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Series : SMA/1

Roll No.

Code No. 58/1/1Candidates must write the Code onthe title page of the answer-book.

Code number given on the right hand side of the question paper should be written on the titlepage of the answer-book by the candidate.

Please check that this question paper contains 8 printed pages.

Please write down the Serial Number of the questions before attempting it.

15 minutes time has been allotted to read this question paper. The question paper will be distributedat 10.15 a.m. From 10.15 a.m. to 10.30 a.m., the student will read the question paper only andwill not write any answer on the answer script during this period.

ECONOMICS

[Time allowed : 3 hours] [Maximum marks : 100]

General Instructions:

1. All questions are compulsory.

2. Marks for questions are indicated against each.

3. Questions numbered 1 to 5 and 17-21 are very short-answer questions carrying 1 mark each. They arerequired to be answered in one sentence each.

4. Questions numbered 6 to 10 and 22-26 are short-answer questions carrying 3 marks each. Answer to themshould not normally exceed 60 words each.

5. Questions numbered 11 to 13 and 27-29 are also short-answer questions carrying 4 marks each. Answer tothem should not normally exceed 70 words each.

6. Questions numbered 14 to 16 and 30-32 are long-answer questions carrying 6 marks each. Answer to themshould not normally exceed 100 words each.

7. Answer should be brief and to the point and the above word limit be adhered to as far as possible.

Studymate Solutions to CBSE Board Examination 2011-2012

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STUDYmate

SECTION-A1. Give meaning of an Economy?

Ans. An economy is a system which provides people with the means to work, and earn aliving. In the words of A.J. Brown, “An economy is a system by which people get aliving and satisfy their wants”.

2. What is Market Demand?

Ans. Market Demand is the demand of all the individuals taken together in a market at agiven price during the given period of time.

3. What is the behaviour of average fixed cost as output increases?

Ans. Average fixed cost declines as output increases. Since TFC

AFCQ

and TFC constant

with increase in output therefore AFC declines.

4. What is the behaviour of average revenue in a market in which a firm can sell moreonly by lowering the price?

Ans. Average revenue falls in a market in which a firm can sell more only by lowering theprice i.e. under imperfect competition.

5. What is a price taker firm?

Ans. A perfectly competitive firm is a price taker firm which takes the price from the marketthat is determined by forces of demand and supply.

6. What is opportunity cost? Explain with the help of a numerical example.

Ans. Opportunity cost is defined as the cost of next best alternative opportunity foregone.The opportunity cost of any commodity is the amount of other good which has beengiven up in order to produce that commodity.

Eg : If a person is working in a bank and gets 2 job offers. 1 as a bank executive @` 30,000 and other as journalist @ ̀ 35,000. In this case the opportunity cost of beinga journalist is ` 30,000.

7. Given price of a good, how does a consumer decide as to how much of that good tobuy?

Ans. Given price of a good, a consumer decides on the basis of the following conditions.

1. MU = price, i.e., x

xm

MUP

MU

2. Total gain falls as more is purchased after equilibrium.

If MUx (money) > P

x, consumer keeps on consuming more units. When he

consumes more unit, the additional utility derived from consuming x keeps onfalling. He keeps on consuming till MU

x (money) = P

x.

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STUDYmate

If MUx (money) < P

x, he will decrease the consumption of x. When he decreases

the consumption of x, the marginal utility of x will increase. He will keep ondecreasing consumption of x till MU

x(money) = P

x.

Thus, MUx(money) = P

x is the condition for consumer’s equilibrium in a simple

commodity case.

8. Draw Average Variable Cost, Average Total Cost and Marginal Cost Curves in a singlediagram.

Ans.

Cos

t(R

s.)

Units of OutputX

AVC

M2

M1

MCATC

O

9. An individual is both the owner and the manager of a shop taken on rent. Identifyimplicit cost and explicit cost from this information. Explain.

Ans. (i) Explicit cost refers to the actual payment made to outsiders for hiringservices of the factors of production. These include wages paid to theemployees, rent paid for hired premises, cost of raw materials, interest on loansetc.

(ii) Implicit cost: Implicit cost refers to the cost of self supplied factors. Forexample interest on self invested capital, rent of own land, salary for the servicesof entrepreneur, etc.

In the above example rent is an explicit cost as it is paid by the owner of the shop.

Imputed value of salary he could have earned as a manager working in some otherorganisation is the Implicit cost.

10. Explain the implication of large number of buyers in a perfectly competitive market.

OR

Explain why are firms mutually interdependent in an oligopoly market.

Ans. A Large Number of Buyers and Sellers:

(a) There are so many buyers and sellers that no individual buyer or seller can notinfluence the price of the commodity in the market.

(b) Any change in the output supplied by a single firm will not affect the total outputof the industry.

(c) To an individual producer the price of the commodity is given. He can sell whateveroutput he produces at the given price, i.e., an individual seller is a price-taker.

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STUDYmate

Pri

ce

OutputO X

P

S

SD

D

Market

Pri

ce

OutputO

P

Firm

d = p = AR = MR

(d) Implication: The perfectly competitive firm is then a ‘price-taker’ and cansell any amount of the commodity at the established price.

OR

Interdependence:

(a) The most important characteristic feature of oligopoly is interdependence amongits firms. The number of sellers is small in this market and each of these firmscontributes a significant portion of the total sale.

(b) As a result when any one of them undertakes any measure to promote its sale,it directly affects other firms and they also immediately react.

(c) Hence every firm decides its policy after taking into consideration the possiblereactions of its rival firms.

