bill of exchange promissory notes, treasury bills, government
securities, etc. The direct lending to commercial bank is referred to as the ‘lender of the last resort’
function of central bank.
2. Explain the “Government’s Bank” function of a central bank.

Ans. A central bank conducts the banking account of government departments. It performs the
same banking functions for the government as commercial bank performs for its customers. It
accepts their deposits and undertakes inter-bank transfers. It also gives loans to the government. A
MONEY & BANKING 42
central bank also provides various services as agent of the government. It manages public debt. It
also gives advice to the government regarding money market, capital market, government loans
and economic policy matters.
Higher Order Thinking Skills

1. What is the main function of money in an economy?
Ans. The main function of money in an economic system is to facilitate the exchange of Goods and
services.
2. Name the System of Note-issue in India.
Ans. In India, the system of note issue is the Minimum Reserve System. The RBI is required to keep
minimum reserves of Rs 200 crores.
3. Define open Market operation.
Ans Open Market operations refer to the purchase or sale of government securities in the open
market by the central bank of the country.
4. Name the additional facility which the businessman gets in the current deposit account of the
bank.
Ans. The businessman gets the facility of overdraft (OD) in the current account of the bank.
5. Money acts as a yardstick of standard measure of value to which all other things can be
compared. Discuss it.
Ans. Money serves as a measure of value in terms of unit of account. Measurement of value Was
the main difficulty of the barter system. Introduction of money has removed this difficulty. 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 services can be expressed in terms
of money. This function of money also enables the trading firms to ascertain their costs, revenues,
profits and losses.
6. The central bank acts as lender of last resort. How?
Ans. 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. Central bank advances loan to such a bank against approved securities.
As a lender of the last resort, central bank exercises control over the entire banking system of the
country.
7. Central bank performs the function of a clearing house. How?
Ans. Every bank keeps cash reserves with the central bank. The claims of banks against one another
can be easily and conveniently 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. 15000
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 Bank A and credited
to the account of B. There is not need of cash transactions between the banks concerned. It
facilitates cash transaction across the entire banking system, it also reduces requirement of cash
reserves of the commercial banks.
8. All the currency issued by the central bank is its monetary liability. How?
Ans. The Central Bank is obliged to back the currency with assets of equal value. These assets
usually consist of gold coin, gold bullion, foreign securities and the domestic government’s local
currency securities. The country’s Central government is usually authorised to borrow money from
the central bank. Government does this, by selling local currency securities to the central bank.
When the central bank acquires these securities, it issues currency. Putting and withdrawing
currency into and from circulation is also the job of the central bank.
9. What is margin requirement of loans.
Ans. Marginal requirement of loan means the difference in percentage between the amount of the
loan and market value of the security offered by the borrower against the loan.

DETERMINATION OF INCOME & EMPLOYMENT – KEYNES THEORY 43
UNIT-3
DETERMINATION OF INCOME & EMPLOYMENT (12 Marks)
Aggregate Demand (AD)
 It is the total demand of goods and services in the economy.
 Basically it represents TOTAL EXPENDITURE on goods and services in the economy.
 Components of AD :
CONSUMPTION EXPENDITURE : Consumption is a function of income i.e consumption function depicts the
portion of income spent on consumption. C = f(Y)

INVESTMENT EXPENDITURE :
Investment is a function of Rate of interest. I = f(r)
There are two types of investment –

1. Induced investment – It refers to the investment made by private sector with a profit earning
motive. It increases with increase in income.
2. Autonomous investment – It refers to the investment made by government with an aim of social
welfare. It remains constant irrespective of level of income.
❖ For the purpose of AD we consider only Autonomous investment because according to Keynes
investment remain constant at all level of incomes during short period.

Aggregate Supply (AS) :
 It refers to value of total output available in an economy during the given period of time.
 AS is also represented by
 Components of AS :

DERIVIATIONS OF SAVINGS CURVE FROM CONSUMPTION CURVE :
 In the above diagram, AC is the consumption curve and OY is the income curve.
 We know that saving is the difference between income & consumption.
 When income = 0, consumption is OA. Thus, the corresponding level of saving is OA I

Hence OAI will be the starting point of savings.
 At point E, income and consumption are equal, i.e Break even point. Therefore savings
will be zero. (i.e point B)
 We shall join AI and B and extend this line to get savings curve.

DERIVIATIONS OF CONSUMPTION CURVE FROM SAVINGS CURVE :

PROPENSITY TO CONSUME
 It means proportion of income spent on consumption or it is also known as consumption function.
 Average propensity to consume (APC) : It is the ratio of total consumption to total income.
APC = C
Y
 Marginal propensity to consume (MPC) : It is the ratio of change in consumption to change in

income.
MPC = C
Y
MPC is slope of
• MPC is denoted by ___

• MPC lies between ______.
RELATIONSHIP BETWEEN INCOME, CONSUMPTION & APC
1. When C > Y ; Then
2. When C = Y ; Then
3. When C < Y ; Then
Inccome (Y) Consumption (C) APC (C/Y)

0 6
10 14
20 22
30 30
40 38
50 46

PROPENSITY TO SAVE
 It indicates tendency of households to save at a given level of income and it is also known as
savings function.
 Average propensity to save (APS) : It is the ratio of total savings to total income
APS = S
Y
 Marginal propensity to save (MPS) : It is the ratio of change in savings to change in income.
MPS = S
Y
MPS is slope of
• MPS lies between ________

