Strictly Confidential (For Internal and Restricted Use only)

Bhutan Higher Secondary Education Certificate Examination

December 2008
Marking Scheme—Economics

General Instructions
1. The Marking Scheme provides general guidelines to reduce subjectivity in the
marking. The answers given in the marking scheme are suggested answers. The
content is thus indicative. If a student has given any other answer, which is different
from the one given in the Marking Scheme, but conveys the meaning such answers
should be given full weightage.
2. Evaluation is to be done as per instructions provided in the marking scheme. It should
not be done according to one’s own interpretation or any other consideration –
Marking Scheme should be strictly adhered to and religiously followed.
3. If a question has parts, please award marks in the right hand side for each part. Marks
awarded for different parts of the question should then be totaled up and written in the
left hand margin.
4. If a question does not have any parts, marks must be awarded in the left hand margin.
5. If a candidate has attempted an extra question, it will be cancelled. The extra question
attempted will be in the last question in the sequence of the question paper.
6. Some examinees may attempt the questions giving equally correct answers in a
different way. If the examiners are convinced that the response given by an examinee
is genuinely correct, full weightage should be given.
7. If there are questions on distinction between two concepts, in such questions,
sometimes some students give one aspect of the difference correctly and the other is
either wrong or not given at all, no marks should be given for such point.
8. There may be few higher level questions requiring the examinees to give new ideas of
their own or give valid justifications and judgments of their own. In such cases, marks
should be awarded for their efforts though there may be several possible answers.
9. If the questions ask for two features/characteristics/point but an examinee writes more
than two features/characteristics/points, say, five of which first is correct, second is
incorrect, the best two should be assessed and the remaining should be ignored.
10. It is expected that the Marking Scheme should be followed objectively to avoid over
strict tendency in marking. For instance, if an examinee scores 30 marks, his/her
marks should not be inflated to 33 simply to pass him/her. Similarly, wherever an
examinee writes answer up to the mark, his/her marks should not be deducted
unnecessarily.
11. Marks should be awarded keeping in view the total marks of that particular question
and not the total marks of the question paper. For example, if one mark is given to a 3
marks question even if nothing is correct then one mark constitutes 33% of the total
marks ear-marked for this answer. This must be avoided.
12. A full scale of marks 0-100 has to be used. Please do not hesitate to award full marks
if the answer deserves it.
13. If the candidate fails in the subject by 1 to 3 marks, the marking may be reviewed.

Page 1 of 22
 PART I
(COMPULSORY 2X15=30)
Question EXPECTED ANSWER Marks
No.
1. (i) What do you understand by “Law of Supply”? Illustrate it with a labelled diagram. (2)

Other things remaining the same, the quantity supplied shares positive and direct 1
relationship with its price.

PQ 1

P
P1

x
0 Q1 Q Q2
Quantity Supplied

(ii) State TWO differences between utility approach and indifference curve analysis. (2)

(a) In utility approach, utility is measured in cardinal numbers whereas indifference

curve analysis follows ordinal measurement of utility.
1
(b) In utility approach, one commodity model is used to explain the consumer’s
equilibrium and law of demand. Whereas indifference curve analysis uses two
commodity model to explain the same concepts. 1
(iii) Explain TWO relationships that Average Revenue shares with Marginal Revenue. (2)

(a) When the Average Revenue Curve falls, Marginal Revenue Curve must be less
than the Average Revenue for every level of output. 1

(b) When Average Revenue Curve is a straight line, Marginal Revenue Curve is also
a straight. 1
(iv) Define oligopoly. Explain ONE of its characteristics. (2)

Oligopoly is a market structure in which there are few firms selling a product so that
there is an intense competition among them. 1

Features (characteristics): Any ONE of the following:

Page 2 of 22
 1. Intensive competition 1
2. Interdependence of firms 1
3. Nature of the product 1
4. Importance of selling cost 1
5. Barriers to entry 1
6. Interdependence of demand curve of an oligopolist. 1

(v) “VMP is equal to MRP under perfect competition”. Is this also true in case of
imperfect competition? Why? (2)

No, VMP is not equal to MRP in case of imperfect competition because under
imperfect competition, demand curve or Average Revenue Curve is sloping ½
negatively. Therefore, Marginal Revenue Curve lies below Average Revenue
Curve implying that Marginal Revenue is less than the Average Revenue.

