1

1 BASIC CONCEPT

Q1 Define final goods.

Ans Final goods are those goods which have crossed the boundary line of Production and
are ready for use by their final users.
Final goods are classified into two categories:
(I) Final consumer goods: Final consumer goods are those goods which are ready
for use by their final user and consumer are their final user. For example:
Bread, Butter etc.
(II) Final producer goods: Final producer goods are those goods which are ready
for use by their final user and producers are their final user. For example:
Tractor etc.

Q2 Define intermediate goods.

Ans Intermediate goods are those goods which have yet not crossed the boundary line of
production, value is still to be added, and the goods are not ready for use by their final
user. For example: Raw material etc.

Q3 Explain the difference between final goods and intermediate goods.

Ans
INTERMEDIATE FINAL GOODS
GOODS
1. These goods may be used as raw
1. These are not used as a raw material for
material for production. the production.

2. These goods may be resold by 2. These goods are not resold by the firm to
firm to make profit. make profit.
3. These goods remain within the 3. These goods are outside the boundary line of
boundary line of production. production.
4. These goods are not ready for use by
4. These goods are ready to be use by their
their final users. final users.
5. These goods are not included in the
5. These goods are included in the estimation
estimation of National Income of National income.

*End use of good is principal basis of differentiate between final and intermediate
good.

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BASIC CONCEPT

Q.4 Define consumer(consumption) goods and its types.

Ans Consumer goods are those goods which are directly used for the satisfaction of human
wants. These are not use in the process of production of another goods.
Consumer goods are classified into four categories:
1. Durable goods:- Durable goods are those goods which can be used for several years
and the value of these goods are very high. For example: car, bike, washing machine
etc.
2. Semi durable goods:- Semi durable goods are those goods which can be used for a
period of one year or slightly more. For example: clothes, shoes etc.
3. Non durable goods:- These are also knows as single use goods. These goods can be
use only single act of consumption. For example: Bread. Butter etc.
4. Services: - Services are those non-material goods which are directly satisfying human
wants. For example: Doctor, Teacher etc.

Q5. Define capital goods.

Ans Capital goods are those goods which are used in the process of production for several
years, Value of these goods are very high. These are the fixed assets of the producers.
For example: Plant & machinery
All machines are not capital goods because if machines are purchased by
consumer than these are called final consumer goods.

Q6. What is investment?

Ans Investment is a process of capital formation in the stock of capital.
Investment has two components:
1. Fixed investment:- Fixed investment refers to the increase in the stock of fixed
assets of the producers during an accounting year. Fixed investment = Closing
stock of fixed assets opening stock fixed assets.
2. Inventory investment:- Inventory investment refers to the increase the stock of
inventory.Inventory includes Raw material, Semi finished goods and finished
goods (unsold).
Inventory investment = Closing stock of inventory – opening stock of . inventory

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BASIC CONCEPT

Q7. Define Gross investment and net investment.

Ans Gross investment = Fixed investment + Inventory investment
Net investment = Gross investment – depreciation

Q8. Define depreciation.

Ans Depreciation is loss of value of fixed assets due to time, uses, wear & tear and expected
obsolescence. Depreciation is also called consumption of fixed capital.

Q9. Define depreciation reserve fund.

Ans It refers to that fund which the producer keep to cope with depreciation losses in the
process of production.

Q10. Explain expected obsolescence and unexpected obsolescence.

Ans Expected obsolescence:- It has two component
(i) Loss of value of fixed assets due to change in technology
(ii) Loss of value of fixed assets due to change in demand
Unexpected obsolescence:- Unexpected obsolescence occurs due to natural
disasters like earth quake, flood etc. It is called capital loss.

Q11. Define stock and flow.

Ans Stock:- Stock is a quantity measured at a particular point of time. For example: -
Wealth, Capital, Bank deposit, Distance, Water in a tank.
Flow:- Flow is a quantity measured over a specified period of time. For example: -
Income, Speed, Interest.

Q12. Define different sector the economy.

Ans Economy is classified into four sectors:-
(i) Household Sector:- This sector includes consumer of goods and services and
household are also the owner of factor of production.
(ii) Producer Sector:- This sector includes all producing units in the economy for the
production of goods and services. Firms hire factor of production from the
household

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(iii) Government Sector:- Government act as welfare agecy for maintaining law and
order and also act as a producer of goods and services.
(iv) External sector:- It includes export and import of goods and service.

Q13. Define Circular flow of income.

Ans It refers to unbroken circularity of real flow and money flow between different sectors
of the economy.

Q13. Define Injection and Leakage.

Ans Injection: - Injections are those macro variable which cause expansion in circular flow.
For example:- Investment, Export
Leakage:- Leakage are those macro variable which cause contraction in circular flow.
For example:- Saving, Import

Q14. What is real flow and money flow?

Ans Real flow: - Real flow refers to the flow of goods and services across different sector
of the economy.
Money flow:- Money flow refer to the flow of money across different sector in the
economy.

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2 NATIONAL INCOME & RELATEDAGGREGATES

Q1. Who is Normal Resident of country?

Ans A normal resident is said to be a person or institution who ordinarily resides in a country
and whose economic interest lies in that country.
* Those persons are not treated as normal resident of the country’s
Foreign visitors, crew members, foreign staff of embassies.

Q2. Define Domestic Territory.

Ans Domestic territory includes:-
Political frontier, Sea area, Ships and aircraft operated by resident of a country, fishing
vessels, oil and natural gas rigs, floating platform, Embassy established of the country
located abroad.

Q3. Define National Income.

Ans National Income is the market value of final goods and services produced in the
Domestic Territory during the period of an accounting year.

Q4. Define Factor Income and Factor Payment.

Ans Factor Income: - Factor incomes are the Income received by the factors of production
for rendering their factor service to the producer like wages, rent, interest etc.
Factor Payment: - Factor payments are the expenditure paid by the producers for
rendering services like payment of wages, rent etc.

Q5. Define Transfer Income and Transfer Payment.

Ans Transfer Income:- Transfer Incomes are one sided income. It is also called unilateral
income. For example: - Charity, Grant
Transfer Payment: - Transfer payments are one sided payment. It is also called
unilateral payment. For example: - Charity, Grant.

Q6. Explain the component of net factor income from abroad

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Ans Net factor income from abroad – It is the difference between factor income earned
by our residents from rest of the world and factor income earned by non-residents
within our country.
NFIA= Factor income from abroad – Factor income to abroad
Component of NFIA
(I) Net Compensation of Employee: - It is the difference between compensation
of employee received by resident worker and a similar payment made to non-
resident worker within the domestic territory.
(II) Net Income from Property and Entrepreneurship: - It is the difference
between income in the form of rent, interest and profit received by the resident
of a country and similar payment made to rest of the world.
(III) Net Retained earning: - It is the difference between the retain earning of
resident companies located abroad and retain earning of foreign company
located within the domestic territory.

Q7. Define Private Income.

Ans Private Income is the Income of private sector obtained from any source.
Private Income = Factor income from domestic product accruing to private
sector + NFIA + Interest on National debt + Current transfer from government +
Current transfer form rest of the world

Q8. Define Net Domestic Product at Factor Cost (NDPFC).

Ans NDPFC = Factor income from domestic product accruing to private sector
+ Factor income from domestic product accruing to public (govt.) sector.

Q9. Define Personal Income.

Ans Personal Income = Private Income – Corporate tax – Undistributed profit (corporate
saving).

Q10. Define Personal Disposable Income.

Ans Personal Disposable Income = Personal Income – Direct personal tax –
Miscellaneous fee and fine paid by the household to government.