INVESTMENT (Output) MULTIPLIER
Working of Multiplier
 Let MPC = 0.8 in the given example and suppose there is increase in investment by Rs. 100 crores.
 Initially, it will lead to increase in income by 100 crores and when MPC = 0.8 ; consumer will spend
80 crores on consumption, which become income for producer in round 2.
 This process will continue till _____________ and it results in increase in income
 The working of multiplier is illustrated with the help of given table :

Ex-ante (Planned) Savings and Investment :
 The savings which are planned or desired or intended to be made by all the households in the
economy at different levels of income during a period of time are called exante savings or
planned savings.
 These are planned at the beginning of the period.
 The investment which is planned or desired or intended to be made by all the producing units in
the economy during a period of time are called ex-ante investment or planned investment.
 It is planned at the beginning of the period.
Ex ante savings and investment may or may not be equal. Equilibrium in

the economy takes place only when these two are equal.
Ex-post (Actual) Savings and Investment :
 The savings which have been actually saved by all the households is called ex-post savings.
 It is measured at the end of the period.
 The investment which has been actually invested by all the producing units is called ex-post
investment.
 It is measured at the end of the period.
Actual savings and actual investment are always equal in the economy. We study
EXANTE AD, AS i.e C, I, S all are planned.

DETERMINATION OF EQUILIBRIUM LEVEL OF NATIONAL INCOME, TOTAL OUTPUT AND EMPLOYMENT
AD- AS APPROACH
 Assumptions
• Price level in the economy is fixed.

• Theory is applicable only under short run.
• Economy is closed i.e No foreign trade.
• There is no government.
 Explanation
• Equlibrium level of National Income is determined by that point where Aggregate demand is
equal to Aggregate supply.
• Symbolically, the equilibrium condition is
(i) IF AD < AS :
 It is a situation of excess supply.
 There will be unplanned increase in stock of goods.
 As excess inventories accumulate, firms will reduce the factor of production to cut down the
production.
 This will reduce the income (output) from OB to OY and stability of equilibrium will be
restored at point E.
(ii) IF AD > AS :
 It is a situation of excess demand.
 The producers will suffer the loss of unfulfilled demand i.e. there is unplanned decrease in
stock of goods
 To avoid this loss, producer will expand the production by hiring more factors of production.
 This will increase the output from OA to OY and stability of the equilibrium will be restored at
point E.

SAVINGS – INVESTMENT APPROACH
 Equilibrium level of National Income can be determined by the point where ex-ante (planned)
savings are equal to ex-ante (planned) investment.
(a) When S > I

It means that households saves more and not consuming as much as the firms expects them to.
As a result, inventory rises above the desired level and to clear the unwanted stock, firms will
reduce the production (i.e from OB to OY) till savings become equal to investment.
(b) When S < I

It means that households are consuming more and saving less than what firms expects them to.
As a result, inventory falls below the desired level and to bring the inventory back to the
desired level, firms will increase the production (i.e from OA to OY) till savings become equal
to investment.

UNEMPLOYMENT
Voluntary Unemployment Involuntary Unemployment
TYPES OF EQUILIBRIUM

EXCESS DEMAND
Reasons for excess demand : ( AD > AS )
Effects of excess demand/ inflationary gap :

DEFICIENT DEMAND
Reasons for deficient demand : ( AD < AS )
Effects of deficient demand/ deflationary gap :

MEASURES TO CORRECT EXCESS DEMAND / DEFICIENT DEMAND

Very Short Answer Type Questions(1 Mark)
1. Give the meaning of ex-ante savings.

Ans. : Ex-ante savings are the planned savings or expected savings
2. Give the meaning of deflationary Gap.
Ans. It is the gap between excess of aggregate supply over aggregate demand at full employment
level.
3. What is Ex-ante aggregate demand?
Ans. It is planned or desired aggregate demand.
4. Give the meaning of Inflationary Gap.
Ans. It refers to the amount by which the actual aggregate demand exceeds the level of aggregate
demand required to establish the full employment equilibruim.
5. What is meant by ex-ante investment?
Ans. : It is planned or desired investment during a particular period.
6. Define aggregate demand.
Ans. Aggregate demand is defined as the money value of total goods and services demanded by an
economy during a given period.
7. What is propensity to consume?
Ans. Which shows the level of consumption at different levels of income in an economy.
8. Define marginal propensity to consume.
Ans. It is defined as measure of the rate at which aggregate consumption expenditure Changes as
national income changes. MPC= C/Y
9. What is involuntary unemployment?
Ans . When people who are willing to work at the giving wage rate do not get work.
10. What is meant by excess demand in macro economics?
Ans. In macro economics, when aggregate demand is more than aggregate supply at full
employment level, then there is excess demand.
11. What can be the minimum value of investment multiplier?
Ans. Investment multiplier K=1/1-mpc if mpc = 0 than K=1/1-0 = 1 which is minimum value of
investment multiplier
12. Give the meaning of aggregate supply?
Ans. Aggregate supply is the money value of total supply of goods and services available for
purchase by an economy during a given period.
13. Can the value of APS be negative?
Ans. Yes, when there are dis savings.
14. Write the relationship between MPS and multiplier?
Ans. K=1/1-MPC = 1/MPS or inverse relationship between MPS and the size of the multiplier
1. In an economy the MPC is 0.75. Investment expenditure in the economy increase by Rs.75
crore. Calculate total increase in national income.
Ans. K=DY/DI = 1/1-MPC
DY= DIx1/1-MPC
= 75x1/1-0.75
= 300 Crore
2. An economy is in equilibrium. Its consumption function is C=300 +0.8Y. and investment is 700
find national income.
Ans. : C= 300+0.8 Y
Y = C+I
Y = 300+0.8Y+700
=1250
3. Giving reasons, state whether the following statements are true or false.
1. When MPC is zero, the value of investment multiplier will also be zero.