VMP=MPP x P(AR)----------------- (i)

MRP= MPP x MR--------------------(ii)
Since AR>MR under imperfect competition from (i) and (ii) it follows: VMP>MRP. 1½

(vi) Distinguish between real flows and money flows. (2)

Real flows of income consist of flow of commodities (goods or services) and factor 1
services among different sectors of the economy whereas money flows consist of
flow of factor incomes and money expenditure on goods and services. 1
(vii) Which of the national income aggregates is technically known as national income? (2)
Define it.
Net national Product at factor cost.
Definition: ½
National income can be defined as factor income accruing to the residents of a
country in a given year.
1½
(viii) What is ‘Double Counting’? How can it be avoided? Write TWO methods. (2)

Definition:
When we add values of intermediate goods or inputs to the values of final goods and
services while calculating the national income, it is called double counting.
1
Methods to avoid double counting; (Any TWO of the following)

(1) By adding only the final values of goods and services. ½

(2) By excluding the values of intermediate goods. ½
(3) By using value added method. ½

(ix) How is balance of trade different from balance of payments? (2)

Balance of payments of a country is a systematic record of all economic transactions

Page 3 of 22
 between the residents of one country and residents of foreign countries during a given 1
period of time.

Balance of trade refers to the balance of imports and exports of visible goods during a 1
given period of time.
(x) ‘Exploitation’ and ‘Dislodging of domestic industries’ are two disadvantages of
international trade. Explain how the trading countries are, sometimes, exploited
and their domestic industries dislodged through international trade. (2)

Exploitation
 Exploitation of under developed countries by advanced countries as they reap ½
bulk of gains from international trade.
 A country having monopoly of some essential commodities for which there is
no close substitutes can exploit others. ½

Dislodging of domestic industries.

Cheaper goods imported from other countries compete out the domestic industries
producing similar products. 1
(xi) Explain ONE positive effect and ONE negative effect of public Debt. (2)

Positive effect (Any ONE of the following)

a) Mobilization of resources for economic development. 1

b) Promotion of saving and Investment 1
c) Enhancement of productive capacity of a country. 1
d) Generation of foreign exchange. 1

Negative effect (Any ONE of the following)

a) The burden of internal public debt 1
b) The burden of external debt 1
c) Unproductive debt 1
(xii) Mention TWO reasons for carrying out deficit financing by a nation. (2)

Reasons (Any TWO of the following)

 Meeting the financial needs of the government in times of war 1

 Increasing output and employment during depression 1
 Useful method for financing development plans of under developed countries
and accelerating their rate of economic development. 1
(xiii) What do you understand by the term ‘MODVAT’? Mention ONE of its objectives. (2)

Definition:
MODVAT is a taxation system in which it takes into account the duty paid on inputs
while calculating the taxes to be paid by the producers. 1

Objectives: (Any ONE of the following)

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  To avoid repeated payments of duties from raw material stage to the final 1
product stage.
 To avoid payment of taxes at different stages of excise duties. 1
 To simplify and rationalize the tax procedures. 1
(xiv) Some of the objectives are seen to be similar in both the Seven Five Year Plan and (2)
Eight Five Year Plan of our country. Mention TWO such objectives.
Any TWO of the following:
 Balanced development in all parts of the country 1
 Development of private sectors 1
 Sustainability in the use of natural resources 1
 Achievement of national self- reliance 1
(xv) Write any FOUR achievements of the First Five Year Plan. (2)

(Any FOUR of the following)

 1170 kms of roads were constructed ½
 108 schools in Bhutan with enrollment of 15, 000 students. ½
 Establishment of Public Health Department. ½
 Establishment of Department of Agriculture ½
 Measures for conserving the forest wealth by Department of Forests in Bhutan ½
 Steps taken with GSI to discover mineral resources ½
 Enhancement of production capacities of food preserving plants and distillery ½
in Samtse.

PART II

(ANSWER ANY SEVEN QUESTIONS)

Q2 (a) How can our country trade with other countries using the Absolute Cost Theory? (5)
Explain with an example.