(d) Thus, every firm is affected by the activities of other firms and it affects othersalso. This is the interdependence of firms.

11. Define an indifference curve. Explain why an indifference curve is downward slopingfrom left to right.

Ans. Indifference curve refers to the graphical representation of various alternative

combinations of the goods, which provide same level of satisfaction to the consumer.

Indifference Schedule

Combinations Good X Good Y Marginal Rate of Substitution

A 1 8 -

B 2 4 4Y : 1X

C 3 2 2Y : 1X

D 4 1 1Y : 1X

The consumer is indifferent between the combinations A, B, C, D. Therefore joiningthese points on the curve, we get an indifference curve.

87654321

1 2 3 4

A

B

CD

ICgood X

good Y

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STUDYmate

The indifference curve slopes down wards from left to right i.e. It is negatively sloped.This is because when consumer increases consumption of X, he must reduceconsumption of Y to keep the utility level unchanged.

[IC doesn’t touch either axis because the assumption of IC curve is that he consumesboth the goods].

12. When price of a good is ` 7 per unit a consumer buys 12 units. When price falls to ` 6per unit he spends ` 72 on the good. Calculate price elasticity of demand by usingpercentage method. Comment on the likely shape of demand curve based on thismeasure of elasticity.

Ans. Q P TE

12 ` 7

12 ` 6 72

Working Notes

P × Q = TE

6 × Q = 72

72Q 12

6

ed = ( )q p

p q

= 0 71 12

= 0

OR

Ans. Percentage change in quantity = 0

10012

Percentage change in price = 1

1007

ed = 0

14.28 = 0

The likely shape of demand curve is perfectly inelastic. It is || to y axis.

13. What does the Law of Variable Proportions show? State the behaviour of total productaccording to this law.

OR

Explain how changes in prices of other products influence the supply of a given product.

Ans. The law of variable proportion show the impact on output when units of variablefactor are increased, keeping fixed factors constant in the short run.

The law states, ‘if more and more units of a variable factor are employed with fixedfactors, total physical product (TPP) increases at an increasing rate in the beginning,then increases at a diminishing rate and finally starts falling.

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STUDYmate

Three phases of production

Land(Acre)

No. oflabourers

TPP(quintal)

APP(quintal)

MPP(quintal)

11

11

01

23

02

612

02

34

–

2Phase I

4

6

11

1

45

6

1618

18

43 6

3

4

2 Phase II

0

11

78

148

21

–4Phase III

–6

Phase I : Stage of increasing returns

TPP increases at an increasing rate.

Unit of variablefactor

M

O

OMPP

R

N

TPPTPP

MPP

Y

Q1Q2

X

Unit of variable factor

Q1Q2

Phase I Phase II

X

MPP keeps rising between O to Q1 level of output and reaches its maximum where

this stage ends.

Phase II : Stage of Diminishing returns

TPP increases at a diminishing rate till it reaches its maximum point (N).

MPP is falling but remains positive.

Phase III : Stage of negative returns

TPP starts declining. As a result TPP curve starts sloping downward as depicted infigure. So phase III is called the phase of negative returns.

MPP becomes negative (–) and its curve goes below x-axis.

OR

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STUDYmate

Ans. Prices of Other Goods:

(a) As resources have alternative uses, the quantity supplied of a commodity dependsnot only on its price, but also on the prices of other commodities.

(b) Increase in the prices of other goods makes them more profitable in comparisonto the given commodity.

(c) As a result, the firm shifts its limited resources from production of the givencommodity to production of other goods. For example, increase in the price ofwheat (other good) will induce the farmer to use land for cultivation of wheat inplace of rice (given commodity).

(d) Decrease in price of other good will shift the supply curve to the right.

Pri

ce(in

Rs.

)

Supply (in units)

P

Y

XO

S1 S

S1 S

Supply curve shiftstowards left due toincrease in pricesof other goods

Q1 Q

Pri

ce(in

Rs.

)

Supply (in units)

P

Y

XO

S S1

S S1

Supply curve shiftstowards right due todecrease in pricesof other goods

Q Q1

Increase in the Prices of other Goods Decrease in the Prices of other Goods

14. Explain how do the following influence demand for a good:

(i) Rise in income of the consumer.

(ii) Fall in prices of the related goods.

Ans. (i) These are two types of goods based on how demand changes due to change inincome of the consumer (i) Normal goods (ii) Inferior goods

Normal Goods: Normal goods are those goods the demand for which increaseswith increase in income of the consumer. In case of normal goods, income effectis positive.

With increase in income of the consumer demand curve of normal goods willshift rightward from D

1 to D

2.

Increase in income of the consumer

0Quantity Demanded

T2

Pri

ce

D2

D2

D1

D1

T1

P1

K2K1

Inferior Goods: Inferior goods are those goods the demand for which decreasesas income of the consumer rises. Thus, in case of inferior goods, income effect isnegative.

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STUDYmate

Example: When income of the consumer increases, demand of coloured TVincreases while that of black and white TV decreases therefore colored TV is anormal good while black and white TV is an inferior good.

The demand curve (figure 1) for inferior goods will shift leftward with increase inincome from D

1 to D

2.

0Quantity Demanded

T1

Pri

ce

D1

D1

D2

D2

T2

P1

K1K2

(i) There are two types of related goods

(a) Substitute goods

(b) Complimentary good

(ii) (a) Fall in price of the substitute goods (Tea & Coffee) : - If price of coffeedecreases, consumer will tend to substitute some coffee in place of tea orhe will demand less tea even when its price is constant. Figure belowillustrate this situation. Initially the consumer was buying OT

1 of tea (=P

1K

1),

now he is buying OT2 (=P

1K

2) of tea even when price of tea is constant

(=OP1). This is a situation of leftward shift in demand curve.