2. Value of APS can never be less than zero
3. When MPC>MPS, the value of investment multiplier will be greater than 5.
4. The value of MPS can never be negative
5. When investment multiplier is 1, the value of MPC is zero.
6. The value of APS can never be qreater than 1.
Ans.
1. False because when MPC = 0
Value of investment multiplier is one K=1/1-MPC = 1/1-0 = 1
2. False because APS is negative when there are dissavings
3. True, if MPC is greater than 0.8 or false if MPC > 0.5 but not greater than 0.8
4. True, since MPS = DS/DY if DS = 0 than MPS can at the most be zero.
5. True because K = 1/1-MPC = 1/1-0=1
6. True, because APC + APS = 1
4. Explain the distinction between voluntary and involuntry employment.

Ans. Voluntary unemployment is that part of the working force not willing to engage itself is gainful
occupation. Involuntary unemployment is that part of labour force which is willing and able to work
at the prevailing wage rate but is out of work.
5. Explain the relationship between investment multiplier and MPC?

Ans. K=1/1-MPC, It shows direct relationship between MPC and the value of Multiplier. Higher the
proportion of increased income spend on consumption, higher will be value of investment multiplier.
Higher the proportion of increased income spend on consumption, higher will be value of investment
multiplier.
Long Answer Type Questions(6 Marks)
1. Explain the role of the following in correcting deficient demand in an Economy.

1. Open market operation
2. Bank rate
Ans:
1. Open market operation refer to the sale and purchase of securities by the Central Bank incase
of deficient demand when AD falling short of AS at full employment, the Central Bank buys
securities in the open market and makes payment to the sellers. The money flows out of the
central bank and reaches the commercial bank as deposits. This raises the lending capacity of
the banks, people can borrow more. This will raise AD.
2. Incase of deficient demand central bank decrease the bank rate which the central bank
charges on the loan given to commercial bank. This forces the commercial banks to reduce
lending rate. Since borrowing become cheaper and people borrow more. Arises.
2. Explain the role of the following in correcting ’Excess demand in an Economy’
1. Bank Rate
2. Open market
Ans.
1. To Correct excess demand central bank can rise the bank rate. This forces commercial bank
to increase lending rates. This reduces demand for borrowing by the public for investment
and consumption. Aggregate demand falls.
2. When there is excess demand Central Bank sells securities. This leads to flow of money out
of the commercial banks to the central bank when people make payment by cheques. This
reduces deposits with the banks leading to decline in their lending capacity. Borrowing
decline. AD declines.
3. Explain the role of following in correcting the deflationary gap in an economy.

1) Govt. Expenditure
2) Legal Reserve Ratio
Ans.

1. In a situation of deflationary gap or deficient demand. The Govt. should raise its expenditure
i.e. there will be more economic activities in the economy like, building of roads, bridges,
canal etc. This will raise the level of employment. It will in turn increase the income and the
purchasing power. Thus aggregate demand will rise.
2. During deficient demand, central bank reduces the CRR. The result of reducing CRR will be
seen in the surplus cash reserves with the banks which can be offered for credit. The bank’s
credit bank reduces SLR, this will have expansionary effect on the credit position of the
banks leading to increase in their leading capacity borrowing increases & AD increases.
4. Explain the role of margin requirements for correcting the deflationary gap.
Ans. Deflationary gap refers to a situation when at full employment level of income AD falls short
of AS. It is called deficient demand.
Margin requirements refers to the margin on the security provided by the borrower. When margin is
lower, the borrowing capacity of the barrow is higher. When central bank lowers the margin the
borrowing capacity of the borrowers increase. This raise AD.
1. Why can the value of MPC be not greater than 1?

Ans. It is because change in consumption can never be greater than change in income.
2. Does an excess of AD over AS always imply a situation of inflationary gap?

Ans. No. Inflationary gap occurs only when AD>AS corresponding to full employment level of
employment.
3. What happens if AD>AS prior to full employment level of employment?

Ans. It is a state of disequilibrium in economics. When AD>AS , producers have to cater to demand
out of their existing stock of goods , implying that the desired level of stocks will decrease. It implies
greater production & therefore there is increase in AS .This process continues till equilibrium is
struck between AD and AS.
4. In poor countries like India , people spend a high percentage of their income so that APC and
MPC are high . Yet , value of multiplier is low . Why?
Ans. Working of the multiplier process is based on one fundamental assumption: that there exists,
excess capacity in the economy , so that whenever consumption expenditure rises (implying increase
in demand ) there is a corresponding increase in production (implying increase in income ) . But
poor countries like India, lack in production capacity.
Accordingly, whenever demand increases (in terms of increase in consumption expenditure), there is
increasing pressure of demand on the existing output (implying inflation or rise in prices) rather than
the increase in output or income.
5. Show a point on the consumption curve at which APC= 1.

Ans. APC = C/Y =1 is possible if C=Y, i.e. Consumption is equal to Income.
6. In what respect foreign trade will be useful in removing the adverse economic effects of
deficient demand?
Ans. Export increases the demand for goods and services produced in the domestic territory and is
helpful to reduce deficient demand.
7. What happens in an economy, when credit availability is restricted and credit is made costlier?
Ans. Aggregate demands falls.