According to the theory of Absolute cost, a country produces some commodities at a

lower cost of production comparing with another country. This is because that
country enjoys favourable soil, climate, resources and technology which enable it to
specialize in the production of those commodities. In other words, all the countries 2
will specialize in the production of that commodity in which they have an absolute
advantage. Table given below is an example showing absolute advantage:

Cost of production in USD. 1

Product Bhutan Japan

Page 5 of 22
 Mushroom 1500 2000
Apples 2000 1000

In this situation, Bhutan can specialize in the production of Mushroom and gain from
trade with Japan because Bhutan is blessed with favourable geographical factors for
its production. Similarly, Japan too can benefit from its trade with Bhutan if it
produces Apples because Apples grow well in Japan.
2
In short, Bhutan has an absolute advantage in the production of mushroom and Japan
in the production of apples. Therefore, cost of production of mushroom is lower in
Bhutan compared with Japan and cost of production of apples is lower in Japan
compared with Bhutan. Hence, both the countries are benefited from trade with each
other.

b) With the help of labelled diagrams, explain what would happen to the equilibrium (5)
price and quantity if:
(a) demand increases in larger proportion than the increase in supply, and
(b) demand and supply increase by the same proportion.

a) If increase in demand is greater than the increase in supply:

When the relative increase in demand is greater than the increase in supply, the
equilibrium price rises. From the fig. below, it is clear that both demand and supply
increase but the demand increases in a larger proportion than increase in supply. ½+½
Equilibrium is at E, corresponding to the intersection of D, with S1. Hence, price
increases to OP1 and quantity to OQ1. Thus, when demand increases more than
supply, price will rise.

S S1

P1 E1

Page 6 of 22
 P E
1½
D1
Price

0 x
Q Q1
Quantity Diagram-½
Labelling-1

(b) If demand and supply increase by the same proportion:

When the demand and supply increase in the same proportion, equilibrium price
remains the same. This is illustrated in the diagram below. D and S are original ½+½
demand curve and supply curve respectively. The original equilibrium is at E. Thus,
0P and 0Q are the equilibrium price and equilibrium quantity respectively. An
increase in demand results in shift of demand curve to D1 and supply curve shifts to
S1 due to increase in supply. In this situation, increase in demand equals increase in
supply. Equilibrium shifts to E1 corresponding to intersection of demand curve D1
with supply curve S1. Equilibrium quantity increases from 0Q to 0Q1, but price
remains unchanged at 0P. Thus, when demand and supply increase equally,
equilibrium price remains unchanged but equilibrium quality increases

S
S1

P E E1

Price D1 1½
D

0 x
Q Q1

Page 7 of 22
 Quantity Diagram-½
Labelling-1
Q.3 (a) ‘Law of demand may not operate in many cases’. Explain FIVE such cases. (5)

Exceptions to the law of demand

i. Giffen goods
ii. Articles of snob appeal 2½
iii. Expectation regarding future prices
iv. Emergencies
v. Quality-price relationship
Points- ½+½+½+½+½ 2½
Explanation- ½+½+½+½+½

(5)
b) What were some of the achievements of our government in the manufacture and
trade during the Sixth Five Year Plan?

Achievements (any FIVE of the following) 1

 Share of manufacturing sector to GDP increased from 3.2 % in 1980 to 7.1%
in 1989. 1
 Foreign trade as the proportion of GDP increased from 53% in 1982 to 75% in
1988.
 The ratio of trade with India to GDP increased from 47% to 56% in 1988, 1
while the share of third country trade rose from 6% in 1980 to 19% in 1988.
 Increase in export of fresh fruits (Apples and Oranges) to Bangladesh. Other 1
important exports to third countries are Cardamom (Mainly to Singapore),
Broom handles (mainly to Netherlands), and philatelic stamps and handicraft
goods to various countries. 1
 Share of exports (in the total trade with India) increased to 32% in 1985 to
89% in 1988. 1
 Share of manufactured exports in the total trade with the third countries
increased from 7% in 1985 to 9% in 1988. 1
 New trade routes and transit points with India and Bangladesh opened.
1
 Funds for the site development and pre-investment studies for Dungsam
cement project in Nanglam used.
 Bhutan Calcium and Carbide Limited, Bhutan Polythene Pipe Company and 1
Gedu Wood Manufacturing Centre started production during the Sixth Five
Year Plan. 1
 Establishment of Furniture-Cum-Training Unit in Thimphu at the cost of Nu.