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Q11. Explain the difference between National Income and private income.
Ans 1) National income includes income of both public & private sector of the economy
on the other hand Private income includes only income of private sector.
(2) National Income includes only factor income while private income includes both
factor income as well as current transfer from government and rest of the world.
(3) Interest on National debt is not included in National Income but it is included in
private income.

Q12. Define Nominal GDP (National Income at current price).

Ans National Income at current price is market value of the final goods and services
produced in the economy during an accounting year and as estimated using the current
year price.
Y=P*Q
Y = National Income at current price
P = Price of current year
Q = Quantity of current year

Q13. Define Real GDP (National Income at constant price).

Ans National income at constant price is the market value of final goods and services
produced the economy during an accounting year and as estimated using the base year
price.
Y’ = P’ * Q
Y’ = National Income at constant price
Q = Quantity of current year

Q14. Define GDP deflator.

Ans GDP deflator = Nominal GDP / Real GDP * 100

Q15. Define externalities.

Ans Externalities refers to positive and negative impact of an economic activity on the other
without involving any price or penalty

3 CALCULATION OF NATIONAL INCOME

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Q1. Explain the Income method of estimating National Income.

Ans According to the income method national income is measured in the terms of factor
income (Wages. Rent, Interest, Profit.).
National Income is estimated as the sum total of factor income earned by the normal
resident of a country during an accounting year. Factor income is also known as Net
Domestic Product at Factor Cost (NDPFC).
*NDPFC is classified in to three categories

(I) Compensation of employees- It includes wages and salaries in term of cash

(wages, bonus, commission, etc.) and kind (Free meal & accommodation,
medical facilities, employer’s contribution to social security scheme etc.)
(II) Operating Surplus- It refers to income from property (Rent, Interest, royalty)
and income of entrepreneur (Profit).
Profit includes Dividend, Undistributed Profit and Corporate (Profit) tax.
(III) Mixed Income- It refers to the income of self employed persons using their
own labour, land and capital to produce goods and services. These incomes are
mixture of wages, rent, interest and profit, so it is called Mixed Income.
National Income is found out by adding NFIA to NDPFC.
NNPFC = NDPFC + NFIA

Q2. What are the precaution regarding income method.

Ans (i) Transfer earning like old age pension, unemployment allowances, scholarship
etc. should not be included in National Income because these are transfer
payment.
(ii) Income from illegal activities like smuggling, gabling etc. should not be included
in National Income.
(iii) Commission paid on the sale and purchase of second hand goods are to include
in National Income because these are reward for factor services.
CALCULATION OF NATIONAL INCOME

(iv) Brokerage on the sale and purchase of share and bonds is to be included in
National Income.

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(v) Imputed rent of owner’s occupied house is to be treated along with rent as a
component of factor income.
(vi) Production for self consumption should be included in the National Income.
(vii) Corporate tax, Dividend and Undistributed Profit are the component of Profit.
Once profit is included then any of these components should not be included.

Q3. Explain the Expenditure method of estimation of National Income.

Ans According to this method National Income is measured in terms of expenditure on the
purchase of final goods and services which are produced in the economy during an
accounting year
Expenditure on the purchase of final goods and services is known as Gross

Domestic Product at Market Price (GDPMP). It is classified in to four categories:

(i) Private final consumption expenditure; - It refers to expenditure on final goods
and services by the individuals and household.
(ii) Government final consumption expenditure: - It refers to the expenditure on
final goods and services by the government.
(iii) Net Export; - It refers to the difference between Export and Import during an
accounting year.
(iv) Gross Domestic Capital Formation; - It is classified in to two categories
a) Gross domestic fixed capital formation- It refers to the expenditure incurred
by the producer on the purchase of fixed assets. For example- Plant &
machinery
b) Change in stock- It refers the difference between closing stock and opening
stock.

*NNPFC = GDPMP – DEP + NFIA – NIT

Q4 Explain the precaution regarding expenditure method.

Ans 1. Only final expenditure is to be taken in account to avoid double counting. So
expenditure on intermediate goods must be avoided.
2. Expenditure on second hand goods is not to be included because value of these
goods has already been accounted during the period of their production.

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3. Expenditure on share an bonds is not included in total expenditure because these

are only paper claims and are not related to the production of goods and services.
4. Expenditure on transfer payment by the government like old age pension is not
included because these are transfer payment.
5. Imputed value of expenditure on goods produced for self consumption should
be included in the estimation of national income.

Q5 Explain the value added of product method for estimation of National Income.
Ans According to value added method National Income is measured in terms of value
addition by each producing enterprises in the economy during an accounting year.

Value added (GVAMP) = Value of output (GVOMP) – Intermediate

Consumption

Value of output = Sales + Change in stock

Sales = Domestic sales + Export

Change in Stock = Closing Stock – Opening Stock

Intermediate consumption:- It refers to the value of non factor input. It includes value

of raw material used in the process of production.

NNPFC = GVAMP - DEP + NFIA – NIT

* Value Added always be equals to Domestic Product

Q6. Explain the precaution regarding product method or value added method.
Ans 1. Value of sale and purchase of second hand goods is not to be included In value
addition because these are already accounted during the year in which they
produced.
2. Commission earned on account of sales and purchase of second hand goods should
be included because these are reward for the services rendered.
3. Value of intermediate goods should not be included in the estimation of value
added.
4. Imputed rent on the owner’s occupied house should be included in value added.

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5. Services for self consumption are not considered while estimating value added
because it is difficult to estimate their value. For example service of housewife.

Q7. Explain the problem of double counting and how to avoid it?
Ans The problem of double counting is the problem of estimating the value of goods and
services more than once. This leads to over estimation of the value of goods and
services produced in accounting year.
To avoid double counting two methods are used
1. Final output method; - Under this method final goods and services in terms of
their End-Use are to be considered in the estimation of national income.
2. Value added method: - It refers to the difference between value of output and
value of intermediate consumption of each producing unit in the economy.

** Do not include the following items in the estimation of national income

- Gifts from abroad
- Unemployment allowances
- Purchases of vegetables by a restaurant
- Expenses on electricity by a factory
- Leisure time activity
- Services rendered by the housewives
- Money received by an individual resident form his son working abroad
- Interest received from a friend on loan offered to him for the purchase of car
- Debenture
- A second hand machine is purchased by a newly opened firm

** Do include the following items in national income

- Defense and security services, these are treated as final services.
- Free Services by the government like free education, medical facility, street
lighting etc. are included in national income because these are the part of
government final consumption expenditure.
- Employer’s contribution to social security scheme
- Rent received by Indian resident on building rented out to foreign embassies in
India because it is income from the rest of the world
- Profit earned by a branch of an Indian ban in London because it is a part of NFIA

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- Wages received by the Indian employee working in abroad embassy because

Indian employee is normal resident of India
- Salary to Foreign technical specialist as a payment of factor income to the non
resident. It reduces national income
- Dividend received by a Indian resident form his investment in the foreign financial
firm
- Royalty income because it is the part of operating surplus
- Dividend received on shares

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4 MONEY

Q1. Define Money.

Ans It refers as a thing that is commonly accepted as a medium of exchange.

Q2. Define C-C economy.

Ans C-C means commodity to commodity. C-C economy is an economy dominated by
barter system of exchange.

Q3. Explain barter system of exchange and is drawbacks.