Q1 :- In an economy total savings are 2,000 and the ratio of average propensity to save and average
propensity to consume is 2:7. Calculate the level of income in the economy.
Q2 :- Find "Savings" from the following :

National income 500 Autonomous consumption 100
Slope of consumption curve 0.75
Q3 :- Given C = 40 + 0.8Y. Find

1) Dis savings 2) Marginal propensity to save
3) Investment multiplier 4) APC given that income level is 4,000.
Q4 :- As a result of increase in investment by 60, national income rises by 240. Find MPC.
Q5 :- It is planned to increase national income by 1,000. How much increase in investment is required to
achieve this goal ? Assume that slope of consumption curve is 0.6.
Q6 :- In an economy 75 percent of the increase in income is spent on consumption. Investment is

increased by 1,000 crore. Calculate : a) total increase in income b) total increase in consumption.
Q7 :- In an economy, income is 12,000. The ratio of MPC to MPS is 3:1. Calculate additional investment
needed to reach new level of 20,000.
Q8 :- Given S = (-) 200 + 0.25Y. Find a) consumption when income is 1,000 b) Investment multiplier.
Q9 :- If national income is 50 and savings are 5, find APC. When income rises to 60 and savings to 9, find
new APC and MPS.
Q10 :- What will be the value of "K" if entire national income is converted into additional consumption ?
Q11 :- In an economy investment expenditure is increased by 400 crore and marginal propensity to
consume is 0.8. Calculate increase in income and increase in savings.
Q12 :- Find change in savings when 2/3 rd of income is always spent as consumption expenditure and
current income is 50% more than the initial income of ` 48,000.
Q13 :- In an economy find equilibrium level of income given that autonomous expenditure is ` 50 crores
and investment multiplier is 5 times.
Q14 :- In an economy, actual level of income is 1,000 whereas the full employment level of income is a bit
more than this. One - fourth of the income is saved in the economy. If there is an increase in investment in
the economy by 150 calculate :(i) new income level at full employment level (ii) change in savings (iii)
change in consumption.
Q15 :- Complete the following table :

Income APC Saving MPC
0 N.A (-) 80 N.A.
100 1.6 - -
200 1 - -
300 0.8 - -

GOVERNMENT BUDGET 62
UNIT – 4
GOVERNMENT BUDGET (6 Marks)
 It is a statement showing item-wise estimated receipts and anticipated expenditure under various
heads, during a fiscal year. (1st April – 31st March)
OBJECTIVES OF GOVERNMENT BUDGET :
1. Redistribution of income and wealth :
2. Reallocation of resources :
3. Economic stability :
4. Management of public enterprises :
5. To reduce poverty, unemployment and regional disparity.

1. Capital Receipts
2. Capital Expenditure
3. Revenue Receipts
TYPES :
1. Tax Revenue – Tax is a compulsory contribution from people to the government. Two types of
taxes are –
(a) DIRECT TAX

 Liability to pay and burden of tax falls on the same person.
 Direct tax is PROGRESSIVE in nature i.e rate of tax increases with increase in income.
 Eg – Income tax, Corporate tax (profit tax), Property tax (estate duty), MAT (minimum
alternative tax)
(b) INDIRECT TAX

 Liability to pay and burden of tax falls on two different persons.
 It is REGRESSIVE in nature i.e rate of tax decreases with increase in income.
 Eg – Entertainment tax, Sales tax, Goods & Services Tax (GST), Excise duty, Octroi duty,
Custom duty (import tax), Sin tax

2. Non-tax Revenue –
 Interest received on loans given by government to state, private enterprises, etc.
 Profits earned by public enterprises.
 Dividend received on investment.
 Fees and fines (passport fees, court fees, license fees, tuition fees in govt. school)
 Grants or donations received.
 Escheat – It is the income of the government in the form of property left out by the people
without legal heir.
 Special assessment – Payments paid in cash in lumpsum by property owners for increase in
property value as a result of development activity taken by the government.
4. Revenue Expenditure
BUDGET DEFICIT
Types of budget deficit are as follows :
1. Revenue Deficit
2. Fiscal Deficit
3. Primary Deficit

MERITS & DEMERITS OF BALANCED BUDGET :
1. MERITS :
(a) A balanced budget ensures financial stability.
(b) A balanced budget avoids wasteful expenditure on part of government.
2. DEMERITS :
(a) A balanced budget restricts the freedom of action on part of government.
(b) A balanced budget hampers the process of economic growth in the economy.
MERITS & DEMERITS OF DEFICIT BUDGET :
1. MERITS :
(a) A deficit budget accelerates the process of economic growth in the economy.
(b) A deficit budget allows the government to focus on welfare schemes of the people.
2. DEMERITS :
(a) A deficit budget may lead to financial instability.
(b) A deficit budget encourages wasteful and innecessary expenditure on part of the
government.

1. Define Budget.
Ans. Budget is a financial statement showing the estimated receipts and estimated expenditure of the
Govt. for coming fiscal year.
2. What is meant by non-tax receipts?
Ans. All the revenue receipt of Govt. other than tax receipts.
3. What are revenue receipts?
Ans. Revenue receipts are those receipts which neither creates liabilities for Govt. nor cause any
reduction in assets.
4. What are capital receipts?
Ans. Capital receipts are those receipts which either creates a liability or leads to reduction in assets.
5. Give two examples of non-tax revenue receipts.
Ans. Interest, Fee.
6. What are the two sources of capital receipts?
Ans. Borrowings, Recovery of loans.
7. Define revenue deficit.
Ans. When total revenue expenditure exceeds total revenue receipts.
8. Define fiscal deficit.
Ans. When total expenditure exceeds total receipts excluding borrowing.
9. Why is repayment of loan a capital expenditure?
Ans. As it leads to reduction in liability.
10. Why is recovery of loan treated a capital receipt?
Ans. As it leads to reduction in assets.
11. What is a balanced budget.
Ans. Balanced budget is that when estimated receipts are equal to estimated expenditure.
12. Define capital expenditure.
Ans. Capital expenditure is that which creates assets and which reduces liabilities.
13. In a Govt. Budget primary deficit is Rs. 25,000 Cr. and interest payments are Rs. 15,000 Cr.
How much is the fiscal deficit?
Ans. Fiscal Deficit = Primary Deficit + Interest Payment
= 25,000 + 15,000
= 40,000 Crore.