Page 8 of 22
 40 million
 Thimphu Agro-Industry project costing Nu. 70 million completed.
Establishment of industries by private sector such as Yangzom Cement plant at 1
Bhalujhora, Dralha Flour Mill in Phuntsholing, Lhaki Cement Plant at Gomtu, Ferro
Silicon Project at Pasakha, A furniture unit at Bhalujhora, Biscuit Manufacturing Unit
at Phuntsholing, Marble Mining and Processing at Gidgom and Integrate Wood
Complex at Lobesa

Q.4 (a) Explain any FIVE causes of disequilibrium in the Balance of Payments that are (5)
applicable to our economy.

Causes:
i. Development activities of the government 1
ii. Import of services 1
iii. Fall in demand 1
iv. Natural factors Points- ½+½+½+½+½ 1
v. Demonstration effect Explanation- ½+½+½+½+½ 1

(b) Define and explain the law of Variable Proportions using an appropriate diagram. (5)

Definition:
The law of Variable Proportions states that as more and more units of a variable
factor are applied to a given quantity of a fixed factor, the total product may increase 1

Page 9 of 22
at an increasing rate initially, but eventually it will increase at a diminishing rate.

According to the law of Variable Proportions, three stages take place, namely stage of
Increasing Returns, Stage of Diminishing Returns and stage of Negative Returns
which are discussed as follows with the aid of a diagram.

y
T

A
Total product

TP

x
0 L1 L2 L3
Unit of labour
y Stage I Stage II Stage III

2½
marginal products

M A
Average and

AP

Page 10 of 22
 0 x
L1 L2 L3
Unit of labour

MP
Stage I
Total Product ½
 Initially increases at an increasing rate and subsequently at diminishing rate

Marginal Product
 Increases first, reaches the maximum and then starts decreasing.

Average Product
 Increases throughout the stage and reaches the maximum.

Stage I is known as the stage of Increasing Returns because average product of the
variable factor increases throughout this stage.

Stage II ½
Total Product
 Continues to increase at a diminishing rate, and eventually reaches the
maximum.

Marginal Product
 Continues to decrease and eventually becomes zero.

Average Product
 From the maximum begins to decrease. This stage is called the stage of
Diminishing Returns because both Marginal Product and the average product
of the variable factor are diminishing in this stage.

Stage III
Total product ½
 diminishes

Marginal product
 is negative

Average Product
 Continues to decrease but is always positive.
This stage is called the stage of Negative Returns, since the Marginal Product of the
variable factor is negative.

Q5
(a) In what ways, do you think, Indirect taxes are better than the Direct taxes. Explain (5)

Page 11 of 22
 Briefly FIVE reasons in support of your answer.

Merits (Any FIVE of the following)

i. Convenience
ii. Elastic 2½
iii. No evasion
iv. Wide coverage
v. Equity
vi. Social welfare
vii. Promote production and Investment 2½
Points-½+½+½+½+½
Explanation-½+½+½+½+½

(b) Describe the Marginal Productivity Theory of distribution using a diagram. (5)

Theory:
The Marginal Productivity Theory of distribution states that the price of a factor 1
service will be equal to its Marginal Revenue Product.
According to the Marginal Productivity Theory, wage rate equals MRP (or VMP).
However, it is the downward sloping part of MRP or VMP curve, which is relevant
for a profit maximization firm.

The rational producer would equate wage rate with MRP to maximize his profits.
Given the MRP curve, the number of workers employed at any wage rate will be
determined by equality of wage rate with MRP, i.e wages=MRP. This gives the
equilibrium point E. In equilibrium the wage rate can neither be more than nor less
than the MRP (VMP). If the prevailing wage rate is OW, the firm will employ OL
units of labour at which MRP=wages. It will not pay the firm to employ more than
OL units of labour because after OL, the MRP (VMP) for each unit is less than the
factor price, ie wage rate. The additional worker will cost more than what it adds to
the revenue of the firm, i.e it would lead the lower profits of the firm. Similarly, the
firm will not employ less than OL units of labour because it would mean that the
labour who produces more (MRP) and costs less (wage rate) is not employed, leading 3
to fall in profits. So, a firm employs factor units till MRP (VMP) =wage rate. This is
what marginal productivity theory says. The implication of this is that a factor gets a
price which equals MRP (VMP). From this, it follows that at higher wage (OW1),
the firm will employ less labour (OL) and at lower wage (OW2), the firm will employ
more labourers ie OL2 as indicated by equilibrium points, E1 and E2 respectively.