0Quantity Demanded

T1

Pri

ce

D1

D1

D2

D2

T2

P1

K1K2

(b) Fall in prices of complementary good (Car and Petrol) :If price of petroldecreases, people will have the tendency to buy more cars, even whenprice of car is constant. This is a situation of increase in demand or rightwardshift in demand curve. Initially P

1K

1 (=OT

1) cars were purchased. As price

of petrol decreases, P1K

2 car are purchased even when price of car is

constant. Accordingly, demand curve shifts rightward from D1 to D

2

0Quantity Demanded

T2

Pri

ce

D2

D2

D1

D1

T1

P1

K2K1

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STUDYmate

15. Explain the conditions of a producer’s equilibrium in terms of marginal cost andmarginal revenue. Use diagram.

Ans. According to this approach, the producer is at equilibrium when the marginalrevenue (MR) is equal to the marginal cost (MC) and marginal cost curve cuts themarginal revenue curve form below. Thus the two conditions are

1. MC = MR

2. MC curve should cut the MR curve from below

MR is the addition to total revenue from the sale of one more unit of output and MCis the addition to total cost for increasing the production by one unit. the basic aim ofevery producer is to maximize the profit. For this, a firm compares its MR with its MC.

As long as the addition to revenue is greater than the addition to cost, it is profitablefor a firm to continue producing more units of output.

Output (in units)

X

Y

AR = MR

MCR K

P

O Q1 Q

Rev

enu

ean

dC

ost

(in

Rs.

)

Producer’sequilibrium

In the diagram, output is shown on the X-axis and revenue and costs on the Y-axis.The marginal cost (MC curve is U-shaped and P = MR = AR.

MC = MR at two points R and K in the diagram but profits are maximised at point K,correspoidning to OQ level of output.

Between OQ1 and OQ levels of output, MR exceeds MC, therefore firm will not stop at

point R but will continue to produce to take advantage of additional profit. Thus,equilibrium will be at point K. where both the conditions are satisfied.

Two other situations may exist

(a) MR > MC.

At output level less than OQ, MR > MC, this implies that the firm is earningprofit on the last unit of output. The marginal profit provides an incentive to thefirm to increase production and move towards OQ units of output. Thereforewhen MR > MC, the firm increases output to maximise its profit.

(b) MR < MC

At output level more than OQ, MR < MC. This implies that the firm is making aloss on its last unit of output. Hence, in order to maximise profit, a rationalproducer decreases output as long as MC > MR. Thus the firm moves towardsproducing OQ units of output.

16. Market for a good is in equilibrium. There is simultaneous “increase” both in demandand supply of the good. Explain its effect on market price.

OR

Market for a good is in equilibrium. There is simultaneous “demand” both in demandand supply of the good. Explain its effect of market price.

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STUDYmate

Ans. Initially, the equilibrium is determined at E0 where the demand curve D

0D

0 and the

supply curve S0S

0 intersect each other. OQ

0 is the equilibrium quantity and OP

0 is the

equilibrium price.

The effect of increase in both demand and supply on equilibrium price and equilibriumquantity can be better understood under three different cases:

Case 1: Increase in Demand = Increase in Supply

(a) In the figure, increase in demand is proportionately equal to the increase insupply. So, the (rightward) shift in demand curve from D

0D

0 to D

1D

1 is

proportionately equal to the (rightward) shift in supply curve from S0S

0 to S

1S

1.

(b) The new equilibrium is determined at E1. As both demand and supply increase

in the same proportion, equilibrium price remains the same at OP0, but equilibrium

quantity rises from OQ0

to OQ1.

Pri

ce(in

Rs.

)

Quantity demanded & supplied (in units)

Y

XO

Increase in Demand = Increase in Supply

D1

E1P

Q1Q0

S1

E0

D0

D1D0

S0

S1

S0

Case 2: Increase in Demand>Increase in Supply

(a) From figure, it is clear that increase in demand is proportionately more than theincrease in supply. Hence, the (rightward) shift in demand curve from D

0D

0 to

D1D

1 is proportionately more than the (rightward) shift in supply curve from

S0S

0 to S

1S

1.

(b) The new equilibrium is determined at E1. As the increase in demand is

proportionately more than the increase in supply, equilibrium price rises from

OP0 to OP

1 and equilibrium quantity rises from OQ

0 to OQ

1.

Pri

ce(in

Rs.

)

Quantity demanded & supplied (in units)

Y

XO

Increase in Demand > Increase in Supply

D1

E1

P

Q1Q0

S1

E0

D0

D1D0

S0

S1

S0

P1

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STUDYmate

Case 3: Increase in Demand < Increase in Supply

(a) In the figure, increase in demand is proportionately less than the increase insupply. Therefore, the (rightw ard) shift in dem and curve from D

0D

0 to D

1D

1 is

proportionately less than the (rightward) shift in supply curve from S0S

0 to S

1S

1.

Pri

ce(in

Rs.

)

Quantity demandedand supplied (in units)

Y

XO

Increase in Demand < Increase in Supply

D1

E1

P0

Q1Q0

S1

E0

D0

D1D0

S0

S1

S0

P1

(b) The new equilibrium is determined at E1. As the increase in demand is

proportionately less than the increase in supply, equilibrium price falls from OP0

to OP1 whereas, equilibrium quantity rises from OQ

0 to OQ

1.