Ans Barter system of exchange is a system in which goods are exchanged for goods.
Drawback of barter system
1. Difficulty of double coincidence of want- It is a essential element of barter
system. It implies that good in position of two different individual are needed by
each other but it is not always so simple. So this system of exchange remains
extremely limited.
2. Lack of common unit of value- Under barter system, goods were exchanged with
goods. It is impossible to fine common unit of value. Evolution of money offered
a common unit of value and therefore a system of accounting.
3. Lack of system for storage and transfer of value- In the C-C economy wealth
was stored in terms of goods but it involve some problems like high cost of storage
and loss of value. Evolution of money made storage and transfer of value much
easier.

Q4. Explain the forms (types) of money.

Ans 1. Fiat money- It refers to money which is use by order or authority of government.
It includes notes and coins.
2. Fiduciary money- It refers to money back up trust between the payer and payee,
not on the basis of any order of the government. For example – cheque.
3. Full bodied money- It refers to money in term of coins whose commodity value is
equal to the money value as and when these are issued.

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4. Credit money- It refers to that money of which money value is more than
commodity value.

Q5. Define money value of money and commodity value of money.

Ans Money value of money- It refers to what is written on paper notes and coins.
Commodity value of money- It refers to value of things of money is made of. If coins
are made of gold/silver then commodity value refers to the market value of the
gold/silver contained in the coin.

Q6. Explain the function of money.

Ans Function of money are classified into two categories
1. Primary/main function
a) Medium of exchange- It means that money act as medium for the sale and
purchase of goods and services. So exchange is now simpler. In the absence of
money goods were exchanged for goods and this require Double coincidence
of want.
b) Measure of value/unit of value- Money serves as measure of value in term of
unit of account. Unit of accounts means that the value of each goods and
services is measured in the monetary unit. Measurement of value was very
difficult in the barter system. There was no common unit of value.
2. Secondary/subsidiary function
a) Standard of deferred payment- Deferred payment refers to those payments
which are to be made sometimes in future. When someone borrows money
from somebody he returns both the principle as well as interest amount. It is
difficult to make such transaction is term of goods and services. Money
performs this function more effectively.
b) Store of value- It implies store of wealth. Storing wealth has become
considerable easy with the introduction of money. Stored wealth is a source of
future investment. It was not convenient to store value in the barter system of
exchange.
c) Transfer of value- Money also serves as a convenient mode of transfer of
value. Goods are purchased from far off places both for consumption as well
as investment. By facilitating transfer of value, money has promoted
consumption and investment across all parts of the world.

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Q7. Define money supply and measurement of money supply.

Ans Money supply is a stock concept. It refers to all the currencies held by the people in a
particular point of time in the country.
Measurement of money supply- In India there are four alternative measures of
money supply known as M1, M2, M3, M4
M1 Measurement--
M1 = C + DD+ OD
C (Currency) - It refers to currency includes paper notes and coin which are held by
public.
DD (Demand Deposit) – It refers to demand deposit of the public with the commercial
banks.
OD (Other Deposit) – It includes demand deposit with RBI of public financial
institutions, foreign central bank, world bank etc.
M2 Measurement – It is a broader concept of supply of money as compared to M1.
Besides all the component of M1.It also includes saving of people with the post office.
Thus
M2 = M1+ Deposit with post office savings account

M3 Measurement – M3 is also a broader concept of money supply as compared to

M1. Besides all the component of M1, It includes net time deposit (fixed deposit) of
the people with commercial bank. Thus
M3 = M1 + Net time deposit with commercial bank

M4 Measurement – M4 concept of money supply is still broader. It is broader even

than M3. It also includes time deposit with post office deposits
M4 = M3 + Deposit with post office savings account

Q8. Explain the difference between Term deposit and Demand deposit.
Ans 1. Term deposits are always for a specific period of time whereas Demand deposits
are not for any specific period of time
2. Depositor can’t withdraw the money from fixed deposit when needed but Demand
deposit can be withdrawn when needed.

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3. Term deposits are not chequeable deposits whereas Demand deposit are
chequeable deposit.

Q9. Define liquidity.

Ans Liquidity of an asset refers to the convertibility in money/cash. Faster an asset can be
converted into cash, more liquid.

Q10. Define high powered money.

Ans It includes paper notes, coin and bank cash deposit.
*RBI issues all paper notes but not the one or five rupee notes and coins. All coins and
one rupee notes are issued by the government of India under the Indian Coinage Act.

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5 BANKING

Q1. Define Commercial bank and its functions.

Ans A commercial bank is that financial institution which accepts deposit from people and
loan offers for the purpose of consumption or investment.
Functions of commercial bank
1. Accepting deposit – A bank accepts deposit from the public. People can deposit
their cash balances as chequeable deposit and non-chequable deposit.
Chequeable deposits are those against which cheques can be issue anytime for
withdrawing money. For example amount in Savings bank account.
Non chequeable deposits are those against which cheques can’t be issued. For
example Fixed deposit amount.
2. Advancing loans – Bank advances loan mostly for the productive purpose against
some approved security. The amount of loan is generally less than the value of
security.

Q2. Define Central bank and its functions.

Ans Central bank is the apex bank that controls the entire banking system of a country. It
is the soul agency of issuing notes in a country.
In India Reserve Bank of India (RBI), in England Bank of England and in America
Federal Reserve System operates as Central Bank.
Functions of Central Bank
1. Issuing notes – Central Bank of a country has the monopoly right of issuing notes.
2. Bankers to the government – Central bank act as a banker, agent and financial
advisor to the government.
As a banker central bank manages accounts of the government bank across all in
the country.
As an agent central bank buys and sells security on the behalf of government.
As an advisor central bank helps the government in framing policies to regulate
the money market.
3. Banker’s bank – It is an Apex Bank of all the banks in the country. Central bank
has almost the same relation with other banks in the country as a commercial bank
has with its customers.

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BANKING

4. Supervision of the Bank – Central bank supervises the commercial banks relates
to –
a) Licensing of the commercial bank
b) Merger of different banks
c) Expansion of the commercial bank in term of their branches

5. Control of credit – It implies increase or decrease in the supply of money by

regulating the creation of credit by the commercial banks. The government needs
to control the supply of money to cope with the situation of inflation or deflation

6. Lender of the last resort – It means that if a commercial bank fails to get financial
accommodation from anywhere, it approaches the central bank as the last resort.
Central bank advance loan to such a bank against approved security.

Q3. Explain the credit/money creation by the commercial bank.

Ans Commercial banks are an important source of money supply in the economy. They
contribute to money supply by creating credit. They create credit in the form of
demand deposit. Demand deposits of the commercial banks are many times more than
their cash reserves.

The Commercial banks know by way of their historical experience that all the
depositors would not show up in the bank to withdrawn all their deposit at a point of
time.

If experience shows that withdrawal are generally 10% of deposits the banks needs to
keep only 10% of the deposit as cash reserve. This is known as Cash Reserve Ratio
(CRR).

If CRR is 10% and deposit is 1000rs, bank allow offer loan up to 10,000.
Demand deposit = 1/CRR * 100
Demand Deposit CRR 10% Loan
1000 100 900
900 90 810
810 81 729
729 72.9 656.1
----- ------ ----
Total= 10,000

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BANKING

Q4. Define Cash Reserve Ratio (CRR).

Ans Cash Reserve Ratio (CRR) – It refers to minimum percentage of a bank total deposit
requires to be kept with the central bank and remaining balance can be offered as loan.
If CRR increases loan capacity decreases and if CRR decreases loan capacity
increases.

Q5. Define Repo rate and Reserve repo rate.

Ans Repo rate refers to the bank rate at which central bank of the country offers loans to
the commercial banks.
Reserve repo rate refers to the rate of interest at which commercial bank can deposit
their surplus fund with the central bank of the country.
• Both Repo rate and Reserve repo rate are fixed by the Central bank.