Labeling-½
Diagram-½
y
VMP, MRP and factor price

1
(wage rate)

Page 12 of 22
 W1 E1

W E

W2 E2

VMP=MRP

0 x
L1 L2 L3
Factor units

Q6(a) From the First Five Year Plan to Fifth Five Year Plan, identify ONE most (5)
important priority opted by our government from each plan and give your own
valid reasons for each priority.

First Plan- Transportation link and building up of infrastructure was the priority
because there was a need to end Bhutan’s isolation from the rest of the 1
world.

Second Plan- Construction of road was still the priority, followed by agriculture 1
because 80 percent of country’s population was in agriculture.

Third Plan- Social service sectors, namely health and education received the priority 1
because the development of human resources was needed for economic
development.

Fourth Plan- Agriculture, industries and forest was given the highest priority because 1
agriculture still had very high percentage of population. Apart from
agriculture, Industries and forest were also accorded high priority to
generate revenue.

Fifth Plan- Revenue generating activities were given high priority to do away with 1
increasing reliance on external aid and become economically self reliant.
(note: Answers might vary)

(b) With the help of a diagram, explain the short-run equilibrium of a firm under (5)
perfect competition earning super-normal profit.

The short-run equilibrium of the firm can be illustrated by combing the short-run
costs curve with the demand curve (AR) faced by the firm. Since the firm is price-
taker, it has to decide the amount of output it should produce at the given price so as

Page 13 of 22
 to maximize the profit. Thus, the firm is output-adjuster under perfect competition.
In order to determine the profit-maximizing output, the firm has to meet two types of
conditions.

First condition:
SMC=MR 1
Second condition:
i. AR>SAC (super –normal profit)
ii. AR<SAC (losses)
iii. AR=SAC (normal profit)

In our case, we need to explain short-run equilibrium of a firm earning super-normal

profit under perfect competition. It can be seen from the diagram below the SMC
curve intersects the P=AR=MR line at point E from below, where SMC=MR. since in 2
all three cases, P>AVC, the firm is in short-run equilibrium. A perpendicular drawn
from point ‘P’ to the X-axis determines the equilibrium output at OQ. At output OQ,

therefore, profit is maximum. The output OQ is thus equilibrium output.

When AR>SAC, or when SAC is below the P=AR=MR line at the equilibrium, the
firm earns super-normal profit as shown by the shaded area in the diagram below.

y
SMC

SAC
P P=MR=AR

2
Price

0 x
Output

Labelling-1
Diagram-1
Q7
(a) ‘GNH is a better measure than GDP in promoting the happiness of the people’. Do (5)
you agree? Give FIVE reasons.

Yes, GNH is a better measure than GDP in promoting the happiness of the people.

Page 14 of 22
(Any FIVE of the following)
 GNH recognizes the material, spiritual and emotional needs of an individual 1
while GDP does not.

 GNH talks about the importance of sustainability in the use of natural 1

resources while GDP does not

 GNH recognizes the need to protect the citizens from the adverse 1
environmental problems created by rapid economic growth while GDP is
silent about these negative outcomes of development.

 FNH tries to take care of social problems and moral degradation that occur as 1
a nation develops while GDP does not address this issue at all.

 GNH gives more emphasis on the production of those beneficial to the

citizens of a country while GDP or increase in GDP can be brought by 1
production of any type of goods and services, good or bad, beneficial or
harmful. GDP gives emphasis on production of goods and services and not on
the composition of these goods and services.

 GNH rejects the strong relationship between wealth and happiness while the 1
concept of GDP advocates wealth as a tool to achieve happiness.

 GNH places the individual at the centre of all development efforts. In other
words, the citizens become the obvious beneficiaries of economic 1
development while GDP gives significance to the economic growth and
development without taking into account its outcomes and who benefit out of
it and who do not.

 The goal of GNH is happiness through economic growth while the goal of 1
GDP is to use economy as a potentially powerful means for achieving other
goals.
OR
No, (Any FIVE of the following)
 GDP fulfills the desires of people through increased production of 1
goods/services.
 GDP leads to faster economic growth and development. 1

 GDP enhances the efficiency of people and increases their competitiveness. 1

 GDP leads to more effective and efficient use of resources. 1

 GDP allows a nation to be self-reliant and economically independent faster 1

than GNH

 GDP helps in enhancing the living standards of people faster than GNH. 1

Page 15 of 22
(b) Explain circular flow of income and expenditure in a Three Sector Model using a (5)
diagram.