Conclusion:

(i) Equilibrium price may remain same, may increase or may decrease.

(ii) Equilibrium quantity always falls.

OR

Ans. Initially, the equilibrium is determined at E0, where the demand curve D

0D

0 and the

supply curve S0S

0 intersect each other. OQ

0 is the equilibrium quantity and OP

0 is the

equilibrium price.

The effect of decrease in both demand and supply on equilibrium price and equilibriumquantity can be better analysed under three different cases:

Pri

ce(in

Rs.

)

Quantity demandedand supplied (in units)

Y

XO

Decrease in Demand = Decrease in Supply

D1

E1

P0

Q0Q1

S1

E0

D0

D1 D0

S0

S1 S0

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STUDYmate

Case 1: Decrease in Demand = Decrease in Supply

(a) In diagram, decrease in demand is proportionately equal to the decrease in supply.So, the (leftward) shift in demand curve from D

0D

0 to D

1D

1 is proportionately

equal to the (leftward) shift in supply curve from S0S

0 to S

1S

1.

(b) The new equilibrium is determined at E1. As demand and supply decrease in the

same proportion, equilibrium price remains the same at OP0, but equilibrium

quantity falls from OQ0 to OQ

1.

Case 2: Decrease in Demand > Decrease in Supply

(a) In figure that decrease in demand is proportionately more than the decrease insupply. The (leftward) shift in demand curve from D

0D

0 to D

1D

1 is proportionately

more than the (leftward) shift in supply curve from S0S

0 to S

1S

1.

(b) The new equilibrium is determined at E1. As the decrease in demand is

proportionately more than the decrease in supply, equilibrium price falls fromOP0 to OP1 and equilibrium quantity falls from OQ0 to OQ1.

Pri

ce(in

Rs.

)

Quantity demanded & supplied (in units)

Y

XO

Decrease in Demand > Decrease in Supply

D1

E1

P0

Q0Q1

S1

E0

D0

D1

D0

S0

S1S0

P1

Case 3: Decrease in Demand < Decrease in Supply

(a) In a diagram decrease in demand is proportionately less than the decrease insupply. So, the (leftward) shift in demand curve from D

0D

0 to D

1D

1 is

proportionately less than the (leftward) shift in supply curve from S0S

0 to S

1S

1.

(b) The new equilibrium is determined at E1. As the decrease in demand as

proportionately less than the decrease in supply, equilibrium price rises from OP0

to OP1 whereas, equilibrium quantity falls from OQ

0 to OQ

1.

Pri

ce(in

Rs.

)

Quantity demanded & supplied (in units)

Y

XO

Decrease in Demand < Decrease in Supply

D1

E1

P0

Q0Q1

S1

E0

D0

D1D0

S0

S1

S0

P1

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STUDYmate

Conclusion:

(i) With simultaneous decrease in demand and supply equilibrium price may remainsame, may decrease or may increase.

(ii) Equilibrium quantity always falls.

SECTION-B17. Define stock variable.

Ans. Stock variable refers to that variable, which is measured at a particular point of time.Stock variables are not measured over a period of time.

18. Define capital goods.

Ans. Capital goods are those final goods which help in production of other good and services.Capital goods are used in future for productive purposes and have expected life timeof several years.

19. What are demand deposits.

Ans. Demand deposits refers to those deposits which are repayable by the banks on demand.They are chequeable deposits. Demand deposits do not carry any interest.

20. Define a Tax.

Ans. Tax is a compulsory payment imposed by the government on people and companiesto meet its expenditures.

21. Give meaning of managed floating exchange rate.

Ans. Managed floating rate system refers to a system in which foreign exchange rate isdetermined by market force and central bank is a key participant to stabilize thecurrency in case of extreme appreciation or depreciation.

22. Calculate Gross Value Added at Factor Cost

(i) Units of output sold (units) 1,000

(ii) Price per unit of output (`) 30

(iii) Depreciation (`) 1,000

(iv) Intermediate cost (`) 12,000

(v) Closing stock (`) 3,000

(vi) Opening stock (`) 2,000

(vii) Excise (`) 2,500

(viii) Sales tax (`) 3,500

Ans. GVOmp = Sales + stock

= 1000 × 30 + (3000 – 2000)

= 30000 + 1000

= 31000 (`)

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STUDYmate

Intermediate cost = ` 12000

GVAfc = GVOmp – Intermediate cost – Net Indirect Taxes

= 31000 – 12000 – (3500 + 2500)

= 19000 – 6000

= 13000 (`)

23. Explain the significance of the ‘Store of Value’ function of money.

Ans. M oney as a store of value

(i) Money as a store of value helps people to transfer their purchasing power from

present to future. Money is a way to store wealth.

(ii) They do this as they know that money will be acceptable at any time in future for

buying any commodity which they desire. Also money provides security to

individuals to meet contingencies, unpredictable emergencies and to pay future

debts.

(iii) Under Barter system, it was difficult to use goods as a store of wealth due to

perishable nature of some goods and high cost of storage.

24. Outline the steps taken in deriving saving curve from the consumption curve. Usediagram.

Ans. We know that income (Y) is the sum total of consumption (C) and savings (S) asincome is either consumed or saved. It means, consumption and saving curves arecomplementary curves.