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6 AGGREGATE DEMAND AND ITS COMPONENTS

Q1. Define aggregate demand and its components ?

Ans . Aggregate demand refers to the sum of total expenditure on the domestically produced
goods and services during the period of accounting year.
Components of Aggregate Demand (AD) :-
1. 'C' (Private Consumption expenditure ) :- It is also called Household
Consumption Expenditure it includes demand for all goods and services by the
household of a country during an accounting year.
2. 'I' (Private Investment Expenditure) :- It refers to expenditure by private
investor on the purchase of such goods which add to their stock of Capital Rate of
Interest is the principle determinant of private investment. Higher rate of interest
implies decrease in investment expenditure.
3. 'G' (Government Expenditure):- It includes both government Consumption and
government expenditure Government Consumption expenditure is the expenditure
on the purchase of consumption goods Government Investment is generally
autonomous investment determined by consideration of social welfare.
4. 'X-M' (Export- Import)->(Net Export) :-
(a) Export refers to demand for domestical produced goods by rest of the world
(b) Import refers to demand by normal residents of goods produced abroad.
(c) Net export is the main Component of Aggregate Demand
AD=C+I+G+(X-M)

Q2. Define Aggregate Demand Schedule .

Ans . Aggregate Demand Schedule is a table showing in the economy for the sake of
simplicity. We are Considering a closed economy with no government. Table shows
Combined behaviour of consumption and investment at different level of national
income.

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AGGREGATE DEMAND AND ITS COMPONENTS

Y AD

Aggregate
Demand

O X
Income

AD starts from 30 on Y axis It suggests minimum level of expenditure.

Q3. Define Consumption function .
Ans . Consumption function :- It is the functional relationship of Consumption income.

Q4. Define Fundamental Psychological Law .

Ans . It state that as income of people rise their consumption also rises but the rate at which
consumption increases is often less than the ratio at which income increases.

Q5. Define Propensity to Consume .

Ans . It refers to the ratio between consumption and income. It shows level of consumption
with respect to a give level of income. It has two aspects :-
1. Average Propensity to Consume (APS)
2. Marginal Propensity to consume (MPC)

Average Propensity to Consume(APS) :- It is the ratio of Consumption expenditure

to any particular level of income.
C
APC=
Y

Y C APC
100 80 0.8
200 120 0.6

Marginal Propensity to consume (MPC):- It refers to the ratio between change in

Consumption (C) and change in income(Y)
MPC= C
Y

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Y C MPC
100 80 -
200 120 -
300 150 -

Q6. Define Algebric expression of consumption function

Ans .
C= 𝐶̅ +by
OR
C= 𝐶̅ +MPC(Y)
C= Consumption
̅ = Minimum level of Consumption of Consumption when Y= 0
∈
C
b= MPC=
Y
Y= Income

Consumption

O X
Income

Q7. Find C when 𝐶̅ =200, MPC=0.5 and Y=1000

Ans .
C= 𝐶̅ + MPC (Y)
C= 200+0.5*1000
C= 200+500 AGGREGATE DEMAND AND ITS COMPONENTS
C= 700
• Value of APC can be greater than 1. It happens when C>Y

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• Value of MPC cannot be greater than 1 because Additional Consumption

is only a part of additional income.

Q8. Define Saving function .

Ans . Saving function refers to the functional relationship between saving and Income
saving is also directly related to the level of income.

Q9. Explain Propensity to save .

Ans . Propersity to save refers to the ration between saving and income. Propensity to save
has two aspects :-
1. Average Propensity to save
2. Marginal Propensity to save

Average Propensity to save (APS):- It is the ratio of saving to income.

S
APS=
Y

Y C S APS
100 80 20 0.2
200 120 80 0.4

APS can be negative when saving is negative

OR
when comsumption >Income
Y C S APS
50 100 -50 -50
=-1[C>Y]
50
50 50 0 0
=0[C=Y]
50

Marginal Propensity to save (MPS) :- It is the ratio of exchange in saving to a

enange in Income.

9289599338
 24
AGGREGATE DEMAND AND ITS COMPONENTS

S
MPS=
Y

Y C S MPS (S/Y)
100 80 20 -
200 120 80 0.6
300 150 150 0.7

Q10. Explain the algebric expression of saving function .

Ans .
S= −𝑆̅+ MPS (Y)
S= Saving
−𝑆̅= Saving when income is 0
MPS= Marginal propevsity to save

S
MPS=
Y
Y= Income

Saving

O Income X

Q11. Explain the relation between APC and APS .

Ans .
Y= C+S
Y C S
= +
Y Y Y
1= APC+APS
APC= 1-APS
APS= 1-APC

9289599338
 25
AGGREGATE DEMAND AND ITS COMPONENTS

Q12. Explain the relation between MPS and MPC .

Ans .
Y= C+S
Y C S
= +
Y Y Y
1= MPC+MPS
MPC= 1-MPS
MPS= 1-MPC
Q13. Can MPC or MPS ever be negative ?.
Ans . Neither MPS nor MPC can ever be negativ because
S
MPS=
Y

C
MPC=
Y
and the slope of saving function and consumption function is always positive because of
positive relation between saving and Income and Consumption and income.
C Saving function
APC=
Y S=-𝑆̅ + MPS(Y)

S Consumption function
APS=
Y C=𝐶̅ + MPC(Y)

C
MPC=
Y

S
MPS=
Y

Q14. Explain Induced and Autonomous Investment.

Ans . Induced Investment :- It is positively related to the level of income in an economy. At
higher level of income Consumption expenditure tends to increase. Increased Consumption
expenditure or the increased level of demand raises expected profitability of the producers
who accerdingly are induced to make greater investment.

9289599338
 26
AGGREGATE DEMAND AND ITS COMPONENTS

Induced

Investment

O X
Income

Autonomous Investment :- An investment which is not influenced by expected profitability or

level of income is called autonomous investment. It is an investment expenditure incurred by
the government with a view to promote the level of aggregate demand in the economy.

Autonomous
Investment

O X
Income

9289599338
 27

7 SHORT RUN EQUILIBRIUM OUTPUT

Q1. Define Short Run

Ans. Short Run:- Short run is defined as a period of time during which level of output is
determined.

Q2. Explain Equilibrium level of output.

Ans. Equilibrium level of output/Income refers to that level of output when:-
AD = AS
And, S = I
To determine equilibrium level of output we hve two approachs :
(1). AD = AS approach
According to this approach, equilibrium level of income is achieved when:
AD = AS
AD:- It refers to desired expenditure in the economy during an according year.
It has Two components :
1. Desired Consumption expenditure:- Desired Consumption Expenditure is
positively related to the level of income . If Income level increase Consumption
Expenditure also increase and C is always positive even when Y = 0 It is called
Autonomous Consumption.
2. Desired Investment expenditure:- Desired investment expenditure is assumed
to be autonomous so that it is not related to the level of income in the economy.

AD=C+I

AD

X
Income

9289599338
28 SHORT RUN EQUILIBRIUM OUTPUT

Aggregate Supply (AS) It is total quantity produces in the economy during an accounting
year. It is estimated by National Income (Value Edit method ).Component of national
income are consumption and savings so these are also the component of AS.

Components of AS are:-
C+S
C = Consumption expenditure
S = Saving is the part of income which is not consumed
Y = C + S = AS

Y= AS

Angle of AS is always 45 
C :- Consumption is a component of income . It is positively related with the levelof
income. Some minimum level of income always be available even when
income equals to zero. It is called autonomous consumption.
S :- Saving is the part of income which is not consumed as a component of Y,
saving can be negative when C > 4. There is a true relation between S and Y.