14. Define a Tax.
Ans. Tax is a legally compulsory payment imposed by Govt.
15. What is Direct Tax
Ans. It refer the tax whose primary and final burden borne by the person on whom it is imposed.
16. Define Primary Deficit
Ans. It is the difference of fiscal deficit and interest paid.
1. Explain the ‘redistribution of income’ objective of a government budget.

OR
Explain how the government budget can help in a fair distribution of income in the economy.
Ans. Budgetary policies are useful medium to reduce inequalities of income for the fair distribution
of income. government can use tax policy and public expenditure as a tool. govt can reduce the
disposable income and wealth of Rich by imposing heavy tax and can spend more on providing free
services to the poor. It raise the disposable income welfare of the poor.
2. Explain the “Reallocation of resources” objective of a government budget.

Ans. Through its Budgetary policy the government directs the allocation of resources in a manner
such that there is a balance between the goal or of profit maximization and social welfare.
Government can provide subsidy and reduction in tax rate to motivate investment into areas where
private sector initiative is not coming. Production of goods which are injurious to social life is
discouraged through heavy taxation.
3. Distinguish between revenue receipts and capital receipts with the help of example.
Ans.
Revenue receipts Capital Receipts
1. These receipts do not create any liability for the
1. These receipts create liability for the govt.
govt.
2. These receipts do not cause any reduction in 2. These receipts cause a reduction in assets of the
assets govt.
3. Example :– Tax receipts 3. Example:– Loan by govt. disinvestment.
4. Distinguish between revenue expenditure and capital expenditure with the help of example.
Ans.
Revenue Expenditure Capital Expenditure
1. These expenditure do not cause increase in govt. 1. These expenditure are causes increase in govt.
assets assets
2. These expenditure do not cause any reduction in 2. These expenditure are causes reduction in
govt. liability govt. liability
3. Example:– transfer payment by govt. 3. Example:– Repayment of loanby govt.
5. Distinguish between direct and indirect tax

Ans.
Direct Tax Indirect Tax
1. Direct tax is a tax whose liability to pay and 1. The liability to pay and incidence of indirect tax
incidence lie on the same person do not lie on the same person
2. Its incidence cannot be shifted to some other
2. Its incidence can be shifted to some other person
person
3. Example :– income tax 3. Production tax

1. What are Budget Receipts?

Ans. Estimated money receipt received by the Govt. from different sources in fiscal year are called
budgetary receipts.
2. In a Govt. Budget, revenue deficit is Rs. 8,00,000 Cr. and borrowings are Rs. 50,000 Cr. How
much is the fiscal deficit?
Ans. Rs. 50,000 Crore.
3. What is disinvestment?
Ans. Disinvestment refers to withdrawal of existing investment.
4. What does zero primary deficit mean?

Ans. Zero primary deficit means that interest commitment on earlier loans have compelled the Govt.
to borrow.
5. Which type of revenue receipts are treated as legally compulsory payment imposed on the
people by the govt.? Give example also.
Ans. Taxes imposed on the people by the govt. such as income tax, sales tax.
6. When the liability to pay a tax is on one person and the burden of tax falls on some other
person, state the type of tax?
Ans: These are indirect taxes such as sales tax.
7. What happens to aggregate demand when the govt. budget is in deficit?

Ans: A deficit budget increases the aggregate demand because the deficit budget means that the
amount of expenditure is more than the amount of tax.
8. Classify the borrowings and recovery of loans into revenue and capital receipts of govt. budget.
Give reason also.
Ans. Borrowings are capital receipts because the government is under obligation to return the
amount along with interest so it creates liability for the government. Recovery of loans are also
capital receipts because these reduce assets of the goverment.
9. How tax revenue is different from administrative revenue?

Ans: Tax revenue is the revenue that arises on account of taxes levied by the government. Taxes are
of two types: direct taxes and indirect taxes. Direct taxes are those taxes levied immediately on the
property and income of persons income tax, corporate tax, wealth tax whereas indirect taxes are the
taxes levied on the production and sale of goods like sale taxes, excise duty etc. Administrative
revenue is revenue that arises on account of the administrative function of the government. It
includes (a)Fees(college/school) (b) License fees paid to get permission to perform a service (c)
Fines and penalties etc.
10. How government reallocates the resources and redistributes the income through Budget?
Ans.
1.Reallocation of resources:- In case, the market economy fails or does not achieve the desired
social objectives, the government has to interfere through budget and reallocate resources
accordingly.
Through its budgetary policy, the government of a country directs the allocation of resources
in a manner such that there is a balance between the goals of profit maximization and social
welfare. Production of goods which are injurious to health is discouraged through heavy
taxation. On the other hand, production of ‘socially useful goods’ is encouraged through
subsidies.