When we add the government sector to the two sector model we get three-sector
model comprising of households, firms and government which is a more realistic
model because government performs a wide variety of economic functions in a
modern economy. The three major activities of the government in the circular flows
are:
i. Taxes
ii. Government spending on commodities and factor services.
iii. Transfer payments.
The government imposes taxes both on households and firms. Therefore, the income
flows from households and firms to the government in the form of taxes. Similarly,
the government spends a part of its tax revenue in purchasing factor services from
households and making payments to them in the form of wages and salaries. The
government incurs expenditure in buying a whole range of goods and services from
the firms and making payments in turn. Accordingly, income flows from the
government to households and firms in the form of government expenditure on factor
services and commodities.
1½
Likewise, the government incurs expenditure in the form of transfer payments as well
when it undertakes various social security and welfare schemes in every economy. In
case of transfer payments, there is a flow of money payments from government to
households and firms.

The figure below shows the primary money flows and real flows between households
and firms. The figure presents only the money flows between government and
households as well as between government and firms.

Page 16 of 22
 Government
Factor purchases and
payments and Government
Flow of factor services subsidies
transfer
payments Factor payments Taxes

Taxes
Households Capital Marker Firms
1½
Payments for goods and services

Flow of goods and services

Diagram-1
Labelling-1

Taxes constitute leakages from the flows because they reduce the income and
therefore, expenditure of the households and firms. On the other hand, the
government expenditure is injections in the flows because it adds to the aggregate
demand in the form of government purchases of factor services from the households
and goods and services from the business sector. Similarly, the transfer payments by
the government are injections in the circular flows. Thus, the government may affect
the level of circular flow of income through its activities of imposing taxes, incurring
expenditure and making transfer payments. However, if the government spends its
entire income (received in the form of taxes from households and firms) in the form
of expenditure and transfer payments, there would be equilibrium in the circular flow
of income.
Q8
(a) What are the differences between international and internal trade? Write FIVE
differences. (5)

Any FIVE of the following:

i) Internal trade
- Trade within the geographical boundary of a nation
- Takes place in same currency
- Less trade restriction 2½
- More of semi – durable goods traded
- Less production
- Less taxes levied

Page 17 of 22
 ii) International Trade
- Trade between/ among two or more countries
- Takes place in different currencies
- More trade restrictions
- More of durable goods traded
- More production 2½
- More duties levied

Points-½+½+½+½+½
Explanation-½+½+½+½+½

(b) What is a budget? Describe the budgetary policy of our country. (5)

Definition:
Budget is the estimates of revenue receipts and expenditures of the government of a
nation for a specific period of time. 1

Budgetary Policy of Bhutan

The expenditures of our government comprise of current expenditure, capital
expenditure, net lending and repayments while the sources of finance comprise of
domestic revenue, other receipts, grants (GOI projects grants and grants from other
sources) and financing, which includes resource gap. And our government’s aim is to
have balance in expenditure outlay and sources of finance. At present, the target is to
meet the projected expenditures by generating the revenue. The Royal Government
will continue to meet the recurrent expenditures and a large portion of the capital
expenditures are to be met by assistance form Bhutan’s development partners. The
main aim of the Royal Government is to curtail expenditures while making significant 4
gains on the resources side, leading to the reduction of resource gap. With the
constitution in place and parliamentary elections in 2008, the ruling party of the
government will decide the budgetary policy on the expected demand from the
opposition party with regard to the sources of income/finance and expected
expenditures.
Q9
(a) ‘Deficit Financing is both good and bad for a country like ours’. Explain THREE (5)
good effects and TWO bad effects of it.

Three merits of deficit financing (Any THREE of the following)

i. Best use of resources 2½
ii. Increase in demand
iii. More saving
iv. Reduces inequality

Two demerits of deficit financing (any TWO of the following)

Page 18 of 22
 i. Inflation 2½
ii. Distribution of income
iii. Change in the pattern of investment.

Points – 1/2+1/2+1/2+1/2+1/2
Explanation –1/2+1/2+1/2+1/2+1/2

(b) What do you understand by the term ‘Fiscal Policy’? Explain any FOUR methods (5)
how fiscal policy can be used to accelerate economic growth in an underdeveloped
economy.

Definition: Fiscal Policy is defined as the policy under which the government uses
the instruments of public spending, taxation and public borrowing to achieve various 1
objectives of economic policy.