AS

AS

INCOME
Equilibrium: It refers to the situation where AS and AD are equal.

Income AS AD Y

0 0 20
AS
10 10 25
AD
20 20 30 AS
E
30 30 35
40 40 40
50 50 45 45°
X
60 60 50

9289599338
 29 SHORT RUN EQUILIBRIUM OUTPUT

When AS > AD :- When AS > AD. Then flow of goods and services in the economy
tends to be high as result unwanted stock increased. To clear unwanted stocks produces
would plan to cut in production. It implies decreases in income and unemployment
increases.

When AS < AD :- When AS < AD, then flow goods and services in the economy tends
to be less than their demand and producer would plan more production.
(2). S and I approach :- According to this approach, equilibrium national income
is achieved when saving is equal to Investment. Saving refers to withdrawl
(leakage) from the circular flow.
Investment refers to Injection into the circular flow :- Saving is posi -
tively related to incomr\e. however at lower level of income S can be (
negative) because at lower level of income C > Y. So, saving is negative when
consumption is greater than income are equal. Saving is positive when
consumption is less than income.

Y
S

Saving

O X
Income

Investment functions are consider only autonomous investment. It is

independent of level of income and Rate of interest. so it is parallel to the X
axis.

9289599338
 30 SHORT RUN EQUILIBRIUM OUTPUT

X
Income
Ex.:-
Income C Saving Investment
0 25 -25 75
100 100 0 75
175 156 19 75
300 250 50 75
350 287.50 62.5 75
400 325 75 75
450 362.50 37.5 75
500 400 100 75

Y I

Saving /
Investment
Income X

When S > I:- In case when S > I, it implies a situation when withdrawal of expenditure
(S is greater than the injection of I), into the circular flew of income. As a result some
output would remain unsold and producers cut have undesired stock.
To clear their stock, the producers would now plan lesser output. This would mean
lesser income lesser saving, the process would continue till S = I.

9289599338
 31 SHORT RUN EQUILIBRIUM OUTPUT

When S < T :- In case when S < T, it implies a situation when withdrawl of expenditure
( S is lesser than Injection Of expenditure I) into the circular flow of income.
According, overall expenditure in the economy would be more than what is required
to buy the planned output.
To cope with the situation the producers would now plan higher output.
Higher output would mean higher income would continue till. S = I.

Q3. Define the shifting of equilibrium

Ans. Injection :- It causes increase in the level of Aggregate Demand . As a result aggregate
demand function shifts upwards and increase I level of output and income. It is also
Known as Excess demand.
AS
Y
AD (C+I+I)

AD (C+I)
AD/AS

X
Income

Leakage:- Leaksge (withdrawl) cause decreased in aggregate demand. As a result in

Aggregate deand function shifts downwards. So level of income and output decreases.
Withdrawl causes a negative multiple effect.
AS
Y
AD (C+I)

AD (C+I- I)

AD/AS

Income
X SHORT RUN EQUILIBRIUM OUTPUT

Q4. Define Investment Multiplier.

9289599338
 32

Ans. Investment multiplier refers to the number which change in investment multiplies to
become change in income.
It is measured as the ratio between change in come and change in investment.
Y
K=
I

Q5. Explain the relation between multiplier and MPC.

Ans. There is a direct relationship between multiplier and MPC.
Higher the value of MPC, higher the multiplier and Lower the value of MPC, Lower
the multiplier

I
K=
I-MPC
I I I
If MPC is 0.5, Then K= = = =2
I-MPC I-0.5 0.5

I 1
If MPC is 0.8. then K= = =05
I-MPC 0.2

MPC K
0.5 2
0.8 5

Q6. Explain the relationship between multiplier and MPS.

Ans. There is a negative relationship between multiplier and MPS. Higher the value of MPS,
lower the value of Multiplier and Vice-versa.

K= I
MPS
If MPS =0.5 then

I SHORT RUN EQUILIBRIUM OUTPUT

K= =2
0.5

If MPS =1, then

9289599338
 33

I 1
K= =
MPS 1

K=1

MPS K
0.5 2
1 1

Q7. Define Forward action of multiplier and backward Action of Multiplier.

Ans. Forward Actiion of Multiplier:-
Multiplier action is forward when there is a multiple increase in income caused by an
increase in investment.

Backward Action of Multiplier:-

Multiplier action is backward if there is a multiple decrease in income causes by
decrease in investment.

Q8. Explain the multiplier process.

Ans. The working of multiplier assumes the following process:

If investment increases by 100 cr and MPC is 0.5, there will be income is increase
two times the increase in investment.

Change in Investment causes change in income, as a result there is a change in

consumption.
Consumption expenditure of one person is an income of the other.
Hence, Change in consumption leads to change in income. This continous till c falls
to 0

9289599338
 34

Round Income in Change Induced Leackage

Investment Income Charge in (saving)
Expenditure Consumption
1 100 100 50 50
2 - 50 25 25
3 - 25 12.5 12.5
4 - 12.5 6.25 6.25
5 - 6.25 3.12 3.12
6 - 3.12 1.56 1.56
7 - 1.56 0.78 0.78
8 - 0.78 0.39 0.39
9 - 0.39 0.20 0.20
10 - 0.20 0.10 0.10
Total 100 200 100 100

In the above eg. Assume than MPC is 0.5. Initial increase is investment by 100 cr.,
there is change in income by 100 crore.
Consumption will increase by 50 cr and remaining 50 cr will be saved .
Because of expenditure of 50 cr on consumption ther will be an increase in income by
50 cr. As a result, increase in consumption is 25 cr and this process continue till C =0
Multiplier is not related to APC. It is related to MPC, because multiplier shows change
in income, as a result of change in investment and MPC shows change in consumption.
As a result of change in income. So,MPC is related to the concept of multiplier not
APC.

Q9. Explain Ex-ante and Ex-post .

Ans. Ex-ante:- It means intended. Ex-ante can also be taken to mean planned or expected.
Ex-post:- It means actual and also means realized.

Q10. Define full employment.

Ans. Full Employment:- It means maximum efficient utilisation of the economy available
resources. An economy is said to be in full employment situation, When the entrie
labour force in the economy is in employment.

Q11. Define Involuntary and Voluntary unemployment.

9289599338
 35

Ans. Involuntary unemployment:- Involuntary unemployment is a situation when a

person have ability to work and willing to work at all existing wagerate but they do
not get work.
Voluntary Unemployment:- Voluntary unemployment is a situation when a person
is not willing to work at all or not willing to work at exiting wagerate.
Q12. Explain structural unemployment and frictional unemployment.
Ans. Structural Unemployment:- It is a situation when person not get work due to
change in technology or change in pattern of demand.
Frictional Unemploymen:- It is a situation when peson is unemployed during
change the job in the dynamic economy.

9289599338
 36

8 PROBLEM OF DEFICIENT DEMAND

AND EXCESS DEMAND

Q1. Define full employment equilibrium.

Ans. Full employment equilibrium refers to that situation in the economy when AD= AS or
S=I along with full utilization of labour force.
OR
Full employment refers to a situation when all those who are able to work and aare
willing to work at the exiting wage rate are getting work.

Q2. Explain this statement “ Full employment doesnot mean a situation of zero
unemployment “
Ans. Full employment never impiles a situation of zero involuntary unemployment . There
always axists some degree of unemployment called Natural unemployment.

Q3 What is natural rate of unemployment?

Ans. It refers to an unemployment due to
1. Time required in shifting form one job to the other.
2. Time required in adjusting to change technology.

Q4. Explain the situation of deficient demand and its causes and consequences.
Ans. Deficient demand refers to the situation when aggregated demand is short of aggregate
supply corresponding to full employment in the economy.