Y

c

O X45°C

onsu

mpti

on(

Cro

res)

`

Income ( Crores)`

Consumption Curve

Y

X

C

Y

C = Y(Break-Even Point)

(Zero saving)

Saving Curve

S

O

SK

S = 0(Break-Even Point)

Income ( Crores)`

Savi

ng

(C

rore

s)`

E

(i) We can derive saving curve from the

consumption curve. Let us understand this with

the help of diagram. As seen in the diagram, CC

is the consumption curve and the 45° line (OY)

represents income. Consumption, at zero level

of income, is equal to OC (autonomous

consumption. The amount of saving is indicated

by vertical distance between consumption curve

and income line. So savings, at zero level of

income, will be OS (= – OC). It means, the saving

curve will start from point S on the negative Y-

axis.

(ii) CC intersects OY at point E (Break-even point)

where savings are zero. It means, saving curve

will intersect the X-axis (point K) at the income

level where the consumption curve and 45° line

intersect each other.

(iii) Beyond point E (Break even point) consumption

is less than income therefore savings are positive

is saving curve is above the x-axis. As income

measures, saving also increases.

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STUDYmate

25. Find national income from the following

Autonomous consumption = ` 100

Marginal propensity to consume = 0.80

Investment = ` 50

Ans. c = ` 100

MPC(b) = 0.80

I = ` 50

At equilibrium, National Income (Y) = C + I

= c + bY + I

= 100 + 0.8Y + 50

0.2 Y = 150

Y = 15000.2

= 750 (`)

National Income = ` 750

26. Distinguish between Revenue Expenditure and Capital Expenditure in a governmentbudget. Give examples.

OR

Explain the role of Government budget in allocation of resources.

Ans. Comparison between Revenue Expenditure & Capital Expenditure

Revenue Expenditure Capital ExpenditureRevenue expenditure neither creates any asset nor reduces any liability

Capital expenditure either creates an asset or reduces a liability.

Revenue expenditure is incurred on the normal functioning of government departments and on the provisions for various services

Capital expenditure is incurred for acquisition of assets, granting of loans and advances and repayment of borrowings.

Revenue expenditure is recurring in nature i.e. an expenditure is made by the government on its day-to-day activities.

However, capital expenditure is non-recurring in nature.

Some examples of revenue expenditures are: Payment of salaries, pensions, interests, expenditure on administrative services, defence services, health services, grants to state, education etc.

Examples of capital expenditures (i) Loan to states and Union territories; (ii) expenditure on building roads, flyovers, factories, purchase of machinery etc; (iii) repayment of borrowings.

OR

Reallocation of Resources: The role of government budget in allocation of resources.

(a) The government aims to reallocate resources according to economic and socialpriorities through its budgetary policy.

(b) Government encourages the production of certain commodities by giving

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STUDYmate

subsidies or tax reliefs. For e.g. government encourages the use of’ khadiproducts’ by providing subsidies.

(c) Government can discourage the production of harmful goods like liquor orcigarettes, by imposing heavy excise duties or taxes.

27. Giving reason explain how should the following be treated in estimating nationalincome.

(i) Expenditure of fertilizers by a farmer.

(ii) Purchase of tractor by a farmer.

Ans. (i) Expenditure of fertilizers by a farmer is not a part of National Income because itis intermediate consumption.

(ii) Purchase of tractor by a farmer is included in National Income because it isgross domestic capital formation.

28. Explain the components of Legal Reserve Ratio

OR

Explain ‘bankers’ bank, function of Central bank.

Ans. Legal Reserve Requirements (Increase in CRR and SLR): It refers to the minimumpercentage of total deposits (time and demand deposits) required to be kept by thecommercial banks with themselves and with the central bank. It is a very quick anddirect method for controlling the credit creation power of commercial banks. Legalreserve has two components:

(i) Cash Reserve Ratio (CRR): It refers to the minimum precentage of total depositsrequired to be kept by commercial banks with the central bank. To curb excessdemand, the central bank increases this ratio and, therefore, cash reserve ofcommercial banks get reduced. This forces the commercial banks to contractcredit.

(ii) Statutory Liquidity Ratio (SLR): It refers to the minimum percentage of totaldeposits which the commercial banks are required to maintain with them. Toreduce the flow of cerdit in the economy, central bank increases this ratio and,thereby, reduces credit availability.

OR

Banker’s Bank and Supervisor

(i) Custodian of Cash Reserves: The central bank is a reservoir of the cash reservesof commercial banks. Commercial banks maintain a certain proportion (CashReserve Ratio, i.e. CRR) of their demand and time deposits with the central bankas reserve.

(ii) Lender of the Last Resort: When commercial banks fail to meet their financialrequirements from other sources, they can approach the central bank whichgives loans and advances as lender of the last resort. The rate, at which thecentral bank advances loans to commercial banks, is known as bank rate. Centralbank assists these banks through discounting of approved securities and billsof exchange. The direct lending to commercial banks by central bank is referredto as the ‘lender of the last resort’ function of a central bank.

(iii) Supervisor: A central bank supervises the functioning of commercial banks. Itmakes rules regarding licensing, management, branch expansion, liquidation,etc. It also undertakes periodic inspection of banks.

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29. Explain ‘revenue deficit’ in a Government budget? What does it indicate?

Ans. Revenue deficit: It refers to the excess of total revenue expenditure of the governmentover its total revenue receipts.

Revenue deficit = Revenue expenditures – Revenue receipts

Implication

(i) It signifies that the government’s current expenses are greater than currentincome. The bulk of these expenses is interest payment, wages for governmentemployees and defence personnel.

(ii) Government makes up this deficit from capital receipts i.e., through borrowingsor disinvestment. It means, revenue deficit either leads to an increase in liability(in the form of borrowings) or reduces the assets (through disinvestment).