2.Redistribution of Income: - Every economy strives to attain a society, where inequality of
income and wealth should be minimum. In order to achieve this objective through govt.
budget the government 37 spends sufficient money on social security schemes, economic
subsidies and public works etc.
11. What are the basis of classifying receipts into revenue receipts and capital receipts?
Ans. Revenue receipts are those which neither create a liability for the govt nor reduce the assets of
govt such as income tax, sales tax, fees, profits etc. Capital receipts are those which either create a
liability for the govt or reduce assets such as borrowings, disinvestment, recovery of loans etc.
12. Why is tax treated as revenue receipt?

Ans. Because tax neither create a liability for the govt nor reduces assets of the government.
13. Find out the value of total receipts of govt. Budget if budget deficit is Rs 2,000 crores and the
total expenditure is Rs 3,000 crores.
Ans:- Budget deficit =Total Expenditure- Total receipts
Total receipts= Total Expenditure- Budget deficit
= 3,000-2,000
= 1,000 Ans. Rs. 1,000 crores
14. What will be the value of fiscal deficit if primary deficit is 53,000 crores and interest on
borrowings is Rs 5,000 crores?
Ans: - Fiscal deficit=Primary deficit + Interest Payment
= 53,000+5,000
= 58,000 Ans. Rs. 58,000 crores
15. State which budget expenditure does not result in creation of assets or reduction of liability.
Give examples also.
Ans. Revenue Expenditure does not result in creation of assets or reduction of liability. Such
expenditures are incurred for the normal running of government departments and maintenance of
services. For example: salaries, old age pensions, interest payments, subsidies, grants etc.
16. What indicates zero primary deficit?

Ans: Zero primary deficits means that the government has to resort to borrowings only to make
interest payments.
17. What indicates revenue deficit?

Ans: Revenue deficits are defined as the excess of revenue receipts.
Revenue Deficit = Revenue Expenditure-Revenue Receipts
Revenue deficit is a reflection of the government’s fiscal policy. The implication of revenue deficit
is that the government is borrowing to maintain even its consumption expenditure. It shows that the
country’s financial system is getting destabilized.
जो भी QUESTIONS , SIR क्लास में कवर करें गे !!

FOREIGN EXCHANGE & BOP 69
UNIT-5
FOREIGN EXCHANGE & BALANCE OF PAYMENTS (6 Marks)
 Foreign exchange is the name given to all the currencies other than the domestic currency.
Eg – US dollars, British pounds, etc.
 Foreign Exchange Rate

• It refers to the rate at which currency of one country is exchanged with currency of another
country.
• It is also known as EXTERNAL VALUE OF CURRENCY.
• Eg – If we import goods from US, then we have to pay the exporter in terms of dollars and
for this purpose we will convert rupees into dollars.
TYPES OF FOREIGN EXCHANGE RATE
1. FIXED foreign exchange rate system (PEGGED FOREIGN EXCHANGE RATE SYSTEM)

2. Flexible (floating) exchange rate system
3. Managed Floating
FOREIGN EXCHANGE MARKET
 Market where sale and purchase of foreign exchange takes place.

 It is of two types –
(a) Spot Market – Market in which sale and purchase of foreign exchange are made immediately
(b) Forward (futures) Market – Market in which sale and purchase of foreign exchange is made
at some future date at the rate agreed upon today.
FUNCTIONS OF FOREIGN EXCHANGE MARKET
1. Transfer Function : This function is used for transferring of funds from one country to another
country.
2. Credit Function : This function is helpful in providing credit for foreign trades. For eg – Bills of
exchange are used for international payments.
3. Hedging Function : It is an activity which reduces the risk of loss of foreign exchange and is generally
adopted by importers and exporters.

DEMAND OR OUTFLOW OF FOREIGN EXCHANGE
Q1) What are the sources of demand for foreign exchange ?

or
Why foreign exchange is demanded by domestic residents ?
Q2) Why does demand for foreign exchange rise with fall in its price ?
Ans (1) Import increases : When the price of foreign exchange falls then foreign goods become
relatively cheaper and it may lead to increase in imports resulting in more demand of foreign
exchange.
(2) Tourism : Fall in price of foreign exchange promotes the tourism of that foreign country
and therefore demand of foreign exchange rises.
(3) Investment : With the fall in price of foreign exchange, investing in foreign countries
become more lucrative which increases the demand of foreign exchange.
Q3) Why does demand for foreign exchange fall with rise in its price ?

SUPPLY OR INFLOW OF FOREIGN EXCHANGE
Q1) What are the sources of supply of foreign exchange ?

or
Why foreign exchange is suppled by foreign residents ?
Ans

DETERMINATION OF EXCHANGE RATE
( How equilibrium rate is attained )
 Flexible exchange rate is determined by the intersection of forces of demand and supply of
foreign exchange.
 As per the diagram, demand and supply of foreign exchange intersect each other at point E
where equilibrium exchange rate is determined at OR.
 If exchange rate rises from OR to OR1 the demand for foreign exchange will fall to OQ1 and
supply will rise to OQ2. This is a situation of excess supply which results in fall in exchange
rate till it again reaches equilibrium level i.e OR
 If exchange rate falls from OR to OR2, the demand for foreign exchange will rise to OQ2 and
supply will fall to OQ1. This is a situation of excess demand which results in rise in exchange
rate till it again reaches equilibrium level i.e OR

BALANCE OF PAYMENT
 It refers to a summary statement in which all the economic transactions that take place between
one country and rest of the world during a given period of time is recorded.
 Economic transactions involves transfer of ownership of goods, services, money or assets.
 Items to be included in BOP :


____________________________________________________________________

________________________________________________________________

1. Define foreign exchange rate.

Ans. Foreign exchange rate is the price of a foreign currency in terms of domestic currency
2. What is foreign exchange?