AD<AS

Y AS
ADF

ADU
AD/AS

O X
Income

9289599338
37 PROBLEM OF DEFICIENT DEMAND
AND EXCESS DEMAND

CAUSES:-
1. Reduction in private consumption expenditure:
Private consumption expenditure ia an important of aggregate demand.
Reduction in private consumption expenditure causes serious deficiency is
aggregate demand.
Comsumption may reduce due to many reasons. The most important is reduction
in propensity t o consumer or increase in propensity to save.

2 Reduction in investment expenditure :-

Investment expenditure also a main component of aggregate demand. Reduction in
investment I situation of poor business sentiments or increase in Interest rate.
In the open Economy With government may also contribute to the deficiency of
aggregate demand.

3 Reduction in government Expenditure:-

It is situation of loss in public enterprises in such situation instead of making fresh
investment the government may resort disinvestment.

4 Decline in Export /Rise in Import:-

Decline in Export may occur due to lack of demand in the rest of the world and
import may rise when international prices are lower than domestic pride.

CONSEQUENCES:-
When AD(aggregate demand) fails to cope with fuller employment of the factors,
producer tend to build up unwanted inventory stock. It means actual stock is
greater than desired stock.
Idle inventory stock would force the producer to plan lesser production. In this
situation producer decrease the level of production output.
Reduction in the level of output causes a situation of reduction is employment. It
implies a reduction in the level of income.

9289599338
 38 PROBLEM OF DEFICIENT DEMAND
AND EXCESS DEMAND

Q5. Define deflationary gap

Ans. Deflationary gap is the short fall in Aggregate demand from the level required to
maintain full employment equilibrium in the economy.
Deflationary gap is measured as the difference between aggregate demand
corresponding to full employment and aggregate demand corresponding the under
employment.

Y AS

ADF

ADU
AS/AS

Deflationary gap

O
Income X

Q6. Define Excess Demand and explain its causes and consequences.
Ans. Excess demand refersto the situation when aggregate demand is in excess of Aggregate
supply corresponding to full employment in the economy.
AD>AS

Y
AS
ADE

ADF

AD/AS

O
Incom X

9289599338
 39 PROBLEM OF DEFICIENT DEMAND
AND EXCESS DEMAND

CAUSES:-
1. Increase in private consumption expenditure which may occur owing to increase in
propensity to consume or decrease in propensity to save.
2. Increase in Investment expenditure occurring due to improvement in business
sentiments.
In an open economy with government may also contribute to excess of aggregate
demand.

3. Increase in government expenditure owing to its active participation in the process

of growth and social welfare.
4. Increase in Export owing to lower domestic price in relation to international prices
and decrease in import owing to higher international prices compared with domestic
price.
CONSEQENCES :-
1. When aggregate demand increase beyond its full employment level, output remains
constant because cannot exceed its full employment level.
2. How of goods and services remains constant, excess demand on the existing output.
3. Excess pressure of demand on existing output causes rise in price. This implies a
situation of inflation.
Q7. Define Inflationary gap
Ans. Inflationary gap is excess of aggregate demand from the level required to maintain
full employment equilibrium.

Y
AS

ADE

ADF

AD/AS

Inflationary gap

O
Incom X

Q8. Explain the Fiscal policy to control the situation of inflation or deflation.

9289599338
 40

Ans. Fiscal Policy: It refers to revenue and expenditure policy of the government. It is also
Known as Budgetory Policy of the government.
Components of fiscal policy:-
1. Government Expenditure:- Government expenditure are incurred on the
expenditure on public work programmes like construction of roads, dams, bridges
etc, expenditure on education and public welfare programmes, expenditure on the
defence and maintenance of low and order situation.
Government expenditure increases the aggregate demand in the economy and also
provides more employment.
In the situation of excess demand (inflation) government expenditure is reduced
and in the situation of deficit demand. Government expenditure should increase
the level of aggregate demand in the economy.
2. Taxes:- Taxes are a compulsory payment mode to government by the household
and the producing sectors .
By increasing the tax burden on the government reduces purchasing power in the
economy.
By lowering the tax burden , the government increase the purchases power in the
economy.
In the cases of deficit demand (deflation) tax burden on household & producer
should decrecase to increase aggregate demand and in the case of excess
demand/inflation tax burden on the household & producer should increases. As a
result aggregate demand is decreases.
3. Public Borrowing/Public Debts:- In the public Borrowing government borrows
money from the public and creates public debts.
Public debts reduce the liquidity with the people. In the situation of deficit demand
(deflation), the government reduces its borrowing from the public so that people
and left with greater liquidity and aggregate demand increases. In situation of
excess demand (inflation) the government step up public borrowing by offering
attractive rate of interest. This reduce liquidity with people so aggregate demand
decreases.
4. Deficit Financing:- It means borrowing by the government form the RBI. The
RBI lends money to the government by issuing more currency. Additional
currency causes additional purchasing power in the economy. It increases
aggregate demand. In the situation of deficit demand, deficit financing policy

9289599338
 PROBLEM OF DEFICIENT DEMAND
AND EXCESS DEMAND
41

should be used to correct the situation of deflation. In case of excess demand,

deficit financing policy should be avoided.

Q9. Explain the monetary policy to control the situation of inflation.

Ans. Monetary policy is that policy of central bank (government) which corrects the
situation of excess and deficit demand by regulating interest rate and availability of
credit in the economy.
Components:-
1. Bank Rate:- It is the rate at which the central bank lends money to the commercial
bank. Market rate of interest is directly related to bank rate. If bank rate increase,
market rate of interest also increases this reduces demand for credit. To correct the
Situation of deficit demand bank rate should be decreases. As a result market rate
of interest also decreases and aggregate demand increases. In the situation of
excess demand, bank rate should increase, as a result market rate of interest also
increases and demand for credit reduces and consumption and investment
expenditure tend to increase.
In the situation of deficit demand , bank rate should demand, as a result market rate
of interest also decrease and demand for credit increase are consumption and
investment expenditure lend to decrease.

2. Open Market Operation:- It is the policy that focuses on increasing and

decreasing the stock of liquidity with the people by the sale and purchase of
security by central bank.
Sales of security sucks purchasing power from the public and purchasing of
security inject purchasing power into the market.
In the situation of excess demand the central bank tries the sells securities in the
market to purchasing power in the economy decreases and aggregate demand also
decreases.
In the situation of deficit demand the central bank tries to purchase power of people
and aggregate demand increases.
3. Cash Reserue Ration:- It refers to the ratio between cash Reserue of the
commercial Banks with the Central Bank & its total deposits commercial Banks
are required to maintain minimum CRR as fined by the Central b ank from time to
time.

9289599338
 42

In the situation of chcess dimand CRR is increased it reduces lending capacity of

commercial banks. It im

Q10. Explain dear money policy and cheap money policy.

Ans. Dear Money Policy :- Interest rate is the cost of credit. The cost of credit is raised and
available of credit is reduced when excess demand is to be corrected. This is called
Dear money policy.
Cheap Money Policy:- Cost of credit is reduce and availability of credit is increased
when deficit demand is to be corrected. This is called cheap money policy.

Q11. Define Boom. Recession, Depression and Recovery

Ans. Boom:- Excess demand generates inflationary pressure which is often referred as to
boom in the trade cycles.
Recession:-Deficiency in demand cause decrease I level of producing as a result many
number of person are unemployed.
Depression:- Continuation of recession drives the system down to the state of
depression.
Recovery:-When aggregate demand strikes up an economy moves towards fuller
utilistion of thefctor ofproduction is known as recovery.
The cycle is completed from Boom to Boom, covering the stages of Recession,
Depression and recovery in between.