(ii) Use of capital receipts for meeting the extra consumption expenditure leads toan inflationary situation in the economy. Higher borrowings increase the futureburden in term of loan amount and interest payments.

30. Find out (a) National income and (b) net national disposable income

(` crore)

(i) Factor income from abroad 15

(ii) Private final consumption expenditure 600

(iii) Consumption of fixed capital 50

(iv) Government final consumption expenditure 200

(v) Net current transfers to abroad (–) 5

(vi) Net domestic fixed capital formation 110

(vii) Net factor income to abroad 10

(viii) net imports (–) 20

(ix) Net indirect tax

(x) Change in stocks (–) 10

Ans. (a) NDPMP = (ii) + (iv) + (vi) + (x) – (viii)

= 600 + 200 + 110 + (–10) – (–20) crores

= 920 crores

NNPFC (NI) = NDPMP + NFIA – Net Indirect Taxes

= 920 + (–10) – 70

= 840 crores

(b) Net National Disposable Income = NDPMP + NFIA – Net Current transfers toabroad

= 920 + (–10) – (–5) crores

= 915 crores

31. Explain the concept of ‘excess demand’ in macroeconomics. Also explain the role of‘open market operation’ in correcting it.

OR

Explain the concept of ‘deficient demand’ in macroeconomics. Also explain the role ofBank Rate in correcting it.

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Ans. Excess Demand: Excess demand refers to a situation where the current aggregatedemand is greater than the aggregate demand that is required to achieve full employmentof resources. Excess demand gives rise to the inflationary gap.

45°

YfO

Agg

rega

tedem

an

d

Income

Y

ADfF

Y

E ADc

Inflationarygap

A

(i) In the figure, the economy achieves full employment level of income at OYf.

(ii) Given the current aggregate demand curve of ADc, this implies that the current

level of aggregate demand (corresponding to full employment income) is AYf.

(iii) Here, aggregate demand AYf is more than the output produced FY

f. When

aggregate demand is more than output, it leads to a reduction in the levels ofplanned inventory stock with producers. This motivates producers to producemore output to reach the desired levels of stock, in turn increasing output,income and the associated levels of employment.

(iv) The economy, therefore, achieves equilibrium at point E with the equilibriumlevel of income being OY. However, this level of real income is not possible inthe case of excess demand.

(v) Since resources are fully employed, production levels at point E are the same asthose at point F, i.e., OY

f level. Hence, there is only an increase in the nominal

value of income in the economy, with no increase in the real output.

Open Market Operations (Sale of securities): Open market operation refers to saleand purchase of securities (mainly government securities) in the open market by thecentral bank. It directly influences the level of money supply in the economy. Whenthere is an inflationary situation, the central bank offers securities for sale. It, notonly withdraws a part of money supply, but also reduces the capacity of commercialbanks to create credit.

OR

Deficient Demand: Deficient demand refers to a situation where the current aggregatedemand falls short of the aggregate demand that is required to achieve full employmentof resources.

Deficient demand leads to an equilibrium level of income that is less than fullemployment level of income. Deficient demand gives rise to the deflationary gap.

Deflationary Gap measures the extent to which the current aggregate demand fallsshort of the aggregate demand that is required to achieve a full employment of resources.

(i) In the figure, the economy achieves full employment level of income at OYf.

(ii) Given the current aggregate demand curve ADc, this implies that the current

level of aggregate demand (corresponding to full employment income) is AYf.

(iii) This aggregate demand AYf is less than output FY

f. In a situation when aggregate

demand is less than output, it leads to a build-up of unplanned inventory stockwith producers.

(iv) This leads to deflationary pressures in the economy as producers reduce stock

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to desired levels. As a result there is a reduction in output, income and theassociated employment levels.

45°

YfO

Agg

rega

tedem

an

d

Income

Y

ADfF

Y

E

ADc

Deflationary gapA

(v) The economy, therefore, achievesequilibrium at point E with theequilibrium level of income being OYand not OY

f. The equilibrium level of

income OY is termed as underemployment equilibrium.

Bank Rate (Decrease in Bank rate): Bank rate refers to the rate at which the centralbank lends money to commercial banks as the lender of last resort. In order to expandcredit to meet the deficient demand, the central bank should follow a ‘cheap moneypolicy’. For this purpose, it reduces the bank rate. It leads to fall in the market rate ofinterest which induces people to borrow more funds. It ultimately leads to increase inthe aggregate demand.

32. Explain the distinction between autonomous and accommodating transactions inbalance of payments. Also explain the concept of balance of payments ‘deficit’ in thiscontext.

Ans.Autonomous

Non Autonomous/Accommodating items

Autonomous items refer to those international economic transactions which take place due to some economic motive (such as profit maximisation).

Accommodating items refer to the transactions that are undertaken in order to maintain the ‘balance’ in the BOP account.

Such transactions are independent of the state of BOP account. For example, if an MNC is making investment in India with the aim of earning profit, then such a transaction is independent of the country’s BOP situation.

These are compensating capital transactions which are meant to correct the disequilibrium in autonomous items of balance of payments.

These items are also known as ‘above the line items’

These items are also known as ‘below the line items’ For example, if there is a current account deficit in the BOP, then this deficit is settled by capital inflow from abroad.

Autonomous transactions take place on both, current and capital, accounts. On the current account merchandise export and imports of goods are autonomous transactions. On the capital account, receipts and repayments of long-term loans by private individuals are autonomous transactions.

Generally, the sources used to meet a deficit in the BOP are accommodating items (i) Foreign exchange reserves; (ii) Borrowings from IMF or foreign monetary authorities.