Four methods of Fiscal Policy to accelerate economic growth. (any FOUR of the
following)
i. The taxation and public borrowing policies may be used to provide incentives
for saving and investment. 1

ii. The government may grant tax relief and subsidies to entrepreneurs to stimulate
investment in the economy. This will have a positive effect on the level of 1
economic activity and economic growth.

iii. Special tax incentives like tax-holiday and subsidies can be given to the
entrepreneurs to set up industries in the backward regions. This will promote 1
development of backward regions.

iv. Revenue collected by the government can be used in promoting development of

agricultural and industrial sectors. The government can also use these funds in 1
providing infrastructure like transport and communication, power, irrigation etc.

v. Public expenditure policy can be effectively used in promoting economic

development. The government may develop social over heads and
infrastructure; establish capital goods, and basic and key industries. It may 1
stimulate development by providing education, training and research facilities.

Q10
(a) Explain the income method of estimating national income of an economy. (5)

The total factor payments received by various factors of production in the form of
Rent, interest, profits, wages etc, during a year. In other words, this method measures
the national income by adding all the incomes generated in the
process of production. This method of calculating national

Page 19 of 22
 income involves the following steps:
1. Identification of producing enterprises
The producing enterprises which employ factor inputs are identified. These
enterprises are 1
- Primary sector
- Secondary sector
- Tertiary sector
2. Classification of factor income
For the purpose of measuring national income, factors of production are classified
Into two major components namely, lab our and capital. Accordingly, factor
Income is classified into the following three categories:
- Lab our income/ compensation of employees….. refers to payments made to
the workers for their lab our services. Therefore, it includes payments made 1
by producers to their employees in the form of wages, salaries & other payments.
It includes:
- Wages, salaries, commission, bonus, DA
- Pension, employer’s contribution to social security & employee’s
welfare fund
- Payment to employees in kind such as free accommodation, medical
And educational facilities etc.
- Capital/property income/ operating surplus
It is the income which is paid for the ownership of capital. It may include:
- Rental income( rent earned on land, buildings)
- Royalty (income earned from patent& copy rights)
- Interest( interest on lended money, interest on government bonds)
- Dividends(on undistributed profits) etc
- Mixed income
It is earned by those people who provide both lab our and capital services in
the production process. The suitable examples of such income can be from
- Agriculture, trading, transport, incomes of
own- account workers(plumbers, carpenters ,sole traders), Legal &
medical professions etc.
3. Estimation of domestic income
The sum total of compensation of employees, capital incomes and mixed
incomes of all the production units in the domestic territory of an economy 1
during the accounting year gives domestic factor income.
4. Estimation of net factor income from abroad
Net factor income earned from abroad is the difference between factor income
received from abroad for providing factor services & the income paid for the factor 1
services provided by non- residents in the domestic territory of a country. It may
include:
- Net compensation of employees
- Net income from property & entrepreneurship such as interest, rent,
dividends & profits
- Net retained earnings of resident companies abroad
In short, net factor income from abroad is added to domestic factor income to arrive

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 at national income
Hence, national income = Compensation of employees + Capital income 1
(operating surplus) + Mixed income +Net factor income from abroad.

(b) From the information given below, compare the elasticity of supply from (5)
commodity A and commodity B.

Commodity A Commodity B
Price Supply (Units) Price Supply
(Nu. Per unit) (Nu. Per unit) (unit)
10 100 8 40
12 140 10 80

es=Percentage change in Quantity supplied

Percentage change in price

= ∆Q X 100
Q = ∆Q X P = ∆Q X P 1
Q ∆P ∆P Q
∆P X 100
P

Commodity A

Q = 100 units P = 10 Es = ∆ Q X P
Q1 = 140 units P1 = 12 ∆P Q 1+1
∆Q = Q1 - Q ∆ P = P1 - P = 40 X 10
= 140 – 100 = 12 – 10 2 100
= 40 units = Nu. 2 = 4/2 = 2

Commodity B
Q = 40 units P=8
Q1 = 80 units P1 = 10

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∆ Q = Q1 – Q ∆P = 10 - 8
= 80 – 40 = Nu. 2
= 40 units

Es = ∆ Q X P
∆P Q 1+1
= 40 X 8
2 40
= 8/2 = 4

Working – 1+1
Formula--1
Correct answer –1+1

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