Y Boom
Recovery

Recession

Depression

O X

9289599338
 43

9 GOVERNMENT BUDGET

Q1. Define government budget.

Ans. Government budget is a statement of the estimation of government receipts and
expenditure during the period of financial year.

Q2. Define Budget Receipts and its components.

Ans. Budget Receipts refers to the the estimated receipts of the government from allsources
during the fiscal year.
Budget Receipts are classified into two categories:-
➔ Revenue Receipts
➔ Capital receipts

Q3. Define Revenue Receipts and its components?

Ans. Revenue Receipts of the government are those money receipts which don’t create a
liability for the government and as well do not lead reduction in the assets of the
government.
Revenue Rececipts are classified into two categories:-
1. Tax Receipts
2. Non – Tax Receipts.

Tax Receipts:- A tax is a compulsory payment to the government by the household

and firm.
Tax receipts are classified into following manner:-
1. Direct Tax:- A direct tax is a really paid by the person on whom, it is legally
impose. For ex: income tax, wealth tax.

2. Indirect Tax:- An indirect tax is imposed on one person but paid partly or
wholly by another . For ex: Sales tax. Excise duty. Custom duty. Etc.

3. Proggressive tax :- A tax is said to be proggressove when the rate of tax

increases with an increase in income.

9289599338
 44 GOVERNMENT BUDGET

4. Regressive Tax :- A tax is said to be regressive, when tax rate is constant at

every level of income. It cause a greates real burden on the poor section of the
society.

Non – Tax receipts:- Non –Tax receipts are those receipt which are received
from sources other than Taxes.
1. Fees:- A fees payment to the government for the services that is rendened to the
people. For ex: Birth and Death registration fees.

2. Fines:- Fines are those payments which are made by the law breaker to the
government by way of economic punishment. The aim is not to earn revenue but
to make people respectfull towards the laws.

3. Escheat :- It refers to that income of the state which are out of the property left by
the people without a legal heir. They are claimed such property.

4. Grants :- Grants received by the government are also a source of revenue in the
event of some natural disasters, citizen of the country makes some grant to the
government.

Q4. Explain Capital Receipts and its components?

Ans. Capital Receipts may be defined as those money receipts of the government which
either creates a liability for the government & cause a reduction in its anets.
Components of capital Receipts:
1. Recovery of loan :- Loan offered to other are assets of the government.
Accordingly recovery of loan causes a reduction in assets of the government. S
these receipts are stsed as Capital Receipts.

2. Borrowings:- While lemding creates assets, borrowing creates liability and

accordingly, borrowing are treated s Capital receipts.

3. Disinvestment:- Disinvestment occurs when the government sell of its shares of

public sector enterprises to private sectors it cause reduction in government anets.
So it is called Capital Receipts. Disinvestment is also known as Privatisation.

9289599338
 45 GOVERNMENT BUDGET

Q5. Define Budget Expenditure & its components?

Ans. Budget Expenditure refers to estimated expenditure of the government relating to its
development as well as non-development programmes during the fiscal year.
Budget Expenditure are mainly classified into two categories:-
1. Revenue Expenditure
2. Capital Expenditure
Revenue Expenditure :- Revenue expenditure refers to estimated exp. of the
government in a financial year which doesn’t creates assets are causes reduction in
liability. For ex : Exp. Subsidy, Defence purchase.
Capital Expenditure :- Capital Expenditure refers to estimated exp. of the
government in a financial year which creates assets are causes reduction in liability.
For ex : Purchase of land & Building etc.

Q6. Explain planned and non – planned expenditure?

Ans. Planned Expenditure:- It refers to that expenditure which relates to five years plans,
it includes both revenue exp. & capital Exp.
Non – Planned Expenditure :- It refers to that expenditure which doesn’t relates to
five years plans, it includes both revenue exp. & capital Exp.

Q7. Define budget deficit and its types?

Ans. Budget deficit/Government refers to a situation when budget expenditure of the
government are greater than the budget receipts. There are three important types:-
1. Revenue deficit
2. Fiscal deficit
3. Primary deficit

Q8. Define Revenue deficit and how to control revenue deicit?

Ans. Revenue deficit is the excess of revenue expover revenue receipts.
R.D = RE – RR
When Re > RR.
To control:-
1. Increase RR though tax and non-tax receipts the government may increase.
2. Decrease revenue expenditure, it may be achieved through cut in subsidy.

9289599338
 46 GOVERNMENT BUDGET

Q9. Define fiscal deficit and its implication?

Ans. Fiscal deficit is the excess of budgeted expenditure over budgeted receipts other than
borrowing
F.D = BE –BR ( borrowing exclude)
Greater fiscal deficit implies grater borrowing by the government.
FD shows government borrowings.
Implications:-
1. Inflationary Spiral:- Fiscal deficit means more government expenditure compare
to government receipts, it implies increase in aggregate demand and it is tht main
causes of inflation.
2. Back log of National Dept for future generation. Recurring borrowing implies back
log of national debt for future generation.

Q10. Define primary deficit and its implication?

Ans. Primary deficit is the difference between F.D and Interest payment.
P.D = F.D – Interest+ Payment
Implication:
Implications of primary deficit are similar to those fiscal deficit except the fact is
interest payments.

Q11. What does zero primary defict mean?

Ans. It means the government has to resort to borrowing only to clear the existing backlog
of interest payment.

Q12. Define balance budgets and its merits & demerits?

Ans. A balance budget is that budget in which government receipts are equal to government
expenditure.
Merits :-
1. The govt. doesn’t involve in wastefull activites.
2. A balance budget ensures economics stability.
Demerits:-
1. Balance budget doesn’t offers the solution of employment in undevelop country.
2. It is not useful in the situation of deflation.

9289599338
 47 GOVERNMENT BUDGET

Q13. Define unbalance budget and its merits and demerits?

Ans. Unbalance budget is that budget in which government expenditure and govt receipts
are not equal. This may be :-
1. Surplus budget
2. Deficit budget
Surplus Budget:-
Surplus budget is that budget in which government receipts are greater than
government expenditure.
Merits:-
Surplus budget desired during inflation.
Demerits :-
It is not desired during the period of deflation.
Deficit Budget :-
It is a budget in which government expenditure are greater than government receipts.
Merits:-
It is a key instrument to correct the situation of deprenion.
Demerits:-
It is not desired during the situation of Inflatiion.

Q13. Explain the objective of government Budget?

Ans. Redistribution of income and wealth:- Through its revenue and expenditure policy
government promotes equality. Tax structure is design to be progrenive, placing
greater burden on richer section of the society. So that their real disposable income
decreases.
Realocation of recourses:- Market economics are believes to achieved optimum
allocation of resources producing such goods & services which the consumer wish to
buy , but market economy cannot produce of public goods which satisfy needs of the
society. Provision of public like law, order, defence is often taken as the primary
responsibility of the government. It is related to revenue expenditure policy of the
government.
Economic Stability:- Economic stability is the pre-condition of development.
Inflation or deflation impact economic stability. During deflation unemployment is
increases and reduce taxes it impiles increase in AD and to control the situation of

9289599338
 GOVERNMENT BUDGET
48

inflation government expenditure should decrease and tav burden increase.It implies
decrease in AD.
Managing Public enterprise:- Through budgetary policy government manage public
enterprises and the main objectives is social welfare. If government is unable to
manage public enterprise and suffer loss. Then govt. should sell these enterprise to put
– sector. This is known as privatization.