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× · × · × · × · ×

Meaning of Balance of Payment Deficit: A deficit in the BOP occurs when duringthe year the autonomous inflow of foreign exchange falls short of autonomous outflow.

i.e. Autonomous payments > Autonomous receipts

Suppose the autonomous inflow of foreign exchange during the year is $1000, whilethe total outflow is $1100. It means that there is a deficit of $100. To meet the shortfall,one option before the country is to borrow from abroad.

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SECTION-A6. What is ‘Marginal Rate of Transformation’? Explain with the help of an example.

Ans. Marginal Rate of Transformation of a particular good along PPC is the amount of aparticular good which is sacrificed to increase the production of the other good by 1unit. It is also called MOC (Marginal Opportunity Cost).

Production Amount of Amount of MRT

possibilities (X) Butter (Y) Guns

(Thousand kgs) (Thousands)

A 0 21 –

B 1 20 1 : 1

C 2 18 2 : 1

D 3 15 3 : 1

E 4 11 4 : 1

F 5 6 5 : 1

G 6 0 6 : 1

MRT Units of one goodsacrified G Y

More units of other good produced B X

9. A producer borrows money and opens a shop. The shop premises is owned by him.Identify the implicit and explicit cost from this information. Explain.

Ans. (i) Explicit cost refers to the actual payment made to outsiders for hiring servicesof the factors of production.

(ii) Implicit cost: Implicit cost refers to the cost of self supplied factors.

Interest paid on borrowed money will be explicit cost where as the imputed rent of theshop premises is implicit cost.

11. Define Marginal Rate of Substitution. Explain why is an indifference curve convex?

Ans. It is the rate at which the consumer is willing to sacrifice one good to obtain one moreunit of the other good.

MRSxy

= Quantity of the good sacrificedQuantity of the good obtained

= YX

Indifference curve is convex as MRSxy

keeps on decreasing due to law of diminishingmarginal utility. As a consumer consumes more of X, the additional utility derived

Code No. 58/1/2

Studymate Solutions to CBSE Board Examination 2011-2012

UNCOMMON QUESTIONS ONLY

Series : SMA/1

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from every successive unit keeps on declining.

Indifference Schedule

Combinations Good X Good Y Marginal Rate of Substitution

A 1 8 -

B 2 4 4Y : 1X

C 3 2 2Y : 1X

D 4 1 1Y : 1X

He is willing to sacrifice less units of Y to obtain additional units of X as shownin the schedule [Initially he is willing to sacrifice 4 units of X, then 2 units andsoon]

12. A consumer buys 10 units of a good at a price of ` 9 per unit. At price of ` 10 per unithe buys 9 units. What is price elasticity of demand? Use expenditure approach.Comment on the likely shape of demand curve on the basis of this measure of elasticity.

Ans. P Qty Expenditure

9 10 90

10 9 90

As per the expenditure approach, when, with a change in price (rise or fall) the totalexpenditure remains unchanged, demand is unitary elastic. (Here e

d = 1)

Since, in the above example, with the change in price, there is no change in totalexpenditure, so ed = 1.

The shape of demand curve, i.e., will be rectangular hyperbola.

SECTION-B22. Calculate Net Value Added at Factor Cost:

(i) Consumption of fixed capital (`) 600

(ii) Import duty (`) 400

(iii) Output sold (units) 2,000

(iv) Price per unit of output (`) 10

(v) Net change in stocks (`) (–) 50

(vi) Intermediate cost (`) 10,000

(vii) Subsidy (`) 500

Ans. NVAFC

Sales = qt × mp GVOMP

= Sales + Net Change in stock

= 2,000 × 10 = 20,000 – 50

= 20,000 = 19,950

GVAmp

= GVOmp

– Intermediate consumption

= 19,950 – 10,000

= 9,950

NVAFC

= GVAmp

– Consumption of fixed capital – Net indirect tax

= 9,950 – 600 – (400 – 500)

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= 9950 – 500

= ` 9,450

25. Find ‘investment’ from the following

National income = ` 500

Autonomous Consumption = ` 100

Marginal propensity to consume = 0.75

Ans. y = 500

c = 100

MPC = 0.75

C = c by

= 100 + 0.75 × 500

= 100 + 375 = 475

At equilibrium Y = C + I

I = Y – C

I = National Income – Consumption

= 500 – 475

= ` 25

27. Giving reason explain how should the following be treated in estimating nationalincome.

(i) Payment of bonus by a firm

(ii) Payment of interest on a loan taken by an employee from the employer.

Ans. (i) Payment of bonus by a firm will be included in national income as it is a part ofcompensation of employees.

(ii) Payment of interest on a loan taken by an employee from the employer will notbe included in the national income accounting as it is assumed that the loan istaken for consumption purpose and therefore treated as a transfer income.

30. Find out (a) Net Product at Market Price and (b) Gross National Disposable

(` crore)

(i) Net current transfers from abroad (–) 10

(ii) Wages and Salaries 1,000

(iii) Net factor income to abroad (–) 20

(iv) Social security contributions by employers 100

(v) Net Indirect Tax 80

(vi) Rent 300

(vii) Consumption of fixed capital 120

(viii) Corporation Tax 50

(ix) Dividend 200

(x) Undistributed profits 60

(xi) Interest 400

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Ans. (a) NDPFC

= Wages & salaries + social security by employers + Rent + corporationtax + dividend + undistributed profits + interest

= 1,000 + 100 +300 + 50 + 200 + 60 +400

= 2,110 crores

NNPMP

= NDPFC

+ NFIA + NIT

= 2,110 + 20 + 80

= 2210 crores

(b) GNDI = GNPMP

+ Net current transfer from ROW

= NNPMP

+ consumptio of fixed capital + Net current transfer from ROW

= 2,210 + 120 + (– 10)

= 2320 crores

× · × · × · × · ×

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SECTION-A6. State reasons why does an economic problem arise?