Ans. Any currency other than the domestic currency.
3. What is balance of payment Accounts?

Ans. It is a systematic record of all economic transactions between the residents of a country and
the rest of the world in a given period (one year) of time
4. State two sources of supply of foreign exchange.

Ans. Exports and foreign tourism.
5. State two sources of demand of foreign exchange.

Ans. Import of goods & services and to get education in abroad.
6. What does a deficit in balance of trade indicate.

Ans. Deficit in balance of trade indicates that the imports of good are greater than the exports.
7. What is meant by balance of trade?

Ans .It is the difference between monetary value of exports and imports of material goods or
visible items.
8. Define balance of payment.

Ans. A balance of payment is a statement of double entry system of all economic transactions
between residents of a country and the residents of foreign countries during a given period of time.
9. When is there a deficit in the balance of trade.

Ans. When the value of imports is more than value of exports.
10. State the components of capital account of balance of payment.

Ans.
1. Borrowing and lending to and from abroad.
2. Investment to and from abroad.
3. Change in foreign exchange reserves
11. Which transactions determine the balance of trade? When is balance of trade in surplus?
Ans. Exports of goods and imports of goods determines BOT. When the value of exports of goods is
greater than the value of imports of goods.
12. What are the components of current account of the BOP account?
Ans.
1. Exports and imports of goods
2. Exports and imports of services
3. Unilateral transfers
13. Explain the meaning of deficit in BOP

Ans. When autonomous foreign exchange payments exceeds autonomous foreign exchange
receipts, the difference is called balance of payments deficit.

14. The balance of trade shows a deficit of Rs. 300 crs. and the value of exports is Rs. 500 crs. What is
the value of imports?
Ans. 800 Crores.
15. List two items included in the balance of trade account.

Ans. Visible items Watch, Petrol, Electronic item.
16. List two items of the capital accounts of balance of payment.

Ans.(i) Direct Foreign Investment
(ii) Loans
17. Give meaning of managed floating exchange rate.

Ans. Exchange rate influenced by the intervention of the central bank in the foreign exchange
market.
18. Distinguish between devaluation and depreciation of domestic currency

Ans. When Government or authorities reduce the price of domestic currency in terms of all foreign
currencies is called devaluation. The fall in market price of domestic currency (due to demand
supply in the market) in terms of a foreign currency is called depreciation.
19. When price of a foreign currency rises its supply also rises. explain why?
Ans. If exchange rate increases, this will make domestic country’s goods cheaper to foreigners. The
demand for our exports will rise. It implies more supply of foreign exchange.
20. What is meant by invisible items?

Ans. Invisible items are all those type of services which are exported and imported.
21. What is meant by unilateral transfer?

Ans. These refers to one sided transfers from one country to other. These are not trading
transactions.
22. What is meant by Autonomous transactions?

Ans. Autonomous transactions refer to international economic transactions in the current and
capital account that are undertaken for profit.
23. Write the name of those economic transactions which are made by the government to make
equilibrium in balance of payment.
Ans. Accommodating items.
24. What do you mean by Fixed Exchange Rate?

Ans. Fixed exchange rate is the rate which is officially fixed in terms of Gold or any other currency
by the govt. or adjusted only frequently.
25. Define Flexible Exchange rate?

Ans. Flexible exchange rate is determined by demand for and supply of a given currency in foreign
exchange market.
26. State two merits of Flexible Exchange Rate.

Ans. (i) No need to hold foreign exchange reserve.
(ii) Optimum resource allocation.

27. State two demerits of Flexible Exchange Rate.
Ans. (i) Fluctuations in foreign exchange rate.
(ii) Encourages speculation.
28. State two merits of fixed exchange rate.

Ans. (i) Stability in Exchange rate.
(ii) No scope for speculation.
29. State two demerits of fixed exchange rate.

Ans. (i) Need to hold foreign exchange reserves.
(ii) No automatic adjustment in the ‘Balance of Payments.’
30. What is the slope of demand curve of foreign exchange?

Ans. Negative slope.
31. What is the slope of supply curve of Foreign Exchange?

Ans. Positive slope.
32. What will be the effect on exports, if foreign exchange rate increases?
Ans. Exports will increase because Indian goods have become cheaper for foreigners.
33. What will be the effect on imports if foreign exchange rate increases.
Ans. Import will decrease because foreign goods have become costlier for Indians.
34. Define Devaluation of Domestic Currency.

Ans. Devaluations means to reduce parity rate of its currency with respect of gold or any other
currency by the Government.
35. What is meant by Depreciation of Domestic Currency?

Ans. When the value of domestic currency reduce with respect to other currency by the demand
and supply forces of foreign exchange in a free exchange market.
36. What is meant by Appreciation of Domestic Currency?

Ans. Appreciation of currency refer when the value of foreign currency reduce with respect to
domestic currency. It occurs in a free exchange market by the forces of demand and supply of
currency.
HOTS (1 MARK)
1. In which circumstances, the devaluation of currency will be in favour of economy?
Ans. Appreciation of currency refer when the value of foreign currency reduce with respect to
domestic currency. It occurs in a free exchange market by the forces of demand and supply of
currency.
2. In which circumstances the appreciation of currency will be non favourable for the economy?
Ans. When we adopt the policy of Import Substitution.
3. Under which circumstances, the purchasing power of foreign currency increases in comparison to
domestic currency?
Ans. Capital account records capital transfer such as loans and investment between one country
and the rest of the world which causes a change in the asset or liability status of the residents of a
country or its government.