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10 Balance of Payment (BOP)

Q1. Define balance of payments and its components?

Ans. Balance of payment refers to the statement of accounts recording of all monetary
tranactions of a country with rest of the world.
Balance of Payment classified into two accounts:-
1. Currrent Account:-Current account records exports and imports of goods,
services and current transfer. Goods are considered as tangible goods and their
exports and imports is called visible trade. Export and import of services is not seen
and is therefore called invisible trade. Current transfer refers to transfer for free,
there are unilateral transfer by way of gifts, grants etc.
2. Capital Account:- Capital account is that account which records all such
transactions between resident of a country and rest of the world which cause a
change in ownership of anets.
Borrowing and investments are the two principles had of capital account:-
1. Borrowing:-
a External commercial Borrowing:- ECB is available at the market rate
of interest.
b External Assistant Borrowing:- EAB is available at the concentioal rate
interest.
2. Investment:-
a Foreign Direct Investment (FDI):- FDI relates to ownership of enterprise
by the non – resident in the domestic economy. For ex: Purschase of assets
like building, etc.
b Portfolio Investments:- This investment doesn’t offer ownership to the
investor like purchase of shares.

Q15. Define Balance of trade?

Ans. Balance of trade refers to the export and import of visible items (Goods only).Balance
of trade is narrow concept compare to balance of payment.

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Balance of Payment (BOP)

Q16. Define autonomous and accommodating items of balance of trade?

Ans. Autonomous Items :- It refers to such BOP transactions which are undertaken for
consideration of profit. These items are the cause of BOP imbalance. These items are
also known as above the line items.
Accommodating Items:- They are free from the consideration of profit. These are
means to correct BOP imbalance these items are also known as Below the line items.
BOP always Balance of trade always balances in case there is any imbalance, it is
corrected through accommodating transaction for e.g gifts.

Q17. What are the causes of disequilibrium in balance of trade?

Ans. This equilibrium in balance of trade is caused by to no. of factors which are
classified into three categories:-
1. Economic Factors:-
a. Huge development expenditure by the government owing to which there
are large scale imports. It may cause deficit BOP.
b. Development of Import substitution, imports are reduced and surplus BOP
aries.
2. Political Factors:-
a. Political instability owing to decrease in foreign direct investment & port-
folio investment. It causes deficit BPO.
b. Populisim policy of the government huge cut in import duty. It may
encourage import & deficit BOP aries.
3. Social Factors:-
a. Change in taste & preferences across different parts of the world owing to
which pattern of demand may changed. A favourable change may generate
deficit BOP.
b. Sometime import Is expensive and len profitable area Of export. Such
situation causes deficit BOP.

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11 FOREIGN EXCHANGE RATE

Q1. Define Foreign Exchange Rate.

Ans. Foreign exchange rate refers to the rate at which one unit of currency of a country can
be exchanged for the number of unit of currency of another country.
Eg : $1= ~50. Or ~1= $ 1/50= 2 units.

Q2. Explain the system of Exchange Rate.

Ans. It is broadly classified into two parts :-
• Fixed Exchange Rate.
• Flexible Exchange Rate.

Q3. Explain fixed exchange rate and its merits and demerits.
Ans. Fixed Rate of Exchange refers to the rate of exchange as fixed by the government.
It has two important components:-
Gold standard system of exchange:- According to this system, gold was taken as
the common unit of value between currencies of difference to countries is circulation.
Each currency was to define value of its currency in term of gold.
Example:- $1= 2 gm of gold and £ 1 (Pound) = 4 gm of gold
It means £1 = $2

Bretton wood system of exchange or Adjustable Peg system.

This system was fixed system of exchange rate but allowed some adjustment. So it
was called Adjustment Peg system of exchange rate.

Merits of Fixed Exchanged Rate (Foreign Exchange Rate):-

➔ Market Stability:- It ensure stability in the international money market.
Traders and investor are not exposed to uncertainties of the market.
➔ Encourages International Trade:- Stable market under the Foreign
Exchange Rate system encourages international trade.
➔ Avoid Speculations: - Because of Foreign Exchange Rate speculation is
avoided in the international money market.

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FOREIGN EXCHANGE RATE

Demerits :-
➔ Huge Reserves of gold: - Foreign Exchange Rate system refers huge reverse
of gold. This is because different currencies are directly/indirectly convertible
into gold.
➔ Discourages venture capital:- (F.E.R) Fixed Exchange Rate discourage
venture Capital.

Q4. Explain flexible exchange rate system and its merits and demerits.
Ans. Flexible rate of exchange is that rate which is determined by the demand for and supply
of different currencies in the foreign exchange market.
The market where foreign currencies are exchanged is called foreign market or
international money market.
MERITS:-
1. Gold reserves not required:- Flexible exchange rate does not require gold
Reserves.
2. Venture Capital:- Flexible exchange rate require capital in the foreign exchange
market. Trading in international currencies itself becomes an important economic
activity.
3. International Mobility of Capital:- This system encourages mobility of capital
in different nation. As a result member countries are no longer required to keep
huge international reserves.
DEMERITS:-
1. Market Instability: - Flexible exchange rate causes instability in the international
money. It implies frequently rise or fall in the exchange rate.
2. Policy formulation becomes difficult: - It is very difficult to draw long period
policy of experts and Imports because of instability in the market.

Q5. Explain the determination of flexible exchange rate in a free market.

Ans. The rate of exchange of a country’s currency is determined by the demand for and
supply of its currency. This is called rate of exchange or equilibrium rate.
Demand for foreign exchange:-
1. Payment of international loan.
2. Gifts and grants to the rest of the world.
3. Investment in rest of the world.

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FOREIGN EXCHANGE RATE

4. Speculation trading in foreign exchange by foreign resident.

Demand for foreign exchange is inversely related to its price. So demand curve for
foreign exchange is downward sloping.

Foreign
exchange

rate
O X
Demand

Supply of foreign exchange:-

1. Direct foreign investment.

2. Purchased of goods and services by non residents in domestic markets.

3. Export of country to the rest of the world.

Supply of foreign exchange and rate of exchange are directly related with rise in rate
of exchange.
Supply of foreign exchange increase so supply curve of foreign exchange in the
international exchange market is upward sloping.

Y
Y

FER
Foreign
exchange

rate
O X X
Supply Demand/Supply

Equilibrium rate of exchange:-

It occurs where supply of and demands for exchange are equal to each other.

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FOREIGN EXCHANGE RATE

Y D S

D
S
O X
Supply & Demand

Q6. Explain the disequilibrium condition in the foreign exchange rate.

Ans. 1. An Increase in Demand: - Due to increase in demand for other currencies in India,
demand curves shifts to the right side and rate of exchange increases. Thus means
than Indian rupee is depreciating.

Y S
D

Foreign
exchange
S
rate D

O X
Supply & Demand

2 A decrease in Demand: - Due to decrease in demand for other currencies in India,

demand curve shifts to the left side to rate of exchange decreases. This means that
Indian rupee id appreciating.

D
Y S

Foreign
exchange
rate

S D

O X
Supply & Demand

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FOREIGN EXCHANGE RATE

3. An increase in supply: - Due to increase in supply of other currencies in India,

supply curve shifts to the right side and rate of exchange decreases. This means
that Indian rupee is appreciating.

D
Y S
S1

Foreign
exchange
rate
S D
S1
O X
Supply & Demand

4. A decrease in supply: - Due to decrease in supply of other currencies in India,

supply curve shifts to the left side and rate of exchange increases. This means than
Indian rupee a depreciating.

S1
D
Y S

Foreign
exchange
S1
rate D
S
O X
Supply & Demand

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