Ans. Scarcity of resources is the basic reason for existence of economic problems in alleconomies. There would have been no economic problem, if resources were not scarce.The scarcity arises due to the following reasons:

(i) Unlimited Human Wants: Human wants are never ending i.e. they can never befully satisfied. Human wants also differ in priorities. That is why, people are ableto allocate resources in order to satisfy some of their wants.

(ii) Limited resources which have alternative uses: Resources are not only scarce,but they can also be put to various uses. Thus, one has to make a choice if theresources have alternate uses. For example, LPG cylinder is used not only forcooking, but also for running cars, gas welding etc.

9. A producer invests his own savings in starting a business and employs a manager tolook after it. Identify implicit and explicit costs from this information. Explain.

Ans. (i) Explicit cost refers to the actual payment made to outsiders for hiring servicesof the factors of production.

(ii) Implicit cost: Implicit cost refers to the cost of self supplied factors.

Imputed value of the interest that a producer would have earned on his savings willbe implicit cost and salary paid to the manager will be the explicit cost.

11. Define an indifference map. Explain why an indifference curve to the right showshigher utility level.

Ans. A set of indifference curves representing various levels of satisfaction is knownas indifference map. Infinite number of indifference curves showing different levelsof satisfaction can be drawn as shown in the diagram.

The higher indifference curve (I2) has higher utility (I1).

Good Y

I2

I1

BA

Y2

Y1

O X1 X2 Good XThis is based on the assumption of ‘monotonic preferences’.

Monotonic preferences means that a consumer always prefers the combination which

Studymate Solutions to CBSE Board Examination 2011-2012

UNCOMMON QUESTIONS ONLY

Series : SMA/1 Code No. 58/1/3

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has either more of both goods or more of at least one good and no less of the othergoods.

As a consumer moves to higher indifference curves, he is able to have more of boththe goods for eg. At point A, he can have OX and OY, but at point B, he can have moreof both X and Y i.e. OX2 and OY2. Thus he prefers to be on I2 than I1. Since, asconsumption increases, his utility also increases

We conclude that higher indifference curve has higher utility.

12. A consumer buys 20 units of a good at a price of ̀ 5 per unit. He incurs an expenditureof ` 120 when he buys 24 units. Calculate price elasticity of demand using thepercentage method. Comment upon the likely shape of demand curve based on thisinformation.

Ans. P Q TE

5 20

5 24 120

ed =

4100 100 2020( ) ( ) ( )0 0100 1005

qqp

p

=

Working Note:

TE = P × Q

120 = P × 24

P = 12024

= 5

Hence, the likely shape of demand curve is parallel to the x-axis, i.e., perfectly elastic.

SECTION-B22. Find Net Value Added at Market Price:

(i) Output sold (units) 800

(ii) Price per unit of output (`) 20

(iii) Excise (`) 1600

(iv) Import duty (`) 400

(v) Net change in stocks (`) (–)500

(vi) Depreciation (`) 1000

(vii) Intermediate cost (`) 8000

Ans. GVOmp = Sales + Change in stock

= Quantity × Price + Change in stock

GVOmp = 800 × 20 + (–500) = 15500 (`)

Intermediate cost = 8000 (`)

GVAmp = GVOmp – Intermediate cost = 15500 – 8000 = 7500 (`)

NVAmp = GVAmp – Depreciation = 7500 – 1000 = 6500 (`)

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25. Find consumption expenditure from the following:

Autonomous consumption = 100 (`)

Marginal propensity to consume = 0.70

National Income = 1000 (`)

Ans. c = ` 100

MPC(b) = 0.70

Y = ` 1000

Consumption Expenditure (C) = c + bY

= 100 + 0.70 × 1000

= 100 + 700

= 800 (`)

27. Giving reason explain how should the following be treated in estimating nationalincome:

(i) Interest paid by banks on deposits by individuals.

(ii) National debt interest

Ans. (i) Interest paid by banks on deposits by individuals will be included in nationalincome as it is a factor income.

(ii) National debt interest will not be included in national income as it is assumedthat government borrows for consumption purpose, therefore it is treated as atransfer.

30. Find out (a) Gross National Product at Market Price and (b) Net Current Transfersfrom abroad:

(` crore)

(i) Net Indirect tax 35

(ii) Private final consumption expenditure 500

(iii) Net national disposable incomre 750

(iv) Closing stock 10

(v) Government final consumption expenditure 150

(vi) Net domestic fixed capital formation 100

(vii) Net factor income to abroad (–)15

(viii) Net imports 20

(ix) Opening stock 10

(x) Consumption of fixed capital 50

Ans. (a) NDPMP = (ii) + (v) + (vi) + (iv – ix) – (viii)

= 500 + 150 + 100 + (10 – 10) – 20 crores

= 730 crores

GNPMP = NDPMP + (x) – (vii)

= 730 + 50 – (–15)

= 795 crores

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(b) Net National Disposable Income = NNPMP + Net current transfers from abroad

750 = 730 – (–15) + Net Current transfers from abroad

750 = 745 + Net Current transfers from abroad

Net current transfers from abroad = ` 5 crores

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