4. With the help of which item BOP gets balanced?
Ans. With the help of international loans (or accommodating items)
5. Does BOP always remain balanced?

Ans. Always in equilibrium in the sense of accounting.
1. State which type of exchange rate has no official intervention in the foreign exchange market?
How it is determined?
Ans. Flexible exchange rate has no official intervention. It is determined by the interaction of
supply and demand in the foreign exchange market.
2. State which of the following is a visible item and which is an invisible item in Balance of payments.
(a) Export of jute product
(b) Software services exports.
Ans. (a) Export of jute product - Visible Item
(b) Software services exports - Invisible Item
3. Name the items which are not included in the current account of India’s Balance of payment,
Ans. The capital transactions in the form of direct and portfolio investment that take place the
countries are not included in the current account of India’s Balance of payments.
4. In which account of balance of payment tourism services to tourist are included?

Ans. Tourism services to tourist are included in current account of Balance of payments.
5. Which transactions- autonomous or accommodating bring balance in the balance of payments.

Ans. Accommodating transactions bring balance in the balance of payment.
6. Why foreign currency/exchange is needed?

Ans. i) To purchase of goods and services from other countries.
ii) To send a gift abroad.
iii) To purchase financial assets in a particular country .
iv) To speculate on the value of foreign currencies.
7. What are the factors responsible for inflow of foreign currency?

Ans. i) foreigners purchasing home country goods and services through exports.
ii) Foreigners investment in home country through joint ventures and through financial market
operation.
iii) Foreign currencies flow into the economy due to currency dealers and speculators
8. When exchange rate of foreign currency falls it’s supply also falls. Explain how?
Ans. When exchange rate falls, experts become less profitable hence supply of foreign currency
through exports falls.
9. When exchange rate of foreign currency falls, its demand rises. Explain how?
Ans. When exchange rate falls, imports become cheaper, demand for imports rises and so rises the
demand of foreign exchange to purchase more imports.
10. What will be the value of imports, if the net imports are Rs 160 crores and the value of exports
are Rs 400 crores.
Ans. Balance of Trade = Exports- Imports

Imports= Exports – Balance of trade= 400-(-160)=560
OR Imports= Exports + net imports = 400+160=560 Ans Rs 560 crores
11. If Balance of payment of a country is Rs (-) 100 crores and total payment are Rs 500 crores. Find
out its total receipts.
Ans. Balance of Payment = Total receipts- Total payments
Total receipts= Total Payment +BOP
= 500 + (-100)
= 500-100=400 Ans Rs 400 crores
12. Balance of payments always balances. Discuss it.

Ans. Balance of payments is always balanced. A negative balance on the current account is equated
with positive balance in the capital account. The monetary authorities may finance a deficit by
depleting their reserves of foreign currencies or by borrowing from the IMF etc. Hence BOP is
always in balance.

UNIT-1 National Income (10 Marks) : Consumption Goods or Capital Goods

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

UNIT-1 National Income (10 Marks) : Consumption Goods or Capital Goods

Uploaded by

Copyright:

Available Formats

NATIONAL INCOME 1

2. Basic activities in economy : (Phases in economy)

BASIS FINAL GOODS INTERMEDIATE GOODS

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

BASIS CONSUMPTION GOODS CAPITAL GOODS

❖ PRODUCER GOODS - includes

4. Factor services/ Factors of production:

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

Circular flow of income

Circular flow of Income

Real Flow Money Flow

❖ LEAKAGES – It is the amount of money withdrawn from flow of income.

❖ INJECTIONS – It is the amount of money added to the flow of income.

BASIS FLOW STOCK

BASIS FACTOR PAYMENTS (INCOME) TRANSFER PAYMENTS (INCOME)

Transaction It is a _____________ transaction. It is a ______________ transaction.

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

BASIS RESIDENT CITIZEN

GDP Deflator is also known as ___________________

❖ How to convert Nominal into Real :

BASIS NOMINAL NI/GDP REAL NI/GDP

Affected by It is affected by price & quantity both. It is affected by quantity only.

Measure of It is not a good measure of It is a better measurement of development of

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

❖ LIMITATIONS OF USING REAL GDP AS INDEX OF WELAFARE OF COUNTRY :

Following are the limitations:

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

 Non-monetary exchanges- Many activities are not evaluated in monetary terms

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

WHAT IS DOMESTIC (ECONOMIC) TERRITORY ?

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

It is NOT domestic territory of

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

BASIC CONCEPTS FOR CONVERSION

BASIS DEPRECIATION CAPITAL LOSS

 Net factor income from abroad (NFIA)

 Market Price (MP) / Factor Cost (FC) :

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

PRODUCTION (VALUE ADDED) METHOD

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

Concept It is a geographical concept. It is an economic concept.

Q3) State the components of NFIA.

Q6) What are the components of Factor income to abroad ?

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

BASIS DEPRECIATION CAPITAL LOSS

(wheat) 100 130 210 250

Value added _____ ______ _______ _______ = _______

Two alternatives of avoiding double counting :

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

Q:- Whether the following are included or not included in

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

Very Short Answer Type Questions (1 Mark)

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

Short Answer Type Questions(3-4 Marks)

3. State whether the following is a stock or flow:

4. State whether the following is a stock or flow:

7. Is net export a part of NFIA? Explain.

8. Calculate gross value added of factor cost :

9. Calculate Net Value added at factor cost :

RKG EDUCATION PVT LTD CLASS 11 | CLASS 12 | CA | BCOM CA PARAG GUPTA

10. Find Net Value added at market price :

Transaction It is a _ transaction. It is a __ transaction.

Value added _ _ _ = _____